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CBAM: What is it and why is it important?

The Carbon Border Adjustment Mechanism, CBAM, is a kind of green tariff that will apply to products imported into Europe based on the carbon footprint of these products.

This new regulation is part of the Fit for 55 package, and has been under discussion for a long time because its implementation is complex.

In the following video we explain the keys to understanding this new scenario, which we also develop in greater depth throughout this post.

The CBAM is a very important regulation for two main reasons:

The first concerns the competitiveness of Europe’s businesses. The fact that our policies are becoming more and more ambitious on climate change, and the emissions market more and more restrictive, may imply certain costs. If companies in other countries do not have such ambitious regulations, companies in Europe lose competitiveness.

The second reason is closely related to the first. If companies in other countries are more competitive, more products will be imported from those companies, affecting the European industry. But more importantly, we will not be doing anything about climate change. It is true that Europe will generate less CO2 but this CO2 will be emitted in other countries with laxer regulation. So global CO2 will not decrease and Europe will not achieve its goal. This effect where CO2 emissions are shifted from one country to another is called carbon leakage.

For this reason, the CBAM introduces a kind of tariff that is applied on the basis of the CO2 emissions of imported products. This tariff will have the same value that the company would have paid if it were on European soil and had to participate in the emissions market. Thus, the rules of the game are the same for everyone.

In other words, this regulation aims at:

  1. Fair competition
  2. Incentivise industries in other countries to reduce their emissions
  3. Avoid carbon leakage

Who will be affected, how and how much?

The entry into force of the CBAM will affect companies that import the following materials: cement, electricity, fertilisers, aluminium, hydrogen, iron and steel. According to EsadeEcPol, both base metals and the automotive sector will be the most affected by more than €1 billion.

Source: Collado, N.; Linares, P.; Martínez, A. (2023). ¿Cuál va a ser el efecto en España del nuevo impuesto de la UE sobre las emisiones en las importaciones? EsadeEcPol Policy Brief, No.40

CBAM implementation schedule

The implementation of CBAM will start in 2027, but referring to 2026 data. Thus, each company will have to report in May 2027 on:

  1. The amount of materials in tonnes imported or electricity in MWh.
  2. CO2 emissions per tonne or per MWh of each commodity or electricity
  3. Verification reports

Until its implementation, a transitional period started on 01/10/2023 and will last until 31/12/2025 during which each importer must submit the “CBAM Report” on a quarterly basis with the following information:

  1. Number of tonnes of each commodity and electricity in MWh
  2. CO2 emissions per tonne of each commodity and MWh

Design issues and likely future changes to the CBAM

This regulation aims to prevent carbon leakage and maintain the competitiveness of companies on European soil. Its complexity, both to comply with the World Trade Organisation and to make comparable carbon footprint calculations, has led the regulator to propose a first proposal that is recognised as incomplete, but which will allow experiences and lessons to be learnt that will improve the regulation in the future.

Some of the current design problems are:

  1. It does not include indirect emissions from some products.
  2. Does not include transport emissions
  3. Does not include many products (e.g. organic chemical polymers, etc.)
  4. Does not include downstream products. This can be a very relevant problem, as it can lead to unintended consequences. For example, if a European industry “A” manufactures an aluminium-based product that it imports from a third country, the aluminium it buys will have CBAM embedded in it. If this industry “A” sells this product to another European industry “B”, the latter will also incorporate this “tariff” (as it passes on the extra cost). However, if industry A relocates to a third country, then when it buys the aluminium it will no longer have to pay the CBAM, because it is no longer on European soil. It then sells the product to industry “B” without a “tariff”, because the product it sells is not a listed product, as it is not aluminium but a product that uses aluminium. Thus, there may be incentives for certain industries to relocate. This possible unintended consequence will need to be further examined.
  5. It allows the use of default carbon footprint values in cases where actual data are not available or cannot be calculated. On the one hand, this is an advantage to ensure easy implementation. On the other hand, it can be a problem, as the most polluting suppliers might prefer to use the “default” value if they see that it is lower than their actual value, arguing that they have not been able to calculate the carbon footprint for some reason.

How companies can adapt to CBAM

As we have seen throughout this post and the attached video, the CBAM is a necessary regulation to combat climate change. But a thorough analysis of the legislation shows that its implementation is complex and contradicts the fireworks we see in different publications.

On the other hand, this complexity and the different challenges are known to the regulator, which is why it starts its implementation with an information gathering phase. In fact, article 30 of the regulation details that the commission will present a report after this first phase to assess all these issues.

When a company is faced with the question of how to comply with this new regulation, there are some relatively simple initial steps it can take.

  • First, it should make a list of all the products it imports and check whether they are subject to the current regulation. Then, you need to calculate the CO2 emissions associated with each product, both in terms of tonnes and in absolute values, to identify which are the most relevant.
  • The next step involves creating different cost scenarios related to the price of CO2 in the regulated emissions market, as this will affect your financial results and help you plan appropriate measures.
  • Finally, it is important to collaborate with key suppliers to improve CO2 emission calculations and establish an action plan that addresses current challenges and possible changes in future regulations.

