The contagion of carbon pricing

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Editor's Note: This is the third of several viewpoints that we will run from MBA students who are members of the Geoeconomics Group at HBS. In these pieces, writers will share their insights gained from engaging with business leaders and scholars around the world on business' role in society. This viewpoint is from Annabel Ware, president and co-founder of the Geoeconomics Group. Annabel has worked in international finance and diplomacy at The Baupost Group, IFC World Bank Group, and the US Treasury Department. She will graduate with her MBA from HBS in 2025.

The adoption of new standards for an international carbon market at COP29 in Azerbaijan has given a breath of fresh air to carbon pricing. That air, however, is fanning flames.

As diplomats deliberate in Baku, MBA students spar in Boston over the responsibility of the private sector in the green transition. In a case discussion of Driving Decarbonization at BMW, several students accused management of “scope creep,” arguing that carbon emissions are peripheral to the firm’s business. Others insisted that leaders should incorporate societal welfare into their decision-making. Both are missing the point.

Curbing emissions can no longer be seen as financially profligate. Nor can it be understood merely as a charitable campaign by well-intentioned leaders. Over the next several years, it will come to make cold-hard economic sense.

A relatively new piece of legislation, the EU Carbon Border Adjustment Mechanism (CBAM), will significantly expand the scope of carbon pricing. Starting in 2026, foreign companies will be held financially liable for the carbon emissions embedded in the goods they export into the EU. Beginning with steel, cement, and aluminum producers, the CBAM will eventually apply to nearly all imports into Europe. In effect, the EU is expanding the jurisdiction of its emissions trading scheme, where firms are required to pay the government €70 for each metric ton of carbon dioxide they emit. This number, determined by auctions and the secondary market, is projected to reach €120 to €160 by 2030.

However, the CBAM comes with a loophole. Companies will not have to pay Brussels the cost of their emissions if they have already paid for their emissions in their country of origin. In other words, the EU is giving governments an ultimatum: either put a price on carbon yourself – and collect the tax domestically – or we will. Any delta between the local carbon price and the EU’s will be payable to the Europeans.

The consequence of this legislation is the acceleration of carbon pricing schemes globally. In the past several years, China, the UK, and South Korea have all launched cap-and-trade programs. Today, India, Turkey, Vietnam, and Brazil are all moving forward to establish their own.

Map showing carbon prices around the world

Source: World Bank Group, “State and Trends of Carbon Pricing Dashboard.

As these programs mature, they too will implement their own carbon tax on foreign goods entering their markets. If they do not, they risk sacrificing the competitiveness of their national champions. In India, for example, a local cement manufacturer would not be able to compete with a Qatari producer if only they had to pay for their carbon emissions. To ensure fairness, all countries with carbon markets will eventually have to tax imports.

So what does this mean for businesses? Take the perspective of a US steel manufacturer that exports a quarter of its product to the EU. Come 2026, the firm will have to pay for 25% of the carbon it emits. However, as more carbon markets are established around the world, the fraction of its business taxed for emissions will grow. Say that in addition to the EU, it sells 15% of its product to India and another 20% to China. Once India and China enact their own CBAM, the business will be taxed for 60% of its emissions – without a single regulatory change in the US.

Of course, the firm could stop exporting. But if other steel manufacturers concurrently turn inwards, excess steel supply in the domestic market could drive many out of business.

The contagion of carbon pricing will force companies – even those in countries where climate regulation is at a standstill – to consider the cost of carbon in their goods. Just like corporate taxes, carbon emissions will have a measurable impact on a firm’s financials. Regardless of one’s stance on the role of the private sector in society, the cost of carbon will come for all.

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