Have you heard of the Carbon Border Adjustment Mechanism (CBAM)?
The European Union is pushing ahead to reach net-zero emissions by 2050. It has agreed to introduce the first-of-its-kind Carbon Border Adjustment Mechanism (“CBAM”) from 1 October 2023. The article will explain the purpose and objectives of CBAM, which is to address the issue of carbon leakage and ensure that industries in the EU and outside are operating on a level playing field in terms of carbon emissions. It will explore how CBAM works, including details about how it would be implemented and its potential impacts on various stakeholders.
What is Fit for 55, and how does CBAM support this EU goal?
The “Fit for 55” is a comprehensive package introduced by the European Union to align its policies with the ambitious climate goals set by the Council and the European Parliament. The name “Fit for 55” stems from the EU’s objective to reduce net greenhouse gas emissions by at least 55% by the year 2030. This package encompasses a series of proposals designed to update existing EU legislation and introduce new initiatives. The overarching aim is to provide a balanced and coherent framework that ensures a just and socially equitable transition, bolsters the innovation and competitiveness of EU industries, and reinforces the EU’s leadership in the global climate change battle.
The proposals within the package address various sectors, including energy-intensive industries, transportation, buildings, and agriculture. Key components of the package include:
- The reform of the EU emissions trading system (EU ETS).
- The introduction of a social climate fund to mitigate the social impacts of new emissions trading systems.
- The establishment of a carbon border adjustment mechanism to counter carbon leakage and reduce global emissions.
The introduction of the EU Carbon Border Adjustment Mechanism (CBAM) is a pivotal component of the “Fit for 55” package. CBAM is designed to level the playing field between EU producers who are subject to strict carbon emissions regulations and non-EU producers who might operate in regions with less stringent climate policies. By imposing a carbon price on specific imports to the EU, the CBAM aims to prevent “carbon leakage,” which occurs when businesses transfer their operations to countries with laxer emissions regulations to avoid the costs associated with carbon reduction.
In essence, CBAM serves a dual purpose: it ensures that the emissions reduction efforts of the EU are not undermined by increasing emissions outside its borders, and it incentivizes non-EU countries to adopt more robust climate policies. By integrating CBAM into the “Fit for 55” framework, the EU is taking a comprehensive approach to achieving its ambitious climate goals, ensuring that both domestic industries and imported goods contribute to the overarching objective of reducing greenhouse gas emissions by at least 55% by 2030.
Businesses are advised to prepare for the CBAM’s implementation starting October 2023
October 2023 will mark a significant milestone in implementing the European Union’s Carbon Border Adjustment Mechanism (CBAM). As of 1 October 2023, the CBAM enters its transitional phase, setting the stage for a more comprehensive application of the mechanism in the future. During this transitional phase, the CBAM will apply to imports of specific goods and selected carbon-intensive precursors at the highest risk of carbon leakage, such as cement, iron and steel, aluminum, fertilizers, electricity, and hydrogen. This phase serves as a pilot and learning period, allowing stakeholders, including importers, producers, and authorities, to gather valuable information on embedded emissions and refine the methodology for the definitive period.
Importantly, while importers will be required to report greenhouse gas emissions embedded in their imports during this phase, they will not be obligated to make any financial payments or adjustments. The transitional phase is crucial as it provides a predictable and proportionate transition for both EU and non-EU businesses, as well as public authorities, ensuring a smooth adaptation to the new regulations. The entry into enforcement of the CBAM signifies the EU’s commitment to ensuring that both domestic and imported goods contribute equitably to its climate objectives, reinforcing the principle that the carbon price of imports should be equivalent to that of domestic production.
What are the goods affected by CBAM imports?
The strategic move to target industries with the highest carbon footprints also encompasses sectors pivotal to the global economy. This includes key industries such as iron, steel, cement, electricity, fertilizers, aluminum, hydrogen, and certain related products. As the EU continues its commitment to reducing carbon, there’s anticipation that the scope of CBAM will broaden.
In the future, the European Commission is considering extending the scope of CBAM to include other goods; potential candidates might include polymers, organic chemicals, and other product categories currently under the EU ETS. Businesses and stakeholders should stay updated with the European Commission’s announcements to be informed about any expansions to the list of affected goods.
How will CBAM be implemented and regulated?
The CBAM will regulate by applying a carbon price to certain goods imported into the EU. This carbon price is essentially akin to a levy on carbon emissions of imported goods. The mechanism is designed to ensure that products imported into the EU have a carbon price that’s comparable to products produced within the EU, thereby leveling the playing field and preventing “carbon leakage” (where businesses might move to countries with less stringent carbon regulations).
