Fairness Concerns Cloud EU’s CBAM

While definitive implementation of Carbon Border Adjustment Mechanism or CBAM is a year and a half away, this transition period is unveiling the magnanimity of challenges.

EU will impose CBAM taxes on new products between 2026 and 2034. All imports of materials and goods into the EU will be subject to CBAM taxes by 2034.

Based on GHG emission intensities, the EU’s CBAM aims to level the playing field for Emissions Trading System (ETS) firms. But, it also raises concerns about fairness and implications.

CBAM’s disproportionate impact on developing countries may hinder economic growth and global market dynamics severely. It places the onus of decarbonization on developing countries.

Developed countries bear more climate mitigation burden due to their 79 percent historical carbon emissions. CBAM goes against Paris Agreement’s principle of common but differentiated responsibilities, imposing environmental standards on developing countries.

Experts believe by doing so, it disregards developed nations’ disproportionate contribution to climate change. I want to recall here developing countries expressed concerns about the negative effects of unilateral trade measures like CBAM on their economies during COP28.

The impact:

A new analysis from Centre for Science and Environment (CSE) India predicts a 0.33 percent decline in Africa’s GDP under partial coverage of products and phasing out free allowances, and a 0.12% decline in India’s GDP under €40 carbon price assumptions.

In 2022-23, India’s total exports to the EU were primarily covered by CBAM-covered goods.

The EU will begin collecting carbon taxes on every shipment of steel and aluminum on January 1, 2026, requiring Indian companies to pay tariffs equal to 20–35 percent of the total.

This presents a big obstacle for the metal industry in India. The country exported $8.2 billion worth of iron, steel, and aluminum products to the EU in 2022, accounting for 27% of its total exports.

Although CBAM also covers cement, fertilizer, electricity, and hydrogen, India does not export any of these goods to the EU.

The tax burden for 2022-23 is projected to be 0.05 percent of India’s GDP. Over the past two decades, OECD countries have imported emissions on a net basis, as their consumption emissions outweigh their production emissions.

Between 1990 and 2021, the EU imported 19% of its emissions annually from abroad, outsourcing a significant portion. However, its 2019 emissions per capita were 6.5 GtCO2, thrice as high as India, and 43 times higher than Ethiopia.

The impact on the Indian MSMEs:

Although, the latest details of the Indian MSMEs contribution in exports to the EU are not available, a Global Trade Research Initiative report said that MSMEs contribute 45% to India’s total exports and 38% of manufacturing output.

As per DGCIS, despite an increase in MSME exports from $154.8 billion in FY20 to $190 billion in FY22, the share of MSME-specified products in exports declined from 49.77% in FY 2020.

A NITI Aayog report on MSME exports released in March this year said, “Exporting is crucial for Indian MSMEs to break away from dwarfism and unlock their true growth potential. Exporting can allow 54 lakh (5.4 million) manufacturing MSMEs to tap into new markets and expand their customer base, leading to increased revenue and profit.”

How effective are the counter measures?

To counter a CBAM, measures such as implementing a domestic carbon price through a domestic carbon market are suggested. India’s Carbon Credit Trading Scheme (CCTS), led by the Bureau of Energy Efficiency, is developing a domestic compliance carbon market. Still, its readiness to offer EU equivalent carbon prices remains uncertain.

The EU may not consider India’s initiatives for decarbonization, such as non-fossil power targets in its Nationally Determined Contributions (NDCs). This is because the CBAM relies on carbon pricing as a matrix to determine the taxation of exporting country goods.

Overemphasis on carbon pricing overlooks non-pricing efforts, undermining effectiveness and disincentivizing alternative decarbonization measures in CBAM, as acknowledgment for these initiatives is lacking.

Additionally, India is pursuing measures to protect its interests and promote sustainable development, including a carbon credit trading system and renewable energy capacity targets. To offset increased trade costs under CBAM, India should convert energy taxes into carbon price equivalents for export calculations. Additionally, it may seek FTA exemptions for the MSMEs to shield them from CBAM-related trade restrictions.

A positive outcome:

The CBAM rollout may prompt the development of robust carbon accounting methods and protocols for domestic industries to initiate emissions monitoring and reporting.

