Carbon Border Adjustment Mechanism (CBAM)

The concept of a Carbon Border Adjustment Mechanism (CBAM) was formally proposed by the European Commission (EC) on 11 December 2019 within the framework of the European Union’s (EU) Green Deal and subsequently approved by the European Parliament (EP). It was adopted by the EU Council on 10 March 2021 as one of four carbon pricing mechanisms in the EU Green Deal. Based on the March 2021 decision, the EC conducted consultation meetings with member states as well as experts, scientists, and businesses regarding the details of implementation and the exact schedule. On 14 July 2021, the EC officially issued a detailed CBAM proposal for review, and the Council issued a further note in March 2022, and in June 2022, the European Parliament adopted a revised CBAM proposal. As the CBAM was not presented as a tax proposal but was structured as a mechanism to support the existing EU’s Emission Trading System (ETS), the EU Council can approve the CBAM through a qualified majority vote of 55% of EU Member States representing at least 65% of the EU population. The CBAM should apply as from 1 January 2023, beginning with a transition period until 2026 during which exporters will receive 100% free emission allowances to ensure a level playing field for companies that export EU-produced goods. With the deepening geopolitical crisis, it however becomes less and less likely that the CBAM decision will be taken before the end of 2022 and the entry into force will thus be delayed.

“The EU's Emissions Trading System (ETS) is the world's first international emissions trading scheme and the EU's flagship policy to combat climate change. It sets a cap on the amount of greenhouse gas emissions that can be released from industrial installations in certain sectors. Allowances must be bought on the ETS trading market, though a certain number of free allowances is distributed to prevent carbon leakage.”

CBAM’s main objective is the prevention of carbon leakage by creating a level playing field between EU producers subject to the EU ETS and competing producers in non-EU countries. The mechanism does this by creating replacements for the free allowances currently allocated to EU producers in sectors that are at high risk of carbon leakage. The EU also expects the CBAM to encourage non-EU trading partners to implement more ambitious measures to limit GHG emissions.

“Carbon leakage occurs when companies based in the EU could move carbon-intensive production abroad to take advantage of lax standards, or when EU products are replaced by more carbon-intensive imports.”

Initially, the scope of CBAM will be limited at the outset in terms of both covered emissions and sectors. CBAM will cover direct emissions (scope 1) of five selected sectors including iron and steel, cement, aluminium, fertilisers and electricity. The Parliament would like to add hydrogen, organic chemicals and polymers. The GHG emissions regulated by the CBAM correspond to those emissions covered by Annex I to the EU ETS, namely carbon dioxide (CO₂) as well as, where relevant, nitrous oxide (N₂O) and perfluorocarbons (PFCs). The coverage of indirect emissions (scope 2) is contested – it is desired by the Parliament but opposed by the EC.

The working principle is that, when CBAM is in force, companies importing goods produced outside the EU into the EU will have to purchase certificates corresponding to the amount of emissions generated in the production of those goods. The EC will calculate the price of CBAM certificates to reflect the average weekly price of EU allowance auctions. Where actual emissions cannot be verified, the number of CBAM certificates needed will be determined (1) based on the average in the country of production according to available data or literature or (2) using default values set at a level corresponding to the emissions of the 10% worst performing sites in the EU. In case the imported goods have already paid CO₂ taxes in the exporting county, the cost of CBAM certificates will be calculated as the difference between the purchase price of CO₂ emissions in the EU and the cost of CO₂ in the exporting country. It remains unclear whether ETS prices or other policy instruments will also be considered. Moreover, it is unclear whether emission credits from international carbon market mechanisms can be used instead of CBAM certificates.

During the transition period, the CBAM will apply without payment for CBAM certificates, with the objective to facilitate a smooth rollout of the mechanism and reduce the risk of disruptive impacts on trade. Declarants will report on a quarterly basis the embedded emissions corresponding to their imports of the previous quarter, detailing direct and indirect emissions and reporting any GHG price paid abroad. The certificates will be phased in between 2026 and 2035, at the same time that the free allowances to high risk industries in the EU are phased out. Violations of CBAM regulations will be sanctioned similar to those in the EU’s ETS.

There are however concerns over the consistency of CBAM with important principles of the World Trade Organization (WTO), including non-discrimination of similar goods, equal national treatment, and modification of the conditions of competition to the detriment of imported products. An official complaint of exporters before the WTO is highly likely.

Nguyen Viet Can

References

https://ec.europa.eu/commission/presscorner/detail/en/qanda_21_3661

https://www.europarl.europa.eu/thinktank/en/document/EPRS_BRI(2022)698889

Background Study on the European Union’s Carbon Border Adjustment Mechanism: Options for Policy Responses. 2021. DiGregorio, M., Ha, T., Bentes, P.

Proposal for a Regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism. 14/07/2021. European Commission.