Policy-makers in the European Union (EU) recently agreed to implement the world’s first carbon border adjustment mechanism (CBAM). The policy, aimed at contributing to global decarbonization efforts, introduces new risks and opportunities for Canadian exporters looking to do business in Europe.
What is a carbon border adjustment mechanism? Well, it’s a fee charged on imports to account for the carbon emissions required to produce a given product. The European policy complements and enhances existing domestic carbon pricing by charging the same price for emissions embedded in imported products as charged domestically. Ultimately, this allows the EU to incentivize decarbonization and prevents evasion of these regulations by relocating production to unregulated jurisdictions.
The first phase of the policy takes effect on Oct. 1, 2023, when EU importers will be required to report on the carbon emissions released throughout the production processes of certain imported products. Currently, these products include steel, iron, cement, fertilizer, aluminum, hydrogen, and electricity, but additional products may be announced at a later date.
The reporting phase will continue through 2025 and be used to inform the final policy. The EU also plans to develop the accreditation process for carbon content verifiers and formalize the policy’s calculation, verification, and pricing processes. Currently, little is known about verification requirements except for the EU’s intent for all declared emissions to be validated in a report by an accredited verifier. These requirements won’t take effect until the full implementation of the policy, in 2026.
At that time, the mechanism will begin to phase in fees for the designated imports. Importers will need to buy CBAM certificates, equal to the total carbon embedded in their imports. The price for these certificates will be directly linked to domestic European carbon prices. If any imported products are already subject to carbon pricing in their country of origin, those costs would be deducted from the fees.
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The policy reduces the competitive advantage of exporters from non-carbon-pricing countries and for those less focused on emissions reduction. Exporters from stringent carbon price jurisdictions, or those engaged in mitigation efforts, will benefit from a levelling of the playing field when exporting to the EU. This has the potential to drastically alter trade flows to the region.
Beyond reshuffling exporter advantages, the policy will also introduce new challenges and costs related to reporting and verification. Low-carbon intensive producers will now need to track and verify their emissions to be given credit for their greener production processes. These added requirements could be burdensome for smaller producers and will increase production costs.
So, what does this mean for Canadian exporters? Canada’s relatively advanced carbon pricing system will offer substantial reductions in EU import fees. Many of our largest competitors in the European market (such as Russia, China, and the United States) don’t have carbon pricing systems and would face additional fees under the new policy.
Canada’s renewable energy electricity grid, which offers extensive opportunities to further decarbonize production processes, could provide an additional boost to our competitive advantage. Overall, the implementation of the EU policy offers significant opportunities for Canadian exporters in key industries if companies are prepared. Luckily, there’s still time before enforcement.
Some major risks for Canadian exporters include:
- new costs for obtaining policy compliance,
- time invested in assessing organizational opportunities, and;
- investments in scaling up capacity to meet new demands.
After Canadian companies build their carbon reporting capabilities, and potentially bolster productive capacities, they may still have trouble connecting with the EU importers, who must now re-evaluate their suppliers.
The bottom line?
The EU’s carbon border policy introduces more uncertainty and challenges for global suppliers, but Canadian exporters are uniquely positioned to capitalize on these developments. With less than three years until fees are phased in, forward planning and action is key to leveraging our ability to meet the evolving demands of the European market.
To learn more about this topic, check out our detailed report.
This week, a very special thanks to William Thomas, research assistant in EDC’s Research & Analysis Department.
This commentary is presented for informational purposes only. It’s not intended to be a comprehensive or detailed statement on any subject and no representations or warranties, express or implied, are made as to its accuracy, timeliness or completeness. Nothing in this commentary is intended to provide financial, legal, accounting or tax advice nor should it be relied upon. EDC nor the author is liable whatsoever for any loss or damage caused by, or resulting from, any use of or any inaccuracies, errors or omissions in the information provided.