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The Carbon Border Adjustment Mechanism (CBAM)
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On August 17th, 2023, the European Commission adopted detailed reporting rules for its newly created Carbon Border Adjustment Mechanism (CBAM). The transitional phase of this new mechanism commenced in October 2023, introducing greenhouse gas reporting obligations for importers of certain carbon-intensive products.
It is hoped that the CBAM will strengthen the effectiveness of the EU's Emissions Trading Scheme (ETS) and reduce carbon leakage.
👉 In this article we'll explore what the CBAM is, why it's been created, and what importers need to know about its implementation.
Why do we need the CBAM?
The European Union has been progressively intensifying policies and regulations in an effort to reduce emissions and to work towards achieving its climate change targets, which include reducing emissions by at least 55% by 2030 and achieving climate neutrality by 2050.
“ A cornerstone of the EU's strategy to achieve these ambitions is the EU Emissions Trading Scheme (EU ETS). According to the European Commission, the ETS is “a key tool for reducing greenhouse gas emissions cost-effectively. It's the world's first major carbon market and remains the biggest one.” ”
The ETS works by assigning a cost to carbon dioxide emissions (known as carbon pricing) which incentivises the reduction of emissions. Under the scheme, companies can buy or receive carbon allowances corresponding to their carbon emissions, which in effect makes using carbon-intensive energy sources like fossil fuels even more expensive, and makes switching to clean energy sources much more attractive.
The EU sets a cap on how much carbon dioxide can be emitted annually, and this cap decreases with every passing year. Companies must have enough carbon allowances to cover their annual emissions. If their emissions surpass the amount covered by their allowance they will be fined. Conversely, if they release less greenhouse gases than their allowances, they can sell their excess carbon allowances.
It's worth noting that free allowances have been issued under the ETS to safeguard the competitiveness of certain energy-intensive industries. However, these free allowances will be gradually phased out from 2026 through to 2034.
👉 Since its inception in 2005, the ETS has helped to reduce emissions in energy-intensive industries such as power generation and manufacturing by around 35%. However, the success of the system is tempered by something known as ‘carbon leakage'.
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What is carbon leakage?
This describes the situation whereby greenhouse gas emissions (GHG) in one country increase as a result of emissions reductions in another country with stricter emissions regulations and policies. For example, one country may have implemented carbon taxes or a cap-and-trade emissions scheme in an effort to reduce GHG emissions, however, companies can avoid these extra costs by simply moving their production processes to another country without such stringent policies in place. In essence, it's a spillover of emissions.
“ The European Commission states that “Carbon leakage refers to the situation that may occur if, for reasons of costs related to climate policies, businesses were to transfer production to other countries with laxer emissions constraints. This could lead to an increase in their total emissions. ”
Because the ETS is a regional scheme, it is vulnerable to the varying emissions policies that exist globally and its effectiveness has been reduced by carbon leakage. Research conducted by the European Central Bank found that companies were moving their carbon-intensive activities from inside Europe to outside of the EU.
This is why, in December 2022, a provisional agreement was reached between the EU Parliament and the EU Council to introduce a new mechanism called the Carbon Border Adjustment Mechanism (CBAM). This tool places emissions tariffs on imported goods with a high risk of carbon leakage, originating from countries that are not members of the EU Emissions Trading System (ETS).
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What is the EU Carbon Border Adjustment Mechanism (CBAM)?
As the European Union increases its policies and regulations in an effort to combat climate change, there is a risk of ‘carbon leakage' - whereby companies based in the EU move their carbon-intensive production or manufacturing abroad to countries with less stringent climate policies or without any form of carbon tax, or where EU products are simply replaced by imported products with higher carbon footprints.
The EU Carbon Border Adjustment Mechanism (CBAM) has been introduced to combat this situation. It's a mechanism that “puts a fair price on the carbon emitted during the production of carbon-intensive goods that are entering the EU, and to encourage cleaner industrial production in non-EU countries.”
Essentially the mechanism's key objective is to level the playing field for European producers operating in the EU market who face a financial impact for their emissions under the EU ETS, while also encouraging industrial decarbonisation globally.
CBAM was officially adopted by the EU Commission on the 17th of August, 2023. The mechanism entered into a transitional period from the 1st of October 2023, which will run until the 31st of December 2025, meaning that the CBAM will come into full effect from the 1st of January 2026.
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How does the Carbon Border Adjustment Mechanism work?
