EU’s Carbon Border Adjustment Mechanism and its Business Implications

On July 14th, 2021, the European Commission adopted a proposal for a new Carbon Border Adjustment Mechanism (“CBAM”) under the EU’s new Green Deal. The CBAM aims to counter the avoidance of EU’s climate targets by outsourcing production to non-EU countries.

In short, when it enters into force, the CBAM applies the already existing EU emission tax to imports.

Some argue that the business impact of such climate policy goes too far, while others argue that the CBAM isn’t enough. This article objectively examines the CBAM, how it works, and its implications for stakeholders on various levels both inside and outside of the EU.

When does it enter into effect?

A pilot version of the CBAM will be implemented starting January 1st, 2023, to facilitate a smooth transition, obtain industry feedback, and determine the reaction of other countries. Under this 2023 pilot, importers will have to record and report the emissions embedded in their imported products. A full version of the CBAM is expected to be in effect in 2026.

How will the CBAM work?

Every year, importers will have to declare the sum of total emissions embedded in their yearly imported products. The importer must then pay the emission tax based on that total emission. However, if the importer can show that a carbon emission tax has already been paid in the country of origin, then the emissions tax amount can be deducted. The US and Canada are also considering adopting domestic carbon border adjustment mechanisms.

What is the CBAM?

The CBAM is a European levy on imports of specific products, covering electricity, cement, aluminum, fertilizer, and iron and steel products[1]. The CBAM addresses the problem of carbon leakage. Carbon leakage occurs when a company transfers its production from a country with strict climate rules to a country with less strict climate rules. CBAM counters this problem by applying the same emission tax that applies inside the EU to these imported products.

With the CBAM, the EU wants to incentivize environmentally sustainable production and the adoption of similar climate policies by outside countries. It further aims to level the playing field between EU-produced products, that are already subject to emission tax, and imports.

How is the emission import tax calculated?

The amount an EU importer will be obligated to pay Is calculated as follows:

Emission Import Tax Burden = Total Carbon Emissions × EU Carbon Price

The financial impact of importing non-sustainably produced goods will be significant. According to a survey by the International Emissions Trading Association (IETA), in 2021, carbon pricing in the EU is expected to average €47.25 per ton between 2021-2025 and €58.62 per ton between 2026-2030[2]. However, the carbon price can reach much higher, as it did in the first half of 2022. EU carbon prices soared from late 2021 to reach a peak of €97 per ton in early February, before dropping below €70 per ton following the Ukraine crisis[3]. In late April this year, Reuters reported that carbon prices are expected to average €85.22 per ton in 2022 and €94.23 per ton in 2023[4]. The Boston Consulting Group (BCG) calculated in 2021 that with an average price of €75 per ton, an average four-door car will have a carbon border tax of €245 for the steel and aluminum used alone[5].

What is the expected impact of the CBAM?

Much is still uncertain regarding the application and impact of CBAM. This will become more clear during the pilot phase of 2023-2026. However, a company currently importing materials into the EU that are produced by carbon-intensive countries like China, Russia, and India may incur cost increases of 15%-30% when CBAM enters into full effect5. This effect will likely increase further in subsequent years with rising carbon emission prices and if the CBAM is extended to more product areas.

As the general cost levels will likely increase, so will the opportunity cost of not opting for green technologies. Subsequently, an increasing number of companies are expected to start considering sustainable and environmentally friendly production technologies and suppliers.

The impact of CBAM will be felt even before 2026 as well. As mentioned, importers will face significant administrative requirements relating to the tracking, recording, and reporting of the embedded carbon emissions in imported products starting in 2023. Importers must find ways to calculate and verify the emissions contained within their products for reporting accurate data to the appropriate authorities. The importer will be liable for failure to do so.

Non-EU producers who export to Europe will also be affected by the CBAM. CBAM’s implementation will put new demands and requirements on non-EU producers, especially regarding sustainable production and accurate tracking of emission data. Non-EU producers who can provide this will gain a competitive advantage over producers who cannot.

Besides importers and non-EU producers, downstream EU producers will also be impacted. Especially in industries that are heavily reliant on steel, such as automotive and construction. Steel production is energy-intensive and a significant carbon emitter as 75% of its energy demand still depends on coal[6]. Industries that rely on steel will experience increased prices, especially when sourced from carbon-intensive countries. EU producers who export their products to non-EU markets may further face competitive price disadvantages if they export to countries that don’t have similar emission taxes in place.

Important factors to keep in mind as a company

Even as the full implementation of CBAM is years away, companies are recommended to execute a self-examination of each product line and its supply chain to determine the company’s emission exposure. Companies need to assess the financial impact CBAM will have on their expected revenue, costs, and financial position.

Companies further need to review their carbon footprint strategy. This means assessing their suppliers, sourcing practices, production materials, processes and methods, logistics, and technology usage. Strategy changes, such as moving or reshaping the supply chain or implementing the usage of new technologies may be required in view of the 2026 implementation of CBAM. 

[1] European Commission. Carbon Border Adjustment Mechanism. Carbon Border Adjustment Mechanism (europa.eu)

[2] Reuters. 2021. Europe carbon prices expected to rise to 2030-industry survey. Europe carbon prices expected to rise to 2030-industry survey | Reuters

[3] The Guardian. 2022. EU carbon permit prices crash after Russian invasion of Ukraine. EU carbon permit prices crash after Russian invasion of Ukraine | Greenhouse gas emissions | The Guardian

[4] Reuters. 2022. Analysts nudge EU carbon price forecasts higher but warn on Ukraine crisis. Analysts nudge EU carbon price forecasts higher but warn on Ukraine risks | Reuters

[5] Boston Consulting Group. 2021. The EU’s Carbon Border Tax Will Redefine Global Value Chains. How the EU Carbon Border Tax Will Redefine Value Chains | BCG

[6] IEA. 2021. Iron and Steel. Iron and Steel – Analysis – IEA

 

 

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