Carbon Tax and Carbon Markets: Anticipated Future Trajectories
By Gerhard Nienaber, Director, KISCH Tax Advisory
Carbon Pricing
Carbon pricing is a mechanism to capture external costs and impacts of greenhouse gas emissions by adding an additional cost to the use of fossil fuels. There are two main approaches to carbon pricing, namely carbon trading markets and carbon taxes, both of which seek to reduce GHG emissions and shift companies, corporations, governments, and individuals towards low-emission alternatives. A carbon market is any trading system through which countries, companies, individuals, and other entities can buy/sell units of greenhouse-gas (“GHG”) emissions to meet their requisite/voluntary emissions limits. Carbon offsetting is central to carbon markets’ functioning and trading of credits and involve entities accounting for emissions by purchasing calculated and third-party verified reductions elsewhere. Such offsets are designed, verified, and marketed either via compliance or voluntarily.
Compliance markets are created and regulated by mandatory national, regional, or international carbon reduction programmes (generally referred to as cap-and-trade markets) in which actors are provided an allowance based on the set emissions target. Each actor will be incentivised to produce less than or equal to the GHG emissions target/cap thereby, in theory, reducing overall emissions from that specific sector. Compliance markets are economically oriented, with companies making decisions regarding investments in new technology and emission-reducing advancements when and how works best for them, recognising that the costs of continuing to emit will increase over time as the cap tightens. Voluntary markets, on the other hand, do not have proper/formal enforcement mechanisms to ensure members do not emit past agreed limits, and those who do can either offset emissions elsewhere (to remain in compliance) or become noncompliant. Instead of enforceable punishments, voluntary carbon markets are driven by corporate social responsibility, ethics, and reputational or supply chain risk. Such offsets are also not always a net reduction in emissions, as an entity can simultaneously increase its GHG emissions while offsetting those emissions.
Carbon Taxes
A carbon tax is a policy in which the government sets a price that emitters must pay for each ton of greenhouse gases they emit, with the key objective being to incentivise businesses, consumers, and other actors to reduce their emissions to avoid paying the tax. Carbon taxes can be categorized as either an emissions tax or a goods tax. An emissions tax is tax based on the quantity of CO2 an entity produces, while a goods tax focuses on goods or services that are generally GHG-intensive, like the gasoline and airline industry.
Green Transition: South Africa
On 21 February 2024, South Africa's Minister of Finance announced the 2024 Budget Review. The sustainability and energy measures included were:
- Carbon tax rates: The Carbon Tax Act No. 15 of 2019 specifies that the initial rate of carbon tax of R120 per tonne will be increased by consumer price inflation (“CPI”) +2% per year until 31 December 2022, whereafter the rate of carbon tax will be increased only by CPI. It is, therefore, no surprise that the carbon tax rate is increased with 19.49% - carbon tax rates increased R190 per ton of CO2, up from R159 per ton of CO2 with effect from 1 January 2024. Treasury is consulting to implement the carbon tax penalty of R640 per ton of CO2 for emissions exceeding carbon budgets. The penalty rate is likely to be effective from 1 January 2025 (announcement pending).
- Carbon fuel levy: From 1 January 2024, the levy increased to 11 cents per litre for petrol and 14 cents per litre for diesel. The carbon tax cost recovery quantum for the liquid fuels sector increased from 0.66c/litre to 0.69c/litre, effective 1 January 2024.
- Carbon offset allowances: Government intends to increase the carbon offset allowance by 5% from 1 January 2026 to drive investment in carbon reduction projects.
- Motor vehicles emission tax: The tax was increased from 1 April 2024 to R146 per gram of CO2 emissions per kilometre for passenger vehicles (up from R132).
- Tax incentive for energy efficiency: The 95 cents per kilowatt/hour rate will continue to apply until 31 December 2025.
- Renewable energy: An increase is proposed in the limit for renewable energy projects that qualify for carbon offset allowances, from 15 megawatts to 30 megawatts to promote further investments in renewable energy.
- Investment allowances for electrical and hydrogen-powered vehicles: A 150% investment allowance is provided for qualifying spend in the initial year of investment, starting from 1 March 2026. This incentive spans a 10-year period and is intended to complement the current support provided by the Automotive Production and Development Programme (unclear whether the incentive will apply to component manufacturers).
