Carbon Border Adjustment Mechanism

The Carbon Border Adjustment Mechanism (CBAM) is a carbon tariff on carbon intensive products, such as steel, cement and some electricity, imported to the European Union. Legislated as part of the European Green Deal, it takes effect in 2026, with reporting starting in 2023. CBAM was passed by the European Parliament with 450 votes for, 115 against, and 55 abstentions and the Council of the EU with 24 countries in favour. It entered into force on 17 May 2023.

A similar UK CBAM will be implemented by 2027.

Contents
The price of CBAM certificates is linked to the price of EU allowances under the European Union Emissions Trading System introduced in 2005. The CBAM is designed to stem carbon leakage to countries without a carbon price, and will also permit the EU to stop giving free allowances to some carbon-intensive sectors within its borders. All this should hasten decarbonization.

After the political (provisional) agreement between the Council and the European Parliament was reached in December 2022, the CBAM entered into force on October 1, 2023 and is passing through several phases:

From October 2023 to the end of 2025 transitional phase: importers of products in six carbon intensive sectors highly exposed to international trade, namely aluminium, cement, electricity, fertilisers, hydrogen and iron and steel will need to report their emissions. During the transitional phase, the regulators will be checking if other products can be added to the list like for example some downstream products.

From the beginning of 2026 importers of products included in these 6 sectors will begin to pay a border carbon tax for their products based on the price of allowances in the European Union Emissions Trading System.

By 2030 all sectors covered by the European Union Emissions Trading System will be covered by CBAM.

By 2034 free allowances in the relevant sectors in the European Union will be phased out as the fully implemented CBAM prevents the possibility of no level playing field for European companies in comparison to importers.

To address the 'lose-lose' scenario of carbon leakage, characterised by a general loss of competitiveness of EU industries with no gain from the perspective of climate protection, the CBAM will require importers of the targeted goods to purchase a sufficient amount of ‘CBAM certificates’ to cover the emissions embedded in their products. Since the main purpose of the CBAM is to avoid carbon leakage, the mechanism tries to subject covered imports to the same carbon price imposed on internal producers under the EU ETS. In other words, the EU is trying to make importers bear an equivalent burden, for what concerns regulatory costs, to the costs of European producers.

Under article 6, importers must make a "CBAM declaration" with the quantity of goods, embedded emissions, and certificates for payment of the carbon import tax.

Annex I sets out the goods that attract the import tax, including cement, electricity, fertilisers (such as nitric acid, ammonia, potassium), iron and steel (including tanks, drums, containers), and aluminium.

Annex II specifies that the CBAM does not apply to the four non-EU member states that are included in the European Economic Area, namely Iceland, Liechtenstein, Norway and Switzerland.

Annex III sets out the methods for calculating embedded greenhouse gas emissions.

Exporters will be required to report their emissions and purchase CBAM certificates, which will increase their costs and reduce their profitability.

Debate
The implementation of the CBAM by the EU is a major step towards addressing the issue of carbon leakage and ensuring a level playing field for European businesses worldwide against cheaper goods from economies outside the EU lacking carbon taxation. The import partners most affected will be Russia, China, Turkey, Ukraine, the Balkans, as well as Mozambique, Zimbabwe, and Cameroon. This mechanism allows the EU to unilaterally impose a levy on imports from countries that do not meet the environmental standards set by the EU.

Compliance and monitoring
However, enforcing the CBAM requires a robust compliance framework that would ensure transparency, accuracy, and effectiveness. Firstly, the EU should establish clear and objective environmental standards that businesses must meet to avoid tariffs. These standards should be based on internationally recognized methodologies and benchmarks. Moreover, they should be regularly reviewed and updated to reflect the latest scientific and technological advances in the field of climate change mitigation. By setting clear and objective standards, the EU can ensure that businesses clearly understand what they need to do to comply with the CBAM.

Secondly, the EU should require businesses to submit detailed data on their carbon emissions and energy consumption. This data should be verified by an independent third party to ensure its accuracy and reliability. Businesses that fail to provide accurate data should be subject to penalties and fines. The EU should also establish a reporting framework that would enable businesses to report their carbon emissions and energy consumption in a standardized and consistent manner. This framework should be compatible with existing international reporting standards.

Thirdly, the EU should establish a robust verification and enforcement mechanism to ensure compliance with the CBAM. This mechanism should include regular audits of businesses' emission data, as well as on-site inspections of their production facilities. Non-compliant businesses should be subject to sanctions, such as fines, product seizures, or the exclusion from the EU market. Additionally, the EU should establish a complaint mechanism that would allow stakeholders, such as NGOs or competitors, to raise concerns about non-compliance with the CBAM.

WTO compatibility and non-discrimination
The EU should ensure that the CBAM is compatible with its international obligations under the World Trade Organization (WTO), according to two legal scholars at the University of Ottawa. This means that the mechanism should not discriminate against any particular country or violate the principles of free trade. The EU should also engage in constructive dialogue with its trading partners, including major emitters such as China and the United States, to ensure that the CBAM is consistent with global climate goals and does not create unnecessary tensions or trade disputes.

Incentivisation of carbon pricing in countries outside the EU
If countries outside the European Union have or will create their own carbon pricing policies, "they will avoid the EU’s carbon border tax and keep the revenues for their own decarbonization projects".

The carbon import fee is not yet proposed to apply to a wide range of other products or services, such as automobiles, clothing, food and animal products (including those that lead to deforestation), shipping, aviation, or the importation of gas, oil and coal.

It has been suggested that the mechanism will help reduce emissions not only by making companies reduce emissions but also by incentivising other countries (like the United States, which lacks federal carbon pricing) to create similar mechanisms. Some authors even argue that the CBAM constitutes the beginning of a climate club, as proposed by Nobel Memorial Prize winner William Nordhaus.

As of November 2023, the Indian Commerce and Industry Ministry under Piyush Goyal is considering levying its own carbon tax to keep the revenues for their own budget.

According to a report of the Asian Development Bank, the CBAM will reduce emissions only a little (which will be quickly offset by the rise in carbon intensive production), while harming import to the European Union. The report says "mechanisms to share emission reduction technology would be more effective".

Developing countries
According to one Amsterdam legal scholar, the EU should provide adequate support to the least developed countries (LDCs) to help them comply with the CBAM. This support could include technical assistance, capacity building, or financial incentives for investments in low-carbon technologies. By providing such support, the EU can ensure that businesses have the necessary resources and knowledge to transition to a low-carbon economy and avoid the risk of carbon leakage. Another author has suggested that the transition to a low-carbon economy requires technology and investment, which may require investment in countries in the Global South. Proposed solutions include technology transfer and green finance.