We all realize the huge risks for the Ukrainian economy associated with the introduction of the Carbon Вorder Аdjustment Мechanism (СВАМ). In addition to direct losses, there are risks of chronic underfunding. Over the next 10 years, an enormous financial burden will be placed on Ukrainian companies due to the implementation of EU environmental directives, launch of BAT (best available techniques), ambitious goals of the Second Nationally Determined Contribution (NDC-2), and responsibility of producers in terms of waste management. Steel producers will need $5–10 billion to meet these requirements in addition to capital expenditures for the maintenance and development projects.

As a result, domestic steelmakers, affected by all these new environmental challenges, might lose competition to their foreign competitors, while the lack of capacities to meet the BAT requirements timely and in full will lead to suspensions and shutdowns.

The introduction of the CBAM will apparently increase the competitiveness of European producers. Three years ago, EUROFER claimed that European steelmakers are in a non-competitive position due to lower environmental costs of importers. Even so, EU companies have their own competitive advantages, such as access to cheap funding and government subsidies, protected domestic markets, etc. One market injustice is therefore fully counterbalanced by other injustices. One needs to look at the whole range of issues, not just at environmental fees.

Nobody will compensate us for the existing imbalance. Nobody will give our enterprises access to cheap funding, EU funds and subsidies. Ukraine is trapped ‘between two fires’: we still have a lot of problems to resolve and will have additional money to pay.

It is extremely important that Ukraine’s environmental commitments be realistic. The Ministry of Environment and Natural Resources has sent the draft NDC-2 to executive authorities for approval. This project is extremely ambitious — in fact, it is not even overoptimistic, but fantastic. Therefore, I would like to ask the authorities and MPs to send the document for finalization.

First, it is necessary to develop an economic model, verify it with the business community, and then draw up a project. The EU wants the document to be adopted until 31 July, but in fact the deadline could be extended until 31 October. We still have time. And there is no need to put the carriage before the horse as our officials often like to do. It is better to do it thoughtfully, taking into account the real state of affairs and the capabilities of the industry.

Why is it important? First of all, in order to keep the arguments anchored in the negotiations with the EU. If we have an appropriate emissions trading mechanism, this will probably be one of the arguments for the EU that we are moving in the right direction, that we have tools to encourage companies’ investments in energy efficiency and cut their СО2 emissions. This mechanism is much more flexible and efficient than the system of СО2 taxes.

Secondly, as soon as the emissions trading mechanism is launched in Ukraine, our companies should still have a possibility to get free emission allowances under Ukraine’s country quota. Indeed, over 90% of emissions in the EU are covered by free allowances.

It is important to remind the EU about the amount of Ukraine’s reduction in emissions compared to 1990. In other words, Ukraine has already made a huge contribution to global decarbonization at the expense of our destroyed industry.

Moreover, every dollar invested in environmental modernization in Ukraine reduces CO2 emissions much more than the same investments in the EU. It is because the EU has already come a very long way in this direction. So, if the Union is really concerned over making Europe carbon neutral by 2050, it should consider Ukraine as part of Europe. Of course, if the CBAM is a matter of climate, not trade restrictions, as the European Union claims.

The introduction of the CBAM will deal a heavy blow to the global economy. Perhaps the EU will find arguments to show that the CBAM is compatible with the WTO rules or the ‘letter of the law’, but it will definitely be incompatible with the spirit of free trade.

The imposition of carbon tax by the EU will set off a chain reaction in global trade. Other countries will be forced to apply retaliatory trade measures and mechanisms. These are real sentiments that I witnessed at a recent meeting of the World Steel Association with industry associations from different countries.

This could hit the entire global trade and, above all, Ukraine. It is because in the CBAM framework, Ukraine much stronger depends on trade with the EU than other countries. The price at stake is higher for us, and therefore Ukraine should have stronger motivation in defending its interests and developing a correct CBA mechanism.

Even if everything goes better than expected now (if the adverse effects are not that strong), the introduction of the CBAM will toughen competition in all other markets. All products that would be squeezed out of the EU will go to the markets in which we are now competing.

The finalized CBAM is expected to be disclosed in June. Let’s wait and see what it’s going to mean for Ukraine. Though we do not know yet what the CBAM model will be, its launch may worsen Ukraine’s global position in all its aspects. And now we need to think over possible compensatory mechanisms to maintain the operation of our steelmaking companies.

The European Union views the Carbon Border Adjustment Mechanism (CBAM) as a special fiscal tool to make producers of imported goods pay the same price for СО2 emissions as European producers. Hence, the purpose of the CBAM is to include in the cost of imported goods the costs that would arise if these goods were produced under the same greenhouse emissions regulation as in the EU.

