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The Carbon Border Adjustment Mechanism (CBAM) is gearing up to cause a revolution in global trade dynamics, presenting a pivotal shift in how countries approach carbon emissions and international commerce with the European single market. As a cornerstone of the European Union's Green Deal, CBAM has an impact on businesses worldwide, compelling them to reassess their carbon footprints and adapt to new regulatory landscapes. This groundbreaking policy not only aims to reduce carbon leakage but also has the potential to reshape global supply chains and stimulate innovation in low-carbon technologies.
To analyze the effects of CBAM, this ebook explores its economic implications, sectoral impacts, and role of technology in global decarbonization efforts. It discusses the challenges and opportunities CBAM presents for developing economies, its influence on international climate negotiations, and strategies for businesses and governments to adapt. The importance of supply chain transparency and advanced emissions tracking solutions is also highlighted.
The European Union has long been at the forefront of global efforts to combat climate change, setting ambitious targets and implementing comprehensive policies to reduce greenhouse gas emissions; the European Deforastion Regulation (EUDR) is an example.
As the world's third largest emitter of carbon dioxide, the EU recognizes its responsibility to lead by example in the transition to a low-carbon economy. The EU's climate leadership is underpinned by a robust framework of targets, policies, and initiatives aimed at driving down emissions across all sectors of the economy.
Central to the EU's climate strategy are its binding emission reduction targets. In 2014, the EU set a goal of reducing greenhouse gas emissions by at least 40% by 2030 compared to 1990 levels. However, in light of the growing urgency of the climate crisis, the EU has since raised its ambition, committing to a reduction of at least 55% by 2030 as part of the European Green Deal This increased target puts the EU on a trajectory to achieve climate neutrality by 2050, in line with the objectives of the Paris Agreement.
To achieve its emission reduction targets, the EU has implemented a range of policy instruments, with carbon pricing playing a central role. The EU Emissions Trading System (EU ETS), launched in 2005, was the world's first and largest carbon market, covering around 40% of the EU's greenhouse gas emissions. Under the EU ETS, a cap is set on the total amount of emissions allowed, and companies must purchase or receive allowances for each ton of CO2 they emit. This creates a financial incentive for companies to reduce their emissions and invest in clean technologies.
While the EU ETS has been effective in driving down emissions within the EU, it has also raised concerns about the risk of carbon leakage — the relocation of carbon-intensive industries to countries with less stringent climate policies — and it has become a cause of concern for EU competitiveness in the global scene. To address this issue and ensure a level playing field for EU companies, the EU is introducing a Carbon Border Adjustment Mechanism (CBAM).
The CBAM will put a carbon price on imports of certain goods from outside the EU, ensuring that the price of carbon is internalized in the cost of these products, aligning with the carbon price paid by EU producers under the EU Emissions Trading System (EU ETS). This will not only prevent carbon leakage but also encourage other countries to adopt more ambitious climate policies, thereby contributing to global emission reductions.
CBAM is governed by EU Regulation 2023/956. It's being introduced in two stages: a trial period from 2023 to 2025, followed by full implementation starting in 2026.
During the transitional period, importers of CBAM goods are required to register with national authorities and comply with quarterly reporting obligations on the quantities of imported goods and their embedded greenhouse gas emissions.
The definitive regime will involve the purchase and surrender of CBAM certificates corresponding to the declared emissions, with the price of certificates linked to the weekly average auction price of EU ETS allowances. By 2030, when fully phased in, CBAM is expected to capture more than 50% of the emissions in ETS-covered sectors.
While CBAM is expected to rapidly expand to other carbon-intensive industry segments, it will initially apply to imports of certain goods and selected precursors whose production is carbon-intensive and at significant risk of carbon leakage. These include:
The specific goods can be identified by their code under the EU's Combined Nomenclature (CN-Code) listed in Annex I of the CBAM-Regulation.
The European Commission will review the product scope by 2026 to assess the feasibility of including additional goods, such as downstream products, and those identified as suitable candidates during negotiations.
