CBAM, ETS reform to impact fertilizer trade

A version of this article was first published on Sustainable Fertilizers, a quarterly newsletter from S&P Global Commodity Insights' Fertecon.

New rules agreed upon in December 2022 to reform the EU Emissions Trading System and launch a new Carbon Border Adjustment Mechanism could have a seismic impact on the global fertilizer trade, potentially changing the rules of the game for both European producers and those who supply the region.

Decarbonization is at the heart of the new measures – part of the EU's Fit for 55 target of a 55% reduction in carbon emissions by 2030, compared with 1990 levels, and climate neutrality by 2050. The climate package aims to provide a reliable price for CO2 emissions through reform of the EU ETS and to protect the EU's industrial sector during the gradual phase out of free emission allocations under the EU ETS through the launch of a tariff on imports based on carbon emissions.

"This deal will provide a huge contribution towards fighting climate change at low costs. It will give breathing space for citizens and industry in difficult times and provide a clear signal to European industry that it pays off to invest in green technologies," MEP Peter Liese, carbon rapporteur for the European Parliament, said after negotiators agreed on terms of the CBAM in December.

As part of the talks to reform the EU's ETS agreed Dec. 18, negotiators agreed that free carbon allowances or allocations to sectors including fertilizers would be phased out over a nine-year period between 2026 and 2034, allowing for the gradual introduction of the CBAM.

Free emissions allowances have been used by the cleanest European fertilizer producers as an incentive to continue production in competition with imports who are not subject to carbon duties. This addresses the problem of carbon leakage, where clean production in one part of the world is marginalized by cheaper, dirtier production.

Under the EU phaseout timeline for carbon leakage sectors, free allocations are expected to be reduced by around 50% by 2030, according to S&P Global Commodity Insights.

With the introduction of the CBAM in 2026, those allocations will be removed entirely by 2034, but industry trade group Fertilizers Europe would like to see additional incentives for both domestic production as well as exports.

"CBAM needs to be tested to ensure it is an effective measure against carbon leakage," said Jacob Hansen, director general of Fertilizers Europe. "We therefore recognize improvements from the initial proposal on free allocations but question the decision of EU legislators to start the phase out already at the beginning of the CBAM introduction. This is likely to impact our value chain, the farmers, and hamper our capacity to deploy green investments."

Reform of the EU ETS will allow for the introduction of the CBAM, which is set to begin as a reporting requirement only from Oct. 1, later than the expected Jan. 1. The CBAM will require EU fertilizer importers to report emissions embedded in their imported goods and to buy so-called CBAM certificates corresponding to the carbon price that would have been paid had the goods been produced in the EU.

Countries most likely to be impacted by the CBAM include those without national carbon markets in force, including those key exporters of fertilizers without major reforms in place, according to S&P Global Commodity Insights carbon analyst Michael Evans.

Key exporting countries of MAP/DAP, urea, ammonia and NPKs include Russia, Algeria and Egypt, which accounted for around 65% of those fertilizer imports into the EU in 2022, according to S&P Global trade data.

The CBAM is likely to have a two-fold effect for European importers – governments from exporting countries will need to consider urgent development of more robust carbon pricing policies, to equalize costs paid in the EU ETS and ensure trade flows are undisrupted, while non-EU producers will need to consider measures to decarbonize in their sectors, to reduce their exposure to the higher costs of exporting to the EU, Evans said.

Impact on industry

Given the long, phased approach of the buildout, the impact on both the economy and traditional trade balances from the CBAM is still difficult to gauge, said Luc Haustermans, Head of EU Affairs at Yara Fertilizer, based in Brussels.

However, European rules would likely encourage companies to shuffle their resources and send the cleanest product to Europe and the dirtiest product elsewhere, he said.

"Fundamentally, the European system is based on the installation, so as long as one installation makes an effort to reduce its greenhouse gas emissions, that product will see a lower carbon cost at the border," Haustermans said.

Companies also could prioritize abatement strategies for products such as nitrates where it makes more sense than to pay the carbon costs, Haustermans said. To abate ammonia requires either carbon capture and sequestration or electrification, which are both expensive options.

"If you are not interested in selling to a market that prices this footprint – if you are a Middle East producer exporting to Africa – would you really invest in the cost of CCS? Or would you keep costs as low as possible because abating CO2 emissions is really expensive?" Haustermans said.

In the end, CBAM could create a further split between larger and smaller companies or between those who have the resources to manage the regulatory requirements and those who do not, he added.

Impact on pricing

Under the CBAM, importers will face obligation costs from 2026, subject to the package being approved early this year by the Council of member states and Parliament.

To calculate the duty on certain commodities such as ammonia would depend on emissions per product and volumes of product imported, multiplied by the carbon price, or the weekly average EU ETS market price.

The charge for importers will be calculated against the weekly average EU ETS market price and will be determined based on the emissions produced for each product set against a benchmark that has not yet been finalized.

In Europe, average carbon emissions at the top 10% of fertilizer plants currently establish an EU benchmark, thereby escaping any carbon taxes, estimated at around 1.57 mt CO2/mt NH3 produced, according to data from the International Fertilizer Society.

For the typical ammonia plant in Europe emitting 1.9 mt CO2/mt NH3, a total of 0.3 mt CO2 would be above the benchmark. With carbon prices at Eur100/mtCO2e, in the absence of any carbon taxes in the country of origin, that would mean a CBAM cost of roughly Eur30/mt NH3 produced.

On a global scale, production is not as clean. The global average is around 2.2 mt CO2/mt NH3, which – with a carbon price at Eur100/mtCO2e would give a CBAM price of around Eur60/mt – becomes more significant.

Carbon prices averaged around Eur81/mtCO2e in 2022, up from around Eur39/mtCO2e in 2021, according to S&P Global Platts data.

The CBAM, along with a reduction of the EU ETS cap and an expansion of the ETS to the maritime sector will increase demand for carbon allowances and tighten supply, driving bullish long-term EU emissions allowance prices above Eur100/mtCO2e by 2030 under S&P Global Commodity Insights latest EUA price forecasts.

Sustainable Fertilizers is a new quarterly newsletter that extends the coverage of Fertecon's Fertilizer Market and Regional Reports and aims to inform on sustainable developments, providing thought leadership on how these developments will impact the industry. Relevant pricing information for these products is included where available. View a sample here.