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The European Union announced a new emissions target that seeks to reduce its net emissions by 55 percent by 2030 from the 1990 levels. As part of the EU’s initiatives to be announced on the 14th of July 2021 - known as the `Fit for 55` package - to reach this ambitious climate goal, a carbon border adjustment mechanism aims to protect European producers’ competitiveness and incentivize other jurisdictions to implement climate policies. According to the draft documents the CBAM could be introduced in a transitional phase from 2023, with further provisions to be finalized before Jan. 1, 2026.

Objective

Ever since the EU has embarked itself for ambitious climate policy targets, it has been acknowledged that energy intensive industry sectors need some protection to avoid carbon leakage, that could threaten European jobs by relocation of production or investments to regions with lower climate or environmental policy standards. Currently, the distribution of free emission allowances within the EU Emissions Trading System (ETS) is the main measure to protect EU energy intensive industries from carbon leakage. This is a defensive policy instrument as it does not provide incentives for ambitious decarbonisation efforts neither within, nor outside of the EU. A CBAM would be a proactive instrument by providing a level playing field for EU enterprises and at the same time encourage more climate action from countries outside the bloc.

Scope

The draft proposal seems to be expanding the EU Emissions Trading System to include certain carbon-intensive imported goods, such as steel, cement, electricity, fertilizer, and iron.

How will the CBAM be applied?

Under the current draft an import tax will be levied on eligible imported goods. There is no mention of providing export rebates to European exporters..  The EU carbon border adjustment would not look like a standard border adjustment used in other tax types such as a value-added tax, which combines an import tax and an export rebate with a domestic tax. Importers will need to purchase emissions certificates from a newly established Carbon Border Adjustment Mechanism Authority to cover the carbon emissions embedded in the goods imported in the previous year. Each CBAM certificate will correspond to one metric ton of emissions embedded in the imported goods. Targeted emissions would include both direct emissions from the production processes of the eligible imported goods and indirect emissions associated with generating the electricity used in the manufacturing processes. Foreign firms will have to proof the CO2 content of their goods, the revenues will be cashed in by the EU while foreign countries will not benefit.

Emission certificate prices are based on the average closing prices for all ETS permit trading each week, which would then apply to the CBAM emissions certificates purchased in the following week. By the end of May every year, importers would be required to report the total amount of emissions associated with the goods imported in the previous year and submit the total required number of emissions certificates they purchased.

The proposal seeks to adopt a differential treatment on imported goods to account for the carbon pricing policies in the country of origin. Imported goods from countries with a carbon price could be fully or partially exempted from the import levy. Specifically, according to the draft document, “an authorised declarant may in its declaration claim a reduction in the number of CBAM certificates to be surrendered corresponding to the carbon price paid in the country of origin for the declared emissions.” 

Critical open issues

What happens with the existing free allowances? 

It’s unclear how much longer the free allowances will continue to be issued to certain industries or manufacturers within the EU ETS.  If the carbon border tax is implemented alongside the existing free allowances, this would certainly be perceived as protectionism. Both policies aim to level the playing field between EU and foreign producers. The European Commission has made it clear that industries covered by the EU’s upcoming carbon border adjustment mechanism will no longer receive free CO2 allowances under the EU ETS. The Commission does not see the two instruments compatible at the same time, it would be a double funding and it would not be WTO-compatible. On the other hand, by a narrow margin, the European Parliament voted against scrapping free carbon emissions allowances under the ETS once a planned carbon border adjustment mechanism is in place. Industry associations, including Eurofer (steel),  CEFIC (chemicals), cement association Cembureau, and Fertilizers Europe  signed an email asking lawmakers to rethink the proposal and demanding the carbon border policy co-exist with the current system of free allocation. It’s a plea also supported by the EU’s employers association, Business Europe. IndustriAll ,on the other hand, formulated a more nuanced position during the consultation process. Accordingly, free allocation (and compensation for the increase of electricity cost) will require further discussion to ensure that no disproportionate windfall profits will be created but also to avoid disruptive change that might threaten short term profitability of sectors at stake. In the same way, the role of free allocation as a trigger to invest in existing plants should be explored.

What carbon prices in third countries can be accounted for to reduce the CBAM levy?

