How CFOs can prepare for EU’s Carbon Border Adjustment Mechanism regulation?

February 1, 2024

Example H2

Introduction

The European Union (EU) has created the world’s first carbon border tax - The Carbon Border Adjustment Mechanism (CBAM) with the aim of reducing carbon emissions and ensure that the EU's ambitious climate goals are not undermined by imports of goods produced with higher emissions standards than those within the EU. Its primary focus is to address an issue called carbon leakage or offshoring emissions. Carbon leakage occurs when companies transfer the production of goods to countries with lower emissions standards leading to an overall increase in emissions. This is in the backdrop of the EU moving forward with its ambition to reduce emissions by 55% by 2030 while its emissions allowance costs are increasing to EUR 80-100 per tonne.

In less than two years, the first stage of the policy will be phased in as it came into force on October 1, 2023. This initial trial phase is focused on high emitting sectors including cement, fertilisers, iron and steel, aluminium, hydrogen, and electricity. Following this, CBAM will be gradually scaled up to include more sectors and will be implemented from 1 January 2026 and accordingly the carbon price be charged.The tax will enable the EU to adjust the carbon price of imports with that of domestic goods. It is intended that this mechanism will create a level playing field, encourage industry decarbonisation, and apply a carbon price to goods entering the Union.

The proposed key design features of the CBAM include

Only imports to the EU are covered. There are no export rebatesFive sectors are proposed at the first stage: cement, steel, electricity, aluminium and fertilisersImporters have to surrender CBAM certificates (priced on the basis of EU Emission Trading System allowances) equal to the embedded emissions in their importsThe CBAM will replace the free allocation of EU ETS allowances currently provided to EU industries in the covered sectors – this will occur gradually while the CBAM is phased-inCountries that are linked to the EU ETS are exemptDirect emissions (Scope 1) are covered as well as emissions from input goods deemed to be within the boundary of the production process (partial Scope 3). Indirect emissions from electricity (Scope 2) are not covered, although this may change laterThe CBAM forces importing companies to purchase CBAM certificates to pay the difference between the carbon price in the country of production and in the EU. The costs will not apply if the importer will be able to prove that the producer has paid a corresponding price in a non-EU country.

What do companies need to do?

We will see companies that import goods into the EU will have to declare in quarterly reports, the total volume of products imported and the quantity of emissions embedded within each product. This includes both direct and indirect emissions. They won’t have to buy any carbon allowances at this stage. But this will get more comprehensive from 1 January 2026, as then applicable companies will need to purchase the equivalent number of CBAM certificates to cover these “embedded” emissions. If importers can prove a carbon price has already been paid during production, the tariff is likely to be reduced to avoid double taxation.

The requirements of companies to meet CBAM regulation

Companies importing goods into the EU will need to work together with suppliers to gather necessary data. For example, asking for the upstream emissions or carbon footprints of each product or materialCompanies importing goods into the EU will need to quantify the financial risk of CBAM and impact of import, then weigh up the pros and cons of production locations.

Importers will need to consider the advantages and disadvantages of choosing low emitting suppliers outside of the EU, or potentially relocating manufacturing to inside the EU.

Suppliers providing raw materials or goods to the EU will need to provide emissions data or carbon footprints on products. As we can see from the above points, the need to adhere to EU cross border trade compliances makes CFOs responsible to take certain decisions when it comes to product sustainability, supplier engagement and financial reporting.

Non - compliance with CBAM regulations would put companies at risk therefore CFOs would need to do the following things:

It would be interesting to see the evolutionary role of CFOs as they take on the responsibility of their business to operate in the EU market with least inhibitions. Here we have put together some factors that CFOs need to be aware of, for the future ahead:

Explore low carbon options: Embedding low carbon technologies at the organisational level that promises long term savings would enable companies to manufacture products that are low in carbon footprint and be leveraged in the EU market. This would mean investing in clean technologies, integrating resource cycling, and reusing materials to reduce operational costs and maximising efficiency

Explore low carbon options: Embedding low carbon technologies at the organisational level that promises long term savings would enable companies to manufacture products that are low in carbon footprint and be leveraged in the EU market. This would mean investing in clean technologies, integrating resource cycling, and reusing materials to reduce operational costs and maximising efficiency.
‍
Promote Supplier chain sustainability: Businesses will now have to undertake detailed carbon accounting throughout their entire supply chain. Companies not initially included in the CBAM scope may also experience the impact of carbon costs being passed down the production chain. CFOs do realise that a better scope 3 management mean: improved equity performance, access to sustainability-linked loans, subsidies, pricing advantages, long term cost reduction, reduced regulatory risks, alignment with net zero commitments, leadership in the market, meeting customer demand for greener products, and forging stronger stakeholder relationships.
‍
Readiness for the external push: An external push further underscores the urgency of Scope 3 management. The impending Carbon Border Adjustment Mechanism (CBAM) regulation will significantly impact companies, particularly in the steel and product carbon footprint (PCF) sectors. By 2026, firms need to budget for extra costs, with estimates indicating a 19% increase for steel and additional expenses associated with PCFs. Moreover, discussions foresee CBAM's coverage expanding from 2030 onward, adding further impetus to supply chain decarbonization.

Given the road ahead will be a bit tricky for the sectors that CBAM applies to, we have prepared an easy check- list titled READ for our CFOs to prepare our professionals in order to meet the CBAM requirements. Let’s find out what these are:

Review: the present methodology of GHG (greenhouse gas) calculations and assess if there is enough detail on CO2 emissions per product and if the methodology would allow to meet the CBAM requirements

Ensure: that the product codes of exported goods are included in the CBAM scope

Assess: IT systems for GHG calculation (if any), if there is possibility to provide data needed for CBAM based on the existing systems

Develop: Roadmaps for preparation to CBAM reporting which entail taking into account the above steps could include development or Update: GHG calculation methodology, development of internal processes, choosing and implementation of IT-systems (both for the producer and EU reporting entity), and regular reporting.

However, the takeaway here is that the domino effects of the CBAM will not end with carbon accounting and reporting alone. In order to remain competitive and in business with the EU, companies will have to scrutinise their supply chain suppliers to rethink their partnerships—either by collaborating together to reduce emissions or scouting out other vendors with lower carbon footprints. Furthermore, there will be an increased emphasis on research and development (R&D) to implement cleaner technologies and processes to reduce the total carbon content of their goods. Massive investments in R&D may even lead some companies to adjust their prices to offset mounting CAPEX and OPEX as well as the added carbon costs. In the coming years, it will be interesting to see the transformational role of CFOs in the context of climate actions and EU regulations as they embark on more decision making responsibilities when it comes to transitioning to low carbon pathways.

Oren’s Sustainability Hub is the one-stop solution for you to manage your GHG emissions accounting for the CBAM and other sustainability compliances like CSRD (Corporate Sustainability Reporting Directive), California’s Climate Disclosure and BRSR (Business Responsibility and Sustainability Reporting).