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Understanding EU Carbon Border Adjustment Mechanism (CBAM)

On October 1, 2023, the first phase of the entry into force of the Carbon Border Adjustment Mechanism (CBAM), or carbon border tax, began. The first years of implementation of the mechanism are first intended to assess imports of polluting materials, to determine a viable taxation methodology, and to set prices based on products and countries of import. However, they will also lead to a profound revision of the European carbon market, driven by an objective: to achieve climate neutrality by 2050.



What is the Carbon Border Adjustment Mechanism (CBAM)?


After several years of work, at the very end of 2022, MEPs and EU member states agreed on three pillars of the Green Deal, or European Green Deal:

  • The Social Climate Fund

  • The reform of the carbon market

  • The Carbon Border Adjustment Mechanism

Across the entire EU territory, actions are being taken to reduce greenhouse gas emissions to the point where they are low enough for their absorption by artificial or natural carbon sinks to be possible. But in the context of globalization and free trade, it is essential to also take into account the carbon emissions associated with imports. In 2021, a report by the Environment Commission conducted as part of the preparatory work on the CBAM estimated that 20% of GHG emissions from imported products account for total European emissions.


The idea of ​​introducing a carbon border tax has come a long way in Europe: proposed for the first time in 1991, it was then rejected by several member states. It will take until 2019 for the idea to return to the agenda of the European Commission. In the meantime, the context has evolved even further and ambitious environmental objectives have been born from the various global climate summits.


In 2021, the year the European Green Deal was launched, the package of 12 Fit for 55 proposals was presented, which includes concrete actions to achieve an intermediate target of reducing greenhouse gas emissions by 55% by 2030. The CBAM is part of these measures.


The CBAM works through a carbon tax applied to products imported into the European Union. This tax is calculated based on the greenhouse gas emissions generated by the production of the imported product.



What is the goal of the CBAM?


The introduction of a carbon border tax at the EU's borders aims to extend European environmental standards to imported products. The CBAM is a key instrument of the European Green Deal, which must allow the EU to achieve its goal of carbon neutrality by 2050. It must also address the competitive difficulties faced by European companies against non-EU actors who are not subject to the same environmental requirements. One of the goals is also to prevent carbon leakage, that is to say, to prevent European multinationals from relocating their activities to escape the ambitious constraints of the EU in the fight against climate change. In the context of a globalized economy, the system must help the European Union to decarbonize its industry, while protecting its industries.



What products are included in CBAM list?


In the first phase, the CBAM does not apply to all imported goods, but to specific sectors that weigh heavily in global greenhouse gas emissions and that are essential levers for achieving carbon neutrality. The European carbon tax thus concerns the most polluting materials, namely iron and steel, cement, fertilisers, aluminium, electricity, and hydrogen. These sectors represent a major part of industrial emissions in Europe. It is already planned to consider expanding this list of products a few years after the entry into force of the mechanism.



What is the timeline of the Carbon Border Adjustment Mechanism?


The implementation of the Carbon Border Adjustment Mechanism (CBAM) must be done very gradually, from its entry into force on October 1, 2023, until its full implementation in 2034.


A first transition period is planned until 2026, during which importing companies will only have to declare the carbon emissions of their products. The tax will be implemented from 2026 onwards, gradually, during a second period of 9 years.


Until 2034, the amount of the tax will increase in stages, at the same time as the free quotas of the Emissions Trading System (ETS) will decrease. This EU Emissions Trading System, established in 2005, commonly known as the carbon market, aims to reduce greenhouse gas emissions responsible for climate change through a system of capping that can force companies to buy additional quotas.


To achieve the EU's climate neutrality objectives, a major reform of the ETS is therefore accompanying the implementation of the CBAM.



How does the Carbon Border Adjustment Mechanism work?


The Carbon Border Adjustment Mechanism (CBAM) works based on the emissions trading system, as the additional costs that will be applied to imported products will be indexed to the current CO2 price on the European carbon market.


In practice, companies that import into the European Union will have to acquire CBAM certificates, the price of which will compensate for the difference between the price of carbon quotas in the EU ETS and the price of carbon in the production country. This will ensure that European and imported products are subject to the same carbon price for every tonne of greenhouse gases emitted.


In the first phase, the transition phase will initially consist of strict reporting: importers of products covered by the CBAM will be subject to an obligation to declare the actual emissions of their products. When this is not possible, they will have to use an equivalence based on a value system based on the product/country of origin pair. The declarations will be subject to verification by experts approved by the European Union and the Member States.


In a second phase, importers will have to buy and return the certificates that correspond to the emissions of their products, at the price in force on the European carbon market. The free quotas granted to European companies will gradually disappear.



Conclusion


The Carbon Border Adjustment Mechanism (CBAM) addresses two major challenges in the fight against climate change. On the one hand, it is part of a necessarily global vision of climate action: the EU's ambitions are to reduce greenhouse gas emissions, not to relocate them. On the other hand, it is part of a requirement for fair competition: the price of carbon should be the same regardless of the continent of production, and European companies should not be penalized by the responsible environmental standards put in place within the EU.

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