The European 'Carbon border adjustment mechanism' is more important than you think

Summary: The European Union has announced it has reached agreement on the much debated Carbon Border Adjustment Mechanism. You might think - so what, just another contribution to the sustainability alphabet soup. Why should I care. But stop for a second, this move could actually turn out to be important. Yes, its years away from full implementation, but for many industries it could be a game changer. Lets just take a few minutes and think about why.

Why this is important: If this proposal is to have any meaning, Europe needs to invest massively in more renewable electricity, and in the array of supporting technologies that will enable the electricity grids to accommodate their variable electricity generation.

The big theme: Europe wants to decarbonise its so called "hard to decarbonise" sectors, which includes much of our heavy industry. If you add the GHG emissions from the impacted sectors together, you get to roughly 1/3 of all global emissions. So working out how to fix this is one of the big challenges. But its hard, they are not called hard to decarbonise for nothing. There are are good reasons why many of them currently use fossil fuels, so decarbonisation is going to need a lot of government assistance.

Summary of a story from Euractiv

EU negotiators reached an agreement early on Tuesday morning (13 December) that will pave the way for Europe to set up the world’s first levy on carbon-intensive goods entering its market. The so-called carbon border adjustment mechanism (CBAM) will mirror the EU’s own domestic carbon price, thereby shielding European industry from cheaper, more-polluting products imported from abroad.

It will initially apply to imports including iron and steel, cement, aluminium, fertilisers and electricity as well as hydrogen. Any companies importing these into the EU will have to buy certificates to cover the carbon emissions embedded in them unless they can prove they have already been accounted for by climate legislation in the producer country. The levy will be launched on 1 October 2023 for a test period that imposes only reporting obligations on the imports of goods covered by the scheme. After this transition period, the full levy will kick in.

Why this is important

Lets park for a moment the question of how this move would stand up in terms of WTO rules on free trade, which might be a mute point given recent moves by the US, which effectively left the appeals process "rendered non-functional". And we will also park the question of how it will work in practice, as until we have more detail (and this announcement is pretty light on detail), any thoughts will just be speculation. We suggest, the big question for sustainability professionals, advisers, companies and investors is what might this mean in practice and what happens next.

We would highlight two parts to this question. The first is what investment is needed to make this viable. We assume that the objective is to accelerate the decarbonisation of these industries (plus others that might get added later). For this to happen we need a rapid acceleration in new lower carbon production processes, some of which will likely involve green hydrogen (especially for iron/steel and fertiliser). We highlighted in a recent blog (entitled "Germany is going for broke") that for this to happen at scale we will need not just considerably more green hydrogen production, we will also need vast amounts of new green electricity. Plus, given the economics, we will need a massive contract for differences programme, similar to the one that was used to get wind and solar up & running.

We can see this being a ten year plus process. This point is worth repeating, this is not a quick fix. If this proposal is to have any meaning, Europe needs to invest massively in more renewable electricity, and in the array of supporting technologies that will enable the electricity grids to accommodate their variable electricity generation. Getting this built and operational will take time, a lot of time. We covered some of this in a recent long blog, that you can read here (you will need to sign up to read the full version, but don't worry its free for now). The industry body Eurelectric estimates that the region needs to increase spending on its electricity grids by 50-70%, so up to as high as €39bn pa (yes pa) for the next decade or more.

The second question is more subtle - what is the future for energy intensive industries in Europe, even with this type of support. If you read the news, you will know that we are seeing the early stages of a global push for "buy domestic" across a range of green industries. China has successfully followed this approach for many years, and with the Inflation Reduction Act, the US is following at pace. While Europe has the ambition, the detailed plans and actions seem to be somewhat "bogged down". Some of these measures are about protecting jobs - to give this context, is the decision by BASF to spend €10bn in a major Chinese chemical complex just the beginning of a "industry drain"? We suspect so, but from a political perspective, its probably not yet to late.

But there is also a longer term, and more important push - building a competitive position in the industries of the future. Mariana Mazzucato (whose various books on this topic are well worth reading) argues that we need to look to governments to galvanise change, not through short term fixes, but using their financial firepower to push a new climate change mission. Having watched the rise and then fall of the German solar industry, we argue this debate is really important for the long term financial success of Europe - which makes the CBAM something really worth tracking.

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