CBAM: Answers to the 7 Most Important Questions

In mid-May 2023, the European Commission published the regulation on the Carbon Border Adjustment Mechanism (CBAM) in the EU Official Journal. Who has to pay the border adjustment? What exactly will companies have to do? What is the best way to prepare? You can find out all this in this blog.

CBAM – What Does That Mean?  

CBAM, also known as the Carbon Border Adjustment Mechanism, is an instrument of EU climate policy. On the one hand, the Commission wants to ensure that imported products meet the same environmental standards as products manufactured in the European Union. On the other hand, the CBAM is intended to protect European companies from competitive disadvantages. The reason for this is carbon leakage, i.e. the shifting of greenhouse gas emissions from the EU to other countries. This effect has increased sharply, especially recently, as carbon prices have risen from around 30 euros per tonne of CO₂ equivalent in the past to 100 euros and more for a short time. This is an incentive for many companies to shift their CO₂ emissions to non-European countries where there are no or lower CO₂ taxes. In these countries, production may be cheaper, but it is usually less climate-friendly. The CBAM now aims to level the playing field in carbon pricing between EU producers and third-country producers. Importers of certain emission-intensive manufactured products from third countries will in future have to purchase so-called emission allowances that cover the carbon content of the emissions contained in these products. This means that importers of non-EU goods will be burdened in a similar way as European producers.

Which Instruments Have Been Used So Far and How Does the CBAM Differ From Them?

Up to now, an emissions trading system (ETS) has been in place within the EU. An upper limit is set for the maximum amount of greenhouse gas emissions that European polluters such as energy producers or industrial companies are allowed to release. This upper limit is continually being lowered, with the aim of achieving complete freedom from emissions in 2050. For every tonne of CO₂ emitted, companies must purchase a so-called ETS certificate. At the end of a year, it has to be proven that the number of certificates purchased also corresponds to the actual amount of emissions caused. If a company has "surplus" allowances, it can sell them on to other operators on an exchange. If, on the other hand, a company causes a surplus of emissions, it can buy additional certificates (emissions trading). The price for a tonne of CO₂ equivalent results from supply and demand on the certificate market. Every year, the available certificates come onto the market either through auctions or through free allocations to companies.

The Carbon Border Adjustment Mechanism is now intended to compensate for certain disadvantages of the emissions trading system.

Here is an example to illustrate how it works: 

A furniture manufacturer is faced with the choice of buying Chinese or Slovakian steel screws for its production. The Slovakian screw producer buys its raw material from a Slovakian steel plant, which has to buy emission certificates for its production. Therefore, additional costs are reflected in the price of his products. The furniture manufacturer will therefore probably buy the cheaper, Chinese steel screws. In the worst case, the Slovakian company will have to close down due to a lack of competitiveness - even though its production is more climate-friendly. A paradox that the EU does not want.

By requiring importing companies to pay a levy in future also for the emissions of products from non-EU countries, this competitive disadvantage is to be resolved. The EU is of the opinion that this does not constitute an inadmissible trade barrier and that the CBAM is in line with the principles of the World Trade Organisation (WTO).

For Whom Is the CBAM Relevant and Which Commodity Groups Are Affected?

CBAM is initially only intended for groups of goods whose production releases particularly high emissions. In addition, there is a particularly high risk of carbon leakage to third countries for these goods. The following product groups will be subject to the CBAM from 2026:

• Cement
• Steel and iron
• Aluminium
• Fertilisers
• Electrical energy
• Hydrogen

These product groups are described in detail by customs numbers. For the most part, assemblies with shares of the materials mentioned are not included; the focus is on individual parts.

The product groups mentioned affect almost the entire manufacturing and processing industry. Even if companies do not produce or process these goods themselves, they must make a declaration, for example if they use containers made of iron, steel or aluminium imported from non-EU countries.

What Is the Timetable for the CBAM Implementation?

The starting date for border adjustment is 1 October 2023, when the transition period begins, according to the Commission Regulation. During this period, companies in the EU must submit a quarterly report on the emissions of the affected goods imported from non-EU countries. Until the end of the transition phase on 31 December 2025, however, no CBAM certificates have to be acquired. The obligation to do so begins with the start of the implementation phase on 1 January 2026.

What Does the CBAM Mean for the Companies Concerned?

For companies, the Carbon Border Adjustment Mechanism initially means only an additional administrative burden. They will have to provide meaningful and detailed emissions data as early as October 2023. Since the first report must already be submitted in January 2024 for the fourth quarter of 2023, companies should act early.

The obligation to purchase CBAM certificates will then follow from 2026. The procedure looks like this:

• In addition to the quarterly declarations, a declaration for the entire previous calendar year must be submitted annually by 31 May. This includes the quantity of imported goods, the direct and, if applicable, also indirect emissions generated in the process, as well as the quantity of CBAM certificates required for the import.
• If companies are unable to provide the required data, the calculation is based on estimates or penalties may be imposed.
• The respective reports are validated by an independent verification body.
• The required certificates must be purchased from the responsible CBAM authority; subsequent purchases or returns are also made at the respective purchase price from the relevant authority.
• The certificates themselves are valid for two years. Their price is based on the weekly average price for one tonne of CO₂ equivalent.
• If a CO₂ price has already been incurred in non-EU countries, this can be credited against the purchase obligation.
  
  In addition to the bureaucratic effort, companies must of course take into account the additional costs incurred through the purchase of CBAM certificates. These in turn affect the prices of their import and export goods.
   
  Last but not least, the CBAM is intended to create incentives for companies to consciously address the issue of sustainability. To remain competitive, they will increasingly switch their production processes to low-carbon methods by investing in sustainable technologies and using renewable energies.

What Can Companies Do to Prepare for CBAM?

First, companies should check whether and to what extent affected goods are imported from countries subject to reporting requirements. In doing so, it is important to quantify the emissions in the upstream value chain. Companies must therefore become experts not only on their own sustainability, but also on that of their suppliers. To do this, they must obtain as many details as possible about the actual emissions of the business partners along the value chain. In addition, they need to work out how the relevant data will be collected, analysed, reported and stored in the future. This may require additional consulting and software.

What Support Does Tset Provide?

Tset advises and supports companies in obtaining detailed information on the emissions of their value chain. Using a bottom-up approach, we include all relevant aspects with the help of our cloud-based and intuitive software. Using intelligent algorithms, we finally create meaningful analyses of product costs and CO₂ emissions. In contrast to common top-down methods such as the cost-per-kilo method, our approach comes much closer to the actual CO₂ values - and this already in the early phase of product development. By combining extensive master data, recognised calculation methodology, the use of intelligent, extensively validated algorithms and a high level of consulting expertise, we help you to better assess potential and existing suppliers and ultimately identify more sustainable alternatives.