
As the global average temperature exceeds the 1.5°C mark, we are ushering in a new phase of environmental regulation. Historically, regulations have been formulated and enforced on a local level, guided by certain international agreements such as the Montreal Protocol, which aimed to phase out substances that deplete the ozone layer.
At present, proposed environmental initiatives are expanding beyond local boundaries, with the potential to influence international trade and diplomatic relations. A prime example of this development is the EU’s Carbon Border Adjustment Mechanism (CBAM).
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An Overview of CBAM
Carbon taxes have been implemented locally in various areas as a response to climate change. However, a uniform global carbon pricing system has yet to emerge, resulting in striking inconsistencies in pricing or even a total absence of it. This gap heightens the risk of carbon leakage; instead of achieving intended reductions in emissions, manufacturing may shift to regions with little or no carbon taxes—an instance of carbon tax arbitrage. The goal of CBAM is to synchronize the carbon pricing of domestically produced and imported goods by levying a charge on the carbon embedded in imports. This charge may be reduced or offset by any carbon tax levied in the exporting country’s jurisdiction.
In light of geopolitical and policy responses, three scenarios may arise:
- Scenario 1: Unified Pricing, Unified Market. The introduction of CBAM by G7[1] countries could motivate all nations to implement a similar local carbon tax framework, ultimately leading to a harmonized global carbon price that becomes integral to commodity pricing.
- Scenario 2: Birth of Dual Markets. A robust G7 market where CBAM is strictly applied, resulting in a strong carbon price, and a non-G7 market formed by countries choosing not to adopt a carbon tax. This would establish two separate markets: one that incorporates the carbon price and another that excludes it. In this situation, the second market may be more competitive due to lower entry barriers (where carbon intensity is not a factor).
- Scenario 3: Targeted CBAM on Essential Commodities. The CBAM could affect crucial commodities necessary for economic development (such as cement, fertilizer, and steel), prompting non-G7 nations to enforce protectionist policies to shield local industries (through border taxes or subsidies). This may lead to localized markets dominated by national policies and rising trade barriers, resembling a quasi-trade war.
Each of these scenarios will have repercussions on the pricing of goods subject to CBAM. Scenario 1 could result in global inflation as the costs of steel, fertilizer, and cement increase. These commodities exist in ‘hard to abate sectors,’ where achieving zero emissions remains a challenge. Attaining zero emissions would be essential to avert impacts on commodity prices.
In Scenario 2, inflation may occur within the carbon-priced market, while increased competition—stemming from more entities competing for a limited resource—may lower prices in the non-carbon-priced market.
Scenario 3 could considerably impede global trade, with commodity prices becoming contingent on trading partners, local production, and geographic location.
Moreover, CBAM is anticipated to create differentiation among manufacturers based on their carbon intensity. Traditionally, competitive advantage stemmed from low-cost production. In this new paradigm, both cost and carbon intensity will be pivotal for competitiveness.
Manufacturers that combine low costs with low carbon intensity (the A-players) are poised to be the most competitive, regardless of the scenario that unfolds.
B-players, who are currently less competitive, may prosper if Scenario 1 materializes, as they could outshine low-cost, high-carbon intensity competitors (X-players). In Scenario 2, they might capture market share in the premium carbon-priced arena but find themselves excluded from the competitive non-carbon-priced market.
X-players may enjoy temporary protection in Scenarios 2 and 3 due to local policies but are in jeopardy under Scenario 1.
The R-players face risks across all scenarios; a CBAM could thrust them into existential predicaments. The heightened competitiveness driven by the changing carbon market could be the tipping point that leads to their decline.
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Unfortunately, South Africa falls into the X-player and R-player categories. The carbon intensity of products manufactured via South Africa’s electricity grid remains high, largely due to its dependence on coal-fired power generation.
Implications for Local Manufacturers
The secondary and tertiary outcomes of any of these scenarios could be substantial for local manufacturers. Initially, if CBAM’s scope expands to include more goods and commodities (such as vehicles), South Africa’s competitiveness could decrease significantly. Furthermore, price volatility and the decline of companies producing locally made input goods may complicate and escalate costs related to local production, threatening overall competitiveness. Ultimately, these evolving global regulatory frameworks may require South African manufacturers to reevaluate their capital allocation strategies, focusing on investments in renewable energy generation rather than production or innovation expansion, putting the country’s medium-term productivity at risk.
Despite these risks, opportunities may emerge to establish a competitive advantage through heightened localization and collaborative alliances with like-minded market players. To mitigate potential declines in export revenues, localization can be optimized by building domestic production capabilities for products that were once exported but are now necessary for local production processes. This strategy holds promise for enhancing productivity, job creation, and skills development, while contributing to the industrialization and diversification of the South African economy, thereby bolstering resilience against external economic shocks.
The synergy of improved trade relations with aligned nations could unlock the potential advantages of progressive policies like the African Continental Free Trade Area Agreement. A broader range of demand, enhanced knowledge sharing, and increased self-reliance among African nations could yield positive outcomes following the implementation of CBAM and its supportive forces driving African economic growth.
Although these proposed regulations pose serious challenges to the foundational tenets of the Paris Agreement’s approach to common but differentiated responsibilities, the true strength of South Africa—and Africa at large—lies in its populace, resilience, and ability to navigate complex power dynamics. It is crucial that we come together to strengthen South Africa and ensure our lasting sustainability.
Heidi Barends is the head of sustainable finance at Absa CIB.
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