PRELIMINARY CBAM PROPOSAL: GOOD NEWS FOR EUROPEAN STEEL PRODUCERS?

Note that this article has been superseded by one published on August 10, 2021, “CBAM and Revised EU ETS: Implications for the Steel Industry.”

Key takeaways

The preliminary draft CBAM proposal from the European Commission which became public earlier this month:

• envisages the continuation of “free” allowances of carbon credits to European steel producers up to the benchmarks under the ETS;

• imposes the same carbon costs on importers as those faced by EU based steel producers by requiring importers to acquire and surrender CBAM certificates for emissions in excess of the existing EU benchmark; and

• preserves for European “green” steel producers (those with carbon emissions below the benchmark) the ability to monetize their increasingly valuable “free” allowances.

This is good news for European steel producers and consumers of steel. It is even better news for “green” steel producers. The celebration may, however, be short lived, as the final CBAM proposal and proposals to amend the ETS are due to be published on July 14, 2021.

Further background

Steel producers in the European Union are subject to the Emissions Trading System (“ETS”) and are currently allocated free allowances of carbon credits based on benchmarks calculated by reference to the 10 per cent. lowest emitting steel producers. This system:

• encourages producers to limit their emissions to the current benchmark to avoid the need to purchase additional credits;

• seeks to protect domestic European Union producers against carbon leakage, the phenomenon where prices of European produced steel are undercut by imports from third countries with less stringent carbon regulation and consequently lower carbon costs for producers; and

• allows “green” producers to monetize increasingly valuable free allowances.

In March 2021, the European Parliament passed a resolution to support the introduction of a Carbon Border Adjustment Mechanism (“CBAM”) which would impose a carbon price on imports of certain goods, including steel, from less climate-ambitious countries. While the resolution left the precise means of implementation to a future European Commission regulation, the resolution set out the European Parliament’s clear intent to create a level playing field for steel (by applying the same carbon costs to importers and to domestic EU producers) while at the same time improving climate action.

While the methods of implementation of the CBAM are still under discussion, earlier this month a preliminary draft of the CBAM regulation from the European Commission unexpectedly became public and we have reviewed it carefully. Under this draft proposal, the CBAM will integrate with the ETS by applying an equivalent regime to certain imported goods (including steel). As such, steel importers would (subject to various offset rights) have to purchase and surrender CBAM certificates sufficient to cover the carbon emissions of the steel imported at a price determined by reference to the ETS price payable by European Union producers.

That said, it appears from the proposal that the system of allocation of free allowances under the ETS will continue in the immediate term, which is good news for European steel producers and consumers. The draft proposal effectively retains the status quo for European steel producers but imposes obligations on importers to purchase CBAM certificates only if their carbon emissions are in excess of the ETS free allowance benchmark (i.e. it gives importers an exemption from the need to purchase and surrender CBAM certificates to the extent they would have received free allowances had they been subject to the ETS). It appears this approach will continue for so long as there is allocation of free allowances under the ETS, which is currently in its fourth phase and applies to 2030.

Such a methodology appears to achieve the double objective of creating a level playing field between domestic EU production subject to the ETS and imports which will be subject to equivalent measures pursuant to the CBAM, while at the same time promoting decarbonization in the EU and beyond. The level playing field would benefit all European steel producers. The promotion of climate action in the EU, by continuing to provide EU domestic “green” steel producers (i.e. those who have emissions lower than the benchmark) with the ability to monetize their increasingly valuable “free” allocation (which appears not to be possible for importers under the CBAM), seems to be even more beneficial for “green” producers.

While the trajectory is favorable for now, the European Commission is also expected to publish a package of revisions to the ETS next month. These revisions are intended to accelerate the decarbonization of the EU economy and may include measures such as further reductions in the number of credits in circulation, expanding the sectors covered by the ETS, adjustments to the “free” allocation rules or changes to the benchmarks for calculating such allocations. The long running suspense as to the interaction between the ETS and the CBAM therefore continues and the current optimism may be short lived.

The European Commission is expected to formally publish the CBAM proposal on July 14, 2021 (together with its proposed revisions to the ETS) and these may ultimately deviate from the draft proposal.

As part of our work on the world’s largest hydrogen projects, we are at the forefront of the complex and evolving regulatory issues affecting downstream uses of hydrogen (such as “green” steel) and are happy to speak with you if you would like further information as these matters evolve.