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EU grasps the nettle of climate change

The European Union (EU) is putting forward a comprehensive package of climate legislation. Whilst still only proposals, the Commission’s measures signal the kind of transformation that climate change demands of us. A difficult and drawn out ratification process seems certain.

At almost exactly the same time that floods were devastating parts of western Europe, the European Commission was putting forward an ambitious package of thirteen legislative proposals to tackle climate change. Whether the ‘Fit for 55’ package will be adopted in its current form remains to be seen. As the individual proposals will be negotiated separately, the stage seems to be set for a long and difficult voting and ratification process.

The aim is to reduce greenhouse gas emissions in the European Union (EU) by at least 55 per cent by 2030, compared to 1990 levels. This will enable the EU to meet its legally binding target of being carbon neutral by 2050 or sooner, which it plans to achieve by internalising more of the costs of climate change and thereby making the cost of greenhouse gas emissions more expensive. Even in a pared-back form, the proposals are likely to lead to noticeable changes in the parameters within which several sectors of the economy operate.

Tougher, faster, broader

Overall, the Fit for 55 package will result in tougher, swifter and broader climate regulation that seeks to provide a financial incentive for protecting the climate. The key points are as follows:

  • Internal combustion engines are to be banned by 2035 and all new cars registered from 2035 will have to be zero-emission. At the same time, the charging infrastructure is to be massively expanded. An EU-wide regulation should ensure that electric car drivers can travel the length and breadth of the continent. The proposals also envisage the creation of a network of 1,000 hydrogen refuelling points by 2030

  • The European Emissions Trading System (ETS) is to be reformed and extended to include shipping emissions. The cap for emissions is to be lowered. Restricting the number of emissions certificates will increase the price of carbon, currently around €50 per tonne (trade)

  • At the same time, an additional, parallel carbon trading scheme is to be developed for buildings and transport. Both sectors have high greenhouse gas emissions but are excluded from the current cap-and-trade mechanism. This will increase the price of fuel used in transport and for heating

  • A Carbon Border Adjustment Mechanism is intended to prevent any competitive advantage for goods made in non-EU countries where carbon taxation or pricing is lower or non-existent (‘carbon leakage’). The EU hopes this measure will ensure that the carbon footprint of these goods is priced as if they were made in the EU. During a transition phase from 2023 to 2025, it will initially apply only to cement, steel, aluminium, fertiliser and electricity. In the longer term, the EU expects this tax to raise around €10 billion annually

  • To mitigate potential social hardship from the increase in fuel prices, a social climate fund will be set up for low-income households, micro-businesses and public transport users

  • The proportion of energy generated from renewable sources should be doubled (compared to 2019 levels) by 2030 to around 40 per cent.

Implementation of the European Green Deal

EU climate targets – the crucial decade

Implementation of the European Green Deal
Source: European Union; as at 15 July 2021.

Far-reaching implications for investors

The market reaction on 14 July when the plans were published was muted. The Fit for 55 package did not make major waves on the emissions trading market. This is probably due to the fact that the implementation of the planned measures is likely to take several years and the markets had already anticipated them anyway. Overall, the EU plans show that it is becoming more important for companies and property owners to prepare for structural price increases for greenhouse gas emissions. The trading volume, market capitalisation and importance of the ETS are therefore likely to increase as more and more financial market players become involved. At the same time, this will create an opportunity to develop a new sustainable asset class with performance potential.

Nor were there any major price movements on the equity markets for the individual sectors that are likely to be particularly badly affected – such as building materials or automotive. Overall, the envisaged measures are likely to be compatible with the expectations of the companies concerned. The devil will be in the detail: the introduction of a carbon border tax is likely to have a particularly severe impact on companies that rely on a high proportion of imported goods with a large carbon footprint. It is hard to make any predictions here – complicated negotiations are already under way with resistance from non-member countries that will be particularly badly affected such as China, the USA and Russia.

The automotive industry is likely to continue receiving support – possibly up to 2030 – in the form of an extension of the purchase incentives for electric or hybrid vehicles. The German car industry is already making good progress in its transformation process and is unlikely to have any problems with a requirement to abandon internal combustion engine technologies by 2035. Opportunities will be created for European battery manufacturers (including recyclers) and for providers of electricity grid and charging point services. Among the easily tradable industrial metals, copper, nickel and platinum are likely to benefit from decarbonisation in the commodities sector and to be boosted in the long term by rising demand.

 

As at 16 July 2021