The Carbon Boarder Adjustment Mechanism and Its Impact on the European Market: Does Everything Need to Change for Things to Remain the Same?

It is reasonable to think that the CBAM might become more of a burden than a blessing for the common market, at least in a short-term perspective. Though the number of companies that consider the environment a priority is increasing steadily in Europe, inequal measures will always raise discontent, which might become particularly alarming at a moment when the European society is shaken by trends of disunity around several political and social issues.

In consideration of all the above, the CBAM might influence the common market and the EU’s social tissue accordingly to the success of its implementation, depending on the EC’s capacity to adapt the measure and to find a balance between goals it has set and the actual situation. This analysis considers the implementation costs (be they moderated or extremely high) and the standard of implementation: equal or unequal.

The first scenario sees high costs of implementation to be born unequally by a restricted part of the market and the society. Seeking the highest possible profit, companies will sell at higher prices, favoured by growing demand, impacting on the whole value chain and resulting in exacerbated protectionism. Discontent will grow among companies, customers and workers and the common market will—eventually—reach a stagnation point. This scenario assumes the edge-case where foreign companies will direct their offer elsewhere massively, suddenly ignoring the European demand because of high importation costs. It eventually leads the discontent to spill over into the political and social fields, with increasing disillusion towards the EU’s environmental policies and a profound sense of scepticism towards the work of the Union.

The second case entails an unequal implementation of the measures (i.e., some sectors bearing the costs of the mechanism earlier or more directly than others) combined with moderated prices. In this way, discontent will spread limitedly but the mild cost will compensate for it. Despite being less alarming than the first one, in this scenario, the CBAM would prove completely ineffective and wouldn’t bring any significant change.

The best-case scenario entails equal implemented measures at moderated prices. For this to happen, the CBAM would have to work perfectly, relying on a flawless bureaucratic machine, precise calculations done by informed, dedicated companies, ready to comply with whatever it takes to protect the environment. In an ideal world, such a model would lead to a global carbon tax applying worldwide with the EU regarded as the pioneer of the global green trade harmonisation.

The fourth scenario, which seems the most realistic, foresees high prices (definitely higher than the current ones) combined with equal measures. This will allow for an overall smooth transition, without disrupting the EU’s trade relations with its partners. Perhaps, companies will even be encouraged to invest more in greener solutions. This entails a functional adaptation to the CBAM combined with the ability from the Commission to smooth the mechanism’s edges. From a short-term perspective, some discontent will surely arise, especially among companies working in the sectors where the measure applies first. Nevertheless, in the long run, the mechanism will serve its scope, perhaps gifting the EU with some new partners willing to harmonise their production measures.

Bearing in mind how difficult of an exercise it is to assess a measure that has not entered into force yet, it is safe to envisage that the CBAM will not make the difference in the short run, nor will it be determinant for all companies to pursue greener production. Nevertheless, if implemented with care and applying the necessary adjustments, it should reveal a precious tool in complementing the EU’s efforts in the field of climate policies and a valuable tool to complete the Fit for 55 Package.

In July 2021, the European Commission (EC) announced the launch of the Carbon Boarder Adjustment Mechanism, the CBAM. It was presented as a climate measure in support of the EU’s ambitious environmental goals, namely achieving the target to cut its carbon emissions by 55% - if compared with the 1990 levels—by 2030. The CBAM has been received with controversies since the beginning, from both companies and countries, in the 27 and abroad.

The mechanism will impact the European market, European and foreign companies and partner countries, with potential political and social implications for the Union. This measure comes at a time when the EU is facing several complex challenges, ranging from the post-pandemic recovery to the unity issues that undermine Brussels’ aspirations to be counted among the great players of the international arena as a unitary actor.

Carbon Boarder Adjustment Mechanism’s ID, timeline and scope

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According to the European Commission, the CBAM will entail three main benefits. First, it will prevent European companies from bypassing the EU’s stringent policies aimed at preventing carbon leakages through dislocating the production to foreign countries.

