It is high time to prepare for the European CO₂ Border Adjustment Mechanism (CBAM)

The European Carbon Border Adjustment Mechanism (CBAM)¹ has entered into force on 17 May 2023 and has been implemented gradually since October this year. The CBMA requires importers of iron, steel, cement, aluminium, fertilisers, electricity and chemicals (although for now only hydrogen is listed as chemical), as well as certain upstream and downstream products, to purchase CBAM certificates and to pay the difference between the CO₂ levy paid in the country of production and the levy due under the EU Emissions Trading Scheme (ETS). Furthermore, producers in third countries are obliged to provide information on their emissions. Hence, it is high time to prepare for this.

Importers of products listed in Annex I of the CBAM Regulation will be required,

during the transitional period from October 2023, to determine and calculate the direct and indirect emissions generated during the production of the imported goods,
to report quarterly on direct and indirect CO₂ emissions in the country of origin and the carbon price paid in the third country (CBAM report),
to register as a so-called CBAM declarant, being authorised to import products subject to CBAM from January 2026 and to acquire the necessary CBAM certificates.

The companies must submit their first reports by the end of January 2024.

In detail:

CBAM and the European Green Deal

Four years ago, in 2019, the European Union as a pioneer in the fight against the climate crisis, set itself the goal of achieving CO₂ neutrality by 2050, delivering on the commitments under the Paris Agreement. The European Green Deal is the overarching strategy implemented by more than fifteen new laws or changes to existing legislation, the so-called 'Fit for 55' package. The goal is to reduce net greenhouse gas emissions by at least 55 % by 2030, compared to 1990 levels.

The 'Fit for 55' package² establishes the CBAM together with changes to the current EU Emissions Trading System (ETS). The CBAM should equalize the carbon price between domestic and foreign products.

In accordance with the applicable legislative procedure, the European Commission put forward a draft which was discussed by the European Parliament (EP) and the 27 Member States in the Council. The draft was welcomed by the EP's Environment, Public Health and Food Safety Committee (ENVI) but the EP rejected the proposal as not ambitious enough. It took several months to find a compromise.

Historical and legal context

The EU has an Emissions Trading System (ETS)³ for more than fifteen years and CBAM is designed to function in parallel with this system, complementing it for imported goods.

The ETS puts a cap on the amount of greenhouse gases companies are allowed to emit. Within the cap it is possible to buy emission allowances that can be traded with. Some of the allowances are auctioned, however, the rest of the allowances are given for free by the European Commission to certain sectors at risk of carbon leakage.

Carbon leakage refers to the problem of companies relocating their production offshore, to countries with fewer environmental protection. CBAM addresses this issue, so that EU efforts to reduce greenhouse gas emissions are not undermined by production shifts causing increased emissions in non-European countries or by importing more CO₂-intensive products.

Even without counting the emissions caused by imports, the EU accounts for around 8 % of global carbon dioxide emissions. It would be counterproductive and against the objective of the Paris Agreement to decrease emissions in the EU while importing more carbon-intensive products from non-EU countries.

How the CBAM works

Under the CBAM, carbon pricing is done through the instrument of CBAM certificates, similar to ETS allowances. "CBAM certificate" means a certificate in elec-tronic format corresponding to one ton of embedded emissions in goods. Importers of certain energy-intensive goods must buy CBAM certificates to be allowed to import those goods into the EU. The required number of CBAM certificates corresponds to the total embedded emissions of the imported goods.

If a company has already paid a CO₂ price for its emissions in the country of origin, Article 9 of the Regulation provides for the possibility of offsetting against the number of CBAM certificates to be surrendered.

According to Art. 2 of the Regulation, third countries can also apply for an exemption from the CBAM if they have an equivalent carbon pricing mechanism or if there is a link with EU emissions trading system. Imports of goods from these third countries are then outside the scope of the Regulation. This already applies to goods originating in Iceland, Liechtenstein, Norway and Switzerland.

Such a linkage could also be considered in the future between the EU and the UK. Following the UK's withdrawal from the European Union, the UK has introduced its own emissions trading scheme. Currently, the UK and the EU are thinking about linking their emission trading schemes. Indeed, a final decision has not yet been made.

Under the ETS free emission allowances are to be phased out for some EU producers and the product scope of the ETS and CBAM shall converge. First, the allocation of free ETS allowances will be phased out from 2026 and completely discontinued from 2034. In addition, the scope of the ETS will also be extended to aviation and shipping from 2024, and to road transport and buildings from 2027. For the aviation sector, no more free certificates will be made available from 2026. Moreover, a shortage of allowances is planned to increase the prices for emission allowances according to the principles of the market mechanism.

