Carbon Border Adjustment is just around the corner ... Now what?

By Kim Sung-woo

The Carbon Border Adjustment Mechanism (CBAM) is a measure to address gaps in carbon prices between countries. Its main purpose is to prevent so-called carbon leakage, a phenomenon that occurs when production facilities move from countries with strict carbon regulations ― which often leads to weakened competitiveness in terms of business environment ― to countries with looser carbon regulations.

The EU will become the first in the world to implement the CBAM. For certain goods imported into the EU, the bloc plans to charge additional prices such that importers of such goods will ultimately pay a price equivalent to the amount paid by EU companies that produce the same goods under the EU emission trading system for carbon emissions.

For the past couple of years, the EU has achieved a few key milestones in bringing the CBAM into the reality. The CBAM was first presented in draft form by the European Commission (EC) in July 2021. In December 2022, the EC, the Council of Europe, and the European Parliament agreed to expand the target goods to steel, cement, aluminum, fertilizer, electricity and hydrogen. While the CBAM in principle applies to direct emissions only, i.e., carbon emissions generated from a source owned and controlled by a company, the EU authorities agreed to extend the CBAM to indirect emissions, i.e., carbon emissions arising from electricity and heat used by a company, under certain conditions. In April 2023, with approval of the Council of Europe on five key legislations for the Fit for 55 package (i.e., reducing carbon emissions by 55 percent by 2030 compared to the 1990 level), the final CBAM introduction plan took effect. In June 2023, the EC also unveiled the Implementing Regulation, which stipulates items for reporting, reporting procedures, emissions calculation formula, etc. The EU is basically all set to launch the CBAM.

Once the "transitional period" between October 2023 and December 2025 is completed, the CBAM will come into full force. During this transition period, exporters to the EU will be required to report the amount of carbon emissions for each product that qualifies as a target goods, and after the transition period, they will bear the cost of purchasing CBAM certificates corresponding to the amount of carbon emissions. Of course, the carbon price already paid to the exporting country through the exporting country's emission trading system, if any, will be deducted from the CBAM certificate price.

What does this mean for Korea? The new CBAM regime will likely strain exports from Korea to the EU. As of 2021, Korea's exports of CBAM target goods to the EU amounted to about $4.8 billion. Notably, steel and aluminum accounted for $4.3 billion and $500 million, respectively, comprising almost all of the $4.8 billion volume. The Korea Energy Economics Institute predicted that Korea's estimated cost of purchasing CBAM certificates would be 259.6 billion won (approx. $197 million), and the Korea Institute for Industrial Economics and Trade predicted a 21.9 percent drop in aluminum exports and a 20.6 percent drop in steel exports to the EU. Moreover, given that the target goods may continue to expand to include other goods with a high risk of carbon leakage, such as petrochemicals, Korea is expected to face an increasingly larger burden.

The burden of the CBAM, however, is not only on Korea but also on many of its competitors. China, the world's largest carbon emitter, may face tougher challenges than Korea. While we do not want to smile at someone else's grief, it is important to look at not only the impact of the CBAM in absolute terms but also in relevant terms vis-a-vis other countries to objectively assess our competitive edge. As an illustrative example, Korean importers of solar facilities benefited from the U.S. regulations on Chinese importers of solar facilities. Further, Korea might be better positioned than some other major exporters to navigate this new environmental reform at the global scale as the country has already been eight years into implementing a nationwide carbon emission trading system ― Korea is the second country in the world to implement such a nationwide emission trading system.

To enhance the competitive edge in the era of CBAM, Korea needs to take various steps in and outside of its border. First and foremost, it needs to analyze the potential impacts of the CBAM in relative terms by comparing its impacts on other competitors who export target goods to the EU.

Korea also needs to communicate closely with the importing countries in the EU while also making an effort in reducing carbon emissions within its border. This is to ensure that the emissions trading system in Korea is widely recognized among the importing countries. Monitoring the response strategies of countries hit hard by the CBAM, such as China, the U.S., Russia and Turkey, is also a prudent strategy. In addition, the Korean government should support vulnerable businesses by analyzing carbon emissions for each product in the value chain of major export industries, while also expediting improving energy efficiency in the industrial sector and expanding the supply of renewable energy in the power generation sector.

The CBAM will only be the starting point for a new international carbon pricing regime across borders. Responding to this unprecedented era with the right strategy and with the right timing will prepare us for the next challenges on the horizon, such as climate clubs and other forms of carbon tariffs.

Kim Sung-woo is head of the Environment & Energy Research Institute at Kim & Chang.