How EU CBAM may increase burden of the war for Ukraine

In 2023 CBAM became a new reality – its transitional phase started, and importers have to submit reports to European Commission about embedded emissions of imports. In 2026 CBAM is expected to start operating fully, so importers will have to make appropriate payments.

European Commission declared that CBAM is climate instrument aiming to reduce carbon emissions globally. However, not everyone agrees with this interpretation. CBAM is complicated instrument which has long-term influence on third countries and international trade. It is necessary to review these issues in more detail.

How CBAM works

In fact, CBAM is an extension of the EU ETS for importers:

• importers have to pay for each ton of embedded carbon emissions from 1 January 2026;
• CO2 price in CBAM will be calculated weekly as average price in the EU ETS;
• number of CBAM certificates should be adjusted to existing free allocation of allowances in the EU ETS.

Carbon costs paid in country of origin should be deducted if they were really paid without any compensations. This condition ensures that European producers and importers will have the same carbon costs per ton of products.

From 1 October 2023 until 31 December 2025 obligations of the importers under CBAM are limited to reporting. However, the start of CBAM payments will launch changes in the EU ETS as free carbon allowances will begin to decrease. For example, in 2026 2.5% of free allowances will be phased out, in 2030 – 48.5%, in 2034 – 100%. CBAM will replace free allowances in the EU ETS and from 2034 there will be no free allowances for sectors which products are subject to CBAM.

So, CBAM will impact on parameters of the EU ETS. CBAM is intended to be a new instrument preventing carbon leakage. However, it can prevent carbon leakage only for domestic European market, while competitiveness of European exporters paying full carbon price will decrease. Companies from third countries with less strict environmental regulation could increase CO2 emissions, rise production and substitute European producers on foreign markets. Discussions on how to solve this problem are ongoing.

Initially CBAM covers a limited number of products: iron & steel, aluminum, hydrogen, cement, fertilizers, electricity. But in the future the scope can be extended as CBAM is expected to be applied to products of all sectors included in the EU ETS. The first step for extension has been already done – European Commission has started study on the potential extension of the scope of CBAM application to processed products.

CBAM impact on Ukrainian economy

CBAM will create new trade barrier decreasing access to European market for those producers who can not comply with European environmental regulations. CBAM will also lead to rebuilding supply chains if European trade partners will not be ready to fulfill stronger climate ambitions.

For Ukraine CBAM is quite painful issue as more than half of Ukrainian goods exports goes to the EU. During the war the EU has become the main trade partner considering blocked Ukrainian seaports. Export allows Ukrainian companies to continue production activity, maintain employment and support local economy.

According to our calculations, CBAM may be applied to 15-17% of Ukrainian exports to the EU. 93% of Ukrainian exports which falls under CBAM regulation is represented by iron & steel sector, especially pig iron, semi-finished steel products, finished long and flat steel products.

CBAM will create additional obstacles for export of Ukrainian companies suffering from the war. Capacity of the Ukrainian domestic market has already reduced, while CBAM will decrease export possibilities. The losses from CBAM for Ukrainian economy will increase over time as CBAM will lead to gradual decrease in free allowances in the EU ETS.Declining free allocation will lead to rising carbon prices in the EU ETS and growing CBAM payments. The higher CBAM payments mean the higher losses for the Ukrainian economy.

In 2026 (the first year of full CBAM introduction) export losses may reach $202 mln. In 2030 this indicator could be $1.4 bln. Due to CBAM in the EU Ukraine may stop export of cement, fertilizers, pig iron, billets, long steel products after 2030.

GDP losses will be greater considering intersectoral links in Ukrainian economy. For example, iron & steel sector impacts on operation of coal and coke industry, machinery, service sector. If in 2026 Ukraine could lose up to $790 mln of GDP due to CBAM, in 2030 these losses could be up to $4.9 bln.

CBAM impact on Ukrainian iron & steel industry

Iron & steel industry of Ukraine will be the most hit by CBAM. In Ukraine, 89% of steel has been produced using BF-BOF or BF-OHF route, that means high average carbon intensity (2.3 tons of CO2 per ton of steel). Ukrainian billet and finished long products would be uncompetitive to products, produced via EAF route in the EU. As a result of CBAM, Ukraine could lose all its billet and longs exports to the EU.

Pig iron sales also could halt as CBAM payments for pig iron could reach $160 per ton in 2030. It would mean that pig iron mainly could be substituted by imported HBI, which production is actively developing in MENA.

Negative CBAM impact on iron & steel industry will result in higher losses for all Ukrainian economy, as iron & steel industry is major contributor to GDP of Ukraine. For example, in 2023 it contributed 5.7% to the GDP of Ukraine, including supply chains. Iron & steel industry also remains one of the largest exporters. In 2023 the sector’s share it total exports was 14.6%. Despite the war, Ukrainian steel companies continue to invest and develop production. CBAM will definitely endanger future prospects of Ukrainian iron & steel industry, which has already suffered from the war.

Possible solution

Now Ukraine is preparing to become EU member. To fulfill the conditions for joining the EU Ukraine is aligning legislation with European climate policy:

• Ukrainian parliament adopted the law about the main principles of state climate policy;
• Ukraine has already launched monitoring, reporting and verification system for greenhouse gases;
• In 2024 Ukrainian parliament adopted the law on integrated prevention and control of industrial pollution;
• Ukrainian government is discussing introduction of emission trading system. According to strategy draft presented by Ministry of Environmental Protection and Natural Resources of Ukraine, pilot stage of Ukrainian ETS can start in 2026;
• Ukrainian Ministry of Environmental Protection and Natural Resources also plans to develop and approve new National determined commitment to Paris agreement in 2025.

Implementing all requirements of European legislation, Ukraine will have the same regulation field as the EU and will not create any carbon leakage risk. Future of Ukraine is connected with the EU. So, the EU should not be interested in worsening state of Ukrainian economy as only strong Ukraine can make the EU stronger.

CBAM regulation sets out the clauses for excluding third countries from obligations under the CBAM in case of unforeseeable, exceptional and unprovoked event, that has destructive consequences on the economic and industrial infrastructure (article 30.7 of the Regulation (EU) 2023/956 establishing a carbon border adjustment mechanism).

Russian invasion, being out of the control of Ukraine, caused significant destructive consequences for economic and industrial infrastructure. According to estimations of Kyiv School of Economics, direct losses alone amounted to $155 bln as of 01.01.2024. Requirements for afterwar rebuilding of energy sector are $50 bln as of 10.06.2024. The losses are increasing with each day of the ongoing war.

Period of the war has been lost for adaptation of Ukraine’s economy to green transition goals. In the post-war period, Ukraine will have reduced opportunities to stimulate decarbonization. The exclusion of Ukraine from the CBAM under Article 30.7 is logical. On the one hand, it will be a real test for the mechanisms included in CBAM regulation. On the other hand, such decision will allow Ukraine to integrate further into the European economy, which is beneficial for the EU.