Carbon Border Adjustment and Car Manufacturing Competitiveness

At the turn of this decade, the EU embarked on an ambitious Green Deal, aiming at carbon neutrality on the continent in 2050, with more than 90% CO2 emission reduction in 2040, compared to 1990. The global context of multilateralism has become non-collaborative on multiple issues, in evidence when one observes the slow progress in the only global environmental forum we have, the Conferences of Parties.

The Green Deal would imply full de-industrialization of the EU with production offshored in less climate-conscious regions, a.k.a. carbon leakage. Not palatable to European legacy industries like car manufacturing, an important sector in EU Members of weight, Germany, France, Italy, for instance, and 8% of the EU industrial production, 13 million employees, one-third of investments on the continent, 392 billion Euros, one-fifth of Member States fiscal revenues and 59 billion Euros of R&D.

To protect the remaining EU industry against imports from climate-oblivious regions, the European Commission has proposed a Carbon Border Adjustment Mechanism (CBAM) an environmental or climate tariff on imports aimed at restoring some economic, social and environmental competitiveness for EU products already subject to carbon taxation, like the Emission Trading System (ETS), which caps (and trades) CO2 emissions in “climate-unfriendly” industries. Alas, not every import has been targeted, for the moment at least. Basic products and services have been targeted, possibly because of the complexity to properly assess CO2 emissions for elaborate products, with transnational supply chains.

Steel, a basic product which standard production carbon footprint is reasonably easy to calculate, manufacturing using either iron ore or scrap and coal in blast furnaces or iron ore and scrap and hydrogen in direct reduction processes, has been included in the scope of the CBAM. It still represents on average more than half of the weight of a car, routinely accounts for one-third of the cost of materials used in light-duty vehicle manufacturing (around 1,000 Euros on average) and is more than 5% of the total cost of production, significant enough in a highly competitive sector, especially in the lower segments (small cars), where a few hundred Euros can make the difference between commercial success and failure in showrooms.

But CBAM, if not applied to all imports, like a full car for instance, may prove insufficient. Coming back to steel in car manufacturing, the overall effect of CBAM is to increase the production cost, whether the steel is imported and suffers CBAM because of a poor sustainability when produced, or sourced in the EU, thus necessarily sustainably produced, at a premium (same story if import is deemed sustainably produced).

Note by the way the double whammy, increased local demand for EU-sourced sustainable steel is inflationary in nature, as it will inevitably drive the cost of CO2 up in ETS. Every sector has diminishing over time CO2 emission caps and productivity gains in terms of CO2 efficiency are hard to achieve nowadays and can become very costly to achieve (manufacturing steel by direct reduction of iron is much more expensive than blast furnace operation).

At the end of the day, the result for the EU car maker is an increase in the cost of manufacturing, and steel is only one of the materials which must improve its carbon footprint in the production step, aluminum, plastics, and batteries (the largest cost element in an electric vehicle) will be treated accordingly. EU cars will then become less competitive compared to imports of vehicles, from China for instance, already well helped, according to the findings of a recent enquiry launched by the European Commission services. (According to one academic study, a Chinese C-segment vehicle would have received 6,000 to 7,000 Euros of state support, 25 % of its average total price tag in a European showroom.)

The road to hell is paved with good intentions, says the conventional wisdom. While the intention to protect the regional industry, forced by law to make costly efforts to be more climate-friendly, makes sense in a non-collaborative world, it seems the regulatory armory to properly tackle the issue has to be extensive, with CBAM being only one useful weapon.

Philippe Marchand is a Bioenergy Steering Committee Member of the European Technology and  Innovation Platform (ETIP).