The CBAM draft proposal states that imported goods from countries with a carbon price could be fully or partially exempted from the import levy. It remains however still open, what type of carbon pricing policy would be deemed acceptable to warrant a credit for reducing the required amount of emissions certificates to be purchased. It seems that only explicit carbon pricing policies such as an emissions permit trading scheme, or a carbon tax, would be acceptable. Since both major trading partners of the EU, the US and China, have emissions trading systems it will be critical how these two countries would be affected.

What low-income countries will be most affected?

It can be seen as a matter of climate justice and of international aid, how lower income countries will be affected by the draft CBAM. Beside India (for steel), Mozambique, Cameroon, Ghana as direct exporters of aluminium, or Guinea with the world's biggest bauxite reserves will be highly affected. These low income countries have low historical carbon emissions; pricing them out of the market might affect the livelihood of their population and undermine their capability for necessary emissions reductions. Oxfam suggests that a part of CBAM revenues could be earmarked for fairness purposes.

Compliance with WTO rules 

An effective EU CBAM must be in line with WTO rules. In early 2021, the European Parliament adopted a resolution about what a WTO-compatible EU carbon border adjustment mechanism should look like.  There are still open questions about the compliance of the latest CBAM proposal with WTO rules and also about possible design details of the proposal that could be changed to ensure this. It is likely that the differential treatment approach would violate the WTO’s most-favoured-nation rule. Using the environmental provision in Article XX to justify the differential treatment approach is also controversial. 

A well-designed carbon border adjustment coupled with a domestic carbon price would effectively and efficiently incentivize emissions reduction. There are many open questions about what the final proposal would look like. The final proposal, due on July 14, 2021, may reflect a significant overhaul of the current draft, as there are many open questions on the table, in particular, as regards the list of covered products. The CBAM proposal will be subject to the EU’s ordinary legislative procedure (without unanimity requirement) and therefore will be reviewed and modified by the European Parliament and the Council of the European Union.

IndustriAll on CBAM – answer to the public consultation:

IndustriAll Europe expressed its support to the general idea of having an EU CBAM to accompany the efforts to reduce emissions by 2030 and 2050 and formulated the following major demands.

To limit the risk of delocalisation of manufacturing activities downstream the value chain, CBAM should also apply to intermediate and finished products. A CBAM that would lead to offshore assembly or finishing industrial activities would be an unacceptable threat to employment in industries and would be in conflict with the EU industrial strategy.

A fair and regulated international trade, based on multilateral rules, remains important for the EU industry. A CBAM should not be designed in a way that would damage the EU industry insertion in global value chains. The EU CBAM must therefore be in line with WTO rules. It must be based on clear and non-arbitrary criteria to provide for equal treatment for all trade partners and also provide equal treatment for domestic and foreign producers.

IndustriAll also stressed that the CBAM implementation should not lead to disruptive changes for workers in third countries, in particular in low income developing countries.

IndustriAll was open to discussions about free emission allowances to energy intensive industries, once the CBAM becomes effective. It added however that preserving the competitiveness of EU exporting industries might require to explore hybrid systems where CBAM would target imports whereas free allocation would be used for exports.

IndustriAll on the `Fit for 55` package

IndustriAll Europe is in favour of climate policy instruments that create the conditions to invest in the technologies and infrastructures necessary to reduce emissions. Luc Triangle, General Secretary, said:

“We need a policy framework for 2030 that helps heavy industries to transform and that is not disruptive. We need a revised ETS, driving investment towards clean technologies, and a policy framework - including a Carbon Adjustment Mechanism - that mitigates the risk of carbon leakage.”

“The upcoming ‘Fit for 55% package’ must consider the current context and the specificities of the various sectors at stake. We should not assume that increasing the carbon price and replacing free allocation of emission allowances by a CBAM will magically lead to decarbonisation and finance the EU Recovery at the same time. This would be a dangerous gamble for the 6 million jobs at stake, as well as for the Commission’s ambition to make EU industry more resilient and less dependent”, stressed Luc Triangle.

The CBAM must complement existing instruments until necessary and additional funding for decarbonisation must be provided for the sectors and regions at stake.

IndustriAll urges the European Commission to deliver a Fit for 55% package that will be in line with the social commitments made in Porto and that will lay the basis for a Just Transition that leaves no one behind.

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