European Commission’s Carbon Border Adjustment Mechanism

European Commission’s Carbon Border Adjustment Mechanism, in fight against climate change and related unfair competition, will impact importing in the EU as from 2023

The Carbon Border Adjustment Mechanism (CBAM) is a levy on carbon intensive products (e.g. cement, iron, steel, aluminium, fertilizers and electricity) imported into the European Union from third countries where carbon prices are lower, or non-existent. Being part of the European Green Deal package, it was initially intended to take full effect as from 2026, with reporting starting in 2023. However, recent EU legislative efforts show that the scope will be broader than expected and the measures will enter into force more quickly.

The first CBAM Regulation of 14 July 2021 (part of the so-called “Fit for 55” policy package) aims to reduce greenhouse gas emissions by at least 55% by 2030, compared to the 1990 levels, with the overarching goal to achieve climate neutrality in Europe by 2050.

The CBAM will introduce a carbon price on certain carbon-intensive products imported into the EU, with the intention of equivalent carbon pricing on imports from outside the EU, mirroring the internal EU Emissions Trading System (ETS), which applies to production in the EU. This is to ensure the competitiveness between EU originated (ETS-covered) and imported (CBAM-covered) goods and prevent the emissions reduction efforts of the EU being offset by relocating the production to certain non-EU countries and increased imports of carbon-intensive products. CBAM initially should function in parallel with the EU ETS and gradually replace it. Under the EU ETS, allowances must be bought on the ETS trading market, though a certain number of free allowances are distributed to certain sectors. After introduction of CBAM, these free allowances will gradually be phased. Similar to ETS, in the CBAM system importers will have to buy certificates. The price of the certificates will be calculated depending on weekly average auction prices. On top of this, importers of the covered goods will have to register with specific authorities, either individually or through a representative.

A mandatory reporting system will apply as from 2023 with the objective of facilitating a smooth roll out and to facilitate dialogue with third countries. After a transition period (i.e. most likely as from 2025), importers will start paying the financial adjustments (which will contribute to the EU’s budget). This entails new roles and responsibilities for the EU customs authorities, as well as for the companies importing the covered goods.

The CBAM proposal will be finally enacted by the European Parliament and Council of the EU, after consultation with the Committee on the Environment, Public Health and Food Safety (ENVI). Recently, the ENVI submitted their recommendations to the European Parliament and the final CBAM is expected to be adopted very soon. From these recommendations, it appears that the initial draft regulation will be amended as follows.

  • Polymers and organic-basic chemicals, and most likely hydrogen and petroleum products (in addition to the initially selected cement, electricity, fertilizers, and products in the iron, steel and aluminum sector) will be CBAM covered goods. Ultimately, CBAM should cover all products covered by the EU ETS, which include a wide range of goods including crude and refined petroleum products, iron and ferrous ores, oils, fats, starch, sugar, malt, textile fibers, pulp paper and paperboards, dyes and pigments, basic pharma, ceramics and many more.
  • The transitional phase shall be reduced to 24 months, from 1 January 2023 until only 31 December 2024 (leaving effectively less than 5 months to prepare for the reporting starting from 1 January 2023).
  • The phasing out of the free emission allowances granted to the manufacturers subject to the EU ETS should be completed by 31 December 2028. This means that EU producers of goods covered by the current ETS must adopt and reduce carbon emissions quicker to stay competitive.
  • Only introduction of explicit carbon pricing policies (e.g. carbon taxes or emissions trading schemes) will make third-country imports exempt from the CBAM. Hence, (besides product classification) the country of origin will play a role (e.g. goods originating from EFTA countries will be exempted).
  • Compared to the initial proposal, a greater centralisation of the CBAM governance (e.g. central registry of CBAM declarants (importers) at EU level) is envisaged. Instead of a decentralized system with 27 CBAM authorities, a single CBAM authority at the EU level will be introduced, to ensure swift, coherent and cost-effective implementation and prevent ‘forum shopping’ between Member States.
  • Most likely, CBAM will have a disruptive impact on global trade and companies trading in covered commodities. Especially developing nations seem vulnerable, as they may struggle to decarbonise fast enough to remain competitive in the global market. While directly exempting the least developed countries from the CBAM was ruled out, the ENVI recommended providing financial support for their decarbonization projects.

Businesses have less than 5 months to assess the impact and implement the measures to adhere to the reporting obligations as from 1 January 2023. The time is now to assess their supply chain and see what the impact of CBAM will be on their imports. Importing itself should be performed by authorized declarants.

The quick phase out of free allocations of ETS allowances means that starting from 1 January 2024, the carbon cost for manufacturers subject to EU ETS, who are offered protection under CBAM, could increase the price of manufacturing much faster than expected given the need to acquire additional ETS allowances. On the other hand, in view of the shortened transition period, the import of CBAM-covered goods will also soon become more expensive. Overall, the market price of any goods subject to ETS or CBAM as well as any derivative products will increase, unless businesses start producing in a more environmentally friendly manner.

In any event, the upcoming (legislative) evolutions need to be further evaluated.