Carbon Border Adjustment Mechanism (CBAM)
- Category: European Union Carbon Market Glossary
European Commission Communication of December 2019 (COM(2019)640) envisioned the Carbon Border Adjustment Mechanism for selected sectors among the key policies and measures needed to achieve the European Green Deal.
15 March 2022
Compared to the initial proposal by the Commission, the Council opted for a greater centralisation of the CBAM governance, where it makes sense and contributes to greater efficiency. For example, the new registry of CBAM declarants (importers) is to be centralised at EU level.
The Council also foresees a minimum threshold which exempts from the CBAM obligations consignments with a value of less than €150. This measure would reduce administrative complexity, as around one third of consignments to the Union would fall under that category, and their aggregate value and quantity represents a negligible part of greenhouse gas emissions of total imports of such products into the Union.
In turn, European Commission Communication of 19 October 2020 on the Commission Work Programme 2021, “A Union of vitality in a world of fragility” contained the following passage:
“As mentioned in President von der Leyen’s Political Guidelines, the Commission will propose a carbon border adjustment mechanism to help motivate foreign producers and EU importers to reduce their carbon emissions, while ensuring a level-playing field conducive to trade in a WTO-compatible way.”
CBAM addresses the risk of carbon leakage by ensuring equivalent carbon pricing for imports and domestic products.
The CBAM will initially apply to direct emissions of those GHG from the production of goods up to the time of import into the customs territory of the Union, and after the end of a transition period and upon further assessment, as well to indirect emissions, mirroring the scope of the EU ETS.
According to the European Commission’s Impact Assessment documents (published as an integral part of the Fit for 55 package) the purpose of a CBAM “is to provide similar conditions between producers within the EU and abroad specifically in respect of any costs for GHG emissions caused by their production”. These costs are generated in the EU by its emission trading system (the EU ETS).
The problem of the compliance with the the General Agreement on Tariffs and Trade (GATT) is further analysed in the European Parliament Report of 15 February 2021 (Report towards a WTO-compatible EU carbon border adjustment mechanism (2020/2043(INI), A9-0019/2021)), which refers to Article XX of the GATT, allowing the World Trade Organization (WTO) members to implement measures that are necessary to protect human, animal or plant life or health (b), or natural resources (g).
The said European Parliament Report of 15 February 2021 also mentions that:
- “the EU should accept that a third country can set up a CBAM if that country implements a higher carbon price”;
- in order to prevent possible distortions in the internal market and along the value chain, a CBAM should cover all imports of products and commodities covered by the EU ETS, including when embedded in intermediate or final products;
as a starting point (already by 2023) and following an impact assessment, the CBAM should cover the power sector and energy-intensive industrial sectors like cement, steel, aluminium, oil refinery, paper, glass, chemicals and fertilisers, which continue to receive substantial free allocations.
The European Commission document of 4 March 2020 “Carbon border adjustment mechanism, inception impact assessment” as regards the type of policy instrument at issue mentions “[v]arious options could include a carbon tax on selected products – both on imported and domestic products, a new carbon customs duty or tax on imports, or the extension of the EU ETS to imports”.
It is also reserved that the details will have to be "carefully assessed" with respect to:
- the legal and technical feasibility of each measure, also in relation to the EU’s trade acquis (the rules of the World Trade Organisation and EU’s trade agreements) and other international commitments;
- the complementarity of the measure with internal carbon pricing, in particular the EU ETS, as well as how it relates to the current measures to avoid the risk of carbon leakage.
The European Commission notes that the measure “should be commensurate with the internal EU carbon price”.
In the Communication of 9 April 2019 (A more efficient and democratic decision making in EU energy and climate policy, COM(2019) 177 final), the European Commission reminds that current energy taxation framework is based on Article 113 TFEU (which provides for a special legislative procedure with unanimity in the Council), hence "the recent call by some Member States to make use of border carbon tax adjustments would also require unanimity".
It is noteworthy, in the Joint letter of 29 June 2021 the major European energy market players (including ENEL, EDF, Iberdrola) called for the inclusion of the hydrogen sector in the CBAM regulation (with the intention to avoid fossil based and highly emitting hydrogen imports, which would be similar to carbon leakage for hydrogen production).
The CBAM is designed as an EU-own resource.
Sectoral scope of the CBAM
As regards assessment criteria for the sectoral scope of the CBAM the relevance in terms of emissions is considered - i.e. whether the sector is a significant emitter of GHG, and whether there is an emission reduction potential.
This must be analysed separately in the following areas:
1. Relevance regarding direct emissions: analysis whether there are there installations in the sector covered by the EU ETS.
