The EU's ambitious and innovative Carbon Border Adjustment Mechanism ("CBAM") was finally adopted as part of a package of other "Fit for 55" climate actions on 10 May 2023. A first Implementing Regulation of over 100 pages was adopted on 17 August 2023 together with over 350 pages of initial guidance.
CBAM is an ingenious mechanism designed to counter "carbon leakage" arsing from the fact that the EU's emission trading scheme ("ETS") creates an incentive for emission-intensive production to move outside the EU. It comes replete with complex mechanisms designed to counter allegations of protectionism and is introduced gradually so as to allow calibration and minimise opposition.
One way of assessing the impact that CBAM will have is to consider the built in timetable:
- 1 October 2023 – The start of the transitional period involving detailed reporting but no obligation to pay for emissions. Importers (and deemed importers) of iron, steel, aluminium, fertiliser, hydrogen and electricity ("CBAM goods") need to start to monitor the carbon content "embedded" in the goods they import. Embedded emissions comprise both the direct emissions from the production process itself and indirect emissions from the consumption of electricity during the production process.
- 31 January 2024 – Importers will be required to report the embedded carbon content of their imports over the last quarter of 2023 to the CBAM Transitional Registry. There will be fines for not doing so. This obligation repeats every three months but during 2024 the report can in some cases simply reproduce reports made in the country of production.
- Q4 2024. Adjustments to CBAM are foreseen through secondary legislation in particular on the accreditation of verifiers, rules on electricity, anti-circumvention and exempted countries
- 1 January 2025 – The reporting regime becomes more stringent and the methodology set out in the Implementing Regulation must be applied to calculate embedded carbon content. In addition, importers can start to apply for "authorised declarant" status (see below).
- Mid 2025 – The Commission will adopt and publish a series of implementing regulations on a range of matters including the calculation of indirect emissions, the detailed "system boundaries" for direct emissions, verifications, the calculation of the carbon price in the country of production, the method for calculating the average ETS price, the percentage of free allowances allocated under the ETS, customs arrangements and declarations. The information and experience during the transitional phase will be used in the design of these regulations.
- 1 January 2026 – The transitional period ends and liability to pay for the embedded carbon content through the surrender of CBAM certificates will start to be incurred. Only "authorised declarants" will be allowed to import CBAM goods. CBAM certificates will be made available from time to time at a price corresponding to the price at which ETS allowances are traded.
- 31 May 2027 – Authorised declarants will need to submit for the first time a CBAM declaration setting out their imports of CBAM goods, corresponding embedded emissions and verification reports for the year 2026. The declaration will also need to contain the number of CBAM certificates to be surrendered corresponding to the embedded emissions adjusted to take account of the carbon price that is shown to have been paid in the country of production and an adjustment for the percentage of EU production still benefiting from free ETS allowances. This becomes an annual obligation.
- 1 January 2028 to 21 December 2034 – Free allowances are progressively phased out for EU operators and the adjustment applying to the reduction of CBAM allowances to be surrendered is correspondingly reduced.
Immediate action needed
It is clear that CBAM is a complex system that will require careful attention from importers and producers of CBAM goods. Although the liability to pay for emissions does not start until 2026, the reporting of embedded emissions will become obligatory for imports taking place from 1 October 2023 and there will be fines for non-compliance.
Although this reporting obligation only applies to importers and deemed importers the Implementing Regulation contains a list of information (Annex IV) that producers are "recommended" to provide to importers. Producers that do not provide this information are likely to be shunned by their customers.
Also, careful application of the reporting obligations may assist in establishing credible data that will later help to secure better treatment in the reductions in allowances to be surrendered due to a "carbon price" paid in the country of production and the avoidance of the application of default values.
The CBAM Regulation itself only exempts the EFTA countries and sets strict criteria for the exemption of other third countries by Commission delegated act. These would not appear to allow the exemption of the UK, for example.
However, there is reference in the recitals to the CBAM Regulation to the creation of a "Climate Club" of countries with comparable climate ambition designed to promote global co-ordination of action and support the comparability of relevant climate measures. This suggests that a further avenue for exemptions will be available through some form of international agreement. It is too early to predict what form these exemptions will take. However, cooperation in the transitional phase and engagement with the Commission on problems that may arise might improve the chances of favourable treatment in any exemption regime.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.