How should the Automotive industry prepare for CBAM?

• The Carbon Border Adjustment Mechanism (CBAM) is a new tool of the EU aimed at extending the EU emissions trading system to imports of goods.
• Since October of this year (2023), many EU importers will be subject to quarterly reporting requirements for imported goods, CO2 emissions, and CO2 taxes already paid in the countries of origin.
• With the start of emissions certificate trading for imported goods from 2026, higher manufacturing costs, the re-design of supply chains and higher compliance costs in the automotive industry can be expected in the long term.
• In particular, the expansion of the CBAM to include all industrial goods would have a strong impact on the automotive industry. Initially, the automotive industry will only be indirectly affected via the supplier network and only directly in specific cases.

The CBAM is intended to create future parity in competition between product manufacturers within the EU and outside the EU, while eliminating incentives for relocation to countries with lower decarbonization ambitions (carbon leakage). 

These objectives are to be achieved by obliging EU importers to acquire CBAM emission certificates as compensation for the CO₂ emissions of the goods they import from outside the EU. The price of the certificates will be based on the market value of a certificate from the EU Emissions Trading System (ETS), thereby treating CO₂ emissions incurred within and outside the EU equally, creating a level playing field.

As CBAM is a complex system, it initially only covers a limited list of CO₂-intensive goods. These include cement, electricity, fertilizers, hydrogen, iron (including iron ore), steel, aluminum, and products thereof. Furthermore, the scope of goods is intended to be expanded to cover all industrial goods by 2030. However, before the start of CBAM certificate trading in 2026, a transitional phase went live in October 2023, during which importers must compile a quarterly CBAM report containing the goods imported, the CO₂ emissions contained therein, and the CO₂ levies already paid in the country of origin.

It is expected that CBAM will have a significant impact on the production of goods by both intra-European industrial companies and foreign manufacturers. Naturally, the question arises as to how the automotive industry will be affected by the planned CBAM measures as one characteristic of the automotive industry is its resource-intensive production processes.

In general, 55% of manufacturing industries can be classified as steel-intensive. With a 12% share of steel in intermediate goods, the automotive industry also plays a crucial role in raw material markets.

Firstly, the exact economic impact of CBAM on the automotive industry can only be estimated at this time, as CBAM is a unique instrument for reducing greenhouse gas emissions within the European Union. More precise assessments of the specific effects on the economy, industry, and climate can only be made retrospectively, after 2026 at the earliest.

However, certain assumptions about the effect of CBAM can be made: one possible outcome is that the production of automobiles may become more expensive due to the inclusion of raw materials and components in the CBAM system, unless the global supply industry actively participates in the green transformation and significantly reduces greenhouse gas emissions.

The significance of iron, steel, and aluminum imports from non-EU countries is also not insignificant for the European industry and has increased due to the ongoing energy crisis. In 2021, for example, 47% of aluminum and 26% of iron and steel were imported. The sharply rising energy prices in 2022 are likely to provide additional momentum to manufacturers from non-EU countries with lower production costs.

Currently (October 2023), the emission certificate price in the ETS is in the range of EUR 90 to EUR 100 per ton of CO₂ and has more than doubled in the past two years. With the introduction of CBAM and the expansion of the ETS to include the "Building" and "Transport" sectors, it is possible that the certificate price will continue to rise in the long term. The gradual reduction of free emission certificates will also contribute to increasing price dynamics.

According to analyst surveys, in the short term it is expected that there will be a relatively stable average emission certificate price of under EUR 100 per ton of CO₂ in 2024. However, a significant increase in the cost of raw materials such as steel and aluminum due to CBAM is seen as a logical consequence in the long term. This particularly affects automotive supply groups with a high production share of these materials (chassis, axles, and structural parts).

Specifically, a significant increase in the CO2 price in the ETS can indeed lead to substantial price hikes for end products in the automotive sector. This is because automobile production relies heavily on raw materials such as steel and aluminum. For example, a vehicle with a curb weight of one ton consists of approximately 600 kg of steel and 90 kg of aluminum. Producing one ton of steel emits 1.8 to 2.5 tons of CO2 and producing one ton of aluminum generates approximately 1.7 tons of CO2. If the additional production costs due to rising CO2 prices resulting from the expansion of the ETS and the introduction of CBAM are passed on to consumers, we can expect automobile prices to increase in the coming years.

It remains uncertain whether these price increases will be significant enough to lead to major shifts in demand. The impact of CBAM on the restructuring of supply chains in the automotive industry should not be underestimated, as German automakers, for example, produced twice as many cars in non-EU countries as they did in Germany in 2021.

Therefore, it is likely that CBAM will accelerate the transformation of the automotive industry toward lower-emission manufacturing methods and technologies. While this transition may be costly in the short term, sustainable investments are expected to pay off for automakers in the long term due to the increasing cost of carbon emissions.

There are numerous factors driving decarbonization in the automotive industry. These include the use of green steel and modern production methods that enable weight and space savings in vehicles. Furthermore, circular economy practices, such as the reuse of secondary raw materials, play a significant role in decarbonizing the automotive industry within the framework of CBAM (Carbon Border Adjustment Mechanism). For example, solid circular economy practices can reduce greenhouse gas emissions in steel production by up to 60%. A similar reduction in emissions can also be expected in the overall production of electric vehicles, which can lead to cost savings. In the long term, it is even conceivable that up to 97% of all emissions could be saved without incurring additional costs.

Since CBAM reporting and pricing are highly individual and complex, it can be assumed that CBAM may meet its objectives in some sectors while falling short in others. These as-yet unpredictable CBAM effects pose additional uncertainties, particularly for automakers. The role of automotive suppliers in the automotive sector has become so significant that they are responsible for a large part of vehicle manufacturing, with the "traditional" automotive manufacturers now producing only about a quarter of a car themselves. Therefore, it will be important to examine how CBAM specifically impacts differently specialized automotive suppliers and to what extent they pass on the additional costs to the automakers.

In general, automotive suppliers are under intense pressure to decarbonize their production processes. Two-thirds of new business for automotive suppliers depend on CO₂-related criteria that OEMs (Original Equipment Manufacturers) use to establish contractual relationships with suppliers to achieve their own sustainability goals. It is not uncommon for OEMs to require these sustainability requirements to be met by the automotive supplier within a swift 18-month timeframe.

Furthermore, within the framework of CBAM, it is imperative to adhere to additional compliance regulations. Failure to take the right measures in a timely manner carries the risk of legal and financial consequences (fines, procurement bans, enforcement of measures by the relevant authority), negative public perception, as well as damage to reputation and liability cases.

However, all companies face the challenge of comprehensively identifying, assessing, and documenting any changes in their value chain network. Therefore, they must conduct a risk analysis to identify mandatory requirements and their individual impact, and then develop and implement solution-oriented processes. It is crucial to monitor the effectiveness of these processes.

How CBAM will precisely influence the automotive industry and whether the potential positive effects in the form of greater technological and sustainability incentives will outweigh the potentially negative impacts such as higher manufacturing and supply chain restructuring costs is uncertain and remains to be seen. Furthermore, the mandatory compliance with binding requirements poses additional organizational and financial challenges for the automotive industry.

The success of CBAM, therefore, depends on its specific political and economic design, which will slowly develop during the transition phase that just became applicable (October 2023).

Authors: Frederik Cappelle, Head of Customs, KPMG Belgium & Stephan Freismuth, Director, KPMG Germany