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Chris Walker: A Carbon Border Tax may be the answer to China’s runaway emissions

China now emits 27% of all greenhouse gases - more than the US, Europe, India, and Japan put together

If you haven’t read the IPCC report ahead of COP26, you should. It makes it clear that the recent freak weather is just the beginning. It also states: "Global warming of 1.5 degrees Celsius and two degrees Celsius will be exceeded during the 21st century unless deep reductions in CO2 and other greenhouse gas emissions occur in the coming decades." We have a problem, and we have to do something about it.

Almost every major investment house has now put in ESG measures across their funds. Or at least told us they have. And yet, as Thierry Philipponnat of Finance Watch, the European NGO, told me this week: “the problem is that we are not yet living in a green world. Asset managers are forced to buy into a world “as is.” Inevitably financial institutions end up investing in a universe that is not yet sustainable. The world is currently set on a path to add between 3.7 and 4.8 degrees to the earth’s temperature.”

This is not to deny that there are many deploying capital to fight this problem. In the last few months, I have met with smart “out of the box” thinkers, like Ed lees who runs the €3.2bn ‘Energy Transition Fund,’ and an ‘EARTH Fund’ which even shorts companies that are failing to act. As he says, he is “playing a major role in bringing capital to entrepreneurs creating change.”

That’s great, and we should support him and others like him. But can we rely just on the market to solve this problem? We live in a world that is increasingly dominated by state-directed capitalism. And while developed nations have already made enormous strides to reduce carbon emissions, the problem lies elsewhere. And it’s called China.

The Rhodium Group estimates that China now emits 27% of all greenhouse gases – more than the US, Europe, India, and Japan put together. Moreover, Chinese estimates are always out of date. I have no doubt the real figure is much worse.

The Chinese deploy arguments to distract us – talking about history or emissions per capita – when the planet is dying. Anyway, their emissions are now reaching such levels that they emit more per head than the majority of countries, including the EU 27, the UK and Japan. China’s further, appalling, carbon contribution through it’s Belt & Road Initiative is all on top of this.

As US climate envoy John Kerry pointed out last week, if China brings yet another 200 gigawatts of coal power online, it will "undo the ability of the rest of the world to achieve a limit of 1.5 degrees.” He summed up: “it really depends on choices at this point that China makes, because we've made our choice."  The US is targeting “ a 50-52% reduction" of carbon emissions relative to 2005 levels by 2030.

This is why COP26 matters so much. CNN, the US TV channel, is suggesting something akin to the “Shootout at the OK Corral.” “Just about every COP in recent history has essentially come down to the US and China rivalry, and Glasgow looks to be no different.”

Unfortunately, there are limits to how much wise counselling/browbeating China will listen to. The question then becomes: is there another way?

Enter the Carbon Border Tax. This is the topic du jour in the EU, the UK and the US.

The EU is leading the way. In July, the European Commission proposed a Carbon Border Adjustment Mechanism (CBAM), or CO2 tariff, on polluting goods from the year 2026. This will force some companies importing into the EU to pay carbon costs at the border on carbon-intensive products such as steel and aluminium.

There will be a lot of wrangling before this becomes settled EU policy. German politician  Friedrich Merz, called the proposal “nonsense” at the Wirtschaftsrat der CDU (Economic Council of the CDU political party), adding “It will be the beginning of a new world trade conflict in which there will only be losers.”

But others are joining in. The United States is the closest it has ever been to imposing a carbon border tax. Thanks to Biden ally, Senator Chris Coons, a proposal has snuck into the $3.5trn reconciliation package. It speaks of levelling “the playing field between U.S. companies which face environmental regulations at home and foreign competitors with less rigorous standards.”

There is a strong argument that a large proportion of the third of manufacturing jobs the US lost between 2000 and 2010 went to China. And that carbon emissions, and poor labour practices, went with them. President Biden has said he would support a carbon border tax to advance climate goals, although John Kerry has called it a “last resort.”

Naturally, China’s reaction to the EU’s policy has been outspoken: "CBAM is essentially a unilateral measure to extend the climate change issue to the trade sector. It violates WTO principles…and (will) seriously undermine mutual trust in the global community."

There are concerns over the complexity of implementation. James Whiteside, Global Head of Multi-Commodity Research at Wood Mackenzie, warned in a note of a “logistical nightmare”, saying: “There is little transparency around carbon emissions associated with products.”

I believe these problems can be overcome. As Mike Trotman, Director and Environmental Tax Expert at accountancy firm, Xeinadin, observes: “Ultimately the infrastructure for introducing a CBAM is already there; in fact the processes for applying import duties are more active today than they have been for decades.”

My main worry with the CBAM is that the proposals do not go far enough. The list of goods targeted is too narrow. The fees will mainly be imposed on steel, aluminium, and fertiliser. Inevitably, the impact is therefore small. Estimates from German think tank, Bertelsmann Stiftung, said it would only lead to an extra 0.2 percentage points reduction in the amount of CO2 discharged into the atmosphere globally.

My other worry is China will not in fact suffer as much as other nations. A study by the Sandbag and E3G think tanks estimated that CBAM fees charged on imported Russian products would reach €1.884bn in 2035, when free carbon emission allowances in the EU are reduced to zero. Igor Sechin, Chief of oil giant Rosneft, reportedly has told the Kremlin that carbon border taxes could inflict far greater damage to Russia’s economy than sanctions.

Well, that’s no bad thing. But according to the Sandberg/E3G study China, the world's biggest greenhouse gas emitter and the EU's biggest source of imports, is forecast to pay a mere €484 million by 2035.

To have teeth, a Carbon Border Tax must be much broader. As Shuting Pomerleau, Climate Policy Analyst at the Niskanen Center told Forbes it must not just cover “primary goods, but (all)of the final consumer goods.”

If we are to bring China to heel, then a concerted effort by all “concerned nations” to introduce a broadly defined carbon border tax must be made.

There’s a lot to talk about at COP26.

 

Christopher Walker is a writer on business and politics. He sat for several years on the asset allocation committee of a major asset manager.