In a Nutshell
The EU Carbon Border Adjustment Mechanism (CBAM) is the EU’s landmark tool to prevent carbon leakage and support the EU’s increased climate ambitions. It works by putting a price on carbon emitted during the production of carbon-intensive goods entering the EU to incentivise cleaner industrial production in non-EU countries.
Carbon leakage refers to the process of shifted production and/or emissions to other jurisdictions with less stringent emission constraints. It is one of the key obstacles for the EU to reach its climate commitments. The CBAM was designed to specifically address this risk. Carbon leakage can occur when a domestic carbon price negatively impacts the competitiveness of an entity operating in this domestic context. This increased cost might result in the entity shifting its production to another country with a lower carbon price to reduce production costs. For example, a steel producer might consider relocating its production outside of the EU to avoid paying for the carbon it emits. Another possible instance of carbon leakage occurs when non-domestic producers that are not subject to the price of carbon enjoy significant competitive advantages compared to domestic producers, resulting in a shift of production abroad.
The sectors that will first be covered by the CBAM are energy-intensive industries, namely cement, iron and steel, aluminium, fertilisers, electricity and hydrogen. When fully phased in, the CBAM will capture approximately 50% of the emissions covered by the EU Emission Trading System (ETS).
The CBAM is based on the purchase of certificates by importers, which represent the embedded emissions in the imported goods. The price of the certificates will be calculated based on the weekly average auction price of EU-ETS allowances, equivalent to Euro per tonne of CO2 emitted.
The CBAM will in principle apply to the imports of goods from all non-EU countries. However, countries participating in the EU ETS and Switzerland are excluded from the mechanism.
Even though carbon removal has not been taken into account by the CBAM yet, the system provides opportunities to create incentives for CDR. There could be several ways to include CDR in the context of CBAM, including using CDR to directly reduce embedded emissions or to compensate for embedded emissions.
What's on the Horizon?
Transitional phase 1 October 2023 to end of 2025: Under the Commission’s proposal, importers will have to report emissions embedded in their goods subject to CBAM without paying a financial adjustment in a transitional phase, providing stakeholders with some time to prepare for the final system to be put in place.
Implementing acts are expected to be drafted and released throughout the transitional phase until 2026, though no clear timeline has yet been established. These include implementing acts on the calculation of default values for embedded indirect emissions and authorised declarant conditions and registries. A delegated act on certificates sale and repurchase is to be expected as well. Clarifications on the methodology for counting embedded carbon emissions, with separate methodologies for different sectors and goods, are also to be expected.
An ongoing public consultation is taking place in the United Kingdom on whether it should introduce an equivalent system to the EU CBAM or not.
While the CBAM does not include CDR explicitly yet, there are a strong rationale for including it and several different ways it could be included.
The CBAM is intended to mirror the conditions that European Economic Zone actors experience when they emit carbon and fall subject to the EU Emissions Trading System (ETS). Assuming the EU-ETS includes permanent CDR within its scope to enable participants to reduce net emissions in 2030 at the earliest, a case can be made to integrate removals in the CBAM to make the two mechanisms work under the same rules. This would require clear rules on MRV mechanisms, with removals limited to hard-to-abate sectors. The CBAM could integrate CDR within its scope first, as it gradually phases in starting 2026.
CDR could be included either directly or indirectly within the CBAM:
- By authorising importers to buy durable removals to compensate a share of the embedded emissions and reduce their CBAM obligations. A clear mention of this measure could be made in Article 7. This addition could be done in accordance with the forthcoming CRCF by clearly specifying that only permanent removals are allowed.
- By recognising CDR as a way to reduce a product’s overall embedded emissions, therefore reducing the product’s net-direct emissions. For example, a steel-making factory in a non-European country could buy durable CDR credits in its country of operations to reduce the product’s emissions.
The revenues generated by the CBAM will go to the general EU budget. Since the CBAM covers many hard-to-abate sectors that will likely continue generating GHG emissions in the long term, it could be argued that some of the revenues generated by the CBAM could be used to incentivise/support CDR development/deployment. A share of the revenues could be used to finance the Innovation Fund.
Including CDR within the CBAM does come with some risks. Among others, it could enable greenwashing and disincentivise decarbonisation along value chains. While the CBAM itself might not contain the tools needed to tackle these two risks, other EU legislations could help address these risks. Greenwashing will likely be prevented by the Green Claims Directive, whilst the EU-ETS incentivises European companies to reduce their emissions.
Whether CDR could be used to circumvent the CBAM or not should be clearly defined, and if yes, clear eligibility criteria should be created and agreed upon. Effectively, only high-quality removals should qualify, and priority should be given to reducing embedded emissions in the first place. EU policymakers still need to discuss and agree on the methodologies related to embedded emissions accounting, which could provide some opportunities to promote a stringent and robust approach to CDR under the CBAM. For example, indirect emissions could be reduced or even negated if BECCS is allowed in the methodology.
CBAM in perspective
The CBAM is not only considered an essential tool to achieve the EU’s climate objectives but also serves to ensure the EU’s industrial competitiveness with the rest of the world. However, while it puts European production on a level-playing field with imported products, European exports are currently still at a disadvantage. How this issue is tackled remains to be seen, as carbon leakage could still occur if a company shifts its share of European production going to the rest of the world outside of the EU.
Other geographies are also engaging with similar ideas. The United Kingdom is currently going through a public consultation as to whether it should introduce a CBAM. Interestingly, one of the questions asked pertains to whether carbon credits should be used to offset emissions. The United States is currently reviewing the “Clean Competition Act”, which would create a CBAM for the USA. California has already put in place a system similar to the CBAM regarding electricity imports in some situations, and Canada is considering adopting a border carbon adjustment mechanism.
Proposal for a Regulation of the European Parliament and of the Council establishing a Carbon Border Adjustment Mechanism adopted by the European Commission.
Adoption by the EU Parliament and the Council.
Publication in the Official Journal of the EU.
The EU Commission adopted detailed reporting rules for the CBAM’s transitional phase.
CBAM will enter into force in its transitional phase (importers will only need to report until 2026, after which they will be required to pay financial adjustments.
First reporting period for traders ends.
Report reviewing how the CBAM is working and whether to extend its scope to more products and services to be published.
The permanent CBAM system will gradually enter into force while the free ETS allowances for CBAM sectors will be gradually phased out.
All free ETS allowances will be phased out, thus CBAM will apply to all emissions in the sectors covered.
Regulation (EU) 2023/956 of the European Parliament and of the Council of 10 May 2023 establishing a carbon border adjustment mechanism (Text with EEA relevance)