The carbon border adjustment mechanism (CBAM): where are we now?

Background

As part of the European Green Deal, the European Commission set its strategy to transform Europe into the first climate neutral continent by 2050 with an initial target of reducing net greenhouse gas (GHG) emissions by at least 55% by 2030. 

The regulatory framework developed by the EU to achieve this ambitious target includes the Carbon Border Adjustment Mechanism (the CBAM), a scheme that is intended to prevent carbon leakage. Carbon leakage occurs when EU manufacturers operating in carbon intensive industries transfer the production of carbon-heavy materials to third party countries outside of the EU that have less stringent emissions and climate change regulations. 

The EU Regulation establishing the CBAM (the CBAM Regulation) entered into force on 5 June 2023 with the initial transitional reporting obligations coming into effect on 1 October 2023.

What will it do?

The CBAM will require importers that bring certain carbon-intensive goods into the EU to pay a levy on those imports. The levy will mirror the unit charge imposed on comparable domestic industries under the EU Emissions Trading Scheme (the EU ETS) and be based on the GHG emissions embedded in the imported goods. However, if the non-EU manufacturer can evidence that they have already paid a price for the embedded GHG emissions and/or carbon used in the production of the goods in the jurisdiction of origin, then that cost can be deducted from the levy to be charged on entry into the EU. The CBAM is intended to disincentivise EU manufacturers from importing carbon-intensive products from jurisdictions with poor GHG emissions regulation, which significantly undermines the objectives of the EU ETS. 

How will it work?

The CBAM will enter into force in a transitional phase on 1 October 2023. It will initially apply to imports of certain, carbon-intensive products that pose the most significant risk of carbon leakage: cement, electricity, fertilisers, iron, steel, and hydrogen.

During this initial transitional period, importers of applicable goods will be required to report the embedded GHG emissions (both direct and, for certain goods, indirect) but will not be required to make any payments under the CBAM. This initial phase will serve as a learning period for all stakeholders (importers, producers, and authorities) to gather useful information that will inform the methodology for the calculation of embedded indirect emissions. To begin with, the indirect emissions in respect of steel, aluminium and hydrogen will not be counted as part of the embedded emissions.

Initially there will be flexibility when it comes to the values used to calculate embedded GHG emissions to allow for adaptation and process development. During the first year of implementation, reporting organisations will have the choice of reporting in three ways: 

1. full reporting according to the new methodology (the EU Method); 
2. reporting based on equivalent third country national systems; or 
3. reporting based on reference values.

From 1 January 2025, only the EU Method will be accepted, and more information will become available about this methodology as it is developed.

The process of implementing the fully operational CBAM will begin on 1 January 2026, meaning that importers will then will be required to buy carbon certificates. The price of a certificate will reflect the unit price of an EU ETS allowance, and at the end of each annual reporting cycle the importer will have to surrender an equivalent amount of CBAM certificates to reflect the price of the total embedded GHG emissions for any relevant goods it has imported over that year. As mentioned above, the price of the embedded emissions will be reduced by any amount the non-EU manufacturer has already paid in respect of those emissions in the originating jurisdiction.

The EU’s phase-in plan for the CBAM includes the gradual decrease of the free allocation of EU ETS allowances over a nine-year period from 2026 to 2034 for the sectors covered by the CBAM. The gradual introduction of the CBAM will be directly linked to the phase out of the EU ETS allocations. This is to ensure that EU-based manufacturers are not treated more favourably than non-EU manufacturers during the phase-in, and in practical terms this means that the CBAM will not be fully implemented until 2034.

How will it impact industry?

The cost and administrative burdens associated with the CBAM will impact EU producers operating in the affected sectors and will require substantial investment in both administrative functions and perhaps identifying alternative supply chains from different market sources. The CBAM will also impact export driven markets such as China and may well lead to restricted market access if such countries fail to introduce stricter regulation on GHG emissions. 

By 31 December 2025, the European Commission will also assess whether to extend the scope of the CBAM to other goods at risk of carbon leakage, including organic chemicals and polymers and other input materials for the goods listed above. Ultimately, the aim is to include all goods covered by the EU ETS by 2030. 

UK and CBAM

As with the EU, the UK’s main measure for dealing with carbon leakage has been the free allocation of allowances to producers of domestic goods under the UK Emissions Trading Scheme. As part of its ‘Green Day’ announcements in March 2023, the UK government published a consultation on potential policy measures to mitigate carbon leakage risk and support decarbonisation of UK industry. The government is committed to exploring potential measures, including a UK version of the CBAM.

Going forward

We will continue to monitor and provide further updates on amendments to the CBAM. Our global climate change and sustainability practice has extensive experience advising clients across all key environmental and carbon markets.