How implementation of carbon pricing will shape the future of the energy sector in B&H

Article published in Bloomberg Adria.

Carbon pricing is a fiscal instrument that governments use to encourage companies and other emitters to transition to renewable energy sources and adopt new technologies to reduce emissions, in order to achieve national and international climate goals.

There are two main types of carbon pricing: emissions trading systems (ETS) and carbon taxes. A carbon tax directly determines the price of emitting carbon dioxide, while ETS sets a cap on carbon dioxide emissions in specific sectors, requiring permits for each ton of CO2 emitted.

The choice of the combination of instruments and payment modalities for carbon emissions depends on political goals and circumstances and is just one of the necessary tools to achieve national and international climate goals. The price of CO2 helps shift the burden of damage to those responsible for it and who can reduce it.

Why is this tax relevant to Bosnia and Herzegovina?

The European Emissions Trading System (EU ETS) has been in place since 2005 and will be further strengthened and expanded in the near future, with the support of the new Energy Tax Directive and the Carbon Border Adjustment Mechanism (CBAM). CBAM is introduced as a fee/tariff for emitted carbon in the production of carbon-intensive product groups (iron and steel, cement, fertilizers, aluminum, electricity, and hydrogen), which will be paid upon import into the EU from 2026.

How to avoid paying CBAM?

According to the draft CBAM regulation, there are two exemptions from CBAM. The first pertains to countries that meet certain conditions for establishing their emissions trading system (ETS) that is compatible with the EU ETS. The second exemption involves integrating the markets of the countries subject to CBAM into the EU process, supported by the Energy Community.

The key difference between CBAM and EU ETS is that in the case of CBAM, the fee is paid by importers into the EU, and this revenue goes into the EU budget, while in the case of ETS, revenues remain in the country that has introduced the system and are used for investments in cleaner technologies.

Initial impact assessments of CBAM on the Bosnian economy

According to a report by the State Regulatory Commission for Electricity (DERK) from 2022, 64% of electricity in Bosnia and Herzegovina is generated from coal-fired power plants. Electricity, along with cement, iron and steel, aluminum, and artificial fertilizers, makes up almost a third of Bosnia and Herzegovina's exports, with exports to the EU in these industries accounting for about 10% of GDP in 2022.

Preliminary data show a drop in exports from affected industries in Bosnia and Herzegovina ranging from 11% to 25%, depending on the level of the carbon tax, which is approximately 1.1% to 2.5% of GDP (according to IMF estimates). In the region, Bosnia and Herzegovina, along with Montenegro, is expected to have the greatest exposure to CBAM.

Taxing CO2 emissions in Bosnia and Herzegovina by 2026?

Bosnia and Herzegovina, along with other countries in the region, has chosen to introduce a CO2 price through the establishment of an Emissions Trading System (ETS) by 2026 to avoid the effects of CBAM and generate domestic revenues (instead of EU revenues) to support the transition to renewable energy and reduce CO2 intensity in relevant sectors.

The introduction of this mechanism is defined by international obligations of Bosnia and Herzegovina, such as the Paris Agreement, the Energy Community Decarbonization Roadmap (of which BiH is a member), and the Sofia Declaration (which BiH has accepted). The Secretariat of the Energy Community monitors and assists members in preparing plans and strategies for CBAM and the introduction of national/regional ETS systems, particularly in the electricity sector. Montenegro is the only country in the region that has successfully implemented an emissions trading system since 2020, covering the energy and industry sectors at a price of approximately 25% of the average EU ETS price.

Next steps and future challenges Bosnia and Herzegovina, like most countries in the region, has established a framework for monitoring, reporting, and verification (MRV) of emissions, which is a crucial prerequisite for the establishment of ETS. Additionally, Bosnia and Herzegovina has prepared a roadmap for emissions trading and has begun to consider options and plan the implementation of various elements of the trading system and associated legislation to determine the prices and scope of this tax in a timely manner.

Therefore, the conditions for further steps have been met, but what is currently lacking at this stage is a concrete platform to connect various sectors working on the same issue, an internal group that will be affected by these changes. The fact is that different sectors, some to a lesser extent and some more, are actively involved but do not act synergistically in achieving common goals. A broader expert and social debate on the key elements of this design and a detailed analysis of various aspects of the changes are necessary because many will be affected, and transformation and adaptation are inevitable for a brighter energy future in Bosnia and Herzegovina.

The implementation of ETS or CBAM will have the most significant impact on the competitiveness of electricity production from coal - coal mines and thermal power plants, as well as other products covered by this policy. Nearly half of CO2 emissions come from thermal power plants. Bosnia and Herzegovina exports 25% of the total electricity produced, although the operational life of most of the thermal power plants in Bosnia and Herzegovina is ending or has already ended. The draft National Energy and Climate Plan does not foresee new thermal capacity and anticipates a 20% reduction in emissions from thermal power plants by 2030. Decisions related to the introduction of ETS must inevitably be accompanied by direct strategic decisions regarding the future of coal-fired electricity production in Bosnia and Herzegovina given these prospects.