The EU’s Carbon Border Adjustment Mechanism

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Insight Summary

  • As part of the EU’s 10-step program titled “Fit for 55,” the commission introduced a controversial proposal for a carbon border adjustment mechanism (“CBAM”).
  • If adopted, the commission will impose a levy on imports in carbon-intensive sectors with lower environmental standards than the EU.
  • The proposal must now undergo the EU’s legislative process that requires the approval of both the European Parliament and the Council before it comes into effect.

CBAM Overview

Last month, the European Union adopted its 2030 Climate Target Plan to reduce greenhouse gas emissions by at least 55% by 2030, compared with 1990 levels. This plan falls under the European Green Deal, which sets the union on a path towards becoming climate-neutral by 2050. It currently represents one of the most ambitious plans by a major economic power to date.

To achieve its targets, the 27-member bloc will need to significantly reduce its dependence on fossil fuels. The EU plans to do so through a combination of taxes and actions detailed in its 10-step program titled “Fit for 55.”

A key part of the “Fit for 55” roadmap is the controversial proposal for a carbon border adjustment mechanism (“CBAM”). If adopted, the commission will impose a levy on imports in carbon-intensive sectors with lower environmental standards than the EU. According to the European Commission, the primary purpose is to “prevent the risk of carbon leakage and support the EU’s increased ambition on climate mitigation, while ensuring WTO compatibility.”

While the EU’s current Emissions Trading System (ETS) has been effective in addressing the risk of carbon leakage, it dampens the incentive to invest in greener production within the union and abroad. The CBAM aims to progressively become an alternative to this.

The carbon border taxes would start in 2023 with a transition period until 2025, when importers would be subject to significant reporting obligations. Beyond 2026, importers would need to purchase “CBAM Certificates” to cover their carbon emissions at prices corresponding to the EU’s current carbon price.

Some of the most important features of the Commission’s proposal include: 

Sectors Impacted

The initial sectors to be affected by the CBAM would be cement, iron and steel, aluminum, fertilizer and electricity. However, it’s important to note that the CBAM would only apply to the direct emissions released during production, not the indirect emissions necessary to generate electricity for the production of products. Additionally, the CBAM would not apply to downstream processing and production. Considering the level of exports to the European Union in these sectors, the countries most exposed to the CBAM would be Russia, Turkey, China, Britain and Ukraine (source). The United States would also see an impact, although it sells significantly less steel and aluminum to Europe.

Imports Impacted

The carbon border tax would apply to all imports from non-EU countries, including the United Kingdom. However, regulation will not be applied to goods originating from Iceland, Liechtenstein, Norway and Switzerland. Additionally, the following territories will be exempt from regulation: Büsingen, Heligoland, Livigno, Ceuta and Melilla. If the UK decided to link its own Emissions Trading System “ETS” to the EU ETS it could also be exempt.

CBAM Certificates

To complement the ETS, the CBAM will be based on a system of certificates to cover the embedded emissions in products being imported into the EU. The price of the certificates will be calculated depending on the weekly average auction price of EU ETS allowances expressed in € / tonne of CO2 emitted. Importers of the goods will have to, either individually or through a representative, register with national authorities where they can also buy CBAM certificates. In practice, only those importers that have been accredited by a designated authority in the Member States would be able to import products covered by the CBAM.

WTO Compatibility 

A number of countries have criticized the EU’s plans to introduce a CBAM and questioned the WTO compatibility. However, as indicated by the European Green Deal, the CBAM would ensure that the price of imports reflects more accurately their carbon content. This measure has been designed to comply with World Trade Organization (‘WTO’) rules and other international obligations of the Union. Furthermore, President von der Leyen has underlined that “carbon must have its price – because nature cannot pay the price anymore. The Carbon Border Adjustment Mechanism should also motivate foreign producers and EU importers to reduce their carbon emission.”

Looking Ahead

The commission’s “Fit for 55” proposal must now go through the EU’s legislative process (which could take many months, even years). There will be much debate around the subject of introducing a carbon border adjustment mechanism (CBAM). Countries outside of the EU will likely examine the proposal’s compliance with the WTO, while EU industry players will need to understand the implications for their competitive positions. The legislative process requires the approval of both the European Parliament and the Council before the proposal comes into effect.

Sources: 

https://ec.europa.eu/info/sites/default/files/carbon_border_adjustment_mechanism_0.pdf

https://www.jdsupra.com/legalnews/fit-for-55-eu-moves-to-introduce-carbon-2398960/

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