CBAM transition phase

The CBAM Regulation is applicable since 1 October 2023. Articles 32 et seq. of Regulation (EU) 2023/956 provide for a gradual introduction. Under EU law, the legal basis of the CBAM is Article 192 para. 1 of the Treaty on the Functioning of the EU (TFEU), which allows the Union to act to achieve the environmental and climate objectives specified in Article 191 para. 1 TFEU.

CBAM started with importer reporting obligations in October 2023. Companies must now request access to the CBAM Transition Registry to submit quarterly reports. Under a European implementing regulation adopted in August⁴, companies must report for the first time by the end of January 2024. Failure to do so will result in penalties between €10 and €50 for each ton of unreported emissions. The actual penalty will be determined pursuant to Art. 16 para. 3 of the Implementing Regulation and can increase if the duration of non-reporting exceeds six months.

The information required in the report includes, in particular, the quantity of goods imported in tons, the total amount of direct and indirect CO₂ emissions per ton of each type of goods, and the CO₂ price paid for the imported goods in the country of origin, if any.

The submitted report can be modified until two months after the end of the relevant reporting quarter. For the first two reporting periods, a modification is possible until 31 July 2024.

In principle, the reporting obligation rests on the importer within the EU of the CBAM goods. However, the importer can transfer the reporting obligation to an indirect customs representative (e.g., the transport company) with consent. Furthermore, the reporting obligation applies directly to the indirect customs representative when the importer is located outside the EU.

CBAM fully effective starting 2026

Once CBAM is fully effective starting 1 January 2026, both EU and non-EU companies importing goods into the EU subject to CBAM will be required to apply for the status of authorised CBAM declarant and purchase CBAM certificates. The price of CBAM certificates is calculated based on the weekly average auction price of EU-ETS allowances, expressed in €/ton of carbon dioxide emitted. If an EU importer can prove that it has already been paid a carbon price during the production of the imported good, the importer will only have to pay the difference between the amount paid and the price of a CBAM-certificate.

Economic consequences and legal issues

As regards the economic consequences in the EU, the emissions-intensive industry considers that the lack of relief of the ETS burden for exports with the simultaneous expiry of the free allocation of certificates leads to imbalance and the increased risk of relocation of industries. While EU-based manufacturers of emission-intensive raw materials would be protected from imports originating in countries with lower carbon dioxide prices, the export of emission-intensive raw materials from the Union would hardly be economically viable, as the production costs would no longer be competitive in international comparison without free allocation of allowances. The U.S. Inflation Reduction Act (IRA) of August 2022 has raised additional concerns about a new subsidy race as well as a debate about the competitiveness of the European Union.

With respect to political considerations, several countries have already voiced their concerns, ranging from CBAM violating trade agreements to decrying it as blatant protectionism. Brazil, South Africa, India and China have stressed the negative implications for developing countries.

In particular, many concerns have been voiced about the compatibility of CBAM with international law. However, a CBAM compatible with the General Agreement on Tariffs and Trade (GATT) is not per se impossible and could be justified on environmental grounds. It could qualify as a border adjustable internal measure under GATT Article III or, if found to be discriminatory, could be justified under the general exceptions of GATT Article XX, relating to the conservation of ex-haustible natural resources (GATT Article XX(g)) or necessity to protect human, animal or plant life or health (GATT Article XX (b)).

Upcoming steps

To fulfil the reporting obligations, companies must first check and identify whether and which imported goods are subject to CBAM. Decisive are the CN codes of the respective goods listed in Annex I of the Regulation, and further guidance is given with sectoral factsheets.⁵

In a second step, importers must obtain all CBAM-related information from their suppliers. The Taxation and Customs Union Directorate-General (TAXUD) published guidance documents for importers in the EU and their suppliers outside the EU, together with templates.⁶

The contractual transfer of the reporting obligation to an indirect customs representative and the related contractual hedging of risks (e.g., in relation to late or inaccurate reporting) must be considered.

If there is an own reporting obligation, access to the CBAM Transitional Registry must be requested.
The quarterly reports must then be completed and submitted no later than one month after the end of the quarter in question, first time at the end of January 2024. If the required information is not yet available, the respective importer may use default values made available and published by European Commission for the transitional period until 31 July 2024.

Prof. Dr Rainer Bierwagen
Gábor Báthory