• Investment
  • 26 July 2021

Big strides forward on climate action

  • China’s nationwide emissions trading system goes live, boosting global efforts to price carbon pollution
  • EU unveils sweeping package of climate proposals including expansion of carbon pricing to new sectors, and carbon border tax
  • US Democrats propose carbon tax on imports

Two key developments this month signal clearly how global efforts to decarbonise economic activity will transform the world economy over the next decade.

First, China’s nationwide emissions trading system has gone live, boosting ongoing global efforts to embed the cost of carbon pollution into policy and regulation, as well as business and investment decisions (see our recent report, The Narrow Path to Net Zero).

Second, the European Union unveiled a sweeping package of proposals designed to fundamentally reshape the EU economy over the next decade and beyond.

The sheer size of the China and EU economies means that their decarbonisation policies will influence the competitive landscape for carbon-intensive industries worldwide.

As we have highlighted earlier, we expect to see an intensifying race for leadership among the world’s major economies in clean energy and green technologies such as electric vehicles, wind generation and hydrogen fuels for years to come (see Climate Action: At A Tipping Point).

European Union’s “Fit for 55” package

On 14 July 2021, the European Commission announced “Fit for 55”, a proposed package of interlocking and mutually reinforcing policies and legislation to accelerate the decarbonisation of the entire European Union economy.

The breadth and scope of the proposals reflects the massive, system-wide transformation required to cut net greenhouse gas emissions across all 27 EU member states by 55% or more by 2030 from 1990 levels, and to net zero by 2050.

 Its key features include:

  • Expanding EU-wide carbon pricing to include shipping, road transport and buildings – sectors not currently covered by the EU emissions trading system – and phasing out free emissions allowances for aviation.
  • Introducing a carbon border tax on imports – initially cement, iron and steel, aluminium, fertilisers, and electricity, to address concerns that the EU’s climate policies would place its industries at a disadvantage. Importers would have to report emissions embedded in their goods from 2023, with the carbon tax starting in 2026.
  • Establishing a Social Climate Fund worth EUR144.4 billion (50% funded by the EU central budget, with matching contributions by member states, for the period 2025-2032) to help vulnerable households and small businesses affected by higher costs as EU-wide carbon pricing expands to include transport and buildings’ heating systems.
  • Stricter emissions standards for vehicles requiring all new cars registered as of 2035 to be zero-emissions vehicles. This means that by 2035, new cars with conventional internal combustion engines would no longer be allowed for sale in the EU. Public funding will be used to build supporting infrastructure for zero-emissions vehicles, including charging stations and hydrogen fuelling stations.
  • A binding EU-level target to increase the share of renewable energy in final energy consumption across the EU from the current 20% to 40% by 2030.

The proposed expansion of EU-wide carbon pricing to new domestic sectors as well as imports is consistent with our view that policymakers across the world are moving towards stricter pricing of carbon emissions to align economic activity with climate goals.

“Our current fossil fuel economy has reached its limits. And we know that we have to move on to a new model,” European Commission president Ursula von der Leyen said at the “Fit for 55” launch. “We chose carbon pricing as a clear guiding and market-based instrument with a social compensation. Emission of CO2 must have a price – a price that incentivises consumers, producers and innovators to choose clean technologies, to go towards clean and sustainable products.”

In particular, the proposed carbon border tax, or “carbon border adjustment mechanism”, is to “ensure that European emission reductions contribute to a global emissions decline, instead of pushing carbon-intensive production outside Europe”, the European Commission said in a statement. “It also aims to encourage industry outside the EU and our international partners to take steps in the same direction.”

This reinforces our long-held view that strong policy support for decarbonisation in the EU will have significant influence well beyond Europe, introducing new risks as well as opportunities for businesses globally. We expect countries that are slow to introduce carbon-pricing schemes will increasingly face difficulties or higher costs in accessing major export markets such as the EU.

The EU’s latest proposals require approval by the EU member states as well as the European Parliament before they become law, a process that is expected to take up to two years.

Some proposals, such as the carbon border tax, are almost certain to face challenges from major trading partners such as China and the US through legal, diplomatic and trade channels.

However, we expect overall climate-related political momentum to continue to build globally in the coming months, with more policy announcements and commitments by the US, China, and other major economies ahead of the UN Climate Change Conference or COP26 meeting in Glasgow in November.

