The Carbon Border Adjustment Mechanism

By Simon G?? and Hendrik Schuldt, Managing Directors of carboneer

This article was published in the spring 2024 edition of the German Chamber Ticker. Read the full issue online here.

On October 1, 2023, the EU Carbon Border Adjustment Mechanism (CBAM) came into effect. The EU CBAM aims to limit carbon leakage and complements the European Emission Trading System (EU ETS) by establishing a carbon price on imported goods that is equivalent to the carbon price on domestically EU-produced goods. CBAM introduces reporting obligations for importers of goods into the European Union. Ultimately, this data needs to come from the manufacturers of the goods in question in third non-EU countries. With large trading volumes between China and the EU, stakeholders and companies need to prepare for this new compliance mechanism in international trade.

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CBAM as a Climate Policy Instrument

The EU CBAM is a policy instrument aiming to reduce the risk of carbon leakage under the EU ETS, the largest carbon pricing scheme worldwide that covers approximately 40% of the EU’s emissions. Carbon leakage occurs when climate policy reduces the competitiveness of domestic manufacturers compared to foreign producers that face less stringent policies and can produce in a less expensive, but more emission intensive, way. The risk then arises that industry moves from the regulated jurisdiction to countries with lower environmental standards. If such carbon leakage is not managed by climate policies, these could lead to the relocation of emission-intensive manufacturers abroad. Emissions would then be exported instead of mitigated, and the domestic economy remains weakened.

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Under the EU ETS, regulated entities, that are subject to the risk of carbon leakage, currently still receive most of their required emission allowances free of charge. This way, the competitive disadvantage of European climate policy is mitigated. This distribution of free allowances is phased out until 2034 while the concurrent phase-in of the EU CBAM will serve as a substitute to reduce the risk of carbon leakage for EU’s industry.

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Mechanism and Scope of CBAM

CBAM started in October 2023 with a transitional period that runs until the end of 2025, during which importers or indirect customs representatives only have reporting obligations for certain goods. Companies that transfer any goods under the CBAM regulation into the EU are obliged to calculate and report the embedded emissions that occur during the production process of these goods and their precursors according to detailed GHG accounting rules. Fulfilling these reporting obligations is by no means a trivial task: It requires close coordination across the supply chain, the exchange of greenhouse gas (GHG) emission data, and if these are not available, the need to set up complex monitor systems to assess embedded emissions of CBAM goods.

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The definitive period of CBAM starts in 2026. From then onwards, importers must purchase a proportional amount of CBAM certificates for each ton of embedded emissions. The price of CBAM certificates will be closely linked to the price of emission allowances in the EU ETS, momentarily around EUR 60 per ton of CO2e and expected to range between EUR 100 and 150 by 2030. Any carbon price due for the embedded emissions in countries where the good has been produced, reduces the number of CBAM certificates to be surrendered and thus the costs borne by the importer of the good into the EU.

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This mechanism assimilates the carbon price due for foreign and domestic CBAM goods that are sold on the EU market. Compared to the system of free allocations, the EU CBAM not only increases the EU ETS revenues (free allocations of emission allowances are phased out), but also incentivizes ambitious carbon prices and industrial decarbonization abroad.

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CBAM currently covers six EU ETS sectors accounting for roughly 50% of emissions in the EU ETS: Aluminum, cement, electricity, fertilizers, hydrogen, and iron & steel. The sector with most diversified production processes and goods is iron & steel, where 478 CN goods are combined into 8 aggregated goods categories that share similar production routes, system boundaries and precursors (see Figure 1 for an exemplary production process). Manufacturers of products therefore must consider the emissions from their own processes as well as those emissions embedded in the products of their upstream supply chain.

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The CBAM Obligations for Importers

Importers or indirect customs representatives must register as authorized CBAM declarants prior to the import of CBAM goods into the EU to fulfill their CBAM obligations. For each calendar year, regulated companies must calculate the emissions embedded in their imports following the methodology set out in the CBAM regulation and report the results through the CBAM declaration by May 31 of the following year. Practically, in many cases this means importers need to receive this data from their non-EU suppliers.

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Within these CBAM declarations, the importers may also claim a reduction of CBAM certificates to be surrendered when a carbon price has been effectively paid in the country of origin. The information contained in the CBAM declarations must be validated by third party verifiers that are accredited under the EU ETS regulation. Importers must get access to the CBAM registry, the platform where data on embedded emissions is communicated to authorities and where CBAM certificates are bought, surrendered, and excess certificates are sold back to the authorities. The obligation to surrender CBAM certificates will be phased in gradually until 2034. For the transitional period, no CBAM certificates need to be purchased. Starting with the definitive period in 2026, importers need to surrender CBAM certificates. The number of CBAM certificates to be surrendered increases proportionally to the phase-out of free allocations in the EU ETS. In 2026, regulated companies must surrender CBAM certificates for only 2.5% of their embedded emissions. This share gradually increases until it reaches 100% in 2034.

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Calculating Embedded Emissions

The EU defined detailed rules for the calculation of embedded emissions. Generally, CBAM declarants (i.e. importers or indirect customs representatives) must consider direct emissions from the production process as well as indirect emissions from the generation of energy used in the production process. For the actual calculation of direct emissions, obliged entities can follow one of the following methodologies:

1. The calculation-based approach where raw materials and inputs used in production are combined with calculation factors such as net calorific values or emission factors.
2. The measurement-based approach where emissions are determined through continuous measurement of flue gas flow and greenhouse gas concentrations in flue gases.

