Carbon Border Adjustment Mechanism (CBAM)

The European Union (EU) has taken a pivotal step to mitigate carbon leakage and level the playing field in the global market with the introduction of the Carbon Border Adjustment Mechanism (CBAM). For corporations operating within the EU or seeking to engage in trade with it, understanding the CBAM is essential in climate disclosure.

What is Carbon Border Adjustment Mechanism (CBAM) in the EU?

The CBAM is an innovative environmental policy initiative spearheaded by the European Union (EU). It is a mechanism designed to equalise the carbon costs for products, whether they are manufactured within the EU or imported from outside. By doing so, it ensures a level competitive playing field, while steadfastly promoting the EU's overarching environmental objectives.

The inception of CBAM finds its roots in the EU’s 'Fit for 55 Package', an ambitious strategy charted out by the European Commission. This package aims to transform the European economy to meet their climate targets. Specifically, it aspires to reduce the EU's greenhouse gas emissions by a substantial 55% by 2030, with a longer-term vision to achieve climate neutrality by 2050 for the entire EU.

The objectives of CBAM

1. Addressing carbon leakage: Carbon leakage is a phenomenon where businesses, to avoid stringent environmental regulations or costs, might relocate their operations to regions with lenient or non-existent carbon emission policies. This not only undermines the EU’s green objectives but also puts undue competitive pressure on businesses that choose to adhere to these environmental norms. CBAM acts as a countermeasure to this, ensuring that goods imported into the EU carry the same carbon costs as those produced within.
2. Ensuring fair competition: At its core, the CBAM is a manifestation of fairness in trade. By balancing carbon costs, it ensures that European businesses aren't placed at a disadvantage against external competitors due to the EU’s progressive carbon policies.
3. Operational mechanism: The CBAM functions by mandating European corporations to pay taxes on specific carbon-intensive goods they import. The crux here is the pricing – the tariffs are meticulously linked to the EU Emissions Trading System (ETS). This system sets the benchmark for carbon pricing within the EU. By aligning tariffs to the ETS, CBAM ensures that the carbon price on both domestic products and imports remains synchronised.

In short, the CBAM stands as a testament to the EU's commitment to environmental sustainability. For corporations, it's not just a policy to understand and comply with, but a glimpse into the future trajectory of global trade, where environmental responsibility and business go hand in hand.‍

What is the timeline of the CBAM?

The Carbon Border Adjustment Mechanism (CBAM) is an integral part of the European Union's robust environmental strategy. Given its significance, understanding the timeline for its phased implementation is crucial for corporations operating within or trading with the EU. Here's a detailed breakdown:

1. 17 May 2023 - official enforcement: CBAM's regulations officially come into effect, marking a pivotal move in the EU's commitment to environmental strategies and equitable carbon costs.
2. October 2023 - data collection begins: Corporations under CBAM's purview are required to start gathering detailed data on the embedded emissions of their respective products. This meticulous collection ensures readiness for the subsequent reporting phase.
3. End of January 2024 - reporting phase launch: By this date, the corporations are expected to begin reporting their collected data, setting the groundwork for CBAM’s future stages.
4. October 2023 to December 2025 - transitional phase: This three-year buffer allows corporations to acclimate to CBAM's protocols. It's a phase of learning, adjusting, and aligning operations according to the guidelines set by the CBAM.
5. 2026 - full CBAM implementation: Post the transitional phase, CBAM's directives become fully operational from this year. Corporations are expected to be in total compliance with the mechanism's guidelines.
6. 2026 onwards (until 2034) - gradual tariff phase-in: After the transitional period wraps up in 2025, a phased approach to introducing carbon-related tariffs begins. These tariffs will be in full swing by 2034.
7. 2034 - expansion of CBAM scope: By this year, the mechanism will extend its reach to almost every product covered by the EU Emissions Trading System (EU ETS).

Given the deliberate and structured rollout of CBAM, corporations have the opportunity to adjust and prepare in each phase. Familiarity with this timeline is pivotal for ensuring compliance and optimising business operations in the face of these evolving environmental policies.

