The Carbon Border Adjustment Mechanism (CBAM) is the European Union’s instrument for setting a fair price for the carbon released in the production of goods imported into the EU while promoting cleaner industrial production in non-EU countries. What exactly does this mechanism entail? How to prepare for it? And when will it come into force? We have summarised all the essentials for you in the following article.
How will it work?
In practice, this will mean that EU importers will buy CO2 certificates corresponding to the carbon price that would have been paid if the carbon pricing rules applicable in the EU had been applied to the production of the goods in question. Conversely, if a non-EU producer can prove that the relevant amount for the CO2 emissions resulting from the production of the imported goods has already been paid in a third country, the EU importer can deduct the full cost.
When will it start to apply?
Based on a political agreement, the CBAM will enter into force in a transitional phase from 1 October 2023. This phase will last until the end of 2025. The CBAM is expected to be fully operational from 2026.
Initially, the CBAM will apply to imports of certain goods and selected precursors whose production is carbon-intensive and poses the greatest risk of carbon leakage: steel and iron, cement, aluminium, fertilisers, electricity, and hydrogen. During this transitional period, importers of goods affected by the new rules will only have to report the greenhouse gas emissions embodied in their imports (direct emissions) but will not have to make any financial payments or adjustments. Indirect emissions will not be included in the scope of the mechanism until 2025, according to the agreement.
When the permanent form of the scheme comes into force, importers will have to report annually both the quantity of goods imported into the EU in the previous year and the greenhouse gases contained therein. Subsequently, they will submit the corresponding number of CBAM certificates. The price of the certificates will be calculated according to the average weekly auction price of emission allowances under the EU ETS, expressed in euros per tonne of CO2 emissions.
3 steps to prepare for the CBAM
- Initial impact assessment: Which of your products will be covered by the CBAM? Where are these products from (i.e. origin)? What is the volume of your imports of these products?
- Setting up a process to collect embedded emissions data: Who in the supply chain has this information? Who reaches out to suppliers?
- Setting up the EU reporting process: Which business function in your organisation will be responsible for CBAM compliance?
CBAM vs. EU ETS and free emission allowances
For the sectors included in the CBAM, the number of free allowances will gradually decrease from 2026 until 2035, when the free allowances will be cancelled altogether. Importantly, until the free allowances are fully phased out, the CBAM will only apply to emissions from activities that are not allocated free allowances under the EU ETS.
The CBAM is intended to complement the EU ETS and is based on a system of certificates that will cover emissions associated with products that will subsequently be imported into the EU. The CBAM differs from the EU ETS primarily in that it is not a trading scheme setting emission caps. Instead, certificates under the CBAM reflect the prices applicable in the ETS.
On the other hand, the CBAM will be similar to the EU ETS in the sense that it will consist of the purchase of certificates by importers of goods. The import of CBAM products, the purchase of CBAM certificates, and the submission of CBAM declarations will require a special authorisation to be issued by a competent CBAM authority to EU importers or agents acting on behalf of one or more importers.
What makes CBAM so important
In summary, the CBAM is a tool that the European Union has decided to use to combat not only climate change but also the “competitive advantage” of producers located outside the European Union. They would be given an advantageous position on the market by not having to buy expensive emission allowances after 2035, which would significantly lower the cost of production, and, consequently, the prices of their products. The CBAM will maintain the competitiveness of European companies, as importers will be obliged to report the quantities of goods they have imported into the European Union and purchase the appropriate number of certificates.
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