Second, to shield the European companies from foreign competitors who work under less tight production regulations and, therefore, offer cheaper products (at a major environmental cost). Third, to encourage foreign companies to turn towards greener standards of production. This might eventually result in policy harmonisation in the long run. The Commission came up with a complex design, carefully structured to comply with the existing internal regulations while avoiding any overlap with the EU ETS [1] . Furthermore, the mechanism is designed to avoid any contrast with the Union’s international commitments, for instance within the IMF and WTO.

The CBAM will consist of a system of certificates to be purchased by companies who wish to import on the European market from third countries. In short, companies will need to purchase certificates for the cost of the manufacturing would have born under EU regulations.

The price of the certificates will be calculated by dividing the weekly average auction price of EU ETS allowances by the tonnes of CO2 emitted during the production process. The mechanism will be managed by national authorities of the 27 EU members states together with importers, sharing responsibilities.

In consideration of the articulated nature of the CBAM mechanism, its implementation will be progressive and start from a limited number of industries that entail a high risk of carbon leakage, namely iron and steel, cement, fertiliser, aluminium and electricity. During an initial transitional period (2023-2026) companies will declare the number of emissions embedded in the goods they are trading, without paying any financial adjustment. This will allow a smooth adaptation to the new system while giving the EC time to evaluate the effectiveness of the CBAM for the markets it will apply. In this way, the Commission will be able to decide whether to extend it to other products and services.

The EC previewed some exemptions from this system, for instance for countries already complying with the EU ETS or those that have an emission trading system already linked to the EU’s. This will be the case for EEAS countries and Switzerland. Similarly, exemptions are set out for companies operating in the electricity sector in such countries. However, the exemption would be offered only if severe de-carbonisation measures are implemented, following the adoption of an emission trading system equivalent to the EU one and will be conditional to review in 2030.

The main question is whether the CBAM will push companies producing abroad to invest in greener manufacturing policies. To do so, it is fundamental to guarantee equal standards of importation to all companies and the bureaucratic machine shall function flawlessly. This said, the CBAM will impact the European common market as well as on trade relations with companies based in third states. The effects of the mechanism might easily spill over onto the political level, with several countries and sectors already looking at the measure with scepticism.

Benefits and challenges

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Along with the above-mentioned benefits, the CBAM is designed to bring some subsequent advantages. EU workers, for instance, will benefit from a less competitive job market, as European companies will be deterred from dislocating their production, seeking for cheaper labour force. This kind of benefit will likely be observed in the medium term, bringing discontent among the companies’ owners, who will have to deal with higher production costs, as the main disadvantage. Another plus side of the CBAM concerns investments and pays off in the longer term. One example is quite evident and it’s linked to the current trend that sees investors devoting particular attention to the environment. In fact, they might be more eager to spend their capital on companies that observe strict climate policies. Investments can also have an advantageous return for the common market and European workers in the field of energy transportation. Renewable energy will require an adequate infrastructural system, therefore new investment opportunities for building trade routes will favour the creation of workplaces.

It is fair to observe that the CBAM will be most beneficial from a long-term perspective. Currently, the main issues with the mechanism concern its implementation and the fact that the Commission itself acknowledged that the system has imperfections. For example, it does not include indirect emissions in the data gathering for calculating the certificates price. This constitutes a disadvantage for certain sectors, notably aluminium, while favouring some other—potentially at higher risk of leakage—ones. In a preliminary assessment released in October 2021, European Aluminium underlined how the sector has to deal with ferocious competitiveness—mainly from Chinese industries—driven inter alia by a growing demand for the product. This can be the case for other markets as well. Some fear the CBAM could escalate to the point that it evolves in a protectionist measure, possibly setting a precedent of local regulations exploited to impose European standards abroad. In this case, the common market risks becoming stagnant, as foreign clients will look elsewhere for cheaper products, European buyers will lose their nerves to growing prices of scarce goods. Another central issue is represented by the CBAM’s calculation criteria, which are said to be inequal, depending on sectors and products. This said, what seems to be annoying the European companies the most is that the mechanism starts applying only to some industries.

It is reasonable to think that the CBAM might become more of a burden than a blessing for the common market, at least in a short-term perspective. Though the number of companies that consider the environment a priority is increasing steadily in Europe, inequal measures will always raise discontent, which might become particularly alarming at a moment when the European society is shaken by trends of disunity around several political and social issues.

