In the face of climate change, governments are designing urgent and decisive policy tools to mitigate the impacts of greenhouse gas emissions. While ambitious environmental policies have been deployed in some countries, the challenge of achieving a balance between climate action and promoting international trade arises. A prime example is the EU Carbon Border Adjustment Mechanism, a transformative and first-of-its-kind carbon pricing proposal designed to address this complex interplay.
EU Carbon Border Adjustment Mechanism: Background and Purpose
The CBAM is part of both the European Green Deal (EGD) and the Fit for 55 package. The former is a comprehensive strategy introduced by the European Commission in December 2019. Its primary objective is to make the European Union’s (EU) economy sustainable and achieve climate neutrality by 2050. The EGD encompasses several policies and measures to address climate change, protect the environment, and promote circular economy principles. The latter is a set of legislations introduced by the European Commission in July 2021. It is a central piece of the EU’s efforts to reduce net GHG emissions by at least 55% by 2030, as compared to 1990 levels. While the European Green Deal sets the long-term vision and policy framework, the Fit for 55 package provides specific proposals to ensure that the EU’s climate goals translate into concrete actions across various sectors, and the EU Carbon Border Adjustment Mechanism (CBAM) is a crucial part of it.
The CBAM officially entered into force last May after its publication in the Official Journal of the European Union, and its application will begin this October under a three-year transition phase, during which there will only be reporting obligations where EU importers of carbon-intensive goods must submit quarterly reports on their emissions to the European Commission. In 2026, after the transition period expires, tariffs will slowly be phased-in and will be fully applicable in 2034. The carbon border tax will initially apply to cement, iron, steel, aluminium, fertilisers, electricity, and hydrogen; however, it is expected that the CBAM will expand its scope to all products covered by the EU Emissions Trading System (EU ETS).
The CBAM’s purpose is to accelerate the decarbonisation of European industries while preventing carbon leakage, which occurs when businesses shift their production to countries with weaker climate regulations to avoid higher carbon costs. This way, European governments will ensure that the competitiveness of local producers is not undermined by the region’s stricter climate policies and that there are no carbon-cost incentives for companies to move out of the EU.
How Will the CBAM Work?
Step 1: Carbon content assessment
In simple terms, the CBAM will levy a tax – reflecting the domestic carbon price – on specific imported products based on the amount of carbon emissions associated with their production. The process begins with calculating the embedded carbon content of the imported goods by determining the GHG emitted during their manufacturing.
Step 2: Carbon price establishment
After determining the carbon content of the covered goods, a carbon price will be assigned to their emissions. Such price will be based on the domestic carbon price of the importing country or region and is meant to represent the cost that local producers would pay for emitting the same amount of carbon in their production processes.
Step 3: Emission of CBAM certificates
To demonstrate compliance, importers must purchase certificates equivalent to the carbon content of their imports. These certificates serve as proof that the carbon emissions associated with the imported goods have been accounted for and offset at the carbon price determined by the importing country or region. Customs authorities will verify the accuracy of emissions reporting and certificate issuance.
Step 4: Border adjustment
Upon arrival, the carbon price of the imported goods is verified, and the appropriate carbon border tax is levied based on the emissions certificates surrendered by the importer.
While the implementation details of CBAM may vary slightly depending on the country and jurisdiction, the overall potential impacts on the environment and global trade are subject to debate.
Here are some key points to consider.
CBAM’s Expected Impact on the Environment
The CBAM will become a central mechanism to achieve carbon neutrality and reduce emissions
Currently, imported goods represent almost 20% of the EU’s GHG footprint, and the emissions embedded in imports have grown in recent years. A recent study found that the direct emissions caused by CBAM goods imported into the EU stand at 83 metric tons (Mt) of CO2, and encompassing all industries considered by the EU ETS would increase the coverage of the CBAM to 179 Mt CO2. The most ambitious and comprehensive CBAM that would address all imports to the EU and all indirect emissions would cover approximately 1,558 Mt of CO2.
The CBAM will encourage global climate action
The CBAM will require countries that want to engage commercially with the EU to implement stronger climate policies to avoid the carbon costs associated with their exports. This could lead to increased adoption of cleaner technologies and practices worldwide. It could also influence the entire supply chain of CBAM products. Exporting countries may encourage their suppliers and manufacturers to adopt more sustainable practices and reduce emissions throughout the production process to remain competitive in the EU market.
The CBAM will raise money to combat climate change on other fronts
Estimates by S&P Global show that the CBAM will generate $80B per year by 2040. The revenues generated from the carbon border tax can be used for various purposes, such as supporting domestic businesses to decarbonise their operations, funding other solutions for climate mitigation and adaptation, or providing financial assistance to developing countries to address their environmental challenges.
CBAM’s Expected Impact on Global Trade
The CBAM could lead to trade tensions and disputes between countries
The CBAM is a first-of-its-kind tool because it is the first to extend carbon pricing to imports; however, some are looking at it cautiously, including the United States, whose government has taken a different approach. Rather than taxing carbon like the EU, Americans are subsidising decarbonisation through tax credits to support the development of green technologies under its Inflation Reduction Act.
When questioned about the CBAM, US Special Presidential Envoy for Climate John Kerry said: “It’s premature to be discussing whether or not you ought to unilaterally go off and do a CBAM… Right now, we’re pursuing multilateral efforts. We’re trying to bring people together. We don’t want to do something that pushes people away.” He also argued that it should be considered a “last resort” if all other solutions for global decarbonisation fail.
The CBAM could cause trade distortions
If countries perceive the CBAM as a protectionist measure or an unfair trade practice, they may retaliate by imposing their own tariffs or trade barriers on goods from the EU. This situation could escalate into a trade dispute and create trade distortions between nations. One of the most impacted countries by the CBAM would be India, which already announced its intentions of filing a complaint to the World Trade Organisation (WTO) and imposing its own tariffs after its trade minister, Piyush Goyal, called the CBAM “a discriminatory measure.”
The CBAM could have an uneven impact on countries
An analysis by the UN Conference on Trade and Development (UNCTAD) found that the CBAM could increase the gap between developing and developed regions in the international trade arena. It estimates that “the simple average reduction in exports by developing countries across the targeted carbon-intensive sectors is between 1.4 and 2.4 percent… however, developed countries do not suffer export declines.”
Such a reduction would represent a collective loss of US$5.9 billion in revenue for developing nations. There is also a risk that developing countries are left out because implementing the CBAM requires complex monitoring, reporting, and verification mechanisms to accurately assess the carbon footprint of exported goods. This could increase the administrative burden on their businesses and customs authorities, leading to higher compliance costs.
The EU Carbon Border Adjustment Mechanism represents a pivotal step towards aligning international trade with ambitious climate goals. By imposing a carbon-related cost on certain imported goods, the CBAM aims to address carbon leakage, promote global climate action, and protect the competitiveness of domestic industries. Its potential implications are multifaceted, ranging from encouraging emission reductions in exporting countries to fostering cleaner production practices along the global supply chain.
While CBAM holds promise in elevating climate leadership, its successful implementation will hinge on careful design, international cooperation, adherence to the principles of fairness and effectiveness, and how well it aligns with global climate goals. Striking the right balance between climate objectives and trade considerations will be essential to avoid potential trade distortions, ensure a just transition to a low-carbon economy, and determine the overall impact of the CBAM on all fronts.
Featured image: Marcin Jozwiak/Unsplash
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