Jul 19, 2023

CBAM: How Indian Firms Should Deal With The European Carbon Border Levy

Indian exporters are waking up to the European 'Carbon Border Adjustment Mechanism'. This is a tax charged at the EU border upon incoming imports, reflecting the carbon embedded in them. The tax charged per unit of carbon will be the market price associated with carbon emissions within the EU. Policymakers in the EU have argued that when governments in the EU restrict the ability of firms to pollute, firms will merely respond by moving production elsewhere. The purpose of the CBAM is to make firms neutral between producing within Europe (where polluting is costly) and producing elsewhere (where polluting is cheap).In India, many politicians, policymakers, and commentators are unhappy with the fairness of the EU's CBAM. It is argued that India did not create the global warming problem and that this is a protectionist measure that was unilaterally thrust upon us. The EU, for its part, is confident that the CBAM is World Trade Organisation-compliant and that voters and firms within the world's largest trading bloc will support it. While debates about climate justice and Indian policy responses to the CBAM are interesting and important, for the present discussion, we focus on optimal thinking for Indian exporters.

The key features of the CBAM are as follows:

From October 1, 2023, companies that export steel and aluminium into the EU must establish systems to measure the carbon intensity of their production processes and provide statements on it. A few other industries are also covered, such as cement, fertiliser, electricity, etc., but they are not important to exports from India to the EU.

From January 1, 2026, companies exporting into the EU will have to purchase CBAM certificates, to bridge the gap between the carbon price paid in the country of production, and the price of carbon allowances in the EU Emissions Trading Scheme.

While the zone of application at present is limited—exporting into the EU only and for the steel and aluminium industries only—the CBAM is an important milestone in the global journey of climate mitigation. It is likely that the CBAM will expand into other sectors (e.g., an Indian information technology services company that sells into the EU) and into other countries. Hence, while Indian exporters of steel and aluminium are at the cutting edge, all exporters from India should take interest in these developments.In the traditional Indian view of first-world pollution control, there is generally an arbitrage opportunity through shifting production to India, given weaker pollution control in India. With the CBAM, this arbitrage opportunity for shifting production out of the EU (or competing with producers in the EU) is absent. For an Indian firm that produces at a facility within the EU or elsewhere, there is a symmetric taxation of carbon intensity. Conversely, for an Indian firm to become more competitive within the EU market, there are gains from reducing pollution—regardless of whether production is done within the EU or not.What this means is that Indian exporters in the first world will need to identify all carbon in their production process and upstream in their supply chain and find ways to reduce carbon intensity. This can be done through three pathways: (a) improving energy efficiency; (b) preserving the present location of production but shifting energy purchases in favour of renewables; (c) shifting the location of production where renewable energy is cheap; or (d) capturing and sequestering carbon. As an example, it is efficient to place large-scale cloud computing facilities in places like Oregon or Greenland, where cooling requires less electricity and renewable electricity is cheap.In the journey of climate transition in India so far, Indian firms have pushed in favour of renewable energy (either captive or purchased) for two kinds of reasons: (a) the cost or reliability was superior to that found on the grid, and (b) ESG investors demanded decarbonisation. The CBAM in Europe, and potentially in other advanced economies, constitutes a third reason in favour of emphasising renewable energy. Firms in India will find that certain locations of production are more conducive in terms of unrestricted and cheap renewable electricity purchases, either through the lack of restrictions by the distribution company or through physical access to the Inter-State Transmission System.

A greater desire on the part of exporters to buy renewable energy will help spur investment in renewable generation (subject to the constraints of being able to connect up to the buyer). Renewable generators that supply power to AAA-rated buyers like Amazon, Johnson & Johnson, and InBev can be more profitable and bankable than those that supply to financially distressed state DISCOMS.

Indian steel and aluminium firms have known about the impending CBAM since the proposal stage in 2021, and many responses are in motion. JSW Steel Ltd. aims to meet up to 60% of its electricity needs from renewable sources by 2030. Tata Steel Ltd. says it will source 100% of its electricity needs from renewable energy by 2030. Both companies are investing in captive solar and wind power generation projects and entering into PPAs with private sector renewable energy producers. Both firms figured in CDP's list of climate change leaders in 2022. ArcelorMittal SA is developing a 989-MW wind-solar hybrid renewable energy project in Andhra Pradesh. It will use this power at the group's steel plant at Hazira in Gujarat and consequently reduce its carbon emissions by 1.5 million tonnes annually.

Tata Steel conducts sustainability assessments of key vendors and has adopted a sustainability-based "responsible supply chain policy", which includes monitoring GHG emissions. It has had a steel-producing site certified by Responsible Steel, an independent verifier of low-emission steel.

Some Indian firms are voluntarily calculating and reporting an "internal carbon price", placing a monetary value on each tonne of carbon they emit. Tata Steel, JSW Steel, Sanyo Special Steel Manufacturing India Pvt., and Hindalco Industries Ltd. all declare their internal carbon prices, and for Tata Steel, the internal rates of return for any project must be above an internal carbon price adjusted hurdle rate. While no Indian company is subject to a formal carbon price yet, calculating hypothetical internal carbon prices will help Indian companies fulfil the reporting requirements of the CBAM as well as assess the risks of their carbon emissions on their businesses when the CBAM does come into effect.These responses speak well for the strategic thinking in these firms and their ability to see a looming problem and respond to it ahead of time. It is time such reasoning filtered more broadly into all Indian exporters.

Ajay Shah is Co-founder at XKDR Forum; Akshay Jaitly is co-founder Trilegal and Trustbridge

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.