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With regulatory measures like the European Union's Carbon Border Adjustment Mechanism (CBAM) on the horizon, businesses exporting into the EU from outside need to prepare to mitigate the impact of having a price associated with their embodied emissions.
The EU’s CBAM policy addresses carbon leakage and promotes cleaner industrial production globally by putting a fair price on the carbon emissions associated with the production of certain goods imported into the EU. This ensures that the carbon price of imports is equivalent to that of domestic production. A resulting rise in the price of international imports is expected, impacting CBAM-affected industries in developing markets such as Latin America. One effective strategy for manufacturers and exporters to manage transition risks and uncertainty of this policy is the use of internal carbon pricing (ICP), a mechanism that allocates a cost to greenhouse gas (GHG) emissions and directly ties them to their source.
The EU’s Carbon Border Adjustment Mechanism (CBAM) encourages greener industrial manufacturing of specific products in non-EU countries by extending carbon pricing mechanisms to imported goods. This approach aims to prevent “carbon leakage,” discouraging companies from displacing carbon-intensive purchases by importing from countries with less stringent climate policies instead of importing from other EU member states. In response, EU importing companies may apply a range of strategies to mitigate the economic impact, such as passing on or sharing the cost with suppliers, switching to low-carbon or local EU suppliers, and intervening in the decarbonization of their supply chains.
Industries like manufacturing, automotive, food production, and construction will be directly impacted by the EU's carbon border adjustment mechanism. The exact impact remains uncertain, as specific materials and components of the imports of these commodities will be subject to a tariff corresponding to the price of emissions allowances under the EU’s existing Emissions Trading Scheme (EU ETS). We estimate that CBAM may add approximately 10% to the cost of applicable commodities entering the EU.
Latin America's growth engines, particularly carbon-intensive industries like cement, steel, aluminum, and fertilizers, face a double challenge from the EU's CBAM. First, they will be hit with significant costs due to the carbon pricing. Second, these sectors face technological hurdles to decarbonize, making it difficult to compete. With an uncertain, but likely rising, carbon price under the EU's evolving climate policy, CBAM could reshape supply chains, potentially locking out Latin American producers from the European market.
However, this may prove advantageous for climate action by urging suppliers and manufacturers to further decarbonize. Adopting a competitive carbon pricing on CBAM-covered products will be imperative for many companies in Latin America, not only to remain competitive in the EU market, but also in future regulations. Strategic moves for companies will be required to facilitate a broader transition to low-carbon technologies, fostering economic growth while managing affordability.
Businesses can use ICP as a strategic tool to invest capital toward low-carbon revenue opportunities, prepare for regulatory requirements, and avoid stranded assets or investments caused by climate change. By managing carbon-related expenses and aligning internal strategies with new and upcoming regulations, this approach enables businesses to drive low-carbon investments. Many industry leaders are already using or planning to use an ICP, driven by regulatory trends and the need to prepare for future carbon costs. According to CDP, the number of companies now using ICP in their operational decision-making doubled from 2016 to 2021, in particular in voluntary and compliance markets in emerging countries, and in leading sectors such as cement.
The benefits of integrating ICP in companies are extensive, covering both internal operational improvements and external contributions to environmental sustainability and global climate action. Companies can stay competitive in changing regulatory environments by strategically positioning themselves to navigate forthcoming regulatory shifts, avoid potential penalties, and maintain market competitiveness. Additionally, cost savings and operational efficiencies can be achieved by streamlining resource utilization and reducing waste, thereby bolstering the bottom line while diminishing environmental impact.
By following a structured timeline, you can ensure a smooth transition and maintain competitiveness in a carbon-conscious market. Here’s a step-by-step guide to preparing for CBAM using ICP:
Choosing the right approach for ICP implementation is crucial. There are three key mechanisms: internal fee, shadow price, and implicit price. By understanding these options, your company can effectively incorporate ICP into its sustainability efforts and make a tangible impact.
As carbon pricing regulations become more prevalent, it is crucial for companies to start preparing now. Implementing ICP is a proactive step to manage costs, drive innovation, and stay competitive. ENGIE Impact offers expertise in developing and implementing ICP strategies tailored to your business needs. Our services help companies navigate the complexities of carbon pricing and ensure compliance with upcoming regulations like CBAM. Reach out today to learn more about our offerings and how we can support your journey toward a sustainable future.
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