6 minute read 5 Sep 2023
EU Carbon Border Adjustment Mechanism

Green Energy Trade Shift: implications of the new EU CBAM norms

Agneshwar Sen
By Agneshwar Sen

EY India Tax and Economic Policy (International Trade) Associate Partner

Leads the international trade vertical and has held various positions in trade related agencies of the Indian government. He is a travel enthusiast and likes to cook and explore different cuisines.

6 minute read 5 Sep 2023
Related topics Tax Tax controversy Energy and resources
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As part of EU’s trade policy for green energy, the CBAM seeks to strike a balance between the carbon pricing norms that apply to goods imported into EU and the goods produced domestically in EU.

In brief 

  • The EU’s carbon adjustment mechanism will initially cover in its ambit certain goods whose production is carbon intensive and is at high risk of carbon leakage: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen.
  • With the CBAM's enforcement on the horizon and regulatory requirements set to kick in from October 1, 2023, it is important for India to evaluate its trade approaches and make necessary preparations.     

In the quest to plug carbon emissions leakage, the European Union’s (EU) carbon border adjustment mechanism (CBAM) is the latest addition to the green energy practices adopted around the world. Essentially, the benefit of this measure is to encourage green energy imports. The CBAM came into force on 17 May 20231.  A transitional period of the CBAM will commence from 1 October 2023 and last through the year 20252.  The first reporting period for importers will end on 31 January 20243.  The obligation for importers under CBAM, which is being referred to as the world’s first carbon border tax, to pay a charge in respect of their imports will enter into force on 1 January 20264.  

As part of EU’s trade policy for green energy, the CBAM seeks to strike a balance between the carbon pricing norms that apply to goods imported into EU and the goods produced domestically in EU. While the latter are subjected to the existing EU Emissions Trading System (ETS), in the former category the importers will be required to pay for the greenhouse gas (GHG) emissions embedded in certain carbon-intensive products by purchasing CBAM certificates. The price of CBAM certificates will be pegged to the price of emission allowances (European Union Allowances / EUA) auctioned under the ETS5,  calculated based on the weekly average auction price of EUA expressed in €/tonne of CO2 emitted6.  

CBAM will be phased in between 2026 to 2034 while the EU ETS free allowances (cap) will be gradually reduced7.  During this period of 2026-2034, CBAM will apply only to the proportion of emissions that does not benefit from free allowances under the EU ETS8.  

The CBAM system will mirror the EU ETS and will work as follows: 

  • CBAM will be applied on the actual declared carbon content embedded in the goods imported in the EU, according to a formula that will reflect the effects of the EU ETS on the production of similar goods in the EU9.  
  • From 2026 EU importers will buy CBAM certificates corresponding to the carbon price that would have been paid had the goods been produced under the EU's carbon pricing rules10.  
  • Conversely, if a non-EU producer has already paid a carbon price in a third country on the embedded emissions for the production of the imported goods, the corresponding cost can be fully deducted from the CBAM obligation11.  

Scope of the CBAM

The CBAM aims to level the playing field for EU’s domestic as well as imported products by ensuring that the imported products also incur comparable CO2 costs and prevent domestic businesses from shifting their production plants / operations to non-EU countries12.  

The EU’s carbon adjustment mechanism will initially cover in its ambit certain goods whose production is carbon intensive and is at high risk of carbon leakage: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen13.  By the end of the transition phase, a review report will be prepared of the CBAM's functioning14.  The report will also assess the inclusion of other goods produced in sectors covered by the EU ETS in the scope of the CBAM mechanism, such as certain downstream products15,  which will be included by 203016.      

CBAM and trade policy issues 

The EU has claimed that the CBAM has been designed to be compatible with the World Trade Organization (WTO) and its other international obligations and simply seeks to place EU based producers at par with the non-EU producers in terms of the carbon cost embedded in the covered products. At a preliminary level this seems questionable due to the trade implications of CBAM. Hitherto, border measures allowed under the WTO have been agnostic of the production process or method (PPM) adopted in its manufacture. For example, whether cotton is grown organically or using chemical fertilisers, the customs duty is the same. With CBAM this long held principle is being changed as the same product depending on the production process (i.e., its carbon intensity) will face differential taxation.

Another often repeated complaint about CBAM from the developing countries is that it overlooks the concept of ‘Common but Differentiated Responsibilities’ enshrined as Principle 7 of the Rio Declaration at the first Rio Earth Summit in 1992. The declaration states: “In view of the different contributions to global environmental degradation, States have common but differentiated responsibilities”17.  Through CBAM, the EU is arguably equalizing the responsibilities by imposing the same carbon cost wherever the exporter may be located and whatever the carbon reduction commitment of that country may be. Further, the revenues from CBAM will contribute to the EU's budget. Thus, instead of aiding developing countries to meet their carbon reduction objectives, the developing countries exporting to the EU will be contributing to the EU’s ambitious carbon reduction commitments. 

Way forward – the road ahead

While international obligations will be debated and settled in appropriate forums, climate policies such as EU’s approach to green energy trade are here to stay. The coming into force of the CBAM is around the corner with its regulatory compliances starting from 1 October 2023.  Countries, such as India, need to take stock of their trade strategies and prepare themselves. 

India has recently launched its Carbon Credit Trading Scheme (CCTS) in the pursuit of its NetZero goals and of promoting green energy. The CCTS will aid the institutionalization and performance of the Indian Carbon Market (ICM) by laying down a process for compliance in which emission goals will be formulated for specific industries and organisations, upon meeting which they will receive credit certificates. Implementing the CCTS in a robust and effective way will help Indian businesses to demonstrate that their goods are manufactured through low-carbon processes using green technology, thereby, attracting lower CBAM charges and enhancing green energy export opportunities in EU. 

Manufacturers in India would need to focus on smart manufacturing by investing in energy-efficient technologies to reduce carbon emissions and adopt sustainable trade practices. Furthermore, while India has been beefing up its green energy initiatives, there is an urgent need for creating complementary green infrastructure that will expedite the transition to clean energy for businesses. 

India is at advanced stages of negotiating trade and investment agreements with the EU. This provides India with a platform to put forth its concerns with respect to the CBAM implications. The country must explore negotiating an exemption or a reduced rate of CBAM for the Indian manufacturers. It is well-accepted that the historical burden of global GHG emissions lies with the developed world. In this context, EU’s goals for promoting green energy through trade policy should take into account the concerns of the developing world. 

The article is also contributed by Esha Sandhu, Senior Manager, International Trade, EY India 

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Summary

India has been beefing up its green energy initiatives, there is an urgent need for creating complementary green infrastructure that may expedite the transition to clean energy for businesses.  

About this article

Agneshwar Sen
By Agneshwar Sen

EY India Tax and Economic Policy (International Trade) Associate Partner

Leads the international trade vertical and has held various positions in trade related agencies of the Indian government. He is a travel enthusiast and likes to cook and explore different cuisines.

Related topics Tax Tax controversy Energy and resources
Upvote