Implications of the EU's Carbon Border Adjustment Mechanism for Fertiliser and Food Markets

Introduction

The European Union's (EU) Carbon Border Adjustment Mechanism (CBAM) will enter its ‘definitive regime’ in 2026. EU importers of certain energy intensive goods and electricity will be required to purchase certificates covering the carbon content embedded in the imports of these goods at the weekly average auctioned price (i.e. carbon price) from the EU Emissions Trading System (EU ETS). An important good covered by the CBAM is mineral fertiliser. In the analysis presented in this article we make use of an agricultural commodity model (see Box 1 for Methodology) to assess the potential impacts that the CBAM may have on production, use and trade of fertiliser and food, with emphasis on critical issues such as reduction of greenhouse gas (GHG) emissions and carbon leakage. Under stringent climate policy, incentives may exist to relocate production to countries with laxer policies and higher emission intensity resulting in ‘carbon leakage’. We also address the implications of extending the CBAM to a set of countries with a similar policy in place, which is referred to as a CBAM club (or climate club) in the literature.

The main findings from the analysis are that a unilateral EU CBAM leads to moderately higher domestic fertiliser prices translating into modest agricultural EU and world market impacts. One third of EU reduced agricultural emissions will be leaked, meaning that they are emitted in connection with higher production in international agricultural markets. A CBAM club will have lower trade-distorting effects than a unilateral CBAM depending on bilateral trade. In terms of leakage, two thirds of CBAM club countries’ GHG emission reductions from agricultural production are instead leaked outside the club.

The EU ETS and CBAM

Since its launch in 2005, companies in highly-emitting sectors under the EU ETS must acquire emission allowances for every tonne of carbon dioxide equivalent (CO₂-eq are calculated on the basis of Global Warming Potentials over 100 years) emitted or they face large fines.

GHG emissions in the EU decreased by 30 per cent from 1990 to 2021 (EEA, 2023) while embedded net imports (imports minus exports) of CO₂ emissions per capita have increased by 23 per cent over the same period (Global Carbon Budget, 2023).

The EU ETS will increasingly reduce the number of permits and free allowances to contribute to achieving EU emission targets, potentially raising carbon prices, compliance costs and the risk of carbon leakage.

To address this problem, the EU introduced the Carbon Border Adjustment Mechanism (CBAM), which will act as an import tariff on GHG emissions embedded in particularly carbon-intensive imports, one of which is mineral fertiliser. The CBAM entered a transitional phase on 1 October 2023, but actual payments will only be required starting in 2026. From 2026, under its definitive regime, importers will have to acquire CBAM certificates equivalent to the GHG emissions embedded in the products exported to the EU minus any carbon price imposed domestically by the countries exporting to the EU. This ensures, in principle, that EU imports will be subject to an emission taxation equivalent to the EU level.

Effects of the EU CBAM on fertiliser imports

As the EU is a net importer of fertilisers, the introduction of a unilateral CBAM on imports is expected to raise domestic fertiliser prices. However, the incidence of the price increase on producers and consumers will depend on the relative responsiveness of supply and demand, and the degree of trade openness. In order to isolate the impact of a unilateral EU CBAM, we perform an ex-ante analysis where we compare this policy against a baseline in which domestic carbon pricing is already implemented (i.e. CBAM policy versus a baseline including the EU ETS with no free allowances). Model estimates suggest that a unilateral CBAM tariff on EU fertiliser imports will increase fertiliser domestic producer price, stimulate domestic production and decrease reliance on imported fertilisers. Results depend on the carbon price and carbon intensities assumed for the EU and its main trading partners. With an assumed international carbon price of 100 USD/t, EU imports of NPK (Nitrogen, Phosphorus and Potassium) fertilisers (all fertiliser quantities and prices are expressed, in our model, in terms of the main nutrients included in the fertilisers) are estimated to decline (by –27 per cent, –9 per cent, and –17 per cent, respectively) by 2040 (Figure 1a). Domestic EU fertiliser producer prices are, in turn, expected to rise (by 12 per cent for N, by 3 per cent for P, and by 4 per cent for K respectively). EU fertiliser production will increase by a similar amount and lower import demand in the EU, so that international fertiliser prices will not be affected much (–1 per cent for N and less than –0.5 per cent for P and K).

