The limits of the EU ETS carbon market 

With the EU-ETS market, Europe has created the first Cap & Trade market to regulate carbon emissions from European industrial activities. With the introduction of a price on carbon emissions generated by EU plants, European companies are subject to a regulatory constraint that does not exist for many of their competitors, based in countries where climate standards are less stringent.

What is the Cap and Trade EU ETS market?

The European Union Emissions Trading Scheme (EU-ETS) is acap-and-trade system in which companies declare their emissions and surrender equivalent emission allowances. Companies can either buy allowances at auction or receive them free of charge (particularly for sectors considered to be at risk of carbon leakage). The ceiling (total quantity) of emission allowances is progressively reduced to encourage European producers to reduce their emissions.

For businesses, this local carbon pricing creates an additional cost that is passed on in sales prices. Passing on the extra cost to end consumers seems unlikely, as customers may switch from local products to cheaper imports. To find out more about the impact of the EU ETS on markets, read the article by Anna Creti, Aliénor Cameron and Marc Baudry (sources and references at the bottom of the page).

Solutions to the limitations of the EU ETS 

Aware of this situation, the EU has allocated free allowances to companies, thereby reducing carbon costs, but going against the principle of dissuasive taxation (polluter pays). With this good intention, the market for rights to pollute becomes less of an incentive to decarbonize: European producers are protected by free quotas, and their non-European competitors generally benefit from less restrictive climate rules in their own countries. With the allocation of free quotas, local supply (blue FA curve) becomes more competitive against imported supply (black curve). 

MACF's protectionist role 

As the solution of free allowances is temporary, the CBAM has the onerous task of correcting the market imbalance caused by the introduction of a carbon price in Europe. The aim of the Border Carbon Adjustment Mechanism is to :

• Reduce the competitive gap between European and non-European producers. The regulation targets internationalized sectors where the market power of European producers is limited by offers from other countries. The idea is that any product offered for sale on the European market should be subject to equivalent carbon pricing.
• Phase out free quotas, thereby replacing part of the ETS system and making all European players fully responsible for their carbon costs.

This is the first reason why the MACF was created: to apply the same carbon requirements to European imports and producers.

New European and global regulations

In a world first, the European Union is imposing a carbon price at its borders. Europe's innovative climate policy instinct is not unprecedented, however, having already been illustrated by the creation of the first emissions trading scheme in 2005, when the EU became the first territory to require European producers of the most polluting industries to measure their greenhouse gas emissions. With the introduction of the MACF, this emissions reporting stage now also applies to all companies exporting to the European Union.

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At Keewe, we offer a unique solution for managing your MACF compliance. Visit our MACF page to find out more and contact us).

The purpose of the MACF declaration

The establishment of the MACF declaration is one of the most influential aspects of this new regulation: asking the rest of the world to assess its carbon emissions. The MACF can be questioned on its scope and implementation - only certain sectors and products are covered at this stage - but its main objective is nonetheless powerful: all producers exporting to the European market must quantify their carbon emissions.

The climate club

Carbon taxation at borders has been on the drawing board for over 30 years, having been introduced at the Rio Conference in 1992. The idea was revived by one of the leading lights of environmental economics, William Nordhaus, to support the creation of a global climate club. More recently, the G7 countries have put forward a joint proposal for such a club.

Source photo : Wikipedia

This club would operate on a simple principle: its members would agree on a minimum tariff for the carbon they emit. Countries outside the club would be subject to a tax on their exports to member countries. These outside countries would then have a choice to make: pay the tax or join the club by adopting the minimum carbon price themselves. 

Using economists' favorite tool, price incentives, countries will consider taxing carbon emissions.

And this is MACF's major decarbonization objective!

MACF or forced carbon tax for exporting countries

The cost of the MACF for companies is calculated via the difference between the supplier country's carbon pricing and that of the European Union (the current allowance price on the emissions trading market). There will therefore be a trade-off between the carbon price to be paid, defined by the climate policies of the supplier countries.

Formula: EU CBAM = EU ETS - Domestic Carbon Pricing

This approach aspires to the incentive policy of the aforementioned "climate club", guiding exporting countries towards raising their domestic carbon tariffs. We explain it all below:

The logic behind MACF suggests that a reduction in demand for imported products, which have become more expensive after carbon adjustment at EU borders, is likely. 

Technical part: The idea is that for the importer, the final cost remains similar, whether paying a high MACF for low-priced products from a supplier, or a lower MACF for products whose price is increased due to a higher carbon tax in the exporting country. 

Nevertheless, we can imagine that for exporting countries, and especially their governments, the second option (raising local carbon taxes) is preferable, as it recovers the revenue generated by the carbon price - rather than letting the European Union pocket the bill.

The Indian government, for example, has already taken a stand on the subject of MACF: "If we collect the tax in India itself and use it for our transition to green energy, which will indirectly help the same exporting companies to switch to cleaner energy and reduce their costs, there will be no additional MACF tax", Minister of Commerce and Industries, Mr. Piyush Goyal.

Source photo : Wikipedia

To broaden the scope of our thinking, we might also ask whether exporting countries will adjust their climate policies according to the zone of export - imposing a carbon price on exports to the European Union, but not on exports to other countries with less stringent climate policies. In this case, like MACF, we'll have to comply with international trade rules.

Studying the MACF can seem complex. At Keewe, our experts can help you understand the challenges of these new regulations. We offer you a unique solution to manage your MACF compliance:

• Easy, automated data collection and management, thanks to integrated transactions and supplier data
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• Simulate the financial impact of MACF on your import costs

Visit our CBAM page to find out more and contact us.