Indian Exports at Crossroads: Analysing the Impact of CBAM on Supply Chains

Recently, following the footsteps of the European Union (EU), the United Kingdom (UK) has also announced its intention to introduce the Carbon Border Adjustment Mechanism (CBAM) starting 2027. Although the specifics of its implementation are still under discussion, CBAM has elicited sharp reactions from both the Government of India (GOI) and Indian industry experts. The implementation of CBAM by the UK is projected to impose a tax ranging from 14% to 24% on approximately $775 million worth of Indian exports. On one hand, policies such as CBAM may render Indian products more costly in the EU markets, creating a competitive disadvantage. On the other hand, these policies present themselves as an opportunity to establish domestic market mechanisms for carbon trading, positioning India to adapt to the inevitable global transition toward carbon prices throughout the global value chains, highlight Dr. Sourabh Bhattacharya, Professor – Operations & Supply Chain Management and Dr Steven Raj Padakandla, Associate Professor, Institute of Management Technology, Hyderabad. 

Carbon Border Adjustment Mechanism (CBAM) is a strategy designed to mitigate the potential risk of 'Carbon Leakage'. Carbon leakage occurs when businesses within the EU relocate their carbon-intensive production activities to countries with less stringent climate policies or when carbon-intensive imports replace EU products. CBAM addresses this issue by placing a price on the carbon emitted during the production and transportation of carbon-intensive goods entering the EU. The goal is to incentivize cleaner industrial production in non-EU countries. By confirming that a price has been paid for the embedded carbon emissions in the production of specific imported goods, CBAM ensures that the carbon price of imports aligns with the carbon price of domestic production. Initially, the CBAM will be applicable to imports of specific goods characterized by carbon-intensive production and a heightened risk of carbon leakage. These include cement, iron and steel, aluminum, fertilizers, electricity, and hydrogen.

Upon full implementation by January 2026, CBAM will require importers to declare the total quantities of goods imported and the corresponding embedded emissions, including the scope 3 emissions, in those goods during the preceding year. Importers will then be required to surrender an equivalent quantity of CBAM certificates as payment for the imposed carbon price. CBAM certificates can be purchased from EU Emission Trading Systems (ETS), an EU carbon market which works on a “Cap and Trade” principle.

INDIA’S EXPOSURE TO CBAM

Upon full implementation in January 2026, CBAM will encompass a restricted range of the most carbon-intensive goods, such as aluminum, cement, electricity, and iron and steel. In later years, the CBAM will likely be expanded to cover additional carbon-intensive goods. Certain non-EU countries export substantial quantities of these goods to the EU where the carbon emission intensity of these goods from non-EU sources notably exceeds that of EU countries. The contrast in carbon intensity between EU and non-EU countries places the latter at a disadvantage, as they are subject to higher carbon taxes than their EU counterparts. Within specific sectors, significant disparities in carbon emission intensity exist (see Figure-1). Within the four sectors, it is the iron and steel industry that significantly dominates the carbon emissions from non-EU countries. The non-EU countries' contribution to carbon emissions in the steel and iron sectors surpasses that of EU countries by over four times. This implies that despite potentially lower trade volumes, the high carbon emission intensity results in a substantial embodied carbon payment per dollar of exports to the EU. Figure-2 portrays the CBAM exposure for selected non-EU countries in the iron and steel sector, while Figure-3 presents the carbon emission intensity for these same countries in the same sector.

India demonstrates a significant exposure to CBAM, particularly in the iron and steel sector. Despite a relatively lower proportion of exports to the EU (23.5%) compared to countries like Zimbabwe, which boasts the highest export of iron and steel products to the EU (91.7%), India's exposure is notably higher. Clearly, the Indian iron and steel sector will bear the consequences of its elevated carbon emission intensity. Conversely, countries like Cambodia and Turkey with significantly low carbon emission intensity, will experience a competitive advantage in the iron and steel sector within EU markets. It's evident for EU importers, the higher their scope-3 upstream emissions, the more CBAM certificates they will have to purchase. Similarly, for Indian iron and steel exporters to maintain competitiveness in EU markets, substantial efforts are needed to decarbonize their supply chain.

