CBAM: Navigating the Why, When and What

Key takeaways

The European Union’s Carbon Border Adjustment Mechanism (CBAM) is a crucial component of the EU’s strategy to achieve Europe’s legally binding net zero targets, avoid carbon leakage and incentivize international decarbonization. It will primarily affect importers and manufacturers in industries such as cement, fertilizer, iron, steel, aluminum, hydrogen, and electricity production. Since its official publication on May 16, 2023, the CBAM Regulation has been supplemented with numerous new rules and additional specifications, further complicating the regulatory landscape. The specific regulation for the transitional period was released on June 13, followed by the comprehensive rules on supplier emission reporting and the overwhelming communication template

In this blog, we go beyong the CBAM-related to dos and give you a complete picture of the why, when and what of CBAM. We’ll explain what carbon leakage is, delve into the role of the WTO in this context, and explore why certain industrial goods, and not others, are chosen for emissions reporting. This comprehensive look aims to deepen your understanding of these critical aspects.

What is Carbon Leakage?

Carbon leakage was a significant issue for the European Union, where strict environmental rules and national carbon taxes prompted companies to shift their production to countries with less strict climate policies. This led to an increase in more carbon-intensive imports in the EU market, inevitably encouraging more polluting production methods elsewhere, thereby increasing total worldwide emissions.

The EU addressed this by implementing the Carbon Border Adjustment Mechanism (CBAM), which required emission reporting on imports with plans to tax them soon. This approach aimed to equalise competition between EU producers and less expensive but more carbon-intensive imports. CBAM thus marked the beginning of an indirect global carbon tax on industrial exporters selling in the EU, potentially leading to a peak in global greenhouse gas emissions.

Navigating WTO Compliance

While the EU leveled the playing field in favor of its local industrial manufacturers, not every exporting country was pleased with the EU’s decision to measure and tax their emissions too.

Aligning the CBAM with WTO rules was a complex task. The mechanism needed to avoid favouring domestic over imported goods, adhering to the WTO’s non-discrimination principle. Furthermore, CBAM had to be compatible with the WTO’s rules on subsidies and countervailing measures, which had as a consequence that only physically paid carbon taxes abroad – and not subsidies – would have been deductible from the price of CBAM certificates. Therefore, designing the CBAM required careful consideration to prevent trade disputes and to promote a sense of fairness and sustainability in international commerce, which ultimately, it managed to achieve.

Key Compliance Dates

The CBAM Regulation, which came into effect on 16 May 2023, outlines a series of important compliance dates, which should serve as signposts for businesses during the transition:

October 1, 2023 : The CBAM Regulation comes into effect, signaling the start of a transitional period that extends until December 31, 2025. During this phase, companies are only obliged to fulfil reporting duties without paying for the CBAM emission allowances.

January 31, 2024: This date is the deadline for the first CBAM Report submission, covering the last quarter of 2023. From this point, there is a gradual shift towards more precise emission measurement rules:

  • Importers can use default values until July 2024 while beginning to collaborate with suppliers.
  • For the report due in October 2024, suppliers must start disclosing initial emissions calculations, which may still utilise non-EU methods.
  • Starting in 2025, all suppliers are required to adopt the official EU method for their CBAM emission measurements.

January 1, 2026 : The end of the transition period.

May 31, 2027 : Companies must submit the first CBAM Declaration (for 2026, i.e., the preceding calendar year), which differs from the quarterly reports.

Reporting declarants

CBAM reports can be submitted by the following three entities:

  • Importer lodging a customs declaration. This pertains to the importer who files a customs declaration in their own name and interest to facilitate the clearance of commodities.
  • Importer indicating goods importation. This bracket contains importers in possession of a license to submit a customs declaration, as dictated in Article 182(1) of Regulation No 952/2013 (the Union Customs Code) and assert the importation of commodities.
  • Indirect customs representative. This applies when the importer is based outside the European Union or when the indirect customs proxy accepts the responsibility to comply with declaration stipulations. In such instances, the indirect customs proxy may file a customs declaration and undertake the corresponding obligations.

CBAM good coverage

The Carbon Border Adjustment Mechanism (CBAM) applies to sectors with a high relative contribution to global greenhouse gas (GHG) emissions. The CBAM encourages greener production methodologies of both exporters and importers by promoting the idea that the pollution cost should be part of the price of products. Let’s look at these key indutries:

  • Cement (CN codes 2507 00 80 to 2523 90 00): The cement industry contributes approximately 7% of global CO2 emissions. Europe has been at the forefront in implementing cleaner cement production techniques, reducing its carbon emissions per tone of cement by around 20% over the last decade.
  • Fertilizer (CN codes 3102, 3103): Fertilizer production contributes about 2-3% of total global GHG emissions, largely through the production of nitrogen-based fertilizers. In Europe, best practices and stringent regulations have resulted in more efficient production processes that reduce carbon emissions.
  • Iron and Steel (CN codes 7206 to 7217, 7224 to 7229): The production of iron and steel accounts for around 7-9% of total global CO2 emissions. The European steel industry is actively exploring and investing in greener steel-making technologies such as hydrogen-based steelmaking.
  • Aluminum (CN codes 7601, 7604 to 7609): Aluminum production contributes roughly 1% of global GHG emissions. Europe has been leading the transition to renewable energy sources for aluminum production, such as hydroelectricity, drastically reducing its emissions compared to global counterparts.
  • Electricity (CN code 2716 00): Electricity and heat production is the largest single source of global GHG emissions, contributing about 25%. The European Union is at the forefront of the transition to renewable energy, with 34% of its electricity generated from renewable sources in 2019, significantly reducing the carbon intensity of its power sector.
  • Hydrogen (CN code 2804 10 00): While hydrogen is a clean energy carrier, its production, particularly from fossil fuels, can be carbon intensive. Currently, its contribution to global emissions is small but could rise if production scales up without renewable energies or carbon capture technologies. The EU is leading efforts to develop ‘green hydrogen’ produced through electrolysis powered by renewable electricity.

These sectors were selected for the CBAM due to their high carbon emissions, exposure to international competition, and the potential for rapid decarbonization. This combination makes CBAM one of the most powerful and impactful green policy tools ever implemented.