Bureaucratic, political hurdles in store as EU's carbon tax enters force

The immediate impact of the EU's new carbon border tax, whose transitional phase started Oct. 1, is likely to be both administrative and political.

The key objective of bloc's Carbon Border Adjustment Mechanism is to accelerate the energy transition and to push peers to decarbonize and adopt carbon prices.

The move has heightened political and trade tensions, especially between the developed and developing world.

CBAM essentially levies a tax on imports of selected carbon intensive materials and products (including aluminum, cement, electricity, fertilizers, hydrogen, iron and steel) into the EU, removing the gap between the EU Emissions Trading System carbon price and the export country of origin's carbon price.

The main purpose of the tax is to reduce the risk of carbon leakage -- EU industries re locating abroad -- and encourage importer nations to introduce their own carbon markets and, so, limit CBAM impacts on their traded goods.

Level-playing field

The mechanism is likely to have a notable impact on the import-heavy cement, fertilizers, and iron and steel cement sectors, with Brazil, South Africa and Turkey particularly exposed, according to analysts at S&P Global Commodity Insights.

"We may also see a reorientation and shuffling of global trade—where the lowest-emitting countries and producers shift a greater share of their exports to meet EU demand," the analysts said.

The EU accounts for around 16% of total global imports, underlying its importance in international trade.

Coralie Laurencin, a senior director at S&P Global, said the main objective of the tax was "to level the playing field".

"Europe is serious about net zero and its energy intensive industry is under growing pressure to decarbonize in the carbon market. The CBAM should be seen in that context," Laurencin said.

Carbon pricing varies significantly on a country-to-country basis as there is no global system. Carbon permits under the EU ETS are almost 10 times the level of compliance prices in China, the industrial powerhouse of the world.

Platts, part of S&P Global, assessed EU Allowances for December 2023 at Eur81.67/mtCO2e ($86.5/mtCO2e) on Sept. 29. China's compliance emissions price was valued at Yuan 75.34/mtCO2e ($10.5/mtCO2e) on Sept. 22, according to the Shanghai Environment and Energy Exchange.

Testing period

The Conference Board, a non-profit think tank, said CBAM will drive up prices of goods within its scope, which could prompt changes in purchasing choices.

"The direct cost of the carbon tax is not the only factor that is expected to drive prices up. EU importers will bear higher administrative costs due to CBAM.," it said in a report.

"Depending on the size of the company importing the goods, a cost in the range of one to several full-time employees required to manage the additional administrative burden can be expected."

In the CBAM's transitional phase until the end of 2025, traders only have to report on emissions embedded in their imports without paying any financial adjustment, which makes it more of an administrative burden.

The first reporting obligations for Q4 2023 under CBAM will only need to be submitted by Jan. 31 next year, so companies have time to prepare for the monitoring, reporting and verification of their emissions.

"The two-year reporting period before CBAM is phased in will likely be used to sort out any wrinkles that the EU Commission identifies as to ease the burden of trade," said Ryan James Dawson, a carbon market policy analyst at the London Stock Exchange Group.

Under the regulation, importers will need to report on the quantity of imported goods, direct and indirect emissions embedded in them, and any carbon price due for those emissions, including carbon prices due for emissions embedded in relevant precursor materials.

The mechanism is to be phased in from 2026 to 2034, in step with the phasing out of free allowances in the EU ETS. Initially, importers will be required to buy certificates for 2.5% of their emissions in 2026, rising to 100% by 2034.

The Conference Board also said it expected a significant bottleneck in the emissions verification for CBAM due to limited verification capacity.

"Importers should also be prepared for variations in customs process times of CBAM goods across member states," it said.

Carbon geopolitics

One of the stated goals of CBAM is to prompt non-EU countries and regions to implement their own of similar carbon levies.

But Laurencin said Europe's hope that its trade partners would introduce carbon markets in response to the CBAM has not yet materialized.

"Our view is that governments may prefer supporting the transition of impacted industries or companies may engage in resource shuffling to avoid paying the EU carbon cost."

But many in the industry believe that the adoption of more carbon pricing globally is inevitable.

"CBAM is going to force everything ex-here to price like Europe in some way shape or form," said Carbon exchange ACX cofounder Thomas McMahon, adding it effectively put the onus on every government to come up with a price for carbon.

China and India have been leading the pushback against EU's CBAM, having proposed multilateral talks through the route of the World Trade Organization.

China is also looking to garner support from impacted countries but intensifying the debate round according to officials and industry sources.

In its WTO communication, China has argued that "the extra-territorial economic costs of the CBAM" will mainly borne by developing countries and could lead to a notable decline in global trade, along with trade distortions and global inequality.

However, the EU insists the measure will help put a fair price on carbon emitted during production of imported products while pushing European industry to decarbonize without being undercut by other geographies.