As for reporting:
- The CBAM will introduce quarterly reporting obligations.
- During this reporting, businesses will need to provide details on the quantity of goods they’ve imported.
- They will also need to report on the quantity of embedded and indirect emissions associated with those goods.
- Information on any carbon price paid in the country of origin of the goods will also be required.
- The CBAM reporting and charges will be based on “embedded emissions,” which refers to emissions that occur during the manufacture of the goods. Some indirect emissions will also be included in this calculation.
- Charges will be paid through the purchase and surrender of CBAM certificates. The price of a certificate will be equivalent to an EU allowance (representing one ton of emissions) under the EU Emission Trading System (ETS).
What does it mean to phase out “free allowances”?
Central to this change is the phasing out of “free allowances” from 2026 to 2034. These allowances, historically provided to certain EU businesses, were designed to prevent them from relocating to regions with less stringent carbon pricing. However, with the CBAM in place, the playing field is leveled, making these allowances redundant. Another pivotal aspect of the CBAM is the introduction of CBAM certificates, which represent the carbon price of imported goods. Notably, these certificates differ from the EU Emission Trading System (ETS) allowances in a significant way: they cannot be traded on the EU ETS market, ensuring a distinct separation between the two systems. Furthermore, the CBAM is designed with a global perspective. Recognizing that some countries already have carbon pricing mechanisms in place, the system allows for adjustments based on carbon pricing in the country of origin. This means that if products have been subject to robust carbon pricing before being imported into the EU, and there’s documentary evidence of this, the CBAM charges can be reduced accordingly, ensuring fairness and avoiding double taxation.
- Significance of the CBAM
- A revolutionary step in carbon pricing policy.
- Reasons:
- Phasing out of free allocation of allowances.
- Charging for Scope 3 emissions of some businesses.
- Impact on businesses previously unaffected by carbon pricing.
- Involvement of trade compliance and tax teams.
- Requirement for advanced reporting and technological capabilities.
What is the impact of CBAM on business?
The CBAM will have wide-ranging effects on businesses both within and outside the EU. From an operational standpoint, there will be direct cost implications for businesses importing relevant goods into the EU due to the need to purchase CBAM certificates. Strategically, businesses selling goods into the EU may face competitive challenges if their products are more costly for EU customers compared to non-CBAM-subjected goods. Additionally, the CBAM introduces complex compliance requirements, potential restructuring of import operations, and increased risk exposure.
Historically, only businesses with high Scope 1 emissions or those voluntarily engaging in ETS markets have navigated carbon pricing structures. As a result, many enterprises, especially those with minimal Scope 1 emissions, have remained largely untouched by these pricing systems and their associated compliance demands.
Embracing Opportunities with the Introduction of CBAM
Historically, only businesses with high Scope 1 emissions or those voluntarily engaging in ETS markets have navigated carbon pricing structures. As a result, many enterprises, especially those with minimal Scope 1 emissions, have remained largely untouched by these pricing systems and their associated compliance demands.
With the introduction of CBAM, a diverse array of industries must now face carbon music and its ramifications on operational expenses and regulatory compliance. This shift necessitates the cultivation of new competencies and roles within these organizations. Industries that will feel the immediate effects due to their import activities are:
- Construction material suppliers
- Automotive companies
- Chemical engineering companies
- Manufacturers of aluminum and steel
- Food retail suppliers with metal products
All importing businesses should scrutinize their imported goods for CBAM applicability. It’s probable that a significant portion of enterprises import fundamental metal components, as categorized in the EU Customs Tariff’s metal chapters. Even if CBAM doesn’t represent a substantial cost for a business, they must still establish compliance protocols, even if they’re small-scale importers.
Trade Compliance and Indirect Taxes: Leading the Way
Historically, carbon pricing initiatives, such as the EU Emission Trading System (ETS), were managed by operational or manufacturing departments. However, with the EU CBAM’s focus on trade compliance and indirect taxation, there’s an exciting opportunity for these departments to play a pivotal role.
The goods under this mechanism are defined by customs codes, emphasizing their origin’s significance. Key aspects, like the “importer of record” (customs declarant), will be celebrated for their precision, alongside the weight of imported items. The choice of customs procedures becomes an avenue for excellence. The CBAM legislation, in its wisdom, promotes synergy between the CBAM authority and regional customs officials, ensuring seamless compliance and enforcement.