The implementation of CBAM follows a phased approach, with a transitional period from October 1, 2023, to December 31, 2025, followed by the definitive regime starting from January 1, 2026.
During the transitional period, importers are required to report the total quantity of goods imported, the embedded direct and indirect emissions, and any carbon price paid abroad.
Importers can utilize different reporting options until the end of 2024, including full reporting according to the EU methodology, reporting based on equivalent methods, or using default values published by the European Commission.
From January 1, 2025, only the EU method will be accepted, with estimates allowed for complex goods if they represent less than 20% of the total embedded emissions.
The definitive regime will involve the purchase and surrender of CBAM certificates, with free allocations under the EU ETS gradually reduced and proportionally offset by CBAM certificates until complete replacement by 2034.
As mentioned, the CBAM is poised to have a significant impact on global trade flows, commodity prices, and the competitiveness of firms both within and outside the European Union (EU). As a carbon tax on imports, the CBAM aims to level the playing field for EU producers facing higher costs due to the EU Emissions Trading System (EU ETS) and incentivize emission reductions in countries exporting to the EU. However, the mechanism's ripple effects on international trade patterns and the global economy are complex and far-reaching.
Let's take a closer look at this.
One of the most immediate consequences of the CBAM will be a shift in trade flows as importers adjust their sourcing strategies to minimize exposure to the new carbon tax. Countries with higher carbon emissions intensities in their production processes, particularly in the cement, iron and steel, aluminum, fertilizers, electricity, and hydrogen sectors covered by the CBAM, may see a decline in their exports to the EU. A study by the European Commission estimates that the CBAM could reduce imports of covered goods into the EU by up to 12%. This could lead to a reorientation of trade patterns, with EU importers favoring suppliers from countries with lower carbon footprints or those that have implemented comparable carbon pricing mechanisms.
The CBAM is expected to exert upward pressure on the prices of covered commodities in the EU market, as the carbon tax will be incorporated into the final price. This could have implications for downstream industries that rely on these commodities as inputs, potentially affecting their competitiveness both within the EU and globally. For example, the steel industry, a major consumer of coal and electricity, may face higher production costs, which could be passed on to end-users such as the automotive and construction sectors.
The extent of price increases will depend on various factors, including the carbon intensity of production in exporting countries, the availability of low-carbon alternatives, and the elasticity of demand for the covered commodities. In some cases, exporters may absorb part of the CBAM cost to maintain their market share, while in others, EU consumers may bear the brunt of higher prices.
We know that the CBAM is designed to protect the competitiveness of EU firms subject to the EU ETS by ensuring that importers face equivalent carbon costs. This should help prevent carbon leakage, where production shifts to countries with less stringent climate policies. However, the mechanism's impact on competitiveness will vary across sectors and firms, depending on their carbon intensity, trade exposure, and ability to pass on costs to consumers.
EU firms in CBAM-covered sectors may benefit from a more level playing field, as they will no longer be undercut by cheaper imports from countries with weaker climate regulations. This could encourage investment in low-carbon technologies and production processes within the EU. However, EU firms that rely heavily on imported inputs from high-carbon countries may face increased costs, potentially eroding their competitiveness in global markets.
For non-EU firms, the CBAM presents both challenges and opportunities. Exporters from countries with carbon pricing systems that are aligned with or linked to the EU ETS may be exempt from the CBAM or face lower adjustment costs. This could create incentives for countries to adopt more ambitious climate policies and engage in carbon market cooperation with the EU. On the other hand, firms from countries without comparable carbon pricing may struggle to maintain their market share in the EU, particularly if they cannot readily reduce their carbon footprint or pass on the CBAM cost to customers.
The CBAM's impact on global competitiveness will also depend on the extent to which other major economies adopt similar measures. If the EU remains the only jurisdiction with a carbon border adjustment, it could face accusations of protectionism and potential trade disputes. However, if other countries follow suit, it could accelerate the transition to a low-carbon global economy and create a more level playing field for firms worldwide.
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