CBAM will force change in carbon-intensive sectors

• The EU’s Carbon Border Adjustment Mechanism (CBAM) will levy a tariff on carbon-intensive imports with the aim of preventing carbon leakage. CBAM forms part of a wave of climate-focused trade policies, including those under the US Inflation Reduction Act (IRA) and the European Green Deal (which covers CBAM). 

• The CBAM will increase global regulatory pressures on companies to invest in combating climate change, but is viewed by affected countries as a form of protectionism that will affect their competitiveness. It will raise the risk of trade wars, may cause shifts in global trade and investment, and will increase some product costs within the bloc. 

• No duties will be levied in the transitional phase of CBAM, which began on October 1st 2023 and lasts until January 2026. However, EU importers in the scope of the policy are now required to report emissions embedded in their imports on a quarterly basis, with fourth-quarter data for 2023 due by January 2024.

In implementing CBAM, the EU has two primary aims: to increase the global pressure to reduce emissions in carbon-intensive industries and to improve the competitiveness of EU-based producers, which currently face far higher regulatory costs than competing imports. However, CBAM will have an adverse effect on exports from resource-rich countries in Africa and the Middle East, as well as economies with a large industrial base (see map). For these countries, the implementation of carbon border taxes in 2026 will make CBAM product exports less competitive in EU markets. Unless these countries manage to secure investment (corporate or government) to decarbonise affected industries, CBAM will push EU importers to look for alternative suppliers, causing a shift in global trade that risks spiralling into retaliatory measures and trade tensions. 

The World Bank, in an index published in June, noted that Zimbabwe is the most exposed country, with about 87% of its total CBAM product exports globally being to the EU. Zimbabwe’s iron and steel exports to the EU alone account for 91.7% of its global exports and 0.42% of its GDP. The carbon emissions intensity of its iron and steel exports is 1.17 kg CO2eq/US$, much higher than the EU average of 0.16 kg CO2eq/US$. Another African country that faces high-risk exposure from CBAM is Mozambique, which exports 74% of its CBAM products to the EU, accounting for about 7% of its GDP. Its most exposed product export, aluminium, has a carbon emissions intensity of 0.68 kg CO2eq/US$, compared with an EU average of 0.07kg. 

The ‘stick’ strategy

CBAM is part of the European Green Deal, which includes a set of policy initiatives that aim to reduce the EU’s net greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels, and achieve carbon neutrality by 2050. The bloc adopts a carrot-and-stick strategy to achieve these climate targets. The carrots include green investment incentives and subsidies, while sticks include the EU’s domestic emissions trading scheme (ETS) and the CBAM, both of which penalise firms for polluting the environment while producing goods and services. 

Both schemes aim to generate funding for the bloc. The ETS is expected to add about €19bn (at 2018 carbon prices) in annual revenue to the European Commission’s budget from 2028, as well as more than €46bn in annual revenue for member states. The EC expects CBAM tariffs to bring in about €1.5bn a year (at 2018 prices) from 2028, of which its own budget will take 75% while member states take the rest. The EU’s carbon price was about €31/tonne at the end of 2018, and the EU expects carbon prices to remain more than €55/tonne going forward, which will push up revenues from the ETS and CBAM.

For the EU’s trade partners, the strategy has fewer upsides (other than combating global climate change). The “stick” of CBAM will hit several developing and low-income economies: as well as Zimbabwe and Mozambique, the World Bank index puts Ukraine, Georgia, India, Belarus, and Trinidad & Tobago, Egypt, Russia and Kazakhstan in the list of the top ten most exposed countries. Ideally, the mechanism will help to drive corporate investment into decarbonisation in these countries. However, the “carrots” to drive this investment, or for developing countries to mitigate and adapt to climate change, remain limited. The Transitional Committee on Loss and Damage Funds, was created in November 2022 at the Conference of the Parties to the UN Framework Convention on Climate Change, COP27, to provide financial assistance to countries vulnerable to the climate crisis. COP28 confirmed the establishment of the fund; however, it only received US$700m, a tiny fraction of the estimated US$400bn annually that is needed.

Implementation of the CBAM

EU importers in the ambit of CBAM will have to adhere to new reporting requirements and submit a quarterly report to the CBAM Transitional Registry, with the first report due in January 2024. The transition phase report will include details of the imported product, including embedded emissions (both direct and indirect), country of origin, and carbon price paid and due in that region. The actual emissions will be considered to be the declared and verified emissions, or the default value based on average emissions for the product in the country of origin, or (in the event of a lack of reliable data) the default value based on the emissions from the most polluting similar installations in the EU. 

The CBAM tariff will be phased in over a period of nine years starting from the beginning of 2026 and will correspond with the phase out of free allowances under the ETS. Starting in 2026, the importers will have to pay financial adjustments for imported goods in the scope and purchase CBAM certificates. The purchase value of these certificates will be the weekly EU carbon price linked to the average EU ETS allowance auction price, effectively charging importers the same cost for imported carbon as domestic firms will pay under ETS. The EU has also said that it will review the product scope of CBAM by end-2025, which means it may add other downstream products, such as chemicals and polymers. 

Carbon price volatility

Overall, the inclusion of carbon costs in input costs, whether through the form of ETS credits or CBAM duties, will increase overall input costs for EU manufacturers. However, the cost of that carbon will be largely equalised between imported and EU-made material inputs. Carbon prices are volatile, however. The EU carbon price rose to a record high of €100 per tonne of CO2 produced in February 2023. It was about €25/tonne at the beginning of 2020 and €80/tonne at the end of October 2023. These prices are expected to stabilise as the policies around carbon pricing firm up, but they will remain at risk from shifts in the energy market. Any rise in ETS trading prices will affect CBAM imports, but will also push up the price of EU-made products, weighing on European cost competitiveness unless other countries adopt similar carbon tariff systems.

Several countries, including Argentina, China, Chile, Japan and South Africa, already have carbon tax policies and/or ETS, mostly focused on the energy sector. However, countries, including Zimbabwe, Mozambique, India and Turkey, with high exposure to CBAM, do not have carbon tax policies in place. For countries with large quantities of CBAM product exports to the EU, it will now be in their best interests to develop their own carbon tax policies and ETS and to collect the revenue for their own budget. Mozambique and Zimbabwe are working towards developing their own carbon credit projects.

There is potential for the EU to negotiate equivalence agreements with countries that have a similar carbon pricing system. In December 2022 the G7 countries set up an international climate club, which will help in the smooth implementation of policies, including CBAM. Even so, it will be difficult for developing countries to keep up with the expanding scope of CBAM as they tackle the global threat of climate change. 

The analysis and forecasts featured in this video can be found in EIU’s Country Analysis service. This integrated solution provides unmatched global insights covering the political and economic outlook for nearly 200 countries, enabling organisations to identify prospective opportunities and potential risks.