September 12, 2023

EU's Carbon Border Adjustment Mechanism (CBAM)

What is the CBAM?

The Carbon Border Adjustment Mechanism (CBAM) is essentially a carbon tax imposed on imported goods from countries outside the EU that have less strict climate regulations. It will put a price on carbon emissions from imported goods, equal to the EU’s carbon price.

Why is CBAM necessary?

With the EU implementing increasingly stringent climate policies, particularly concerning permissible CO2 emissions within the EU region, the CBAM becomes crucial in addressing the risk of carbon leakage. i.e. the phenomenon where EU companies move carbon-intensive production abroad or import carbon-intensive goods to evade higher costs.

The CBAM ensures that imported goods account for their embedded carbon emissions, aligning with domestic carbon pricing. This safeguards the EU’s climate objectives and remains compliant with WTO regulations.

How does the CBAM works?

The CBAM will enter into force in its initial phase as 1 October 2023 and will impact initially only certain imports in six high carbon intensive sectors: cement, steel, aluminum, fertilizers, electricity, and hydrogen.

Starting from October 2023, companies must quantify the amount of carbon dioxide produced from their imported goods without making any financial payments or adjustments.

The reporting phase will continue until the end of 2025. Starting January 1, 2026, when the permanent CBAM system takes effect, importers will need to report annually on the quantity of goods they imported into the EU in the previous year and their embedded greenhouse gas (GHG) emissions.

They will then surrender the corresponding number of CBAM certificates. The price of each certificate will be calculated based on the weekly average auction price of EU Emissions Trading System (EU ETS) allowances, which are expressed in euros per tonne of CO2 emitted. The phasing out of free allocation under the EU ETS will take place in parallel with the phasing in of CBAM in the period 2026-2034.

Final thoughts

The CBAM will have many implications for EU trade, both positive and negative.

On the positive side, it will help to level the playing field for EU producers, who currently face higher costs due to the EU’s carbon pricing system and will also encourage non-EU countries to adopt their own carbon pricing systems.

On the negative side, it could lead to higher prices for consumers, and could harm EU trade with countries that are major exporters of emissions-intensive goods, such as China and Russia.

Despite its potential drawbacks, the CBAM is a powerful tool for achieving net-zero emissions. Many other countries, such as Canada, Australia, and theUK, are considering implementing similar systems.

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