How carbon pricing may impact companies in Asia-Pacific

Companies should monitor carbon policies and measures for a sustainable supply chain to remain competitive in the long term. 

The importance of climate change is undeniable. 

Ensuring a price is paid on greenhouse gas (GHG) emissions from the supply of goods and services is seen as a way to balance demand, shift costs to those responsible and as a result, lower emissions. Carbon price, also known as carbon tax, is the price that emitters will need to pay based on the amount of carbon that they emit in the production of goods and services. 

According to current World Bank statistics¹, there are 64 carbon pricing initiatives implemented or scheduled for implementation globally, covering 45 national jurisdictions. In 2021, these initiatives would cover 11.65 gigatons of carbon dioxide (CO2) equivalent (GtCO2e), representing 21.5% of global GHG emissions. These initiatives range from emission trading systems (ETS) in the European Union (EU), South Korea and China, to carbon taxes such as Singapore’s carbon tax at S$5 per ton of CO2 equivalent (tCO2e).

These carbon pricing and trading schemes are generally national in nature, while production chains are not. Although global targets exist, there is no globally agreed synchronised carbon reduction initiative to date. 

In June this year, the International Monetary Fund (IMF) outlined a proposal for an international carbon price floor among large emitters². The IMF believes that if just six participants – Canada, China, EU, India, the UK and US – were to implement a US$75 per ton carbon price by 2030 for advanced countries, US$50 per ton for higher income emerging economies and US$25 per ton for lower income emerging countries, this will help to bring emissions in 2030 in line with keeping the increase in global warming to below 2°C.

Policing carbon emissions beyond national borders

In the face of these developments, countries and regions are unilaterally proposing and putting into place cross-border or extraterritorial carbon pricing schemes without waiting for global consensus.

The EU has recently launched the EU Carbon Adjustment Mechanism (EU CBAM) detailed proposal, which will require EU importers to purchase carbon certificates corresponding to the carbon price that would have been paid, had the goods been produced under the EU’s carbon pricing rules³. This will be phased in gradually and applied to iron, steel, cement, fertiliser, aluminum and electricity generation initially, and only for direct carbon emissions. A reporting system will apply from 2023 and importers are expected to start paying a financial adjustment in 2026.

In the US, there has been a proposal by some members of the Democratic Party for a US carbon border tax, which is intended to raise US$16b annually⁴. This proposal will have a tariff applying in 2024 to roughly 12% of US imports covering petroleum, natural gas, coal, aluminum, steel, iron and cement initially. 

In general, the reasons for a carbon border tax are reflected below. 

Firstly, it can be designed to alleviate the burden on a country that has imposed a tax or a price on carbon dioxide emissions by transferring part of the cost to companies in other countries. 

Secondly, this will also encourage other countries to price carbon and lower emissions. For example, the EU CBAM allows deduction of carbon cost in imported goods if a non-EU producer can show that they have already paid a price for the carbon in its production, which is subject to further negotiations and dialogue with third countries. 

Thirdly, it can potentially prevent leakage, where companies with carbon pollutive manufacturing processes will be deterred from simply relocating to countries with less stringent environmental rules. Instead, these companies will now have to invest in putting in processes to reduce carbon emissions. 

The intent of carbon border taxes is to impact companies that are in the upstream of the supply chain outside of the market destination. This means that second-tier, third-tier and even fourth-tier manufacturers and suppliers will be affected no matter how far away they are geographically from the final market of sale.

Challenges for companies faced with carbon border tax

1. Increased compliance and import costs

Affected companies will likely face high compliance complexities that arise from differing carbon pricing and calculation methods, and different carbon pricing mechanisms from different global markets. 

As carbon calculation extends to companies’ suppliers, an additional factor for consideration will be added to sourcing decisions and landed cost analysis, fueling a rethink of current supply chain and production models. 

For companies, being carbon-ready will require new work processes and skills, as well as training in the short to medium term. 

Take for example the case study conducted by the MIT Center for Transport & Logistics, which details the process of estimating the carbon footprint of a banana. The companies involved had to overcome various challenges and one of which is the gathering and tracking of data required⁵. Data is often not available as it has to come from sources outside of the partner companies. Eventually, as there may be many uncertainties, companies may have to internally develop their own assumptions and allocation or tracking systems and methods. 

      2. "Spaghetti bowl” complexities and increasing trade barriers

Some opponents to carbon border mechanisms have argued that these increase the prospect of trade barriers and also tit-for-tat actions. The protectionism concern is particularly obvious, when allowances or benefits are given to national producers but not foreign producers, while carbon prices on their products remain the same. 

Australia’s trade minister, Dan Tehan, has argued that there is no level playing field unless EU removes their agricultural subsidies and exemptions under its emissions trading scheme⁶. The Federation of Korean Industries which represents more than 400 businesses including conglomerates like Samsung and LG, has sent a request to EU President Ursula von der Leyen to exempt Korea from the EU CBAM, as this would lead to unfair double taxation and a new type of trade protectionism. Korea already has an emissions trading scheme that was launched in 2015⁷. 

While it is still too early to predict the operationalisation of these measures, differentiated treatment of countries and sectors through carbon border measures and the corresponding reciprocal differentiated treatment by other countries could be the beginning of a new “spaghetti bowl” of trade rules for global companies to navigate.

     3. Close monitoring of carbon pricing trends in Asia-Pacific

Singapore already has a carbon pricing act in force since 2019, and Korea’s emission trading scheme (ETS) has been in force since 2015. China’s carbon emission trading scheme also made its debut in July 2021. More countries in Asia such as Indonesia, Malaysia and Thailand are looking at carbon pricing mechanisms and Japan is seeking input from lawmakers on a carbon tax as well⁸.

Companies will thus need to carefully monitor these policies for planning purposes and accept that medium- and long-term plans may change with every new measure in place. 

Early adoption as a competitive advantage

As many countries’ carbon policies and measures remain in the infancy state, the level of uncertainty makes planning for companies difficult. 

To mitigate such uncertainties, companies should focus on ensuring sustainable and diverse sourcing to decarbonise the value chain, assessing the impact of new taxes and incentives for a sustainable supply chain, and enabling visibility, disclosure and accountability for stakeholders. 

Take the EU CBAM for instance. Once effective, companies transacting with EU markets in the six industries concerning iron, steel, cement, fertiliser, aluminum and electricity generation will be the first to be affected. The prices on the imported products in these industries will be gradually impacted from the transition period starting 2023, with full implementation in 2026. Affected companies are recommended to assess the potential impact of compliance and reporting obligations arising from the CBAM regulations. Companies also need to assess the financial impact based on their existing supply chain and whether there is a need to restructure the supply chain.    

Reviewing supply chains through the lens of sustainability and climate change can be an opportunity to reduce inefficiencies, review cost and incentive options, as well as improve customer and government satisfaction. This could transform carbon considerations for the firm from a compliance cost in the short to medium term to a competitive advantage in the long term.  

The co-authors of this article are Toh Shuhui, Partner, Tax Services from Ernst & Young Solutions LLP and Mok Sze Xin, Director, Indirect Tax from EY Corporate Advisors Pte. Ltd.