The CBAM will apply to goods produced in countries that are not covered by the EU ETS. This includes both goods that were produced in their entirety outside of the EU and goods that underwent substantial production outside of the EU.
The CBAM has been designed to support businesses during this period of change which is why it gradually increases in scope. As of October 1, 2023, the transitional period began. What this means is that importers of certain goods whose production is carbon intensive and susceptible to carbon leakage will have to report on GHG embedded in their imports. At this stage, however, they are not expected to make any financial payments.
Goods that will fall under the transitional period of the CBAM include:
- Iron and steel
- Cement
- Aluminium
- Fertilisers
- Electricity
- Hydrogen
- Some downstream products that contain iron and steel - for example, screws and nails
In 2026, the transitional period will come to an end and importers will be expected to start paying adjustments. This ensures that the carbon price of imports is equivalent to the carbon price of domestic products and that the EU's climate objectives are not undermined. It's possible that at this point the scope of CBAM requirements will be expanded and that further goods will also be subject to the carbon levy.
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The CBAM transition period
The transition period of the CBAM's implementation began in October 2023 and will run until December 2025. The intention of this transition period is to allow for a gradual phasing in of the CBAM, allowing businesses (both within and outside the EU) to transition to the new system.
With only GHG reporting obligations at this point, businesses will be given some flexibility when it comes to reporting on emissions embedded in their imports. During the first year of implementation, businesses will have a choice of completing their quarterly reports in one of three ways:
- Full reporting in line with new EU methodology;
- Reporting based on equivalent third-country national systems;
- Reporting based on default emissions data (also referred to as default values or reference values).
However, as of January 2025, only the EU method will be accepted.
The European Commission has developed in-depth guidance, IT tools, training materials, and tutorials that will support importers who must calculate and report emissions when the CBAM transitional period begins. To access these CBAM implementation training tools and documents, head over to the European Commission's website.
❗Good to know: Importers are expected to collect data from the fourth quarter of 2023, however, their first report will not need to be submitted until the end of January 2024.
CBAM after 2026
The permanent system will come into effect from January 1st, 2026. This means that importers will need to declare the number of products imported to the EU in the preceding year (known as the annual CBAM declaration), along with data on their embedded greenhouse gas emissions.
Importers will then need to surrender CBAM certificates corresponding to the GHGs embedded in imported CBAM goods, effectively imposing a carbon price. The cost of these certificates will be determined by the weekly average auction price of allowances under the EU carbon market. Importers will have to purchase CBAM certificates for the same amount per tonne of carbon dioxide as if the goods had been manufactured within the EU. In other words: the price of CBAM certificates will correspond to carbon prices at the EU ETS.
If an importer does not hand over the correct number of corresponding CBAM certificates, they will have to pay a fine for each tonne of carbon dioxide equivalent. Where the goods have been imported by a person who is not a CBAM declarant, the penalty will be between 3 and 5 times higher than this, depending on the “duration, gravity, scope, intentional nature and repetition” of the non-compliance.
💡 A note on embedded emissions: These are the direct GHG emissions from the manufacturing of goods, that are generated from activities the manufacturer owns or controls.
CBAM expansion
The European Commission will perform a review of the CBAM prior to the end of its transitional period. It will also be determined whether or not the scope of the mechanism should be expanded to include other product groups (for example organic chemicals and downstream products). A timetable is expected to be produced which will outline the sectors covered and the inclusion of other goods already covered by the EU ETS.
By 2030 it is hoped that all goods covered by the EU Emission Trading Scheme will be included in the CBAM.
The European Commission is also expected to consider whether or not it should expand emissions covered by the CBAM to include both direct and indirect emissions. As it stands the EU CBAM applies to direct emissions of greenhouse gases emitted during the production phase of the covered products, as well as to indirect emissions for a subset of those products.
