Understanding EU Carbon Border Adjustment Mechanism (CBAM EU)
What is the Carbon Border Adjustment Mechanism (CBAM EU)?
The carbon border adjustment mechanism (CBAM) is the world’s first carbon tax, which was introduced by the European Union Commission, to reduce carbon emissions and push for global decarbonisation. In simpler terms, CBAM is the EU’s tool to put a fair price on the carbon emitted during the production of goods outside the EU that are meant to enter the European market.
CBAM EU is designed to promote cleaner industrial production in non-EU countries and prevent carbon leakage, which happens when EU companies shift their production units to other countries with lax climate policy to offshore their emissions.
CBAM is a replica of the European Union’s internal Emissions Trading System (EU ETS) that is meant to restrict and minimise the production of carbon-intensive items. However, EU ETS is not applicable to the countries not part of the European Union, which means products from other nations without a similar carbon tax could disrupt the EU market at cheaper prices and create price disparity. Hence, CBAM was introduced to ensure level-playing field and remove unfair competition.
CBAM’s trial phase (Transitional Phase) started on 1 October 2023, meant to act as a pilot learning period for all stakeholders in iron and steel, aluminium, hydrogen, cement, fertilisers, and electricity sectors. Moreover, eu carbon border adjustment mechanism reporting will become mandatory 1 January 2026.
Why Did the EU Introduce CBAM?
The European Union Commission introduced the CBAM to prevent carbon-leakage, create a level playing field between EU importers and non-EU exporters and push for global decarbonisation under its ‘Fit for 55’ initiative aimed at making EU climate-neutral by 2050 as per the Paris Agreement.
Primary Reasons to Introduce CBAM:
Prevent Carbon Leakage: The top most reason to introduce the CBAM for non-EU exporters is to prevent carbon-leakage or offsetting of emissions to any other countries. eu carbon border adjustment mechanism acts against attempts to compromise in reduction of carbon emissions.
Price Parity: Second objective of CBAM is to create a level-playing field and not result in any kind of price disparity for either EU buyers or suppliers to the EU. It ensures an equal carbon pricing imposed on all players in the European market.
Global Decarbonisation: Through CBAM, EU plans to push for more effective decarbonisation strategies and incentivise cleaner productions across the globe.
What are the sectors covered under the EU CBAM?
Currently, CBAM is applicable only to the most carbon-intensive sectors and products entering the EU market. The most carbon-intensive sectors covered under the CBAM are:
- Cement
- Iron and Steel
- Aluminium
- Fertilisers
- Electricity
- Hydrogen
This focused scope allows for a smoother rollout, with the intention to expand to all sectors covered by the EU ETS by 2030.
How the carbon border adjustment mechanism Works?
CBAM functions by requiring importers of covered goods to purchase and surrender CBAM certificates.
Here’s a step-by-step breakdown of the process:
- An EU importer/buyer brings goods from a non-EU country into the EU market.
- The importer calculates the embedded direct (and later indirect) greenhouse gas emissions in those goods, following EU methodologies.
- The importer declares the total embedded emissions in their quarterly CBAM report.
- The importer purchases CBAM certificates corresponding to the declared emissions. The price of these certificates is linked to the weekly average auction price of EU ETS allowances.
- The importer surrenders the required number of CBAM certificates to the national authority annually.
- A key feature: If a non-EU producer can prove they have already paid a carbon price for the manufacturing of the imported goods in their home country, the corresponding cost can be fully deducted for the EU importer.
CBAM Implementation Timeline
CBAM is being rolled out in two phases:
- Transitional Phase (October 1, 2023 – December 31, 2025)
- Objective: This phase is a pilot learning period for all and data collection and testing of the mechanism will be tested during this period.
- Requirement: Importers must submit quarterly CBAM reports declaring the embedded emissions in their imports. The first report was due by January 31, 2024.
- Financial Cost: No financial payments are required during this phase, only reporting is mandatory.
- Definitive Phase (Starting January 1, 2026) CBAM reporting becomes mandatory.
- Objective: Full implementation of CBAM will be in force. CBAM TAX WILL BE APPLICABLE.
- Requirement: Importers must declare the embedded emissions annually and surrender the corresponding number of CBAM certificates.
- CBAM Tax: CBAM tax will be applicable for all quarterly reports from January 2026. However, the tax calculated will have to be paid only from January 2027.
- Phased Integration: As CBAM is phased in, the free allocation of EU ETS allowances to sectors covered by CBAM will be phased out.
Reporting and Compliance Requirements Under CBAM
Compliance is mandatory and administered by national authorities in each EU member state.
