David vs Goliath CBAM’s
threat to South African
manufacturers

Today, proposed environmental regulations are stretching beyond local borders, with their effects potentially spilling into trade and international relations. The EU’s Carbon Border Adjustment Mechanism (EU CBAM) is a prime example of this.  

A short explainer on CBAM: Carbon taxes have been introduced at a localised level in various jurisdictions to combat climate change. However, a global carbon price does not yet exist, resulting in prices varying or being non-existent. This creates the risk of carbon leakage – instead of reducing emissions (as the tax tries to achieve), factories are moved to a new jurisdiction that has no, or lower carbon taxes – a carbon tax arbitrage. The purpose of a Carbon Border Adjustment Mechanism is to ensure that the price of carbon is the same for locally produced and imported goods, through a penalty on the embedded carbon on the imported goods. This penalty can be reduced or offset by any carbon tax paid in the producing countries local jurisdiction.  

From a geopolitical and policy response perspective, three scenarios may play out:  

1. Scenario 1: One price, one market. The implementation of CBAM by G71 countries, which has the desired effect of forcing all countries to adopt a similar carbon tax regime locally and ultimately resulting in a global carbon price. The carbon price will be an integral part of the commodities prices.  
2. Scenario 2: Two markets emerge. A G7 market, where the implementation of CBAM by G7 countries results in strict enforcement and a strong carbon price in G7 jurisdictions; and a non-G7 market, consisting of countries outside of the G7 which refuse to adopt a carbon tax. This would ultimately result in two markets: one in which commodities include the carbon price and a second in which the carbon price is excluded. In this scenario, the second market will most probably be more competitive, due to lower barriers of entry (Carbon intensity of production not a factor).  
3. Scenario 3: The implementation of CBAM on critical commodities that are integral to economic development (cement, fertilizer, steel), results in non G7 countries implementing protectionist measures to protect local production (border taxes or local subsidies). This could result in highly localized market, driven by local policies and increased trade barriers – a quasi-trade war.        

In each of these scenarios, the price of CBAM included goods will be impacted. Scenario 1 will most probably result in global inflation, as the price of steel, fertilizer and cement increases. These commodities are in ‘hard to abate sectors’, meaning, with current technologies, it is hard to reduce these sectors’ emissions to zero. Zero emissions would be required to have no impact on the commodity prices.  

In Scenario 2, inflation would be expected in the carbon-priced market, while increased competitiveness – as more players compete for a smaller pie, may result in compressed non-carbon priced markets.  

In Scenario 3, global trade may be significantly impeded, and the price of commodities may ultimately depend on trading partners, local production, and location.

Furthermore, CBAM would most probably result in manufacturers being differentiated based on their carbon intensity. Historically, low-cost production drove competitiveness. In this new world, the combination of cost and carbon intensity could drive competitiveness.

Those manufacturers that have low cost, and low carbon intensity production (the A-players), will emerge as the most competitive, regardless of which of the three scenarios plays out.  

B-players, that may not be as competitive today, may emerge victorious if scenario 1 plays out, as they edge out low-cost high-carbon intensity competitors (X-players). In Scenario 2, they may gain market share in the premium carbon-price market but be shut out of the competitive non-carbon price market.  

X-players may be protected in scenario 2 and 3, due to local policies, but are at risk of faltering, in scenario 1.  

The R – platers are at risk regardless which scenario plays out, and a CBAM may be catalyst that puts them at existential risk. Higher competitiveness driven by a changing carbon market may be the straw that breaks the camels back, ultimately resulting in these companies being shut down.  

Unfortunately, South Africa falls into the X-player and R-player categories. The carbon-intensity of goods produced using the South African grid remains high given electricity is still predominately coal-fire generated.   

The second and third-degree impacts of any of these scenarios may be vast for local manufacturers. Firstly, if the scope of CBAM is expanded to include other goods and commodities (e.g. cars), South Africa’s competitiveness may reduce significantly. Secondly, price volatility and the closure of companies producing locally manufactured input goods may increase the complexity and price of local production, further threatening competitiveness. Lastly, this changing global regulatory landscape could force South African manufacturers to alter their capital allocation decisions, opting to invest in their own renewable power generation capabilities rather expanding production lines or investing in innovation. This poses a threat to South Africa’s medium-term productivity.  

Amidst these threats emerge opportunities to develop competitive advantage through improved localisation and fostering partnerships with like-minded market participants. To mitigate against a loss of export revenue, localisation can be supercharged through developing onshore production capacity, where products that were previously exported are used in production processes within our borders. Not only would this lead to improved productivity, job creation and skills development, but it would add to the industrialisation and diversification of the South African economy, making us more resilient to economic shocks originating offshore.  

The above, coupled with improved trade relations with like-minded countries, could lead to the actualisation of the benefits of progressive policy developments such as the African Continental Free Trade Area (AfCFTA) Agreement. Diversified demand, strengthened knowledge sharing and increased independence of African countries may be positive byproducts following the implementation of CBAM, and the tailwinds that spur African economic development. 

While the proposed regulations severely threaten the tenets of the Paris Agreement of common but differentiated responsibility, the strength of South Africa and Africa more broadly, is its people, its resilient spirit and ability to emerge amidst distorted power dynamics. Let us work together to strengthen South Africa, and ensure our longevity.