EU Carbon Border Adjustment Mechanism (CBAM) overview
Date of publication: July 6th, 2023
The introduction of the Carbon Border Adjustment Mechanism (CBAM) in the European Union (EU) will have a significant impact on businesses importing goods into the EU, as well as their suppliers exporting to the EU.
The regulation on the CBAM officially entered into force on May 17, 2023, and the transitional period will begin October 1, 2023. A link to the regulation can be found at the EU Official Journal.
What is CBAM?
CBAM is one of numerous regulatory initiatives in the Environmental, social, and governance (ESG) arena that is drawing a lot of attention from global traders. CBAM is a component of the larger EU “Green Deal” which has a goal reducing carbon emissions by 40% by 2030 and making the EU the first continent to go carbon neutral by 2050.
Within the Green Deal is the “Fit for 55” package which includes multiple proposals to accomplish this goal, including CBAM, as well as the EU Emissions Trading Scheme (ETS).
While both of these regulations are designed to address carbon emissions and carbon leakage generated by specific industries, they focus on different areas:
- ETS is focused on goods produced within the EU and will apply a market-based price to carbon emissions that are generated by certain industries. The ETS initially launched in 2005 and entered into force in 2020.
- CBAM is focused on goods imported into the EU. It will apply a price to carbon emissions embedded into certain goods, which are then imported into the EU. This cost is linked to the carbon price payable under ETS when the same goods are produced within the EU. It is designed to reduce ”carbon leakage”, which is the risk of companies relocating outside of the EU due to disparity in carbon pricing.
What products/industries are impacted?
Currently, there is a specific list of goods that are subject to the requirements of CBAM.
Product categories included in the CBAM regulation are shown below and a complete list, including corresponding HS numbers can be found in Annex I and II (page 92 and 96) of the regulation itself. Indirect emissions under certain conditions, certain precursors as well as some downstream products (e.g., screws and bolts) are also included.
Aluminum | Iron and Steel | Cement (Mineral Products) |
Electricity | Hydrogen | Fertilizers |
Due to the nature of the regulation, and the commodities involved, it is expected that this regulation could impact a wide range of industries including automotive, aerospace & defense, consumer products, retail, and manufacturing to name a few.
The scope of the regulation is expected to expand so it will be important to monitor for if/when your goods may become subject to CBAM.
Additionally, there are some origin countries/regions (Annex III - page 99) that are excluded from the requirements due to existing regulations that could result in double taxation.
Excluded Countries | Other Minor Territories Excluded |
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How will it work?
Authorized CBAM Declarants will need to submit quarterly reports (the first report due on January 31, 2024) on their embedded emissions on subject goods imported. Importers that are required to surrender CBAM certificates will need to apply to become an “authorized CBAM declarant”, and set up at CBAM account with the EU Member State. The declarant could be an importer or an indirect customs representative.
note
What is meant by “embedded emissions?” This means “direct emissions released during the production of goods and indirect emissions from the production of electricity, that is consumed during the production process”. The methods to calculate these values are set out in Annex IV (page 100) of the regulation.
In the case of CBAM, as it applies to imported goods, EU companies will be relying on their suppliers outside the EU to provide this data. Therefore, impact of this regulation does not just fall on EU importers. Companies exporting to the EU will need to be prepared to provide this information to their EU customers.
In the case that a company is not able to calculate and verify their embedded emissions using the methods spelled out in Annex IV, the Declarant will be forced to use “default values”. These default values are based on the average emissions of the lowest performing EU ETS installations and are likely to be less favorable.
The EU limits the amount of carbon emissions regulated companies can produce in the Union through a system of emissions allowances. If companies want to emit more than their allowances dictate, they must purchase additional allowances (CBAM certificates). This increases cost and could make a product less competitive in the market.
During the transitional phase, starting October 1, 2023, the Declarant will need to prepare and file the quarterly reports, including goods imported, direct emissions, indirect emissions and any carbon price paid abroad. Starting January 1, 2026 (first report due May 31, 2027), the Declarant must prepare and file the report, as well as purchase/surrender any CBAM certificates equivalent to the embedded emissions noted in the report (less any carbon taxes paid in the country of origin).
What are the penalties for non-compliance?
Penalties for non-compliance with reporting obligations during the transitional period range from €10 to €50 per tonne of unreported embedded emissions. This range will increase with inflation through the European index of consumer prices.
Competent authorities will determine the precise penalty amount, considering seven factors, which include the amount of unreported information, unreported quantities of goods and emissions, intentional or negligent behavior, level of cooperation, and duration of the failure to report. The penalty may increase if the duration of the failure to report exceeds six months.
In addition to the fine, Member States may apply administrative or criminal sanctions for failure to comply with the CBAM legislation in accordance with their own national rules.
Of course, it should also be noted that being on the wrong side of efforts to address climate change / carbon emissions risk is not necessarily good for brand reputation.
What should companies do to prepare?
In preparing for CBAM, companies should be conducting an assessment of their regulatory carbon pricing risk and seeking feedback from their suppliers regarding their emissions related polices. Starting this process early is key to having a robust strategy to minimize risk exposure.
For EU Importers:
- Identify which of your products will be covered by the CBAM. Check your product records / HS Numbers against the regulation Annex I and II (page 92 and 96).
- Review your supply chain to identify where you source them from (i.e., country of origin). Are any subject to possible exclusion based on origin country?
- What is the volume of your imports of these products?
- Understand what the default values are for your products. This will be important to know when reviewing potential cost impact should you need to use them because actuals are not known.
- Set up the process to collect and store data on the embedded emissions: who in the supply chain holds this information? Who will reach out to the suppliers? If suppliers are not tracking emissions currently, encourage them to start now.
- Set up the reporting process in the EU: determine the business function within your organization responsible for the compliance requirements of the CBAM.
- Verify under whose name the goods are imported into the EU. Will you be the declarant, or will that be your indirect customs representative?
- Consider use of tools like the ONESOURCE Global Trade Supply Chain Compliance solution to assist in outreach to provide insight into climate-related policies and actions of your suppliers.
- If necessary, evaluate and analyze your supply chain to find additional sourcing options for products with lower embedded carbon emissions. ONESOURCE Global Trade solutions like Trade Lane Analyzer can assist in analyzing sourcing options. For Exporters to the EU:
- Identify which of your products will be covered by the CBAM. Check your product records / HS Numbers against the regulation Annex I and II (page 92 and 96).
- Review the required methodology for calculation emissions in Annex IV (page 100). Do you have a method to collect the necessary data to supply to your EU customer?
- Review the default values for your impacted product(s) to understand the possible cost impact to your EU client if you are unable to provide actual emissions data for reporting purposes.
- Set up the process to collect, store and share data on the embedded emissions. The timeline for the regulation provides for a transition period and companies would be wise to start the process for complying now as the focus on carbon emissions and leakage is expected to grow in the coming years. Other countries – including the US – have introduced legislation that is similar in nature, so monitoring the legislative arena on this topic will be important to ensure that practices implementing remain compliant.
Timeline
Date | Event |
|---|---|
December 22, 2022 | EU Commission and EU Parliament reach agreement on CBAM. |
May 17, 2023 | CBAM regulation entered into force. |
October 1, 2023 | Transitional phase begins, companies must report emissions quarterly, but will not make payments of CBAM certificates yet. |
January 1, 2026 | Permanent phase begins, companies must report and pay using CBAM certificates. |
2034 | First year in which importers will be responsible for paying for 100% of the carbon embedded in imported products (vs. allowances). |