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The Carbon Border Adjustment Mechanism (CBAM) is a transitional phase of the carbon tax

Initiated on October 1, 2023, and extending until the end of 2025

12/12/2023 – By Giovanna Guzella, Metallurgical Engineer / Energy Efficiency at Vetta

The goal established in the 2015 Paris Agreement to achieve "Net Zero" stipulates that, to mitigate climate change, there must be a balance between greenhouse gas (GHG) emissions released into the atmosphere and emissions removed or offset through sustainable measures. This is in line with the commitment to limit the global temperature increase to 1.5°C by the end of the century. Achieving carbon neutrality requires substantial efforts, particularly in the energy sector. This involves increased investments in renewable energies, improving energy efficiency, enhancing particulate emissions control, among various other strategies.

According to the World Steel Association, in 2020, 1,860 million tons of steel were produced, with the sector's total direct emissions reaching around 2.6 billion tons, accounting for 7% to 9% of global anthropogenic CO2 emissions. As steel production is one of the most energy-intensive sectors in the industry, there is growing pressure to establish clear climate-related business policies, disclosing the amount of energy used and carbon emitted. Anticipating these changes is crucial for industries to gain a competitive advantage over others.

To address climate change and promote sustainable practices, nations worldwide are adopting emission control mechanisms such as Carbon Credit Markets, Emission Trade Systems (ETS), and, recently, the European Union (EU) introduced the Carbon Border Adjustment Mechanism (CBAM). CBAM is a border adjustment mechanism designed to tax carbon emissions related to imported products from non-EU countries, ensuring equivalence in carbon values with those produced in EU member states.

What is the goal of the Carbon Border Adjustment Mechanism (CBAM)?

The main objective of CBAM is to prevent "carbon leakage," where companies shift production from EU nations to other countries with more lenient emission restrictions. The idea is to compensate emissions from the production of specific imported products to the EU through "CBAM Certificates," ensuring that importing companies do not have a financial advantage regarding emission fees, regardless of the production location.

What are "CBAM Certificates"?

Starting in 2026, importers or indirect customs representatives will have to purchase CBAM certificates corresponding to the aggregate emissions of the imported goods. In the initial implementation phase, only direct emissions will be considered—those generated during the production of specific goods at the facility level, such as in combustion processes. Each sector detailed in Figure 1 is specified for taxation by CBAM:

• Cement: cement clinker, Portland cement, alumina cement, and other derivatives producing direct CO2 emissions during their production.
• Electricity: electricity produced from the combustion of carbonaceous gases, such as steel gases in power plants, for example.
• Fertilizers: nitric acid, ammonia, potassium nitrates, mineral or chemical fertilizers producing direct CO2 and/or N2O emissions during their production.
• Iron and steel: pig iron, semi-finished and finished steel, some manufactured steel products, and downstream products like screws, locks, bolts, and similar iron and steel articles, and other derivatives producing direct CO2 emissions during their production.
• Aluminum: primary aluminum and semi-finished aluminum, including derivatives producing direct CO2 and/or PFC emissions during their production.
• Hydrogen: hydrogen produced from carbonaceous sources without a coupled carbon capture system, e.g., from natural gas (also known as steam methane reforming).

How are certificates priced?

The value will be calculated based on the average auction price of the previous week in the European Carbon Market (EU ETS), expressed in euros per ton of emitted CO2. Importers will have the opportunity to claim a reduction in CBAM certificates if a carbon price has been paid in the production country, avoiding double counting.

Figure 2 illustrates the CBAM pricing mechanism. For example, a steel producer in Brazil wants to export a coil to the EU and has paid a tax according to the Brazilian carbon taxation system for the emitted carbon during the production, represented by the red area in the graph. When the EU importer buys the coil, they only have to pay the difference of this tax, calculated as the balance between the EU and Brazil prices. Thus, the importer will purchase enough certificates to reflect the carbon tax they would pay if the imported coil had been produced in the EU, represented by the green area in the graph.

How will CBAM be implemented?

