In the first two articles of our series ‘CBAM in Asia: A Golden Opportunity’ we explored how the European Carbon Border Adjustment Mechanism (CBAM) presents opportunities for companies to take action on their scope 3 emissions. We also looked at the financial risks of the new border tax on high-emission goods like aluminium and steel, affecting both European companies and Asian exporters to Europe. In this third and final article by Sam Nunn, we delve into the immediate actions companies can take to capitalize on the new legislation, get an edge on the competition, and reduce environmental impact along the supply chain.
Introduced by the European Union to address carbon leakage and encourage global emission reductions, CBAM is a policy initiative that aims to ensure that imported goods into the EU are subject to the same carbon costs as those produced within the EU. Over the past 6 to 9 months, companies affected by CBAM have become accustomed to the policy. We are now well into the transition period, and those with high-exposure to CBAM materials have begun reporting their emissions using the EU’s default emissions values. Until now, this has been fairly straightforward for companies with accurate records of their imports (what they have imported, and from where).
Tighter regulations set to add complexity from July 2024
Unfortunately, things are about to get a lot more complicated: from July this year, companies will only be able to use the default values to report up to 20% of their overall embedded emissions, and will need to get real supplier emissions data for the remainder. Those that don’t are liable to be fined 10 – 50 EUR per tonne of unreported emissions.
To add to this, once we enter into the active period in January 2026, we are likely to see the effective prices for materials skyrocket and supply bottlenecks emerge. This will be a result of the additional CBAM fee paid by companies per tonne of embedded CO2 imported, the subsequent shift of the market to lower-carbon materials (which are still available in limited quantities), and the gradual re-distribution of global supply chains as further CBAM schemes emerge in other countries. For reference, some sources estimate that the effective price of blast-furnace steel imported from China and India could double by 2030.
Don’t get caught on the backfoot!
The speed of the CBAM rollout and the complexity of reporting supply chain emissions have taken a lot of companies by surprise, however it should still be viewed as an opportunity. Although the EU is considering measures to make the transition easier (for example a gradual phase-in of certificate payments starting at only a certain percentage of the company’s total emissions), it’s clear that CBAM will have wide-ranging and profound impacts. To avoid paying excess costs, companies need to act rapidly to start decarbonizing their supply chains and rethink their use of high-risk materials. Companies that can get ahead of the curve stand to gain the most.
How can you prepare for CBAM, and what are the first key steps?
Your focus will depend on whether you are an EU-based importer or an Asian based manufacturer exporting to the EU, but the core message is the same; all companies should get a better understanding of their upstream supply chain an how their products are produced. This first key step will allow greater transparency on actual carbon emissions, and also help to identify opportunities to reduce CBAM exposure by decarbonizing the supply chain — or shifting to greener suppliers.
As an importer, businesses need to report not only the operational emissions of their tier 1 suppliers, but also the embedded emissions in the precursor materials that are purchased to manufacture your products. Currently, many companies only engage with tier 1 suppliers and lack transparency on the supply chain further upstream. Typically a standardized questionnaire is sent to the tier 1 supplier who then sends it out to all tier 2 suppliers. This approach has to change.
Short-cuts beware! Rushing the data collection phase is unwise
The data collection phase is the core of a good decarbonization strategy, and rushing it is a mistake for a number of reasons:
- Tier 1 suppliers are often very inexperienced in gathering carbon data from tier 2, leading to significant data inaccuracies and exposure to unnecessary costs.
- Tier 1 suppliers often do not have a reason to dig deep into the operations of tier 2 suppliers. This is an opportunity to work together with them on other topics such as traceability and quality.
- Tier 2 supplier operations can vary significantly, meaning that data availability is highly variable. Standardized questionnaires cannot capture this and will lead to unreported data.
Combatting the complexity with AI tools may seem tempting, but platforms in the market claiming to simplify CBAM reporting generally use standardized data which is unrepresentative of the actual situation on the ground. It’s worth spending the time to go through a detailed data gathering and training process together: understanding the whole supply chain allows importers to work together with their tier 1 suppliers to capitalize on the significant decarbonization opportunities in tier 2.
Take the hotspot approach: effective, high-impact targeting of your key carbon emissions
Once you have worked with tier 1 suppliers to map out the tier 2 supply chain, the second step is to identify carbon hotspots. This involves collecting data from tier 2 suppliers and identifying which suppliers, processes or materials account for the majority of carbon emissions. In general, hotspots will be found in suppliers or materials contributing large overall procurement volumes, or in processes with high energy input (for example steel smelting, casting, hot-forging).
Taking a hotspot approach means that when it’s time to plan actions to reduce carbon emissions in the supply chain, a company can develop targeted, high-impact action plans in a few key areas, rather than trying to make changes across the board. Given that EU Emissions Trading System (ETS) price data is publicly available, it is also possible to calculate the direct CBAM certificate cost exposure from these hotspots.
After identifying carbon hotspots in the tier 2 supply base, a company can consider three main courses of action:
- Supplier Action Plans: Identify high-emission manufacturing processes and develop a plan with tier 2 suppliers to make changes. These could include energy-efficiency initiatives, electrification of processes and purchasing of renewable energy, and phasing out onsite coal/gas fired processes.
- Supplier Changes: For tier 2 suppliers that are unwilling/unable to decarbonize, explore similar suppliers that are operating with lower emissions. This could mean shifting purchase volumes within the existing supply base, or identifying new suppliers. This action can also incentivize slower moving suppliers to act before they lose business.
- Material Changes: For particularly high-emission materials (such as blast furnace steel), work on longer-term plans to replace these with low-carbon alternatives such as green steel. Although supplier action plans can help limit price vulnerability in the short-term, divestment from these materials is the best long-term plan.
In summary: A sign of things to come
In this article series we have delved into the wide-ranging impacts of CBAM; the potential financial penalties for non-compliance, the immense opportunity for businesses to decarbonize their supply chains, and the actions businesses can take on the road to decarbonization. CBAM is a first-of-its-kind law, but we should prepare for similar laws to come into force in other jurisdictions, and indeed they are already being discussed in the UK, Australia, and California. Although seen as an inconvenience by many companies, CBAM is a major policy signal that decarbonizing a country’s economy also means addressing its imports. Companies should take this as a sign of things to come and work to accelerate their own decarbonization efforts, benefitting not only themselves but everyone.
If your business needs tailored support and guidance to navigate CBAM speak to our expert team here.
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