China's preparations for European Union’s Carbon Border Adjustment Mechanism (CBAM)

Introduction: A New Global Trade Paradigm

The introduction of the European Union’s Carbon Border Adjustment Mechanism (CBAM) represents a significant pivot in international trade relations. Designed to protect the EU’s ambitious decarbonization agenda, CBAM will ensure that imported goods are subject to the same carbon pricing as those produced within the EU. This mechanism, initially targeting high-emission industries such as steel, aluminum, cement, fertilizers, and electricity, is set to reshape the global trade landscape, with profound implications for China.

China, as the world’s largest manufacturing hub and one of the most carbon-intensive economies, is acutely impacted by the shift towards carbon-conscious trade policies. CBAM challenges Chinese manufacturers to either decarbonize or face substantial cost increases on exports to the EU, a market that accounted for over €700 billion in trade with China in 2022. With China's heavy reliance on coal for energy production, particularly in industrial sectors, the country’s manufacturers are now facing rising pressure to align with global carbon standards or risk losing market access.

This analysis delves deeply into China’s current position, its preparation for CBAM, the initiatives being undertaken, and the targets set for the coming decades. We will also explore the potential impacts and the broader geopolitical and economic implications for China.

1. China’s Current Carbon Footprint and Trade Exposure

a. Carbon Intensity of Chinese Exports

China is the world’s largest emitter of carbon dioxide (CO2), with more than 10 billion tons of CO2 emissions annually, accounting for nearly 30% of global emissions. Industrial sectors such as steel, aluminum, and cement are the largest contributors. These industries, critical to China’s export economy, are characterized by high carbon intensity due to their reliance on coal-powered energy sources.

• Steel: China produces more than 1 billion tons of steel annually, contributing to approximately 15% of the country’s total CO2 emissions. On average, Chinese steel production emits around 2.1 tons of CO2 per ton of steel, significantly higher than the EU’s 1.2 tons per ton, where electric arc furnaces are more commonly used.
• Aluminum: The aluminum sector is another major emitter, with Chinese production responsible for approximately 10-13 tons of CO2 per ton of aluminum produced, compared to the EU average of 6-8 tons, largely due to the use of coal-fired electricity in China’s aluminum smelters.
• Cement: Cement production is responsible for approximately 8% of global CO2 emissions, and China accounts for over half of global cement output. Chinese cement production emits around 0.8-0.9 tons of CO2 per ton of cement, compared to 0.6 tons in Europe.

Given these figures, CBAM’s carbon pricing on Chinese exports will significantly raise the cost of importing these goods into Europe. For instance, Chinese steel exports could face an additional cost of €75-90 per ton, aluminum could see a tariff of €100-120 per ton, and cement imports could rise by €10-15 per ton, all based on emissions data and current carbon pricing in the EU.

b. Key Export Markets Impacted by CBAM

The EU is one of China’s largest trading partners, accounting for nearly 16% of China’s global exports. The introduction of CBAM will have a profound impact on trade in carbon-intensive goods. For example, in 2022, China exported approximately 3 million tons of steel to the EU, valued at over €2 billion. With CBAM in place, the cost of these exports will rise, reducing their competitiveness relative to European producers who already operate under the EU Emissions Trading System (ETS).

Aluminum exports, worth nearly €1.5 billion annually to the EU, will also face similar cost pressures. The added carbon tariffs under CBAM could force Chinese exporters to either absorb the costs, reducing profitability, or pass them on to European consumers, potentially reducing demand for Chinese goods in favor of lower-emission alternatives from within the EU or other regions.

2. China’s Preparation and Response to CBAM

a. Domestic Initiatives to Decarbonize

Recognizing the challenges posed by CBAM and other global carbon pricing mechanisms, China has launched a series of initiatives aimed at reducing the carbon intensity of its industries and energy sector. These efforts are part of China’s broader goal to achieve peak carbon emissions by 2030 and carbon neutrality by 2060. However, the timeline for these decarbonization efforts must be accelerated to align with the impacts of CBAM, which comes into full effect by 2026.

China’s key initiatives include:

• National Carbon Market: In 2021, China launched the world’s largest carbon trading market, initially covering the power generation sector. This market is expected to expand to include other high-emission industries such as steel, cement, and chemicals. The goal is to use market-based mechanisms to incentivize emission reductions and spur investment in cleaner technologies.
• Coal Reduction Strategies: China is actively seeking to reduce its reliance on coal, which accounted for 57% of its energy mix in 2022. The government has announced targets to cap coal consumption by 2025, with a gradual phase-out planned through 2035. Renewable energy sources, including wind, solar, and hydro, are being prioritized, with China already leading the world in installed renewable capacity.
• Electrification and Hydrogen Development: China is investing heavily in electrification projects, particularly in the steel sector. The transition from blast furnaces to electric arc furnaces (EAFs) could significantly reduce emissions, as EAFs rely on recycled steel and renewable energy. Additionally, China has launched hydrogen production projects aimed at decarbonizing its heavy industries. Hydrogen-based steel production, for example, holds the potential to produce zero emissions when powered by renewable energy.

b. Technological Investments and Innovation

To meet the challenges of decarbonization, Chinese manufacturers are investing in green technologies that will allow them to reduce their carbon footprint. This includes:

• Carbon Capture, Utilization, and Storage (CCUS): China is scaling up its CCUS capacity, particularly in industries where direct emissions reductions are difficult. Pilot projects have been launched in the steel, cement, and chemical sectors to capture and store CO2 emissions. CCUS is seen as a crucial technology for China to meet its carbon neutrality goals, though its deployment is still in the early stages.
• Renewable Energy Integration: China’s leadership in renewable energy is another key factor in its decarbonization strategy. By 2022, China had installed over 1,100 GW of renewable energy capacity, including wind and solar. The challenge moving forward is integrating this capacity into industrial processes to reduce reliance on coal-fired electricity.
• Green Hydrogen: Hydrogen is viewed as a critical component of China’s long-term energy transition, particularly for industries like steel and chemicals, where electrification alone may not be enough to achieve deep decarbonization. China’s National Development and Reform Commission (NDRC) has outlined plans to scale up green hydrogen production, with the goal of producing 100,000 tons annually by 2025 and further expanding capacity by 2030.

3. China’s Targets and Expectations Towards 2035

a. Carbon Peak by 2030

China’s most immediate goal is to achieve peak carbon emissions by 2030. To meet this target, China has set ambitious interim goals, including:

• Energy Efficiency Improvements: China aims to reduce energy consumption per unit of GDP by 13.5% by 2025, relative to 2020 levels. This will involve upgrading industrial facilities, retrofitting energy systems, and investing in high-efficiency technologies across sectors.
• Renewable Energy Expansion: By 2030, China expects to increase its share of non-fossil fuel energy to 25% of the total energy mix, up from 16% in 2022. The country is targeting 1,200 GW of installed solar and wind capacity by 2030, which will play a critical role in decarbonizing energy-intensive industries.
• Electrification and Decarbonization of Key Sectors: China’s 14th Five-Year Plan (2021-2025) outlines key decarbonization targets for the steel, cement, and aluminum sectors, including mandatory emissions reduction targets and incentives for companies to adopt cleaner technologies.

b. Carbon Neutrality by 2060

While CBAM is directly linked to near-term emissions, China’s longer-term goal of carbon neutrality by 2060 reflects the country’s broader commitment to aligning with global climate targets. Achieving carbon neutrality will require:

• Deep Decarbonization of Heavy Industry: Industries such as steel, cement, and chemicals will need to undergo deep decarbonization. This will involve not only adopting low-carbon technologies like CCUS and hydrogen but also rethinking production methods and supply chains to prioritize sustainability and energy efficiency.
• Zero-Carbon Energy Systems: By 2060, China aims to transition to a fully decarbonized energy system, with renewable energy, nuclear power, and green hydrogen playing dominant roles. This transition will require major investments in grid infrastructure, energy storage, and cross-border energy trading to ensure stability and reliability in a renewable-dominated energy mix.
• Circular Economy Initiatives: China is also focusing on circular economy strategies to reduce emissions and resource consumption across industries. This includes recycling materials such as steel and aluminum, reducing waste in production processes, and creating closed-loop systems where waste from one industry becomes the input for another.

c. Expectations Toward 2035

Looking ahead to 2035, China’s industrial and energy landscape will be significantly reshaped by its decarbonization efforts:

• Lower Carbon Intensity: By 2035, China’s carbon intensity is expected to decrease substantially, aligning more closely with international standards. The use of clean energy in manufacturing, combined with advanced emissions reduction technologies, will reduce the carbon content of Chinese exports. This will help mitigate the cost impact of CBAM and similar carbon pricing mechanisms expected to emerge in other regions.
• Green Technology Leadership: China is poised to become a global leader in green technologies, including renewable energy, CCUS, hydrogen production, and electric vehicles. By 2035, these technologies will likely account for a significant portion of China’s export economy, shifting the country’s reliance away from traditional carbon-intensive goods.
• Global Trade Adjustments: The global trade environment will continue to evolve in response to climate policies such as CBAM. China will likely diversify its export markets, focusing on regions that have less stringent carbon policies or where Chinese green technologies can gain a competitive foothold. This could include expanding trade with countries in Africa, Southeast Asia, and Latin America.

Conclusion: Navigating the Carbon-Conscious Trade Environment

The European Union’s Carbon Border Adjustment Mechanism is set to redefine the global trade landscape, with Chinese manufacturers facing significant challenges due to the carbon intensity of their production processes. However, China is not standing still. The country is actively preparing for the shift towards carbon-conscious trade, launching initiatives to decarbonize its industrial sectors, invest in green technologies, and align with global climate targets.

By 2035, China’s industrial base will likely look very different, with lower carbon intensity, greater use of renewable energy, and leadership in green technology exports. While the road to decarbonization is fraught with challenges, particularly in energy-intensive industries, China’s long-term goals of carbon neutrality by 2060 and peak emissions by 2030 provide a clear pathway for adaptation. The success of these efforts will not only determine China’s ability to compete in a carbon-constrained world but also its position as a leader in the global low-carbon economy.

Kjeld Friis Munkholm Associate Parter at Vejle - China Business Center

www.munkholmconsulting.com

? 2024 Kjeld Friis Munkholm. All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means without the prior written permission of the author. transmitted in any form or by any means without the prior written permission of the author.