CBAM, carbon trap, and impact of irrational gas policies

The EU’s Carbon Border Adjustment Mechanism (CBAM) is now a pressing challenge for exporters worldwide. By pricing the carbon content of imports, CBAM ensures companies outside the EU face the same climate costs as European manufacturers under the EU Emissions Trading System (ETS). It is a key part of the EU’s goal to be carbon neutral by 2050, preventing “carbon leakage” ensuring that all carbon emissions - regardless of origin - are equally penalized.

In its first phase (2023–2025), the CBAM targets high-carbon sectors such as iron, steel, cement, aluminum, and fertilizers. However, from 2030 onwards, textiles are expected to be included, posing serious implications for textile manufacturing countries.

While textiles are not as energy-intensive as the sectors currently covered under CBAM, the policy could still undermine Pakistan’s export competitiveness, given the dependency on textile export revenue.

With the EU as Pakistan’s largest export market and textiles as its major export, future market access will increasingly depend on the carbon footprint of Pakistani goods. Given the price-sensitivity and highly elastic nature of textiles, even marginal cost increases from carbon tariffs could lead to a noticeable drop in demand.

For Pakistan, the risk of losing competitiveness is especially urgent due to three interrelated structural challenges in its industrial sector.

First, industrial emissions in Pakistan have steadily risen over the past five decades, driven by a growing reliance on coal. This shift could make the country’s manufacturing base increasingly carbon-intensive and less competitive in a climate-conscious global market.

Second, Pakistan is a net importer of carbon emissions - an often overlooked aspect of its climate profile. The carbon embedded in imported raw materials and intermediate goods adds to the emissions footprint of its export value chains, inflating the overall carbon intensity of its final products.

Third, recent energy reforms - such as the gas levy and the proposed CPP levy legislation under IMF conditionalities - appear designed to push industries away from cleaner, gas-based self-generation toward the more carbon-heavy national grid, risking an increase in emissions per unit of output.

Together, these trends not only raise Pakistan’s exposure to CBAM-related costs but also risk non-compliance with international climate obligations under the UNFCCC, the Paris Agreement, and Sustainable Development Goals (particularly SDG 7 on clean energy and SDG 13 on climate action).

In an era where climate standards are becoming a precondition for access to global markets, Pakistan’s energy trajectory - marked by rising emissions, imported carbon, and coal reliance - could undermine its export competitiveness and expose it to carbon and trade penalties if left unaddressed.

Coal reliance and accelerating carbon emissions in Pakistan:

Pakistan’s emissions profile underscores the urgent challenge ahead. Coal power, which accounts for 40% of the country’s energy mix, is a significant contributor to rising emissions. Despite its environmental costs, Pakistan remains heavily reliant on coal imports due to its low cost and CPEC-linked investments that have deepened this dependence.

However, this reliance clashes with the global shift toward carbon accountability. Over the past five decades, carbon emissions from industrial processes in Pakistan have increased at an average annual rate of 5.3%, signaling not only sustained but accelerating carbon intensity in domestic production (see figure 1).

Pakistan as a net importer of carbon:

Importantly, Pakistan’s carbon challenge extends beyond domestic emissions. As a net carbon importer, much of the emissions embedded in its exports come from imported raw materials and machinery, particularly from high-emission economies like China (figure 2).

This outsourced carbon, combined with rising local emissions, could make Pakistan’s supply chains carbon intensive - a situation that should be avoided at all costs.

Since CBAM taxes emissions across the production process, Pakistan’s status as a net carbon importer heightens the vulnerability of its exports. In contrast, regional competitors like Vietnam, China, and India are net carbon exporters (figure 3), shifting their emissions abroad.

For instance, Zhang and Chen (2022) find that over 6% of China’s exports contain carbon transferred to other Belt & Road Initiative countries, most of which are net carbon importers. Pakistan’s growing reliance on Chinese inputs raises the embedded emissions in its textile exports - thereby potentially eroding Pakistan’s price competitiveness in major markets.

Policy paralysis:

Recent IMF-backed energy reforms further compound this challenge. At the center is the CPP levy, which taxes gas supplied to industrial captive power plants (CPPs) and is set to rise incrementally to 20% by August 2026, over and above grid parity.

