The emerging trend is that of a tectonic shift in the World’s Climate Change Response Order, whereby the Net Importing Countries are proposing the introduction of mechanisms to the likes of CBAM, while the countries that bank heavily on Positive Balance of Trade are developing their own domestic carbon pricing instruments (carbon tax or emissions trading system)!
The author is the Founder and Managing Director of KBS Certification Services Limited – the world’s leading Validation, Verification, Product and Process Certification, Assurance and Sustainability Services’ Organization.
The Carbon Border Adjustment Mechanism (abbreviated as CBAM) is a compliance mechanism introduced by the European Union to prevent carbon leakage, i.e., the phenomena of shifting of the production of goods to non-EU countries where the emission reduction regulations are allegedly laxed with much lower or no carbon cost associated with their production. The mechanism is applied to CBAM goods imported to the EU and specified in an EU Regulation (Regulation (EU) 2023/956 of the European Parliament and of the Council of 10 May 2023 establishing a carbon border adjustment mechanism) to make a level playing field for domestic companies which fall in mandatory Carbon Pricing (EU-ETS). This mechanism is a part of European Union’s Fit for 55 Package.
The Objective of CBAM is to account for the imported products’ carbon content in its overall price. The CBAM also endeavours to encourage third countries, foreign producers and EU importers to progressively reduce their emissions.
The CBAM has commenced in its transitional phase with effect from October 2023. Only reporting obligations arise during the transitional period while financial obligations apply with effect from 2026.
This explains why European Union’s Carbon Border Adjustment Mechanism is such a hot topic of discussion among the countries that export to the Union. Ever since EU has announced CBAM, divided opinions have been emerging from the countries across the globe. While on one end of the spectrum Japan, Korea and Singapore apparently are ardent supporters of the European Union’s move, India, Brazil, South Africa, Iran and Russia on the other are opposing CBAM as trade distortionist and unilateral measure that will have potentially adverse impact on equitable and just transition within the larger context of sustainable development and shared prosperity.
I support the Common but Differentiated Responsibilities (CBDR) of Nations in strategizing their Climate Action Plans considering the phase and growth trajectory, they find themselves in. Hailing from the same ideology, I still uphold that the cost of ensuring compliance that will be imposed on exporting companies for adhering to CBAM or equivalent will be huge and will require fast action to minimise the impact.
In the aftermath of EU’s CBAM several countries are resolute to introduce their own versions of CBAM. The Australian Government commenced feasibility assessment of introducing a local CBAM back in 2023. The second round of consultations is currently underway. The final decision is yet to be made. Four climate bills were submitted to the American Congress in 2023. One of the bills provides for the introduction of import duties on products with a higher carbon intensity than products produced in the United States. Taiwan’s Carbon Border Adjustment Mechanism (CBAM) is set for a launch in the latter half of 2025. The United Kingdom is all set to introduce CBAM in January 2027. It will cover aluminium, iron and steel, cement, fertilizers and hydrogen. After 2027, the scope of the UK CBAM is planned to be reviewed to consider new evidence on the risk of carbon leakage.
Clearly, the emerging trend is that of a tectonic shift in the World’s Climate Change Response Order, whereby the Net Importing Countries are proposing the introduction of mechanisms to the likes of CBAM, while the countries that bank heavily on Positive Balance of Trade are developing their own domestic carbon pricing instruments (carbon tax or emissions trading system).
The CBAM currently applies to selected goods in the following sectors: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen. By 2030, the European Union plans to extend the CBAM scope to all EU ETS sectors exposed to the risk of carbon leakage. On 01st October 2023, the CBAM entered its transitional phase. In this phase, importers of CBAM goods are required to submit quarterly reports, including data on imported products and their embedded carbon emissions.
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Let us understand what the CBAM Regime would mean for Indian Exporters. I am taking up the case of Steel and Aluminium for explanation.
India is the second-largest producer of steel in the world. It contributes to almost 2% of the Nation’s GDP and employs over 2 million people. Almost 30% of India’s iron and steel exports head to the European Union which is no small deal. India is also the world’s third-largest exporter of aluminium, with more than 20% of its exports going to the European Union.
The Carbon Border Adjustment Mechanism (CBAM) by the EU will impact India’s steel and aluminium industries the most as the compliance regime will add nearly 13% tariff on steel and 6% on aluminium, resulting in a loss of revenue to the tune of USD 1.00 to 1.7 billion.
