Despite not even being implemented yet, the new carbon border adjustment mechanism is having an impact globally
EXPORT INCENTIVES
Some carbon-intensive industries bemoan a lack of support for European exports that reduced their environmental impact
GLOBAL INTEGRATION
Different markets have taken different approaches in response to the EU’s border tax plans
KEY QUOTE
This is the first time anyone, anywhere has attempted to do carbon border taxation on this scale and teething problems are inevitable
When the European Union agreed on a net-zero emissions target for 2050 and began work on its Green Deal, it was clear that to get industry on board, its concerns would need to be addressed.
One of its major worries is the phenomenon known as carbon leakage, which could see manufacturers shut up shop within the EU in order to escape regulatory oversight and relocate to a country where emissions standards are less financially punishing.
New regulations that force up the carbon price set by the bloc’s emissions trading system (ETS), coupled with cheaper imports produced in countries with fewer green standards, means there is a risk that energy-intensive industries such as steelmakers, aluminium smelters and alike could decide to relocate to save on costs.
This is where the carbon border adjustment mechanism (CBAM) comes in. It will impose charges linked to sustainability standards on imports, specifically cement, iron and steel, aluminium, fertilisers, electricity, hydrogen and certain precursors.
The CBAM charges will be tagged to the carbon price of the ETS, meaning that non-EU industries looking to do business within the bloc will be subject to the same “polluter pays” principle. It is essentially intended to level the playing field and make things fairer.
After months of wrangling and a delay while separate negotiations dealt with a full reform of the ETS itself, EU negotiators signed off on a CBAM agreement in December 2022, paving the way for it to start taking effect in October 2023.
MORE TO COME
But that final deal is by no means the end of the road for CBAM, as plenty of extra details still need to be worked out by the EU’s executive branch, the European Commission.
In mid-June 2023, the Commission opened a consultation on rules that will govern how importers report goods that will be covered by CBAM, as well as a draft methodology for calculating their embedded emissions.
“During the transitional period, the Commission will also publish calls for feedback on the 13 other pieces of secondary legislation, implementing and delegated acts, to be put in place before CBAM becomes operational in its definitive phase on January 1st, 2026,” a Commission spokesperson explains.
CBAM’s transition phase begins on October 1st, 2023. During this two-year period, affected importers will have to monitor, report and verify the emissions of their products. No charges will actually be levied at this stage. This “soft opening” will run to 2026 when CBAM phase two begins and actual charges are issued. The idea is to give sectors enough time to adapt to this new trade reality and also for the system to be given a full shakedown.
This is, after all, the first time anyone, anywhere has attempted to do carbon border taxation on this scale and teething problems are inevitable.
GETTING READY
Potential banana skins include the nitty-gritty details that are still yet to be finalised by those 13 pieces of follow-up rules still to be decided by the European Commission. This includes setting the methodology to calculate the emissions embedded in goods, which will vary between sectors; what default averages should be allocated to different industries; how carbon pricing in other countries should be considered; and what kind of penalties will be distributed for non-compliance.
Aaron Cosbey from the International Institute for Sustainable Development, a think tank, says there is a mountain of work to be done before 2026 when CBAM is fully operational but that some decisions need to be made quicker than others.
“Reporting starts in October, so the draft implementing regulation on reporting obligations is a big piece of it. Also, we need to have the EU’s published default values, to be used in reporting embedded indirect emissions, so from electricity inputs and default values for input goods,” Cosbey explains.
A delegated act that sets the conditions for accrediting verifiers, who will certify emissions data, is also required, Cosbey adds. “All the other details are important, but not critical for the commencement of the reporting period,” he says.
PRICE DIFFERENCES
One of the many complex issues that will need to be addressed before 2026 is how to calculate charges when the importing country already prices carbon. Systems vary so a general set of criteria will have to be established.
For the likes of Switzerland and the United Kingdom, whose carbon markets are either linked or replicate the EU system, there are likely to be no charges, as emissions will already be priced in. But other countries use different instruments like offsets, taxes and varying forms of emissions trading to price carbon, with different sector coverage and free allowances all used to different degrees.
China’s ETS uses emissions intensity and its carbon price is still relatively low, while Australia’s new Safeguard Mechanism deals in carbon credits, so it is difficult to compare them to the EU’s scheme.
When the United States unveiled its Inflation Reduction Act (IRA) earlier this year and its hundreds of billions of dollars in subsidies available for climate measures, tax analysts were quick to suggest that the EU would perhaps factor the act into its CBAM calculations.
However, Cosbey suggests that this will not be the case. “There very likely will be no accommodation for the IRA, which is basically subsidies for heavy industry, as opposed to imposing costs on them,” he says.
CHINA ADAPTATION
China’s government has softened its stance on the CBAM, urging trade partners to explore multilateral solutions to climate challenges instead
UNSATISFIED INDUSTRY
Policies that prevent carbon leakage have been one of European industry’s biggest asks in recent years, as climate and energy legislation kicks in and the financial cost of decarbonisation begins to bite. EU-based sectors largely welcomed plans to implement CBAM as an attempt to level the green playing field. However, there are aspects of the final agreement that have left some players far from totally satisfied with what is to come.
The cement sector emits about 8% of global CO2 emissions and alone would rank third behind China and the United States if it were a country. Efforts to decarbonise through electrification, material substitution and carbon capture are all in the pipeline but extra incentives are still needed.
Over the last six years, cement imports to the EU have climbed from 2.5 million tonnes to more than 10 million tonnes, as the increasing carbon price has made life more difficult for Europe’s domestic industry.