Intended to shift industrial demand to the national grid, this policy has unintended climate consequences. By making gas costlier, it pushes manufacturers toward cheaper but dirtier fuels - primarily coal - undermining Pakistan’s climate targets and increasing emissions per unit of output just as global buyers tighten carbon-related standards.

While this levy may force some additional units to shift to the grid, its overall impact remains marginal, as gas/RLNG consumption has already declined by 75% due to prohibitively high OGRA-notified prices.

The long-term costs are steeper: elevated emissions, rising industrial energy costs, and greater exposure to carbon border taxes. With more trading partners adopting carbon accountability frameworks, Pakistan stands to lose billions in export revenues unless it aligns its industrial energy policy with global climate goals. While the IMF has recently proposed a domestic carbon levy for Pakistan, the detailed framework is yet to be developed.

Potential violation of international conventions:

The implications extend beyond trade and competitiveness. Increased coal use driven by distorted energy pricing risks violating Pakistan’s international commitments.

As a signatory to the United Nations Framework Convention on Climate Change (UNFCCC), and the Paris Agreement, Pakistan is obligated to reduce emissions by 20% by 2030 and transparently report its progress. Increased reliance on coal will spike carbon emissions, drawing international scrutiny and weakening Pakistan’s credibility in climate negotiations. It also risks non-compliance with the EU’s GSP+ scheme, where upcoming monitoring missions - such as the one expected in June - assess adherence to environmental commitments.

More broadly, continued coal dependency clashes with the global shift toward Environmental, Social, and Governance (ESG) standards under WTO frameworks, increasing the risk of non-tariff barriers and reduced market access. It also undermines Pakistan’s progress toward Sustainable Development Goals—particularly SDG 7 (Affordable and Clean Energy) and SDG 13 (Climate Action) - and threatens the country’s broader 2030 development agenda.

CHPs for industrial decarbonization:

To avoid the rising costs of carbon non-compliance and trade penalties, Pakistan must urgently reorient its industrial energy strategy. The path forward lies in smartly integrating renewable energy with gas-based Combined Heat and Power (CHP) systems. CHP offers a low-carbon, flexible solution capable of stabilizing the intermittency of renewables like solar, while leveraging existing gas infrastructure.

Additionally, CHP engines can be integrated with solar PV and battery energy storage systems (BESS), creating a practical and scalable route to decarbonize industrial energy use while reducing dependence on imported coal.

These systems also extract maximum economic value from gas molecules by simultaneously generating electricity and useful heat.

In this context, gas and RLNG emerge as essential bridge fuels - classified as cleaner technologies - that can complement renewables and enable the transition to a low-carbon industrial base. Aligning with this strategy not only supports compliance with CBAM but also helps uphold Pakistan’s international climate commitments by lowering industrial emissions.

When reforms backfire:

However, while the need for decarbonization is clear, current policy measures are pulling in the opposite direction. The growing disconnect between Pakistan’s energy reforms and its climate obligations must be urgently addressed to preserve the country’s industrial future.

The objective of the IMF-backed policy - aimed at maximizing grid usage to lower tariffs by increasing consumption and spreading fixed costs over a broader base - has failed to materialize. Instead, frequent outages and rising costs have pushed consumers toward solar and industries toward alternative fuels like RFO, coal, and biomass.

What persists is an unreliable and unsustainable national grid, burdened with massive stranded costs. If these issues are not urgently resolved, they could lead to a permanent loss of industrial competitiveness and severe environmental consequences.

Meanwhile, the combined circular debt of the gas and power sectors has already exceeded Rs 5 trillion (as of March 2025) - a figure that will only increase if reliance on the fragile grid continues, expensive RLNG is diverted to the household sector, and domestic oil and gas fields are shut down.

Too often, policies are crafted in isolation, overlooking their long-term consequences on industrial vitality and export growth. Yet, in a landscape where fiscal reforms are essential, sacrificing sustainable revenue streams like exports is a risk Pakistan can no longer afford.

Therefore, an open cost-benefit analysis is urgently needed for all policies that currently overlook social, environmental, and economic costs to end this policy disconnect before the consequences become irreversible.

Copyright Business Recorder, 2025