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EU’s Carbon Border Adjustment Mechanism (CBAM) – origins and future

26.5.2023 13.04

The EU’s Carbon Border Adjustment Mechanism (CBAM) will be applied from 1 October 2023. However, at the beginning, the CBAM will only involve a reporting obligation. From the start of 2026, it will gradually be used to collect charges based on the emissions of products.

The purpose of the CBAM is to combat carbon leakage to non-EU countries, that is, to prevent the relocation of emissions-intensive production from the EU to countries with less stringent climate policies. In doing so, it aims to promote its actual objective of reducing greenhouse gas emissions in the EU and globally. At the same time, the aim is also to encourage businesses in third countries to start using low-carbon technology.

The CBAM is a new type of instrument in the EU’s climate policy toolbox. The EU will use it to impose a charge in the EU that, for the first time, is based on emissions from production and directed at goods imported from outside the EU. The charge is a means for the EU to ensure that the imported products targeted by the mechanism will face a similar emissions charge as the one imposed on products manufactured in the EU as a result of the EU’s emissions trade. Initially, the charge will be collected for certain products from the iron, steel, fertiliser, aluminium and cement sectors, as well as for electricity and hydrogen and certain raw materials in the mining industry.

New instrument, old idea

Even though the CBAM is a new EU instrument, the idea behind the CBAM has been discussed in EU circles for some time already. The CBAM has French roots stretching back more than 15 years. One event that can be considered key in the emergence of the CBAM was a proposal by French president Jacques Chirac in 2007 at the Grenelle Environment Forum, where he suggested that a carbon tax be introduced for goods imported into the EU.

The attitude in the EU towards Chirac’s initiative was reluctant. The CBAM was seen as causing trade policy risks and endangering the progress in international climate negotiations, as it would be a unilateral climate policy instrument that would mean additional costs for those EU imports that cause emissions. What is more, the EU had already adopted the free allocation of emissions allowances in its emissions trading system in order to combat carbon leakage and to level out differences in competitiveness.

However, France did not give up. Every French president after Chirac has brought attention to the CBAM in some form or other. Eventually, what made the initiative gain ground was the EU’s will to reach climate neutrality faster than the rest of the world and the growing tensions in the international trade in emissions-intensive products (especially steel). The winds of change were blowing in favour of the CBAM in the EU. In 2019, the European Commission included the CBAM in the EU Green Deal, and in 2021, it published the legislative proposal for the CBAM, proposing that the mechanism be implemented as an emissions certificate system rather than through a carbon tax.

The EU institutions reached a preliminary agreement on the CBAM in December 2022, and it was officially adopted as part of the EU’s legislation in May 2023. The most significant issue in the CBAM negotiations was how the CBAM would interact with the free allocation of emissions allowances and what the associated impact would be on the competitiveness of European manufacturing. To ensure the compatibility of the CBAM with the rules of the World Trade Organization WTO, the EU will phase out the free allocation of emissions allowances for the products covered by the CBAM. This change will pose challenges for exports to countries outside the EU, as these will lose the free allowances while not receiving any cost concessions from the CBAM in return. This may lead to increased carbon leakage in the markets outside the EU, if EU manufacturing in these countries loses market shares to production that causes higher emissions.

Despite repeated efforts at the EU negotiations, no solution was found to the problem of EU exports that would have been satisfactory to all parties as well as WTO compatible. However, there was finally an agreement that the CBAM’s negative effects on competitiveness would be mitigated through a long transition period for the phase-out of the free allocation of emissions allowances and through special funding for the CBAM sectors from the EU’s Innovation Fund. The key to reaching an agreement was also the mutual understanding that the effects of the CBAM on the climate and the economy will be monitored and assessed in the coming years, and that based on these assessments, the EU will take any actions needed to improve the functionality and effects of the CBAM. 

What next?

The preparations for the implementation of the CBAM will continue in the EU and the EU member states in the coming years. In the current and the next two years, the European Commission will introduce a significant amount of subordinate legislation to complement the CBAM Regulation so that the CBAM can be implemented. In addition, based on a proposal by the Commission in December 2021, there are currently negotiations in the EU on channelling the revenue from the CBAM as a new own resource, that is, as a source of revenue in the EU budget.

Besides preparing for the implementation, the EU is in discussions with third countries to make sure that the CBAM does not conflict with the EU’s international commitments on trade, climate or other objectives once the collection of emissions charges starts in 2026. As part of these discussions, the aim is also to create conditions for global partnerships and for clarifying the role of the CBAM in the international fight against climate change.

In due course, a topic of discussion will be the possible expansion of the CBAM to cover new products and indirect emissions more extensively than in the current agreement. However, any expansions of the scope will require a new legislative proposal from the Commission and the preparation of new reviews and impact assessments for this purpose. The Commission is expected to produce its first reviews on the expansion of the scope by the end of 2025. Still, it may be that any proposals for broadening the scope will be postponed until after the start of 2026, by which time some experience will have been gained of how of the CBAM works in practice.

- Ilari Valjus

The writer works as Senior Financial Adviser at the Budget Department of the Finnish Ministry of Finance. He represented Finland as desk officer in the EU negotiations on the European Commissions proposal for the Carbon Border Adjustment Mechanism.