Global warming is a global problem that needs a global solution. Not all countries are on the same page regarding climate policies. Some countries have stricter climate policies to tackle climate change while others have less stringent policies. This difference gives rise to a concept called 'Carbon Leakage'.

Carbon leakage refers to the phenomenon where the implementation of strict climate policies in one country or region results in the transfer of industrial polluting production of goods to another country or region with lenient climate policies or when products are replaced by more carbon-intensive imports. This causes a net increase in global emissions. It is a concern for countries and businesses attempting to reduce emissions, as it can undermine their efforts and lead to a competitive disadvantage.

The European Union has a collective goal to become carbon-neutral by 2050 and with the European Green Deal, they strive to become the first climate-neutral continent. Therefore, to tackle the concept of carbon leakage the EU has developed a tool called the 'Carbon Border Adjustment Mechanism (CBAM)'. In this article we will deep dive into what is CBAM, its key elements, how will it work, and its future scope.

What is the Carbon Border Adjustment Mechanism (CBAM)?

On 13 December 2022, the European Union proposed a policy called Carbon Border Adjustment Mechanism (CBAM) to deal with the issue of carbon leakage, which occurs when businesses move their operations to nations with laxer climate regulations & policies, leading to an increase in global emissions. The CBAM seeks to level the playing field for businesses operating in the EU and lower carbon emissions worldwide.

The CBAM is essentially an import tax based on the carbon footprint of the goods. This means that, depending on their carbon emissions, nations without a carbon pricing mechanism will have to pay an additional tax to import goods into the EU. Industries that will be subjected to the CBAM in its first phase of implementation are Cement, Iron & Steel, Aluminum, Fertiliser, Electricity, & Hydrogen.

The rationale behind the Carbon Border Adjustment Mechanism (CBAM) is:

• To prevent companies from simply moving their operations to countries with less stringent climate policies

• Companies operating in the EU are not at a competitive disadvantage compared to companies operating in countries with lower environmental standards

• To encourage other countries to adopt stricter environmental standards by demonstrating that it is possible to reduce carbon emissions while maintaining economic growth

• To encourage companies to adopt cleaner technologies and reduce their carbon emissions

Key Elements of the CBAM

In accordance with the political agreement, the CBAM will start its transitional period on October 1st, 2023. The CBAM will first be applicable to imports of specific products and chosen precursors, including cement, iron and steel, aluminum, fertilizers, power, and hydrogen, whose manufacturing is carbon-intensive and poses the greatest risk of carbon leakage. When fully phased out CBAM will cover more than 50% of the emissions in ETS-covered sectors.

The Emissions Trading System (ETS) is a market-based method created to lower greenhouse gas emissions in the European Union. Power generation, the manufacture of iron and steel, the production of cement, glass, pulp, and paper, as well as aviation, are some of the energy-intensive industries covered by the ETS.

The CBAM will be gradually implemented over time with the permanent system entering into force on 1 January 2026. During the gradual phasing in of the CBAM, importers of goods falling under the purview of new regulations will solely need to declare the greenhouse gas (GHG) emissions, both direct and indirect, associated with their imports. They will not be required to make any monetary payments or modifications. The agreement predicts that indirect emissions for some industries (cement and fertilisers) will be included after the transitional period, subject to the development of a methodology in the interim. The intention of this period is to function as a trial and educational phase for all concerned parties (importers, producers, and authorities), as well as to gather useful data on embedded emissions to fine-tune the methodology for the permanent period.

Workings of the Proposed CBAM

Once permanently implemented in 2026, it will work as follows:

1. Importers from the EU of products covered by the CBAM must register with national authorities.

2. They can also buy CBAM certificates from the national authorities.

3. The cost of the certificates will be determined based on the EU ETS allowances' weekly average auction price, which is expressed in euros per tonne of CO2 emitted.

4. The amount of goods and embedded emissions in those goods that were imported into the EU during the previous year must be declared by the EU importer by May 31 of each year.

5. The importer also hands over the quantity of CBAM certifications necessary to account for the products' total greenhouse gas emissions.

6. If importers can demonstrate that a carbon price was previously paid during the production of the imported goods, based on verified information from third-country producers, the appropriate amount might be deducted from their final bill.

Conclusion

Before the permanent system is implemented, a review will be conducted on how CBAM operated during its transition phase. Additionally, there will be an evaluation of whether to add other goods produced by industries covered by EU ETS to the CBAM's scope, including downstream products and those identified during negotiations. The report will also outline a schedule for their incorporation into the CBAM by 2030.

Reactions to the CBAM have been conflicted. While some nations have praised the plan as a helpful step in lowering global emissions, others have slammed it as discriminatory and protectionist. There are also worries that the CBAM would lead to retaliatory actions from the nations that must pay the levy.

Despite these reservations, the CBAM is regarded as a critical step in tackling the issue of carbon leakage and lowering world emissions. Additionally, it is viewed as a tool to persuade other nations to adopt stronger environmental regulations and to encourage the creation and use of cleaner technologies.