To become the first climate-neutral continent, the EU has implemented the world's most extensive carbon-pricing system, the emission trading system (EU ETS) to encourage industrial decarbonization. However, regulating emissions causes the risk of carbon leakage, whereby EU industrial companies move their production abroad. To prevent this from happening, the EU is implementing a border tax on CO2 emissions, called the Carbon Border Adjustment Mechanism (CBAM). 

THIS ARTICLE IS WRITTEN BY LINN LÖFLING AND GIDION LONT. LINN ([email protected]) AND GIDION HAVE A STRONG FOCUS ON REGULATORY DEVELOPMENTS REGARDING ESG WITHIN RSM NETHERLANDS BUSINESS CONSULTING SERVICES.

Over the past 2 months, National Customs Offices have started sending letters to companies to inform them that they will be in scope of the CBAM. CBAM is a new regulation that tackles issues resulting from differences in carbon pricing and climate regulations among EU and non-EU countries. The mechanism seeks to safeguard domestic industries against unfair competition while ensuring a level playing field for EU companies and preventing the relocation of carbon-intensive activities to regions with less stringent environmental standards.

Foundation of CBAM

The operational framework of CBAM involves the implementation of a carbon price on specific goods imported into the EU, which will be determined based on the emissions from the production processes embedded in these goods. Importing companies must report the embedded emissions associated with the products they import into the EU. Companies importing CBAM products will be obligated to purchase corresponding CBAM certificates from EU authorities. The price of these CBAM allowances will be aligned with that of the EU ETS, while the rate is reduced by the possible carbon tax already paid in the exporting country. This way, a level playing field between European and non-European producers of carbon-intensive products is ensured. 

Product scope 

The products initially covered by CBAM are:

Direct emissions of all products are included, while indirect emissions of iron and steel, aluminium, and hydrogen are excluded. Before 2026, the EU Commission will assess the possibility of expanding the scope to include indirect emissions of iron, steel, aluminium and hydrogen, and embedded emissions from the transport of the goods and input materials (precursors) for the goods listed. Over time, the scope of CBAM will be extended to match the product groups covered by the EU ETS and to the list of products with a risk of carbon leakage, such as crude petroleum and petroleum products, inorganic basic chemicals, industrial gas, and synthetic rubber.

Affecting global trade dynamics

The introduction of the CBAM is expected to have significant implications for global trade dynamics. As a first implication, EU companies may experience increased prices from goods covered by CBAM. Prices of imported products are directly increased because importers must purchase the CBAM allowance before importing. In addition, the increased administrative costs from carbon emissions reporting of exporting non-EU companies could lead to a minor price increase. 
As the EU imposes a carbon price on imported goods, trade flows and competitiveness may shift. Both EU and non-EU companies must start (re)considering the carbon intensity of the products they supply to the EU market, potentially driving changes in production practices and encouraging the adoption of cleaner technologies globally. 

Timelines 

The initial phase of CBAM implementation is set to commence on October 1, 2023, requiring importers of regulated products to file quarterly reports of which the first is due on January 31, 2024. This initial phase enables companies to gather crucial data and familiarize global suppliers with the new EU regulatory framework. Subsequently, starting in 2026, importers will be obliged to use CBAM certificates to cover the embedded emissions of the imported products. The percentage of embedded emissions in imported goods covered by certificates will be phased-in gradually, starting at 3.5% in 2026 and rising to 49.5% in 2030, culminating in full coverage (100%) in 2034. From 2026 onwards, annual instead of quarterly reporting will be required to be filed on the 31st of May. 

The transitional period allows businesses to assess and modify their operations, supply chains, and reporting systems to meet the CBAM requirements. The phase provides an opportunity for proactive exploration of carbon reduction strategies, investment in cleaner technologies, and enhancement of carbon accounting capabilities.

How can you prepare?

The financial implications of CBAM do not start until 2026. However, the reporting period starts on October 1, 2023 and the report must be filed by January 31, 2024. To be prepared for the transition period, we advise you to take the following steps:

  • Determine responsibilities and operational procedures required to effectively fulfil CBAM requirements. 
  • Compile your purchasing data and determine which of the goods you purchase/import are in scope of CBAM. Since CBAM is expected to also affect the EU market and prices of EU products, these should be included in the scope.
  • Engage with suppliers to inform them about your reporting duties and what you will expect from them. It is expected that many non-EU suppliers currently do not have reliable carbon emissions data available. It could be important to take a cooperative approach towards measuring the embedded carbon emissions. 
  • Estimate the potential impact of CBAM. For companies importing carbon intensive products, the impact of CBAM on their cost structure, competitiveness or strategy could be significant. This could inform decision-making about taking any precautionary measures.  

By embracing CBAM’s transitional period companies can not only ensure compliance but also proactively drive sustainable practices, foster innovation, and establish resilience in an evolving global trade landscape.