The European Union’s Carbon Border Adjustment Mechanism (CBAM) is set to reshape the landscape of carbon pricing and emissions regulations. In response to carbon leakage concerns within the European Union Emissions Trading System (EU ETS), CBAM introduces a carbon levy on certain imports. This article explores the impact of CBAM on Procurement departments, highlighting key takeaways such as enhanced data collection, anticipation of potential price increases, and staying informed about evolving carbon regulations. In a rapidly evolving landscape, proactive adaptation is essential for businesses to navigate CBAM effectively and contribute to a sustainable, low-carbon future.

Introduction of ETS

The EU ETS is one of the most important economic instruments in the fight against climate change. As a cap-and-trade system, it places emission limits on the participating installations that are required to hold permits (“allowances”) for each tonne of CO₂ equivalent (tCO₂e) they emit. Participants who want to increase their emissions need to buy allowances from the EU ETS market; those who reduce their carbon footprint can sell their allowances in the same marketplace.

Currently (Sep 2023), EU ETS allowances are traded for approx. €80 per tCO₂e[1]. The EU ETS currently covers carbon emissions from electricity & heat generation, energy-intensive industry sectors (e.g. oil refineries, steel, iron, aluminium and many more), intra-European aviation and maritime transport, which make up about 40% of the EU’s greenhouse gas emissions.[2] A similar system was set up for the UK due to Brexit (UK ETS).

Addressing Carbon Leakage through Free Allowances

One of the primary concerns in the context of the EU ETS is the issue of carbon leakage. Carbon leakage occurs when companies, driven by the financial implications of stringent climate policies, shift their production to countries with more lenient emission regulations. This relocation can lead to a net increase in global emissions, particularly impacting energy-intensive industries.

To prevent carbon leakage, industries at substantial risk of this phenomenon currently receive specialised support within the EU ETS to maintain their competitiveness in the global market. These industries are currently eligible to receive 100% of their allowance allocation for free to ensure they are not at a competitive disadvantage to peer industries outside of the EU.[3]

However, this strategy has encountered a significant limitation – it doesn’t provide sufficient incentives for the relevant industries to reduce their carbon footprint. Emissions from energy-intensive industries have remained relatively stable between 2013 and 2019,[4] signalling the need for additional incentives to promote carbon reductions. Free allowances are expected to mute the carbon price signal, hindering innovation and investment in cleaner production processes.

Introducing the Carbon Border Adjustment Mechanism (CBAM)

To address the limitations of free allowances and further bolster its efforts in reducing carbon leakage, the EU is rolling out the CBAM; a policy instrument designed to mitigate carbon leakage. The CBAM imposes a carbon levy on imports of specific carbon-intensive goods from non-EU regions. Simultaneously, the EU is initiating a gradual phase-out of free allowances for domestic industries over a nine-year period, from 2026 to 2034. The introduction of the CBAM will align with the phased reduction of free allowances under the EU ETS, providing a complementary approach to carbon leakage prevention.[5]

From this perspective, the EU has changed its strategy to simultaneously address carbon leakage and the problem of free allowances. Rather than releasing EU polluters from their duty to pay for the emissions they cause, the idea is to create a level playing field by imposing a levy on the imports of energy-intensive goods into the EU.

Understanding CBAM’s Implementation Timeline

The implementation of the CBAM unfolds in distinct stages:

1. Transition Period (Starting 1 October 2023): Importers of goods at high risk of carbon leakage, including iron and steel, aluminium, electricity, specific fertilisers, cement, hydrogen, and select downstream products, will be required to report greenhouse gas emissions embedded in their imports. No financial payments are mandated during this period, however, this reporting requirement is crucial in gathering essential data to assess the emissions associated with imported products.
2. Implementation (Starting in 2026): Importers will commence payments under the CBAM during this phase. They will be required to purchase CBAM certificates, covering the difference between the carbon price in the producer’s country and the EU. The weekly average auction costs of emission allowances under the EU ETS determine the certificate price. Exemptions are available if importers demonstrate that producers have paid an equivalent price in a non-EU country.
3. Full Implementation (Due 2030-2032): The CBAM is expected to encompass all goods the EU ETS covers. At this stage, the CBAM will have achieved its goal of ensuring that imported carbon-intensive goods are subject to the carbon pricing equivalent of their domestic counterparts.

Key takeaways for Purchasing departments in the era of CBAM

In the ever-evolving landscape of carbon pricing and emissions regulations, the Carbon Border Adjustment Mechanism (CBAM) will impact how Procurement departments across industries operate. Here are key takeaways to consider:

1. Enhanced data collection and reporting requirements: Procurement departments must prepare for collecting and reporting detailed product carbon footprint data. This includes emissions per tonne of imported goods and information on foreign carbon pricing systems. Accurate and comprehensive data will be essential for compliance with CBAM regulations and strategic decision-making.
2. Reduce carbon footprint of purchased goods: Prices for carbon-intense products will likely increase on both sides of the EU from 2026 onwards when the CBAM’s transition period begins. Import prices may rise due to the additional costs associated with CBAM certificates, and prices for goods produced in the EU will increase due to the gradual fade-out of the free allowances within the EU ETS. As low-carbon alternatives are often a scarce commodity (take for instance green steel or biobased chemicals), those who are not making a timely investment will face a strong competitive disadvantage later. [See our whitepaper on carbon incentives here]
3. Comparable Price Changes and Alignment with EU ETS: It’s crucial to recognise that the expected price rise for products from non-EU suppliers due to CBAM is expected to be comparable to that of EU suppliers. This is because EU suppliers will undergo a gradual reduction of EU ETS free allowances within their respective sectors. CBAM-related price changes are designed to be equitable, and that domestic and foreign producers of the same goods face similar carbon pricing pressures.[6]
4. Stay informed about carbon pricing and regulations: The evolving landscape of carbon pricing and regulations will play a pivotal role in shaping Procurement decisions. Staying informed about these changes is essential for making strategic choices within the context of the CBAM and the broader carbon market. Being proactive in adapting to regulatory shifts will afford competitive advantage.

In addition to these factors, while the CBAM offers promises of addressing carbon leakage, notable uncertainties remain. These uncertainties revolve around the scope of CBAM coverage, which is still under discussion by the European Commission and could potentially encompass additional industries. The evolving definition of emissions, encompassing greenhouse gases and possibly broader scope 3 emissions, introduces complexity.[7] Moreover, it is currently unclear which markets will ultimately be affected by CBAM. The UK, for instance, has its own UK ETS, but since the price currently (Sep 23) diverges significantly from the EU ETS price, it is not definite yet whether the UK ETS will be considered an equivalent carbon pricing system.[8] Furthermore, the absence of a clear export rebate policy necessitates the exploration of alternative, WTO-compliant methods, underscoring the EU’s commitment to address climate change whilst ensuring fair global trade practices.[9]

In conclusion, the introduction of CBAM marks a significant shift in the landscape of carbon pricing and emissions regulations. To effectively navigate these changes, Procurement departments should proactively focus on data collection, decarbonisation of purchased goods, and staying informed about evolving carbon-related policies. By embracing these key insights and adapting their Procurement strategies accordingly, businesses can successfully address the challenges and opportunities CBAM presents and contribute to a sustainable, low-carbon future.