Government to heavily tax the biggest construction, chemical factories, oil refineries and fossil fuel producers

New Hungarian tax will also affect the functioning of the ETS

To understand how much of a burden the new Hungarian carbon tax and the new transaction fee are, it is worth knowing how the ETS works.

Facilities that emit significant amounts of carbon dioxide or pollutants from their operations are covered by the so-called ETS rules, the European Union's emissions trading scheme, which regulates and encourages these companies to operate greener. They can do this by using carbon credits, known as EU allowances (EUAs), which are the equivalent of the right to emit 1 tonne of carbon dioxide equivalent (CO2e) per year. The EU makes available a certain number of free allowances (the number of free allowances decreases each year) to countries, industries and production companies, based on different average calculations. However, if the number of allowances cannot cover the actual emissions of companies (or there is a surplus of allowances), companies are free to trade allowances either on the spot market or on the futures or options market.

The price of these quotas has already reached the €100 level (per tonne of carbon dioxide equivalent) this spring.

In simple terms, large carbon emitters get a certain amount of "free" pollution quotas from the EU, and if they pollute more than that, they have to buy more per tonne. In order for large thermal power plants, cement factories, etc. to gradually switch to green operation, the EU is reducing the total amount available in the system each year, as well as the number of free emission quotas.

New Hungarian intervention will tax the biggest emitters heavily

The new taxes, published on 17 July, apply to medium and large emitters covered by the ETS who emit more than 10,000 tonnes of CO2 per year and who receive a significant free allocation (the regulation defines them as "having received a free allocation of allowances equal to at least 50% of their average total verified carbon dioxide emissions over the previous three years").

Two new taxes will now be levied on some emitters,

• a carbon tax of €40 per tonne of CO2,
• and a 10% transaction tax on the transfer of free allowances.

We asked Bernadette Papp, senior analyst at Pact Capital, about the scope of the tax, among other things: "The measure affects medium and large polluters (with emissions above 10,000 tonnes of CO2 per year), which will also receive a significant free allocation. The measure could have two objectives: on the one hand, to provide a real incentive for these companies to lower their emissions - although this would be a task for the EU ETS alone - and on the other hand, to generate significant additional revenue for the budget.

The companies involved are active in different sectors. Electricity generators will not have to pay the new charges, as under Directive 2003/87/EC of the European Parliament and of the Council they will not be eligible for free allocation and will have to buy all their allowances on the market to cover their emissions.

However, in addition to them, large emitters in the cement, glass, ceramics, fertiliser, steel, brickworks, sugar and spirits, oil refining, chemicals and some thermal power/ district heating companies are also affected,

the expert said.

She added that, according to the European Commission's official figures, there are 45 plants and factories in Hungary that had emissions above 10,000 tonnes in 2022 and received significant free allocations.

There will be exceptions

As mentioned above, electricity producers are not covered by the regulation as they are not eligible for free allocation. Moreover, even if a large emitter is in liquidation, it will not be subject to the new tax. It is also worth mentioning the usual lobbying activities of large companies, which tend to occur after more drastic market interventions - not only in Hungary but all over the world - and which often lead to the regulator making mitigating additions, new exemptions. (But this will only become clear in a possible future amendment to the regulation.)

The regulation also provides for a 50% reduction of the tax base, Bernadett Papp said, adding that it will be available to installations that

have not substantially reduced their capacity or production (i.e. are not profiting from free emissions), based on their verified annual emissions report,

and whose carbon dioxide emissions per unit of output have decreased by an amount equal to the current linear reduction factor of the EU ETS. The linear reduction factor is 2.2% in 2023, but will jump to 4.3% next year. The question is which companies can achieve this reduction.

What do the transaction fee and quota tax mean in practice?

"Compared to bank transaction fees, the 10% transaction fee on transfers is high. But when you add the €40 tax, we are talking about a very significant amount. The majority of facilities are net buyers in the long term, as they can meet their compliance obligations with these units. Most of them already find the current quota price of close to €90 high, as the past years (Covid, energy crisis, inflation, high interest rates) have made it difficult for them to operate. As they are likely to need the allowances in the future, sales are usually only made in case of urgent liquidity needs. Over-allocation, i.e. a facility getting more units for free than it needs, is not common," the expert said.

Asked whether the new tax would encourage emitters to make green investments, Bernadett Papp said, "The measure would encourage companies to reduce their emissions if they had the resources to introduce modern technologies that would allow them to reduce their emissions in the long term or if there were meaningful public funds and tenders available for such investments.

