Romito: Time to Evaluate Carbon Price

At the end of 2023, the global energy mix remained ~82% reliant on fossil fuels, down only 5% from 2010. If this trend remains at its current pace, fossil fuels will cease to exist within the global energy mix in approximately 2225 or, in other words, not anytime soon.

However, global demand for fossil fuels did not remain flat last year. Instead, Asian demand is anticipated to drive fossil fuel demand to record highs. For example, as China and India continue to increase their society’s standard of living, they must provide the energy to fuel the immense demand for power, heating and transportation. 

Both countries installed a record amount of renewable power but also burned a record amount of fossil fuels in 2023. This dynamic is not relegated to just China and India. All developing countries are not transitioning away from fossil fuels. Instead, they are expanding, enhancing and innovating their ability to access all types of energy.

Global detractors must accept that a worldwide move away from fossil fuels will not happen over the foreseeable future. Objective analysis indicates fossil fuels will be required for at least six more generations. While developing countries execute their industrial revolution, their focus will naturally be prioritized ahead of any Western-based climate-related agenda. 

The U.S. accounted for only approximately one-fifth of the 26 MMmt of CO₂ released by the world’s 10 largest emitters in 2022. For perspective, China, India and Russia account for nearly 62% of the emissions released by the world’s top 10 emitters during the same period. It is unlikely that China, India and Russia can be convinced to reprioritize their emissions policy at the expense of future economic progress.

We can pursue net zero to enhance environmental and financial priorities in the U.S., but it is a questionable strategy on the international stage to permanently adopt an absolute and universal “net-zero or bust” mentality. 

As these realities come to light, we think the capital markets and the regulatory landscape will move away from demanding absolute net zero. Capital is a finite resource, and investors cannot continue to splurge on investments that yield little to no return.

A balance between policy and alpha is required. Whether intentional or not, the European Union’s introduction of the Carbon Border Adjustment Mechanism (CBAM) represents an alternative attempt to impact emissions-based policy and investment. CBAM essentially assigns a carbon price to specific carbon-intensive imports by taxing foreign producers with less stringent emissions-based regulations. 

The primary imports falling under the purview of CBAM include iron, steel, aluminum, electricity, cement, hydrogen and fertilizer. Implementation of CBAM will come in four distinct phases. Phase One was enacted in October 2023 and is intended to allow operators, importers and EU member states to “develop and refine necessary processes.” Phase Two is scheduled to begin in January 2026 and marks the beginning of payment obligations. Phases three and four are ambiguous but focus on creating a reporting infrastructure to expand the roster of goods included. 

Since Europe is the forerunner that typically impacts policy in the U.S., we envision the regulatory environment to increasingly entertain the thought of similar directives. The EU, New Zealand and Mexico have a “cap and trade” system. Some U.S. states, namely California and Washington, have enacted carbon pricing, with Hawaii anticipating passing something similar soon.

The industry should also increasingly become more aware of the PROVE IT Act from Sen. Chris Coons (D-Del.), which “would put high-quality, verifiable data behind manufacturing practices to bolster transparency around global emissions intensity data and to hold countries with dirtier production accountable.” 

Politically speaking, it seems unlikely that those clamoring for net zero will reverse course. However, given the emerging geopolitical environment and the fact that China is a leading global exporter of iron and steel, there is a realistic chance that net-zero cynicism will coincide with an increased enthusiasm for a domestic instrument like a carbon border tax.

Assuming there exists a genuine desire on behalf of policymakers to decarbonize, a U.S. carbon border tax displays a high likelihood of passing if the largest exporters of carbon-intensive products also happen to be the countries with a lower focus on emissions. Rampant existing inflation plus the incremental potential cost deriving from such a tax would have to be considered. Theoretically, increasing the competitive positioning of the U.S. could be aided by such a measure. 

That said, the U.S. cannot institute a border tax without establishing a carbon price. Suffice it to say, based on regulatory trends in Europe, energy demand movements in Asia and the current state of global pro-net zero policies, the fossil fuel industry must better understand its respective cost of carbon and how a CBAM-equivalent tax within the U.S. will impact its strategy.