On July 14, the European Union introduced new legislation, Fit for 55, to cut its GHG emissions by 55 per cent by 2030 and to net zero by 2050. This is a welcome step for climate action since it turns the EU’s announcement into law, protecting it from the winds of political change. It opens new markets for Indian industry, for example for electric vehicles. However, it also introduces a potentially adverse policy called the carbon border adjustment mechanism (CBAM).
The EU has had a carbon emission trading system since 2005, with a current market price of 50 euros per tonne of carbon. With Fit for 55, the EU will bring more sectors into this trading scheme and tighten its allocation of permits. The EU’s carbon price is likely to go up as a result, making its domestic products more expensive than imports from countries that do not have such rules. The new CBAM is meant to level the playing field between domestic and imported products.
CBAM will require foreign producers to pay for the carbon emitted while manufacturing their products. Adding the price of carbon is meant to discourage consumers from buying carbon-intensive products and encourage producers to invest in cleaner technologies. The adjustment will be applied to energy-intensive products that are widely traded by the EU, such as iron and steel, aluminium, cement, fertiliser, and electricity. It may also affect downstream industries — for example, automobile manufacturers may buy domestic low-carbon steel rather than imported high-carbon steel. India is Europe’s third-largest trading partner, and it does not have its own carbon tax or cap. So, CBAM should be a cause for concern for it. A UNCTAD study released on July 14 predicts that India will lose $1-1.7 billion in exports of energy-intensive products such as steel and aluminium — India’s goods trade with the EU was $74 billion in 2020.
The CBAM will undoubtedly be very complex to administer. The adjustment rate will vary by country and product, depending on the carbon intensity of the production technology and the electricity mix. It will require verification of data reported by every foreign supplier, including intermediate products from third countries. It may have to rely on country defaults or sectoral benchmarks, at the risk of less than perfect outcomes.
The EU Parliament’s endorsement is expected to take two years, which will be followed by a three-year transition period before the CBAM is imposed in 2026. What should Indian industry do to prepare in the interim? First, it should enter clean technology partnerships with European industry. For example, India exports semi-finished and flat-rolled products of iron or non-alloy steel, but such partnerships can help enhance the competitiveness of its high-technology stainless or alloy products.
Second, Indian companies should invest in more renewable electricity and energy efficiency. They can adopt science-based targets for emission reduction and internal carbon pricing to incentivise low-carbon choices. The government can extend the perform-achieve-trade scheme to more industries and provide finance to MSMEs to upgrade to clean technologies. WRI India’s analysis shows that carbon dioxide emissions from the iron and steel industry can be reduced from 900 million tonnes to 500 million tonnes in 2035 through greater electrification, green hydrogen, energy efficiency, and material efficiency.
Third, India can try to diversify its exports to other markets and products. For instance, it could increase its market share of crude steel compared to more emission-intensive producers like China, Russia and Ukraine.
At present, the CBAM may seem obstructionist. But over the long-term, it can provide regulatory certainty to industry by harmonising carbon prices, and Indian industry can position itself as a strong player in the trade landscape of the future.
This column first appeared in the print edition on July 26, 2021 under the title ‘A problem of adjustment’. Kelkar is Director, Climate Program, World Resources Institute India. Views are personal