Europe has long been recognized as a major region leading the way in sustainable growth and climate neutrality. Since 2019, with the introduction of the European Green Deal, the European Union has consistently delivered action plans that strive to tackle key areas of climate change, including emissions, pollution, and biodiversity loss, among others. The most recent plan delivered by the EU consists of the Carbon Border Adjustment Mechanism (CBAM).
The EU has steadily strived to reduce its share of GHG emissions since the 1990s, accounting for 6.22% of global emissions and ranking as the world’s 4th largest emitter, according to Climate Watch data. While the region already has an Emissions Trading System in place, with the widest coverage and revenue across the globe, they are looking to gradually replace this system and expand it, tackling production emissions of not only European goods but also external manufacturing that is imported by regional traders, encouraging other countries to reduce their emissions to maintain competitive prices.
The initial period of the CBAM came into effect this past October 1st, covering limited product areas that include cement, iron and steel, aluminum, fertilizers, electricity, and hydrogen. During this probationary period, importers are only required to gather data on the emissions generated by these products and report it by the end of January 2024, with the enforcement of the tariff for carbon-intensive imports beginning in 2026, inaugurating the consolidation period that will culminate in 2034 with full coverage of emissions and higher costs. Apart from its sustainability-related advantages, this tariff could prove to be a considerable budget increase for the EU, with S&P estimating that they could be raising over US$80 billion per year.
The underlying concepts of this new system are carbon leakage and decarbonization. The former implies avoiding offshore production of carbon-intensive products as well as displacement of European goods by highly polluting imported products, protecting the European economy and the region’s climate-neutral strategy. Likewise, European efforts of decarbonization entail the promotion of “simple goods” over “complex goods”, with the key difference between both categories being embedded emissions. While simple goods are free of direct and indirect GHG emissions, complex goods are the target for this tariff, aiming to tax all emissions associated with their production. Given the growing concern and awareness regarding the importance of transparent reporting, the system also implements declarations of emissions that need to be presented annually, favoring accountability and traceability of decarbonization efforts. The data will be gathered and presented according to a common methodology, established by the Implementing Regulation on reporting requirements and methodology of the CBAM.
The tariff will be implemented similarly to the current Emissions Trading System, namely in the form of certificates. Once the tariff is effective, importers will be required to not only be authorized to import carbon-intensive goods covered by the CBAM, but also participate in the trading of CBAM certificates to account for the emissions generated, either purchasing or surrendering allowances, priced according to the weekly auctions of EU ETS credits. It is important to note that, to abide by the World Trade Organization’s non-discriminatory trade principles, the EU states that importers will only have to pay the tariff when there isn’t already a carbon price in place in the country of origin. In the case of different carbon pricing, the imported goods will only be charged the price difference, with the original carbon tax deducted.
One of the greatest strengths of the CBAM lies in its efforts to expand decarbonization efforts beyond Europe, protecting the region’s economy while ensuring fair trade with external producers. Nevertheless, some controversies have arisen regarding the lack of differentiation between the country of origin, stating that underdeveloped nations are not prepared to be subject to the same requirements as traders from the leading markets in the world. The probationary period will be key to understanding and analyzing the implications of the system, which will hopefully be successful in its mission.
At Frost & Sullivan, we are working on our upcoming reports on Climate Technologies and ESG, including a Frost Radar and Research Study focusing on the Global ESG Reporting and Platforms Industry, as well as the 2023 Climate Tech Pioneers: Top 100, focusing on solutions for climate adaptation and mitigation.