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.
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.”
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).
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.
The draft CBAM regulation envisions a spectrum of specific mechanisms as regards electricity, in particular regarding:
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.
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.