Could The SEC Climate Rule Help Carbon Taxation?

Things have been quiet at ExxonMobil Corp. ever since activist investor Engine No. 1 unexpectedly snatched a quarter of the company’s board seats last June in a strong rebuke of the company’s climate strategy.

Engine No. 1 was able to stage a coup because ExxonMobil’s shareholders were fed up — no small feat in an industry in which several oil giants have been repeatedly accused of obstructing climate change policies and lobbying against anti-climate-change legislation.

But ExxonMobil stood out for its long-time failure to embrace a net-zero-emissions strategy, unlike its peers. There were repercussions: In 2020 the company, for the first time in nearly 100 years, was removed from the Dow Jones Industrial Average. ExxonMobil’s total shareholder return was tanking.

Even though Engine No. 1 managed to green up ExxonMobil’s board, it was clear from the start that it would take some time to clean house. Just three months after Engine No. 1’s board rout, the Climate Leadership Council — a consortium of oil giants, lawmakers, and economists who support a U.S. graduated carbon tax and a border carbon adjustment — suspended ExxonMobil from the group after an embarrassing climate-related lobbying scandal.

It turned out that an undercover Greenpeace activist had secretly recorded a then-ExxonMobil lobbyist saying that the company, which for years has backed a U.S. carbon tax, only supported a tax because it felt the measure would never gain enough political support to become law.

Darren Woods, ExxonMobil’s CEO, immediately apologized and maintained that the company understands the challenges presented by climate change and is actively trying to reduce its emissions. But talk is cheap, and there was a lot of pressure on ExxonMobil to formally pledge to zero out its net carbon emissions, keeping in line with the Paris Climate Agreement. That agreement aims to keep global warming below an average of 2 degrees Celsius this century. It has been ratified by nearly 190 countries, all promising to zero out their carbon emissions by 2050.

The company had long maintained that it “respects and supports society’s ambition to achieve net zero emissions by 2050” but kept quiet on whether it would do the same — a major sticking point for Engine No. 1 and other shareholders. In the months since the lobbyist controversy, ExxonMobil has made a sharp about-face and in January pledged to reach net zero by 2050.

In the face of dire climate change projections — the U.N. says the window to halt catastrophic global warming is rapidly closing — we should expect the unexpected.

Recently, another unexpected climate-related development came from the SEC, which in late March issued its first-ever set of proposed rules mandating public companies to report their greenhouse gas emissions and other standardized climate change disclosures.

This proposal, the so-called SEC climate disclosure rule, is now open for public comment and if it is finalized, could provide key transparency for regulators in the United States and abroad on carbon pricing and carbon taxation, a form of carbon pricing. As more countries contemplate both, there is growing discussion about international coordination and what that could look like, especially because carbon prices vary widely around the world.

SEC Climate Disclosure Rule

March’s SEC climate disclosure rule seemingly came out of nowhere, but in fact it was quietly years in the making. The SEC already has a set of guidance for companies interested in voluntarily making climate-related disclosures, but it’s not the only game in town.

Companies have several models to rely on: Corporate sustainability reporting standards like the Global Reporting Initiative, the Task Force on Climate-Related Financial Disclosures, and the Carbon Disclosure Project all provide climate disclosure templates.

However, the information companies are disclosing is not standardized and that’s becoming increasingly problematic as climate disclosures increase in popularity. A recent SEC review of nearly 7,000 annual reports submitted in 2019 and 2020 found that a third included some sort of climate change disclosure.

The SEC’s proposed climate disclosure rule would require public companies to disclose climate-related risks that are reasonably likely to have a material impact on their business, operational results, or financial condition.

“Material impact” information is information with which “there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment or voting decision, or information that would have “significantly altered the total mix of information made available” (Basic Inc. v. Levinson, 485 U.S. 224, 231-232 (1988)).

