Executive summary
Last summer, the European Commission (the Commission) presented a set of proposals (“Fit for 55” legislative package). This package aims to align the European Union (EU) climate, energy, land use, transport and taxation policies with the goal of reducing net greenhouse gas (GHG) emissions by at least 55% from 1990 levels by 2030 with the overarching goal to achieve climate neutrality in Europe by 2050.
One of the proposals is the Carbon Border Adjustment Mechanism (CBAM), which will introduce a carbon price on certain products imported into the EU. The CBAM proposal will be enacted by the European Parliament (EP) and the Council of the EU. The ordinary legislative procedure sets out that the responsibility committee for CBAM is the EP’s Committee on the Environment, Public Health and Food Safety (ENVI). In December 2021, the ENVI completed the first reading of the proposal and submitted their recommendations to the EP. The recommendations are seen as a substantial transformation of the initial draft, aimed at rapid deployment with wider coverage. More details on the recommendations are provided below.
Detailed discussion
The CBAM is a key element of the Commission’s “Fit for 55” legislative package, which aims to reduce net greenhouse gas emissions by at least 55% by 2030, from 1990 levels, as set out in the European Green Deal (EGD).
Key elements of the CBAM include:
Imposition of a carbon price on imports of a targeted selection of products to ensure that ambitious climate action in Europe does not lead to “carbon leakage”
More rapid phase out of free emission allowances for goods covered by CBAM, aviation and include shipping emissions in the EU ETS (Emission Trading System)
Alternative Fuels Infrastructure Regulation requires that aircraft and ships have access to clean electricity supply in major ports and airports
Maximum limit on the greenhouse gas content of energy used by ships calling at EU ports
A revision of the Energy Taxation Directive proposes to align the taxation of energy products with EU energy and climate policies
The ENVI is the responsible committee for CBAM and has submitted recommendations to the EP. Other concerned committees including the Committee on International Trade (INTA), Committee on Economic and Monetary Affairs (ECON), and Committee on Agriculture and Rural Development (AGRI) have also provided their recommendations to ENVI to be considered for the amendment of CBAM proposal.
Summary of CBAM recommendations from ENVI and other committees
- Accelerated phase out of free allocations: The ENVI suggests phasing out free allocation of emission allowances in applicable CBAM sectors, granted to the EU manufacturers subject to the EU ETS starting from 1 January 2024 and completely phased out by 31 December 2028. The phase out shall ensure that imported goods covered by the CBAM are not unfairly treated as compared to the EU-produced goods of the same class. The plan effectively means that EU producers of goods covered by the ETS must adopt and reduce carbon emissions even quicker to stay competitive. Likewise, the import of CBAM-covered goods will accordingly be subject to higher landed cost into the EU as the price of CBAM certificates (necessary for placing CBAM covered goods on the EU market) will be linked to the price under the EU ETS. To ensure competitiveness, both the manufacturer of the ETS-covered goods in the EU, as well as the import of CBAM-covered goods to the EU will be more commercially attractive for less emission-intensive goods.
- New products included: Extension of scope with a large group of goods in categories of polymers and organic-basic chemicals. Hydrogen may be added to the initial list of goods covered by the CBAM. The initial list contains selected products in the cement, electricity, fertilizers, iron and steel, and aluminum sectors. There are continued discussions at the EP level on the inclusion of petroleum products.
- Ultimate product coverage of CBAM: Ultimately, CBAM should cover all products covered by the EU ETS, which include a wide range of goods including crude petroleum, refined petroleum products, iron and ferrous ores, oils / fats, starch, sugar, malt, textile fibers, pulp paper and paperboards, dyes and pigments, basic pharma, ceramics and many more.
- Transition period: It is clarified that the transitional phase shall span 24 months, i.e., from 1 January 2023 until 31 December 2024, leaving effectively less than 12 months to prepare for the reporting obligations, possibly starting from 1 January 2023.
- Emissions covered: The CBAM shall cover “direct emissions” related to the production processes of goods over which the producer has direct control, including emissions from the production of heating and cooling consumed during the production processes, as well as “indirect emissions related to GHG emissions from the generation of electricity which is consumed during the production processes of goods. However, further to the indirect emissions, the recommendations also suggest the inclusion of downstream products to be covered by CBAM’s scope. Accordingly, the scope of CBAM may be extended in the coming years. Notably, if the EU may adjust the intra-EU Emission Trading Framework going forward, this can reflect accordingly on CBAM rules.
- Role of customs authorities: The customs authorities shall ensure that each importer (customs declarant) is previously registered with the central CBAM authority.
