Decarbonizing the chemical industry in Europe and beyond

The EU has dedicated itself to sustainable development and has set a very ambitious target of becoming the first climate-neutral continent by 2050. As a milestone towards this goal, the EU pledged to reduce greenhouse gas (GHG) emissions by 55 percent, compared to 1990 levels, by 2030.

The Green Deal, introduced in 2019, is essentially a roadmap of tax and non-tax policy initiatives designed to achieve the 2050 target. The Deal consists of eight major policy areas, each of which consists of dedicated regulations, strategies, and funding sources for projects under different stages of maturity — all of which should result in smarter, more sustainable transport, a cleaner environment, sustainable use of resources, more affordable energy, the creation of new jobs, and overall better quality of life.

Several funding mechanisms are in place to facilitate the Green Deal and help to ensure a just and inclusive transition, totalling over EUR 1 trillion. The goal is to transform EU member states from high to low-carbon economies without reducing prosperity. Funding is provided through grants and contracts, and the EU is moving boldly to other forms of support involving guarantees, financial instruments and even equity.

As part of the Green Deal, the European Commission proposed the first set of targets to be met by 2030 and adopted the “Fit for 55” Package in July 2021. The package is a set of legislative proposals designed to align the EU’s climate, transport, land use, energy and taxation policies with its 2030 goal of cutting net GHG emissions.

While the Green Deal represents a general action plan to fight climate change, the Fit for 55 package offers the preparatory path to meet the Green Deal targets. It focuses on specific topics that need particular attention, as well as a robust green transition to achieve climate neutrality. The most relevant Fit for 55 policies that are expected to impact the chemical industry include:

• The revision of the EU ETS¹
• The introduction of the EU CBAM
• The revision of the EU’s Energy Taxation Directive (ETD)²
• The amendment of the EU’s Energy Efficiency Directive (EED)³
• The revision of the Renewable Energy Directive (RED)⁴

Currently, carbon-intensive industries, such as the chemical industry, are most affected by these changes, especially as governments look toward decoupling economic growth from resource use. There is an increased demand from consumers for sustainably produced goods and services, and the laws and measures proposed under the Green Deal will likely only strengthen this.

There are rapidly evolving consequences for businesses involved with the cross-border import of goods with greenhouse gas-embedded emissions into the EU. This means that not only EU-based companies should be sitting up and taking note.

As a new carbon pricing framework in the EU, CBAM will have a transformational impact on companies engaged in international trade of the foreseeable growing list of covered commodities codes and is expected to reshape global trade.

Some of the immediate direct impacts that EU companies may feel include possible higher import prices of covered goods (e.g., raw materials and base chemicals) and increased costs of secondary goods that have components of covered goods (e.g., vehicle manufacturers buying polymer parts that contain imported higher-priced raw materials and base chemicals). To sell covered goods to the EU, non-EU companies must implement carbon accounting to track the embedded emissions associated with these products (and have these embedded emissions independently verified), as this product-specific information must be provided to the authorized declaration upon importation. Additionally, supply chain disruptions may occur if imported goods are stopped at the border due to imported covered goods not being declared to customs by an authorized declarant or incorrect classification of goods according to the CN codes.

Assuming that the ETS covers EU installations of chemical companies, changes to this system will directly impact chemical businesses and increase their carbon costs. Moreover, the chemical industry is already deemed at high risk of carbon leakage given its high trade and energy intensities leading to a significant risk of investment leakage. Combined with a stabilizing demand and declining investments in the EU chemical industry, effective measures against carbon leakage are crucial to safeguard the EU’s competitiveness and the massive investments needed to achieve the climate transition.

The chemical industry value chain is very complex, interlinked and diverse. Its products are used in and supplied to all sectors of the economy. If the CBAM is applied to the chemical industry, its effects are likley to be noticed in other sectors and industries as well. Polymers, organic chemicals⁸, hydrogen and ammonia could be included in the initial scope of covered products by CBAM. This will likely directly impact chemical companies’ supply and value chain, increasing costs and putting pressure on the industry.

Businesses should already be preparing to adapt to the upcoming changes that are almost upon us. The most urgent item for companies to align themselves with the CBAM regulation is adherence to reporting obligations beginning 1 January 2023. As mentioned previously, businesses are required to report the embedded emissions in imported goods every quarter (during that quarter of a calendar year), detailing the direct and indirect emissions and any carbon price effectively paid in the country of origin.

For businesses to achieve a smooth roll-over in the upcoming transition period (from reporting to financial obligations by 2026/2027) and minimize the disruption to their business model and costs, all importers of initial covered products — both those included (i.e., cement, iron and steel, aluminium, fertilizer, electricity) and those potentially included (i.e., polymers, organic chemicals, hydrogen, ammonia) — must be ready for these transitional period reporting obligations.

As more products fall into the scope of the expanded execution of CBAM, more and more businesses will need to prepare for its implementation. It is critical for companies and importers of CBAM goods into the EU to remain well-informed of these developments and begin evaluating the overall impact on their business activity, which may not be limited to a view on their customs data only, but also impact their sourcing and supply chain.

Few companies will know in what country the actual emissions relating to the development of their goods were generated. Companies that consume covered products could face significant additional cost pass-through from existing suppliers due to the emissions occurring in geographies without commensurate low carbon policies and those associated with transporting the goods to the EU. Organizations should ensure that they understand the geographical composition of their emissions to enable them to undertake a supply chain review, where required, making conscious cost versus carbon trade-offs and ensuring the resilience of their pricing model to the proposed changes.

Notwithstanding the administrative costs associated with this tax measure, businesses should begin focusing on the quality and availability of their data elements, prepare for a global supply chain review, and assess the implications of CBAM on their business model, set-up and trade flow to stay competitive.

As more products fall into the scope of the expanded execution of CBAM, more and more businesses will need to prepare for its implementation.

KPMG Global Trade and Customs practices provide specialized assistance in global trade and customs matters, including CBAM. Working alongside KPMG firms’ Trade and Customs specialists, ESG, sustainability and green taxes subject matter professionals can assist you with an initial assessment of the CBAM implications for your business and, if required, conduct a more in-depth supply chain review.

KPMG professionals are ready to work with clients on the journey to a low carbon future.