As a front-runner in climate protection and a driver of the global environmental agenda, Europe intends to
- reduce EU greenhouse gas emissions by 55 per cent by 2030, when compared to 1990 levels, and
- aims to become the world’s first climate-neutral continent by 2050.
The first set of legislative proposals, which were designed to facilitate the necessary acceleration of GHG emissions reduction by 2030 and align the EU’s climate, transport, land use, energy and taxation policies with this milestone target, was adopted by the European Commission in July 2021 under the “Fit for 55 package” banner.
One component of the Fit for 55 package is the revision of the EU’s current ETS. The amendments seek to fortify current provisions (by decreasing free emission allowances and phasing them out for specific industries) and expand the scope to cover additional sectors to achieve the revised ambition.
EU ETS
A second component of the Fit for 55 package is the introduction of the world’s first carbon border adjustment mechanism (CBAM). The aim of CBAM, which is a supplementary measure to, and mirrors the EU ETS, is to counteract the risk of carbon leakage arising from the removal of the free ETS allowances. It operates by imposing a charge on the embedded carbon content of certain imports that is equal to the charge imposed on domestic goods under the ETS, with adjustments being made to this charge to take into account any mandatory carbon prices in the exporting country recognised by the EU.
Scope of CBAM
The initial scope of CBAM covers imports into the EU of goods from six emissions-intensive sectors deemed at greater risk of carbon leakage into the EU customs territory, namely electricity, iron and steel, cement, aluminum, hydrogen and fertilizers, except for products originating and imported from those countries participating in, or which are linked to, the EU ETS. Certain precursors as well as some downstream products (such as screws and bolts and similar articles of iron or steel) are also included in the CBAM scope.
Transition Phase
CBAM will be introduced in a phased approach (at the same rate that the free allowances in the ETS will be phased out). During a transitional phase commencing 1 October 2023, affected importers will only be required to fulfill reporting obligations. Thereafter, from 1 January 2026, CBAM will be fully operational and CBAM certificates will have to be surrendered (i.e., financial obligations take effect). By 2034, CBAM will be fully phased in and no free allowances will be available.
What is the impact of CBAM on your business?
Many EU-based corporates will be monitoring the emissions performance of their supply chain in order to meet the monitoring, verification and reporting standards now expected of most corporate entities. However, few companies will know in what country the actual emissions, relating to the development of their goods, were generated in.
Companies that consume products covered within the scope of the EU ETS, e.g. manufacturing, could face significant additional cost pass-through from existing suppliers if the CBAM is implemented, due to the significant emissions occurring in geographies without commensurate low carbon policies and the emissions associated with transport of the goods to the EU.
Corporates should ensure that they understand the geographical composition of their emissions to enable them to undertake a supply chain review, where required, making conscious cost versus carbon trade-offs and ensuring the resilience of their pricing model to the proposed changes.
As more products fall into the scope of the expanded execution of CBAM, more and more businesses will need to prepare for its implementation. It is critical for companies and importers of CBAM goods in the EU to remain well informed of these developments and begin evaluating the overall impact on their business activity, which may not be limited to a view on their customs data only, but also impact their sourcing and supply chain.
Notwithstanding the administrative costs associated with this tax measure, businesses will have to begin focusing on the quality and availability of their data elements, prepare for a global supply chain review and assess the implications of CBAM on their business model, set-up and trade flow to stay competitive.