Departments that have expertise in carbon pricing are now in a prime position to collaborate with trade compliance and other business departments. In this era of sustainability, where carbon pricing is gaining momentum, trade compliance and related departments are set to play a central role in CBAM’s successful implementation.
Reporting & tech
In addition to the customs and trade data, businesses are empowered to calculate and document embedded emissions. While there are standard or default emission values available, businesses have the autonomy to determine the most accurate values.
To achieve this, businesses are equipped to gain deep insights into their supply chains and emission data, fostering collaboration with stakeholders across the value chain. The era of digital transformation offers cutting-edge technological solutions, enabling businesses to gather and authenticate data on embedded emissions and carbon prices efficiently.
Categories of Impact
Cost Implications
- The introduction of CBAM will have direct operating cost implications for businesses importing relevant goods into the EU. They will need to purchase CBAM certificates, representing a new cost element.
- While some businesses may have the ability to offset these costs if they’ve already paid for carbon pricing in their country of origin, others may face increased expenses.
- Additionally, costs may be passed along the value chain, affecting both suppliers and consumers.
Competitiveness Challenges
- Goods entering the EU that are subject to CBAM may incur higher costs, potentially making them less competitive compared to goods not under the CBAM.
- Emissions-intensive manufacturers might find themselves at a competitive disadvantage, as their goods could face higher CBAM costs upon EU import.
Compliance Requirements:
- The CBAM introduces complex compliance requirements. Businesses will need to obtain and monitor emissions data, purchase and surrender CBAM certificates, and submit CBAM declarations.
- Importers, even those with small volumes, will need to establish compliance protocols, ensuring they adhere to the new regulations.
- Trade compliance and tax departments will play a more central role, given the CBAM’s ties to trade compliance and indirect taxation.
Structural Changes:
- The CBAM will necessitate changes in how businesses operate. For instance, once CBAM is implemented, only “authorized declarants” will be qualified to import CBAM-covered products. This might limit the flexibility of which party can handle imports, prompting some businesses to reorganize their import structures.
- The phasing out of “free allowances” from 2026 to 2034 will also drive businesses to reconsider their carbon emissions strategies and sourcing decisions.
Risk Management:
- With the CBAM, there’s an increased level of risk exposure for goods covered by the mechanism. Businesses will need to scrutinize activities throughout their supply chains more closely.
- Effective risk management strategies will be essential, especially as companies navigate the new landscape of carbon pricing and its implications on their operations and bottom line.
The EU’s CBAM is a testament to its commitment to environmental sustainability, and while it presents challenges, it also offers businesses an opportunity to innovate and adapt in a rapidly changing global landscape.
Guidance for enterprises
Enterprises should consider the following five steps:
- Evaluate Potential Effects: Scrutinize their EU import activities to ascertain if they are subject to the CBAM provisions.
- Delegate Duties: Allocate specific roles to team members or departments for effective CBAM readiness.
- Determine Vulnerabilities: Pinpoint necessary data for adherence and forecast the prospective financial outcomes.
- Strategize and Execute Solutions: Formulate a strategy to address the new directives, potentially encompassing enhancements in supply chain processes, instituting new operational protocols, and leveraging technology to facilitate CBAM oversight.
- Stay Informed: Continuously monitor the progress of CBAM and related global carbon pricing measures to ensure proactive and synchronized actions.
The CBAM represents a bold and forward-thinking step by the European Union in the global fight against climate change. By leveling the playing field and ensuring that all industries, both within and outside the EU, contribute equitably to carbon reduction, the mechanism underscores the importance of collective responsibility. As the world grapples with the urgent need to address climate change, the CBAM serves as a beacon, highlighting the direction in which global policy should move. It’s a hopeful testament to the possibilities of innovative policymaking, reminding us that we can create a sustainable future for all with unity and foresight.
Whether you’re working on Scope Emissions Reporting, CBAM, or ESGs, our comprehensive impact reports and environmental metrics reporting are vital to your growing business. Elevate your sustainability strategy today and work with the best. Contact us at denise@armarketinghouse.com.
Resources
https://taxation-customs.ec.europa.eu/carbon-border-adjustment-mechanism_en
https://ccsi.columbia.edu/content/event-highlights-carbon-border-adjustments-eu-us-and-beyond
https://www.csis.org/analysis/analyzing-european-unions-carbon-border-adjustment-mechanism
https://crsreports.congress.gov/product/pdf/R/R47167
https://www.nature.com/articles/s43247-023-00788-4
https://www2.deloitte.com/nl/nl/pages/tax/articles/eu-carbon-border-adjustment-mechanism-cbam.html