Four scenarios for the EU’s market

In consideration of all the above, the CBAM might influence the common market and the EU’s social tissue accordingly to the success of its implementation, depending on the EC’s capacity to adapt the measure and to find a balance between goals it has set and the actual situation. This analysis considers the implementation costs (be they moderated or extremely high) and the standard of implementation: equal or unequal.

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The first scenario sees high costs of implementation to be born unequally by a restricted part of the market and the society. Seeking the highest possible profit, companies will sell at higher prices, favoured by growing demand, impacting on the whole value chain and resulting in exacerbated protectionism. Discontent will grow among companies, customers and workers and the common market will—eventually—reach a stagnation point. This scenario assumes the edge-case where foreign companies will direct their offer elsewhere massively, suddenly ignoring the European demand because of high importation costs. It eventually leads the discontent to spill over into the political and social fields, with increasing disillusion towards the EU’s environmental policies and a profound sense of scepticism towards the work of the Union.

The second case entails an unequal implementation of the measures (i.e., some sectors bearing the costs of the mechanism earlier or more directly than others) combined with moderated prices. In this way, discontent will spread limitedly but the mild cost will compensate for it. Despite being less alarming than the first one, in this scenario, the CBAM would prove completely ineffective and wouldn’t bring any significant change.

The best-case scenario entails equal implemented measures at moderated prices. For this to happen, the CBAM would have to work perfectly, relying on a flawless bureaucratic machine, precise calculations done by informed, dedicated companies, ready to comply with whatever it takes to protect the environment. In an ideal world, such a model would lead to a global carbon tax applying worldwide with the EU regarded as the pioneer of the global green trade harmonisation.

The fourth scenario, which seems the most realistic, foresees high prices (definitely higher than the current ones) combined with equal measures. This will allow for an overall smooth transition, without disrupting the EU’s trade relations with its partners. Perhaps, companies will even be encouraged to invest more in greener solutions. This entails a functional adaptation to the CBAM combined with the ability from the Commission to smooth the mechanism’s edges. From a short-term perspective, some discontent will surely arise, especially among companies working in the sectors where the measure applies first. Nevertheless, in the long run, the mechanism will serve its scope, perhaps gifting the EU with some new partners willing to harmonise their production measures.

Bearing in mind how difficult of an exercise it is to assess a measure that has not entered into force yet, it is safe to envisage that the CBAM will not make the difference in the short run, nor will it be determinant for all companies to pursue greener production. Nevertheless, if implemented with care and applying the necessary adjustments, it should reveal a precious tool in complementing the EU’s efforts in the field of climate policies and a valuable tool to complete the Fit for 55 Package.

Bibliography

European Aluminium, Preliminariìy Assessment—Draft Regulation on the introduction of an EU Carbon Border Adjustment Mechanism, 7 October 2021

Carbon and Capture, The Economist, 17^th July 2021

Making Trade Greener, The Economist—Special Report World Trade, 9^th October 2021

Carbon Border Adjustment Mechanism: Questions and Answers, European Commission, 14^th July 2021 (https://ec.europa.eu/commission/presscorner/detail/en/qanda_21_3661)

EU Emissions Trading System (EU ETS), European Commission (https://ec.europa.eu/clima/eu-action/eu-emissions-trading-system-eu-ets_en).

1. The EU Emission Trading System, also known as the EU ETS, is the first emission trading system launched by the EU in 2005. The EU ETS sets a limit on the amount of greenhouse gas emissions that can be released from industries in specific sectors. Allowances can be bought in this system, though a certain number is distributed for free. The main limit of the ETS system is that it does not encourage investments in greener production in third countries. To avoid overlapping and controversies, the ETS system will integrate gradually with the CBAM until full substitution. The complete takeover is thought to be put in place within 2035. Meanwhile, the CBAM will apply only to the part of the emissions not benefitting from allowances under the ETS system. (https://ec.europa.eu/clima/eu-action/eu-emissions-trading-system-eu-ets_en).