- Who Reports?
The “authorised declarant” – typically the EU importer/buyer of record. - What is Reported?
Total embedded direct emissions (Scope 1) for each product, detailed by production facility and Indirect (Scope 2) emissions along with the precursors emissions data (raw materials used to make another CBAM covered product). - How to Report?
Via the European Commission’s central CBAM Transitional Registry. - Penalties for Non-Compliance:
Failure to report or surrender certificates can result in financial penalties (€10-50 per tonne of unreported CO2e) and potentially other sanctions.
Impact of CBAM on Global Trade
CBAM is poised to reshape global trade dynamics:
- For EU Importers: Increased administrative burden and potential cost increases for covered goods, requiring new due diligence and reporting systems.
- For Non-EU Exporters: Producers in countries without carbon pricing will face a new cost barrier to the EU market, creating a competitive disadvantage unless they decarbonize.
- For Global Supply Chains: Companies worldwide will be incentivised to track and lower the carbon footprint of their products, pushing transparency and green manufacturing up the value chain.
- Geopolitical Tensions: CBAM has been met with concerns from major trading partners who view it as a protectionist measure, potentially leading to trade disputes at the WTO.
Benefits and Challenges of the EU CBAM
Benefits:
- Effective Climate Tool: Directly prevents carbon leakage and ensures global decarbonisation.
- Promotes Innovation: Drives investment in low-carbon technologies globally.
- Global Standard-Setter: Encourages the global adoption of carbon pricing and emissions accounting.
- Fair Competition: Protects EU industries committed to decarbonisation and creates a level playing field for all businesses.
Challenges:
- Administrative Complexity: The reporting and verification requirements are significant for businesses and authorities.
- Trade Friction: Risk of retaliatory measures and disputes with trading partners.
- Methodological Hurdles: Accurately calculating embedded emissions, especially in complex supply chains, is challenging.
- Data Collection: Collecting accurate embedded emissions data is a big challenge as it involves third-party data gathering and maintaining data hygiene.
- Equity Concerns: Potential disproportionate impact on developing economies.
How Businesses Can Prepare for CBAM
Proactive preparation is key to managing CBAM’s impact.
- Conduct a CBAM Assessment: Determine if your imported or exported goods fall under the current or future scope.
- Map Your Supply Chain: Identify all production facilities and their locations to understand your exposure.
- Develop Emissions Accounting Capabilities: Invest in systems to accurately measure and report the embedded carbon in your products.
- Engage with Suppliers: Start conversations with non-EU suppliers about their carbon footprint and emission reporting capabilities.
- Explore Decarbonisation Strategies: Assess opportunities to reduce the embedded emissions of your products through efficiency improvements, fuel switching, and green technology.
- Seek Expert Advice: Consult with sustainability and trade law experts to navigate the complex regulatory landscape.
Future of the eu carbon border adjustment mechanism
CBAM is not a static policy. Its future evolution is expected to include:
- Expansion of Scope: The inclusion of more sectors, such as chemicals, plastics, and refined petroleum products, is highly likely post-2030.
- Integration with Other Policies: CBAM will become more deeply integrated with the broader EU Green Deal framework.
- Global Proliferation: Other jurisdictions, like the UK and Canada, are already considering similar border carbon measures, which could lead to a patchwork or eventual harmonization of global carbon pricing at the border.
- Refinement of Rules: Methodologies for calculating embedded emissions, particularly for indirect emissions and complex goods, will continue to be refined.
FAQ
Who is affected by CBAM?
EU importers of covered goods are directly responsible for compliance. Indirectly, non-EU producers and exporters of those goods to the EU are significantly affected, as the cost and reporting requirements will flow down the supply chain.
How is the price of a CBAM certificate determined?
The price is not fixed. It is based on the weekly average auction price of EU ETS allowances (EUAs), expressed in €/tonne of CO2e.
Can I get an exemption from CBAM?
There are no blanket exemptions. However, the cost of a carbon price already paid in the country of origin is fully deductible. Goods from countries fully integrated with the EU ETS (like Iceland, Liechtenstein, Norway, and Switzerland) may be excluded.
What is the difference between the EU ETS and CBAM?
The EU ETS is a cap-and-trade system for emissions from installations within the EU. carbon border adjustment mechanism is a border carbon adjustment on the embedded emissions of specific goods imported into the EU. They are designed to work together.
Where can I find official information and guidance?
The European Commission’s Directorate-General for Taxation and Customs Union (DG TAXUD) is the primary source for official CBAM documentation and guidance.