Carbon pricing: Well intended, not well done; Abolishing fossil fuel subsidies & Europe's semiconductor industry, a long way towards autonomy

To quote (freely) Francis Bacon: Some reports are to be tasted, others to be swallowed, and some few to be chewed and digested (our home turf): as a starter, we tackle the implications of the EU carbon border adjustment mechanism and what is required to restore a level playing field for industries heavily exposed to carbon pricing. For the main course, we are analyzing what it takes to abolish fossil fuel subsidies and at what the repercussions are in certain regions. As a dessert, we are looking at the European semiconductor industry and its long way toward industrial autonomy. The digestif is our latest episode of our Tomorrow podcast, this time with our ESG expert, Markus Zimmer, on the energy transition and the green deal. Bon appétit!

EU CBAM: Well intended is not necessarily well done

The devil is in the details: The EU carbon border adjustment mechanism (CBAM) will not only become more expensive than anticipated, but likely fall short of its aim to restore a level playing field for industries heavily exposed to carbon pricing because it is an invitation for greenwashing, troubled by the free allocation of emission certificates, and is lacking a common EU actions to support the industries included in the EU CBAM.

It is an invitation for greenwashing. A company can use an individual assessment of its emissions instead of the default emission intensities provided by the EU. The first observable reaction will be that foreign companies will find ways to attribute their already existing green shares e.g. of green electricity completely to the goods exported to the EU.

The focus on keeping the free allocation of certificates in place (instead of reimbursing carbon taxes of exports), ultimately shifts the competitiveness and carbon leakage issues just one step down in the value chain. While trying, for instance, to conserve the competitiveness of EU steel producers, the burdens passed through to the EU automobile industry are neglected (which ultimately pays the carbon price levied from steel producers by higher steel prices).

Kind of a third-best solution to “heal” the conceptual shortcomings above would be to ensure that the European “green” versions of basic goods covered by the EU CBAM are cost competitive to their foreign brown counterparts in other markets. While Germany, for instance, will introduce a subsidy mechanism called “carbon contracts for difference” to achieve this, a coordinated and adequate EU strategy in this respect is lacking.

Additionally, due to calculating default emission intensities at the worst 10% of similar EU producers (instead of EU averages), the burdens threats for importers from the EU CBAM are much higher than previous independent studies anticipated. An indicative assessment suggest that this increases the carbon price around 70% on average with steel and fertilizers facing increases of more than 90% of previous expectations.

Please find our full perspective here. For additional insights, please also refer to our previous publications on the topic (EU CBAM & Country Exports; EU Climate policy goes global).

Abolishing fuel subsidies in a green and just transition

Fossil fuel subsidies account for 0.5% of global GDP, almost exactly the size of the funding gap needed to comply with the Paris Accord. Abolishing fossil fuel subsidies and directing the funds to renewable energy seems like an easy win for the climate: After all, estimates from the OECD and IEA put the total value of fossil fuel subsidies at USD468bn as of 2019 (for 81 countries). Fossil fuel subsidies outpace those for renewable energy in most countries, with the EU-28 and the US being notable exceptions. On the other hand, exceptionally high subsidies are paid in the MENA region (Middle East & North Africa) or in Venezuela, i.e. in countries with a large domestic fossil fuel industry, which tends to have strong political and lobbying power.

Getting rid of them comes with steep costs for consumers, particularly the poorest households. The richest 20% of households receive six times the subsidies of the 20% poorest households, but the poorest households still get hit harder as they spend around 7% of their income on energy related expenditures compared to about 3% that the rich households spend. Nevertheless, abolishing fossil fuel subsidies should free enough fiscal room for redistribution.

In this context, abolishing fossil fuel subsidies requires a holistic approach to secure a just transition. Abrupt measures will not work. What is required are comprehensive plans for phasing-in and sequencing price increases to enable the whole population to smoothly adjust. This has to be accompanied by targeted cash transfers to poor households, e.g. expanded safety net programs or increased spending on programs benefiting primarily the poor (targeted health, education or infrastructure expenditures).

You can find the full analysis here.

Semiconductors ‘Realpolitik’: A reality check for Europe

European industrial autonomy in semiconductors is far out of reach. The recent shortage of semiconductors has highlighted one of Europe’s vulnerabilities, prompting the European Commission to set targets to bring the region’s share of global semiconductor production to 20% by 2030 and to ramp up chip production using the most advanced manufacturing technologies (5nm node and below). But we find that these targets are not only overly ambitious but also unnecessary.

For Europe to jump from 7% to 20% of global chip output, it would need to invest far more than the entire industry. However, Chinese, Taiwanese and South Korean players are far outpacing European peers in this regard. Moreover, looking beyond the 2030 time frame, Europe would need to develop corresponding needs for semiconductors because proximity of production matters. Europe’s need for chips mostly comes from the automotive and industrial sectors, which together account for just about 20% of global chip sales. The region’s semiconductor bill has remained broadly unchanged over the past 15 years, while global demand for chips over the same period doubled. The absence of local demand also makes the objective of having local state-of-the-art chip-making capacities questionable.

Instead, Europe should play the long game, placing chips where they matter the most. Support could be focused where the needs are the most acute and proven, i.e. in manufacturing capacities serving the European automotive and industrial sectors. These industries will see growing demand within 10 years as cars and industrial goods go greener and more digital. Following the lead of the US, China, South Korea and Taiwan, Europe could stimulate investment in local manufacturing capacities through a mix of tax breaks and grants. To protect against future vulnerabilities, investment can be focused where competition seems comparatively more open and Europe’s future needs certain. A stronger ecosystem in critical future semiconductor technologies with a large number of application across European industries, including artificial intelligence and in a more distant future quantum computing, would most certainly reduce Europe’s future reliance on foreign components and technologies and translate into a naturally broader semiconductor manufacturing footprint. Our entire report can be found here.

Tomorrow podcast

The latest episode of our Tomorrow podcast, this time with our ESG expert, Markus Zimmer, on the energy transition and the green deal: https://www.allianz.com/en/economic_research/podcast.html

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