EU CBAM agreed

The European Parliament and EU Council have reached agreement on the details of an EU Carbon Border Adjustment Mechanism (CBAM) to prevent carbon leakage. The scheme will involve importers being required to buy CBAM certificates to compensate for carbon emissions in the country of production.

The CBAM scheme is to commence from October 2023, but with an initial period of reporting only. Full implementation is dependent on the phasing out of allowances provided to EU businesses under the existing European Emissions Trading System (ETS), which means that it is due to be phased in fully between 2026 and 2034.

Background

A CBAM is seen as one of a range of options to counter so-called “carbon leakage”. Carbon leakage is where countries impose local environmental requirements on domestic industries, which results in these industries either relocating or losing out to competitors in cheaper countries with lower environmental standards.

The introduction of a CBAM was agreed in principle within the EU in March 2022, following the presentation by the EU Commission of a legislative proposal as part of its “Green Deal” in July 2021. However, a number of preconditions remained outstanding at that point. Progress was dependent on a number of issues closely related to CBAM, including phasing out allowances provided to the industries covered by the CBAM, ensuring WTO compatibility and proposals by the EU Commission for the proceeds from the sale of CBAM certificates to go towards the EU’s own resources.

December 2022 agreement

Under the deal reached in December 2022, an EU CBAM will be set up to equalise the price of carbon paid for EU products operating under the EU ETS and the one for imported goods. This will be achieved by obliging companies that import into the EU to purchase CBAM certificates to pay the difference between the carbon price paid in the country of production and the price of carbon allowances in the EU ETS.

The new agreement is designed to be compliant with World Trade Organisation (WTO) rules (though this may be tested in the long run). As such, it is not designed as a tax or duty. In particular, a tax or duty would require unanimity amongst the EU Member States to implement and the Commission has been keen to avoid this situation. In addition, a duty would make it more difficult to comply with WTO requirements.

To avoid double protection of EU industries, implementation will be linked to the phasing out of the free allowances under the ETS. This was subject to separate negotiations and agreement has also now been reached on this aspect.

The CBAM scheme will apply from October 2023 but with a transition period where the obligations of the importer will initially be limited to reporting only. However, the CBAM scheme will be phased in as the free allowances under the ETS are phased out – meaning that CBAM will therefore commence in earnest in 2026 and be fully phased in by 2034.

Next steps

The final text of the CBAM rules are still awaited. Once these have been published, the agreement will still need to be formally adopted by before it becomes final.

The scope of CBAM

CBAM will cover iron and steel, cement, aluminium, fertilisers and electricity, as proposed by the Commission, and extended to hydrogen, indirect emissions under certain conditions, certain precursors as well as to some downstream products such as screws and bolts and similar articles of iron or steel.

CBAM charges will be calculated based on emissions arising from manufacture (embedded emissions), as well as certain indirect emissions. Where goods are imported into the EU that have been subject to local carbon pricing regimes in the country of production, the CBAM charge will take these charges into account so that only the difference with the price of carbon allowances in the EU will be payable.

Before the end of the transition period, the Commission will be required to assess whether to extend the scope to other goods at risk of carbon leakage, including organic chemicals and polymers, with the goal to include all goods covered by the ETS by 2030. The Commission will also assess the methodology for indirect emissions and the possibility of including more downstream products.

Governance and review

The governance of CBAM will be in the hands of the Commission, which will be in charge of most administrative aspects.

One of the goals of CBAM is to incentivise non-EU countries to increase their climate ambition and ensure that EU and global climate efforts are not undermined by production being relocated from the EU to countries with less ambitious policies. By the end of 2027, the Commission will perform a complete review of CBAM including an assessment of progress made in international negotiations on climate change, as well as the impact on imports from developing countries, in particular the least developed countries (LDCs).

Comment

The CBAM is likely to prove a controversial development internationally, with many other trading nations arguing that it creates protectionist barriers to competition and developing nations arguing that it negatively impacts important exporting industries in those countries least responsible for the climate emergency. Nevertheless, CBAM and similar schemes are gaining support, with the UK to consult on a possible CBAM and other major trading nations such as Canada looking at similar schemes.

However, other problems may arise even if other countries introduce similar systems. It seems certain that the structure of each national scheme will vary, leading to overlaps and additional administrative burdens. Carbon border taxes are likely to differ based not only by reference to the country of destination but also by country of origin, and (whilst the EU CBAM can technically be presented as compliant with WTO principles), it is unclear how these might comply with the WTO's most favoured nation principle.