Emmanuel Brutin, at the European Cement Association, a trade body, insists that the CBAM is a step in the right direction by the EU but that the “proof will be in the pudding” once it is implemented. “We must make sure that CBAM is water-tight,” Brutin insists, adding, “[there] will be a degree of novelty” for all sectors involved but that issues like reporting and verification are not new concepts for the cement industry at least.
EXPORT SUPPORT
One aspect of the CBAM agreement that disappointed the industrial sector was the lack of export solutions that would provide an incentive for EU-based industries to export their greener wares to the rest of the world.
The Commission held off from proposing a form of rebate or subsidy scheme because it could fall foul of World Trade Organisation (WTO) principles, which was already a major concern for the EU when the new policy was being designed.
A review is planned in 2025 to address the issue but will only take into account the data collected from October 2023. It will also only conclude after the CBAM implementation is in full swing in 2026. “We will be calling on the next European Commission to reassess its position and propose a suitable solution,” says Jasmine Barahman at Fertilisers Europe, which represents another sector that will fall under the new system’s scope. European elections will be held in 2024.
“By not having a mechanism to protect exports, a significant part of fertiliser production in Europe is very likely to become uncompetitive,” Barahman warns, adding there might also be environmental impacts, as low-carbon European exports are replaced by cheaper, higher-emission goods.
What form that support would take is still very much an open question, although Brutin suggests that ETS revenues, which are set to increase the more the carbon price goes up, should be funnelled towards helping exporters.
BORDER CHECKS
The CBAM itself will generate billions of euros in revenue once fully up and running but the idea of using those profits to support EU exporters would likely be a step too far for the WTO, as it arguably veers into unacceptable trade practices.
Sectors covered by the CBAM are also wary about how imports will be vetted by customs authorities, who will be responsible for checking that goods are as green as their importers claim them to be. It will be an easier task for some wares than others.
The emissions intensity of cement, for instance, is largely dictated by the mix of ingredients used to produce it but because the final product is invariably a grey material no matter how “green” it is, it will be difficult to check its environmental credentials. Unscrupulous importers may successfully claim that dirty cement is cleaner than it actually is if customs officials are not provided with the resources needed to thoroughly vet the wares.
It may also end up being a matter of priorities, as border authorities may see more merit in trying to stop drugs and other more harmful items rather than checking to see if cement shipment paperwork is legitimate.
GLOBAL IMPACT
Part of the CBAM’s raison d’etre is to inspire increased climate ambition in areas of the world beyond the EU’s regulatory jurisdiction, by essentially convincing trading partners that it is cheaper to go green than pay the border tax charges.
Countries that are exposed to CBAM’s scope generally fall into two groups. The first opposes the policy outright and insists that it is in breach of World Trade Organisation principles. The likes of Indonesia, Russia and South Africa have threatened legal action.
The second group includes countries that have already started planning for life with CBAM, by starting consultations or informal discussions about setting up their own versions of the policy. Canada, South Korea, the UK and the United States are among those to have seriously considered the merits of carbon border taxation, although none have decided to implement a CBAM of its own as yet.
Much like the EU’s ETS carbon market, which took a number of years to set up and start pricing emissions effectively, countries may be waiting to see how CBAM pays off before jumping on the bandwagon.
According to a spokesperson for the Canadian government’s global affairs department, “Canada believes the CBAM should be implemented in a manner consistent with the EU’s international trade obligations and that its implementation should not be more burdensome to trade than necessary.”
The Canadian government is also evaluating the draft EU legislation that has been published, as well as giving further consideration to deploying its own system after a consultation period closed in early 2022.
India, which according to Chatham House’s trade data portal is among the top ten countries that will be exposed to the CBAM, is also contemplating how best to react to the EU’s policy. About 4% of India’s EU exports, mainly aluminium and steel, could be within its scope. In May 2023, Indian officials asked the EU to exempt its small and medium-sized companies from CBAM charges during a trade and technology council in Brussels. Talks are ongoing.
WHAT ABOUT CHINA?
China was one of CBAM’s earliest and most vocal critics, insisting that the EU would break WTO rules if it is implemented. Chatham House estimates that more than 10% of Chinese exports to the EU would be covered by the new tax. But Beijing has recently softened its stance on the policy and at a WTO meeting in June 2023 held off from directly criticising CBAM, instead urging trading partners to explore multilateral solutions to climate challenges instead.
Yan Qin of Refinitiv, a market analysis firm, suggests that the Chinese government is not overly concerned by CBAM, as its lawmakers have decided that the amount of exports covered by its current scope is acceptable.
“[The] CBAM has already been used by the Chinese authorities as an external driver to put pressure on [its] domestic industry to decarbonise, for example increasing the uptake of green electricity in steel and aluminium production,” Qin explains.
This means that an EU policy that has not even been implemented yet may well be aiding the Chinese authorities in meeting their ambitious targets to peak carbon emissions before 2030 and reach carbon neutrality by 2060.
Indeed, Chinese companies are keen to start living life in a CBAM world as soon as possible and want more information about embedded emissions methodology and accounting rules, according to Qin. “I have observed that exporters are eager to prepare for the CBAM sooner rather than later, despite knowing that it is only starting with reporting obligations now and operational from 2026,” she adds.
As far as the rest of the Southeast Asia region is concerned, the CBAM might well have a wider catalysing effect on climate policies, particularly in countries that have not adopted policies like emissions trading or carbon taxes.
“Given how the CBAM discussions have sped up the construction of China’s national ETS and also the expansion to include CBAM-exposed sectors in the ETS, I am confident that the EU’s CBAM will drive more jurisdictions in Asia to implement stricter carbon pricing schemes,” Qin suggests. “From this perspective, the EU’s CBAM has already fulfilled one of its key objectives,” she adds. •
TEXT Sam Morgan IMAGES Chuttersnap, Nuno Alberto, Unsplash