This article first appeared in Forum, The Edge Malaysia Weekly on November 6, 2023 - November 12, 2023

The European Union (EU) carbon border adjustment mechanism (CBAM) storm is on the horizon. In July 2023, the EU rolled out the CBAM to achieve its climate ambitions — a 55% reduction in greenhouse gas emissions (GHG) by 2030 and ultimately the net zero emissions (NZE) target by 2050. This is a new mechanism that claims to complement the EU Emission Trading System (EU ETS).

When the CBAM comes into effect, the EU’s importers will be required to purchase CBAM certificates to offset the associated GHG emissions embedded in imported goods. The pricing of CBAM certificates is indicated to mirror the EU ETS price. As at Aug 4, the EU ETS was trading at €83.65 per tonne of CO2 equivalent emissions. Imported goods that are targeted in Phase 1 of CBAM implementation are goods like cement, iron and steel, aluminium, fertilisers, hydrogen and electricity.

For Malaysia, the implementation of the EU CBAM certificate would change the trade flows between it and the EU. On the one hand, exports to the EU market would contract significantly if the difference in pricing of CO2 emissions was material. On the other hand, if the carbon cost imposed through the CBAM certificate was to be absorbed fully by Malaysia’s exporters, this would either marginalise the price advantage in a best-case scenario or price them out of the market in a worst-case scenario. Moreover, goods imported from the EU would also become more expensive.

Based on statistics obtained from the Department of Statistics Malaysia (DOSM), in 2022, Malaysia’s exports to the EU were worth RM126 billion and imports were at RM90 billion. This translated into a trade surplus of RM36 billion, and was contributed from electrical and electronic products, palm oil and palm-based oleochemicals, rubber gloves, iron and steel, services and refined petroleum products.

Based on the targeted goods under CBAM Phase 1, this means 2% from the iron and steel segment and 12% of products from the palm oil and palm-based oleochemical segment (due to fertilisers and potential hydrogen generation) will be impacted outright by the CBAM certification. The remaining 86% will also be subjected to indirect CO2 emissions impact from electricity consumption. Although goods will not be banned, the condition is that the EU importers must cover embedded GHG emissions with CBAM certificates. Hence, imported goods become more expensive due to the added cost.

According to the latest Malaysian biennial update report (BUR 4th edition) under the United Nations Framework Convention on Climate Change (UNFCCC), Malaysia’s total CO2 emissions in 2019 were reported to be 330,358 kilo tonnes. The nationally determined contribution (NDC) for Malaysia is set to reduce the CO2 equivalent emissions (CO2qe) intensity of gross doemstic product by 45%, using the 2005 level of 0.531 CO2qe/GDP as the baseline. This reduction target translates into a cap of 0.29 CO2qe/GDP by 2030. In 2019, the magic number was 0.22 CO2qe/GDP, which is better than the NDC’s cap. However, is this NDC achievement alone sufficient to address the carbon leakage specified in the CBAM?

More work needs to be done. The CBAM carbon leakage is measured in two steps. The first-level assessment is quantitative with established thresholds provisioned for the respective sectors. The second-level assessment would either involve further quantitative measurement with specified criteria or qualitative assessment. The latter assessment is applicable to cases where carbon leakages exceed the established thresholds.

The “carbon leakage indicator” is derived by multiplying trade flows between the EU and the exporting countries and the emissions intensity of specific sectors. In short, reducing CO2 emissions by sector alone will only solve part of the puzzle. The other part requires bilateral/multilateral agreement to tackle the trade flows. Spoiler alert! Regulators should explore the utility of supposedly low embedded GHG emissions (for example, carbon credits) in goods imported from the EU exporters.

In the context of sustainability finance — based on Malaysia’s BUR 4th Edition, the reported carbon sink estimated from the land use, land-use change and forestry (LULUCF) sector in 2019 is able to absorb the CO2 equivalent emissions in a quantum of 214,715 ktCO2qe. This translates into a net-off of 115,644 ktCO2qe that is subjected to carbon pricing. Using the EU ETS at €83.65 tCO2qe as the referenced price, Malaysia’s net CO2 equivalent emissions would cost €9,673 million or RM48,365 million (based on the exchange rate of 1:5). To put it in perspective, that is a 3% impact to a RM1.5 trillion economy.

The most potent target is the energy sector. This sector alone is the highest contributor that accounts for 234,858 ktCO2qe or 71% of total CO2 emissions, and it has a high pass-through effect across all sectors (indirect CO2 emissions). The National Energy Transition Roadmap (NETR) rolled out by the Ministry of Economy in July is spot on. Under the NETR framework, 10 catalysts were defined with emphasis on renewable energy sources to transform the energy sector. It is claimed that the RM25 billion required investment for this transition plan will create 23,000 new jobs and reduce 10,000 ktCO2qe annually. The NETR also indicates that the future state of energy mix will consist of 70% renewable energy source for Malaysia to achieve the NZE target by 2050. To achieve this 30:70 energy mix, funding of RM637 billion is required.

A back-of-the-envelope calculation shows that the annual investment requirement worked out to be around RM24.5 billion (from 2024 to 2050). Using the net CO2 equivalent emissions in 2019 as a reference, the annual investment amount would translate to RM21.2 tCO2qe. Comparing that amount to the RM418.25 tCO2qe that the CBAM certificate would cost, the choice is obvious.

The other leg of work is the direct CO2 emissions generated through manufacturing and production processes. On that note, the EU CBAM targeted segments such as the cement segment in Malaysia generates 9,121 ktCO2qe, followed by the iron and steel segment that generates 7,553 ktCO2qe, and the aluminium segment that generates 3,833 ktCO2qe. These segments are categorised as the hard-to-decarbonise industries due to their fundamental production processes.

These industries must proactively engage the CBAM authorities and stakeholders to pinpoint the carbon leakage measurement in order to determine the hedging requirements and the strategic paths (for example, hydro energy to produce aluminium) going forward. Last but not least, all eyes must be on the details and all hands must be on deck for Malaysia to be prepared for the coming storm. The CBAM task force will start collecting data on GHG emissions embedded in imported goods starting 2026 and imposing CBAM certificates on the EU importers by 2030. The clock is ticking away.

Dr Lim Kok Tiong is a financial economist, credit and climate risk specialist, seasoned project/programme manager and independent researcher

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