The cost of carbon emissions is rising

With global attentions distracted by recent COP events, the introduction of the EU’s Carbon Border Adjustment Mechanism (CBAM) may have gone relatively unnoticed. In essence, CBAM is a tariff on carbon-intensive products imported into EU countries. It forms part of the European Union’s ‘Fit for 55’ climate policy initiative to help member states reduce greenhouse gas (GHG) emissions by 55 percent by 2030 compared to 1990 – and it plugs an important gap.

Domestic emissions reduction measures, such as the Emissions Trading Scheme (ETS), incentivise cleaner production processes within Europe, but they bring a new problem: carbon leakage. If EU companies face higher production costs at home due to carbon pricing, they are likely to shift production to countries with looser regulations – exporting the emissions problem instead of addressing it.

CBAM removes this loophole by attaching a carbon price tag to imports entering the EU. If carbon tax is already paid in the originating country, it will be adjusted accordingly to avoid double taxation – but whatever the final calculation, there is no escaping the bill.

The initial scope of CBAM targets six key sectors that account for almost half of the EU’s industrial emissions embedded in imports: cement, iron and steel, aluminium, fertilisers, hydrogen, and electricity. However, the scope is expected to expand to encompass additional sectors, potentially impacting many more industries.

Across sectors, CBAM will be implemented in two phases: the transitional phase and the operational phase.

The transitional period began in October 2023 and is scheduled to run until December 2025. During this time, importers must report quarterly GHG Scope 1 and Scope 2 emissions to the ‘Net Carbon Account’ of their respective countries, without making any financial payments or adjustments. This allows everyone involved – importers, producers, and regulators – to learn the ropes and gather data on their products. After the initial trial run, the information gathered will be used to fine-tune the system.

The operational phase is scheduled to begin in January 2026. At this stage, companies will be required to report the amount of goods they imported into the EU in the previous year and the related GHG emissions. They will then need to provide the corresponding certificates under CBAM, priced based on the weekly average auction price of ETS allowances, expressed in euros per tons of carbon dioxide equivalent (€/tCO2) emitted. Meanwhile, the free allocation of EU ETS allowances will be phased out between 2026 and 2034.

GCC faces carbon tariff challenge

For an exporter in the GCC, this comes as a warning. The advantage of cheaper manufacturing costs that GCC exporters enjoy is likely to be negated by the CBAM tariffs and EU importers will be compelled to look elsewhere for deals.

Take aluminium for example. The GCC is one of the primary exporters to the EU in the aluminium industry. If the new CBAM tariff is assumed to be EUR 100/tCO2e, some estimates place the potential carbon tax at approximately EUR 700-750 per ton. This is likely to shift the scales to countries with stricter climate norms and greener technologies.

The European Commission estimates that annual revenues from the tax covering CBAM products both inside and outside the EU will reach EUR 9.1 billion (almost $9.9 billion) by 2030, with 25 percent distributed among member states for domestic use and 75 percent allocated to broader climate action.

With CBAM’s transitional phase underway, proactive adaptation is critical – and for some carbon-intensive industries it is a game of catch up. An increasing number of companies across sectors are already implementing internal carbon pricing (ICP) into their operations and decision making on a voluntary basis to divert investments away from carbon-intensive activities.

Given CBAM’s immanency, industry leaders may wish to accelerate their response and consider the action points below:

• Assess your exposure: Assess compliance costs by identifying products, emissions, and CBAM liabilities, while incorporating financial planning and budgeting for potential investments and managing cash flow disruptions.
• Invest in cleaner technologies: Explore clean technologies, assess feasibility, evaluate cost-effectiveness, optimise emission-intensive processes, adopt best practices, and prioritise investments for maximum emission reduction impact.
• Decarbonise your supply chain: Engage suppliers, set expectations, collaborate on emission reduction, provide support and incentives, assess viability of carbon credits and transform the supply chain with sustainable practices.
• Engage with policymakers: Industry should step up engagement with policymakers to formulate a wider response across the domestic and international ecosystem. It is important to drive wider awareness and to collaborate with industry alliances, NGOs, and research institutions to mobilise research and action for a broader decarbonisation movement.

By embracing its potential and taking proactive steps, industry leaders can emerge as winners in the race to a low-carbon future. Sustainability is no longer a niche concern; it is the new competitive edge and it’s deciding winners and losers.