An Overview of CBAM: why, what, when and how?
The Carbon Border Adjustment Mechanism, so called ‘CBAM’, is an EU climate policy instrument coming into play from October 2023. It will affect many large European corporates within industry and trade that import certain products from third countries.
In this article, we take a closer look into what the policy is geared up to solving, its scope, timeline, mechanics and how corporates can effectively prepare.
Why has CBAM come about?
Following the introduction of the EU Emissions Trading Scheme (EU ETS), the EU’s first climate policy instrument requiring corporates and industrials to financially compensate for emissions, EU companies where incentivised to move carbon-intensive production abroad to avoid the requirement to compensate for these emissions in their ETS quotas. This spill-over effect, termed ‘carbon leakage’, meant supply chains were moved to regions where carbon impact went unaccounted for, often to markets with little to no carbon regulation and higher grid emission intensities.
The Carbon Border Adjustment Mechanism has been devised to equalize the price of carbon between goods produced domestically within the EU and non-EU imports. By associating a carbon price on imports based on emission intensity of their production processes, CBAM addresses this spill-over effect and aims to close the carbon leakage loophole.
What is in scope and who is affected?
The CBAM will have an extended reach regarding GHG emissions and sectors, affecting a large cohort of European industry, also global operations and supply chains. Scope 1 and 2 GHG emissions related to the production processes of goods over which the corporate has direct control are included. Also, it considers Scope 3 related to both upstream and downstream emissions. In the first iteration, EU companies importing iron and steel, fertilizers, aluminium, and cement sectors will be included in CBAM. However, its sectorial scope could be extended.
This policy instrument will also impact beyond the EU corporates falling under the CBAM regulation. It effectively imposes a levy on EU imports, depending on the emission content of production and the difference between the EU ETS price and any carbon price paid in the production country. CBAM-covered goods will become more expensive unless businesses reduce their greenhouse gas emissions. In a nutshell, there will be growing interest in products that emit fewer emissions, and the export competitiveness of several countries in the Asia-Pacific region could be impacted.
When are measures coming into force?
The transition phase of CBAM kicks off in October 2023 and will run to 31 December 2025. During this period, CBAM will exist without financial adjustment and only reporting obligations, in order to reduce risks of disruptive impacts on trade.
From 1 January 2026 onwards, the CBAM including the financial adjustment for imported goods will be fully applied.
How will it be operated?
During the transition phase, corporates will have to determine and document all direct and some indirect emissions arising from the production of imported goods, as well as providing a quarterly CBAM report detailing the volume of imported goods, their embedded emissions, and the price of carbon paid in the country of production (if any).
From 1 January 2026, corporates will in addition have to ensure they are registered under the CBAM scheme, ensure third party verification of their reporting via an accredited partner and purchase and retire CBAM certificates to cover the reported and verified direct and indirect emissions. This process will be undertaken on an annual reporting cycle for goods imported in the previous calendar year and the corresponding number of CBAM certificates purchased and retired accordingly.
The pricing of CBAM allowances will be tied to the EU emissions allowances, whereby corporates will buy CBAM certificates from EU Member States at pricing corresponding to the carbon price that would have been paid, had the goods been produced under the EU’s carbon pricing rules.
Explicit carbon pricing policies in countries of origin such as carbon taxes or national Emissions Trading Schemes, will reduce the CBAM adjustment payment. These obligations paid in the exporting country would be directly deducted from the CBAM pricing obligations.
How can corporates prepare?
- Conduct an impact assessment: Check whether imported goods fall under the CBAM Regulation, then evaluate potential CBAM impact on operations and quantify potential exposure.
- Assess CBAM compliance: Analyse data availability and determine which data will be needed to fulfil expected CBAM compliance obligations across own operations and supply chain.
- Monitor the evolving landscape of carbon pricing in third countries: where there exists a carbon pricing scheme, there is potential to credit against CBAM exposure, which could comprise an important cornerstone of the corporate sourcing strategy.
- Undertake Emission reduction measures: build an emission reduction strategy which aligns with the findings from the CBAM impact assessment, thus quantifying the potential savings of implementing certain emission reduction measures across own operation and supply chain.
- Engage with suppliers on emission reduction: CBAM offers a clear business incentive for supply chain players to implement emission reductions measures to reducing their clients’ CBAM exposure. Ensure targeted engagement, clear communication and strategic support to encourage suppliers to adopt reduction measures and build a low-carbon supply chain.
- Adopt an Internal price on Carbon: assigning a shadow carbon price or carbon tax or trade system across the company instils effective carbon management across an organisation. Not only does it ensure operational readiness in the context of reporting, but it steers strategic decision-making to prioritise low-carbon options, thus reducing exposure to incoming policy instruments such as Emissions Trading Schemes and CBAM.
Jorge Estremadoyro Ruiz
Renewable Energy Project Manager
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