Higher EU fertiliser prices lead to modestly lower use in the scenario (less than 1 per cent) and, thus, lower crop production in the EU (except for nitrogen fixing crops), with consequent impact on both domestic and international crop prices. However, the impacts on EU agricultural commodity markets are quite modest (Figure 1b). Slightly lower agricultural production leads to slightly higher domestic prices with lower exports and higher imports in the range of ±2 per cent. EU prices of most agricultural commodities increase (although by less than 0.5 per cent), given the lower EU fertiliser use and production (less than 0.5 per cent in absolute value). To compensate for the lower domestic production of fertilisers, imports increase and exports fall, especially of the fertiliser intensive commodities with more negative production effects (e.g. maize).

A ‘CBAM club’ mitigates impacts

Other countries may also consider implementing a CBAM to balance market competitiveness issues arising from their climate mitigation action (EC, 2021). In addition, main EU foreign trade partners will realise that CBAM revenue accrued to the EU is foregone revenue in their countries. This realisation may incentivise more countries to adopt similar climate ambition. The formation of a ‘CBAM climate club’, may limit the incentives to trade with countries which take no or more limited climate mitigation action. We implement a model scenario to study the impacts of extending the EU CBAM framework to other trade partners who have similar emission taxes in place, such as Canada and the United States (Box 1). The effects are similar to the EU unilateral case (Figure 2) but price effects are muted given that some of the Club members are main global traders in fertilisers (e.g. Canada in K). In the club countries, the CBAM disincentivises imports from non-club members. To the extent that bilateral exports can be diverted from other destinations to buffer demand within club countries, fertiliser price increases are reduced.

Trade between countries is affected by the carbon prices (and emission permits) faced by fertiliser producers in each of the club countries. As the largest net importer among club members, the EU faces the largest adjustment for all fertilisers. Fertiliser prices in the USA and Canada are less affected for P and K. These impacts illustrate that price impacts for P and K are different among trade partners as the EU imports more potassium from Canada, but reduces imports of N from the USA, due to relative competitiveness. EU imports of fertilisers from non-bilateral trade partners are reduced (Figure 3).

The primary impact of the CBAM climate club is on trade. Specifically for the EU, total imports and exports are less affected compared to the scenario with a unilateral CBAM.

Due to the climate club design, potassium trade is diverted from countries outside the climate club to countries within the club, since bilateral trade partners have a competitive advantage.

Drops in exports and imports are smaller for the climate club scenario than for the unilateral CBAM scenario, especially for nitrogen. There is almost no difference among scenarios in the case of phosphorus and potassium. Prices and production in the EU are increased slightly less in the climate club scenario than in the unilateral CBAM as bilateral imports among club members satisfy internal demand.

The results for most agricultural commodities show generally lower absolute effects on production, and lower imports and exports in the climate club scenario than in the unilateral CBAM, resulting in larger price effects.

In general, the climate club scenario indicates a lower impact on EU fertiliser production, and higher imports and especially exports compared to the unilateral CBAM scenario, thus implying a lower disruptive effect on trade.

A ‘CBAM Club’ reduces emissions more than a unilateral CBAM

Compared to the baseline, a unilateral EU CBAM increases EU emissions from higher fertiliser production (see CBAM scenario in Figure 4a). This is more than offset by the drop in such emissions in the rest of the world though, resulting in an estimated net reduction (–1,224 kt CO₂-eq) in global emissions from fertiliser production (Figure 4a). However, higher EU fertiliser prices induce a reduction in domestic EU agricultural commodity production and increases in commodity production and emissions abroad (see Figure 4b). GHG emissions in the world (from use of fertilisers, and changes in land area and animal numbers) are marginally lower than in the baseline by –214 kt CO₂-eq (Figure 4b). Summing all contributions from fertiliser production and consumption, changes in land area and animal numbers, the EU unilateral CBAM decreases total world level emissions by –1,439 kt CO₂-eq (see CBAM scenario in Figure 4c).

The climate club scenario implies higher emissions than in the baseline in the EU, USA and Canada from increased fertiliser production (Club scenario in Figure 4a). In the EU, the emission increase is not as much as in the unilateral CBAM scenario because part of the production is replaced by imports from bilateral trade partners. These emission increases are more than offset by decreases in fertiliser production in the rest of the world though. Global emissions from fertiliser production in the climate club scenario are therefore lower by –2,642 kt CO₂-eq (Figure 4a). The opposite effects in emissions derive from fertiliser use, change in land use and animal numbers (Figure 4b). A reduction in agricultural production in the EU, in Canada, and in the USA implies reductions in emissions of approximately –317 kt CO₂-eq for the EU and of –987 kt CO₂-eq for the USA and Canada together. This decrease is offset by emissions leaked to the rest of the world (854 kt CO₂-eq), which is approximately 65 per cent of the reduction in club countries. Summing these numbers together, in the climate club scenario, the world has a reduction in GHG emissions from fertiliser use, change in land area, and animal numbers of around –450 kt CO₂-eq which is more than twice as much as the reduction from a unilateral CBAM policy (Figure 4b).

