In today's Finshots we see why the EU's plans to attain climate neutrality has one big problem

But before we begin, if you're someone who loves to keep tabs on what's happening in the world of business and finance, then hit subscribe if you haven't already. If you’re already a subscriber or you’re reading this on the app, you can just go ahead and read the story.

The Story

The European Union (EU) is setting itself  up to achieve an ambitious goal: attain climate neutrality by 2050. In simpler terms, they want to balance out the greenhouse gases (GHG) they emit with what our planet can naturally absorb.

And to make this happen, the EU is wielding a powerful tool: the 'polluter pays' principle. It's a fancy way of saying they're putting pressure on industries that emit a lot of greenhouse gases.

Here’s how they are doing it:

The EU has a master plan called the Emissions Trading System (ETS). It specifically targets GHG emissions from power generation and energy-intensive industries like steel, aluminum, cement and the likes.

To give you a perspective, these industries alone belched out nearly a quarter of the EU's total GHG emissions in 2019. To rein them in, the EU slaps an annual cap on how much CO2 they can pump into the atmosphere. That cap gets tighter every year, pushing companies to clean up their act. Now, these companies must purchase emission allowances from the government for each ton of CO2 they produce, and if they exceed their limit, they face fines.

But here's the cool part. If these companies manage to cut their emissions below the set cap, they can sell their spare allowances for a tidy profit. It’s like turning pollution into a commodity—a green incentive program for businesses to invest in cleaner, more efficient production practices.

And it’s working wonders for the EU. In 2022, the EU ETS generated 38.8 billion euros in emission allowance revenue, which flowed either to the EU member states’ budgets or the EU’s innovation and modernisation funds.

What a masterstroke, right? The EU is achieving two big wins at once: cutting down on greenhouse gas emissions and making a hefty amount of money!

But there’s a catch.

Complying with these stringent climate laws means paying more to lower emissions, which hikes up production costs for EU companies. However, not every company is happy about this. Some are trying to bypass the EU’s ETS regulations by importing these commodities from countries (like India) with less rigid climate regulations or moving their operations to such countries to slash costs.

However, this practice, known as carbon leakage, does not actually reduce global emissions, contrary to the EU's goal!

On top of this, the EU is concerned that the lower costs of imported goods could threaten the revenues and market share of local European companies. To address these concerns and plug in the loopholes, the EU rolled out the Carbon Border Adjustment Mechanism (CBAM) in 2023.

How does this plug the loophole?

Imagine a company based in China that manufactures steel and exports it to the European Union. Prior to the implementation of the CBAM, this company could sell its steel in the EU at lower prices compared to European manufacturers, partly because it didn’t incur the same carbon emission costs that EU-based manufacturers faced under the EU Emissions Trading System (ETS).

So the European Manufacturer simply outsourced their greenhouse gas emissions.
With the CBAM in place since 2023, the scenario changes:
When the Chinese steel manufacturer exports to the EU, the carbon content of the steel is assessed. This includes calculating emissions produced during the manufacturing process.

Based on this assessment, the importer—either the Chinese company itself or the European company purchasing the steel—must buy CBAM certificates. These certificates are priced equivalently to the EU Emission Allowances (EUAs). If the EU Emission Allowances are priced at, say, €50 per ton of CO2, and the steel production involves emitting 2 tons of CO2 per ton of steel, the importer needs to buy certificates costing €100 (€50 x 2) per ton of steel.

This mechanism ensures that the imported steel is subject to similar carbon costs as steel produced within the EU, thereby leveling the playing field. Now the EU manufacturer has no incentive to outsource production. They pay the same price anyway.

So you could argue that the EU has done its job. It has prevented carbon leakage as well as protected local industries from cheaper imports.

But this has created a new set of problems for countries like India.

Look, the EU is a crucial market for Indian aluminium and steel. In fact, about 27% of India’s aluminium exports worth $2.7 billion and 38% of its steel exports worth $3.7 billion go to the EU. With CBAM in play, things would get tricky for these industries, potentially shaking things up for Indian exporters.

The tax currently ranges from 7-15% of the product’s value, but if the EU starts considering emissions from electricity, this could skyrocket to 25-50%. This could make it extremely difficult for Indian exporters to compete in the EU market.

Interestingly, an independent think tank, the Centre for Science and Environment (CSE), has recently criticised the EU’s CBAM in its latest report, pointing out its impact on developing nations. For India, it could lead to a 0.05% reduction in GDP.

Furthermore, the report highlights how affluent nations have been major carbon dioxide emitters since the Industrial Revolution. Their extensive use of fossil fuels and industrial methods propelled their prosperity. Now, they are urging developing economies to transition to cleaner energy sources, which is challenging due to the high costs involved.

Besides these observations, the report has a banger suggestion.

It says that countries, particularly those that haven't historically contributed much to climate change, should, in turn, impose a "historical polluter tax" on these more affluent, historically polluting countries.

These proceeds would eventually help fund the developing countries’ efforts to reduce carbon emissions. It isn’t a retaliatory action but more about making the historically polluting countries pay for their long-term use of cheap, polluting energy.

So yeah, while the European Union may succeed in curtailing GHG emissions locally, they still have an obligation to make sure they pay their fair share for having contributed extensively to the predicament we find ourselves in.

Will they do it?

We don’t know.

Until then…

Don't forget to share this story on WhatsApp, LinkedIn and X.

📢Finshots is also on WhatsApp Channels. Click here to follow us and get your daily financial fix in just 3 minutes.

🚨Term Life Insurance Prices are About to INCREASE!

A prominent insurer is set to raise their term insurance rates in the next few weeks. This means if you don’t secure a term plan now, your premiums could significantly go up!

Here’s why this matters: When you purchase a term life insurance policy, you pay a premium or a small fee each year to protect against financial risks. In the unfortunate event of your passing, the insurance company pays out a substantial sum to your family or loved ones.

The best part? By buying early, you can lock in your premiums, ensuring they're not affected by any future rate hikes.

If you've been considering a term plan, now is the perfect time to act. To assist you in the process, our advisory team at Ditto is here to help. Click on the link here to book a FREE call with our IRDAI-certified advisors.