Decarbonization in exporting countries’ manufacturing sectors necessitates comprehensive mitigation strategies and sustained international financing to support these efforts.

The carbon border tax, currently affecting only 1.64 per cent of India’s total exports, is an additional tax burden and trade barrier.

Decarbonization is unlikely to be incentivized in jurisdictions outside the EU. This is because developing countries are expected to fund it entirely through their domestic budgets without EU support.

Conclusion:

The CSE reports that the EU’s introduction of the CBAM will result in a 25% tax on India-exported carbon-intensive goods.

The report suggests a 0.5% tax burden on India’s GDP in 2022-23, with a counter-tax imposed on rich countries historically responsible for climate change.

The CSE report also suggests a ‘historical polluter’ counter-tax on rich countries responsible for climate change, enabling non-historical countries to finance their decarbonisation efforts.

We agree that India should develop a domestic mechanism to counter the severe effect of CBAM on Indian enterprises. In simple words, this means that we will see our domestic carbon markets evolving at must faster pace.

One in five CFOs in large enterprises is prepared to meet upcoming requirements to report and seek external assurance on climate-related risks and opportunities.

An Accenture survey indicates that despite the majority of executives anticipating an increase in sustainability reporting requirements in the coming years, well-prepared executives are more likely to view sustainability as a potential opportunity for their companies.

The company has released the report during a period of increasing global sustainability regulations and legislation. These include EU’s CSRD regulation and CBAM, and the US SEC’s climate disclosure rules; measures to enhance market transparency, set carbon content-based import prices, and provide grants for sustainable activities.

Key findings:

According to the survey:

90% of respondents agreed that ESG issues will be a major focus for them over the next five years.
Nearly 85% of respondents said they expect mandatory disclosure to increase over the next three years.
Over 80% of respondents indicated that they are under pressure from three or more stakeholder groups to take sustainability-related action. The most frequently mentioned groups exerting pressure are shareholders, board members, and regulators.
Just 22% of CFOs reported feeling well prepared to disclose on climate-related risks and opportunities and to seek external assurance on their disclosures.
Additionally, only 10% of CFOs felt well prepared to meet these reporting requirements in all sustainability areas, such as resource use and circularity.

These results suggest that finance executives are feeling the pressure of the changing regulatory landscape. The findings suggest that even though finance executives are under increasing pressure to address sustainability issues, most do not yet feel ready to meet many of the new requirements.

Ratings per ESG measurement:

The study found a wide range of preparedness across the nine capabilities.

In this, it rated 12% of businesses as weak, 73% at a moderate level, with some having automated ESG data capture and most approaching the integration of ESG into their management systems, and 15% as having strong capabilities, including gathering comprehensive ESG data, automatically monitoring quality, utilizing ESG data to enhance business decision making, identifying potential ESG risks with predictive analytics, and developing complementary skills within their finance and sustainability teams.

According to the survey, 68% of the “weak” group’s companies reported finding it difficult to strike a balance between profitable growth and sustainability, compared to only 20% of the “strong” group. Additionally, “strong” companies were more than twice as likely (20%) to already view sustainability as a significant value driver for their organizations than the “weak” group (9%).

The study revealed a noteworthy association between businesses that perceive sustainability as a potential area for growth and opportunity and those that are well-prepared for ESG measurement and management.

How prepared are the Indian CFOs?

Indian Chief Financial Officers (CFOs) are the most optimistic in the APAC region, with 94% of them expressing confidence in their country’s economic future, according to the most recent Deloitte Asia Pacific (APAC) CFO Survey 2023 which was released in September last year.

Indian CFOs, also demonstrated an urgency when it came to putting in place suitable processes to comply with climate requirements. Approximately 59% of Indian CFOs plan to implement the required processes in the future, and 37% have already done so. Twenty-two percent of Indian CFOs were found to be adequately prepared to handle ESG challenges, according to the survey.

Using more sustainable materials (55 percent), encouraging or requiring suppliers and business partners to meet specific environmental sustainability criteria (53 percent), and adopting public policy positions that promote sustainability and actions to address climate change (65 percent) were the top three proactive sustainability initiatives by Indian CFOs.

