EU Green Deal: The Carbon Border Adjustment Mechanism (CBAM)   

The European Commission published a proposal for a Regulation establishing a Carbon Border Adjustment Mechanism (CBAM) for the purpose of tackling the so called 'carbon leakage' which could potentially obstruct EU's decarbonisation plans. It is part of the Commission's Fit for 55 package published on 14 July 2021 and aimed at achieving the EU target for a 55% reduction in greenhouse gas (GHG) emissions by 2030 (against 1990 levels).

What is CBAM?

Accelerated climate efforts at EU level entail a high risk of carbon leakage in non-EU countries where less stringent environmental and climate policies prevail (e.g. companies based in the EU could relocate their carbon-intensive production abroad to take advantage of less rigorous standards). Such leakage can shift emissions outside of Europe and ultimately, it has the potential to undermine climate objectives both at European and global level.

The Carbon Border Adjustment Mechanism (CBAM) foresees for EU importers to buy carbon certificates corresponding to the carbon price, which would have been paid, had the goods been produced under the EU carbon pricing rules. Furthermore, if a non-EU producer shows they have already paid a price for the carbon used in the production of the imported goods in a third country, the corresponding cost can be fully deducted for them.

The main goal of the CBAM is to help reduce the risk of carbon leakage by encouraging producers in non-EU countries to “green” their production processes. Revenues from the CBAM will contribute to the EU budget, pursuant to the Interinstitutional Agreement of December 2020.

To ensure legal certainty and stability for businesses and third parties, CBAM will be introduced gradually and will apply firstly to a selected number of goods that pose a high risk of carbon leakage such as iron, steel, cement, fertilizer, aluminium and electricity. To facilitate the gradual transition, a reporting system will apply as of 2023 for these products with a view to encouraging participation and dialogue with third countries. Moreover, importers are foreseen to start paying the financial adjustment as of 2026.

Emissions Trading System as a predecessor to the Carbon Border Adjustment Mechanism

The EU’s Emissions Trading System (EU ETS) is the world’s first international emissions trading scheme and the EU’s main policy to tackle climate change. Its purpose is to set a maximum amount of greenhouse gas emissions that can be released from industrial installations in certain sectors such as electricity and heat generation and commercial aviation.

The system operates by prescribing that allowances must be bought on the EU ETS trading market, whereby a certain number of free allowances are distributed to prevent carbon leakage. On top of addressing the risk of leakage, EU ETS attempts to incentivise the investment in greener production at home and abroad. In this regard, CBAM will gradually become an alternative to EU ETS. In many aspects CBAM mirrors the ETS as it is designed in compatibility with WTO rules and applied uniformly at Union level. 

Pursuant to the Commission’s proposal for a revised ETS which is also part of the set of legislative proposals presented in the Fit for 55 packagethe number of free allowances for all sectors will decline over time so that EU ETS can have maximum impact in fulfilling EU’s ambitious climate goals. Furthermore, with regard to CBAM sectors the free allowances will gradually be phased out from 2026. CBAM will begin to apply to the products covered gradually and in direct proportion to the free allowances granted by ETS. In short, until they are completely phased out in 2035, CBAM will apply only to the proportion of emissions that does not benefit from free allowances under the EU ETS, thus ensuring importers are treated equally compared to EU producers. By introducing the same carbon price as domestic producers under the EU ETS, CBAM will comply with the equal treatment for products made in the EU and imports from elsewhere and avoid carbon leakage.

Transitional phase

On the basis of the CBAM proposal, importers are obliged to report the emissions from their goods and will not pay any adjustment fee in the so-called transitional phase starting from 2023 and finishing at the end of 2025. During these two years, the final system must be efficiently implemented. The gradual introduction of CBAM, together with this transitional phase will provide certainty and predictability for all stakeholders - businesses from the EU, third-country parties, and authorities. It is expected that by 2026, CBAM will be fully functional and importers will have to declare on an annual basis the quantity of goods and emissions in the total goods imported in the preceding year. Additionally, they will have to provide the corresponding amount of CBAM certificates.

Enforcement of CBAM

Similarly to EU ETS, CBAM will be based on the purchase of certificates by importers. The price of each certificate will be calculated depending on the weekly average auction price of EU ETS allowances in euro/tonne of CO2 emitted. Certificates will be bought either individually or by a representative registered with the national authorities, which will authorise the registration in the CBAM system, as well as review and verify declarations.

For an importer to offer goods under CBAM in the EU, it must declare by 31 May each year the quantity of goods and the embedded emissions from the imported goods during the previous year, while providing the CBAM certificates purchased in advance from the respective authorities.

What is next?

The Proposal will be submitted to the European Parliament and Council under the ordinary legislative procedure. In general, such legislative initiatives take two or more years. However, the duration of the procedure could not be predicted at this point, taking into account the controversial nature and technical complexity.

One potential areas of debate both in the European Parliament and the Council could be the treatment of energy-intensive sectors and their ability to continue to obtain free allowances under the ETS after CBAM comes into force. Since the CBAM is a proposal for regulation, it will become directly applicable as soon as it comes into force. Consequently, Member States will not have any discretion when it comes to transposition into national law. In light of this, intensive lobbying is expected from different stakeholders including those outside the European Union.