‘A race to the top’: CBAM’s impact on global carbon pricing

The European Union’s (EU) carbon tax on imported industrial goods has the potential to accelerate global efforts to better price greenhouse gases. Investors in carbon markets stand to benefit from new opportunities arising from the growth of emissions trading schemes (ETSs). These include accelerated price convergence and an improved ability to hedge against the transition risks of higher carbon prices on portfolios. 

 

A level playing field for the cost of carbon

By phasing in a carbon tax on imported goods from high-emission sectors, such as steel and electricity, the EU’s Carbon Border Adjustment Mechanism (CBAM) aims to level the cross-border playing field by applying its carbon prices on offshore and domestic producers alike.  

The EU has the world’s highest carbon price of any emissions trading system (ETS) and some of the most stringent climate policies to deliver its aim of Europe becoming the first continent to achieve net-zero by 2050. It has introduced CBAM with two goals: 

1. To prevent shifts or ‘leakages’ of emissions from the EU to countries with less-strict climate standards 
2. To encourage less emissions-intensive production of goods outside EU borders 

The CBAM, which aims to cover a wider range of sectors as it is fully implemented, marks a historic turning point. By extending the EU’s higher carbon prices on importers, it has already started promoting international climate action and is reversing the age old ‘race to the bottom’, in which nations compromise on environmental standards to gain economic advantages. 

Instead, countries now have a growing economic incentive to compete in a ‘race to the top’ for greater climate ambition.  

The mechanics of CBAM

CBAM, which started being implemented on 1 October, applies to imports into the EU from six emissions-intensive sectors: iron and steel, electricity, cement, aluminum, hydrogen and fertilisers. It aims to incorporate other sectors after 2030, with full implementation to be completed by 2035. 

During the current transitional phase, importers of goods from these sectors will be required to report on the carbon embedded in their products. As of 2026, they will need to start paying for a gradually increasing proportion of these emissions by purchasing and surrendering a corresponding number of ‘CBAM certificates’ that will match the price of carbon allowances in the EU ETS. 

But if the importers can demonstrate they have already paid a carbon price during the production of the goods, they will only need to pay the difference between the prices on EU ETS and what they have already paid.  

To align with rules set by the World Trade Organisation, CBAM will also result in the phase-out of free allowances under the current EU ETS for industrial companies that fall within the six covered sectors.  The allocation of free allowances currently serves as the primary means of mitigating potential leakage of industrial emissions resulting from the EU’s carbon price. 

From resistance to adaptation 

The levies that CBAM will introduce are projected to be significant. According to the EU’s own analysis, CBAM will generate as much as USD 1.5 billion per year as of 2028. Independent analyses have pointed to much higher numbers: from USD 9 bn per year by 2030 to up to USD 80 bn per year for the EU by 2040.  

The imminent financial impact has led many countries to voice strong opposition to CBAM. But despite these public protests, many have unveiled carbon-pricing strategies to align with its directives. For example, China, along with other BRICS countries (Brazil, Russia, India, and South Africa), initially branded CBAM as “discriminatory” due to its impact on the export sectors of developing countries.  However, recent developments suggest a notable shift in these countries’ stance:  

• Chinese officials announced plans to fast-track the expansion of its national ETS within the next two-to-three years to encompass sectors delineated under CBAM, notably cement, aluminum, iron, and steel  
• Brazil’s Senate has just approved a bill to establish a national ETS, which is expected to pass the lower house and be signed into law this year 
• Similarly, India is considering selectively taxing companies exporting goods to Europe while setting up an Indian Carbon Market (ICM) that will serve as an ETS  
• Even Russia, which before the war in Ukraine was one of the countries most exposed to CBAM, unexpectedly announced a carbon-neutrality target for 2060 and the groundwork for a future carbon monitoring system  

Other countries, including Turkey, Ukraine, and Taiwan have also explicitly accelerated their domestic carbon pricing schemes in reaction to CBAM.

As the tax accelerates action on international carbon pricing, other countries are exploring CBAM-like approaches, including the US, Japan, Canada, the UK, Australia and New Zealand. This could trigger a chain reaction where countries that rely on carbon-intensive exports must either adapt their methods by embracing carbon pricing and cleaner production, or bear the brunt of a new wave of carbon levies.

Implications for investors 

While the introduction and potential proliferation of carbon taxes like CBAM are likely to still face practical challenges (and potentially legal ones), the trend already appears to be accelerating the adoption and expansion of carbon-pricing policies around the world. Whether they pay at home or abroad, a growing set of companies will be exposed to carbon prices. This could result is significant transition risks to traditional investment portfolios.        

At the beginning of October, the average price on global emissions was just over USD 5 per ton when accounting for the fact that most emissions remain unpriced, while the emissions-weighted average price across every ETS worldwide was just USD 27¹. CBAM is likely to promote the rise and convergence of carbon prices towards the EU’s level, which is currently about EUR 80 per ton. 

Such an escalation would intensify the transition risk facing companies and sectors exposed to these prices. It would also increase the value of companies that have a competitive advantage in navigating the continuing decarbonisation throughout the economy, as domestic climate policies facilitate a race to the top in terms of climate action. 

As CBAM takes effect, this also means that companies importing to Europe will likely begin seeking to hedge their carbon-price liability by gaining exposure to the EU ETS, thereby increasing participation in the EU market.  More generally, however, CBAM and its ripple effects will increase opportunities for investors in carbon markets – particularly in the new and emerging ones poised to see the greatest price appreciation.

 

sources. 

1 Real Carbon Price Index constructed by Monash/C2Zero, Bloomberg, LOIM calculations as at October 2023. 

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