The CBAM is a sore point for Ukraine, because the EU is our main trading partner. The role of the EU as a trading partner has significantly increased as a result of Ukraine’s commitment towards European integration over the past 5–6 years. The share of Ukraine’s exports to the EU increased from 34.1% in 2015 to 41.5% in 2019. Things have come to such a point that, for example, domestic steelmakers sell more to the EU market than to Ukraine’s domestic market.

Needless to say, the strengthening of economic ties can be regarded as a positive factor. However, there is also a downside to the coin. Ukraine’s excessive dependence on the EU market may in the long run become disastrous for its economy. A third of Ukrainian exports to the EU are carbon-intensive products that are potentially subject to the CBAM. These are products made of ferrous metals, fertilizers and other chemicals, as well as electricity. The introduction of the CBAM will mean a decrease in the competitiveness of Ukrainian exports, losses for the domestic economy, and a break in production chains between European and Ukrainian companies. In other words, Ukraine will suffer more than other countries from the introduction of the CBAM because of our close and partner relationships with the EU.

In its turn, the European Union expects to achieve the following goals due to the CBAM.

Reduce the risk of carbon leakage

Carbon leakage means an increase in greenhouse gas emissions outside the country, which occurs as a result of the transfer of production abroad due to differences in environmental policies of different countries. That means industrial production will decline in countries with tough environmental policies and increase in those with soft policies. The СВАМ aims to hinder this process.

Eliminate differences in climate ambition between countries

In the framework of the Paris Agreement addressing climate change, countries independently determine their goal to cut СО2 emissions. For instance, the EU is set to become carbon neutral by 2050. The targets of many trading partner countries are less ambitious.

Eliminate the asymmetry of climate policies in different countries

Combating climate change is a global challenge. Global goals can be attained only through global efforts. The EU has the Emissions Trading System (ETS). Carbon allowance prices are growing every year. But not all trading partner countries levy taxes on their CO2 emissions. Moreover, their applicable СО2 tax rates are lower than those in the EU. Trading partners have started to realize the importance of carbon neutrality of their economies only after the EU announced its plans to introduce the CBAM.

Having signed the Association Agreement with the European Union, Ukraine has become part of the European space and has undertaken to implement the EU environmental directives. Ukraine has developed a strategy for decarbonizing the economy and expressed readiness to join the European Green Deal. In terms of reduction of greenhouse gas emissions, Ukraine is moving in the same direction as the European Union, and the CBAM introduction in relation to Ukrainian exports therefore seems unreasonable and destructive for bilateral economic relations.

Moreover, the CBAM is a very controversial tool in terms of its effects. The EU expects the CBAM to help level the ‘rules of the game’ in terms of environmental policies in the European Union and partner countries. For Ukrainian producers, the CBAM will mean an increase in costs and unequal rules of the game, because capacities for government’s decarbonization incentives and the ability of businesses to raise funds are much poorer in Ukraine than in the EU.

The European Union intends to maintain the competitiveness of local producers through the CBAM. In this respect, the CBAM is another trade restriction for Ukrainian exports to the Union.

The CBAM will be an additional source of raising money for the EU budget. At the same time, Ukrainian producers will have no access to revenues from the CBAM accumulated by the EU. In actual fact, European producers will modernize their own facilities at the expense of Ukrainian companies.

The introduction of the CBAM will create conditions for the emergence of a market for low-carbon products in the EU. Yet Ukrainian producers will not be able to enter it, since they will not have the same support for decarbonization as in the EU.

The European Union expects to use the CBAM to foster active decarbonization across its borders and contribute to the global reduction of СО2 emissions. However, the CBAM will lead to a decrease in the investment resource of Ukrainian producers, which in turn will slow down the decarbonization process in the country.

The CBAM will have adverse implications for the Ukrainian economy. In the steel industry alone, these can mean a loss of up to 0.5% of GDP. These include both a decrease in export volumes and a curtailment in investments. Furthermore, there are risks of more significant losses in a long-term perspective, which currently cannot be identified. If the CBAM is applied to Ukraine on a general basis, it will slow down decarbonization in the country. The CBAM should not be applied to Ukraine, which has already undertaken a commitment to achieve the goals of the European Green Deal. Conversely, the exclusion of Ukraine from the scope of the CBAM will be an incentive for the Ukrainian economy.

The article was originally posted here.

From 2023, Ukrainian producers will face a new barrier to access the EU market, a carbon border adjustment mechanism (CBA). This is a very controversial instrument, declared to achieve good goals, though it might have some negative implications. No one in the European Union, or even more so in Ukraine, fully understands their scale. Meanwhile, Ukraine’s steel sector will be among the most affected by the CBA.

The CBA potentially covers steel exports from Ukraine worth €2.5 billion. The dependence of the domestic industry on the EU market is high. One can even call it excessive. Paradoxically, steelmaking companies sell more in the EU market than domestically. 26% of all marketable products are supplied to the EU, and 23% to the Ukrainian market. Therefore, any changes in the EU policy will seriously affect domestic manufacturers.