This means that if a sector’s structure is such that installations are typically too small for being covered by the EU ETS, the sector does not face emission costs and is per definition not exposed to carbon leakage.
Explanatory Memorandum to the draft CBAM Regulation explicitly states declares that "mechanism is an alternative to the measures that address the risk of carbon leakage in the EU’s Emissions Trading System".
Hence, sectors without EU ETS installations are excluded from the CBAM.
2. Relevance regarding indirect emissions:
This sub-criterion would identify sectors in which carbon leakage risk is induced by the increase of electricity prices due to the carbon costs borne by the producers of electricity from fossil sources.
No EU-wide list of installations falling within this category is available, as only few Member States (according to the Commission’s evaluation (SWD(2020) 194), 12 EU Member States and Norway provide compensation pursuant to Article 10a(6) of the EU ETS Directive) apply the indirect cost compensation.
To establish whether a sector should be covered by this criterion the indirect carbon leakage indicator (based on the EU State Aid Guidelines for indirect EU ETS cost compensation) is used.
The starting point is that the CBAM is intended as an instrument to establish a comparable carbon price on goods produced in or imported to the EU with the objectives of creating consistent incentives for emissions reduction, to limit the risk of carbon leakage from the EU ETS, and to incentivise the use of carbon pricing as policy measure to mitigate GHG emissions in other parts of the world.
Consequently, the CBAM is intended to focus on those sectors that have already been identified as being at risk of carbon leakage.
The applicable criteria for defining the carbon leakage risk are laid down in Article 10b of the EU ETS Directive and the list of sectors adopted by the Commission based on these criteria is given in Commission Delegated Decision (EU) 2019/708.
However, the carbon leakage list contains 50 sectors at 4-digit NACE level and further 13 sectors at more disaggregated level (6 or 8 digit PRODCOM).
It was assessed that for successfully implementing a CBAM, those 63 sectors and the multitude of products and materials produced by them might be too difficult to regulate - hence, to make the CBAM simpler and more manageable, it is proposed to focus on fewer sectors, at least for a pilot phase.
Import of electricity is included in the scope of CBAM. Recital 37 of the draft Regulation reads:
“Import of electricity should be included in the scope of this Regulation, as this sector is responsible for 30 per cent of the total GHG emissions in the Union. The enhanced Union climate ambition would increase the gap in carbon costs between electricity production in the Union and abroad. That increase combined with the progress in connecting the Union electricity grid to that of its neighbours would increase the risk of carbon leakage due to increased imports of electricity, a significant part of which is produced by coal-fired power plants”.
In line with approaches applied to the material products, a reference value for emissions embedded in imported electricity needed to be established in the context of determining the corresponding CBAM obligation.
Two alternative options were employed to determine the reference value for embedded emissions for electricity namely:
(a) average GHG emission intensity of the EU electricity mix and
(b) average GHG emission factor of the EU electricity mix.
As regards electricity the preferred option is to apply the CBAM based on the carbon emission factor including the possibility for importers to demonstrate lower emissions.
Both options contribute to mitigating the risks of carbon leakage by discouraging in the mid-term the build-up of carbon-intensive power generation sources in the vicinity of EU borders which might replace EU-based generators exposed to increasing carbon costs.
However, the option based on the carbon emission factor displays superior effectiveness in preventing carbon leakage while keeping administrative costs low.
As was said, importers would still have the possibility to prove that their installation level emissions are lower than the above reference values.
The draft CBAM Regulation envisions a spectrum of specific mechanisms as regards electricity, in particular regarding:
Comparison with the EU ETS
The CBAM departs from the ETS in some limited areas, however, in particular since it is not a ‘cap and trade' system.
To complement the ETS, the CBAM will be based on a system of certificates to cover the embedded emissions in selected products (based on actual emissions) being subsequently imported into the EU.
It was also suggested to introduce CBAM progressively against a correspondent reduction of allowances allocated for free in the corresponding EU ETS installations.
It is intended that the CBAM certificates will mirror the ETS price.
References to the EU ETS are contained in Recitals 14 - 21 of European Commission Proposal of 14 July 2021 for a Regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism (COM(2021) 564 final).
Among similarities of the two systems Recital 18 of the said Proposal enumerates:
- a common objective of pricing GHG emissions embedded in the same sectors and goods through the use of specific allowances or certificates;
- both systems have a regulatory nature;
- both systems are justified by the need to curb GHG emissions, in line with the binding environmental objective set out in Union law to reduce the Union’s net GHG emissions by at least 55 per cent below 1990 levels by 2030 and to reach economy-wide climate neutrality by 2050.
