The EU’s Carbon Border Adjustment Mechanism (CBAM), part of the European Green Deal, will encourage greener industrial manufacturing of specific products in non-EU countries by extending its carbon pricing mechanism to imported goods. Placing a tariff on a select group of carbon-intensive imports, CBAM is intended to address ‘carbon leakage’ by ensuring that imported goods are subject to carbon costs comparable to goods produced in the EU.
This disincentivizes companies from relocating carbon-intensive production abroad to countries where less stringent climate policies are in place than in the EU. In doing so, CBAM also aims to ensure the EU’s climate ambitions are not undermined, as carbon leakage merely shifts emissions outside of Europe but does not reduce them globally.
We estimate that CBAM may add, on average, 10% to the cost of applicable commodities entering the EU: iron and steel, cement, aluminum, fertilizers, electricity and hydrogen*. Clearly, this will have major implications for domestic industries importing carbon-intensive commodities into the EU, as well as for those exporting such goods to the EU.
However, by subjecting imports of these commodities to a tariff corresponding to the price of emissions allowances under the EU’s existing Emissions Trading Scheme (EU ETS), CBAM is also designed to prevent the green investments already made by EU manufacturers from becoming a competitive disadvantage, signaling that the EU’s manufacturing sector will not be undercut by imports facing weaker emissions standards.
On the domestic market at least, CBAM should level the playing field between EU-produced goods subject to the ETS and externally produced goods that are not. Whether it will protect EU products from a competitive disadvantage in external markets is another matter. Our concern here is to disentangle the impact of CBAM on European manufacturers, importers and consumers.
With the European Parliament officially adopting CBAM on April 18 and the introduction of CBAM slated for the end of October 2023, this article looks at what companies should be doing to mitigate their risk, the opportunities available for companies to accelerate their decarbonization ambition, and how to collaborate with suppliers to develop lower-emission materials and products.
* This calculation is based on 60€/ton of CO2, 2021 trade data (price and volumes), and the average carbon intensity for CBAM commodities, as provided by sectoral associations.
The initial list of items subject to CBAM include carbon-intensive commodities most at risk of carbon leakage: iron and steel, cement, aluminum, fertilizers, electricity and hydrogen, as well as certain precursors and some downstream products such as screws and bolts and similar articles of iron or steel. The European Commission will assess before the end of the trial period (2026) whether to extend the scope to other goods at risk of carbon leakage, including organic chemicals and polymers, with the goal to include all goods covered by the EU ETS by 2030.
It will cover direct (Scope 1) emissions generated during the production process as well as indirect emissions from input materials (e.g., Iron Ore Pellets (IOP) for steel manufacturing, and clinker for cement production). Scope 2 (electricity purchased) emissions are in the current CBAM scope for cement and fertilizers, but are excluded for iron & steel, aluminum and hydrogen. In total, we estimate GHG emissions covered by the current CBAM commodities to represent approximately 24% of the total corresponding emissions generated by the EU industrial sector.
The first, transitional phase of CBAM is slated to enter into force on October 1, 2023, and will run until 2026. During this phase, importers of goods under the scope of the new mechanism will have to report the Greenhouse Gas (GHG) emissions embedded in their imports without making any financial payments or adjustments.
The questions on most companies’ minds at this point are who will pay, and when? Once the transition phase ends and CBAM enters the compliance phase on 1 January 2026, importers will have to purchase CBAM certificates to pay for the difference between the carbon price in the country of production and in the EU. These costs won’t apply if the importer can prove that the producer has already paid a corresponding price in a non-EU country. The price of the certificates will be calculated according to the weekly average auction price of EU ETS allowances expressed in €/ton of CO2 emitted. The phasing-in of CBAM will take place gradually over the period from 2026-2032, following the phasing-out of free allocation under the EU ETS.
Successfully getting commodity manufacturers exporting to the EU to lower their emissions will take time, planning and significant capital. We also assume that importers and EU-based manufacturers reliant on imported goods, particularly in the automotive, construction, consumer goods and agricultural space, will not wait until 2026 to pass on any incremental CBAM costs. By inference therefore, we would also hypothesize that EU manufacturing companies will increasingly look to source lower-intensity commodities such as green steel and cement. In short, early movers will mitigate future costs.
The financial impact of the CBAM levy or import duty will be substantial. Bloomberg estimates that future payments from CBAM, the price of which follows the EU ETS carbon price, could be around €33 billion per year if the EU ETS reaches 100 €/tCO2e [it has been fluctuating around €90- €100 per ton of CO2 emissions at the time of writing in April 2023].
The exact marginal cost EU importers will have to pay from CBAM will therefore vary depending on the price of carbon, as well as the carbon intensity of individual producers. If this cost cannot be passed on to consumers, manufacturers will have to find solutions with their suppliers, or switch to greener options. This may prove advantageous for climate change but challenging for suppliers and manufacturers with long and sometimes opaque supply chains.
Looking across sectors, and while acknowledging that estimating future CBAM costs is highly complex, we have calculated a hypothetical marginal price increase for each sector. We estimate that, on average, CBAM could result in a 10% increase in the price of raw materials and commodities in relevant sectors. This estimate varies by sector based on the embedded emissions content of those commodities, with cement likely to have the biggest price increase (about 36%) and electricity the smallest (<1%).
Price increase due to CBAM on concerned products given avg. production carbon intensity and carbon price at €60/tCO2e
CBAM will impact three key actors across the global supply chain. What does it mean for each of them?
1. Commodity buyers in the EU will be directly impacted by increased import tariffs for the carbon ‘embedded’ in goods they buy. At a macro level, we can make some qualitative judgments on the impact on buyers from each of the relevant EU manufacturing sectors listed below.
