How Europe’s new carbon adjustment mechanism will impact global infrastructure

The transitional phase of a radical new carbon emissions policy will begin in the European Union next year with major impacts expected for infrastructure, both inside and outside the bloc. What should firms expect?

When the EU introduced a Carbon Emissions Trading Scheme (ETS) to incentivise heavily polluting industries to decarbonise nearly 20 years ago it was considered radical policymaking. But the threat of carbon leakage, where businesses move overseas to avoid the tax, has hampered the ETS’ impact. 

Now Bloc legislators are ready to unleash a new framework in January 2023 targeted at solving this specific problem. Called the Carbon Border Adjustment Mechanism, or CBAM for short, the new policy will, in the first instance, apply a carbon price equivalent to that of the ETS (currently at around 60=70 euros per ton of CO2), to imports of electricity, iron, steel, cement, aluminium and some fertilisers. It will also eventually phase out ETS ‘free allowances’ currently given to heavy industry to stop them offshoring. 

Firms won’t have to pay any new tax until 2026, but from next year they will need to start counting the carbon embedded in their trading products.

“The idea is to have an ETS that bites,” explains Yves Melin, a trade lawyer and partner at ReedSmith LLP. “The removal of free allowances and the introduction of CBAM at the border will require everyone to pay for the right to emit carbon, creating a strong incentive to decarbonise industrial processes.”

How will CBAM aid decarbonisation? 

In practice this means companies using imported CBAM products, such as the construction, energy and automotive sectors, will need to show how much CO2 is imbedded within them and purchase CBAM certificates accordingly. 

This, Melin says, creates a new risk for businesses. “Many firms could be priced out because they are either not importing green CBAM products or they are but can’t prove it. There’s no time to waste: the future belongs to the prepared.”

A consequence is that manufactured goods that contain CBAM commodities are also vulnerable to carbon leakage, which is why Melin expects the mechanism to ‘fairly quickly’ be extended to downstream products ‘by the end of the decade’. 

The overarching ambition of the revolutionary new policy is to reduce greenhouse gas emissions. Steel, for example, is accountable for an estimated 7 – 9 per cent of global carbon emissions. CBAM can support European users to buy more responsible steel by effectively levelling the price differential between cheaper, higher emissions steel produced in China, for example, and carbon free steel produced in Europe, says Carla Wellens, the Director of QHSE at offshore wind fabricator Smulders, which has made a commitment to use, procure or specify 100% net zero steel by 2050 as part of the SteelZero initiative

By the middle of the decade, it is expected several steel manufacturers in Europe, mostly Sweden-based, where there is a large renewable energy source, will be producing low carbon steel. 

“[Without CBAM] if clients are only looking at price, not emissions, then the low carbon steel will find it hard to compete with product coming out the Middle East or Asia,” Wellens explains further.

These mills won’t produce enough steel to meet European demand by 2026, however, meaning the cost of building new infrastructure in the EU is still going to rise.

How will CBAM affect the UK?

Impacts will of course also be felt elsewhere. Exporters from European Economic Area countries that participate in the EU’s ETS, such as Switzerland, will be exempt from the measures.  Other countries can negotiate to have their carbon trading systems recognised in this way. 

The UK, however, is particularly exposed to CBAM as the government decided not to link up its ETS with the EUs. Initially CBAM will add yet another layer of paperwork for UK exporters already reeling from increased bureaucracy post Brexit. 

It could also see firms experience a ‘double whammy’ in carbon taxes, says Professor David Bailey at the Birmingham Business School, who is also a Senior Fellow of the Economic and Social Research Council’s ‘UK in a Changing Europe’ programme. 

“UK firms are already paying for carbon locally and could then face a tax to export to the EU, some sort of alignment will be necessary otherwise, pretty soon, we’ll be put at a competitive disadvantage,” he says. 

Lee Adcock, British Steel’s environment and sustainability director has called for the UK to establish its own mechanism, which the government is considering. 

“If the EU establish a carbon border adjustment mechanism, we see no alternative but to establish a UK version. This would protect domestic steel manufacturing from high carbon imports as we invest and decarbonise our production processes,” he says. 

As for Northern Ireland, CBAM is expected to fall within the remit of the Northern Ireland Protocol. Though this is yet to be confirmed. 

CBAM’s global impact

Outside of Europe, some believe the upcoming legislation has encouraged others, such as China, to start considering or enacting carbon pricing. China introduced a national carbon trading system last year. 

Though there is a criticism that the framework could have a negative impact on developing countries buying from and supply to the EU as they may be unable to do the necessary sophisticated carbon accounting.  It has been suggested a developing country mechanism that would see CBAM money reinvested through aid, or another mechanism, could be created. 

These details are yet to be decided as the EU Commission, Parliament and Council produce the final draft by as early as June or July. But as this happens, given the rising costs and supply chain challenges already dumped on business post-pandemic and because of the Ukraine-Russia war, could legislators choose to water it down instead? 

Melin doesn’t think so. “There is a very important policy objectives in the ETS and CBAM, which is not only to stop emitting greenhouse gases, but also for the EU to become less dependent on imported gas and oil,” he explains. “The ongoing crisis has made this even more of a priority and there is energy sovereignty for the EU in it and nothing is more important than that now.”