| Phase | Timing | Application |
|---|---|---|
| Transitional Period Begins | October 2023 | Importers report GHG emissions for carbon-intensive goods, no financial payments required. |
| First Year Reporting Options | October 2023 - October 2024 | Businesses choose reporting method: full EU reporting, third-country equivalent systems, or default emissions values. |
| Full Reporting in Line with EU Methodology | January 2025 | Only EU methodology for GHG reporting accepted. |
| End of Transitional Period | December 2025 | Importers start preparing for full financial adjustments. |
| Permanent System Begins | January 1, 2026 | Importers start paying adjustments based on GHG emissions embedded in their imports. |
| Scope and Coverage Review | End of 2025 | Review of CBAM's scope and potential expansion to new product groups. |
| Potential Expansion of Covered Goods | 2026-2030 | Possible inclusion of organic chemicals and downstream products; extension of coverage to indirect emissions. |
| Full Scope Implementation | By 2030 | Expected full implementation covering all goods under the EU ETS. |
What companies in the US need to know about CBAM
The Carbon Border Adjustment Mechanism (CBAM) is likely to have significant implications for US businesses exporting to the European Union, particularly those in carbon-intensive sectors such as steel, aluminum, cement, and fertilizers. As the US does not have a national carbon pricing mechanism equivalent to the EU’s Emissions Trading Scheme (ETS), American exporters will need to adapt to the new CBAM regulations.
Key ways CBAM could impact US businesses include:
New Reporting Requirements:
US exporters of covered goods will need to report the GHG emissions embedded in their products to comply with CBAM. This will require them to track their emissions, potentially leading to increased administrative costs, especially for businesses that have not previously monitored their carbon footprint in detail.
Increased Export Costs:
From 2026, US businesses will be required to purchase CBAM certificates for products exported to the EU, reflecting the carbon price they would have paid if they were part of the EU’s ETS. This could raise the cost of US goods in the EU market, potentially making them less competitive compared to lower-carbon or EU-produced alternatives.
Pressure to Reduce Carbon Intensity:
US businesses will face growing pressure to reduce their carbon emissions to mitigate the impact of CBAM. Companies that successfully decarbonize their production processes could reduce their CBAM-related costs, making their exports more competitive in the EU market.
Trade Tensions:
There is a possibility that CBAM could exacerbate trade tensions between the US and the EU, especially if the US government views the mechanism as a protectionist measure. However, US businesses may also lobby for the introduction of a national carbon pricing system or other climate policies to level the playing field with European competitors.
Supply Chain Management:
For US companies that export carbon-intensive products, managing Scope 3 emissions from their supply chains will be crucial. Working with suppliers to reduce emissions could lower their overall carbon footprint and reduce the cost of CBAM compliance.
Overall, CBAM will likely increase costs for US businesses exporting carbon-intensive goods to the EU. However, those that act early to reduce emissions may gain a competitive advantage, positioning themselves as leaders in sustainability and global trade.
What importers need to know
Importers of goods manufactured outside of the EU, that fall within the scope of the CBAM, should look to familiarise themselves with their obligations. They will also need to ensure that they:
- Register with national authorities before importing goods;
- Declare the volume of imported goods and their embedded GHG emissions annually (this will require the collection of emissions data, including emissions stemming from their supply chain);
- From January 2026, they will need to obtain the corresponding amount of CBAM certificates to cover embedded emissions;
- Maintain compliance documentation.
The CBAM Transitional Registry
The European Commission has created a transitional registry for CBAM to assist EU importers in fulfilling and reporting their CBAM-related responsibilities. Importers should request access to this registry via the National Competent Authority (NCA) in the relevant EU Member States.
What about Greenly?
Greenly is here to guide your business through the transition to a more sustainable future, offering robust carbon management solutions to help reduce environmental impact:
Carbon Management with Greenly
Measure Your GHG Emissions: Monitor your Scope 1, 2, and 3 emissions using advanced technology, providing an overview of your business’s carbon footprint.
Tailored Action Plans: Collaborate with Greenly’s team of climate experts to develop customized strategies targeting key areas of improvement, helping you implement high-impact actions to reduce emissions and support sustainable growth.
Supply Chain Decarbonization
Addressing Scope 3 emissions from your supply chain can be one of the toughest challenges in carbon reduction, but it’s vital for achieving your net-zero goals. Greenly helps you engage suppliers, transition to low-carbon alternatives, and build more sustainable relationships. Our solutions boost transparency and enable you to cut emissions throughout your entire supply chain.
Intuitive Platform
Our easy-to-use platform streamlines the process of tracking and managing your carbon footprint. With Greenly, you can monitor your environmental impact, measure progress against ESG goals, and embed sustainability into every aspect of your operations.
Why Choose Greenly?
Greenly provides end-to-end support throughout your sustainability journey - from accurate carbon measurement and tailored action plans to supply chain decarbonization and effortless platform integration.
Begin your journey toward net zero with Greenly today and help shape a more sustainable future for all.
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