Ukraine’s dependence on the EU market is the highest compared to other exporting countries. For instance, Russia’s share of supplies to the EU is around 11% of the marketable output. In Asian countries, this figure does not exceed 4.5%. That is, by and large, they ‘do not care’ about the CBA. Turkey is highly dependent on the EU (18%), but 71% of the country’s steel output is EAF-produced, which is associated with three to four times less greenhouse gas emissions. In other words, Turkey can get an advantage as a result of the CBA imposition.

The structure of capacities in Ukraine fundamentally differs from that in Turkey. 95% of our steel production is based on the use of iron ore (BOF and OHF routes) compared to 64% in Russia. At the same time, the CBA would make a blind bit of difference to Asians. This means that due to the structure and sales markets of the domestic industry, the imposition of the CBA will inflict heavier losses on Ukraine at the national level than on our competitors.

Though there’s a reason behind the established industry structure. Access to iron ore gives Ukraine a competitive advantage, and its dependence on the EU market increased over the past 5–6 years as a result of Ukraine’s course towards European integration. EAF steelmakers and countries that trade less with the EU will benefit from the imposition of the CBA. Ukrainian manufacturers will consequently lose their advantages.

The size of possible losses depends on parameters of the CBA mechanism. Two main scenarios for CBAM application are being currently considered: the first one suggests allocation of free emission allowances for producers of imported products (Scenario 1), whereas the second scenario implies no free import quotas and abolishment of free quotas for EU producers (Scenario 2). So, scenario 2 assumes many times higher amounts of CBA fees and is the least acceptable for producers of imported products, in particular Ukrainian ones. For instance, CBA fee for imports of rolled products from Ukraine under Scenario 1 may amount to €30.4 per ton, and €100 per ton under Scenario 2.

As of now, it is difficult to forecast the likelihood of the implementation of Scenario 1 or Scenario 2. This is a very controversial issue in fact. The point is that the main idea of CBA is to avoid carbon leakage. Though the allocation of free allowances in due time was also aimed at carbon leakage prevention. In other words, there may be duplication of instruments. The alternative is therefore not that easy: either a milder, but illogical scenario, or a more reasonable, but tougher scenario for both importers and EU manufacturers, because their costs would also grow significantly.

According to a survey by GMK Center, losses of Ukraine’s steel sector from the imposition of the CBA are estimated at €100–200 million per annum, depending on scenario. Those losses would result from not only increase in costs, but also decrease in export volumes. Hence, because of the imposition of the CBA, manufacturers of long products will lose on costs to all EAF steelmakers — both local EU manufacturers and other exporters. As a result, it is possible to expect a 10% fall to around 110 thousand tons in exports of long products. Manufacturers of long products (AMKR, DMK, DMZ) will be the most affected, because EAF steelmakers hold a 85% share in the capacity structure of the EU long products segment. Supplies of pig iron may be stopped as well, which means an additional loss of around 0.5 million tons. Pig iron is the least marginal product, and additional fiscal burden on it will lead to losses.

Furthermore, the CBA will result in a decrease in the amount of investment resources and capital investments in the sector — minus €130 million per annum, or 12% against 2019. A decrease in investment resources will trigger a number of negative long-term implications:

For the entire economy, losses from the CBA will amount to a €700 million decline in GDP per annum. These are the losses of the steel industry, as well as of other sectors of the supply chain and related industries. Hence, the government will incur losses of €140 million as a result of reduced tax revenues. Though the implications for the economy might be much more serious:

The CBA issue is critical for the steel sector and its long-term sustainability. The price for the economy would exceed 0.5% of GDP each year. These are just implications for the steel industry. But CBA also covers other products and other industries such as energy and chemicals. That means the losses would be much higher.

It is difficult, but still possible to reverse the situation due to:

  1. Ukraine’s active position in the discussion of the CBA format to exclude domestic products from the CBA. Compared to 1990, a cut in greenhouse gas emissions is Ukraine is more considerable than in the EU. Ukraine has committed to introduce an emissions trading system similar to that operating in the EU. Ukraine sets ambitious emission reduction targets similar to those of the EU;
  2. Access to finance from funds that will accumulate CBA proceeds. Otherwise, European manufacturers will be decarbonized at the expense of their Ukrainian competitors;
  3. A consistent environmental policy in Ukraine to encourage decarbonization (preferential loans, tax deductions, other methods of financing). The CBA in fact means applying the EU environmental regulation to foreign manufacturers, but only in terms of taxation. To avoid distortions, it is recommended to also introduce other EU policy measures in Ukraine.

Ukraine has little success in trade disputes so far. Though the CBA could be a major success for the Ministry of Economy and the Ministry of Foreign Affairs and a breakthrough in trade issues. I’d like to believe that we do care about ourselves. Otherwise, we are in for a long-term decline in industrial production. Producers will go green, but at the same time shrink.

The article was originally posted here.