The European Parliament has recently adopted several key pieces of legislation that are part of its Fit for 55 Package, which is its plan to reduce greenhouse gas (GHG) emissions within the EU bloc by at least 55% by 2030 when compared to 1990 levels. One such key development is the Carbon Border Adjustment Mechanism (CBAM).
What is CBAM?
The CBAM is set to complement the EU’s Emissions Trading System (ETS), which has been in place since 2005 and which is a mechanism allowing for the purchasing and trading of emission allowances by certain carbon-intensive sectors.
The ETS operates under a ‘cap and trade’ principle, meaning that participants can only emit up to the amount covered by their allowances (the cap). In the case that such allowances do not cover their needs, they can purchase additional allowances at a price determined by the market. The cap is being reduced on an annual basis, essentially implying that carbon prices within the EU will rise as the stock/ supply of available allowances decreases.
As free allowances under the ETS are gradually phased out, the risk of carbon leakage increases. Carbon leakage occurs when companies based in the EU move carbon-intensive production to countries outside of the EU which have less stringent climate policies in place, or when EU products are replaced by more carbon-intensive imports, offsetting the decarbonisation efforts being made by the EU.
The CBAM aims to mitigate carbon leakage risk, by introducing a levy upon the importation of certain carbon-intensive products into the EU, based on their emissions footprint.
In other words, CBAM is therefore another indirect tax on the importation of carbon-intensive products.
How will it work?
The CBAM will initially apply to six carbon-intensive industries, those producing:
mineral products (cement),
electricity,
fertilisers,
iron and steel,
aluminium,
hydrogen
but the likelihood is that more industries will be brought into scope over time.
In terms of the current scope, the industries that are likely to be impacted by CBAM include aerospace and defence, automotive, chemicals, energy, engineering and construction, manufacturing, metals, pharma and life sciences, power and utilities, among others.
For the selected industries, a trial period beginning in October 2023 will require importers of in-scope goods to fulfil certain data collection and reporting obligations, including:
Registration with the responsible national authority as a declarant for CBAM purposes;
Collating of certain prescribed data in relation to imported goods. The data includes imported volume and for each type of product and supplier, the corresponding embedded emissions and carbon price paid (if any);
The submission of such data through a quarterly CBAM report. (This means that the first CBAM report will need to be submitted as early as January 2024).
Following the trial period, CBAM will come into force from 1 January 2026, from which point importers will start to face the financial burden of the system. Additional obligations will arise, including:
The purchasing of CBAM certificates, based on embedded emissions of the products they estimate to import for the year;
Verification, by independent verifiers, of embedded emissions of actual imports;
Submission of annual reports (as opposed to quarterly reports during the trial period) and surrendering of purchased certificates by 31 May of the following year. Unlike the ETS, unused CBAM certificates cannot be traded but are written off.
The price of CBAM certificates will initially be based on ETS prices. However, given the ETS phase-out period from 2026 to 2034 (mirrored by CBAM’s phasing-in period during the same years), the impact will be felt gradually.
It is expected that some suppliers may be unable to provide the necessary emissions data that EU importers will be required to report under CBAM. In such instances, default emissions data issued by the EU can be used, but this is expected to be more punitive.
How we may assist
CBAM will impact businesses operating in carbon-intensive industries and will challenge in-scope operators both administratively and financially. It is much more than a reporting or payment obligation and will involve a change in how suppliers and customers share and rely on critical sustainability-related data.
If you think that this latest EU initiative might affect your business, reach out to us so that we may assist you further.
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