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EU taxes carbon while the UK goes for tech

The first significant post-Brexit divergence should come in environmental policy after the EU and UK set out their respective de-carbonisation stalls
July 21, 2021

Whether the timing was deliberate is hard to say, but announcements by both British government and the EU showcased starkly different approaches as to how to tackle de-carbonisation in the economy.

Unsurprisingly, the political backdrop means that any such policy is going to be seen through the Brexit lens, with the potential for a whole debate on the divergence in standards, differing approaches to business, even laissez-faire versus dirigisme. But beyond the usual complaining from various special interest groups (“It doesn’t go far enough,” versus “It is an intolerable burden on business” etc.), do the differing policy approaches – Britain using technology to keeps things moving, while the EU proposes to tax anything that moves - have any real impact on the industry sectors involved and the shareholders who invest in them?

 

The end of cheap flights?

The most eye-catching contrast is how the EU and UK propose to tackle the thorny issue of the carbon emissions caused by short-haul flights. The EU proposes a broad tax on aviation fuel, which given that companies can hedge this easily, will likely add on costs for frequent flyers.

The UK’s policy is linked more closely to the development of new technology. While some commentators think that approach merely pushes the problem back by a decade, there is some substance to the argument that clean tech aircraft engines utilising hydrogen as a fuel are a realistic possibility.

If the UK is to reduce aviation net emissions to zero by 2050 as the government hopes, then a new generation of aero engines must be developed that run on alternative fuel sources.

The first hydrogen powered flight took off last year from Cranfield Airport using technology developed by a venture start up called Zeroavia, started by a former Google product developer called Valery Miftakhov. The company has received £12.3m of investment from the Department of Business to develop its hydrogen engine further. Coincidently, last year also saw the first flight of a fully battery-powered plane, in what could be an exciting aviation-themed rerun of the Betamax versus VHS wars of the early 1980s.   

It is fair to say that most of us would think twice about stepping on board a battery-operated airliner. Currently, a battery’s efficiency is measured at 250 watt-hours per kilogram, whereas you need a minimum of 800 watt-hours per kilogramme to contemplate powered flight. By contrast, a kilogram of high-octane aviation fuel delivers 12,000 watt-hours of electricity. In short, not even Duracell is going to get you across the Atlantic.  

 

Knowing me, knowing EU

Where an EU-wide aviation tax leaves the airlines is open to question, though it is true that they have been lobbying furiously against the Commission’s proposals since they first surfaced in April. The market, strangely perhaps, reacted with barely in shrug in the direction of airline shares. While you might put this down to a feeling that valuations are so bombed out that another bit of bad news isn’t going to much any real difference, it is also acknowledging the reality that the Commission’s proposals must pass some very big hurdles before they can become law.

There is no doubt that the EU’s proposals are far broader and much more ambitious in scope than those set out by the UK. For instance, it targets a 55 per cent reduction in carbon emissions by 2030. To put that into context, with all current environmental legislation in place, carbon emissions are down by an aggregate 23 per cent in the EU since 1990.

The EU’s decision-making process is going to have a huge impact on what kind of legislation is eventually passed. For measures like a tax on aviation fuel, or entry taxes for construction staples like cement or steel, agreement must be reached with all 27 members of the EU as the bloc has no legal tax imposing power of its own. Here lies the sticking point.

 

Very cross borders

Over the past decade or so, countries like Germany have effectively exported their carbon-intensive industries to Eastern European economies via foreign direct investment initiatives, with the infrastructure to make this possible paid for by the EU’s €600bn structural fund.

The advantages of this were twofold. To begin with, German companies benefited from having a large pool of highly competent skilled workers who earned on average about half of their German counterparts. For instance, Poland receives about a fifth of its foreign direct investment from its neighbour and management consultancy McKinsey reckons that subsequent economic growth has raised purchasing power parity to around 70 per cent of the German average. On an environmental level, Germans didn’t have to put up anymore with belching smokestacks spoiling the view from their BMWs.

While that growth has been great for shipyard workers in Gdansk, or more pertinently vast new Amazon (US:AMZN) and Ikea logistics hubs next to the main A2 motorway to the Federal Republic, the new-found concentration cost of carbon-intensive industries means de-carbonisation taxes would fall disproportionately on those countries within the EU whose citizens are least able to afford it. Poland would not be alone in feeling aggrieved. Hungary, a perennial troublemaker in the EU’s eyes, the Czech Republic, Romania, and others would have serious issues with the proposals as they stand.

In summary, investors can be forgiven the world-weary view that, like so many plans with long timelines and plenty of scope for disagreement, they’ll believe it when they see it.