As is shown, the construction, agriculture, automotive and packaging manufacturing sectors in the EU could be highly impacted by an increase of their primary raw materials supply costs due to CBAM. For example, we estimate that there could be an incremental increase in price of products such as wheat and corn by around 7% or re-enforced concrete by around 15%, when considering CBAM price increase of their main raw materials (i.e., respectively fertilizers or cement & steel), assuming global average production carbon intensity of CBAM products and carbon price set at 60€/tCO2, and based on the assumption that 100% of the raw material is imported.
Under CBAM, EU manufacturing sectors that engage with suppliers and source ‘lower carbon’ commodities will – all things being equal – pay less per commodity unit, and therefore enhance their price competitiveness for finished goods. Aligning a company's supply chain strategy with imported goods with lower embedded emissions requires significant time and effort, as commodity-based supply chains can be opaque and complex, with many players spread out across geographies.
2. Global commodity producers exporting into the EU will be impacted indirectly by CBAM as their competitiveness on the EU export market will depend on the carbon ‘embedded’ in their goods, and thus correlatively on whether they invest in cleaner production technologies and processes to reduce their emissions. With the introduction of CBAM, commodities manufactured by less carbon-intensive producers are likely, all things being equal, to be more price competitive in EU markets than those of their competitors.
In theory, this should incentivize changes to the manufacturing process, renewable energy sourcing, energy efficiency improvements and the introduction of breakthrough technologies (e.g., green hydrogen, CCUS (Carbon Capture, Utilization and Storage), material changes, etc.) required to decarbonize these sectors. But the decarbonization challenge is complex and highly capital-intensive. For example, new technologies such as green hydrogen will not be readily available on a commercial scale until at least the end of the decade. However, we do see growing markets for low(er) carbon commodities, supported by sector-relevant standards (e.g., Responsible Steel, Concrete Sustainability Council, etc.). Indeed, some EU importers/buyers/offtakers are increasingly willing to pay a ‘green premium’ for commodities with lower emissions, which may allow future funding of capital deployment.
3. Commodity producers in the EU (i.e., the EU’s domestic steel, cement, aluminum, etc., manufacturers) will be impacted indirectly as the EU ETS free allowances are phased out and CBAM is introduced. The EU’s domestic commodity players will have to pay the same or similar ‘carbon levy’ as CBAM importers. In Europe, the playing field will be fair.
However, the main flaw of the CBAM mechanism, as raised by many stakeholders, is that EU producers will lose export competitiveness overseas, as they will pay the full EU ETS carbon price for manufacturing in the EU. This will create a price disadvantage in overseas markets where local or other international players are not subject to the same environmental costs. Overseas, the playing field will not be fair. To address this issue, companies in some EU sectors, such as steel, have called for a carbon price rebate on exports. The European Commission has not yet agreed.
While the main impacts of CBAM will not be felt until the transitional phase is over and the tariffs trigger in 2026, companies should not wait until then to prepare. For example, commodity importers or direct purchasers in the EU will have to register with EU CBAM authorities in October 2023 before importing the goods. Being prepared for CBAM’s introduction, however, will entail more than taking care of the formalities. Managing the risks and maximizing the opportunities associated with CBAM requires all players across complex global supply chains to create a CBAM strategy and start to execute it now.
Actions we recommend taking to navigate the regulatory hurdles and find opportunities include:
Commodity manufacturers exporting products to the EU should calculate the carbon footprint of products currently sold (or that will be sold) in the EU using the relevant CBAM method, attributing embedded emissions to different types of goods. Manufacturers can then make a financial assessment by simulating the impact of CBAM on product prices and assess its impact on commercial strategy.
Commodity buyers should assess where CBAM-related commodities are present in their supply chain by conducting a detailed assessment of raw materials and upstream emissions sources. Buyers should then simulate the impact of various carbon price scenarios on procurement categories, commodity prices and the impact on purchasing strategy.
Commodity manufacturers exporting products to the EU should develop a long-term decarbonization roadmap from strategy to implementation over a 5-to-10-year period, including assessing relevant levers, breakthrough technologies (e.g., green hydrogen, CCUS, material change, etc.) and key process transitions required to decarbonize these sectors.
Commodity buyers in the EU should develop their own roadmap which involves engaging with suppliers, implementing targeted decarbonization campaigns with supplier groups, providing incentives to boost engagement, and giving actionable advice to priority suppliers.
To emerge as winners from CBAM, exporters and buyers should start now on developing long-term relationships and agreements to purchase lower carbon versions of their commodities. These lower carbon commodities will ultimately be included in the lower carbon vehicles, buildings and products that European consumers are increasingly demanding.
Agreements between offtakers and sellers (even if informal or for small amounts of product in the future) help set the direction and solidify commercial and value propositions internally. Achieving these agreements takes time, but there are a number of sector initiatives, developed for most carbon intensive industries, which are helping to set common standards, technical requirements and bring buyers and sellers together. Such initiatives include:
Once CBAM reaches its full implementation in 2032, we estimate that it will add, on average, 10% to the marginal cost of key commodities in the carbon-intensive industries to which it currently applies. To comply with CBAM regulations, all parties across the supply chain should clarify their role, responsibility and disclosure requirements now.
To reduce the future financial impact of CBAM, commodity producers exporting into the EU should start planning to lower the emissions associated with manufacturing their products through long-term, investment-ready decarbonization plans. Commodity importers need to better understand the scope of CBAM-related emissions across their supply chain, and what suppliers plan to do about it.
Ideally, importers and suppliers should look to establish long-term offtaker agreements for lower carbon products in the future. This will help to reduce emissions from imports and establish markets for greener commodities across the EU, the stated aim of CBAM.
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