- Single, central CBAM authority: It is proposed that instead of a decentralized system with 27 CBAM authorities in each EU Member State, a single CBAM authority at the EU level is introduced, to ensure swift, coherent and cost-effective implementation. Such solution would also make “forum shopping” between Member States impossible.
- Recognition of explicit carbon pricing policies only: It is clarified that only introduction of explicit carbon pricing policies (those which place a price on carbon directly – such as carbon taxes or emissions trading schemes) could make a third-country imports exempt from the CBAM.
- Support for Least Developed Countries: While directly exempting the least developed countries from the CBAM was ruled out, one of the recommendations provides for financial support for their decarbonization projects.
- Origin of the goods: The non-preferential origin of goods is a key factor when determining the carbon emissions subject to CBAM charges when applying country-based average emissions based on benchmarked values. The recommendation clarifies that non-preferential rules of origin as per the Union Customs Code shall apply. In the context of the proposed scope, it means that goods production which involves more than one country or territory shall be deemed to originate in the country or territory where they underwent their last, substantial, economically justified processing or working, in an undertaking equipped for that purpose, resulting in the manufacture of a new product or representing an important stage of manufacture. There are also specific rules for certain goods.
Overall, the recommendation emphasizes the political intention that CBAM shall be implemented as planned or even accelerated, and will be expanded to meet EGD goals. Businesses have less than 12 months to assess the impact and implement the measures to adhere to compliance obligations from 1 January 2023. The rapid phase out of free allocations of ETS allowances would mean that starting from 1 January 2024, the carbon cost for manufacturers subject to EU ETS who are also offered a protection under CBAM could increase the price of manufacturing much faster than expected given need to acquire additional ETS allowances.
On the other hand, import of CBAM-covered goods will also in most instances become more expensive. Overall, the market price of any goods subject to ETS or CBAM as well as any derivative products will increase unless businesses reduce their greenhouse gas emissions.
The future legislation on carbon pricing, energy tax and related regulations are yet in the political process. A number of interest groups pursue quite divergent goals. Tough discussions on the political level are expected and in the detail some regulations will look different compared to the July 2021 proposal and the recommendations of the ENVI and other committees. Nevertheless, the direction of the regulations is quite clear and key EU representatives repeatedly emphasized the political will for implementation. Therefore, despite the fact that some details may still be unclear or proposed legislation may in the detail look different in the final state legislation, EU manufacturers, traders, importers, foreign exporters and all other parties that are potentially impacted by carbon pricing measures should quickly initiate comprehensive analysis of the expected impact of CBAM, changes to the ETS, Energy Taxation and other relevant fields of law. Specifically, EU manufacturers of the ETS-covered goods need to evaluate their market position since according to current plan there may be no export refund or rebate scheme reducing the need for the EU ETS allowances.
Key actions for businesses
A variety of factors should be examined when evaluating the potential impact of CBAM, for example, identifying the required call(s) for action, priority ranking, interdependencies between measures. The following key points should be taken into consideration:
- Evaluate potential CBAM impact on operations, i.e., examine customs data, purchase data, bill of material, transactional model, and logistic flows to ascertain CBAM applicability
- Quantify potential exposure, i.e., calculate potential impact of CBAM costs and expected cost for administrative governance as a base for subsequent strategic analysis of future supply chain flows, procurement, contracts, infrastructure, mergers and acquisition strategy
- Analyze data availability and quality, i.e., determine which data elements will be needed to fulfil expected CBAM compliance obligations, ascertain which data is available and assess data quality, as respective gaps must be closed in due time in order to prepare for the expected administrative obligations
- Review global value chain and footprint as they relate to the EU region and the expected CBAM. In addition, review EU ETS implications to determine cost optimization options and better determine strategy for investing in manufacturing installations to reduce emissions, transform to alternative products and other undertake appropriate measures
- Review implication on business model, i.e., analyze the impact on the business model in view of the competitive landscape and the corporate value
Implications
The EU Green Deal and similar initiatives in jurisdictions across the world are gradually taking shape and will have a tangible impact on the effort toward reducing GHG emissions. The impact is not limited to the EU, rather it impacts across the global sourcing and distribution footprints of businesses.
The expected changes will have a significant disruptive impact for emission and energy-intensive industries and businesses. It is critical to timely identify potential impacts, plan measures and have enough time to realize change before expected increases of direct and indirect carbon costs. The proposed measures also provide an opportunity for businesses to review their environmental, social, and governance (ESG) responsibility preparedness. In summary, businesses should proactively embrace the changes and prepare to align their business model to the expected carbon emissions framework.
For additional information with respect to this Alert, please contact the following:
Carbon Border Adjustment Mechanism
- Richard J. Albert, Leipzig
- Ashish Sinha, Zurich
- Kasia Klaczynska-Lewis, Warsaw
For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.
