Provisional agreement reached on the European Union’s Carbon Border Adjustment Mechanism

The Council of the European Union issued a press release on Tuesday, stating that negotiators representing the European Parliament and Council had agreed terms on which to implement a Carbon Border Adjustment Mechanism (“CBAM”). This agreement concludes 18 months of internal European Union (“EU”) negotiations on the CBAM proposal.

The aim of the CBAM is to address the risk of carbon leakage, by avoiding the emissions reduction efforts of the EU being offset by production of emissions-intensive products being moved to countries with less stringent regulatory requirements.

Background

The European Commission first announced its desire to implement a CBAM in December 2019 as part of the European Green Deal, stating that “[s]hould differences in levels of ambition worldwide persist, as the EU increases its climate ambition, the Commission will propose a carbon border adjustment mechanism.”[1]  

Carbon leakage is defined by the European Commission as “the situation that may occur if, for reasons of costs related to climate policies, businesses were to transfer production to other countries with laxer emission constraints. This could lead to an increase in their total emissions.”[2] Carbon leakage can also take the form of businesses increasing imports of emissions-intensive products from non-EU countries. Crucially, some sectors are considered to be more at risk of carbon leakage than others, and the CBAM proposal aims to target these sectors. 

Key features of the CBAM proposal 

The CBAM works to ensure that the carbon price of imports is equivalent to the carbon price of production in the EU, by requiring that a price be paid for the embedded emissions generated in the production of certain goods imported into the EU.

The EU intends that the CBAM will function in parallel with the EU Emissions Trading Scheme (“EU ETS”), acting as an alternative to the EU ETS measures that address the risk of carbon leakage, and to reinforce the EU ETS. The CBAM would gradually replace these measures.

The CBAM will cover imports of specific emissions-intensive products that are at risk of carbon leakage, including iron and steel, cement, fertilisers, aluminium, electricity and hydrogen, into the EU customs territory.[3] The mechanism will also cover some downstream products and indirect emissions, subject to further review and refinement of the applicable methodology. The intention is that the CBAM will cover more than 50% of the emissions of the EU ETS covered sectors once fully phased in.[4] 

The CBAM will be phased in gradually, to allow businesses to adequately prepare for its implementation. Under the current agreement, the CBAM will apply in a simplified manner from October 2023 onwards. Importers of in-scope goods will be subject to reporting obligations, to enable the collection of data, but will not have to make financial payments or adjustments. Following this, the EU will phase in full obligations, in parallel to phasing out free EU allowances under the EU ETS. Importers will need to make an annual declaration of the quantity of in-scope goods imported, and their associated greenhouse gas emissions. They will then be required to surrender the corresponding amount of CBAM certificates (with the price of such certificates being calculated by reference to the weekly average auction price of EU ETS allowances). However, it is worth noting that the phase-out rate of free allowances under the EU ETS remains under discussion. The EU plans to resolve this issue as part of broader EU ETS negotiations.

Next steps 

The CBAM must be adopted by the European Parliament and Council before it can enter into force. Certain technical details still require clarifying in order to finalise the proposal, which will be informed by negotiations taking place regarding the EU ETS. As noted above, the EU intends for application of the CBAM to commence in October 2023, albeit on a simplified basis.

The EU considers that the CBAM remains compatible with the EU’s international trade law obligations, including World Trade Organization rules. However, some have labelled the proposals as protectionist and damaging to the economies of non-EU developing countries. In 2021, Brazil, South Africa, India and China produced a joint statement expressing their “grave concern” regarding the CBAM.[5] The CBAM could be challenged under World Trade Organization law, a move which would likely take years to play out. 

We understand that the UK government is closely monitoring developments in this space, with a view to potentially implementing its own CBAM. Decisions around the design of any such measure may have an effect on UK-EU ETS linking discussions.
  

[1] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52019DC0640

[2] https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets/free-allocation/carbon-leakage_en

[3] Annex I of the proposal lists the products to which the CBAM applies.

[4] https://ec.europa.eu/commission/presscorner/detail/en/ip_22_7719

[5] https://www.gov.za/nr/speeches/joint-statement-issued-conclusion-30th-basic-ministerial-meeting-climate-change-hosted