On December 13, 2022, the Council of the European Union and the European Parliament came to a provisional agreement on the final text of the Carbon Border Adjustment Mechanism ("CBAM") regulation.

The European Parliament and the Council have reportedly agreed on the CBAM Regulation entering into force on 1 October 2023, followed by a three-year transition period during which only reporting obligations will apply. After the transition period, the CBAM will be gradually phased-in, as ETS (European Trading System) free allowances in sectors covered by the CBAM will be gradually phased-out.

The CBAM will initially apply to imports of certain goods and selected precursors whose production is carbon intensive and at most significant risk of carbon leakage: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen as well as downstream products such as screws and bolts and similar articles of iron or steel. With this enlarged scope, CBAM will eventually – when fully phased in – capture more than 50% of the emissions in ETS covered sectors. Under the political agreement, the CBAM will enter into force as of 1 October 2023.

Before the end of the transition period, the Commission will be required to "assess whether to extend the scope to other goods at risk of carbon leakage, including organic chemicals and polymers”. The goal is to include all goods covered by the EU ETS by 2030. A proposal should also be made by 2026 by the Commission to include further downstream products.

Once the permanent system enters into force on 1 January 2026, importers will need to declare each year the quantity of goods imported into the EU in the preceding year and their embedded GHG. They will then surrender the corresponding number of CBAM certificates. The price of the certificates will be calculated depending on the weekly average auction price of EU ETS allowances expressed in €/tonne of CO2 emitted. The phasing-out of free allocation under the EU ETS will take place in parallel with the phasing-in of CBAM in the period 2026-2034.

 

How will it be calculated?

According to the deal reached, an EU Carbon Border Adjustment Mechanism (CBAM) will be set up to equalise the price of carbon paid for EU products operating under the EU Emissions Trading System (ETS) and the one for imported goods. This will be achieved by obliging companies that import into the EU to purchase so-called CBAM certificates to pay the difference between the carbon price paid in the country of production and the price of carbon allowances in the EU ETS.

The law will incentivise non-EU countries to increase their climate ambition and ensure that EU and global climate efforts are not undermined by production being relocated from the EU to countries with less ambitious policies.

The new regulation will be the first of its kind. It is designed to be in full compliance with World Trade Organisation (WTO) rules. It will apply from 1 October 2023 but with a transition period where the obligations of the importer shall be limited to reporting. To avoid double protection of EU industries, the length of the transition period and the full phase in of the CBAM will be linked to the phasing out of the free allowances under the ETS.

 

Background

CBAM is part of the “Fit for 55 in 2030 package", which is the EU’s plan to reduce greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels in line with the European Climate Law.

 

What’s the objective of the EU’s CBAM?

According to the European Commission’s proposal, a Carbon Border Adjustment Mechanism (CBAM) would contribute to the achievement of climate neutrality by 2050. It would operate alongside the other policy tools in the ‘Fit for 55’ package by addressing the risks of so-called carbon leakage resulting from the EU’s increased climate ambition. Carbon leakage is the hypothetical situation in which European producers competing in international markets would shift their production and pollution to countries with less stringent or no climate policies to lower their compliance costs.

 

How will it work in practice?

Companies that want to import goods produced outside the EU into the EU will have to purchase certificates corresponding to the amount of emissions generated in the production of those goods. The European Commission will calculate the price of CBAM certificates to reflect the average weekly price of ETS auctions. This means that CBAM certificates will be pegged to the ETS. This will ensure that the price of CBAM certificates is as close as possible to the price of ETS allowances while also ensuring that the system remains manageable for the administrative authorities.