Our take:

India is at the cusp of entering the ESG/sustainability mainstream. Global compliances and domestic mandates such as the BRSR Core are promoting the community to closely monitor the corporate ESG strategy, compliance and reporting. They are working closely with the BU Heads as well as the ESG teams and external partners to not just understand the new concepts, but also the ramification of non-compliance and the financial impact on the business!

The regulatory mandates in India have evolved to be more supportive and balance growth and sustainability.

In 2023, carbon pricing revenues reached a record $104 billion, according to the World Bank’s annual “State and Trends of Carbon Pricing 2024” report.

Key findings:

Large middle-income countries including Brazil, India, Chile, Colombia, and Türkiye are making strides in carbon pricing implementation.

While traditional sectors like power and industry continue to dominate, carbon pricing is increasingly being considered in new sectors such as aviation, shipping, and waste.

Currently in a transitional phase, the EU’s Carbon Border Adjustment Mechanism, or CBAM is also encouraging governments to consider carbon pricing for sectors such as iron and steel, aluminum, cement, fertilizers, and electricity.

The India story:

India legalized a carbon market in 2022, establishing an ETS based on existing energy efficiency schemes in emission-intensive sectors, potentially evolving into a compliant carbon market.

Countries like India, Indonesia, Morocco, Türkiye, Ukraine, Uruguay, and the Western Balkans are implementing or considering direct carbon pricing to reduce compliance costs and capture EU revenue.

Government crediting mechanisms have been launched in five jurisdictions since 2023, bringing the total to 35 globally. 11 jurisdictions are considering carbon crediting mechanisms, including India revising its carbon pricing plans and Thailand upgrading its domestic crediting mechanism to Premium T-VER for international buyers.

Overestimation of cookstove impacts underscores need for accurate assessment methodologies. China and India remain largest host countries, but issuance volumes decrease 40% annually.

Carbon taxes and emissions trading systems currently cover 24% of global emissions, with significant progress in middle-income countries like Brazil, India, and Turkey. These countries recognize the need for climate action and the role of carbon pricing in climate mitigation strategies.

New carbon credit sources are emerging, and middle-income countries are integrating crediting frameworks into their policies. China, the EU, India, and Vietnam are relaunching their schemes, with voluntary action accounting for most demand, while compliance demand is slowly building.

Challenges:

Despite record revenues and growth, global carbon price coverage and levels remain too low to meet the Paris Agreement goals.

Currently, less than 1% of global greenhouse emissions are covered by a direct carbon price at or above the range recommended by the High-level Commission on Carbon Prices to limit temperature rise to below 2ºC.

The Paris Agreement’s temperature goals require urgent action to align mitigation efforts with cost-effective policies like carbon pricing. Implemented carbon taxes and emissions trading systems cover a quarter of global emissions, with revenue exceeding $100 billion in 2023.

The report notes that closing the implementation gap between countries’ climate commitments and policies will require much greater political commitment.

However, concerns over market integrity persist, leading to declining market activity and a growing pool of non-retired credits.

Data:

There are now 75 carbon pricing instruments in operation worldwide. Over half of the collected revenue was used to fund climate and nature-related programs.

When the first report was released, carbon taxes and Emission Trading Systems (ETS) covered only 7% of the world’s emissions. According to the 2024 report, 24% of global emissions are now covered.

“Carbon pricing can be one of the most powerful tools to help countries reduce emissions. That’s why it is good to see these instruments expand to new sectors, become more adaptable and complement other measures,” said Axel van Trotsenburg, World Bank Senior Managing Director. “This report can help expand the knowledge base for policymakers to understand what is working and why both coverage and pricing need to go up for emissions to go down.”

The way forward:

Governments are also increasingly using carbon crediting frameworks to attract more finance through voluntary carbon markets and facilitate participation in international compliance markets.

The steel industry’s decarbonization has been the main focus because it is essential to meeting the world’s net-zero emission targets. However, the cost of green steel production, lack of incentives, and regulations have created hurdles. But the good news is that the goal is achievable. While the cost of producing green steel may not be a hurdle for a few, regulations and price incentives are essential to drive the shift in investment and consumption towards green steel production, at large.