However, there are also numerous differences, in particular:
- while the EU ETS sets an absolute cap on the GHG emissions from the activities under its scope and allows tradability of allowances (so called ‘cap and trade system’), the CBAM does not establish quantitative limits to import, so as to ensure that trade flows are not restricted;
- while the EU ETS applies to installations based in the European Union, the CBAM is to be applied to certain goods imported into the customs territory of the European Union;
- CBAM certificates have some specific features compared with the EU ETS emission allowances including on the calculation of the price of CBAM certificates, on the possibilities to trade certificates and on their validity over time (these are due to the need to preserve the effectiveness of the CBAM as a measure preventing carbon leakage over time and to ensure that the management of the system is not excessively burdensome in terms of obligations imposed on the operators and of resources for the administration, while at the same time preserving an equivalent level of flexibility available to operators under the EU ETS);
- while on the EU ETS market the price of allowances released into the market is determined through auctions, the price of CBAM certificates is designed in different manner to reasonably reflect the price of such auctions through averages calculated on a weekly basis (the Proposal in Recital 21 explains that “such weekly average prices reflect closely the price fluctuations of the EU ETS and allow a reasonable margin for importers to take advantage of the price changes of the EU ETS while at the same ensuring that the system remains manageable for the administrative authorities”).
The CBAM will apply on imports of goods at the price of carbon determined by the EU ETS system through the system of auctions.
Importers would either be charged on the basis of a default value or based on the actual emissions embedded in the imports.
The possibility to demonstrate that the carbon efficiency of their product is better than the default value, would increase the complexity of the system, but this also provides emission reduction incentives for the share of materials that is exported to the EU.
It is argued that considering that installations covered by the EU ETS are subject to a carbon price assessed on their actual emissions, imported products in the scope of the CBAM should also be assessed based on their actual GHG emissions.
However, in order to allow businesses to adjust to such an approach it is proposed to start with a transitional period without financial adjustment.
European Commission Proposal of 14 July 2021 for a Regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism, COM(2021) 564 final, 2021/0214 (COD), Recitals 14 - 21
(14) This Regulation should apply to goods imported into the customs territory of the Union from third countries, except where their production has already been subject to the EU ETS, whereby it applies to third countries or territories, or to a carbon pricing system fully linked with the EU ETS.
(15) In order to exclude from the CBAM third countries or territories fully integrated into, or linked, to the EU ETS in the event of future agreements, the power to adopt acts in accordance with Article 290 of TFEU should be delegated to the Commission in respect of amending the list of countries in Annex II. Conversely, those third countries or territories should be excluded from the list in Annex II and be subject to CBAM whereby they do not effectively charge the ETS price on goods exported to the Union.
(16) This Regulation should apply to the continental shelf and to the exclusive economic zone declared by Member States pursuant to the United Nations Convention on the Law of the Sea12, with a view to preventing the risk of carbon leakage in offshore installations.
(17) The GHG emissions to be regulated by the CBAM should correspond to those GHG emissions covered by Annex I to the EU ETS in Directive 2003/87/EC, namely carbon dioxide (‘CO2’) as well as, where relevant, nitrous oxide (‘N2O’) and perfluorocarbons (‘PFCs’). The CBAM should initially apply to direct emissions of those GHG from the production of goods up to the time of import into the customs territory of the Union, and after the end of a transition period and upon further assessment, as well to indirect emissions, mirroring the scope of the EU ETS.
(18) The EU ETS and the CBAM have a common objective of pricing GHG emissions embedded in the same sectors and goods through the use of specific allowances or certificates. Both systems have a regulatory nature and are justified by the need to curb GHG emissions, in line with the environmental objective set out in Union.
(19) However, while the EU ETS sets an absolute cap on the GHG emissions from the activities under its scope and allows tradability of allowances (so called ‘cap and trade system’), the CBAM should not establish quantitative limits to import, so as to ensure that trade flows are not restricted. Moreover, while the EU ETS applies to installations based in the Union, the CBAM should be applied to certain goods imported into the customs territory of the Union.
(20) The CBAM system has some specific features compared with the EU ETS, including on the calculation of the price of CBAM certificates, on the possibilities to trade certificates and on their validity over time. These are due to the need to preserve the effectiveness of the CBAM as a measure preventing carbon leakage over time and to ensure that the management of the system is not excessively burdensome in terms of obligations imposed on the operators and of resources for the administration, while at the same time preserving an equivalent level of flexibility available to operators under the EU ETS.
