As a part of the European Union’s Fit for 55 initiative, the European Commission has introduced the concept of a Carbon Border Adjustment Mechanism (CBAM), with the aim of eliminating carbon leakage. This is to prevent that organizations could skirt carbon pricing mechanisms by importing goods from regions where these types of carbon pricing mechanisms are not yet in place.

Effectively, when organizations take this approach to importing, producers in the EU are facing unfair competition. This is because European producers, by participating in the European Union’s Emissions Trading Scheme (ETS), will have to pass through these carbon prices to the consumer, whereas other producers outside the bloc do not have to do so. The CBAM will, effectively, seek to eliminate this imbalance through requiring importers to pay a levy equivalent to a two-week average price of the EU ETS at the time of import.

Entry into force is anticipated for 2023, when only reporting requirements will be implemented. Companies will then have until 2026 before they are required to pay the additional fees. With this, organizations will be forced to reimagine and reevaluate their supply chains as former pricing advantages may diminish providing a strong business case for activating to decarbonize supply chains.

How will the regulation work? What does it seek to do?

In the age of international supply chains where companies are often sourcing from partners worldwide, this regulation will have vast impacts on the way corporates think about their supply chains. In particular, in taking a closer look at Scope 3 emissions and reevaluating if imported goods will start to equalize in terms of pricing. This will have a particularly large impact on the five industrial sectors that were selected for the initial rollout of the mechanism. These industries are:

1. Iron and Steel
2. Cement
3. Fertilizers
4. Aluminum
5. Electricity and Hydrogen

For the five selected industries, that were prioritized due to their potential for elevated carbon leakage, there will be two elements the companies will have to comply with. The first, during a transition period, organizations for whom the regulation applies will be responsible for producing a quarterly report that includes information on the quantity of covered products imported, total embedded emissions associated with these products, and any carbon price paid in the country of origin. The second element, will come only in 2026, when importers will be charged with purchasing emissions certificates equivalent to what would have been charged on the EU Emissions Trading System (EU ETS).

While these are the industries that will be the first targets of the regulation, the CBAM could also expand to include other industries after it enters into force. This would likely be with a focus on industries with high embedded carbon such as refined petroleum products, iron and ferrous ores, and more. The European Parliament had also initially proposed that the initial scope of the regulation be expanded to include organic chemicals and polymers, so this is likely one category that it is sure to assess whether to include in the scope before the transition period ends.

The downloadable summary at the top of the article provides an overview on CBAM and suggest how companies can start preparing for the new regulation.

Supply chain visibility becomes crucial

For companies who have already created a strong approach to the management of supply chain issues, it is likely that the organization will have a strong foundation to comply with the new regulations. Having visibility on its suppliers will be crucial for a company to understand the relevant carbon pricing legislation that is in place, and to be able to quantify the embedded emissions of a product that the organization is sourcing from abroad.

Many companies have worked to incorporate technology to gain better visibility in their supply chains, including the chemical industry. This, given the industries' possible inclusion in the scope of the CBAM will give the industry an important leg up.

However, even if the industry has made some initial progress, the chemical industry has a significant amount of work remaining to decarbonize its value chain. The various efforts that the industry is making and an exploration on roadblocks the industry faces can be further explored in Finch & Beak’s report on trends in the chemical distribution industry. A key takeaway from this report is that decarbonization efforts are tricky for chemical distribution companies, as there are few chemical products with net-zero emissions meaning that companies can only focus on the offset of product emissions. This means a big first step for companies is to start calculating emissions.

While technology can be a powerful tool in helping to understand the path of products, utilizing impact measurement & valuation can also provide strong insights as to where a company has its impact. This is particularly true for being able to understand the production of raw materials upstream and have visibility on what percentage of the impacts of the products come from.

While this will help a company to comply with the CBAM regulations, it can also facilitate a company taking action on decarbonizing its value chain. As companies face more and more scrutiny for the emissions profiles of their products, companies can take the regulatory mandate as an opportunity to expand their emissions and reduce overall value chain emissions beyond just the raw material imports.

This approach of incorporating life-cycle analysis can help to drive customer savings and if a company wishes to further understand its impact on society it can expand its view to the approach of impact measurement & valuation. This can help to ensure that a company is not only prepared for CBAM regulations, but also more resilient against various social and environmental issues arising in the supply chain.

Tips for mobilizing the supply chain

While companies do have a significant lead time to prepare for this regulation, see the below tips for how to ensure that the needle begins to move towards progress in decarbonizing your company’s supply chain.

1. Define and prioritize impact categories:
   Understanding which impact categories to focus on is a critical first step and it is advised that companies do this by linking impact categories to its material issues. Take a step back to define, evaluate, and prioritize the impacts of your company, with a focus on which products have the highest environmental and social impact profile.
2. Select the right tools to analyze:
   Undertaking an impact and measurement evaluation can be a key first step in understanding this. For a more baseline analysis, a life-cycle analysis could also be used. Or, for those who already face the regulator mandate of TCFD, scenario analysis could provide insights into the impact of a company.
3. Engaging the right team:
   There should be clear mapping of responsibility for actions on engaging the supply chain with a specific focus on the Procurement, Operations & Supply teams, and the Finance and Legal teams all working in conjunction with the sustainability team. Externally, companies can utilize a supply chain analysis to identify key suppliers—particularly those with the top spend. This provides a power leverage point to engage with the suppliers and encourage changes such as switches to renewable energy which then has a pass-down effect for the company who receives the materials supplied.

Get in touch to learn more about decarbonizing your supply chain

Do you want to get a better grip on knowing and actively managing your company's main impacts along the value chain, and improve your ESG performance? Reach out to Gijs-Jan Groeneveld at gijs-jan@finchandbeak.com or at +31 628 021 880 to learn more about how Finch & Beak can support you with TCFD alignment and Impact Measurement & Valuation.

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