In the US, lawmakers from the Democratic Party have proposed legislation to introduce carbon tariffs on certain imports such as steel, natural gas, petroleum, and coal, as well as a national "clean energy standard” to cut US power sector emissions to net zero by 2035, just days after the EU’s announcement.

China’s emissions trading system goes live

Trading on China’s much-anticipated nationwide emissions trading system (ETS) began on 16 July 2021 at CNY48 per tonne of CO2, climbing to CNY51.23 at the close of trading. A week later, allowances traded at CNY56.97 at the close on 23 July 2021 on the trading platform run by the Shanghai Environment and Energy Exchange.

At inception, China’s ETS is already the world’s largest, spanning more than 4 billion tonnes or 40% of China’s carbon emissions and 12% of global carbon emissions.

The ETS is expected to be a key pillar of China’s efforts to reach its “30-60” target of peak emissions before 2030 and net zero emissions by 2060.

The ETS is expected to spur emissions reductions by improving the efficiency of China’s coal-fired power plants, and by expanding the use of new technologies such as carbon capture and storage in the power sector.

China is estimated to need well over CNY100 trillion of new investment in energy infrastructure over 2020-2050 to set it on a pathway consistent with the Paris Agreement’s 1.5°C goal, according to a study by Tsinghua University’s Institute for Climate Change and Sustainable Development.

We expect that the Chinese authorities will focus initially on strengthening emissions monitoring and disclosure by power plants covered by the ETS, before expanding coverage further. For now, the power plants are allocated free emission rights based on their past emissions, power output and carbon intensity.

With the ETS now live, power plants that improve their efficiency will be able to profit from selling excess allowances in future, while those that exceed their initial allowance will have to buy additional emission allowances or face a fine.

Over time, we expect China to expand the ETS to cover more sectors of the economy and to tighten carbon allowances, raising the cost of carbon pollution and stimulating investment in low-carbon technologies.

Embedding the cost of carbon pollution into business and investment decisions will provide a much-needed boost to global efforts to align economic activity worldwide with climate goals.

In Singapore, the government is reviewing the level and trajectory of its carbon tax – currently at SGD5 per tonne – and is expected to announce the outcome at next year’s Budget.

Singapore will need to move to a steeper trajectory than originally planned of rising carbon prices in future to help its transition towards a greener economy, Monetary Authority of Singapore managing director Ravi Menon said in a speech on 14 July 2021. “Singapore can afford significantly higher carbon taxes than currently envisaged and still remain competitive as an economy.”

Extreme weather events worldwide spurring greater urgency to fight climate change

The rising frequency of extreme weather events across the world – most recently deadly floods in China’s Henan province as well as parts of Europe that killed more than 200 people and forced over a million more to relocate – serves as a devastating reminder that the cost of doing too little to improve the climate resilience of infrastructure and other parts of the economy could eventually be far greater than the cost of investing in adaptation and mitigation measures before disaster strikes.

This urgency is necessary. Recent climate trends are worrying: June 2021 was the 438th consecutive month with global surface temperatures above the 20th century average, according to the latest data from the US National Oceanic and Atmospheric Administration.

New opportunities emerging

The latest policy developments reinforce our view that global efforts to pursue sustainable, climate-resilient development paths and mitigate the threat of climate change will drive wide-ranging, significant changes to the global economy for years to come.

Businesses that anticipate and adapt successfully to these changes stand to benefit from the reshaped economic landscape as policymakers worldwide strengthen their response to the threat of climate change.

Various new opportunities are emerging for businesses and investors, including opportunities in decarbonisation technologies such as carbon capture and storage, as well as renewable energy.

Other segments that also offer excellent opportunities for long term secular growth are companies with indirect exposure to the ongoing decarbonisation of manufacturing, transport, construction and urban design.

These include suppliers of specialised chemicals, chips or other critical components used in clean-air systems to reduce emissions from vehicles and industrial plants and to produce batteries for electric vehicles, as well as sophisticated automation systems to reduce wastage and improve energy efficiency in buildings or manufacturing facilities.

We see even more opportunities emerging as the transition to a low-carbon economy accelerates in the coming years, encompassing all parts of the global economy.

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Version: July 2020