That’s not all!
It is a known fact that iron, steel and aluminium production are highly energy intensive. The energy for production of these commodities is sourced from coal. Therefore, the carbon intensity of these products becomes significantly higher compared to that of the EU and other countries that export to the EU. This deals a blow to the competitiveness of Indian exports leading to a loss of revenue for the Indian Industries as they end up paying higher price under the CBAM.
India is one of the countries that bet big on a Positive Balance of Trade or earning Foreign Exchange by sprucing up its Exports. Therefore, one of the definitive steps that India has taken to make up for the ground that it is losing on account of unilaterally imposed measures like CBAM Compliance, is the process of implementation of a National Emission Trading System (ETS) also known as the Indian Carbon Market, which will put a price on carbon.
CBAM regulation stipulates that countries will be “allowed to claim a reduction in the number of CBAM certificates to be surrendered corresponding to the carbon price already effectively paid in the country of origin for the declared embedded emissions.” This effectively means that if the exporting industries are already paying a price on carbon in their home country during production, they will be partially or fully exempt from CBAM depending on the price of carbon prevailing in the home country with respect to that in the EU Emission Trading System. Therefore, by institutionalising the National Carbon Market, and attributing carbon pricing for the goods manufactured in India, we can avoid the taxation in EU market and minimise the impact on our exports revenue due to CBAM. The carbon pricing mechanism will generate additional carbon revenue and contribute to our Nationally Determined Contributions (NDCs) through progressive mitigation of Greenhouse Gases. On the other hand, additional incentives can be provided by the Government for transitioning to clean technologies/ energy sources and for any measures that are taken to reduce the emissions.
The Energy Conservation (Amendment) Act 2022 enabled the Government of India to implement a Carbon Credit Trading Scheme (CCTS)/ Indian Carbon Market in India. The responsibility for formulating this scheme has been vested with the Bureau of Energy Efficiency (BEE).
You would be aware that India already has in place two market mechanisms to lower its emission reductions. These two are Perform, Achieve and Trade (PAT) scheme and the Renewable Energy Certificate (REC) scheme. Under the PAT scheme, targets are set for energy consumption for different industries. Accordingly, Energy Saving Certificates (ESCerts) are given to industries that overachieve their prescribed targets, which can then be traded to industries that cannot achieve their targets. Similarly, the Renewable Energy Certificate (REC) scheme binds industries by an obligation to source certain percentage of their energy consumption as renewable energy. Those exceeding the requirements can trade the RECs with those not fulfilling them.
The Indian Carbon Market builds on these two established frameworks and broadens their scope by creating a single unified carbon market. The carbon market is set to be implemented in a phase-wise manner. The Indian Carbon Market has two components namely the Compliance and Offset Mechanism. The Indian Carbon market’s compliance mechanism mandates that obligated entities (which includes all the products currently covered under European Union’s CBAM) meet specific greenhouse gas (GHG) emission intensity targets, with those exceeding targets earning Carbon Credit Certificates (CCCs) and those failing to meet targets needing to purchase or surrender CCCs.
It is not surprising to note that in India, the rollout of the CCTS/ or the National Carbon Market is aligned with the timeframes stipulated by CBAM. The transition period of CBAM, which requires exporters to report their emissions, coincides with phase 1 of the CCTS/ National Carbon Market, where different markets are merged into one single carbon market. As the European Union’s CBAM will go into effect by 2026, the National Carbon Market will start its operation at the same time, covering the same industries as those that are included under the CBAM. 2034 is when CBAM would go full throttle, covering all exports entering the EU, which is the same timeframe by which the Indian Carbon Market will become mandatory, covering several sectors whose products have significantly high embedded emissions.
Thus, the National Carbon Market is a very well thought, synchronised and calibrated response of the Government of India to not only EU’s CBAM but also to several other compliance frameworks that will be imposed by other Importing Countries following suit. The National Carbon Market thus will not only help our exports get more competitive in the wake of environmental compliances but shall also be a testament to India’s Climate Leadership towards reducing GHG emissions thereby getting progressively closer to achieving its Nationally Determined Contribution (NDC).
About the Author
The author is Founder and Managing Director of KBS Certification Services Limited – world’s leading Validation, Verification, Product and Process Certification, Assurance and Sustainability Services’ Organization.
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