CBAM will be implemented in two phases:

• Phase 1: In effect from October 2023 to December 2025, serving as a transitional and adaptation period. Identifying and registering emissions may be challenging for most companies, requiring high digital maturity and investment in suitable tools to track and accurately calculate the carbon footprint of each product. During this phase, EU steel importers are only obligated to collect and report information on the greenhouse gas emissions incorporated in the product, without having to pay for these emissions.
• Phase 2: January 2026 marks the complete implementation of the mechanism. Declarants will be required not only to report embedded emissions in imported goods but also to pay fees for these through CBAM certificates. From this date, it is also expected that other industry sectors will be covered by the mechanism.

Consequences for Governments

Concerns about carbon revenue leakage to the EU under CBAM are expected to encourage other governments to establish national carbon prices. In other words, EU trading partners could retain a portion of carbon revenues collected that would otherwise be captured by CBAM.

Furthermore, since the CBAM rate is determined by the difference between the EU ETS price and the exporting country's carbon price, EU trading partners are incentivized to raise their internal carbon prices to avoid revenue leakage.

This move will also enhance the effectiveness of CBAM, as other governments will implement increasingly stringent legislation, encouraging audit and oversight programs in industries. Consequently, incentives for decarbonization projects will increase over time in non-EU countries.

Consequences for the Steel Industry

• Short-term:

• Exporters will be compelled to reorganize their production and sales, prioritizing the export of low-emission steel to the European market as a short-term alternative where possible.
• There might be a shortage of steel supply in Europe, as industries with higher emission intensity try to avoid exporting to the EU, prioritizing markets with lower penalties.
• Higher prices and additional pressures on steel supply chains could make the energy transition more expensive in Europe than in other regions, given the widespread use of steel products in the energy sector, such as wind turbines and electric vehicles.

• Medium/Long-term:

• Exporters from third countries wanting to maintain access to the EU market must decarbonize their operations to mitigate the high costs of CBAM. This strategy involves studying and implementing engineering projects, such as building a power plant in a steel plant to reuse steel gases and generate electricity. Another considered strategy would be a production route change, for instance, replacing part of direct iron ore-based steel production with indirect production using scrap as the main raw material.
• Since third-country governments will have a strong incentive to establish national carbon prices, global consumers may experience higher prices in various products, such as cars, construction items, appliances, among others.
• Moreover, higher prices for steel raw materials and basic goods may lead to a decrease in employment in manufacturing industries. For example, an automaker relying on inputs from the steel industry may face a significant price increase, prompting cost-cutting considerations and potential layoffs in the sector.

Will Brazil be affected?

The Brazilian government is likely to work towards implementing stringent emission restrictions incrementally to retain a portion of carbon revenues collected that would otherwise be captured by CBAM. Currently, the draft legislation for the Brazilian Greenhouse Gas Emissions Trading System (SBCE) has been introduced in the Brazilian National Congress and is under consideration for implementation. This mechanism would function as an ETS, establishing a mandatory emissions trading system to help the country achieve its climate goals of reducing emissions by 50% below 2005 levels by 2030 and achieving climate neutrality by 2050. The project is expected to be discussed and approved in the coming months.

Additionally, the government will likely encourage steel industries to invest in emission tracking and management, providing fiscal incentives and other facilities. An increase in financing availability for sustainability projects and research related to energy efficiency, emission tracking, and renewable energies is also anticipated.

In the near future, a more robust audit strategy regarding emissions within the industry is likely, with adopted restrictions in Brazil continually improving, including the standardization of norms regulating how emissions should be reported. As a result, companies will be pressured to stay ahead of technologies and methodologies to increase transparency in tracking greenhouse gas emissions, reduce emissions, and gain competitiveness alongside other companies.

References:

• IEA - Net Zero Roadmap A Global Pathway to Keep the 1.5 °C Goal in Reach (2023 Update)
• The European Commission: Webinar session on the iron & steel sector (2023)
• Wood Mackenzie: Implications of the CBAM for the iron and steel sector
• Official Journal of the European Union: L130 (2023)
• ICAP: Brazil Introduces Draft Law Cap-and-Trade System

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