(21) In order to preserve its effectiveness as a carbon leakage measure, the CBAM needs to reflect closely the EU ETS price. While on the EU ETS market the price of allowances is determined through auctions, the price of CBAM certificates should reasonably reflect the price of such auctions through averages calculated on a weekly basis. Such weekly average prices reflect closely the price fluctuations of the EU ETS and allow a reasonable margin for importers to take advantage of the price changes of the EU ETS while at the same ensuring that the system remains manageable for the administrative authorities.
Practical feasibility of a CBAM
According to the European Commission’s Impact Assessment documents (published as an integral part of the Fit for 55 package) the embedded emissions of a material or product are required to calculate the CBAM obligation, and if the embedded emissions cannot be determined at least as a reasonable default value, the material or product cannot be included in the CBAM scope.
For the practical feasibility of a CBAM two aspects are particularly relevant:
Firstly, the products and materials must be defined to a sufficient degree that the appropriate amount of the obligation (i.e. the amount of tax to be paid, the emission data to be declared or the number of CBAM certificates to be surrendered) under the CBAM can be determined by the designated authority.
Recitals 38 and 39 of the draft Regulation read,
“(38) As importers of goods covered by this Regulation should not have to fulfil their CBAM obligations under this Regulation at the time of importation, specific administrative measures should be applied to ensure that the obligations are fulfilled at a later stage. Therefore, importers should only be entitled to import CBAM goods after they have been granted an authorisation by competent authorities responsible for the application of this Regulation.
(39) The CBAM should be based on a declarative system where an authorised declarant, who may represent more than one importer, submits annually a declaration of the embedded emissions in the goods imported to the customs territory of the Union and surrenders a number of CBAM certificates corresponding to those declared emissions”
For this purpose it is not enough to clarify only the (carbon leakage exposed) sector using a NACE or PRODCOM code like in the Carbon Leakage List, but to list specifically all the products from within those sectors which are to be included in the CBAM.
This has to take into account that within the NACE sectors value chains can be found, with subsequent productions steps leading to different amounts of emissions.
Focus on the steps with highest emissions and including those products along the value chain that satisfy the criterion of identifiable products will help to find the right balance between administrative burden and effectiveness against carbon leakage.
For applying the CBAM in practice, all product categories which satisfy all criteria for including them in the CBAM should be defined by specifying their PRODCOM codes or better: CN codes, together with the applicable default reference values for the embedded emissions required for defining the amount of obligation under the CBAM, if not the actual emissions option is at hand.
Secondly, it must be considered whether materials and products can be sufficiently identified in practice for making the CBAM enforceable.
This means that it must be possible that a product or material is unambiguously linkable to its definition and its reference value for embedded emissions.
Such distinction would be for example difficult when the same basic material products can be made of primary or secondary (i.e. recycled) materials, if differentiated treatment were allowed or required.
Such differentiation can create incentives for resource shuffling, and where distinction is difficult to monitor, it may invite for fraud.
The most prominent case here are metals in general, which can be easily recycled, and in particular the different production routes blast furnace (primary) and electric arc furnace (almost exclusively secondary) steel.
While it would be justifiable based on the EU ETS benchmark methodology to assign different levels of embedded emissions to primary and secondary materials even in the absence of verified emissions data, it might be quite appealing for importers to claim their product to be recycled and therefore subject to the lower CBAM obligation.
The proposed approaches for avoiding incorrect claims in this regard are either to require independently verified emissions data following strict MRV rules, or to rely fully on default values for embedded emissions.
If those MRV rules are applied appropriately, only in rare cases of suspected fraud actual (chemical) analyses would be required to distinguish primary and secondary materials.
Analytical methods would have to be made available to the designated authorities together with reference data for selected tracer elements which would allow identifying non-primary materials to a sufficient assurance level.
For the moment it seems an excessive effort to develop such methods.
Instead, the MRV rules in the CBAM applicable to emissions from foreign countries will require the importer to provide credible evidence (confirmation with reasonable assurance by an accredited verifier applying international standards and in line with relevant EU legislation), which would also have to confirm what production process at which installation of provenance has been applied.
For other cases of doubt, e.g. whether a certain CN code has to be applied, already now sufficient instruments exist, since all kinds of custom tariffs need to be confirmed in practice, too.
If both criteria are satisfied, i.e. products are defined and it is ensured they can be identified, the remaining issue is whether the embedded emissions of a material or product can be determined.
This question is intertwined with the design of the MRV system and the approach chosen for determining default values.
However, a solution will almost always be possible if the system boundaries of MRV are chosen reasonably.
