In July, the European Commission proposed the world’s first system of carbon tariffs, the Carbon Border Adjust Mechanism (CBAM). The new tax is part of a rapidly developing priority for businesses: the decarbonisation of international trade.
CBAM is a tax on carbon-intensive products like steel, aluminium, cement and fertiliser, part of the EU’s strategy to cut greenhouse gas emissions by at least 55% by 2030. The system is designed to level the playing field for European companies.
Currently, many EU manufacturers must buy permits to cover the carbon emissions they create. However, much of the rest of the world – including China, Russia, Turkey and the US – don’t face the same emissions rules, allowing them to export to the EU at much lower costs. CBAM would change this by holding importers responsible for these greenhouse gas emissions, just like domestically produced products.
The mechanism is also designed to staunch “carbon leakage”, when goods that would normally be purchased locally are imported from countries that don’t have the same regulations and are therefore cheaper. This leakage also occurs when local companies move their production to another country to avoid having to cut their emissions.
The UK has a similar carbon pricing mechanism to the EU, so the charge is unlikely to apply, at least initially. However, the new tax is certainly cause for thought for UK businesses that trade with the bloc.
Carbon taxes
CBAM has already proved controversial. Critics argue the system is little more than economic protection in a green cloak, which penalises developing countries that don’t yet have the technologies to cut their industrial emissions.
However, it’s part of a growing trend, joining such initiatives as the Task Force on Climate-related Financial Disclosures (TCFD), with its mission to improve the reporting of climate-related financial information. The EU also operates the Non-Financial Reporting Directive, which can mandate companies to look at their climate risks and opportunities, along with a range of other diktats aimed at strengthening due diligence along supply chains.
Jamie Pitcairn is a technical director at Ricardo Energy & Environment, an engineering and environmental consultancy, which helps countries develop their carbon reduction plans.
There is going to be substantial change in the market driven by climate change … Exporters will need to be a lot more aware and informed
Carbon taxes, he says, are one of the regulatory tools that most countries are using to create their Nationally Determined Contributions (NDCs), commitments made as part of the Paris Agreement on climate change. As a result, he says, taxes are only going to increase in number and cost.
Businesses must try to insulate themselves from these changes, Pitcairn advises. “There is going to be substantial change in the market driven by climate change … Exporters will need to be a lot more aware and informed.”
In the push to make products as low carbon as possible, Pitcairn expects to see a reduction in the movement of goods and raw materials, as companies try to cut the carbon impact of travel, as well as more on-shoring and a greater emphasis on local supply chains.
Businesses are also starting to look more closely at emissions, which are broken down into different “Scopes”. Scopes 1 and 2 cover a company’s direct and indirect emissions and are relatively easy to calculate. But to have a valid net zero strategy, businesses must also consider Scope 3: emissions in their supply chain.
“What we are seeing now is global manufacturing businesses looking at their suppliers all round the world and asking them for data on their carbon emissions and using this as a basis for procurement and future business,” Pitcairn says. “It’s no longer sufficient for that business to make a product, sell it, and then forget about it.”
Going circular
Another key legislative change across Europe are “Right to Repair” laws, which require manufacturers of electrical goods to make their products repairable for at least 10 years. Europe also has a system of Environmental Product Declarations (EPD) that are effectively a product’s footprint and a sign of the manufacturer’s commitment to reduce its environmental impact.
According to Nicolas Lockhart, a partner on global arbitration, trade and advocacy at the law firm Sidley Austin, regulations around the circular economy – especially what happens at end-of-life – aren’t far off, and could make a bigger contribution to green trade than mechanisms like carbon border taxes.
“The day is coming when countries won’t allow the importing of products which don’t for instance come with a full lifecycle analysis,” he says.
Laws that promote longer product life, clearer guidelines around product design and an infrastructure for recycling will create the incentives that companies need to invest in R&D.
This innovation can help to future-proof exports, says Lockhart. Last year he worked with the World Economic Forum (WEF) and came across companies, particularly in electronics and plastics, whose ambitions were far greater than those of many governments.
Some of this was consumer-driven, with companies under pressure to meet customers’ desire to know how products are made. But much of this R&D was also based on “perceptions of where the market is going”, Lockhart says.
Companies are planning and looking ahead, he adds. Some will have seen the flipside to the push for greener international trade: the development of markets for premium products, sold at a premium price.
In August, for instance, the first batch of green steel left a factory in Sweden bound for the truck-maker Volvo. It was forged using a mixture of renewable energy and hydrogen to create the intense temperatures needed. Traditional steel production uses coal and coke, and accounts for around 8% of all global greenhouse gas emissions.
Countries with stringent climate change targets need such innovation, says Pitcairn, and they’re prepared to pay for it. As Net Zero pledges grow, “markets will be much more climate-aligned … trade is definitely going to be impacted but potentially in a good way.”
