CBAM: Creating a Level Playing Field

by Reinout Debergh and Giulia Bonazzi

Among the measures proposed in the European Union’s ‘Fit for 55’ package, one is that of a Carbon Border Adjustment Mechanism (‘CBAM’). This sets a carbon price at the European border [1]. CBAM’s aim is two-fold: it creates a level playing field between the climate regulations that EU producers are subject to and their absence in third countries, thus ensuring that the EU’s ambitious climate targets are not undermined; simultaneously, it encourages other countries to increase their efforts to tackle climate change [2]. 

Scope of CBAM

Countries & Products 

According to the current proposal, CBAM will apply to all countries outside of the European Economic Area (EEA) except Switzerland, whose Emissions Trading System (ETS) is linked to the EU ETS [3, 4]. In the beginning, CBAM will only cover those sectors most at risk of carbon leakage, namely cement, iron and steel, fertilizers, aluminium and electricity; however, it does not cover all products in these sectors [3, 4, 5, 6]. Subsequently, this could be extended to cover additional sectors [3]. Products are defined via a Combined Nomenclature (CN) code [6]. 

Emissions

CBAM does not cover all emissions. While a leaked draft covered both scope 1 (direct) and scope 2 (indirect) emissions, the current proposal only covers scope 1 [4, 7]. However, the proposal does leave room for expanding its emission scope later [3]. The leaked draft also covered the same greenhouse gases (GHGs) as the ETS, while the current proposal does not (table 1) [4, 7]. 

Sector	GHG
Cement	CO2
Fertilizers	CO2 and N2O
Electricity	CO2
Iron & Steel	CO2
Aluminium	CO2 and PFCs (perfluorocarbons)

If embedded emissions cannot be calculated accurately, default values are used. For products, these are either based on 1) the average emission intensity of the exporting country increased by a yet to be determined amount or, if that is not possible, 2) the average emission intensity of the 10% worst-performing EU installations for that type of good. Similarly for electricity, default values are based on either 1) the average CO₂ emission factor in tCO₂/MWh or, if that is not possible, 2) the average CO₂ intensity of electricity produced by fossil fuels in the EU [8].

How does CBAM work?

Member states have to appoint a competent authority (CA) responsible for implementing CBAM. Important companies have to be authorized by this CA and submit a ‘CBAM declaration’ which states 1) the quantity of imported goods in the preceding calendar year, 2) the embedded emissions of the goods (which must be verified) and 3) the number of certificates to be surrendered [4]. The number of certificates to be surrendered can be reduced to reflect the extent that a carbon price has been paid in the country of origin and/or that allowances under the EU ETS are still given for free [4, 9].

Certificates are sold by the CA and the price equals the average carbon price in the ETS from the week before. Companies have to surrender certificates to the CA each year. If they have certificates left over, they can request the CA to re-purchase up to one-third of the total number of certificates bought during the previous calendar year. After 30 June, all certificates bought in the year before the previous calendar year are cancelled [4]. In case of non-compliance, the penalty is the same as for the EU ETS, namely €100 per excess tonne of CO₂ equivalent, adjusted for inflation since 2013. Additionally, certificates still have to be surrendered for the excess emissions [4, 10]. 

During the transitional period (1 January 2023 through 31 December 2025), no certificates have to be surrendered and thus no price has to be paid. During this time, companies have to submit quarterly reports to the relevant CA with information on the amount of imported goods, embedded emissions (including indirect emissions) and any carbon price paid in the country of origin. By 2026, CBAM will be fully phased in [11]. 

The proposal also addresses circumvention. For example, if trade in a covered good from a third country to the EU decreases, but trade in downstream goods that use the covered good increases, the Commission can act and thus extend the scope of CBAM. This only applies if there is no other economic reason for the change in trade other than avoiding CBAM [12]. 