Undoubtedly, steel production is a major contributor to global carbon emissions, accounting for about 8% and roughly 30% of the segment emissions, respectively. In addition, the steel sector is also the leading consumer of coal, a key source of the heat and carbon required to convert iron ore into steel.

The good news is that the domestic primary steel producers are set to achieve their goal of reducing carbon emissions. According to a recent report from rating agency Crisil, Indian steel companies had set an ambitious target of reducing carbon emissions below 2 tCO2/tcs by 2030. The industry has already made significant progress. Steel manufacturers’ reported carbon emissions have decreased from over 3 tCO2/tcs in fiscal 2005 to 2.35 tCO2/tcs, which translates to a 65% reduction in targeted emissions.

The report also highlighted the benefits of emission reduction. Reducing emissions broadens fund-raising avenues, improves export competitiveness, and has a positive impact on credit quality. However, Crisil acknowledges the challenges that lie ahead to completely transitioning to low-carbon steel, also known as green steel.

Shifting Towards Low-Carbon Steel Production
Coal-fired steel plants are major contributors to CO2 pollution. To address this challenge, companies are exploring alternative solutions, such as using low-carbon energy sources like hydrogen, coal gasification, or electricity for steel production.

Meanwhile, media reports in China indicate that the nation’s steel industry could reduce carbon emissions by as much as 11% by 2025 if the government sets a more aggressive goal for the use of electric arc furnaces (EAFs).

Cost of Green Steel Production
The cost of green steel production in comparison to traditional methods and the viability of large-scale production are important considerations in this discussion. While the cost premium exists, it is not as high as initially feared, depending on the production location and method. The cost premium for green steel can range from negligible to around $150 per metric ton.

Crisil previously discussed the difficulties that Indian steel producers may encounter as a result of the EU’s CBAM. This mechanism may result in a 17% increase in the cost of India’s steel exports to the EU. When paired with greenflation, the overall effect might reach 40%.

The CBAM Deadline:
As per CBAM regulations, exporters will need to submit quarterly reports on their emissions starting October 1, 2023. From December 31, 2025, they will be required to purchase Emissions Trading System (ETS) certificates to offset their greenhouse gas emissions. Initially, industries will be granted free allowances to ease the transition, but these allowances will progressively disappear by 2034. The ETS tax will then become applicable to the portion of emissions not covered by free allowances.

The Indian steel industry is emerging as a frontrunner in decarbonization. Their significant progress in slashing emissions, exceeding halfway to their 2030 target, is a testament to their commitment to environmental stewardship.

SAIL has on-boarded Bengaluru-based Sentra.world to measure carbon emissions.

Harsh Choudhry, CEO and co-Founder, Sentra.world, confirmed the development. He affirmed that Sentra will implement its software solutions to measure carbon emissions at SAIL.

The software will enable SAIL to align with global standards and protocols. “Besides internal data analysis, our software also connects with suppliers for scope-3 emissions. We have also implemented some AI and blockchain-based applications to monitor carbon production and emissions,” Choudhry told WriteCanvas. “The objective is to develop a comprehensive strategy to combat climate change, with a focus on green steel.”

On its part, SAIL has adopted a three-pronged approach to measure carbon emissions. This involves increasing the use of scraps, utilizing renewable energy for energy efficiency, and using natural fuels for steel production.

It is also planning developing initiatives to combat climate change and prevent carbon leakage-a CBAM pre-requisite. The EU has announced that it will impose taxes on carbon imports from six sectors including steel.

Accordingly, Sentra will first deploy the data analytics software in Durgapur, with an aim to review submissions across all the plants. SAIL Durgapur steel plant, also known as DSP, is a 2200 thousand tonnes per annum (TTPA) blast furnace (BF) and basic oxygen furnace (BOF) steel plant operating in Durgapur, West Bengal, India.

According to Choudhry, the software integrated with the PSU’s ERP systems will measure the carbon emissions and provide SAIL clarity on their baseline enabling them to manage their compliance reporting effectively, and helping them achieve net-zero across multiple steel plants.

