Explainer on CBAM

Explainer on CBAM: 101

EVER HEARD OF THE CARBON BORDER ADJUSTMENT MECHANISM?

The European Union’s (EU) Carbon Border Adjustment Mechanism (CBAM) is a recently enacted landmark policy to protect European industry from carbon leakage. Carbon leakage may occur when a (significant) carbon cost in one country or region causes industry to relocate to another country or region with laxer greenhouse gas (GHG) emission constraints. This could result in an increase of overall emissions especially when it comes to energy-intensive industries.

DID YOU KNOW ABOUT THE EU EMISSIONS TRADING SYSTEM (EU ETS)?

The EU Emissions Trading System (EU ETS) is a ‘cap and trade’ system to reduce emissions by putting a price on carbon. It is a so-called market-based mechanism and does this by allocating a maximum amount of European Emission Allowances (EUAs) per year to participants, including electricity producers, heavy industry and intra-EU aviation. Over time, the number of allowances is reduced, thereby tightening the cap and lowering the overall amount of GHGs that installations are legally allowed to emit.

Depending on the activity, EUAs are either auctioned or allocated for free. Companies can subsequently sell any surplus allowances to companies that have a shortfall thereby creating a market price. To reach its climate goals, the EU has decided to phase-out the free allocation over time. This will increase the costs of emissions on industry to more fully reflect the environmental harm done, and in conjunction the risk of carbon leakage. At the time of writing, the EUA price hovered around €80 per tonne of carbon dioxide (tCO2).

Managing Carbon Leakage

To counter the risk of carbon leakage, the EU has implemented the CBAM. The CBAM aims to impose an equivalent cost on carbon emissions on the import of certain goods and selected precursors (see below on sectors covered) into the EU, as is imposed through the EU ETS on EU domestic producers. Upon full implementation, importers will have to declare the embedded emissions of their products and surrender so-called CBAM certificates corresponding to the average EUA auction price in the week before importation. As EUAs, the CBAM certificates are expressed in € per tonne of CO2 emitted.

European Emission ALLOWANCE Price
Learn CBAM graph

Source: Sandbag

PHASE-IN – NO CBAM PAYMENTS YET

The implementation of CBAM follows a gradual approach consisting of two phases to allow for information collection and learning:

Transitional phase (October 2023 – December 2025) where only reporting of direct and indirect embedded emissions is required. It’s a dry run and no CBAM certificates need to be bought. This will allow importers to get familiar with data submission requirements and the EU to collect sufficient data to finetune the system going forward. Reporting will have to be done on a quarterly basis.
Mandatory phase (January 2026 – onwards) where importers will have to surrender CBAM certificates on the embedded emissions in their goods and selected precursors.

During the mandatory phase, free allocation for EU ETS installations will be reduced gradually and the CBAM levy on importers increased at an equivalent rate over an 8-year period. This is referred to as the CBAM factor.

SECTORS COVERAGE

Initially, only the following carbon-intensive sectors will be included in the scope of CBAM:

Learn CBAM sectors 05

Cement

Learn CBAM sectors 09

Electricity

Learn CBAM sectors 08

Fertiliser

Learn CBAM sectors 06

Iron & Steel

Learn CBAM sectors 07

Aluminium

Learn CBAM sectors 10

Hydrogen

However, it is that stated objective in the CBAM regulations to increase the coverage to all industries included in the EU ETS by 2030.

MONITORING, REPORTING AND VERIFICATION (MRV)

The administration of CBAM is complex and requires substantial monitoring, reporting and verification (MRV). To this end, the European Commission has published Implementing Regulations that contain several rules in this regard. These include declaration forms, product codes, goods production routes, system boundaries and precursors, calculation methodologies for embedded emissions, emission factors and so forth. To navigate this space, a variety of guidance documents, templates and webinars have been made available by the European Commission on its website.