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CBAM declarants can also ask their suppliers to register themselves as operators located in a third country within the CBAM registry. The non-EU suppliers may apply the above calculation methodology to their products and obtain verification according to EU ETS standards. Suppliers can then disclose the information on embedded emissions to CBAM declarants who in turn use this information within their CBAM declarations.

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When CBAM declarants lack the required data to perform the calculations, they can revert to default values to be used as emissions factors under certain circumstances. Global default values have been published by the EU Commission in late 2023, however these can only be used under certain circumstances (see below).

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Rules during the Transitional Period until the End of 2025

Acknowledging the challenges posed by the CBAM for all stakeholders — from importers and customs representatives over the authorities to the producers of CBAM goods in non-EU countries — the EU gradually implements the mechanism with a transitional period: It started on October 1, 2023, and ends on December 31, 2025. This transitional period functions as a trial and educational phase and CBAM obligations are reduced to reporting during the transitional period.

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To increase the learnings during the transitional phase, instead of annual CBAM declarations, declarants must submit CBAM reports on a quarterly basis. The first report, covering the embedded emissions from imports during Q4 2023, had to be submitted by January 31, 2024, while the reporting for Q1 2024 is due by April 30, 2024. The calculation and reporting requirements are, however, somewhat eased for the transitional phase, and two additional methodologies are available:

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1. Until December 31, 2024, embedded emissions can be determined through third country national systems such as carbon pricing schemes or monitoring systems, whose accuracy and coverage is similar to the EU ETS.
2. Until July 31, 2024, embedded emissions can be determined using only default values from the EU or elsewhere if calculation methodologies align.

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Penalties can be imposed by the national competent authorities in cases where the reporting declarant fails to submit a correct or complete CBAM report or doesn’t rectify errors when initiated, with penalties ranging from EUR 10 to EUR 50 per ton of unreported emissions.

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Immediate Tasks for Companies

While the definitive period of CBAM is still two years away, companies should prepare at once to comply with the legal obligations of the transitional period and to get a head start for the definitive period. Below are some immediate tasks companies whose business is touched by CBAM should consider:

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Preparation and Capacity Building

? Identify which imports or products are subject to CBAM regulations. Collect information on carbon pricing schemes in countries of origin for CBAM goods.

? Build up CBAM competency internally and in the supply chain.

? Get registered as CBAM declarant or have indirect customs representative getting registered.

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CBAM Reporting

? Get access to the transitional CBAM registry. This is the interface for regulators and regulated entities for the transitional period. CBAM reporting for the first reporting period was especially challenging, as access to the CBAM transitional registry was not available until close to the deadline. Automation of data flows and CBAM reporting can help to reduce workload and simplifies the interactions of stakeholders during reporting (see Figure 2).

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Emission Monitoring

? Engage with suppliers and manufacturers to gather emissions data for imported goods.

? Develop GHG monitoring schemes in non-EU companies and installations.

? Learn how to handle the CBAM reporting template published by the EU.

? Establish processes to collect emissions data and set aside personnel capacities to handle CBAM duties.

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Strategic Optimization

? Make use of EU ETS allowance price forecast and embedded carbon projections to assess the medium- and long-term economic implications of CBAM regulations on supply chain and business.

? Understand the implications of CBAM on your supply chain and assess price and regulatory risk in different countries.

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With the introduction of CBAM, emission monitoring and reporting along with carbon pricing systems will play an ever more important role for Chinese manufacturers as well. While the emission reporting obligations during the transitional period of CBAM are new to many companies and require comprehensive preparation, regulations on CBAM will evolve during the coming years and should be closely monitored by third country and EU producers, as well as traders and importers alike.

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Several implementing rules on certain aspects of CBAM will still be published by the EU in the coming months and years. Amongst others, these will deal with details on emission monitoring, third party verification, the eligibility of carbon pricing systems, the treatment of green electricity procurement through power purchase agreements in non-EU countries, and an updated CBAM goods list.

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Greener manufacturing processes leading to lower embedded emissions in products are pivotal for company competitiveness in a world where climate policies and carbon pricing enter global trade: UK and Australia are contemplating the introduction of their own CBAM systems. Understanding and incorporating the obligations and requirements of regulations such as the EU CBAM into business decisions ultimately call for a strategic approach towards these new realities of global trade and decarbonization.

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Simon G?? is an energy engineer and expert on energy and carbon markets and managing director at carboneer. He led consultancy projects, studies and more than 150 workshops and trainings on energy and carbon markets, trading and policy.

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Hendrik Schuldt is an environmental economist, climate policy advisor and managing director at carboneer. He previously worked at the Potsdam Institute for Climate Impact Research (PIK) and still heads the non-profit climate protection organization, Compensators.

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carboneer is a Berlin-based consulting company with expertise in the areas of CO2 markets, CBAM, decarbonization & climate neutrality. carboneer accompany manufacturing companies, service providers and other organizations in integrating these multifaceted topics into existing processes.

The German Chamber Ticker is the business journal of the German Chamber of Commerce in China. This free English language?magazine features quality content from member companies and those with Sino-German expertise. Readers benefit from practical and in-depth cover stories, features and op-eds on a range of economic, social, technological, environmental and governance topics. The Ticker has a readership of over 35,000.

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