Agreement reached on Carbon Border Adjustment Mechanism (CBAM)

The European Parliament and European Council reached a provisional agreement on the EU Carbon Border Adjustment Mechanism.

Executive summary

On 13 December 2022, the European Parliament (EP) reached a provisional agreement with the Council of the EU (CEU) to implement an EU Carbon Border Adjustment Mechanism from 1 October 2023.

The CBAM is intended to prevent carbon leakage whereby emission-intensive production is relocated to third countries. The CBAM is essentially a levy applied on imports of products in certain product categories namely iron and steel, cement, aluminum, fertilizers, hydrogen, and electricity.

Compared to the original proposals, the provisional agreement includes some new key developments including:

• Timing: Regime will apply from 1 October 2023 (previously 1 January), with a transition period (free allocation phase-out period yet to be agreed upon)

• Scope: Scope will be extended to hydrogen and some downstream products, while some indirect emissions will need to be reported

• Governance: European Commission will now be in charge of the governance of the regime

The provisional agreement is an outcome of the ongoing trilogue discussions, which followed the vote and adoption of the package of carbon legislation by the EP in June 2022 and included the revision of the EU ETS, the new CBAM, and the Social Climate Fund (see EY Global Tax Alert European Parliament adopts carbon legislation package, final negotiations with EU Member State representatives expected soon, dated 23 June 2022).
 

Background

In July 2021, the European Commission introduced its climate package of 13 interconnected legislative proposals and revisions. The package is a key enabler for a climate-neutral Europe by 2050 and in reducing emissions by 55% from 1990 levels by 2030.

A critical element is the new EU CBAM, which results in a carbon price on certain goods imported into the EU. Specifically, the new mechanism seeks to mitigate the effect of carbon leakage resulting from the nature of carbon pricing regimes currently applicable, while also maintaining World Trade Organization principles.
 

Main characteristics as confirmed as part of the latest developments

The regime will come into force from 1 October 2023, with a transition period with only reporting obligations.

The EU CBAM will apply a price on emissions to a wide range of goods comprised in the following categories which are imported into the customs territory of the EU.

• Iron and steel including some downstream products (e.g., including screws, bolts)

• Cement

• Aluminium

• Fertilizers

• Electricity

• Hydrogen

The scope of CBAM will be assessed before the end of the transition period and might be extended to include other product categories including organic chemicals and polymers, with the overall aim for the scope to potentially include all goods covered under the EU ETS by 2030 (e.g., including mineral oil products, lime, glass, ceramics, pulp, paper, cardboard, acids, and bulk organic chemicals plus others).

The CBAM charges will be calculated based on “embedded emissions,” which refers to emissions occurring upon manufacture, as well as indirect emissions under certain conditions.

The payment of CBAM charges will be facilitated through the purchase and surrender of CBAM certificates upon final implementation. CBAM certificates cannot be traded on the EU ETS market. A program of “free allowances” will be applied to CBAM certificates initially, similar to the EU ETS.

For goods imported into the EU that have been subject to carbon pricing regimes in the country of production, the CBAM charge will take these charges into account therefore only the difference between the carbon price paid in the country of production and the price of carbon allowances in the EU ETS will be payable under the new mechanism.

The details on the transition period will be dependent on the decisions regarding the phasing out of the free allowances under the EU ETS, which are expected to be negotiated as part of the wider EU ETS reform proposals in the upcoming weeks. In parallel, the legislative process for additional implementation acts is also progressing.
 

Implications

CBAM will impact businesses both in the EU and across the globe, from an operational perspective and in terms of strategic decision-making. Impacts may be either direct or indirect. A holistic approach across the value chain and supply chain is recommended.

The transition phase including CBAM reporting obligations is planned to be effective from 1 October 2023. Initial steps include: (i) assigning internal responsibility for management of the regime; (ii) reviewing the EU import footprint and potential (cost and process) impacts considering the new proposed scope of CBAM; and (iii) starting to prepare to comply under the transitional period requirements. In particular, this includes reviewing required data (e.g., on embedded emissions and carbon price at the location of manufacturing), identifying potential gaps and gathering information.

It will be important for businesses to monitor developments as the legislative process continues for CBAM and the closely interlinked EU ETS reform.
 

Next steps

Following the EU legislative process, the next step will be the formal approval of the agreement by EP and EUC before the new law comes into force. The partial deal that has been reached is dependent on an agreement on the reform of the EU Emissions Trading System (which will include the phasing out of free allowances for CBAM sectors).