Decarbonization policy shifts from incentives to penalties

Some businesses may well be aware, and many may well not be, that the EU’s wide-ranging initiative to drive decarbonization and promote less carbon-intensive manufacturing – the snappily named Carbon Border Adjustment Mechanism (CBAM) – is nearly upon us.

It will apply in the EU from January next year – just six months away – and from January 2027 in the UK. But what business really needs to be aware of is that these are just the skirmishing salvoes at the start of something much, much bigger.

CBAM is, in effect, the offspring of the many COPs that have been held around the world in recent years, including COP26 in Glasgow, at which world leaders spoke passionately about the need to create a greener economy and, more importantly, to change business behavior around carbon emissions.

The underlying concept is that only by attaching a significant price to the production of greenhouse gases will businesses be incentivized to find other, less harmful ways of creating their products. It will be a gradualist approach, but there is no doubt whatsoever that, over time, it will involve less carrot and more stick.

The EU version of CBAM is already in its reporting phase as a new tool to put a cost on the carbon emissions embedded in certain imports – initially, the most emissions-intensive industrial goods, including aluminum, cement, fertilizer, hydrogen, and iron and steel.

Steps have been taken to minimize “carbon leakage” – that is, the movement of production and associated emissions from one country to another to take advantage of different levels of decarbonization effort, since not all jurisdictions are moving at the same pace.

This is where the “adjustment” in CBAM comes in. The intention is to ensure that anything imported into the EU will carry the same carbon costs, create a level playing field, and reduce the temptation to circumvent the measures by switching to other, less committed countries.

The UK, now, of course, outside the EU, is taking its own rapid action on industrial decarbonization, although it is well aware that aligning more closely with Europe will bring the added benefit of not creating more friction to trade.

Indeed, in the most recent agreement between the UK Prime Minister and the EU over a “reset” of relationships with the bloc, CBAM figured prominently, and there appeared to be a will on both sides to bring the schemes into as much synch as politically possible.

Of course, since the EU’s carbon trading price is higher than in the UK, this will have the effect of pushing up raw material prices across a number of sectors in Britain, most notably in construction and in agriculture, which will bear the brunt of more expensive fertilizer imports.

Businesses need to be conscious of the fact that, although the EU scheme is starting at a low percentage of the price per ton of carbon (unlike the UK, where the full price will apply from the outset), that price is projected to rise in the years ahead, and the amount of CBAM payable will also be ramped up between next year and 2034.

It is also important for businesses to factor into their long-term planning that, while at the moment CBAM only applies to upstream products – i.e., the activities involved in sourcing raw material, manufacturing, and production – in the foreseeable future it will almost certainly be applicable to downstream activity, such as manufacturing and production or delivering the goods to end customers.

One of the immediate challenges for importers is to get hold of the accurate data needed for CBAM calculations. When the EU commenced registration, only 10% of companies reported the first quarterly returns, mainly due to a lack of awareness of the need to do so.

To get around this stumbling block, estimated data was allowed. It was subsequently phased out but is now to be reinstated, with the catch that the use of estimated data will be more expensive than actual numbers. But standards will become ever stricter and, ultimately, scheme administrators will require actual data across the board.

What can companies that are initially affected by CBAM do at the moment?

First, they will have to register, then work out what the relevant emissions are, and then find out where they can obtain the data. They will have to identify qualifying products throughout the supply chain – and most of all, they will have to get it right.

Currently, we are seeing the velvet glove. But the iron fist is not that far away. The EU is clear that penalties will apply and, eventually, non-compliant entities face the risk of not being allowed into the single market, as well as potentially serious reputational damage.

The other side of that coin is that those who make the effort to digest the new rules and understand the position will have such a clear trading advantage that they will leave competitors in their dust.

Professional advice will be crucial. The clock is ticking, and the time for forward-looking enterprises to seek guidance and make their dispositions is now.

Craig Stobo is a Partner and CBAM specialist at VITA.

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