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.

EU member states have approved a directive delaying the adoption of sector-specific sustainability disclosure standards and sustainability reporting from non-EU companies under the Corporate Sustainability Reporting Directive (CSRD).

The EU Council and Parliament have agreed to delay the deadline for sector ESRS by two years, urging the Commission to publish and adopt sector reporting standards soon.

The new directive will postpone the adoption of the ESRS for non-EU companies to June 2026, and delay 2028 reporting obligations by two years to 2030.

The Council has officially approved a directive, extending the deadline for the adoption of sector-specific sustainability reporting standards for EU companies and general sustainability reporting standards for non-EU companies.

This modifies the Corporate Sustainability Reporting Directive (CSRD) for specific industries and third-country undertakings, allowing the affected companies additional time to implement the European Sustainability Reporting Standards (ESRS), the Council said in a press release.

The European Union’s CSRD, which began in 2024, requires companies to report on sustainability-related impacts, opportunities, and risks.

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.

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.

As India plans its carbon tax, it is likely to accept the EU’s Carbon Border Adjustment Mechanism (CBAM)

India is set to comply with the EU’s default carbon emissions calculations during the transition phase (Jan 2024-June 2024) of CBAM.

CBAM mandates nations to process values for calculating carbon emissions during the production of identified polluting items. India’s steel and aluminum industries may face additional levies of 20-35% if they don’t comply with EU standards. Little wonder, the new mandate may pinch the Indian exporters from sectors such as steel, cement, aluminum, and fertilizer. That doesn’t mean the sectors are insulated, they also will have to follow suit soon.

Meanwhile, India is planning its carbon tax, particularly for exports to European nations.

India, which has set a target to achieve net zero by 2070, aims to reduce the total projected carbon emissions by one billion metric tons and reduce the carbon intensity of its economy by at least 45 percent, by 2030.

It must be noted that CBAM was implemented on October 1, 2023, to increase carbon pricing for EU-produced goods, aiming to level the playing field between EU producers and international competitors.

Carbon taxes on carbon-intensive goods covered under CBAM will not kick in before 2026 and thus EU-based importers only need to report data on the embedded emissions only till the end of 2025.

Also, as of today, India does not have a carbon verification and accreditation system. This may make it difficult for the country to determine its emissions. During the transition, using the EU’s default value for emissions could be more prudent.

The European Union (EU) has taken a firm stand against forced labor.

As part of the stringent action, the EU has decided to ban all products (internal and international) made with forced labor. With the latest resolve, the EU has strengthened its commitment to the S or the social quotient of ESG.

A set of rules that will also be implemented to look into forced labor in the companies’ supply chains will ensure the move. The rules will cover the transport, storage, and distribution of goods segments in the supply chain.

The new charter empowers law enforcement agencies to seize products developed by forced labor at the borders. Offending suppliers will be suspended. The supplier can, however, re-enter the EU market by complying with the new laws, which align with the ILO standards.

The new law introduced can adversely hit developing countries as there could be forced labor violations. Every new law/ regulation introduced by the EU raises fresh concerns among traders, especially in these countries.

It may not be an immediate concern as any regulation could take time to implement. Therefore, it is an opportune time for the exporters of India to change strategies and start looking at complying with these new regulations. Other regions will follow suit.

Recalling here, the EU has a carbon tax for products entering its markets. In addition, in June this year, it introduced regulation on deforestation-free products.

Our forests are getting the global attention they have always deserved.

Recent developments:

European Union on June 29, 2023, introduced a regulation on deforestation-free products. In a press release, the EU said, “The main driver of these processes is the expansion of agricultural land that is linked to the production of commodities like soy, beef, palm oil, wood, cocoa, coffee, rubber and some of their derived products, such as leather, chocolate, tyres, or furniture. As a major economy and consumer of these commodities linked to deforestation and forest degradation, the EU is partly responsible for this problem and it wants to lead the way to solving it.”

How this translates into a real-world scenario is this: operators trading these commodities in the EU market must have a certificate or legal documents to prove that the products do not originate from recently deforested land or have contributed to forest degradation.

