Decarbonizing the chemical industry in Europe and beyond

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.

Pricing carbon in the EU and beyond

The revision of the EU ETS entails strengthening the current ETS, i.e., a faster reduction of allowances and a phase-out of free allowances and extending the ETS to additional sectors, such as the inclusion of maritime transportation with phased obligations: 40% for 2024 emissions, 70% for 2025, and 100% from 2026, and the creation of a new, separate emissions trading system, ETS2, for buildings, road transport, and small industry, fully operational in 2027 with monitoring and reporting starting in 2025.5

The obligation to purchase and surrender CBAM certificates will apply from 2026. The CBAM, which is a supplementary measure to, and mirrors, the EU ETS, operates by imposing a charge on the embedded carbon content of certain imports that is equal to the charge imposed on the production of domestic goods under the ETS, with adjustments being made to this charge to take into account any mandatory carbon prices in the exporting country.

Currently, the ETS only covers companies that operate within the EU. This means importing goods from the covered sectors into the EU could have a lower price than domestic EU producers, which may lead to carbon leakage.6 By imposing an equivalent carbon price on the imports of covered goods, the playing field is levelled for both EU producers and EU importers of such goods as partner countries are encouraged to decarbonize their production processes. CBAM will replace the free ETS allowances currently granted to EU producers to help ensure that there is no double benefit afforded to EU producers. As a result of placing a price on the carbon content of EU imports, the CBAM also makes non-EU sectors and companies responsible for their emissions. And in line with the level playing field, carbon pricing in the non-EU exporting country could be deducted from the CBAM amount.

A new de minimis mass threshold of 50 tonnes per importer, per year, has been introduced to simplify compliance for small importers, replacing a previous value-based threshold. The initial scope of CBAM proposed by the European Commission covers imports of goods from five emissions-intensive sectors deemed at greater risk of carbon leakage into the EU customs territory: electricity, iron and steel, cement, aluminium, and fertilizers. Polymers, organic chemicals, hydrogen, and ammonia may be included in the initial scope of covered products.7 It is expected that both the target industries and the list of covered commodities will be extended in the future.

The phase-out of free allowances under the EU ETS for CBAM-covered sectors is aligned with the gradual phase-in of CBAM. CBAM will replace the free ETS allowances currently granted to EU producers to help ensure that there is no double benefit afforded to EU producers.

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 it’s not only EU-based companies that 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 (raw materials and base chemicals) and increased costs of secondary goods that have components of covered goods (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.

Impact on the chemical industry — a cause for concern?

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 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 likely to be noticed in other sectors and industries as well. Polymers, organic chemicals,8 hydrogen, and ammonia could be included in the initial scope of products covered by CBAM. This will likely impact chemical companies’ supply and value chain directly, increasing costs and putting pressure on the industry.

Next steps

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, as well as 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.

How KPMG can help

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.

_Footnotes

_{1 The EU ETS, which currently applies to limited energy-intensive, high emitting industries, is a cap-and-trade system that sets an annual cap on the amount of greenhouse gases that companies in covered sectors may emit. This amount is covered by allowances, which are tradeable. Within the cap, companies either receive emission allowances for free or buy them, and unused allowances can be sold or used the following year. The cap decreases every year, ensuring that total emissions fall. Substantial penalties are levied when these caps are exceeded or where the number of allowances held do not cover the emissions generated.}

_{2 The directive is the framework for the taxation of electricity and energy products used, such as motor fuel or heating fuel. The proposed revision links taxation levels to the energy content and environmental performance of an energy product. It aims to ensure that fossil fuels are subject to higher minimum tax rates. Taxation is, therefore, no longer determined by consumption volume.}

_{3 The proposal entails a revision of the EED to raise the energy efficiency target for primary and final energy consumption from 32.5 percent to 36 percent and 39 percent, respectively.}

_{4 The proposal entails increasing the target share of renewables in the energy mix from 32% to 40% by 2030. Emphasis is on sectors with relatively slower renewable integration, such as buildings, industry, heating and cooling, and transport.}

_{5 EU Emissions Trading System (EU ETS) (europa.eu)}

_{6 Carbon leakage is linked to the risk that European producers will delocalise their production to countries where either a lower (or no) carbon price is levied, or consumers will switch from buying EU-produced goods to purchasing substitutes from non-EU countries.}

_{7 KPMG International, Fit for 55 mid-July 2022 legislative update, July 2022.}

_{8 HS codes 29 (Organic chemicals); 2804 10 000 (Hydrogen); 2814 10 000 (Anhydrous ammonia); and 2814 20 00 (Ammonia in aqueous solution).}