SAIL aims to significantly decrease CO2 emissions by 2030, increase renewable/non-conventional energy usage, and achieve net-zero emissions by 2070.

It must be noted that in August 2023, SAIL signed a Memorandum of Understanding (MoU) with Germany’s SMS Group to explore sustainable steel production solutions. The MoU aims to reduce carbon emissions and promote environmentally friendly technologies in SAIL’s integrated steel plants, aligning with India’s goal of achieving net-zero emissions by 2070.

A parliamentary panel has recommended that the Indian government delay the submission of MSMEs’ Carbon Border Adjustment Mechanism (CBAM) application to the European Union for at least three years.

The move aims to alleviate financial constraints on Indian MSME manufacturers who may not be able to meet CBAM’s demands. The committee has emphasized the need for a robust support mechanism for Indian MSME manufacturers to adapt to CBAM’s requirements.

The committee expressed optimism about achieving a $300 billion target for engineering exports by 2030 but raised concerns about potential obstacles from US and EU tariff and non-tariff barriers.

It must be noted that starting January 1, 2026, EU importers will face a 20-35% tax on steel imports, requiring the declaration and purchase of CBAM certificates to cover emissions.

In the recent past, we have seen a mixed bag of developments. On the one hand, we saw the rollout of CBAM by the EU, and on the other hand, we saw some of the countries taking stock of their net zero plans.

The CBAM rollout by the EU has invited strong reactions from many countries exporting into Europe, including India and China. Protecting the trade of a country is necessary; it is also equally important to protect our environment. CBAM, according to me, is a beginning, and we should have stricter compliances in place to protect Mother Earth.

We have, in the recent days, seen insufficiency in action by nations and corporates alike. For example, to meet its climate goals, the EU needs to cut its carbon emissions three times faster. This is as per the latest report released by the European Commission on the State of the Energy Union. New estimates from the European Environment Agency suggest current policies in EU member states will cut emissions in 2030 by just 43%. At the same time, if include the planned policies which are yet to be implemented, the number can rise to 47 percent, which is way less than the target of 55 percent.

It is now believed that Canada’s emission reduction plans may be insufficient to meet its 2030 targets. By 2030, Canada has aimed to cut emissions by 40-45% to its 2005 levels. The latest report by the country’s auditor general states that the measures taken by the country are insufficient or not prioritized. That means the country will miss its commitment to the Paris Agreement on climate change.

While on the corporate side, half of the world’s 2,000 biggest listed companies have set a target to achieve net-zero emissions by 2050.

In another development, a news report by the agency Reuters says only a fraction of these companies meet the United Nations guidelines for what constitutes a quality pledge. This is based on a report published by Net Zero Tracker.

“Net Zero Tracker, an independent data consortium including Oxford University, said corporate targets from Forbes2000 index companies had jumped 40% to 1,003 in October 2023, from 702 in June 2022, covering two-thirds of revenues, some $27 trillion. However, just 4% of the companies meet the criteria laid down by the UN’s Race to Zero campaign, for example, by covering all emissions, starting to cut them immediately, and including an annual progress update on interim and longer-term targets.”

Some positive movements are also seen. China, the world’s biggest polluter, had announced to set up green pilot programs in 100 cities as it chases the 2030 carbon-peaking, net-zero targets.

The 35 pilot programs and relevant policy mechanisms are expected to crystalize in 2025 and progress significantly by 2030.

Even Indonesia, Southeast Asia’s largest economy, has slashed carbon emissions targets for its power sector by 2030 and pledged to boost its share of renewable energy. It released a roadmap as it seeks to wean itself off coal.

The country has set a target to achieve net-zero power sector emissions by 2050 in return for financing for the $20 billion Just Energy Transition Partnership (JETP) plan. Under the plan, Jakarta has pledged to slash its power sector carbon emissions to a peak of 250 million metric tonnes by 2030, down from a previous cap of 290 million. It also plans to boost its renewable energy generation share to 44 percent by 2030, up from an initial target of 34 percent, the planning document said.

In one word, announcing targets and emission reduction projects must be implemented with stricter vigor. That is the only way to save Mother Earth from man-made damages and save us from further catastrophes.

Tag: CBAM