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Decarbonization is no longer a choice, but a global priority: 140 countries, accounting for more than 90% of greenhouse gas (GHG) emissions, pledged to reach net zero emissions by 2050 and launched a barrage of regulations that will only accelerate in the coming years. The European Union is leading the way. The Emission Trading System (ETS) taxes internal production based on GHG emissions, spurring investments in greener processes. This mechanism, however, risks incentivizing relocation of production to countries with lower or no carbon costs (a problem that is now inefficiently addressed by granting free emission allowances to the most carbon-intensive industries).

How the EU carbon tax affects imports and decarbonization

The situation has created the need for the new Carbon Border Adjustment Mechanism (CBAM), which covers imports from outside the EU. Producers and importers will have no choice but to pay a price on their carbon footprint, either within the ETS or the CBAM, respectively. There will be no more carbon leakage and no more free allowances — all products will be taxed based on their CO2 emissions, regardless of their origin. The combination of ETS with CBAM will protect EU producers’ competitive standing while providing strong cost incentives for decarbonization, both within and outside the EU.

Exhibit 1: CBAM outlook

Many different types of companies will need to make significant changes in anticipation of CBAM, which will cover commodities including steel and iron, aluminum, cement, fertilizers, hydrogen, and electricity when it starts in 2026. Its impact is expected to grow exponentially through 2034, driven by scope expansions (such as more commodities, finished products, and Scope 2 and 3 emissions ), as well as gradual removal of free allowances and projected spikes in carbon prices due to more stringent emissions limits that will increase demand for CO2 certificates. On average, CBAM is expected to increase imported commodities prices by 20-30%, but highly carbon-intensive products such as chemicals and cement could skyrocket by up to 200%.

Exhibit 2: Percent increase in the cost of imports due to CBAM, by industry

The new regulation will not only affect imports; the consequent free allowances removal will also raise EU prices for products manufactured with the EU. The increase will be smaller because EU producers have a lower carbon footprint on average than competitors from other regions, but the effect will be relevant nonetheless.

The changes companies need in the post-CBAM era

CBAM effects will reverberate well beyond costs, affecting industries’ environmental performance and strategic choices. The construction, automotive, chemical, and agriculture industries will be first to be hit, but sooner or later the disruptive impacts of CBAM will extend to every sector. EU companies need to act now with short-term strategies to extend their carbon accounting capabilities and assess their suppliers’ carbon footprint to estimate current and future carbon costs.

Exhibit 3: Key actions industries are required to take

The need for value chain disruption and decarbonization investments

To remain competitive in internal and global markets, players will need to disrupt their value chains, pushing decarbonization investments and the adoption of cleaner products such as green steel and green ammonia, in line with future CBAM scope extension and longer-term net zero targets. This could be achieved by driving suppliers through pragmatic, short-term decarbonization paths. In particular, the first step for all companies will be extending carbon accounting capabilities to Scope 2 and 3 by 2026. Next, they must rethink the cooperation between their sustainability and procurement functions, shifting from pure economic convenience to investment in decarbonization, and from sourcing from carbon-intensive suppliers to a focus on emission reduction.

The key steps for a new procurement strategy and value chain reconfiguration

Indeed, all companies need a new procurement strategy and value chain reconfiguration that are able to integrate purchase strategies aimed at minimizing costs and environmental impact as well as strengthening company positioning versus competitors. To do so, companies must assess all suppliers’ carbon footprints. They also need to reassess current suppliers’ cost competitiveness by evaluating all producers’ carbon footprints to identify the most convenient option.

Finally, while companies will have to estimate the current and future impact of CBAM and the free allowance phaseout, suppliers will be required to develop both an investment plan for decarbonization and an emission reduction plan to maintain their competitiveness against the lower emitters.

This initiative will not only help reduce emissions, but also will give a boost to companies that first invested in sustainability, as well as advantage sustainable European champions over higher emitters outside Europe.