The Carbon Border Adjustment Mechanism (CBAM)

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 ahead of its introduction.

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. 

The ETS works by assigning a cost to carbon dioxide emissions (known as carbon pricing) which incentivizes 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'. 

👉 Why not take a look at our article on the EU ETS, which covers everything you need to know about the trading scheme? Or if you'd like to learn more about carbon pricing head over to our article examining the need for a global carbon price.

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.

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).

👉 Read our article on carbon emissions to learn more about the harmful effects of greenhouse gases. 

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 will enter 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.

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.

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 2023, 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.

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.

The European Commission will perform a review of the CBAM before 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 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.

👉 To read more about the different types of emissions involved in the manufacturing of goods, read our article which explains the different scopes of emissions.

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 prior to 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.

At Greenly we can help you to assess your company’s carbon footprint, and then give you the tools you need to cut down on emissions. Why not request a free demo with one of our experts - no obligation or commitment required. 

If reading this article has inspired you to consider your company’s own carbon footprint, Greenly can help. Learn more about Greenly’s carbon management platform here.