EU Parliament votes to extend the Emissions Trading System to include shipping
Why is there a Carbon Border Adjustment Mechanism (CBAM)?
The EU aims to become carbon neutral by 2050 and, as part of this objective, it has introduced measures such as the EU Emissions Trading System (EU ETS) which impose a cost for carbon on producers in the EU.
As the EU imposes costly environmental and climate policies on business within the EU, there is a risk that carbon leakage will occur. In other words, emissions would be shifted outside the EU with the result that EU products are replaced by carbon intensive imports.
Under the CBAM Regulation a carbon border tax is imposed on embedded carbon.
It is hoped that CBAM will create an equal playing field, incentivising countries with weak climate regulation to comply with growing international and EU standards. However, some believe that CBAM will act as a trade barrier to European markets, negatively impact export-driven economies, and result in retaliatory measures in such markets as the US and China.
The UK is also considering co-ordinating moves with the EU on a new carbon border tax that would impose a levy on imported carbon-intensive goods arriving in the UK.
On 10 May 2023, the European Parliament and the Council of Europe signed the final CBAM Regulation.
Regulation 2023/956 was published in the EU’s Official Journal on 16 May and will come into force on 5 June 2023. There will be a transitional period to allow importers to prepare for implementation.
How will it work?
When CBAM is fully in force, EU importers will be required to make annual declarations of the goods they have imported into the EU and the amount of their embedded carbon.
They will be required to purchase CBAM carbon certificates for the amount of carbon. The certificates will be priced by reference to the weekly average auction price of EU ETS allowances expressed in €/tonne of CO2 emitted.
In other words, the price of CBAM certificates will track the EU ETS carbon price so that the price of carbon between domestic products and imported products in the sectors selected will equalise. This should in turn incentivise investment in green technology in third countries.
Non-EU producers are expected to communicate the information on embedded emissions for CBAM regulated goods to importers registered in the EU.
However, if such information is not available when the goods are being imported, EU importers will be able to use default values on greenhouse gas (GHG) emissions for each product to determine the number of certificates they need to purchase.
EU importers will however be able to demonstrate actual emissions during a reconciliation procedure for the purpose of surrendering the appropriate number of CBAM certificates.
If a non-EU producer can show that they have already paid a price for the carbon used in the production of the imported goods in the place of manufacture, the corresponding cost can be deducted when calculating the number of CBAM certificates that must be bought.
The EU recognises the need for a level playing field and that the issue of free allowances to its own carbon intensive industries distorts the market. It has, therefore, decided to phase out free allocation in stages until 2035.
As a result, CBAM will only apply to products imported in proportion to the proportion of emissions that don’t benefit from free allocation under the EU ETS.
The issue of CBAM certificates will be supervised and administered by the EU Commission in conjunction with the relevant competent authority in each member state.
There will be a central platform for selling CBAM certificates to importers, and all emissions will need to be reviewed and verified.
Importers or their representatives will need to be registered to take part and buy CBAM certificates.
In addition, importers will need to declare by 31 May each year the quantity of goods and embedded emissions in their imported goods and surrender CBAM certificates to the Commission.
The rules for reporting emissions will be set out in an implementing act which is still to be adopted.
What will happen when?
Initially, CBAM will only apply to imports in certain sectors. These have been chosen on the basis that they are carbon intensive and there is the most risk of carbon leakage.
The initial sectors are:
- Iron and steel
When fully phased in, this will capture more than 50% of the emissions in the sectors which the ETS covers.
There are a limited number of exceptions for products to which CBAM will not apply, which include goods where the consignment value is less than €150.
The CBAM will start on 1 October 2023 with a transitional phase which continues until the end of 2025.
During this phase, importers will have to report emissions embedded in their goods, which are subject to CBAM, and there will be no requirement to make any payment or obtain certificates.
The first reporting period will be the end of January 2024. This is because it is recognised that there are no internationally approved standards for measuring carbon content and businesses will need time to develop the necessary measures.
CBAM will apply to direct emissions of greenhouse gases emitted during the production process as well as indirect emissions for a number of products that are listed in Annex 1A of the Regulation.
Importantly, there will be no sanctions for failure to comply with the reporting obligation until after the end of the transitional phase.
The CBAM will become fully operational from 1 January 2026.
From then EU importers will have to make annual declarations of the quantity of goods and the total embedded emissions in the goods they have imported into the EU in the preceding year. This must be accompanied by a surrender of the corresponding amount of CBAM certificates.
The EU recognises that CBAM is a work in progress, and it will need to consider extending it to additional products and examining how it has worked in practice before the end of the transitional phase when a report will be prepared.
UK CBAM Consultation
The UK is also considering introducing its own form of CBAM, having set up a UK Emissions Trading Scheme (UK ETS) on 1 January 2021 to “increase the climate ambition of the UK’s carbon pricing policy, while mitigating the risk of carbon leakage through free allowances.”
Earlier this year, the UK government launched a consultation on whether to introduce a UK “carbon border adjustment mechanism” (UK CBAM) as part of its broader net zero strategy.
The consultation is open for comment to all interested parties in the UK and internationally until 22 June 2023.
It seeks to assess how businesses expect carbon leakage risk to impact them as well as what measures might help them to invest in decarbonisation.
The proposed UK CBAM would apply a carbon price to UK imports with high embedded emissions and is expected to apply to sectors covered by the UK ETS.
Timelines for implementation are still to be decided, but a UK CBAM is unlikely to be introduced before 2026.
Impact on other markets
The EU’s CBAM is likely to have greatest impact on export driven markets such as China and will restrict market access for carbon intensive products if the affected countries fail to tackle carbon emissions.
It will benefit EU domestic producers who are already subject to the additional cost of paying for their emissions under the EU ETS.
There is a concern that CBAM may lead to retaliatory measures by countries seeking to restrict access to their markets for EU products. We have already seen measures by the US to restrict the access of EU steel and aluminium products to the US under section 232 of the US Trade Expansion Act.
There is also a risk that some importers may prefer to sell their carbon intensive products to non-EU markets rather than pay for CBAM certificates.
Both Brussels and the UK will be watching developments to determine their impact.
Meanwhile EU importers will need to set up procedures to measure the amount of embedded carbon in their products and apply for registration.