As an overview, the SEC wants companies to disclose climate-related information in their registration statements, Form 10-K in the case of domestic companies, Form 20-F in the case of foreign filers, and other periodic reports. The information would include:

• climate-related risks and their actual or likely material impacts on the registrant’s business, strategy, and outlook;
• governance of climate-related risks and relevant risk management processes;
• level of greenhouse gas emissions (disclosures made by accelerated and large accelerated filers on some emissions would be subject to assurance);
• some climate-related financial statement metrics and related disclosures in a note to the company’s audited financial statements; and
• information about climate-related targets and goals, and transition plan, if any.

The proposed rule is a staggering 490 pages; some companies are already rumbling about potential compliance costs. Meanwhile, the turnaround time is rather short: The largest filers would start filing in 2024, while smaller ones would start in 2026.

An important part of the proposal is that companies that calculate an internal carbon price would be obligated to disclose their internal carbon pricing and how that pricing was set. An internal carbon price, under the SEC’s proposed rules, is defined as “an estimated cost of carbon emissions used internally within an organization.”

Companies deploy internal carbon pricing for a myriad of reasons. In some cases, they use carbon pricing to identify climate-related risks and opportunities.

They also use carbon pricing to identify areas in which they can generate energy efficiencies and reduce costs. Internal carbon pricing is also useful for making capital investment decisions and forecasting a company’s potential costs if a broader governmental carbon price is implemented, the SEC notes.

Given these uses, the SEC regards internal carbon pricing as “a key data point” for assessing how well a company is managing climate risks and planning for future ones. Under the proposed rules, companies using internal carbon prices would have to disclose:

• the price per metric ton of carbon dioxide equivalent, issued in the company’s reporting currency;
• the total price, including how it is estimated to change over time, if applicable;
• the boundaries for measurement of overall carbon dioxide equivalent on which the total price is based; and
• the rationale for selecting the internal carbon price applied.

Companies that use more than one internal carbon price would have to disclose each and explain their reasons for using different prices. These disclosures would provide important data in the rather opaque area of internal carbon pricing.

One foundational question is whether the internal carbon pricing thresholds that companies are setting are accurate. There is no formal global standard for carbon pricing. Consulting firm McKinsey & Co. investigated this question and found that internal prices diverge greatly, because companies are picking values that make sense for their industries or geographic regions.

In Europe the median internal carbon price is $27 per metric ton, and in Asia it’s substantially lower at $18 per metric ton. Globally, on average, companies’ internal pricing hovers around $40 per metric ton, according to McKinsey & Co. The problem is that these carbon pricing values are generally too low.

The High-Level Commission on Carbon Prices — a collective of academics, corporate leaders from companies including Rio Tinto and Bank of America Corp., and politicians like former Mexican President Felipe Calderón — has estimated that companies should have been setting internal carbon pricing between $40 and $80 per metric ton back in 2020 and will need to increase that to $50 and $100 per metric ton by 2030 to reduce emissions in line with the Paris Agreement.

In the face of this finding, the internal carbon pricing metric contemplated by the SEC could provide valuable data not just for investors, but also for the broader climate change fight and for governments considering carbon pricing and taxation and how to multilaterally coordinate that pricing.

The International Argument

The world lacks a global carbon price floor. The IMF thinks we need one. In its April 2022 Fiscal Monitor, the IMF dedicated a considerable number of pages to carbon pricing and taxation, calling it one of the most important areas in international tax coordination and a requirement for fighting climate change.

The report makes it clear that the world needs some form of international cooperation on carbon pricing and needs the largest emitting countries to multilaterally commit to carbon taxation or other regulation to truly make an impact in reducing emissions.

Meanwhile, unilateral attempts to impose carbon pricing could backfire, because countries with high carbon prices could unwittingly incentivize emitters to move to “cheaper” countries and disadvantage their domestic producers, according to the IMF.

If governments establish a carbon price floor for large-scale emitters via a minimum carbon tax — with the understanding that governments can tax higher than the floor — the world could see emissions fall nearly a third by 2030, the IMF estimates. That would keep global warming below 2 degrees Celsius, in line with the Paris Climate Agreement.

