Impacts of a Uniform Global Carbon Tax
Investors and businesses should not underestimate potential future liabilities, says Bethan Rose, Sustainable Investment Analyst at Evenlode Investment.
The World Bank accepts that carbon prices need to grow over the long-term to drive investments at the necessary scale and pace. To keep global warming below 2°C, consensus suggests prices must reach between US$50/tCO2 and US$100/tCO2 by 2030. Although globally there are currently 73 carbon taxes or emission trading systems (ETSs) currently in operation, as of April 2023, less than 5% of global GHG emissions were covered by the suggested range for 2023.
Revenue allocation
According to data collected by the Institute of Climate Economics, approximately 40% of revenues from carbon taxes and ETSs were earmarked for dedicated purposes, in particular green spending, and 10% for direct transfers to vulnerable households and firms. New research from the Organisation for Economic Co-operation and Development indicates there is greater public support for climate policy, including ETSs and carbon taxes, only if the revenues are used to fund green infrastructure and low-carbon technologies or redistributed to low-income households and those most affected by the policy. Currently most indirect carbon price systems revenues are not allocated to specific purposes.
It is difficult to create a uniform carbon pricing model across industries due to their unique characteristics and supply chains, thus creating a consensus will be challenging. Carbon pricing across sectors would be more effective if it was accompanied by complementary government policies that created common ground.
Applying a uniform tax
Eight of the top ten highest emitters across the Evenlode portfolios are exposed to some kind of carbon pricing mechanism, usually in the form of an ETS. However, this often only covers a small portion of Scope 1 emissions and the occasional Scope 2 emissions (Scope 2 emissions are generally the lowest as they measure electricity/energy where renewable alternatives are available). For pricing mechanisms to fulfil their intended purpose, they must cover a larger proportion of company emissions.
On a positive note, using the generally accepted carbon price range needed, six of the ten companies are using an internal shadow carbon price of US$50+. For companies that do not currently utilise a shadow carbon price, necessitating closer monitoring and more targeted engagement, the risks are higher. Such companies may find themselves financially unprepared for a mandatory carbon tax.
Using our recent carbon emissions analysis, we took the top ten emitters in our portfolios (on an absolute basis) and calculated what the financial impact of a carbon price at £50, £75, and £100 (US$133) would be. This aligns with the scientific consensus that a carbon price between US$50-100 is needed by 2030.
For example, if Proctor & Gamble’s (P&G) emissions were taxed at the lower end (£50 per tCO2), this amounts to £112 million for Scope 1 and £7.8 million for Scope 2. Scope 3 upstream emissions would equal approximately £1 billion. While this seems high, if we look at the carbon liability as a proportion of revenue, it is only 2.14%. For operating income, this is considerably higher at 7.89%. Significantly, if a carbon tax was imposed tomorrow, this would cause a US$7 billion hit to operating income until 2030. The cost of inaction, in P&G’s case, is higher than the cost of action.
If we used a carbon price of £100 for P&G, the firm’s liability would be just shy of £240 million for Scope 1 and 2 emissions and over £2.1 billion for Scope 3 upstream emissions – a total liability of 4.32% of revenue and 15.78% as a proportion of operating income. The complexity of taxing Scope 3 emissions highlights the potential financial liability that P&G could face, though unlikely.
It is also important to consider the different ranges of internal prices that companies set and what the difference to liability would be in practice. As an example, If P&G uses a carbon price of US$8-US$100/£6.57-£90, the liability could range from £156.5 million-£2.15 billion. These carbon prices (while presently theoretical internal shadow prices) guide capital allocation decisions.
The overarching message is clear: the potential future carbon cost or liability could be significant and should not be underestimated.
Revenue, margin, pass through
In the absence of a co-ordinated approach, businesses subject to carbon prices could be at risk of being undercut by competitors operating in countries with fewer environmental regulations. This tempts moving production abroad, known as ‘carbon leakage’.
Firms can determine the extent to which they pass on costs, but if the costs are absorbed upstream, incentives to change consumer behaviour are diminished. These figures are difficult to determine as certain industries included in the EU ETS do not pass on costs. This is partly explained by concerns around competition and maximising market share. It also impacts labour costs as taxes often play a larger role in determining product price.
If not carefully designed, a carbon price tax can hit lower income households disproportionately as spending on carbon-intensive goods is a larger proportion of their expenses. They may be unable to afford the upfront investment in lower carbon alternatives, such as insulation or electric vehicles.
How are companies responding?
Carbon offsetting gets discussed a lot in conjunction with carbon pricing. For example, carbon credits serve to neutralise emissions. Carbon offsetting does have a role in the transition, especially in hard-to-abate sectors, and companies differ as to whether they will use emissions offsets as part of their transition plan.
Unilever’s annual report notes that natural climate solutions could provide <37% of emissions reductions needed by 2030. The firm’s €1 billion Climate & Nature fund invests in projects that positively address climate change through protection and regeneration. Unilever has stated that some projects might generate carbon credits, however, this occurs not as a means of, but in addition to achieving emissions reduction – a crucial distinction.
Unilever makes it clear that credible net zero strategies must lead with science-based emissions reductions pathways, complemented with carbon removals, when all feasible reductions have been implemented. This is a statement that all firms should lead with. Companies must be reducing emissions whilst simultaneously investing in carbon sink projects.
Better engagement
An important outcome of the analysis will be a more targeted engagement strategy towards the most emission-intensive holdings in our portfolio. Companies must adequately account for carbon, and consequently their long-term GHG emissions reduction targets, when making financial planning decisions. This aligns with the Net Zero Investment Framework and will ensure companies can reach their carbon reduction targets while protecting their capital.
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