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Carbon Border Adjustment Mechanism: basic notions

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By illuminem

· 6 min read

This article is part of Carbon Academy, a new illuminem series exploring the essential concepts within the world of carbon.

1. Introduction

In our article on Compliance Carbon Markets, we highlighted carbon leakage as a significant issue within these markets and pointed to the Carbon Border Adjustment as a key measure adopted by the EU to address this concern. Here, we provide the basics of this policy tool, with information directly sourced from the EU website, and break it down into easily understandable terms.

2. Definition and Purpose

2.1. Definition

A Carbon Border Adjustment (CBA) is a policy tool designed to address concerns related to the competitiveness of domestic industries in the face of varying carbon prices between different countries. 

2.2. Purpose

The concept involves imposing a charge on the carbon content of imported goods to ensure that they face a similar carbon cost as domestically produced goods, thereby preventing companies from relocating production to regions with lower environmental standards.

The Carbon Border Adjustment strive to achieve 4 key objectives:

  • Leveling the Playing Field: By including the carbon cost in the price of imported goods, the carbon border adjustment aims to level the playing field between domestic and foreign producers. It encourages companies to adopt cleaner technologies and practices regardless of their location.
  • Addressing Carbon Leakage: Carbon leakage refers to the situation where businesses move their production to regions with laxer environmental regulations or lower carbon prices, potentially undermining global efforts to reduce greenhouse gas emissions. A CBA aims to mitigate this by leveling the playing field in terms of carbon costs.
  • Ensuring Fair Competition: A CBAM is designed to prevent a competitive disadvantage for domestic industries that are subject to carbon pricing mechanisms by ensuring that imported goods face a similar carbon cost.
  • Promoting Global Climate Goals: By discouraging the relocation of carbon-intensive industries to areas with lower environmental standards, a Carbon Border Adjustment can contribute to global climate goals by promoting more consistent and equitable emission reduction efforts across regions.

3. How does it work?

3.1. Main Steps

The CBAM works as follows: EU authorized declarants, representing the importers of certain goods, will declare embedded emissions within their imports. Embedded emissions are both direct emissions released during the production of goods and indirect emissions from the production of electricity that is consumed during the production process. The infographic below clarifies this concept:

Source: PwC

Embedded emissions will be calculated based on the carbon data provided by the supplier to the importer. Importers will then purchase and surrender CBAM certificates based on the embedded emissions of their imported goods and surrender the corresponding number of certificates at the same price they have been purchased. This will become compulsory in 2026 (see below ‘Timeline’). The certificates surrendered by the CBAM declarant shall correspond to the amount of embedded emissions of the relevant goods expressed in tonnes of CO2. 

Question: what if suppliers cannot or don’t want to provide details/data needed to do the CBAM reporting? This presents a significant issue within the CBAM. Currently, the CBAM reporting system lacks a legal framework requiring suppliers to disclose data, placing the responsibility squarely on importers. In cases where suppliers resist sharing data, importers may eventually seek alternatives, such as relying on default values.

3.2. Sectors under the scheme

The CBAM initially applies to imports of goods in the following sectors:

  • Cement
  • Iron and Steel
  • Aluminium
  • Fertilisers
  • Hydrogen
  • Electricity

3.3.  Embedded Emissions Calculations

Importers have two options for calculating emissions reductions:

  • They can employ a methodology aligned with the reporting standards of emissions under the EU Emissions Trading System (EU ETS) for producing identical goods. More detailed information on the methodology can be found here
  • Alternatively, if companies are unable to calculate embedded emissions, they will have to rely on default values. These default values will be based on the average emissions of the lowest performing EU ETS installation. Until June 30, 2024, all embedded emissions in imports may be determined using default values. During the subsequent transitional period (from July 1, 2024, to December 31, 2025), estimated values can be used for up to 20% of the total embedded emissions

3.4. Timeline

CBAM will go through two main phases: a transitional and a definitive period

  • Transitional Period: The transitional phase lasts between 2023 and 2026.  During this phase, the importer will submit a CBAM report on a quarterly basis, with information on the goods imported during the previous quarter 
  • Definitive Regime: From 2026 EU importers will become financially liable: they will register with national authorities and will be required to buy the CBAM certificates

3.4.1. CBAM Certificate Price

Within the framework of the EU ETS, the allocation of free allowances diminishes across all sectors as time progresses. The Carbon Border Adjustment Mechanism (CBAM) will be phased in gradually as free allowances decrease. Particularly for CBAM sectors, this reduction rate will escalate starting from 2026, ensuring that the EU ETS effectively contributes to the EU's ambitious climate objectives. The cost of these certificates will be directly linked to the EU Emission Trading System (EU ETS) allowance price. Once the full CBAM regime becomes operational in 2026, the system will adjust to reflect the revised price of EU ETS allowances. The price will be based on the weekly average auction price of EU ETS allowances, expressed in € per tonne of CO2 emitted. The goal of this approach is to harmonize the carbon pricing for imported goods with those produced within EU ETS participating installations.

 N.B. At its core, the Carbon Border Adjustment Mechanism (CBAM) applies to imports from all non-EU nations. However, countries with their own emission trading systems are exempt. An authorized CBAM declarant can apply for a reduction in the number of CBAM certificates to be surrendered if non-EU producers have already paid for embedded emissions under a carbon emissions reduction scheme, whether in the form of a tax, levy or fee or in the form of emission allowances.

3.5. A Recap

The infographic below provides a recap of the functioning of the CBAM scheme:

Source: PwC

5. Regulation & penalties

Both Reporting of embedded emissions (from 1 October 2023) and the purchase of CBAM certificates (from January 2026) are compulsory.
Each Member State has appointed a National Competent Authority (NCA) tasked with verifying the accuracy of the quarterly CBAM reports, with support from the Commission. In instances where CBAM reports are found to be missing, incorrect, or incomplete, the National Competent Authority (NCA) may impose penalties ranging from EUR 10 to EUR 50 per tonne of unreported emissions.

6. Conclusion

The purpose of the CBAM extends beyond mere compliance—it's a crucial support for the EU's heightened climate ambitions. It safeguards against the risk of relocation to regions with less stringent policies. Simultaneously, it incentivizes non-EU producers to adopt greener practices and encourages other nations to implement carbon pricing measures. In essence, the CBAM's purpose is to track and report emissions directly associated with the production processes of products subject to its regulations.

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