However, the companies we interviewed reported that they will not be able to invest in the light of the new measure, and some of them may even face the risk of production being halted,

the senior analyst said, and asked whether other countries have such an additional burden on industrial companies, she said:

"The declared aim of the EU emissions trading scheme is to provide a price signal to the market and to companies with compliance obligations that will give them sufficient incentive to reduce their emissions. If the exchange rate is lower than the cost of introducing new technologies, companies will buy allowances and continue to pollute. If the cost of compliance is higher than the need to invest, firms will choose to modernise. After the 2008-2009 crisis, the exchange rate for allowances was for a long time below €10 (one allowance is equivalent to one tonne of carbon dioxide emissions), so firms were not motivated to reduce their emissions. During this period, some EU countries imposed extra taxes on polluters, but these remained well below €40 per tonne.

However, thanks to reforms introduced in the second half of the decade, the price of quotas has risen dramatically and this spring they were trading at €100. The sudden rise in the price of allowances is of course a heavy burden on companies, and the Commission must also monitor when the price reaches a level that threatens to put companies out of business or cause them to go bankrupt or relocate production to a third country where they do not have to pay for their emissions. Industrial installations receive free allocations to avoid the latter risk of relocation, and a mechanism to offset the carbon intensity of imported goods will soon be introduced, which in principle protects industrial installations within the EU, but will gradually phase out free quotas.

Thanks to the now higher quota prices, it is not typical for member states to impose extra burdens on EU ETS installations. "In recent years, it has been more common to tax emissions from sectors not covered by the Emissions Trading Directive (e.g. land transport and heating of buildings in Germany and Austria) at a national level," said Bernadett Papp.

Unit prices have risen sharply since 2018

The average price of the benchmark product, the 2023 carbon quota, is €89.10, but this spring the exchange rate has already been trading at the €100 level. The transaction fee of €40 +10% is therefore significant.

What impact could the two new financial liability items have on the Hungarian market?

Papp Bernadett elmondta, hogy legtöbb megfelelési kötelezettséggel rendelkező vállalatot meglepetésként érte a bejelentés, és nem tudtak felkészülni rá. A tavalyi kibocsátásuknak megfelelő kvótamennyiséget április végéig leadták. Akinek maradt többlete, az lehet, hogy értékesítette azt a piacon, bár az általános gyakorlat inkább az, hogy nem elegendő az ingyenes kiosztás és a hiányt a piacon kell megvásárolniuk a cégeknek. Ha a hiány nem jelentős, ezt megtehetik a leadási határidő előtt is, ha azonban sok egységgel kell kipótolni az ingyenes kiosztást, akkor a cégek év közben folyamatosan vásárolnak. Az említett árfolyamemelkedés miatt már a megfelelés is súlyos kihívások elé állította a cégeket. Az új terhek miatt elképzelhető, hogy néhány vállalat inkább csökkenti, másik országba helyezi vagy felszámolja tevékenységét.

Bernadett Papp said that most companies with compliance obligations were caught by surprise and could not prepare for the announcement. They had surrendered their quota equivalent to last year's emissions by the end of April. Those with surpluses may have sold them on the market, although the general practice is that free allocation is not enough and companies have to buy the shortfall on the market. If the shortfall is not significant, they may do so before the delivery deadline, but if there are many units to make up for the free allocation, firms will buy continuously throughout the year. Even compliance has been a major challenge for firms due to the aforementioned exchange rate hike. The new burdens may lead some companies to cut back, relocate to another country or liquidate.

From this point of view, it does indeed seem that those who have invested and adopted environmentally friendly technology and thus reduced their emissions have done well.

If this regulation is now in force, the question arises as to whether the tax can be paid into the treasury from next year or even earlier. The transaction fee must be paid within 30 days of receipt of the decree by the operator of the installation into the payment account of the administration of the Ministry of Energy at the Hungarian State Treasury.

"As we understand it, taxpayers will already have to pay tax advances on their free distributions and transactions this year, as the regulation refers to the tax year starting 31 December 2022 and requires taxpayers to assess, declare and pay tax advances for the first, second and third quarters of the 2023 tax year by the 15th day of the second month following the third quarter," Bernadett Papp said.

"The 2023 free quotas were received by companies in the last few months, so the €40/quota will be paid in November. The 10% is due when a transaction has taken place," the expert added.

Cover photo: Péter Zelei via Getty Images