The EU Carbon Border Adjustment Mechanism (CBAM)

What is the EU CBAM?

The EU Carbon Border Adjustment Mechanism (CBAM) is an environmental policy designed to tackle carbon leakage. Carbon leakage refers to the situation where EU producers relocate their production facilities to regions outside the EU that lack carbon pricing mechanisms or have less stringent climate policies in place. It can also occur when customers choose to substitute EU products with cheaper imports that have higher embedded emissions.

The EU CBAM aims to address these issues by ensuring a level playing field inside the EU for domestic and foreign producers and encouraging global efforts to reduce greenhouse (GHG) emissions. This mechanism complements the EU Emissions Trading System (ETS) – the cornerstone of EU climate policy – by introducing an equivalent set of rules to the import of certain goods into the customs territory of the Union.

EU CBAM Scope

Unlike the EU ETS, which applies at the facility level, the EU CBAM operates at the product level. It covers the goods listed in Annex I of the CBAM regulation as identified by their Combined Nomenclature (CN) codes: cement, aluminium, iron and steel, chemicals (hydrogen), fertilisers, and electricity.

Shipments with a value below EUR150, including the ones contained in the personal luggage of travellers coming from third countries, are not covered. Goods moved or used in the context of military activities do not fall under the scope of the EU CBAM either.

In terms of its geographical scope, the EU CBAM is applicable to goods that originate from a third country, meaning a country or territory outside the customs territory of the European Union. However, if the production of those goods has already been subject to the EU ETS or to a carbon pricing system fully linked with the EU ETS, the mechanism does not apply.

Liable Party

Subject to EU CBAM obligations are authorised CBAM declarants, who will be the only ones entitled to import Annex I goods into the customs territory of the Union. To receive the status of authorised CBAM declarant, an application for an authorisation will have to be submitted via a CBAM registry. According to Article 36.2 (a) of the CBAM regulation, the obligation to apply for a CBAM authorization will not come into effect until December 31, 2024.

Who will be able to act as an authorised CBAM declarant and hence be subject to CBAM obligations?

• The importer of the goods, acting in its own name and on its own behalf, or acting through a direct customs representative. In either case, the importer would remain liable, as the direct customs representative must act in the name and on the behalf of the importer, as stipulated in Article 18.1 of the Union Customs Code.

• An indirect customs representative appointed by the importer. In this case, the indirect customs representative would be subject to the CBAM obligations and hence liable in case of non-compliance, as he/she must act in his or her own name but on behalf of the importer. However, this only applies if the indirect customs representative agrees to assume the role of authorized CBAM declarant.

Carbon Accounting

The EU CBAM has its own set of rules for measuring embedded emissions. The regulation specifically covers three greenhouse gases (GHGs): carbon dioxide (CO2), nitrous oxide (N2O), and perfluorocarbons (PFCs). Different GHGs are covered for different goods, as outlined in Annex I.

The obligation to measure only Scope 1 (direct) or both Scope 1 and 2 (indirect) emissions also depends on the type of goods, with goods listed in Annex II only subject to Scope 1 calculations. Furthermore, the CBAM introduces specific criteria for determining when to use “default” or “actual” values in calculating embedded emissions. Actual emissions are based on primary data from the installation in the third country producing the goods, and have to be calculated in accordance with the methods set out in Annex IV of the CBAM regulation.

The CBAM regulation also differentiates between “simple” and “complex” goods, requiring the use of different formulas to calculate the actual embedded emissions for each category. Simple goods are defined as those produced using input materials and fuels with zero embedded emissions.

Complex goods are those with upstream emissions. From a product GHG inventory perspective, this means that the carbon footprint of these goods is not solely determined by the emissions produced during their direct manufacturing process. To fully understand the carbon footprint of complex goods, one needs to consider the entire supply chain, from raw material extraction to the finished product.

Carbon Price

Article 2 (29) of the CBAM regulation defines ‘carbon price’ as “the monetary amount paid in a third country, under a carbon emissions reduction scheme, in the form of a tax, levy or fee or in the form of emission allowances under a greenhouse gas emissions trading system”.

There are several references to the concept of ‘carbon price’ throughout the regulation, with Article 9 specifically dedicated to carbon prices paid in third countries. In the EU CBAM context, ‘carbon price’ refers to explicit forms of carbon pricing like Emissions Trading Systems (ETSs) and carbon taxes. In addition, point 12 of Article 2 of the CBAM regulation leaves the door open for the Union to “conclude agreements with third countries or territories with a view to taking into account carbon pricing mechanisms in such countries or territories”.

Any rebates, such as the one contemplated in the South African carbon tax legislation, or other forms of compensation like allowances allocated for free, also need to be taken into account when making the necessary adjustment to calculate CBAM liability.

Transitional Period

The EU CBAM has a transitional period that will start October 1, 2023 and will end December 31, 2025. During the transitional period, the mechanism will apply without financial adjustment, but importers will be subject to certain reporting obligations.

Specifically, they will have to issue a quarterly CBAM report containing information on:

• the total quantity of each type of goods specified for each installation producing the goods in the country of origin;

• the actual total embedded emissions calculated in accordance with the method set out in Annex IV;

• the total indirect embedded emissions;

• the carbon price due in a country of origin for the embedded emissions in the imported goods, taking into account any rebate or other form of compensation available.

The first CBAM report is due at the end of January 2024. Failure to comply with the reporting obligations might result in penalties.

Reducing CBAM liability

Although during the transitional period no CBAM certificates will have to be purchased or surrendered, importers will have two main forms of reducing their CBAM liability in the future.

On the one hand, through the purchase of goods with less embedded emissions. On the other hand, by deducting the carbon price that has been effectively paid in the country of origin, which means that in the absence of one, no amount will be deducted.

Even though the monitoring of actual emissions will take place outside the EU, the responsibility and costs of providing the information regarding this monitoring lies with the EU importers.

Preparing ahead of the implementation period can provide businesses with an opportunity to reduce the administrative and compliance costs associated with CBAM. This can also help them make any appropriate adjustments to their procurement and supply chain strategies.