Row of rolls of aluminum lie in production shop of plant
In less than three years, the European Union will require importers of certain carbon-intensive goods to pay for their products’ embodied carbon emissions. The policy, known as the Carbon Border Adjustment Mechanism (CBAM), could have a significant impact on the competitiveness of countries that export these goods to the EU – developing countries in particular. To help them prepare, the World Bank developed the CBAM Exposure Index.
When it takes full effect in January 2026, the CBAM will cover a limited number of the most carbon-intensive goods – including aluminum, cement, electricity, and iron and steel. Some developing countries export large quantities of these goods to the EU. Zimbabwe, for example, is a major exporter of iron and steel to the EU, and Ukraine sells large quantities of fertilizer to the bloc. In later years, the CBAM will likely be expanded to cover additional carbon-intensive goods.
CBAM complements the Emissions Trading System (ETS), the cornerstone of the EU’s policy to cut greenhouse gas emissions. Under it, the EU sets annual caps on allowable greenhouse gas emissions from industries covered by the plan and auctions or distributes these EU allowances (EUAs), which are tradable on secondary markets. A company must obtain and surrender allowances corresponding to its emissions each year; if it wishes to emit more than its allocation, it must buy more. The trading sets a price on carbon, providing an incentive for firms to reduce emissions. EUAs have been trading in the range of €80–100 (US$86–108) per ton of CO2 over the last two years.
The risk with such a system is that EU manufacturers may seek to avoid paying for their emissions by outsourcing production of carbon-heavy goods to countries where carbon prices are lower or nonexistent. The CBAM is designed to prevent this “carbon leakage” by requiring companies that import covered goods from outside the EU to report the volume of emissions generated in their production and buy a corresponding number of CBAM certificates, tied to the EUA price.
The calculation of carbon includes both direct emissions (scope 1) and indirect emissions from electricity (scope 2). However, certain sectors—aluminum, as well as iron and steel, where scrap metal processing is electricity-intensive—receive compensation in the EU for their indirect emissions, so only their scope 1 emissions will be covered until that compensation is phased out.
A country’s exposure to the CBAM for any particular good can be measured in absolute terms—reflecting the total potential cost of certificates for its exporters—and in relative terms—reflecting the effect of the policy on their competitiveness in EU markets. To estimate the cost of certificates, we assume a carbon price of $100 per ton. Then we calculate how many tons of carbon are emitted for each dollar of the good—its carbon intensity. We multiply the resulting unit cost by the total value of exports to the EU to get the total potential cost of certificates.
For the Absolute CBAM Exposure Index, we scale this cost by the total value of exports of those products; exporters that send more of their products to EU markets will be more exposed than those trading more with other partners. The absolute exposure index thus represents the potential CBAM costs as a percentage of the total value of product exports.
For the Relative CBAM Exposure Index, we calculate the excess cost of CBAM certificates paid by exporters over the cost paid by an average EU producer of the same output. This excess is then scaled by the share of exports in that product going to the EU. This index recognizes the cost changes in the EU market, given that EU producers will also have to pay fully for their emissions. The implication is that relatively clean exporters may gain competitiveness, even if they are required to purchase certificates.
Figure. Absolute and Relative CBAM exposure in iron and steel
Source: Brenton et. al. (2023, forthcoming)
Consider Zimbabwe, which sends 92 percent of its iron and steel exports to the EU. The country's iron and steel industry emits 1.17 kilograms of carbon dioxide for every US dollar of exports, which is 7.2 times higher than the EU average. Emissions are even higher when the carbon-dioxide discharged by coal-fired power plants that supply electricity to iron and steel plants is included. Counting these scope 1 and 2 emissions, Zimbabwe stands out as the exporter most significantly exposed in both absolute and relative terms (see the figure).
Calculating embedded emissions may be beyond the technical capacity of many developing countries. In cases where actual emissions are not disclosed, the EU will use one of two possible defaults: the average emissions intensity of the exporting country or the average intensity of the three worst-performing EU producers of those goods. Ultimately, the full CBAM effects will depend not only on its application but also on the response by all players in global markets.
The CBAM exposure index helps identify the countries that would benefit from domestic action or international assistance to reduce the unpriced carbon content of their industrial products and help improve competitiveness in EU markets. Developing countries have until January 1, 2026 to get ready, with support from The World Bank Group and other international financial institutions.
If you want to see the Relative CBAM Exposure Index, click here.
References:
Brenton P., V. Chemutai, M. Maliszewska and I. Sikora, 2023 (forthcoming), Trade and Climate Change: Policy Considerations for Developing Countries, WBG.
Chepeliev, M., Aguiar, A., Farole, T., Liverani, A., and van der Mensbrugghe, D. 2022. “EU Green Deal and Circular Economy Transition: Impacts and Interactions.” Paper presented at the 25th Annual Conference on Global Economic Analysis (Virtual Conference).
Chepeliev, M., and Corong, E. 2022. “Revisiting the environmental bias of trade policies based on an environmentally extended GTAP MRIO Data Base.” Center for Global Trade Analysis, Purdue University.
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