.svg)
Carbon markets and taxonomy: where do we stand today?
1. What is MACF
In 2005, Europe set up the world's largest carbon market with the aim of controlling and limiting the quantity of greenhouse gases emitted: the Emissions Trading Scheme (ETS). Member States set an annual degressive cap on the amount of carbon traded on the market, which they then allocate free of charge or by auction to companies - some 11,000 installations in 31 countries, accounting for around 45% of the EU's GHG emissions. The scheme is designed to reward the most virtuous companies, which can resell their assets, and to penalize those that emit too much carbon, which are forced to buy allowances on the market.
Today, the EU is working on a new mechanism to complement the ETS: the Border Carbon Adjustment Mechanism (BCAAM ), commonly known as the border carbon tax:
- It was in March 2022 that the European Council reached agreement on the regulatory text that will govern it.
- On December 16 and 17, 2022, the EU agreed on new points covering, in particular, a broadening of the sectors impacted and an acceleration of the mechanism's implementation, including more ambitious medium-term targets.
For a quick reminder of the framework, the MACF text is part of the "Adjustment to Target 55" package proposed as part of the Green Pact for Europe, regulated by European climate law. The pact's objective is to be the first climate-neutral continent by 2050, with an intermediate target of reducing Europe' s GHG emissions by 55% by 2030 compared to the 1990 baseline. In this article, we'll look at what the Border Carbon Adjustment Mechanism is all about, and how it's closely linked to the EU ETS.
2. Why a new carbon system?
With the European Green Deal, the EU is demonstrating its strong ambition to become a pioneer in the ecological transition. As a result, this ambition is inevitably accompanied by highly restrictive regulations, sometimes penalizing local businesses.
The main risk of this asymmetry between the EU and the rest of the world (non-EU zones, European Economic Area and Switzerland) is the relocation and transfer of greenhouse gas emissions to countries with less stringent environmental requirements. Some companies would benefit from relocating their most emissions-intensive activities to non-EU countries (cost reduction), and some EU products would risk being replaced by more carbon-intensive imports.
Themain aim of the carbon tax is therefore to prevent carbon leakage from the EU, and to limit the transfer of responsibility for polluting emissions to these countries, even though the goods and services produced would be destined for Europe. Failure to contain such leakage would considerably undermine the EU's efforts to reduce GHG emissions, since from a global point of view real local reductions would be offset or even exceeded by the increase in relocated emissions.
Finally, by imposing this carbon adjustment mechanism at borders, Europe also hopes to encourage its partner countries to introduce carbon policies as ambitious as Europe's, in order to remain competitive on its market.
3. How does MACF work?
The border carbon adjustment mechanism will require importing companies to purchase certificates, i.e. carbon allowances at the market price (the amount of which, expressed in €/tonne of CO2, is set each week by the ETS) depending on the goods imported, or to prove that the producer has already paid the corresponding amount.
To comply, importers will have to declare by May 31 each year the goods imported over the last 12 months, the associated carbon volume, and justify their purchases of the corresponding MACF certificates. The number of allowances purchased must correspond to the carbon density of the same product manufactured within the EU. Depending on the difference, the balance will be rebalanced, with a penalty if the company does not justify enough certificates, and a deduction if it does.
Today, the OECD notes that there is little relocation of carbon generated by the ETS. In time, this may no longer be the case, as Europe moves towards decarbonization in line with the Green Pact objectives. The ultimate aim of the MACF is therefore to replace the current system for allocating free ETS allowances, and to prevent possible carbon leakage. These free rights to pollute will be phased out gradually, and will disappear altogether by 2034. At the same time, allowances offered on the market will be reduced by 62% in 2030 compared to 2005, in contrast to the 43% reduction set prior to this new agreement, again with the aim of further accelerating the transition to MACF.
As for the revenues collected by this new carbon tax, 75% of them will be earmarked for the EU budget to boost the European economy and make it more independent of other economies.
4. MACF: who is concerned ?
To ensure the implementation of the carbon adjustment mechanism at borders, the planned roll-out is progressive in terms of the sectors and emission categories taken into account(scopes 1, 2, 3). The products concerned will therefore evolve over the coming years. For the moment, the MACF only affects direct emissions (scope 1) in product manufacturing, and concerns five of the most emissive sectors at risk in terms of carbon delocalization. The sectors are as follows:
- Cement
- Aluminum
- Fertilizers
- Power generation
- Iron and steel
- Hydrogen
In December 2022, the European Union reached agreement on the application of this tax on fuel, gas and heating oil, which will have a major impact on households. It also adopted an extension of the tax's scope, which will subsequently cover the maritime sector, emissions from intra-European air flights and waste incineration sites (still under discussion within the EU).
Among the sectors that would be interesting to see included in this MACF are the paper and cardboard and chemicals industries. Between them, they account for 8% of European industrial emissions.
To date, only primary products have been targeted by the MACF, as they are simpler to track from a carbon point of view, unlike the rest of the value chain, whose reporting complexity increases with product diversity. The risk of restricting MACF to primary products is to create a carbon leakage downstream from production, and thus limit the desired emission reduction results. We'll have to wait for the second phase of deployment and the results obtained to hope for a revision of the products covered by the MACF and push for a broader decarbonization of the value chain.
5. What are the next key dates for MACF?
Different phases have been defined for the rollout:
- 2023: Start of reporting by the companies concerned on emissions linked to their imported products,
- 2026: Start-up of MACF and coexistence with SEQE (allocation of free carbon quotas), with possible updating of scopes and industries covered,
- 2034: End of SEQE free carbon allocation and full transition to MACF.
6. Some reservations about MACF
The complexity of monitoring and setting up the Border Carbon Adjustment Mechanism will lie in several important points, including :
- The difficulty of carbon traceability (for example, tracking the origin of electricity consumed) and the cost of setting up carbon reporting. The EU is giving companies three years to refine their carbon reporting.
- Dialogue with third countries on the measure to avoid possible trade retaliation. It is to be hoped that partner countries will be encouraged to introduce a similar carbon pricing system and/or invest in "greener" production technologies, with a view to facilitating trade under the MACF.
- The risk of higher prices for both raw and finished products. The impact is already measurable following the agreements reached at the end of 2022, which notably concern primary fossil fuels still widely consumed by households. The EU will have to justify how it will support the most vulnerable consumers in the face of the added carbon tax, by redistributing aid from its "Social Climate Fund".
- The risk of a drop in European export competitiveness, as the MACF only applies to imports into the EU.
- The current limitation for the first phase of deployment to scope 1 product emissions.
As the planned roll-out is gradual and subject to adjustment, the EU may, after assessing the effects during the first phase of deployment (reporting of imported emissions from 2023), extend this border carbon tax to several new sectors. It would be interesting and relevant toextend this tax to emissions from scopes 2 and 3 of products, which are currently not taken into account.
Conclusion
The MACF is an important step forward in the plan to decarbonize the European economy and make the continent carbon neutral by 2050.
While many points will need to be fine-tuned and monitored as it is rolled out, the Border Carbon Adjustment Mechanism is encouraging, as it shows that the EU is making progress on the issue ofcorporate carbon responsibility, with more ambitious measures that involve players from outside the continent. The targets set by the EU for 2050 are thus integrated into the global economy, and could encourage more countries to follow the path of decarbonization in line with the challenges of environmental transition.
Bibliography
1 - Carbon adjustment at borders - risks and opportunities for European industry
3 - Border carbon adjustment mechanism: Questions and answers
4 - Council agreement on the Carbon Border Adjustment Mechanism (CBAM)
