Introduction 

How the CBAM Tax was Supposed to work… 

Initially, the general belief was that CBAM taxes would phase in gradually over a 9-year period, starting with the tax accounting for just 2.5% of total imported emissions in 2026 and incrementally increasing to 100% by 2034. Importers were not overly concerned, as the CBAM was expected to be: 

• Based on pre-established CBAM factors: A fixed and predictable percentage of the imported embedded emissions was to be taxed from 2026 onwards. 
• Gradually increasing: Despite some minor variations, its growth rate was generally steady, averaging 11% annually. 
• Applied equally: The same CBAM factors were to be applied uniformly across all types of manufacturers and products (CN codes), regardless of their emission intensity. 

Following this reasoning the financial cost would have been relatively low in the first few years. An estimated cost parity between carbon intensive products and their green alternatives was supposed to be reached around 2029 and 2030.

How the CBAM Tax is Actually going to work…

To better understand how the system will actually work, let’s break it down with a specific example. The emissions subject to CBAM will be calculated as follows:

Emissions subject to CBAM Tax = embedded emissions – [CBAM benchmark × (1 – CBAM factor)]

Suppose you are importing a product into the EU in 2026, and that product has embedded emissions of 2.5 tons of CO2 (tCO2e). The CBAM benchmark for this product might be set at 1 tCO2e, in this system, you won’t be taxed on the entire 2.5 tons in 2026, but on a bit more than the difference between them.

Using the reversed CBAM factor for 2026, which is 97.5% (equal to 100% – 2,5%), the emissions subject to the CBAM tax would be 2.7 – 1 x 0.975 = 1,525 tCO2e/t. This means that 64% (1,725 / 2,5), and not 2.5%, of the total embedded emissions for that CN code would be taxed in 2026.

The same example in 2030, with a reversed CBAM factor of 51.5%, would result in 2,185 tCO2e being taxed: around 81%. This figure would then gradually rise to 100% in 2034, after which no benchmark adjustment will be foreseen, as CBAM would simply apply to the entire carbon footprint.

If you believe that buying products with embedded emissions lower than the benchmark value would allow you zero CBAM tax expenditures, you’re wrong. Below an example of how the situation would look like with embedded emissions = 0.5 and the benchmark = 1. Initially the tax would be zero but starting from 2031 onwards the tax would kick in anyway. No subsidy in the initial years is currently planned.

How much is it going to cost?

CBAM Cost = (Emissions subject to CBAM Tax) * (Average weekly EU ETS price)

Case Study: Impact of CBAM on Iron Tubes and Aluminium Wires

In this case study, we explore the potential impact of the Carbon Border Adjustment Mechanism (CBAM) on two specific products: iron tubes and aluminium wires. These products are crucial in various industries, and understanding the cost implications of CBAM is vital for manufacturers and importers alike.

Products and Benchmarks

1. Iron Tubes (CN Code 730300)
   • Estimated Benchmark: 1 tCO2e
   • Current Price: €1,200 per ton

1. Aluminium Wire (CN Code 760500)
   • Estimated Benchmark: 5 tCO2e
   • Current Price: €975 per ton

These benchmarks are based on educated estimates and may change once the official values are released by the European Commission. For each product, we analysed the projected cost increases from 2026 to 2034 under three different scenarios based on their embedded emissions.

Results

The CBAM tax will lead to substantial cost increases for both iron tubes and aluminium wires, particularly for products with higher carbon emissions. The analysis reveals some crucial points:

• Progressive Cost Increase: Both products show significant cost hikes over time, with the most considerable increases seen in the high carbon scenarios.
• Emissions-Based Impact: Products with higher embedded emissions will face steeper cost increases, creating a strong incentive for manufacturers to reduce their carbon footprints. The closer a product’s emissions are to the benchmark, the lower the cost increase.
• Market Competitiveness: Lower-carbon intensive products will gain a price advantage, highlighting the need for early emissions reduction to stay competitive under CBAM.

Why this Benchmark all of a sudden?

CBAM is designed to mirror the EU Emission Trading System (ETS) as its objective is to level the playing field for local EU production and imports. Therefore, CBAM not only covers the same goods and types of greenhouse gas emissions as the EU ETS, but it also mimics its current pricing system: the free allowance attribution, which is based on sectoral and performance-based benchmarks.

As for now, under the EU ETS, free allowances are distributed to local EU factories to prevent that cheaper and more carbon-intensive imports from outside the EU would substitute them. Only if companies would surpass their annual allowance cap, they’d have to purchase some more in ETS auctions. This means the local EU “carbon tax” is applied only on marginal emissions and the incentive to decarbonise is little to non-existent.

Therefore, a benchmarking system was necessary, which provided:

• Fewer free allowances to sectors that were easier to decarbonize, or else, sectors where the green alternative technology was already cost competitive with the traditional one, such as in the electricity generation sector (fossil fuel vs. renewables). In fact, utilities currently trade most EU ETS allowances (or EUAs).
• Fewer free allowances to factories with higher emission intensity compared to their peers of the same sector. Green leaders would be incentivised for their behaviour while laggards would pay for an increased amount of EUAs.

In the EU ETS, benchmarks are set for the “ideal” carbon emissions of production processes and goods. If a producer’s emission intensity exceed these benchmarks, they receive less free allowances. EU ETS benchmarks reflect the average emissions of the top 10% least carbon-intensive producers.

Similarly, benchmarks will be introduced into the CBAM tax framework too. The greater the difference between imported embedded emissions and the CBAM emissions benchmark, the higher the financial burden. The CBAM obligation for importers will be the same as for EU factories producing the same goods. Free allowances will be phased out with the same speed as the CBAM factor will increase, while the CBAM emission benchmarks at CN code level will serve the same role as the free allowances in the EU ETS. This mechanism ensures equal treatment for goods produced in the EU and third countries, while setting the base the world’s first and economically fair carbon price.

2026 is Tomorrow

Bottom line, 2026 CBAM taxation won’t be on 2.5% of imported embedded emissions but might be as high as 60% or more. Products like iron tubes and aluminium will see steep price increases depending on the level of their embedded emissions and the CBAM benchmark they will be compared to.

While many decision makers might be tempted to think that this carbon tax is simply inflationary and “applies to everybody anyway”, it actually marks the beginning of a decarbonization race within the industrial sector. This tax, combined with already tight margins, could significantly alter the competitive dynamics of the industry, in which first movers will see returns for their proactive green measures already tomorrow.