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EU Carbon Border Adjustment Mechanism

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A clear signal to decarbonise.

  • The EU’s Carbon Border Adjustment Mechanism is set to ruffle feathers
  • The material issue for covered sectors is the loss of free emissions allowances
  • Our view is this will drive clean investment and accelerate structural change

Europe looks set to formally adopt a Carbon Border Adjustment Mechanism (CBAM): The CBAM will ensure that certain goods (including iron & steel, aluminium, cement, fertiliser, electricity and hydrogen) face the same carbon price whether they are imported or produced in the European Union (EU). The aim is to level the playing field, reduce “leakage”, and ensure that the EU's climate objectives are not undermined.

Plugging the leak:The European Commission defines carbon leakage as the transfer of EU production to non-EU countries with lower emission reduction ambitions, or when EU products are replaced by more carbon-intensive imports.

CBAM in, free allocation out: The CBAM replaces the previous policy of free European Union Allowance (EUA) allocation. European Commission modelling finds that the new policy will be significantly more effective at reducing leakage. Free allowances will be phased out from 2026 as CBAM is phased in, with the phase out process complete by 2034.

Free allocation phase-out is the key material issue: Many EU business sectors that will be affected by the new policy oppose it. They currently receive an emissions subsidy of around EUR20 billion a year that will be removed completely by 2034. Some have predicted the change in policy could raise input costs, constrain their ability to invest in decarbonisation, and have a significant negative impact on employment and output.

A clear signal to decarbonise: In our view, however, the current free allocation subsidy is holding back faster decarbonisation in covered sectors, which are key to meeting the EU’s 2030 and 2050 emissions targets. A strong carbon price signal will incentivise investment in clean research and development and the deployment of new clean technologies.

Issues to watch: There are plenty of questions to consider during the transition period as the new policy is introduced. For example: what further measures might EU policymakers take to prevent export leakage? What is the risk of developing countries raising objections through the World Trade Organisation? And what impact could the policy have on global trade flows, or climate policies in other jurisdictions?

How to prepare: Investors should monitor company CBAM reporting preparation and encourage strong decarbonisation plans, in our view. In our full report, we provide questions for investor engagement on these issues.

First Published 19th January 2023.

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