Driven by a strong tax policy angle, net zero objectives remain unambiguously important in the fight for climate change. Tax policy can sometimes be a stick or a carrot, or both simultaneously. This is the case for the Carbon Border Adjustment Mechanism.
The CBAM is much more than ‘a new tax’, ‘another leakage’, or ‘a cost of doing business’. The CBAM is an interesting policy measure because it represents an opportunity to redesign the value chains of multinational corporations (MNCs). In particular, the CBAM addresses:
The costs of externalities; and
The localisation at a transactional level of CO2 emissions.
As a reminder, the CBAM is a mechanism, broadly similar to an import duty, that will target imports of carbon-intensive products within the EU and will address the risk of carbon leakage. Carbon leakage is the risk that companies delocalise production into countries with less stringent environmental rules, or opt for suppliers within these countries.
The products covered under the CBAM proposal are:
Iron and steel;
Aluminium;
Fertilisers;
Cement; and
Electricity.
The CBAM is under discussion among the EU co-legislators and its adoption is high on the political agenda.
The Council of the European Union and European Parliament have adopted, in May and June 2022, their final positions on the Fit for 55 package, and thus also on the CBAM. The positions vary on a wide array of elements. For instance, the European Parliament is in favour of a centralised CBAM option (for example, centralised oversight and review of emissions reports), while the Council of the European Union is pushing for a decentralised version.
On top of that, the European Parliament is more ambitious with regard to the CBAM’s scope, pushing to take into account indirect emissions and add polymers, hydrogen, and organic chemicals to the list of covered products.
Since the adoption of their negotiating positions, the trilogue discussions to achieve a final agreement have begun. The first political trilogues brought little progress, but the institutions made progress during the trilogue discussions on November 8. The Czech presidency remains hopeful of achieving an agreement on the CBAM by the end of 2022.
Threat: compliance from 2023
The European Commission’s proposal provides for a gradual introduction of the CBAM starting from 2023. Initially, only reporting obligations will apply, but as of 2026, the CBAM should be fully applicable and CBAM certificates will have to be surrendered.
Under the proposed timeline, importers will therefore need to be ready to be compliant with the CBAM by 2023. For example, importers will have to report on a quarterly basis the embedded emissions in the production process for products falling within the CBAM’s scope.
Furthermore, importers will need to apply for a CBAM authorisation and report on the direct emissions stemming from their production processes, as well as on the carbon price paid abroad.
The European Commission explains in the CBAM proposal that European importers will face the compliance costs and the monitoring obligations of actual emissions. Emissions can be declared at default value, which limits the monitoring costs and avoids heavy emissions mapping burdens for international producers.
However, relying on default values instead of verified emissions can lead to covering emissions that were not necessarily generated during the production process, if the supplier has a less carbon-intensive production process compared with the default values. On the other hand, monitoring the actual emissions from the production process creates additional costs for the various taxpayers.
The CBAM is expected to have a greater impact on flows from certain countries, namely:
Russia;
Ukraine;
Turkey;
China;
The US; and
The UK.
Opportunity: assess your supply chain
Besides additional compliance obligations, there will also be a financial impact from 2026. Importers must surrender CBAM certificates corresponding to the total amount of embedded emissions of the goods imported. The prices of CBAM certificates reflect the average price of the EU Emissions Trading System allowances closing prices for each calendar week.
The CBAM is a one-size-fits-all policy (exceptions might be added) that might have a greater impact on certain industries, especially if indirect emissions are taken into account. The implication for companies that rely on CBAM products throughout their value chain can be extremely important.
The potential financial impact is such that it is crucial for companies to assess their exposure, throughout their value chain, and opt for alternatives if necessary.
Takeaways
The adoption of the CBAM is moving smoothly, and decisive advancements are expected by the end of 2022.
As the legislative process continues, this is the time for MNCs to:
Assess the volume and granularity of the CBAM in terms of the overall business;
Consider whether they are impacted by the CBAM and the other green taxation-related measures in the Fit for 55 package; and
Rethink the supply chain where needed.
