The European Union has targeted to reach net-zero emissions by 2050. For European industry, which has had relatively stable emissions over the last decade, this has profound implications. Massive investments in energy efficiency, new production techniques and adaptation to low-carbon fuels will be required to reduce emissions quickly.

Even as Europe seeks to cut emissions, it also wants its industry to remain competitive on the global stage, and to continue to provide jobs. This is every bit as high a priority as the climate target. To support industrial firms as they embark on complex and expensive decarbonization programs, Europe plans to introduce an as-yet undefined tax on some high-carbon imports—a so-called Carbon Border Adjustment Mechanism (CBAM). A CBAM is also being touted as a means of driving decarbonization beyond Europe's borders, and of giving the European Union an additional source of funding.

IHS Markit recently issued a report delving into the options of the CBAM and its prospects, four main conclusions stand out:

The likely shape of a CBAM? Various concepts have been proposed for a CBAM, with speculation rife and facts few and far between. Reading the tea leaves in Brussels suggests it is very likely to end up as an import duty pegged to the price of carbon allowances on Europe's carbon market (EUAs). In IHS Markit's view, the key questions which shape the impact and effectiveness of the CBAM:

• Which industrial sectors will be included in the first iteration of the CBAM?
• Which countries will be covered, and which exempted—and on what basis?
• How precisely will the carbon intensity of imported products be determined?
• What mechanisms will be put in place for monitoring, verification, and reporting?
• How will the CBAM interact with the planned reform of the EU Emissions Trading System?

A Herculean challenge. Achieving internal agreement on the details of a CBAM will be extraordinarily difficult given the national and industrial interests at stake. Aligning the new mechanism with World Trade Organization (WTO) rules and dealing with inevitable pushback from trading partners will complicate matters further. IHS Markit believes that a slimmed-down CBAM could be introduced by 2025 at the earliest.

Europe, a regulatory superpower for emissions? EU officials have stated that no CBAM will be applied to countries with decarbonization programs that meet certain (as yet undefined) criteria. The ability to grant exemptions will, in theory, give the EU influence to shape policies around the world—while adding another layer of complexity to the implementation of a CBAM.

Failure is not an option. Despite the massive challenges that the European Union will face in developing and implementing a CBAM, EU leaders see no alternative way of meeting climate targets without threatening European industry.

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Posted 09 April 2021 by Coralie Laurencin, Senior Director, Gas, Power, and Energy Futures, S&P Global Commodity Insights and

Laurent Ruseckas, Executive Director, Gas Industry, EMEA, S&P Global Commodity Insights

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.