- Plastic bag levy: The levy increased from 28 cents per bag to 32 cents per bag, as of 1 April 2024.
Global Concerns
Cited from the ‘SARB Occasional Bulletin of Economic Notes April 2024: Carbon Taxation in South Africa and the Risks of Carbon Border Adjustment Mechanisms’ the following were deduced:
South Africa’s Carbon Problem
South Africa’s 1% share of GHG emissions is the lowest among the top fifteen emitters. Carbon intensity of output, however, is one of the highest in the world, making South Africa a net exporter of carbon. At the same time, the effective carbon tax is one of the lowest. South Africa’s carbon tax was introduced in June 2019 in a phased approach to ease the transition to net zero. However, the tax-free allowances to cushion the potential adverse impacts on energy intensive sectors such as mining, and iron and steel, the coverage of only direct emissions and the exemption of Eskom implied an initial effective carbon tax rate range as low as R6 to R48 (or about US$0.30 to US$2.60) per tonne of CO2e. This compares with a global average of US$6 by the end of 2022. The National Treasury is targeting an increase to US$30 by 2030. However, the extension of South Africa’s phase one carbon tax from the end of 2022 to the end of 2025, together with an uncertain future trajectory and lack of clarity on future exemptions and the use of carbon budgets points to an effective carbon tax rate that is likely to remain well below the IMF’s recommended US$50 by 2030 for emerging markets, and far below the implied carbon price of above €90 per tonne CO2e (or US$100) currently traded on the EU emission trading system (“ETS”) carbon market.
A Brief Overview of the EU CBAM (Carbon Border Adjustment Mechanism)
The European Parliament in April 2023 approved the design and implementation of a phased in CBAM to replace the free allocation of allowances under the current ETS for the most trade-exposed emitting sectors: iron and steel, cement, fertiliser, aluminium, hydrogen, and electricity. The CBAM aims to preserve the competitiveness of EU exports and prevent carbon leakage by equalising the price of carbon between domestic products and imports in selected sectors. It will therefore function as a carbon price levied on the embedded carbon content of imports to the EU for which the embodied carbon emissions price is below the EU price. It is also intended to increase global climate action by encouraging countries that are subject to the EU CBAM to raise their emissions targets and increase their own carbon price to allow them to both eliminate their export liability and benefit from the higher tax revenue for use in their own countries.
Potential Impacts of EU CBAM on South Africa
The introduction of the EU CBAM will increase the cost of South African exports to European markets. This will reduce their competitiveness and hence the value of future exports to the EU. Serious questions that need to be answered:
- What happens to South African exports under the current EU CBAM proposal?
- What happens to South African exports if the EU CBAM is extended to cover all goods and services and all direct and indirect emissions from upstream value chains?
- What happens to South African Exports if all countries impose a CBAM?
The EU is South Africa’s largest trading partner. In 2019, the share of total exports to the region was 19%, and the total value of exports subject to the EU CBAM was roughly US$1.5 billion or 1.6% of total exports. This has earned South Africa a spot in the list of top 20 countries most exposed to the EU CBAM. However, the net impact on trade will depend on the ease of substitution of exports with less carbon-intensive options. It will also depend on the ability to shift exports to other destinations with less stringent climate-related trade restrictions. Countries like the US, Canada and Japan are also considering the implementation of carbon border adjustment measures, thereby exposing South Africa to more transition risk.
South Africa has a high carbon intensity and low effective carbon tax. This combination exposes the country to import carbon adjustment mechanisms that can significantly reduce demand for South African exports. Even if South Africa manages to negotiate exemptions from the EU, changing consumer sentiments pose an additional risk to the country’s exports. Other countries transitioning faster in response to the CBAM or having higher carbon prices may also put South Africa at a disadvantage in the medium term as they position themselves as green production destinations. Mitigating against this risk requires a higher and more predictable carbon tax that will also generate significant financial resources to help the economy transition and possibly offset any negative impacts from having a higher carbon price.
If you have any queries on the above or require any tax advice, please contact:
Gerhard Nienaber
Director
KISCH Tax Advisory
+ 27 82?771 9549
Gerhardn@kisch-ip.com