DECARBONIZING INDIAN STEEL SUPPLY CHAIN

India 's steel sector contributes approximately 12% to the country's carbon dioxide (CO2) emissions, exhibiting an emission intensity of 2.55 tonnes of CO2 per tonne of crude steel (tCO2/tcs). This is in contrast to the global average emission intensity of 1.85 tCO2/tcs. Annually, the steel industry in India is responsible for approximately 297 million tonnes of CO2 emissions, and this figure is anticipated to double by 2030, given the Indian government's ambitious target of increasing the steel production to 300 million tonnes annually from its current level of 120 million tonnes. The heightened emissions in India can be attributed to the fact that 50% of steel manufacturing employs the emission-intensive Blast Furnace-Basic Oxygen Furnace (BF-BOF) process. Moreover, the emission intensity of alternative steel production processes in India, such as coal-based Direct Reduced Iron (DRI) or gas-based DRI, exceeds the global average.

The Government of India (GOI) has implemented measures to reduce carbon emissions in the steel sector, which include the Steel Scrap Recycling Policy 2019 to encourage enhanced resource efficiency and material circularity. Additionally, the Perform, Achieve and Trade (PAT) scheme has been introduced to boost energy efficiency. However, the pivotal initiative is the National Green Hydrogen Mission (NGHM), where the Ministry of Steel has been allotted 30% of the pilot project budget, amounting to Rs14.66 billion (US$177 million), with the aim of advancing the utilization of green hydrogen in the steelmaking process. In addition, carbon capture, usage, and storage (CCUS) is another area that holds significant promise to reduce the carbon emissions in the steel industry. CCUS entails capturing CO2 primarily from significant point sources like power generation or industrial facilities utilizing fossil fuels or biomass. When not utilized on-site, the compressed CO2 is transported via pipelines, ships, rail, or trucks for various applications or injected into deep geological formations like depleted oil and gas reservoirs or saline aquifers.

Nevertheless, there are hurdles in expanding these approaches. Firstly, the cost associated with establishing these technologies are excessively high. According to an estimate by S&P Global, DRI plants incorporating upstream green hydrogen generation might incur costs of around $4000 per tonne. Likewise, the installation of a CCUS facility for an iron and steel plant with a capacity of 2 million tons per annum would necessitate an initial investment ranging between $340 million and $430 million. Furthermore, the effectiveness of CCUS (Carbon Capture, Utilization, and Storage) technology is a subject of debate, with experts expressing scepticism about its capability to significantly reduce emissions. Secondly, the existing infrastructure to support these initiatives is presently insufficient. There is a substantial need for the expansion of network infrastructure to transport and store captured carbon.

COMBATING CBAM TO CREATE FAIR PLAYGROUND

Although the GOI’s endeavour to make Indian industries and their supply chains carbon neutral may take some time to come to fruition, the immediate challenge it faces is the CBAM which will render Indian exports to EU and UK costlier and less competitive. To combat this pressing problem the GOI has certain plans.

• Carbon tax at the country of origin: Pointing to the perceived unfairness of applying the same carbon price in both India and Europe, the GOI is contemplating to implement carbon taxes domestically by developing a domestic carbon credit trading system. The revenue generated from these taxes will be directed toward India's green energy transition. This strategy indirectly supports exporters, enabling them to transition to cleaner energy practices and subsequently reduce their carbon footprint. As a result, there won't be an additional Carbon Border Adjustment Mechanism (CBAM) tax imposed at the European border.
• Negotiate the prices of imports to counterbalance the carbon tax: Another proposal under consideration involves negotiating and including in the ultimate price of a finished product (manufactured using the previously exported item) arriving from European Union nations, or on similar items, an amount equivalent to the imposed carbon tax on exports from India. This indirect approach aims to repatriate the tax collected from Indian companies back to the country.
• Carbon tax on imports: Imposition of a carbon tax on imports from nations with high per capita carbon emissions can be a possible response to combat CBAM.

As we contemplate the implications of CBAM, it becomes evident that this is just the initiation of a broader global carbon taxation regime. Given the escalating severity of climate change, such mechanisms are poised to evolve into standard practices in global trade. Companies will be compelled to devise mechanisms for evaluating the environmental impacts of their operations, extending scrutiny beyond scope-1 and 2 emissions to encompass scope-3 emissions involving both upstream and downstream partners. Crucially, government support will play a pivotal role in facilitating the development of infrastructure and providing financial assistance to facilitate the transition toward greener production. Moreover, addressing the disparities arising from mechanisms like CBAM necessitates the establishment of a domestic carbon credit trading system. In essence, navigating the future of global trade will require a comprehensive approach, integrating environmental considerations, governmental collaboration, and innovative financial frameworks.