Under the Commission’s proposal of 14 July 2021, the CBAM will first be introduced in a transitional phase until the end of 2025, and, once fully in place as of 2026, it will work as follows:
- EU importers of goods covered by the CBAM register with national authorities where they can also buy CBAM certificates;
- 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;
- the EU importer must declare by 31 May each year the quantity of goods and the embedded emissions in those goods imported into the EU in the preceding year;
- at the same time, the importer surrenders the number of CBAM certificates that corresponds to the amount of greenhouse gas emissions embedded in the products;
- if importers can prove, based on verified information from third country producers, that a carbon price has already been paid during the production of the imported goods, the corresponding amount can be deducted from their final bill.
So, among several available options the European Commission has decided to choose the certificates system which seems to be economically equivalent to CO2 emissions allowances. It is said to be compliant with the WTO rules (Q&As document).
According to the European Commission’s Impact Assessment documents (published as an integral part of the Fit for 55 package) the CBAM proposal will inevitably increase costs for both imports and domestic production due to:
- producers of basic materials will have to pay a carbon price on their emissions;
- imports of basic materials from third countries will face carbon costs similar to the costs of European producers.
Producers will face, in particular, the following costs:
- increase in carbon costs,
- monitoring the quantity of imported products,
- tracking the place of origin,
- monitoring the embedded GHG emissions of products stemming from the production process,
- verification of the monitored emissions,
- cost related to the documentation of the process, including the submission of information to the CBAM registry,
- costs related to making the payment,
- costs related to the preparation for controls by the authorities,
- buying and surrendering of import certificates (CBAM certificates).
Compliance costs are likely to be higher for small and medium-sized enterprises (SMEs).
However, the investment in low carbon technologies will improve production efficiency and prepare businesses for more sustainable production processes.
The possibility to demonstrate that the carbon efficiency of their product is better than the default value, would increase costs, but this also provides emission reduction incentives for the share of materials that is exported to the EU.
All the above initiatives will be aligned with:
- the revision of the EU ETS;
- the revision of the Energy Taxation Directive (ETD); and
- the EU’s increased level of ambition regarding climate change for 2030.
An interesting leeway has also been envisioned as the document ents explicitly state that "Agreements with third countries could be considered as an alternative to the application of CBAM in case they ensure a higher degree of effectiveness and ambition to achieve decarbonisation of a sector".
Hence, there is a room for manoeuvre and the negotiation field between the EU and the third countries in case CBAM would severely impact bilateral trade.
Implementation and transitional phase
The CBAM is expected to be introduced in 2023.
A simplified system of the CBAM scheme will be in place for the first years after the entry into force.
Specifically, a transitional period will apply to facilitate the smooth roll out of the CBAM and allow traders and importers to adjust.
Simplifications include the procedures applied at the border when goods are imported and the use of default values to determination the CBAM obligation.
During the transitional period of the CBAM implementation, the CBAM mechanism will apply as a reporting obligation as set out in Articles 33 to 35 of the draft Regulation.
It is considered appropriate to begin moving from a system in which carbon leakage is addressed by free allowances to a system in which carbon leakage with respect to imports is addressed by a carbon border adjustment mechanism as soon as this is reasonably possible! taking into account the technical and economic feasibility, including administrative constraints and the legitimate expectations of all economic operators, in an even-handed manner.
Once that pilot phase is complete, the process of transitioning from free allowances to a carbon border adjustment mechanism will accelerate in earnest and in a manner that ensures no discrimination between domestic and imported goods, or between imported goods from different countries.
European Commission's Questions and Answers (Q&As) explain:
"Carbon Border Adjustment Mechanism will be phased in gradually and will initially apply only to a selected number of goods at high risk of carbon leakage: iron and steel, cement, fertiliser, aluminium and electricity generation.
A reporting system will apply as from 2023 for those products with the objective of facilitating a smooth roll out and to facilitate dialogue with third countries, and importers will start paying a financial adjustment in 2026.
Finally, as a potential EU own resource, revenues from CBAM will contribute to the EU's budget, as laid out in the December 2020 Interinstitutional Agreement on budget and own resources. [...]
To ensure a level playing field between EU and non-EU businesses, and once the full CBAM regime becomes operational in 2026, the system will adjust to reflect the revised EU ETS, in particular when it comes to the reduction of available free allowances in the sectors covered by the CBAM.
This means that the CBAM will only begin to apply to the products covered gradually and in direct proportion to the reduction of free allowances allocated under the ETS for those sectors.
Put simply, until they are completely phased out in 2035, the CBAM will apply only to the proportion of emissions that does not benefit from free allowances under the EU ETS, thus ensuring that importers are treated in an even-handed way compared to EU producers".
The above European Commission's document also mentions that "for the CBAM sectors, the free allowances will gradually be phased out as from 2026".