On 1 October 2023, the EU's Carbon Border Adjustment Mechanism ("CBAM") regulation officially entered into its transitional period, which will run until 31 December 2025. The CBAM is effectively an import tax on carbon-intensive products, such as cement, steel, iron, aluminium and electricity. It works in a similar way to the EU's Emission Trading System (the "EU ETS"), by creating a market mechanism that puts a price on carbon. However, unlike the EU ETS, which requires companies to pay a levy on emissions generated within the EU, the CBAM will require companies to pay a levy on the carbon emitted during the production of carbon intensive goods outside the EU that are entering the EU, in order to "encourage cleaner industrial production in non-EU countries."
By seeking to equalise the price that EU and non-EU producers pay on carbon, the European Commission hopes to disincentivise the migration of energy intensive production from the EU to third countries with less onerous environmental regulation – thus mitigating 'carbon leakage' while simultaneously encouraging these jurisdictions to improve their emission standards. You can read more about the CBAM, and its relationship with the EU ETS, in our detailed briefing here.
Since July, the Commission has published several key updates related to the CBAM. On 17 August 2023, the Commission adopted the CBAM Implementing Regulation (the "Implementing Regulation"), which outlines the reporting rules that are applicable during the CBAM's transitional phase. More specifically, the Implementing Regulation details the methodologies to be used by importers to the EU when calculating their embedded emissions (i.e. Scope 1 and Scope 2).
During the first year of implementation, companies will have the choice to report in three ways: (i) full reporting based on the new methodology set out in the Implementing Regulation (the "EU method"); (ii) until 31 December 2024, reporting on the basis of a carbon pricing scheme, an emission monitoring scheme or a compulsory emission monitoring scheme at the installation where the goods were produced or (iii) until 31 July 2024, in relation to each import of goods where the relevant reporting party does not have certain information as set out in the Implementing Regulation, reporting based on any other referenced method for determining emissions – including the default values published in the Implementing Regulation. As of 1 January 2025, only the EU method will be accepted.
During the first reporting period, which will end on 31 January 2024, reporters will be required to submit by that date the type and quantity of goods they are importing, the direct and indirect emissions produced, and any carbon price already paid for the emissions in respect of goods imported during the fourth quarter of 2023.
Implications for the infrastructure sector
There is no doubt that costs for energy and infrastructure actors importing significant pieces of hardware and components into the EU are set to increase, though with corresponding decreases in freely allocated emissions allowances under the EU ETS, the EU would argue that it is creating a level playing field whilst at the same time driving decarbonisation efforts in sectors traditionally recognised as hard to decarbonise. At the same time, it is expected that certain countries will respond by imposing their own carbon pricing mechanism, reducing CBAM exposure but nonetheless increasing costs for market actors in those jurisdictions (which can be viewed, depending on perspective, as a necessary contribution to tackling the climate emergency).
Parts of the UK electricity sector, which is highly interconnected to the EU, has called the measure a "new trade barrier" and questioned whether it will really lead to a reduction in carbon emissions. The renewable energy sector, parts of which have profited greatly from lower manufacturing costs outside the EU making renewable energy more accessible and cost-competitive with fossil fuel energy, will not receive any special treatment under CBAM – importing a wind turbine blade will be subject to CBAM in exactly the same way as importing parts of an oil rig tower.
Although in-scope companies have a few years before the obligation to purchase CBAM certificates applies, the costs associated with complying with CBAM during the transitional reporting phase have already started. All companies which are doing business in the EU may face further costs in the near future as a result of CBAM. Though the reporting and compliance obligation sits with the importer, it can be expected that exporters of both raw materials and finished products subject to CBAM may try to pass on costs to other parties in the supply chain, and many will be reviewing contract terms to ensure that these costs are properly allocated.
While the UK does have its own emissions trading system (the UK Emissions Trading Scheme), as of 21 September this year, the cost per tonne of carbon dioxide produced was trading at less than half of the value per tonne of the EU ETS. If this trend continues, it could make UK exports less attractive from an EU importer perspective, though any carbon price in the country of origin will serve to reduce importers' liability to CBAM costs.
To address these concerns, the UK Government recently ran a consultation in relation to proposals around implementing a domestic UK CBAM (see consultation here). Updates on this consultation are expected before the end of the year. In the meantime, companies should begin to understand which products are covered by CBAM, what reporting requirements apply to each product, and how their business might be impacted from a supply chain perspective (particularly once the initial transitional phase has finished).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
