In the context of the “Fit for 55 Package”, aiming towards a 55% reduction in carbon emissions by 2030 compared to the 1990 levels, the European Commission proposed a Regulation establishing a carbon border adjustment mechanism on July 14, 2021 (hereinafter: “CBAM”).

The aim of the CBAM is to regulate greenhouse gas emissions embedded in certain goods originating outside the EU, upon their importation into the customs territory of the EU and to ensure equivalent carbon costs between these goods. The main goal is therefore to prevent the risk of carbon leakage, meaning that companies based in the EU would move carbon-intensive production abroad (i.e. outside the EU) or that EU products would be replaced by more (non-EU) carbon-intensive products, thus undermining the EU’s climate efforts.

Today, the risk of carbon leakage is regulated through, amongst others, a free allocation mechanism of EU ETS allowances with the objective of preventing relocation outside the EU. In this regard, the CBAM seeks to replace this existing mechanism through a gradual phase-out of EU ETS by ensuring equivalent carbon pricing for the import of third country goods into the customs territory of the EU and goods produced within the EU.

What is the scope of the CBAM? The CBAM would initially apply to goods originating from countries outside the EU, when these goods, as well as  products processed from them, are imported into the customs territory of the EU.

The CBAM would apply to the following goods or products processed from them:

• Cement;
• Iron and steel;
• Aluminium;
• Fertilizers; and
• Electricity

However, it has been proposed to extend the scope to polymers and organic chemicals  (e.g. Alcohol, Ether, etc.).

The CBAM also includes certain countries and territories for which an exception applies, meaning that the products originating from these countries and territories are not subject to the CBAM. Currently, the following countries are included in this list: Iceland, Norway, Liechtenstein and Switzerland. Additionally, goods originating from the territories Büsingen, Helgoland, Livigno, Ceuta and Melilla also don’t fall in scope of the CBAM.

How does the CBAM work?

EU importers of CBAM goods register with the national authorities where they can purchase CBAM certificates. The price of the certificates is based on the weekly EU ETS allowances. The EU importer will have to report the emissions embedded in its imports and surrender the corresponding number of certificates each year. If importers can prove that a carbon price has already been paid during the production of the imported goods, the corresponding amount can be deducted.

What is the process proposed by the CBAM? The stakeholders from the above-mentioned sectors will have to comply with a number of requirements in order to be able to import the goods covered by the CBAM into the customs territory of the EU:

• Obligation to apply for an authorization: Any importer/declarant, before importing goods covered by the scope of the CBAM, must apply for an authorization to import these goods into the customs territory of the EU to a competent authority (which will be either a national authority or a central CBAM authority). The customs authorities will not allow the import of these goods into the customs territory of the EU unless the declarant has first received the required authorization from the competent authority.

• Obligation to submit an annual CBAM declaration: By May 31^st of each year, each authorized declarant (see above) shall submit a declaration for the preceding calendar year, containing, amongst others, the following information: (i) the total quantity of each type of goods imported during the year preceding the declaration, (ii) the total embedded (direct and indirect) emission and (iii) the total number of CBAM certificates corresponding to the embedded emissions to be surrendered.

• Obligation to surrender CBAM certificates: By May 31^st of each year, the authorized declarant shall surrender to the competent authorities a number of CBAM certificates corresponding to the reported integrated emissions of the imported goods.

How are the embedded emission calculated?

The embedded emissions are calculated based on specific calculations methods, which are included in Annex III of the CBAM. Where actual emissions cannot be adequately verified, the number of CBAM certificates to be surrendered shall be determined using default values, which are set at the average emission intensity of each export country, increased with an additional allowance. In case there is no reliable information available in this regard, the default values are set at an average level corresponding to the emission intensity of the 10 % worst performing sites in the EU for that specific type of goods.

How is the price of the CBAM certificate determined by the competent authority?

The competent authority shall calculate the price of CBAM certificates based on the average of the closing prices of all auctions of EU ETS allowances auctioned on auctioning platforms during each calendar week.

If a carbon price has already been paid in a country of origin of goods, declarants can request a reduction of the number of CBAM certificates to be surrendered, as such taking into account the carbon price paid in the country of origin for the reported embedded emissions.

What are the sanctions?

Penalties in the form of fines as included in the CBAM shall apply in case of infringements on the CBAM. Additionally, Member States should apply administrative or criminal sanctions for infringements of the CBAM and ensure that they are properly enforced. These additional sanctions should be effective, proportionate and dissuasive.

What is the transitional period for the implementation of the CBAM?

Based upon current drafts of the proposal, first reporting obligations will take effect at the beginning of the transitional period starting January 1^st, 2023. The transitional period is to end on January 1^st, 2026.  However, it remains to be seen in the coming months whether this timetable will be maintained in the final approved text.. Nevertheless, we highly recommend to companies/EU importers of the products covered by the CBAM to carry out an assessment of the supply chain to evaluate the impact of the CBAM on their business.

In our next article “How to get ready for CBAM?”, we will take a closer look at the next steps to be taken to prepare to the CBAM as a company from a legal perspective.