In summary, CBAM is an essential regulation to address climate change, but, as we have seen, it is not perfect. Businesses must prepare not only to comply with current regulations, but also to meet future challenges that may arise.The Carbon Border Adjustment Mechanism, CBAM, is a kind of green tariff that will apply to products imported into Europe based on the carbon footprint of these products.

This new regulation is part of the Fit for 55 package, and has been under discussion for a long time because its implementation is complex.

In the following video we explain the keys to understanding this new scenario, which we also develop in greater depth throughout this post.

The CBAM is a very important regulation for two main reasons:

The first concerns the competitiveness of Europe’s businesses. The fact that our policies are becoming more and more ambitious on climate change, and the emissions market more and more restrictive, may imply certain costs. If companies in other countries do not have such ambitious regulations, companies in Europe lose competitiveness.

The second reason is closely related to the first. If companies in other countries are more competitive, more products will be imported from those companies, affecting the European industry. But more importantly, we will not be doing anything about climate change. It is true that Europe will generate less CO2 but this CO2 will be emitted in other countries with laxer regulation. So global CO2 will not decrease and Europe will not achieve its goal. This effect where CO2 emissions are shifted from one country to another is called carbon leakage.

For this reason, the CBAM introduces a kind of tariff that is applied on the basis of the CO2 emissions of imported products. This tariff will have the same value that the company would have paid if it were on European soil and had to participate in the emissions market. Thus, the rules of the game are the same for everyone.

In other words, this regulation aims at:

  1. Fair competition
  2. Incentivise industries in other countries to reduce their emissions
  3. Avoid carbon leakage

Who will be affected, how and how much?

The entry into force of the CBAM will affect companies that import the following materials: cement, electricity, fertilisers, aluminium, hydrogen, iron and steel. According to EsadeEcPol, both base metals and the automotive sector will be the most affected by more than €1 billion.

Source: Collado, N.; Linares, P.; Martínez, A. (2023). ¿Cuál va a ser el efecto en España del nuevo impuesto de la UE sobre las emisiones en las importaciones? EsadeEcPol Policy Brief, No.40

CBAM implementation schedule

The implementation of CBAM will start in 2027, but referring to 2026 data. Thus, each company will have to report in May 2027 on:

  1. The amount of materials in tonnes imported or electricity in MWh.
  2. CO2 emissions per tonne or per MWh of each commodity or electricity
  3. Verification reports

Until its implementation, a transitional period started on 01/10/2023 and will last until 31/12/2025 during which each importer must submit the “CBAM Report” on a quarterly basis with the following information:

  1. Number of tonnes of each commodity and electricity in MWh
  2. CO2 emissions per tonne of each commodity and MWh

Design issues and likely future changes to the CBAM

This regulation aims to prevent carbon leakage and maintain the competitiveness of companies on European soil. Its complexity, both to comply with the World Trade Organisation and to make comparable carbon footprint calculations, has led the regulator to propose a first proposal that is recognised as incomplete, but which will allow experiences and lessons to be learnt that will improve the regulation in the future.

Some of the current design problems are:

  1. It does not include indirect emissions from some products.
  2. Does not include transport emissions
  3. Does not include many products (e.g. organic chemical polymers, etc.)
  4. Does not include downstream products. This can be a very relevant problem, as it can lead to unintended consequences. For example, if a European industry “A” manufactures an aluminium-based product that it imports from a third country, the aluminium it buys will have CBAM embedded in it. If this industry “A” sells this product to another European industry “B”, the latter will also incorporate this “tariff” (as it passes on the extra cost). However, if industry A relocates to a third country, then when it buys the aluminium it will no longer have to pay the CBAM, because it is no longer on European soil. It then sells the product to industry “B” without a “tariff”, because the product it sells is not a listed product, as it is not aluminium but a product that uses aluminium. Thus, there may be incentives for certain industries to relocate. This possible unintended consequence will need to be further examined.
  5. It allows the use of default carbon footprint values in cases where actual data are not available or cannot be calculated. On the one hand, this is an advantage to ensure easy implementation. On the other hand, it can be a problem, as the most polluting suppliers might prefer to use the “default” value if they see that it is lower than their actual value, arguing that they have not been able to calculate the carbon footprint for some reason.

How companies can adapt to CBAM

As we have seen throughout this post and the attached video, the CBAM is a necessary regulation to combat climate change. But a thorough analysis of the legislation shows that its implementation is complex and contradicts the fireworks we see in different publications.

On the other hand, this complexity and the different challenges are known to the regulator, which is why it starts its implementation with an information gathering phase. In fact, article 30 of the regulation details that the commission will present a report after this first phase to assess all these issues.

When a company is faced with the question of how to comply with this new regulation, there are some relatively simple initial steps it can take.

  • First, it should make a list of all the products it imports and check whether they are subject to the current regulation. Then, you need to calculate the CO2 emissions associated with each product, both in terms of tonnes and in absolute values, to identify which are the most relevant.
  • The next step involves creating different cost scenarios related to the price of CO2 in the regulated emissions market, as this will affect your financial results and help you plan appropriate measures.
  • Finally, it is important to collaborate with key suppliers to improve CO2 emission calculations and establish an action plan that addresses current challenges and possible changes in future regulations.

In summary, CBAM is an essential regulation to address climate change, but, as we have seen, it is not perfect. Businesses must prepare not only to comply with current regulations, but also to meet future challenges that may arise.