S&P Global: How the EU's CBAM Regulations Will Affect Trade

The European Union's Carbon Border Adjustment Mechanism (CBAM) kicks into full operation in 2026 and will require EU importers to report the carbon emissions linked to their imports.

Carbon pricing will be applied to essential commodities including aluminium, cement, fertilisers and iron and steel, creating potential trade-related challenges for dependent sectors.

A new piece of research by finance giant S&P Global suggests that the implementation of CBAM may lead to US$15bn-25bn in additional costs each year, linked to import values for these materials throughout the coming decade.

How CBAM will affect trade

CBAM's objective is to prevent 'carbon leakage', while also promoting more sustainable manufacturing of products and resources. Following a transitional phase beginning in 2023, complete implementation will arrive in 2026.

As part of these new requirements, EU firms will have to report on the sustainability of their imports. As a result, the cost of imported goods will likely align more closely with domestically manufactured alternatives.

A period of restructuring across European supply chains is expected to follow the rollout of CBAM as company executives look to reduce their costs.

While the materials that fall under CBAM's purview will remain essential to European infrastructure, domestic EU manufacturing capacity is currently limited. In years gone by, this has created a heavy dependence on foreign imports.

Throughout 2021-2024, the EU brought in average annual volumes of 11 million tonnes of cement, nine million tonnes of aluminium, 17 million tonnes of fertilisers and 76 million tonnes of iron and steel goods. These purchases averaged US$120bn annually. Demand levels vary across products:

• Aluminium imports face 70%-80% of demand
• Fertilisers dependence is 40%-60%
• Steel imports are 27% of demand
• Cement imports only cover 3%-4% of demand.

The case for diversified sourcing

The EU maintains varied supplier networks for aluminium, steel and iron. Leading aluminium providers in 2024 included China (11%), Turkey (10%) and the United Arab Emirates (5%). These nations have already felt CBAM's influence.

This reveals that most imports arrive from numerous smaller suppliers, indicating EU sectors possess greater adaptability in transitioning to more economical aluminium sources.

Certain sectors will get free allocations covering manufacturing emissions, which are intended to discourage businesses from moving operations beyond EU borders.

The EU is putting an emphasis on smooth transition, with CBAM charges phasing in gradually while complimentary allowances are phased out. Proceeds from CBAM are presently earmarked for advancing the EU's environmental objectives.

S&P's assessment finds that 5-15% of cement entering the EU demonstrates higher emission intensity compared to European equivalents. For aluminium the proportion reaches 50-60%, whilst for fertilisers, steel and iron it exceeds 90%.

The ramifications for supply chains

S&P forecasts that by 2035, CBAM may generate US$222bn in accumulated extra expenses. The analysis suggests initial implementation year costs could average US$7bn-8bn.

Various scenarios developed by S&P estimate commodity expenses. Should EU carbon pricing rise without corresponding increases elsewhere, CBAM might produce annual supplementary costs of US$16bn-$25bn during the initial decade.

"Our scenario analysis indicates CBAM could add at at least US$15bn annually to these goods' import values over the next decade, all other factors unchanged," states Terry Ellis, Director, Climate Transition Risk at S&P Global and co-author of the analysis.

"That compares to about US$120bn of annual trade in those goods in the last four years. We estimate EU import prices could increase annually by 2%-3% under our moderate carbon price scenarios. Although these goods, overall, represent less than 1% of GDP in most exporting countries, some sectors could face increasing exposure as supply chains adjust."

European importers will need to manage an increasingly complicated sourcing environment, as locating suppliers offering reduced emissions becomes crucial for controlling additional expenses.