The IMF favors a carbon price floor for several reasons. One, a carbon price floor can integrate with existing emissions trading systems. Two, we’re in an era in which international taxing floors are gaining momentum — the IMF points to the OECD’s 15 percent minimum corporate tax rate under pillar 2 as an example.

That said, there’s still a risk, even with a carbon price floor, that companies could shift investment away from countries with higher prices to those with lower ones. If the ultimate result of a carbon price floor is a race to the minimum, governments would have to ensure that the global minimum is adequate to reduce emissions in line with the Paris Agreement.

Three, the flexibility of carbon pricing means that a different set of requirements could apply to developing countries based on their level of economic development and their level of emissions.

One idea the IMF does not favor: unilateral border carbon adjustments, which it says wouldn’t make a substantial dent in lowering emissions because emissions in traded products are typically well below 10 percent of countries’ total emissions.

Carbon Pricing Proposals

The SEC’s proposed rules don’t mandate a specific carbon pricing method — they can’t go that far because internal carbon pricing is still an evolving area. The SEC notes that many companies may not track that information and that it may not be possible for some to develop pricing in the absence of an active carbon market.

This could change. During the notice and comment period, the SEC has asked stakeholders to weigh in on whether it should require companies to disclose their internal carbon pricing, their method for calculating it, and how they use that information. The SEC wants to know if the disclosures could hurt companies’ competitiveness and whether the information would be material for investors.

If the SEC internal carbon pricing proposal is kept in the final rule, it could bolster several legislative proposals to implement carbon taxation in the United States, where there is no federal carbon price. That puts the United States behind several of its peers, some of which are updating or implementing their own national carbon pricing programs.

In the United States, the Biden administration’s Build Back Better infrastructure bill, which passed the House and languished in the Senate, contained several climate provisions but did not include a carbon tax. That was a missed opportunity, according to the Committee for a Responsible Federal Budget.

A carbon tax between $20 and $40 per metric ton that is indexed to grow 1 to 5 percent faster than inflation annually would raise between $650 billion and $1.55 trillion over ten years and reduce greenhouse gas emissions up to 21 percent by 2030, according to a recent Committee for a Responsible Federal Budget report.

Private industry is lobbying for a U.S. carbon tax within similar parameters. The American Petroleum Institute, which supports carbon pricing, recently drafted a carbon tax proposal of $35 to $50 per ton on emitters like gasoline wholesalers and power plants, according to The Wall Street Journal.

The Climate Leadership Council, which suspended ExxonMobil, has its own proposal for a $40-per-ton carbon tax that would increase by 2 to 5 percent annually, reaching $65 per ton by 2030. But that idea has not yet been translated into legislation.

Meanwhile, data on internal carbon pricing could breathe new life into a stalled 2021 House bill, the Energy Innovation and Carbon Dividend Act (H.R. 2307), which would introduce a carbon tax at a much lower rate of $15 per metric ton, but grow it by $10 each year to $115 per metric ton by 2030.

The wide range of proposals in the United States, from $20 per metric ton up to $115 per metric ton, is not too dissimilar from the wide range of carbon prices around the world.

Canada, which has a C $50-per-metric-ton carbon tax, plans to increase its federal carbon price to C $170 per metric ton by 2030 — considerably higher than other countries, which generally hover around the $20 to $50 range.

In Austria the government is preparing to implement a new carbon tax that will start at €30 per ton and increase to €55 per ton by 2025. The measure will go live on July 1.

Meanwhile, South Africa, which has faced criticism that its carbon tax is too low, on January 1 increased its carbon tax rate from ZAR 120 (about $7.58) per ton to ZAR 144 per ton.

Denmark is also moving quickly on a planned broad-based carbon tax that would help the country reduce its greenhouse gas emissions by 2030. The tax would work in tandem with the EU’s emissions trading system, and companies covered by the system would pay DKK 375 (about $54) per metric ton of carbon dioxide, and companies outside of the system would pay DKK 750 per metric ton of carbon dioxide. The government is negotiating the provisions.