Who falls under the scope of CBAM?

The CBAM primarily affects EU importers of products from specific carbon-intensive sectors. If you're importing cement, iron and steel, aluminium, fertilisers, electricity, or hydrogen into the European Union, then you need to be familiar with the CBAM regulations.

Targeted sectors

‍Initially, CBAM targets specific carbon-intensive sectors that have a higher risk of carbon leakage. The EU Commission has identified these sectors due to their significant carbon emissions and the potential for businesses to relocate in regions with laxer environmental standards. Here are the five key sectors under the CBAM’s spotlight:

1. Iron and steel: Key materials in numerous industries with notably high carbon emissions during production.
2. Cement: A major player in construction, with a significant carbon footprint in its production process.
3. Aluminum: Widely used across sectors, its production is energy-intensive and emits substantial carbon.
4. Fertilisers: While vital for agriculture, its production process results in notable greenhouse gas emissions.
5. Electricity generation: Given the focus on clean energy, this sector's carbon emissions are under close scrutiny.

Criteria for foreign businesses

‍The CBAM levy is particularly aimed at foreign businesses that haven't adopted carbon pricing equivalent to their EU counterparts. Simply put, if a business outside the EU operates in a region without similar carbon costs as those in the EU, it could face CBAM tariffs upon importing to the EU.

Exceptions and exemptions:

• Geographical exclusions: Although the CBAM generally encompasses imports from all non-EU nations, exceptions do exist. Countries that are participants in the EU Emissions Trading System (ETS) or have an emission trading system linked with the EU's are exempt. This includes members of the European Economic Area and Switzerland.
• Special provisions for electricity: For countries aiming to integrate their electricity markets with the EU, CBAM will apply to their electricity until the integration process is complete. Upon full integration, under specific conditions, these nations might gain exemption. However, the European Union will review such exemptions in 2030. By then, these countries should have adopted the decarbonisation strategies they've pledged to and should have in place an emissions trading system in line with the EU's standards.

For businesses and industries interacting with the EU market, a clear understanding of CBAM and its scope is essential to navigate the changing trade and regulatory landscape.

What products does CBAM apply to?

Initially, CBAM will apply to imports of certain goods and selected precursors whose production is carbon-intensive and at most significant risk of carbon leakage, including cement, iron and steel, aluminum, fertilisers, electricity, and hydrogenThe list of products is likely to be extended, with the European Commission tasked to assess whether other products, such as organic chemicals and polymers, should be included in the fully operational CBAM before the end of the transitional period.

How does the CBAM reporting system works?

The CBAM is structured to reflect the workings of the EU Emissions Trading System (EU ETS). Essentially, it operates based on a carbon credit system, accounting for both direct and indirect emissions associated with products.

Carbon credit system under CBAM

• Objective: The central idea behind the CBAM carbon credit system is to level the playing field in terms of carbon costs. It aims to standardise the carbon price paid by EU products operating within the EU ETS – the EU's primary carbon pricing mechanism based on the 'cap and trade' principle.
• Mechanism: The CBAM introduces a precise methodology to determine the embedded carbon emissions in imported goods. Consequently, companies will be mandated to purchase carbon credits that correspond to the prices EU industries pay under the ETS.
• Relevance: The rationale behind this system is clear: to promote fairness and curb carbon leakage. By ensuring that importers pay the same carbon price as their domestic EU counterparts, the CBAM fosters equal treatment and prevents undue competitive advantages stemming from carbon cost discrepancies.

Four steps for CBAM reporting requirements

• Carbon impact assessment: The first step is to ascertain which products fall under the CBAM. This involves gauging the carbon content embedded in imports, which is determined by the greenhouse gases (GHG) released during their production.
• Pricing the CBAM: Every emission tied to the stipulated products will have an associated carbon price. This is derived from the weekly average auctioning price of EU ETS allowances, expressed in € per tonne of CO₂ emitted.
• Emissions and the role of CBAM certificates:
• Importers, either directly or through representatives, are required to register with national authorities and subsequently purchase CBAM certificates.
• These certificates are pivotal. They not only authenticate the import of CBAM-regulated goods but also verify that the associated carbon emissions have been factored in and compensated at the defined carbon price.
• National authorities play a central role in this process. They handle the registration, certificate issuance, and verification of declarations.
• Border adjustment: When goods are imported, their carbon pricing is validated. Based on the pre-bought CBAM certificates, the appropriate carbon tax is then applied.