In the climate club scenario, the higher decrease in GHG Emissions from fertiliser production in the rest of the world and consequent drop in total emissions (Figure 4a) is compounded by the agricultural market effects (Figure 4b), which implies that, all in all, in the world (Figure 4c), global GHG emissions from a climate club scenario decrease more than in the unilateral CBAM (–3,092 kt CO₂-eq in the climate club scenario instead of –1,439 kt CO₂-eq in the unilateral CBAM). This larger decrease is mostly due to emission decreases in the non-club members (from fertiliser production) not completely offset by the increases in fertiliser production emissions in club members, thanks to lower Global Warming Potential Intensities.

Conclusions and discussion

Coherence of policy approaches across countries is important for achieving shared GHG emission reduction goals. Models are helpful in assessing the ex-ante effects of policies intended to lower GHG emissions, given that some of these policies may seriously affect domestic industry competitiveness, either positively or negatively. The results of the current analysis show the considerable effect of CBAM on fertiliser trade and GHG emissions. They also indicate potential benefits of a wider CBAM club. The results do depend critically on market characteristics, such as net trade balances, and for a club, the extent of bilateral trade among members. Furthermore, elasticities of supply and demand, as well as of trade, have a critical influence on estimated effects. Fertiliser markets affect agricultural production and prices modestly due to the inelastic fertiliser demand by EU farmers. A unilateral EU CBAM is estimated to increase domestic emissions, reduce carbon leakage, and modestly reduce global emissions. A CBAM climate club scenario lowers total world emissions more than twice that of a unilateral CBAM scenario.

Several caveats to this research should be noted. The EU CBAM also applies, in principle, to products derived from the ones on which CBAM applies directly. It is yet unclear to the authors how this provision applies to fertilisers. Moreover, the current scope of the EU CBAM may be widened to include more sectors directly, such as agricultural and food production, especially if an ETS were extended to those sectors. The low effects on the agricultural commodity markets originate from a specific set of elasticities and assumptions about carbon prices. Even though leakage is observed, low agricultural market reactions imply that emission increases in the rest of the world are not enough to offset the decreases in CBAM countries, thus implying a total decrease in global emissions from agricultural markets. Moreover, drops in agricultural production derived from increases in fertiliser prices may be critical for a portion of farmers that are barely making a profit, thus potentially driving these farmers into debt or completely out of the market. GHG intensities from production of fertilisers are assumed not to change in the period analyzed while they might change in reality due to technological improvements incentivised by CBAM. It is also critical to remember that these results are obtained by comparing scenario results with a baseline already including a carbon price but not including free allowances for fertiliser producers. Additionally, the results are contingent on the evolution of carbon prices in the future. We execute a sensitivity analysis with carbon prices at 50 and 200 USD/t. The results remain qualitatively the same proportionally, while, in absolute terms, there are stronger effects for larger carbon prices. Finally, our analysis focuses on a CBAM on fertilisers while analyses including a CBAM on agricultural goods may obtain different results (Fournier Gabela et al., 2024).

Disclaimer

The opinions expressed and arguments employed herein are those of the authors and do not necessarily reflect the official views of the European Commission.

A multilateral CBAM would have lower trade-distorting effects than a unilateral CBAM, while reducing global greenhouse gas emissions twice as much.

Un mécanisme multilatéral d'ajustement carbone aux frontières aurait moins d'effets de distorsion sur les échanges qu'un mécanisme unilatéral, tout en réduisant deux fois plus les émissions mondiales de gaz à effet de serre.

Ein multilaterales CO2-Grenzausgleichssystem hätte geringere handelsverzerrende Auswirkungen als ein unilateraler Mechanismus und würde die globalen Treibhausgasemissionen doppelt so stark reduzieren.

Nitrogen, Phosphorus and Potassium: main fertiliser constituents © 753476031/ALLAI AdobeStock

Urea fertiliser facility © 1009714954/Fernando Cortez AdobeStock

Fertiliser spreading © 1091630560 /Dzmitry AdobeStock