August 2020

Trends and Resources

Business Trends: The impact of a carbon tax on the European chemical industry

Over the past several years, greenhouses gas (GHG) emissions have become a pressing global issue.

Saxton, D., FaÍsca, N., Nexant Energy and Chemicals Advisory

Over the past several years, greenhouses gas (GHG) emissions have become a pressing global issue. Europe is leading global efforts to become climate-neutral by 2050 but may do so at the expense of its chemical industry.

Private and public stakeholders are in pursuit of how carbon-related price signals can drive global emissions reduction. A wide range of approaches and paths allows governments, businesses and institutions to select the method best suited to the broader policy environment, although the most common policies are emissions trading schemes and carbon taxation. It is a divisive subject within the European industry, given that poorly implemented legislation harms the competitiveness of local manufacturing assets. The challenges for CO2 pricing include:

  • Carbon leakage
  • Policy overlap or inconsistency
  • Ineffective use of revenues
  • Baseline for emissions.

The European chemical industry could benefit from a carbon tax on traded goods—the most transparent mechanism is to implement a tax per ton of traded chemical. Carbon emissions can be estimated per ton of product and the price on emissions set by the cost of capturing 1 metric t of carbon dioxide (CO2).

Imported goods would be taxed at the EU border based on the estimated volume of emissions per ton of goods sold at the port of origin (e.g., fuel mix and best available technology). Individual European producers are not responsible for reducing emissions upstream of their feedstock if it is produced in Europe, as the value chain would be taxed twice. They are also not responsible for emissions downstream of their product. However, importers should be accountable for their upstream procurement value chain and taxed on a well-to-product basis to ensure both European and non-European producers are treated on the same basis.

Using methylene diphenyl isocyanate (MDI) as an example, the introduction of a CO2 tax would increase regional MDI prices (FIG. 1). However, it would penalize producers differently and effectively increase the competitiveness of European assets. Note: Freight and logistics are marginal contributions to total CO2 emissions (FIG. 2).

FIG. 1. Delivered cost ($/t) of MDI to Rotterdam, Netherlands, 2019.
FIG. 2. Delivered CO2 equivalent emissions (1 metric t CO2 equivalent per ton of MDI) to Rotterdam, Netherlands, 2019.

This scenario represents the EU 2050 target of carbon neutrality (i.e., 100% of carbon emissions are taxed).

Emissions trading system (ETS) pricing

Under the European ETS, each installation can trade credits below an overall system cap depending if they need to emit more or can emit less. The price is essentially the value of reducing carbon emissions to producers based on the availability of carbon credits on the market and their own emissions reduction. The cap is central to setting the price, as it influences the availability of credits.

Given there is an agreed price, the cap may be used to combat carbon leakage by including importers. If importers are allowed access to the EU ETS and operate under this cap-and-trade system as part of an EU carbon border tax, there may be several issues in its implementation. The main problem is that it may raise non-discrimination rules under the World Trade Organization’s General Agreement on Tariffs and Trade (GATT).

From a price viewpoint, the cost of capturing 1 metric t of CO2 is $130 in Western Europe. If a dedicated capture company sells carbon credits, they would receive $25/t from an emitter (February 2020 price) and would be bankrupt by the end of the month. The system only allows for tree planters!

Cost-based approach to pricing

The authors propose that CO2 has a floor price at the cost of capturing it at sufficiently high purity as:

  • It introduces a cost basis to the pricing of CO2
  • It can act as a reference for carbon pricing efforts by governments and influence their budget spending on capture initiatives
  • It could incentivize dedicated carbon capture by companies.

The cost of carbon capture includes variable costs, fixed costs, depreciation on the newly built capture plant and an adjustment to account for the CO2 released by the utilities used to capture the CO2 (FIG. 3). The EU ETS would not accept this price floor, as the system is not on a cost basis.

FIG. 3. Cost of carbon capture in Western Europe, 2019. Cost is based on $/t of captured CO2 (technology: amine absorption).

The development of new markets for CO2 needs an initial incentive—i.e., CO2 has to be priced on a cost-plus-return basis. This ensures the focus is both on the reduction of emissions and the development of cheaper technologies to recover CO2.

European competitiveness

As European utilities are generally cleaner, producers in Europe are more competitive under the proposed CO2 taxation scenario.

European MDI producers—buying benzene on the market—enjoyed better margins than global competitors on the product delivered to Rotterdam in 2019. The introduction of the carbon tax would increase this advantage.

Taxing importers on their well-to-product emissions ensures an equal playing field for all involved. It prevents leakage of transformation steps, and potentially relocation of higher CO2 emissions assets, to outside the EU—i.e., the feedstock-to-product tax would incentivize producers to relocate upstream assets outside the EU and export the last transformation step).

The tax is likely to promote the consolidation of integrated value chains in Europe—as exemplified for the polyurethane value chain. However, care must be taken not to penalize importers that:

  • Use EU suppliers, as the CO2 is taxed for the EU supplier and also the importer
  • Reduce their utility footprint, as the importer’s upstream emissions are still a major contribution. An example of this case is BASF’s new polypropylene unit in Mundra, India.

In these cases, exceptions (waivers or rebates) should be considered to ensure importers are not unfairly treated.

Are consumers ready?

The authors have analyzed the effect of a carbon tax on the price of rigid polyurethane (PUR) foam panelling typically used as an insulation material in construction. Rigid PUR foam is produced by the reaction of MDI with polyols and includes various additives.

PUR rigid panels cost $9–$10, and the carbon tax would add $1.30/panel (FIG. 4). The increase is significant—above 85% of average annual inflation—and it is anticipated to stress the PUR value chain further. However, genuinely disruptive technologies and companies with advantageous CO2 footprints will be able to seize the opportunity.

FIG. 4. Price increase of PUR rigid foam panelling in Western Europe by 2030.

The analysis assumes that MDI is sourced from Western Europe to assess the impact of MDI taxation on the PUR panelling price in Western Europe. A future carbon tax would also impact other ingredients in PU formulations; however, in this analysis, only a carbon tax on MDI was considered. Moreover, the authors are assuming that European producers are operating with the minimum profit margin and are passing all additional costs to the end user.


The authors believe that a carbon tax is necessary to incentivize the reduction of GHG emissions in Europe and indirectly in exporting markets. If implemented correctly, it could benefit the cost competitiveness of the European chemical industry.

The most transparent mechanism is to tax products based on the ratio of tons of CO2/t of delivered goods. The pricing mechanism for CO2 should consider the price of capture using best available technologies. It has the merits of incentivizing the reduction of emissions (i.e., volumes) and also the development of better CO2 capture technologies.

Consumers have the final say. The commitment to the Paris agreement to address the roots of global warming, such as GHG reduction, needs an initial financial incentive to disrupt the status quo of the manufacturing industry and consumption patterns. HP

The Authors

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