Advantage or disadvantage?

Even as the world deliberates on the new developments and a concentrated effort to re-forest the deforested areas and stop further damage. When the European Union introduced a regulation on deforestation-free products, back home some observers believed that India will be in an advantageous position as the country has clearly demarcated agricultural and forest land.

However, Nagaraj Prakasam, author of the book, Back to Bharat—In search of a sustainable future, and a farmer, cautioned that it is time to ascribe value in modern and scientific terms to much that we have considered old or traditional or tribal. Compare, for instance, the carbon footprint of a farmer living in a village of thatched-roof houses whose family weaves textiles to someone living in Bengaluru, New York or London.

“Obviously, he is more considerate about the future than his counterparts elsewhere, but we call him poor instead of celebrating his simplicity and providing him carbon credits. We have become focused on encouraging carbon fixers, without appreciating or rewarding the carbon preventers. While India’s GDP, totalling $3.6 trillion, is one-eighth that of the US whose GDP is $25 trillion (IMF 2022), per capita carbon emission in the US is 6.9 times more than that in India. If carbon is the new gold, then who is rich? India’s per capita greenhouse gases (GHG) emissions, at 2.7 tonnes of CO2, are significantly lower than the global average (6.6 tonnes), the US’s (18.4 tonnes), or China’s (8.2 tonnes), a fact we need to recognize urgently,” Mr Prakasam noted.

The background:

Forests that have traditionally contributed a large part of the green cover on Planet Earth, are slowly and gradually diminishing.

The reasons are aplenty: increased population, rapid urbanization, climate change, migration, industrial agriculture, timber logging, mining, expansion and infrastructure, and draught among others. The impact is just not on the economy, but wildlife, natural conversation and bio-diversity as well as human beings—the entire extended value chain.

Data and analysis:

According to Our World in Data, globally we deforest around ten million hectares of forest every year. That’s an area the size of Portugal every year. Around half of this deforestation is offset by regrowing forests, so overall we lose around five million hectares each year. Nearly all – 95% – of this deforestation occurs in the tropics.

The London School of Economics and political science in a paper on the scale of deforestation and its role in climate change noted that land use change, principally deforestation, contributes 12–20% of global greenhouse gas emissions. Forest degradation (changes that negatively affect a forest’s structure or function but that do not decrease its area), and the destruction of tropical peatlands, also contribute to these emissions. As a result of deforestation and degradation, some tropical forests now emit more carbon than they capture, turning them from a carbon ‘sink’ into a carbon source.

While the regulators are tightening compliance standards and introducing or upgrading frameworks at regular intervals to combat climate change and mitigate risk, the focus on forests (our green cover) has gained prominence in the last few years.

The roadmap:

The good news is that the global forums effectively led by the UN and EU, WB, ADB, and back home, the GoI are making efforts to salvage the natural resource.

Take for example, the UN’s SDG 15 which aims to protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification, and halt and reverse land degradation and halt biodiversity loss.

In lieu of the same, experts recently deliberated on methods to achieve global forest goals and ways to enhance sustainable forest management at an event on United Nations Forum on Forests.

The initiative gained significance as the UN Forum for Forests has pegged the year 2023 as a pivotal year for the United Nations Strategic Plan on Forests and the 2030 Agenda on Sustainable Development. Contextually, it has revealed specific forest-based actions that address interconnections and advance the fight against climate change for sustainable development.

Similarly, the European Union prepared the world with the introduction of a regulation on deforestation-free products.

Likewise, the Lok Sabha (lower house of the Parliament in India) has passed the Forest (Conservation) Amendment Bill 2023, last week. While more details and clarity are awaited, I believe that the bill will enable permission to use or clear the forest land for security installations. It is true that the India’s forest cover is increasing. Going by that yardstick, the Indian agricultural segment has a wider market opening up globally.

These are some of the recent policy developments in the two regions. We anticipate that more will follow in the future.

Tag: EU