How carbon pricing may impact Asian earnings

As December approaches, the possibility increases that the United Nations Framework Convention on Climate Change meeting in Copenhagen will become a catalyst for the wider introduction of carbon pricing. It is effectively part two of the Kyoto Protocol as it is scheduled to establish a global climate change agreement for the period between 2013 and 2020.

In a research report titled How would carbon pricing impact Asian company earnings, UBS analyst Simon Smiles argued that even if nothing is passed in Copenhagen, Asia has to sit up and take notice. There is reason to believe that carbon pricing in one form or another will begin to affect a range of companies across every Asian market within the next three years. Smiles predicted three potential scenarios, of which one is most likely.

The first scenario is one of domestic pricing, which means that both domestic-focused companies and exporters pay for the CO2 they emit. But most analysts agree that this isn't likely to happen quickly, as the political will is just not there yet in Asia to impose carbon pricing domestically.

Another scenario is one of climate change duty, which means exporters directly or indirectly pay for the CO2 their home country emits -- but this scenario implies that politicians truly are 100% focused on implementing climate change laws with teeth to them, and while there are proponents who dream of this, realistically it is even further into the future, say analysts.

"When it comes to carbon pricing, the general assumption is that governments are not going to introduce it in Asia, therefore we don't have to worry about it," Smiles said in an interview with FinanceAsia. "But there is a way that carbon pricing could still impact companies: other countries could impose carbon-related import duties on Asia."

That is the final scenario: an equalising duty might be introduced in the US and Europe. Here's how that could happen. The US introduces domestic carbon pricing, which effectively puts its carbon-emitting industries in the same boat as those in Europe. As a result, carbon-emitting industries in the EU and US then successfully lobby for the introduction of "equalising" extraterritorial carbon duties on imports from competitors operating in countries which do not have domestic carbon-pricing mechanisms, for example China or India, but certainly not limited to just these two countries. This could take the form of direct duties levied on importers, or levies on the companies that purchase the imports. Either way, exporters pay for carbon based on the amount of CO2 they emit, but domestic-focused companies do not, explained Smiles.

Politicians are already prepping the public for this. In the US Congress, the Waxman-Markey discussion draft, which was proposed in March, calls for US companies using primary products such as iron, steel, aluminium and cement manufactured by foreign facilities that do not have greenhouse gas reduction requirements equivalent to those proposed for the US to have to purchase international reserve allowances to offset the carbon implied in the products.

In November 2007 then French Prime Minister Dominique de Villepin said that France was urging the EU to study "the principle of a carbon tax on the import of industrial products from countries which refuse to commit themselves to the Kyoto Protocol after 2012". This was followed up by French President Nicolas Sarkozy saying in 2007 at an environmental forum in Paris: "We need to profoundly revise all of our taxes... to tax pollution more." He went on to say that France should urge the EU Commission head to "...examine the option of taxing products from countries that do not respect the Kyoto Protocol". And US energy secretary Steve Chu told Congress in March this year that a carbon border tax would "level the playing field".

Put simply, the political murmurings that precede an effective import tax are already in place.

Which sectors would be most impacted? To figure that out, Smiles assumed that the implied cost of carbon imposed via an extraterritorial carbon import duty would be roughly equivalent to the cost that would apply if a direct carbon tax was applied domestically and electricity providers then passed through 100% of their cost.

Smiles concluded that the sectors most likely to be affected by a carbon import tax would be the airline and marine transport sectors, which are relatively carbon-intensive and are exposed to the EU and US, and the electrical components sector, which has moderate cost exposure via its use of electricity, low margins and, at the same time, high exposure to the EU and US.

So airlines such as EVA Airways, Thai Airways, Korean Air, Cathay Pacific and Singapore Airlines, which offer a significant number of flights to the US and Europe might be impacted, whereas Air China, China Eastern Airlines or AirAsia would be less impacted as their flight offerings are more regionally focused.

In shipping, some of the big names that theoretically could be hit include Hyundai Merchant Marine, Evergreen Marine and Neptune Orient Lines.

On the electrical components front, Haier Electronics sells into Europe, and Samsung Electronics sells extensively to the US and into the EU. Another company that in theory could be hit is bicycle maker Giant Manufacturing. Sure, it produces a green product, but it is made of steel.

The irony of this scenario is that while a carbon import tax removes the competitive disadvantage faced by carbon-intensive industries in markets with carbon costs, it is a form of protection and, prima facie, against the spirit of the WTO, noted Smiles in his report. Furthermore, he reasoned, while it partially removes the disincentives for emerging countries with low-carbon efficiency and large export sectors to introduce carbon pricing, it does not actually result in meaningful reductions in CO2 emissions for non-participating countries as the companies being taxed are typically not the companies with the largest direct emissions. 

But the likelihood of this kicking into effect is strong, and worth considering as you ponder sectors that may face protectionist hurdles in the name of cleaner air.