Article by Moritz Hirschmann
Despite current efforts to combat climate change and its causes, global CO2 emissions have increased by around 1% in 2022 compared to 2021. While emissions rose less rapidly than in 2021, the European Union (EU) is not on track to achieving its own goals under the European Green Deal and has introduced more policies to combat climate change. These measures include the Carbon Border Adjustment Mechanism and the regulation on deforestation-free supply chains.
The Carbon Border Adjustment Mechanism (CBAM)
The CBAM mechanism aims to reduce carbon leakage not only from industries inside the EU, but also from products imported into the EU. A major concern for the EU, carbon leakage is when pollution is outsourced to countries that have more relaxed legislation or when EU products are replaced by more carbon-intensive imports. As outlined in the European Green Deal, the EU’s goal is to reduce net greenhouse gas emissions by 55% by 2030 and reach climate neutrality by 2050.
Within this context, the EU earlier set up the Emissions Trading Scheme (ETS), which is designed to incentivize companies to reduce their emissions by making pollution more expensive through the purchase of pollution allowances. While ETS can reduce carbon leakage, it has not incentivized companies to invest in greener production in the EU or elsewhere. In this way, the CBAM complements the ETS by working externally instead of only offsetting emissions of imports at the border.
The CBAM mechanism will be based on a certificate system that covers the emissions embedded in products imported into the EU. Prices for CBAM certificates will mirror the ETS prices. Further, if a company outside the EU can prove that they have already paid a “carbon tax” during the production process, this cost can be deducted for the EU importer, thereby encouraging a swifter transition to greener imports. To assure a smooth transition, CBAM will be introduced for products with a high risk of leakage first. 2023 will mark the start of a reporting system for those products, with 2026 as the start for adjustment payments. According to one assessment, CBAM is set to reduce carbon leakage by 29% in 2030, and emissions in CBAM relevant sectors by 1% in the EU and 0.4% worldwide.
EU Regulation on Deforestation-Free Supply Chains (EUDR)
Deforestation is another key driving force behind climate change and is responsible for the loss of 420 million hectares of land between 1990 and 2020. This land loss comes mostly in the form of agricultural use, for example for growing soy, beef and palm oil, all of which are major EU imports. To address its role in deforestation, the EU introduced the EU Regulation on deforestation-free supply chains (EUDR). This regulation aims to ensure that imports to and exports from the EU are not on the list of goods identified as key drivers of deforestation.
The EUDR will require relevant companies to practice due diligence in their supply chains. This due diligence includes proof in the form of checks that products are both deforestation free and legally produced, as well as geographical data on where the products were grown. This data can be accessed by EU agencies to ensure the continued compliance of companies. When the EUDR enters into force, companies will have 18 months to comply with the new regulations. Companies in non-compliance with regulation will face fines of up to 4% of their annual turnover in the EU.
Opportunities for Action
CBAM and the EUDR represent one of the next steps in achieving the Green New Deal, targeting high-risk products to reduce emissions globally and within the EU. With increased regulation targeting EU supply chains, companies would benefit from establishing stronger criteria for their supply chains thereby helping them to comply with CBAM and EUDR, among other regulations. One potential step is a supply chain due diligence assessment. This assessment focuses on the impacts of supply chains on the environment and on human rights. These kinds of assessments already can have the added benefits of more resilient supply chains and better risk management. In the context of CBAM and EUDR, they also can mean potentially decreasing pollution from imports while cutting costs. The increasing complexity of supply chains and compliance also can be an opportunity for companies to innovate by integrating AI into their risk and supply chain management to increase efficiency and sustainability.