The European Commission has released the long-awaited "Fit for 55" climate change package. While centered on tighter emission-reductions targets, such as reaching EU greenhouse gas emissions that are at least 55% below 1990 levels by 2030, the package includes 12 new measures that will have both direct and indirect challenges for supply chains. It is likely that it will take at least two years for the whole package to become EU law, but there are two likely major outcomes.

First, logistics will get more expensive. The EU is including maritime shipping in the emissions trading scheme, or ETS, for the first time and removing free permits for the aviation sector. Expectations of an expanded scheme may have been a major reason for a surge in carbon dioxide permit prices, with S&P Capital IQ data showing EU ETS permit prices rising 30.6% during the second quarter of 2021 to reach a record high of €55.4 per ton ($65.6) on June 30.

That came alongside a surge in container shipping rates globally with an increase of 53.7% during the second quarter of 2021, also to reach a record high, according to S&P Global Platts data. The latter was driven by a mismatch between supply and demand rather than pricing in carbon emission costs, however.

There will also be new instruments to encourage the increased use of sustainable fuels in both the maritime and aviation sector. The container shipping sector has been investing heavily recently in new capacity, with LNG being the preferred fuel, as discussed in Panjiva's research of April 23.

Firms that have been less aggressive — including A.P. Møller - Mærsk A/S, which "supports the phased approach chosen in ETS and the strong focus on spurring and financing innovative and not yet commercially viable technologies," — may be able to take better advantage of the new fuels policy once it is implemented. On the basis of experience from the shift to low sulfur fuels and the surge in shipping rates during the pandemic, it is likely that higher costs will be passed through to customers.

The biggest new policy for supply chains is the application of a new Carbon Border Adjustment Mechanism, or CBAM. At its heart, this is a tariff designed to equalize the "carbon cost" of imported products versus their EU equivalents.

Perhaps unsurprisingly, the devil will be in the details. The proposed plan anticipates a system of CBAM "certificates," analogous to the emissions trade scheme, which will be phased in over several years focused on specific products rather than their downstream uses (i.e., steel but not steel-bodied cars).

As widely trailed, the initial coverage of the scheme will include iron/steel, aluminum, cement and fertilizers, though other products, particularly petrochemicals, could also be ruled in. The EC has an initial estimate of the cost of the CBAM for importers of €9.1 billion ($10.8 billion) by 2030.

As discussed in Panjiva's Q3'21 Outlook, the CBAM will prove to be highly controversial with the EU's trading partners. Only a handful of other countries already have a carbon emissions trading scheme and even for those, the level of pricing will drive the tariffs charged. The launch of the Chinese government's national emissions scheme may put China's exporters in a better position as the CBAM is phased in than their U.S. counterparts.

The CBAM's precise coverage is still being defined. For example, within iron and steel, the proposals would exclude ferroalloys and stainless steel due to the high diversity of products and variety of production measures. Indeed, none of the major steel sectors are definitively ruled in so far. Coverage of aluminum and fertilizers is likely to be wider with all major categories to be covered, while two of the three main types of cement will be included.

Panjiva's data shows that Russia and China were the leading suppliers of basic aluminum products to the EU in 2020, accounting for 14.5% and 12.6% of shipments, respectively. There has been a broad downturn in EU imports with shipments dropping 20.0% year over year in dollar terms.

The imposition of the CBAM will likely cause friction with most of the major aluminum supplier nations to the EU. In the case of Canada, which represented 1.5% of EU imports in 2020, it is not clear that the Comprehensive Economic and Trade Agreement allows for the imposition of carbon taxes. Relations with the U.K., which accounted for 7.5% of shipments, are already fraught because of post-Brexit custom negotiations, though the existence of a carbon trade scheme in the U.K. already may help.

Similarly, relations with China are already strained due to the pause in the Comprehensive Agreement on Investment, though China has also implemented a carbon trading scheme. The EU's relations with Russia have proven complex with national security and energy policies already clashing.

With regards to the U.S., which supplied 2.5% of EU imports, the introduction of CBAM may incentivize the Biden administration to retain Section 232 duties on imports of aluminum in particular.

It would not be a surprise to see direct retaliation against a CBAM. While members of the Democratic Party are proposing a carbon-related import tax as part of the current infrastructure bill proposals, as reported by The New York Times, it may struggle to pass a closely balanced Congress.

The presence of tariffs has depressed U.S. seaborne imports from the EU compared with competitors from Canada, which are not subject to Section 232 duties. While those tariffs have been in place since April 2018, there has been a continued downturn in shipments recently. Panjiva's data shows that imports linked to Constellium SE and Hindalco Industries Ltd.'s EU subsidiaries fell 31.7% and 55.7% year over year, respectively, in the second quarter of 2021.

Not all producers are suffering a downturn, though, with shipments linked to Viohalco SA up 33.2% over the same period. That also meant that imports linked to Viohalco were 42.5% higher in the first half of 2021 than in the same period of 2017. AMAG Austria Metall AG has also seen a recovery in its shipments over the same period of 119.4%, despite an 11.7% reversal year over year in the second quarter of 2021.

Christopher Rogers is a senior researcher at Panjiva, which is a business line of S&P Global Market Intelligence, a division of S&P Global Inc. This content does not constitute investment advice, and the views and opinions expressed in this piece are those of the author and do not necessarily represent the views of S&P Global Market Intelligence. Links are current at the time of publication. S&P Global Market Intelligence is not responsible if those links are unavailable later.

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