Categorising emissions

• Direct emissions: These are emissions that arise directly from production processes that the producer has direct oversight of. This includes emissions resulting from the generation of heating and cooling during production.
• Indirect emissions: Emissions from electricity usage during the manufacturing of imported products, irrespective of where this process takes place.
• Embedded emissions: This is a comprehensive count. It considers both direct and indirect emissions and also accounts for emissions from essential materials or "precursors" required for the production process.

In conclusion, the CBAM is a strategic EU instrument to ensure fairness in carbon pricing, whether for domestic products or imports. By understanding its intricate workings, corporations can better navigate this regulatory landscape, ensuring compliance and optimising business strategies.

What is the EU ETS and how does it relate to CBAM?

The EU Emissions Trading System (EU ETS) stands as the world's pioneering carbon market, initiated in 2005 to combat the challenge of rising greenhouse gas emissions in the EU Operating on a 'cap-and-trade' foundation, the system functions in the following manner:

• Cap: A restriction is established on the total quantum of certain greenhouse gases that can be emitted by entities covered under this system.
• Trade: Within the confines of this cap, operators either receive or purchase emission allowances. The scarcity of these allowances ensures they possess monetary value, facilitating their trade amongst entities.

The strategic reduction of the cap over time guarantees a systematic decrease in overall emissions. The presence of a price signal on emissions stimulates reductions and spurs investments into low-carbon and innovative technologies. The very design of this system promotes emission cuts where it's most economically efficient.

The CBAM is intricately linked to the EU ETS. As a supplementary measure, CBAM addresses the carbon pricing disparity between domestic and imported goods. Specifically:

• CBAM imposes charges on the embedded carbon in certain imports, ensuring they bear a similar carbon price to products manufactured domestically under the EU ETS.
• CBAM adjusts its charges based on the exporting country's carbon pricing, maintaining a balanced carbon cost for products entering the EU.

What is the difference between CBAM and ETS?

While both CBAM and EU ETS are engineered to reduce carbon emissions, they serve different purposes and operate distinctively:

• EU ETS is a mechanism that restricts and prices carbon emissions within the EU creating a market for emissions allowances.
• CBAM levels the carbon cost playing field for imported goods. By introducing carbon charges on certain imports, CBAM ensures that both domestically produced and imported products shoulder comparable carbon costs.

Will CBAM replace ETS?

No, the CBAM will not substitute the EU ETS. They are designed to function in parallel. The EU ETS remains committed to decreasing emissions within the EU. Conversely, CBAM seeks to ensure that imports, just like domestic products, bear a similar carbon cost. Though CBAM doesn't replace the entire EU ETS, it does supersede the free EU ETS allowances that were previously assigned to EU producers perceived to be at heightened risk of carbon leakage.

Is CBAM part of the Green Deal?

Yes, CBAM is part of the European Green Deal, which is the EU's commitment to be climate-neutral by 2050. The plan to introduce CBAM was first announced by the EU in December 2019 as a key pillar of European climate policy, alongside the parallel reform of the EU ETS.

The introduction of the Carbon Border Adjustment Mechanism (CBAM) marks a pivotal step in the European Union's commitment to environmental responsibility, ensuring that both domestic and imported products bear a comparable carbon cost. Working in tandem with the EU ETS, CBAM serves as a testimony to the EU's innovative approach to combatting climate change, balancing global trade dynamics, and pushing for worldwide carbon pricing harmonisation.

Staying ahead in this rapidly evolving regulatory landscape is crucial for businesses. Plan A offers tailor-made solutions to navigate climate disclosure and compliance with such legislation. To understand how Plan A can streamline your transition and compliance journey, book a demo with us. Embrace the future with confidence and play an active role in the fight against climate change.