Part 2 of the ‘Tip of the Iceberg’ series

The EU Carbon Border Adjustment Mechanism (CBAM) started in a transition phase from October 2023. Even though the trial period lasts until the end of 2025, this controversial regulation is already setting in motion a domino effect that is spurring global climate action.

Solving a global problem

The EU considers climate change as a global problem and CBAM is a step towards reaching a global solution. Right from the start, CBAM generated strong responses from trading partners around the globe, especially Asia. Reactions centered around concerns of potential trade barriers and potential violation of World Trade Organization (WTO) rules. However, the EU maintains that the intention is for CBAM to strictly adhere to WTO rules. This pre-requisite is in fact behind much of the complexity of this new regulation.

Levelling the playing field as a correction to ETS

Keep in mind that CBAM is considered an urgent correction to the ETS, and one of the goals is to provide EU producers with a level playing field. As such, several other countries that already have an ETS or carbon pricing initiative in place, are considering taking a similar approach.

The UK and Canada are just two examples of countries with ETS schemes that indicated that they may follow suit and introduce their own border adjustment mechanisms, to ensure that their local producers also have a level playing field.

Establishing a climate club and comparability

From 2026 onwards, imported emissions in the EU will be subject to CBAM certificates. If it can be proven that an equivalent price was already paid outside the EU, that cost can be deducted. For the EU CBAM to remain aligned with World Trade Organization (WTO) rules, imported goods cannot be subject to higher duties than goods produced within Europe. Even if there is a carbon pricing initiative or an ETS in place in another country, that does not mean that it is fully aligned or ‘equivalent’ to the EU ETS. There could be differences between the sectors and coverage.

Consequently, the EU is establishing a climate club with other countries, to enhance synergies and improve co-operation. This may lead to closer alignment between ETS schemes globally, similar to how the EU is aligning with China or Korea and their schemes. Ultimately, over time, the goal could be to link markets.

Default values for countries vs actual data from site of origin

The transition phase provides a limited grace period for importers to collect data from their suppliers. In case there is no data available, default values can be used – but only until July 2024 and from then on only up to 20% for a product.

Although the default values are not yet included in CBAM acts, a JRC report will be used as the basis for these factors. Using the same methodology and actual data, the report shows that there are considerable differences between the impacted countries. For example, default product benchmarks for steel from countries like Russia, India and South Africa are trending higher.

The burden of proof to show that a product has a lower emission factor than the default, falls on the producers outside the EU. During the transition phase, there is no need for verification, but this will be required from 2026. The EU plans to work with local regulators in these countries to ensure that there are checks in place.

Raising climate ambitions to retain local revenues

Initially, default values or the supplier’s actual emission factors will only be used for reporting obligations, but from 2026 onwards importers will need to purchase CBAM certificates unless a carbon price was paid elsewhere. A country’s relative exposure to CBAM therefore depends not only on the annual export quantities and default product emission intensities, but also on local carbon pricing instruments that are already in place.

Hence, CBAM is causing political introspection in countries that are currently without an ETS or other forms of carbon pricing, to look at their own climate ambitions. Countries like the US or India are scrambling to see how they could retain some of the EUR 80 bn in potential revenues from CBAM within their own jurisdictions.

Australia is an outlier compared to this, as CBAM affects only limited volumes of exports. An ETS was introduced in 2012, but it was repealed by 2014 due a lack of bipartisan support. This was followed by a ‘baseline and credit’ type of scheme, while the most recent reforms of the Safeguarding Mechanism started July 2023. Policy makers launched a public consultation to assess and address carbon leakage. This study will investigate various options, such as an Australian CBAM, mandating product standards and public co-investment.

Another example of an outlier is Mozambique, but again for different reasons. CBAM impact studies highlighted that smaller countries with a high percentage of trade reliance on the EU are the most exposed in terms of barriers to comply and potential socio-economic fallout. To counter this, the EU will dedicate a portion of the revenue generated by CBAM to contribute to climate efforts in developing countries.

From controversy to opportunity

In summary, EU CBAM seems to be having the intended global reach, causing a wide spectrum of responses. Countries that already have carbon pricing mechanisms, will likely follow the EU’s lead, and adopt their own CBAMs. Countries without carbon pricing or regulatory instruments, are starting to see benefit in retaining some of that revenue with their own regulations, rather than letting it flow to the EU.

The impacts of CBAM are playing out not only at country-level, but also on a corporate level. In the next blog, we will look at how the ripples caused by the world’s first CBAM will continue to play out, as the different types of impacted companies start to break down the complexity and assess the impact on their own operations.