INTERVIEW: CBAM challenged by other CO2 taxes, does not protect manufacturing

The EU's Carbon Border Adjustment Mechanism formula, although still raw and calculation-heavy, makes sense from a policy justice viewpoint as exporters with low CO2 emissions will pay less, but regulators should prevent the new tax from being eroded by other carbon pricing systems with noncommittal climate goals, and also extend it rapidly downstream to protect the end-users too, said Nicolas Endress, Founder and CEO of ClimEase, a Swiss provider of CBAM compliance software.

CBAM remains a work in progress: the country-specific default values that have leaked in Excel format have major flaws, and so are not the final ones, Endress, who currently specializes in the interaction between CBAM and the steel industry, told Platts, part of S&P Global Energy, in an interview. "The blast furnace benchmark for China is too low; there is a big error for Indonesia too, which shows eight tons of CO2 instead of two or three."

However, the readiness of default values, given that they are more penalizing and will not be the regular suppliers' preferred option, is not what Endress is most concerned about. The deduction of international carbon prices is looming large, with the European Commission reviewing other emissions pricing systems to see whether carbon taxes that exporters pay in their home country should be factored in.

As of early 2024, 36 carbon pricing instruments had been implemented worldwide, covering 18% of global emissions, according to the International Carbon Action Partnership.

"CBAM is a tariff, but it is also a climate policy, the twin of the EU ETS for imports, and the ETS is a long-term commitment to net zero. By 2040, we will have zero certificates available, so no more emissions," said Endress. "When we allow third-country taxes to be deductible, those tax regimes should have the same climate ambition, so essentially, be aligned with the pledge to stay within two degrees of global warming."

Additional cost

Endress appreciates that the buy-side of the steel market views CBAM in terms other than justice -- it is effectively an additional cost, which market participants are figuring out.

"Everybody is shooting out their tax estimates. Being conservative, I would say that so far, on average between 0.5 ton and 1 ton of CO2 per ton of steel will be charged," he said, adding that traders should not blindly trust online CBAM cost estimates, but calculate them based on the emissions they receive from suppliers.

So far, depending on the level of emissions and given today's emissions trading system prices, the actual tax could range from Eur40 ($46.50) to EUR 70-90/mt in most scenarios, regardless of the production route, according to Endress.

"The emissions of the electric arc furnace are lower, but so is its free allocation, and the logic is just to tax the difference between the actual emissions and the benchmark," he said, stressing that with the EAF benchmark of 0.2-0.3 tCO2e/mt, and real steel production emitting, for example, 0.6 tCO2e/mt, the tax will be levied on the 0.3-0.4 tCO2e/mt difference.

The steel products now cost Eur600-750/mt, although it's too early to say how the new tax will impact mills' prices and profitability, but it is safe to assume that the tax will be more easily absorbed by manufacturing importers. Machinery or automotive producers buy downstream products, which are more expensive, but the absolute CBAM charge is largely the same. And instead of 5%-15% price increases expected for lower-cost applications, these sectors may see 2%-5% rises in their steel-related procurement costs.

Traders are more exposed to risks here: for them, a small mistake on a 10,000-100,000 mt order will make a difference. To hedge their CBAM cost exposure, some started buying EU ETS allowances, expecting them to increase in price, which, according to Endress, is a fair assumption to take, at least for the long term.

"What we are also seeing is that traders are already asking suppliers to confirm in contracts their taxable emission and benchmark values, because there will be emissions that, by contract, will be payable by the importer, the trader," he said. "It is probably once a year that a supplier will have to reconfirm their benchmarks and emissions. And if [retroactively] emissions turn out to be higher than expected, the supplier will pay the balance. This forces suppliers to pre-verify their emissions as early as possible."

Big role of verifier

The way to minimize CBAM costs, aside from actual decarbonization, is to calculate emissions and benchmarks from cradle to gate.

The regulator aims to make this estimation very granular, and the calculation is complex; however, ClimEase and its peers are building software tools to automate the process, taking into account suppliers' major production technologies and how they use metallic inputs.

Once an exporter is verified, it receives a benchmark that corresponds to the processes of its installation and that is then summed up with the benchmark of the mill's precursor -- pig iron, scrap or direct-reduced iron, or their combination.

Precursors are emissions-intensive and it is economical to have that benchmark (pre)verified too, which should not be a problem for a producer with backward vertical integration, but if the mill obtains its raw materials from third parties and does not want to disclose their origin or if their supplier does not have their emissions verified, the EU has own product-specific benchmarks, including for various precursors, that will be used instead, Endress explained.

These and other benchmarks, both product- and production method-specific, represent CO2 emissions possible with the greenest available technologies. The difference between these duty-free allocations and real embedded emissions is what imports will be taxed on.

CBAM is not meant to prioritize one production route over the other; neither is it expected to prompt consolidation among traders, not to the extent the EU import quotas could, according to Endress, but reflecting on potential market changes it could entail, the expert thinks China could become even more driven to export downstream goods, rather than intermediary materials in the scope of CBAM.

"There's a lot of attention now given to steel, but steel is just a little part of that big problem that more and more finished goods like washing machines, cars, etc. are entering Europe, disrupting its automotive, white goods and other industries," said Endress.