Carbon Border Adjustment Mechanism and renewable energy procurement

As global trade faces new climate-related regulations, the EU’s Carbon Border Adjustment Mechanism (CBAM) presents both challenges and opportunities for South African exporters— particularly those in energy-intensive industries. CBAM, designed to impose carbon costs on imports from countries without stringent climate policies, could have profound implications for South African exporters to the EU. In response, renewable energy procurement is becoming an appealing strategy for South African manufacturers seeking to lower their carbon footprints and maintain competitiveness.

However, transitioning to renewable energy is not only a strategic decision but also an accounting challenge. To comply with International Financial Reporting Standards (IFRS), manufacturers must carefully evaluate the implications of renewable energy procurement on their balance sheets, especially under IFRS 16 (Leases), IFRS 10 (Consolidated Financial Statements) and IFRS 11 (Joint Arrangements). This blog explores how CBAM impacts South African exports, the potential benefits of renewable energy procurement and the balance sheet considerations under IFRS standards for manufacturers shifting to renewable energy.

CBAM is part of the EU’s Green Deal, which aims to make the EU carbon-neutral by 2050. The mechanism places a carbon cost on certain imported goods, effectively imposing a carbon-based tariff on products manufactured in countries with limited carbon-reduction policies. For South Africa, where coal is a primary energy source, carbon-intensive exports like steel, iron and aluminium are directly affected, facing potential tariffs that could reduce their competitiveness in EU markets.

For South African exporters, CBAM introduces immediate challenges:

Renewable energy procurement offers South African manufacturers a way to reduce carbon emissions and mitigate CBAM-related costs. By integrating solar, wind or other renewable energy sources into their operations, manufacturers can lower their carbon footprint and potentially avoid CBAM charges. However, renewable energy procurement also impacts financial reporting, particularly under IFRS standards, which affects balance sheet and income statement presentations.

When South African manufacturers procure renewable energy through Power Purchase Agreements (PPAs), IFRS 16 (Leases) often applies. Under IFRS 16, companies must assess whether their PPA arrangements qualify as leases, given that these contracts may grant control over specific assets, like solar panels or wind turbines, for a predetermined period.

By contrast, if the renewable energy PPA is structured to avoid lease classification, it may result in no balance sheet impact and simpler income statement treatment.

For manufacturers that invest directly in renewable energy assets, such as installing solar panels or wind turbines on-site, IFRS 10 (Consolidated Financial Statements) becomes relevant when ownership or control arrangements are shared with third parties. In cases where manufacturers partner with renewable energy providers, determining whether the manufacturer has control over the project or a joint arrangement with the partner is essential under IFRS 10.

For South African manufacturers collaborating on renewable energy infrastructure through joint ventures or joint operations, IFRS 11 (Joint Arrangements) provides guidance on accounting treatments:

Each arrangement type has different income statement and balance sheet implications, and given the financial complexity, manufacturers must carefully assess these impacts based on their renewable energy investment strategy.

Other considerations: Energy transition

• Transitioning to renewable energy often requires significant upfront capital investment, whether through direct asset purchases or PPAs. 

• Where renewable energy projects are consolidated, total assets and liabilities increase, influencing capital ratios and potentially impacting access to additional financing. 

• While renewable energy investments entail upfront costs, they often reduce operational costs over time.  

• Renewable energy investments may qualify for tax incentives or generate carbon credits, offering financial benefits. Tax benefits can offset some upfront costs, while carbon credits might be sold to generate revenue, manufacturers should assess these benefits in light of IFRS requirements related to fair value adjustments and impairments. 

• As the EU places increasing emphasis on low-carbon imports, renewable energy procurement enhances a company’s brand value by aligning with ESG standards. This positioning can attract environmentally conscious customers and improve EU market access, a critical benefit for South African exporters facing CBAM.

To navigate CBAM and optimise renewable energy procurement within IFRS requirements, South African manufacturers should consider the following:

• Evaluate PPA terms carefully.

• Consider joint ventures carefully.

• Optimise tax benefits carefully. 

• Collaborate with stakeholders: Industry and government collaborations can facilitate renewable energy adoption and provide support for smaller manufacturers, who may struggle with the capital requirements and IFRS complexities of renewable energy projects.

As CBAM reshapes the competitive landscape for South African exporters, renewable energy procurement emerges as a strategic response. Yet, under IFRS standards, manufacturers must carefully assess the accounting implications of renewable energy investments to optimise financial outcomes. By strategically leveraging IFRS guidelines, South African manufacturers can balance the need to reduce carbon footprints with financial health, ensuring sustained competitiveness in EU markets and aligning with global sustainability trends.