A newsletter to help you understand the key challenges of climate finance.
What is the CBAM 2023 regulation? In 2023, a significant addition to the European Union Emissions Trading System (EU ETS) was introduced—the EU ETS Carbon Border Adjustment Mechanism (CBAM). This mechanism requires importers to pay for the carbon intensity of their products. The aim is to preserve the industrial competitiveness of the EU.
It is important to understand the carbon adjustment mechanism, some talk about a “carbon border tax” and this is often confusing. The CBAM establishes a fair environment for European companies and protects them from potentially more competitive prices coming from regions not subject to comparable climate policies. Moreover, the objective is to promote the adoption of carbon pricing mechanisms worldwide as part of a global effort to address a global challenge: the fight against climate change.
The EU ETS is a carbon pricing mechanism designed to raise the cost of carbon emissions for industries - it incentivizes them to invest in decarbonization. However, achieving this objective requires the financing of greener technologies - those are often very expensive. So, there is a risk of carbon leakage, when companies may opt to relocate outside the EU to jurisdictions where they are not subject to carbon-related expenses.
The risk of carbon leakage introduced the need to implement a mechanism aimed at preserving European competitiveness. The EU ETS CBAM seeks to establish a level playing field, ensuring that carbon-intensive products manufactured in Europe maintain price parity with those produced elsewhere.
Previously, sectors exposed to carbon leakage risks were receiving state aid in the form of free allowances. In other words, regulators were helping those companies by distributing EUAs at no cost. However, this mechanism has proven inefficient and is being phased out - the climate integrity of the EU ETS has been limited because of the free allocation mechanism. Now the introduction of CBAM aims to replace this industry support as free allowances are progressively phased out.
The objective is to establish a just pricing structure for CO2 emissions associated with the production of carbon-intensive goods entering the EU. Basically, other countries are expected to monitor and account for the carbon emissions generated during the production of specific products. Then, importers are required to pay a price for carbon corresponding to the volumes in question.
Initially, from 2024, the CBAM will exclusively target imports of:
Over time, its scope will broaden to cover more sectors, such as polymers and chemicals. This will be examined after 2026 (the actual start of CBAM after the transitional phase).
The EU ETS CBAM entered its initial transitional phase on October 1, 2023, with the initial reporting period for importers ending on January 31, 2024. During this first phase, some flexibilities are offered to enable affected industries to adapt to the new regulations. For instance, entities needing time to put in place systems to accurately account for the carbon intensity of their products may initially use benchmark universal values. This transitional period is set to end in December 2025.
During the initial phase, industries will only be required to surrender allowances to only offset a proportion of the carbon emissions associated with the production of imported goods. The progression of these requirements is as follows:
The introduction of the CBAM does not have the same effect on all regions outside of the EU - this depends on how much they were trading with the EU in the first place, but also on the carbon intensity of the products exchanged. Below is a graph showing the quantities of CO2 emissions by country falling under the scope of the CBAM.
The precise numbers are (in million tonnes of CO2 forecasted between 2026 and 2040)
The financial implications will also be asymmetric, with South Africa, Brazil, and Turkey facing the highest monetary risks after the beginning of the CBAM mechanism, as seen below.
During the early discussions concerning the CBAM, the BRICS countries (Brazil, Russia, India, China, and South Africa) said that the new policy is discriminatory. The Australian Minister for Trade, Dan Tehan, also expressed concerns, stating that the CBAM "would be detrimental to global growth and to free trade globally." African nations expressed concerns as well, considering that implementing such a mechanism would impose an unjust economic burden for them, potentially threatening their economic development. They emphasized that the CBAM could disproportionately affect countries with lower economic capacities.
Following some initial concerns, China has taken a less prominent stance on the CBAM as it now focuses on establishing its own Emissions Trading System (ETS).
Similarly, India initially expressed discontent but is progressively becoming more ambitious in its climate efforts, setting targets for climate neutrality by 2070 and implementing two carbon pricing mechanisms of its own.
CBAM has incentivized Turkey to enhance its climate commitments. At COP26, Turkey ratified the Paris Agreement and announced plans to develop a national ETS similar to the European model.
Finally, initially resistant, the United States, expressed concerns about CBAM's potential economic impacts. However, several months later, some policymakers in Washington softened their stance, recognizing a carbon tax as a tool to level the playing field, particularly concerning Chinese producers.
Sources:
Associazione Italia Asean, 2022. Carbon pricing on imports to the EU is coming
BBC, 2021. COP26: India PM Narendra Modi pledges net zero by 2070
Euractiv, 2022. United States lawmakers are at a CBAM tipping point
European Commission, 2023. Carbon leakage
European Parliament, 2023. Carbon border adjustment mechanism as part of the European Green Deal
Financial times, 2021. John Kerry warns EU against carbon border tax
The times of India, Brics nations join India in opposing EU carbon tax
Politico, 2021, Australia attacks EU carbon border levy plans
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