Last January, we explored the opportunities in the emerging landscape of carbon markets, focusing on the UK and EU’s Carbon Border Adjustment Mechanism (CBAM) and other market-based initiatives like the EU Emissions Trading Scheme (ETS) and Carbon Capture and Storage (CCS). These mechanisms are critical drivers of decarbonisation, encouraging low-carbon production, creating market opportunities, and pushing governments to adopt domestic carbon pricing systems.

As the EU CBAM moves into the first full year of the so called transitional phase, the European Commission is providing more clarity on the operational aspects and the reporting requirements of the mechanism and the scale of the task is becoming increasingly apparent.

In this follow-up to Capitalising on Green Initiatives, we dive into the critical role of Monitoring Reporting and Verification (MRV) of emissions and the importance of carbon risk management strategies for businesses.

The expanding impact of carbon pricing on businesses

CBAM presents an immediate and potentially material threat to businesses, both operationally and financially. It is becoming increasingly clear that the CBAM will have a profound impact on both exporters and importers, particularly in industries such as Cement, Iron & Steel, Aluminium, Fertilisers, Electricity and Hydrogen. As the CBAM is fully phased in by 2034, the simultaneous phase-out of free EU Allowances (EUAs) will lead to significantly higher carbon costs for European industries.

In addition, with the implementation of EU ETS 2, the new ETS covering the buildings and road transport sectors and the extension of the existing ETS to cover maritime transport, carbon pricing within Europe is being widely extended to cover the majority of the EU’s CO2 emissions by 2027.

Given this rapid roll out of carbon pricing within the EU and the ambitious compliance targets being set for European businesses, it is likely that CBAM, over time, will be expanded to include several other products. The final text of the CBAM Regulation already stipulates that the European Commission will review the list of CBAM products at the end of the transitional phase in 2025, with a view to increasing the scope of the mechanism. Indeed, it is clearly stated in the Regulation that the ultimate objective of CBAM is broad product coverage and it is reasonable to assume that most products covered by a carbon price in Europe will eventually be in scope.

Global implications and strategic responses

The prevailing carbon prices within Europe will therefore become increasingly relevant on the world stage, as the EUA price (and perhaps the ETS 2 price as it will not be the same) have either a direct or indirect impact on businesses trading CBAM goods with the EU. The difference between the EUA price and the equivalent price of carbon in the exporting country, if any, becomes a key factor, as importers of CBAM goods where an equivalent carbon price has already been paid in the exporting country, can mitigate their liability under the EU CBAM.

It remains to be seen, however, what the European Commission considers to be an “equivalent” carbon price in a foreign jurisdiction, or what it recognises as suitable MRV standards. This should become more clear over the coming year, in the run up to the full CBAM definitive regime implementation in 2026.

As we head into the new world of CBAM and increasing prevalence of carbon pricing, it is likely that those businesses that fully understand the embedded emissions of their products and supply chains, and those of their competitors, will be at a significant advantage. The importance of well-defined and executed MRV frameworks to understand the emissions of all products and goods will be key to this.

Importance of a robust MRV strategy

Understanding the embedded emissions of their products will enable businesses to manage them more efficiently, enabling them to optimise their portfolios and maximise value through for example, regulatory and geographical arbitrage.

Through robust MRV and carbon accounting, companies can create low carbon products that are differentiated from their competitors, leveraging improvements in technology and production efficiencies, or by creating lower carbon products by capturing and permanently storing carbon emissions through CCS. Armed with accurate data and a full understanding of their emissions, businesses can begin to more effectively manage them.

Once businesses possess this enhanced insight, the opportunities to engage with carbon markets will more readily present themselves. Whether that be through managing a compliance obligation such as the EU ETS, or through developing a strategy to participate in the Voluntary Carbon Market (VCM).

In the case of the EU, the carbon price is highly volatile and is driven by multiple and varied factors. Where a business has an exposure to the EUA price, either directly or indirectly through CBAM, the importance of understanding the market and having a risk management strategy in place cannot be over stated. Failure to consider the potential implications of materially higher carbon prices, or having a strategy in place to mitigate and manage those risks, could lead to significant financial implications and potentially loss of competitiveness.

At Energex, we work with companies to help them understand the regulatory developments around carbon pricing systems and carbon markets and help those who are exposed directly or indirectly to market developments to devise and implement risk management strategies.

If you would like to understand more about carbon markets, the CBAM and their implications for business, please contact Michael Fulton at Energex Partners mfulton@energex.partners