Conclusion

CBAM is a complex system. It is therefore not surprising that it is fairly limited in scope in its initial phase. Hopefully, it will not only ensure a level playing field but also encourage other countries to introduce carbon pricing mechanisms. CBAM could have an impact if done in the right way but there are still issues under discussion, as will be described in part two. 

References:

[1] European Green Deal: Commission proposes transformation of EU economy and society to meet climate ambitions, European Commission, URL: https://ec.europa.eu/commission/presscorner/detail/en/ip_21_3541, accessed on 15/10/2021. 
[2] Whitmore et al., 2021, Making a Difference in European Carbon: fitting in a CBAM to support heavy industry transformation, Bellona Europa, URL: https://bellona.org/publication/making-a-difference-in-european-carbon-fitting-in-a-cbam-to-support-heavy-industry-transformation, accessed on 15/10/2021.  
[3] Carbon Border Adjustment Mechanism (CBAM) – EU proposal, Gide, URL: https://www.gide.com/en/actualites/carbon-border-adjustment-mechanism-cbam-eu-proposa, accessed on 11/10/2021.
[4] Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL establishing a carbon border adjustment mechanism, European Commission, URL: https://eur-lex.europa.eu/legal-content/en/TXT/?uri=CELEX%3A52021PC0564, accessed on 11/10/2021
[5] Schiedek, L., Wilson, A., 2021, European Union: Carbon Border Adjustment Mechanism, ClimaTalk, URL: https://climatalk.org/2021/09/27/european-union-carbon-border-adjustment-mechanism/, accessed on 11/10/2021. 
[6] Commission Implementing Regulation (EU) 2020/1577 of 21 September 2020 amending Annex I to Council Regulation (EEC) No 2658/87 on the tariff and statistical nomenclature and on the Common Customs Tariff, European Commission, URL: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32020R1577, accessed on 12/10/2021.
[7] Taylor, K., 2021, LEAK: EU’s carbon border tariff to target steel, cement, power, Euractive, URL: https://www.euractiv.com/section/energy-environment/news/eus-carbon-border-tariff-to-target-steel-cement-power/, accessed on 12/10/2021.
[8] Marcu et al., 2021, The EU Carbon Border Adjustment Mechanism (CBAM) Preliminary analysis of the European Commission proposal for a regulation establishing a Carbon Border Adjustment Mechanism, 14 July 2021 (COM(2021) 564 FINAL), ERCST, URL: https://ercst.org/wp-content/uploads/2021/07/20210714-CBAM-proposal-preliminary-analysis-v4.pdf, accessed on 12/10/2021. 
[9] Dumitru, A., Kölbl, B., Wijffelaars, M., 2021, The Carbon Border Adjustment Mechanism explained, RaboResearch, URL: https://economics.rabobank.com/publications/2021/july/cbam-carbon-border-adjustment-mechanism-eu-explained/, accessed on 12/10/2021. 
[10] Debergh, R., 2021, EU ETS: An Introduction, ClimaTalk,  URL: https://climatalk.org/2021/09/20/eu-ets-an-introduction/, accessed on 14/10/2021. 
[11] European Commission releases proposal for a Carbon Border Adjustment Mechanism, Ernst & Young LLP., URL: https://globaltaxnews.ey.com/news/2021-5822-european-commission-releases-proposal-for-a-carbon-border-adjustment-mechanism, accessed on 14/10/2021.
[12] Molyneux, C. G., Mertenskötter, P., 2021, Will the EU CBAM Cover More Than What You Think? Complex Goods, System Boundaries, and Circumvention Under the Commission’s CBAM Proposal, Covington, URL: https://www.insideenergyandenvironment.com/2021/07/will-the-eu-cbam-cover-more-than-what-you-think-complex-goods-system-boundaries-and-circumvention-under-the-commissions-cbam-proposal/, accessed on 14/10/2021.

For more information on how CBAM works, head over to ClimaTalk’s article CBAM Part 2: Points of Discussion