On December 13th, a provisional agreement took shape for the creation of the EU Carbon Border Adjustment Mechanism (CBAM). This significant development imposes emissions tariffs on imported goods with a high potential for carbon leakage, originating from countries outside the EU Emissions Trading System (ETS).
Climate change indeed demands global solutions, and the European Union (EU) recognizes the risk of “carbon leakage” as it elevates its climate ambitions while many non-EU countries maintain less stringent climate policies. Carbon leakage occurs when EU-based companies shift carbon-intensive production to regions with laxer climate regulations or when carbon-intensive imports replace EU products.
To address this challenge, the EU has introduced the Carbon Border Adjustment Mechanism (CBAM), a pivotal tool that imposes a fair carbon price on goods entering the EU that have a significant carbon footprint from their production. This mechanism encourages cleaner industrial practices in non-EU countries.
Why do we need CBAM?
The European Union has ambitious climate goals, aiming to reduce emissions by at least 55% by 2030 and achieve climate neutrality by 2050. Central to these goals is the EU Emission Trading System (ETS), which the CBAM complements.
CBAM is a policy tool designed by the EU to combat carbon emissions. It achieves this by imposing a carbon tax on imported products, ensuring they bear comparable carbon costs to products manufactured within the EU. It’s part of the “Fit for 55 in 2030 package,” a strategy aimed at reducing greenhouse gas emissions by a minimum of 55% by 2030 compared to 1990 levels.
CBAM’s primary goal is to prevent carbon-intensive imports from undermining the EU’s climate objectives. It also encourages the adoption of cleaner production practices worldwide. Importers under CBAM must declare the quantity of goods and their associated greenhouse gas emissions annually. They’ll then need to surrender CBAM certificates to offset these emissions, with certificate prices determined by the weekly average auction price of EU ETS allowances in euros per tonne of CO2 emitted.
CBAM incentivizes non-EU nations to implement stricter environmental regulations, reduce global carbon emissions, and discourage companies from relocating to countries with weaker environmental standards. Furthermore, the revenue generated from CBAM supports EU climate policies, setting an example for other nations to promote green energy.
Addressing ETS Loopholes:
The EU ETS operates through a cap-and-trade system, setting emission limits for organizations with tradable allowances. The European Emissions Trading System (ETS) is a significant initiative that currently covers carbon dioxide (CO2) emissions stemming from two major sectors:
- Electricity and Heat Generation: This includes emissions produced during the generation of electricity and heat, a crucial aspect of energy production.
- Energy-Intensive Industries: This encompasses a wide range of sectors, such as oil refineries, steelworks, production of iron, aluminum, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids, bulk organic chemicals, and commercial aviation within the European Economic Area.
While the ETS is an effective instrument for regulating emissions within the EU, its regional scope creates a concern known as ‘carbon leakage.’ Carbon leakage occurs when it becomes economically advantageous for companies to source goods from regions with less stringent climate regulations or when EU-based companies relocate their operations to areas with more lenient climate standards. This phenomenon undermines global efforts to combat climate change by shifting emissions rather than reducing them.
The Carbon Border Adjustment Mechanism (CBAM) is designed specifically to tackle this problem. CBAM works by equalizing the carbon price paid abroad for foreign products and within the EU.
Scope of CBAM:
CBAM applies to goods manufactured in non-EU countries, encompassing those wholly produced outside the EU and those involving significant production phases outside the EU.
The CBAM aims to progressively encompass all goods covered by the ETS by 2030. During the transition period from October 1st, 2023, to 2026, obligations will be limited to reporting and will target goods at high risk of carbon leakage, including iron and steel, cement, aluminum, fertilizers, electricity, hydrogen, and select downstream products. Starting in 2026, importers will begin making tariff payments, and the European Commission will evaluate the inclusion of other high-risk products and potentially indirect emissions requirements. Around 2030-2032, CBAM is expected to cover all goods under the ETS.
Cost of the Tariff:
Importers will need to pay the same per-tonne CO2 emission cost as if their goods were produced within the EU, using CBAM certificates. These certificate prices will align with the weekly average auction costs of emission allowances under the ETS.
CBAM encourages cleaner industrial practices in non-EU countries. Importantly, the phased introduction of CBAM aligns with the reduction of free allowances allocated under the EU Emissions Trading System (ETS), supporting the decarbonization of the EU industry.
By levying carbon costs on imports, CBAM promotes a level playing field, discouraging carbon-intensive practices and incentivizing the adoption of cleaner technologies globally. It not only protects the competitiveness of EU industries working to reduce emissions but also catalyzes international efforts to combat climate change, emphasizing the EU’s commitment to global climate leadership.