The Carbon Border Adjustment Mechanism of the European Union
By Helge Wieggrefe, Research Assistant at the University of Münster and Co-Founder of kolum.earth
In May last year, the European Union agreed to introduce the Carbon Border Adjustment Mechanism (CBAM), the first border tax adjustment for carbon pricing. To this end, a second emissions trading scheme will be set up that will apply to goods imported into the European Union from 2026.
The problem of carbon leakage or why is the EU issuing CBAM?
The European Union wants to tackle the problem of carbon leakage with the Carbon Border Adjustment Mechanism. If the EU pursues a particularly ambitious climate protection policy but its trading partners do not, goods produced in the EU bear a higher cost burden and therefore have a comparative cost disadvantage. The result is that European, lower-emission products are pushed out of the European market or that the production of the goods themselves migrates to third countries. Both scenarios result in a shift in greenhouse gas emissions. The ambitious climate protection policy therefore only results in a regional reduction in greenhouse gas emissions, limited to the EU. This will not reduce the global level of emissions; in the worst case, it will even increase due to the carbon leakage effect. The CBAM is now intended to equalize the different levels of CO2 pricing for imports and compensate for the comparative cost disadvantage of European products.
Which goods are affected by CBAM?
The CBAM initially comprises goods from six industrial sectors. These are iron and steel, aluminium, fertilizers, cement, hydrogen and electricity. The goods are classified via the Annex to the CBAM Regulation using the customs tariff numbers or more precise: the Combined Nomenclature. Several intermediate and end products are already included. The obligations of the regulation arise with the import of the goods or a product from inward processing into the customs territory of the European Union. The decisive factor is the release for free circulation. Exemptions exist above all for goods originating in Liechtenstein, Norway, Iceland or Switzerland. In addition, the exemption for goods worth less than €150 per consignment may also be relevant. This exemption is also already known from the customs code.
The transitional phase from October 2023 to the end of 2025
The mechanism came into force on October 1 last year with a transitional phase. During this phase, importers of the goods concerned are not yet required to purchase CBAM certificates. The greenhouse gases released during production in the third country are therefore not yet priced. However, importers of CBAM goods are already subject to a reporting obligation.
In addition to the type of goods imported – broken down by Combined Nomenclature number – and the quantity imported, the report must also show the direct and indirect emissions associated with the imported goods. This refers to the quantities of emissions released by the production of the imported goods in the third country. During the introductory phase of the transitional period, i.e. until July 31, 2024, the companies concerned may rely entirely on default values. After that, the actual emission values must be determined and reported. Recourse to default values will then only be possible to a very limited extent. If an emissions monitoring system or emissions trading system has been set up in the country of origin of the goods, the values collected under such a system may still be used until December 31, 2024. From January 1, 2025 at the latest, the specific CBAM calculation method must then be used in all cases. This method differs in many aspects from known emission calculation methods like the Greenhouse Gas Protocol and carbon footprint estimations. It reflects the emission monitoring of the EU ETS.
The CBAM report is generally due one month after the reporting period. In addition, the submitted reports may be amended up to one month after the submission deadline. By way of derogation, the first two CBAM reports may be amended until July 31, 2024.
The phase of full implementation from January 2026 onwards
In the phase from 2026, importers of CBAM goods must have the status of an authorized declarant. In addition, from 2026, a CBAM declaration must be submitted annually by May 31. Among other things, the reporting with the CBAM declaration includes the quantities of the imported goods, the embedded emissions, and the corresponding number of CBAM certificates. It replaces the CBAM report that needs to be submitted quarterly during the transition phase.
Carbon emissions in the supply chain will be priced
From January 1, 2026, importers will be obliged to purchase one CBAM certificate for every tonne of CO2 emissions embodied in their CBAM goods. However, this obligation will be gradually phased in and is only fully in place in 2034. The price of the CBAM allowances will be based on the average closing price of EU ETS allowances in the previous week. It fluctuates accordingly from week to week. In comparison to the EU ETS there will not be a limit to the amount of CBAM certificates. Also, the CBAM certificates can not be traded with other authorized CBAM declarants. The CBAM declarant can only resell the CBAM certificate to the European Commission respectively the Member States. In doing so he gets the money back he originally paid for it. He can not make a profit with it. Unlike the EU ETS, CBAM is not a cap-and-trade mechanism.
CBAM creates incentives for third countries to issue national carbon pricing schemes
The CBAM only wants to raise the CO2 price for imports to the European level, but not beyond. The number of certificates required can therefore be reduced by a CO2 price already paid abroad. This leads to an incentive for third countries to follow the European Union on their way of carbon pricing. For the exporter of that third country it does not matter whether the country has a carbon pricing scheme in place or not. The imports from that third country will bear the same carbon cost when they enter the customs territory of the EU anyway. But if it does a part or even the whole allocated revenue of that carbon price will stay with the government of that third country rather than accrue to the Member States. CBAM is therefore a strong instrument to foster (worldwide) carbon pricing.
Legal challenges according to WTO law
The principle of non-discrimination is anchored in the core of the GATT agreement in order to guarantee free trade in goods. This consists of the principle of national treatment and the most-favored-nation principle. The principle of national treatment ensures that imported goods may not be treated less favorably than similar domestic goods. It could be argued that CBAM violates this principle in various ways.
The most-favored-nation principle stipulates that any trade advantage granted to one product must also be granted to any other similar product, regardless of its origin. Here, too, it can be argued that CBAM does not comply with this principle.
Ultimately, however, a violation of the principle of non-discrimination would not constitute a violation of the GATT agreement. A violation of the agreement can be justified under Art. XX GATT. To do so, the measure in question must pursue certain politically desirable objectives. These are enumerated in Art. XX GATT. Above all, Art. XX (b) and XX (g) GATT would be worth looking at. This is because CBAM could be a measure that serves climate protection and thus environmental protection or the protection of finite natural resources. A justification based on Art. XX GATT therefore could have a good chance of success.
Conclusion
CBAM is a huge milestone in greening international trade law. An old and in international trade law well known instrument like the border tax adjustment is now used for sustainable purposes. For companies making business in this area, CBAM leads to serious challenges. It is a very difficult task to gather actual emission data through the supply chain. Especially when keeping in mind how rough the start of the EU ETS and the beginning of emission monitoring in the European Union was. In third country installation there is often no knowledge of the regulation nor measurement infrastructure.
In the next months the European Commission will publish the first drafts of some important implementing regulations. The mechanism is still under construction. But it also faces legal challenges. The former Polish government filed a complaint against that mechanism with the European Court of Justice. It states that it is a fiscal instrument and therefore would be subject to the unanimous voting procedure applies. Also, India filed a complaint with the WTO.
However, first successes can already be seen. The UK announced their own CBAM starting in 2027. Other countries like Australia or Canada are currently reviewing whether they will also complement their emissions trading scheme with such a carbon border adjustment. CBAM is only the first step towards carbon pricing in international trade.
