The first quarterly report of carbon emissions, that businesses must provide in compliance with the EU’s Carbon Border Adjustment Mechanism (CBAM), is due by 31 January, next Wednesday.
CBAM – the world’s first carbon border tax, introduced 1 October 2023 – is designed to prevent ‘carbon leakage’, the practice of offshoring production processes in cheaper, higher-polluting countries.
Ultimately, the EU hopes it will disincentivise carbon-intensive production processes and ensure EU firms don’t face unfair competition from high-polluting rivals.
Sandra Cooper, trade and customs specialist in ESG at the Institute of Export & International Trade (IOE&IT), said that the legislation is expected to have a “huge impact on global trade, despite not affecting EU importers financially during its initial phase”.
“It should effectively reduce carbon emissions and have a palpable environmental impact.”
Who’s affected?
Firms importing products into the EU are required to submit records showing the level of carbon emissions attached to their products, with reporting requirements encompassing the full supply chain.
This means firms acting as suppliers to the EU can also expect a trickle-down effect in which their customers request more emissions data.
Cooper added that for UK business owners, “it's essential to ensure that your data and systems are strong enough to meet the expectations of EU importers”.
“By providing quality and verifiable data, businesses can avoid punitive assumptions and potential loss of business.”
Phased introduction
This first reporting phase will target high-emitting sectors, including cement, fertilisers, iron and steel, aluminium, hydrogen, and electricity.
Over the next two years, the scope will be expanded to include more sectors, until it comes into full effect from 1 January 2026.
No levies will be raised before 2026, after which a certificate system will be used to collect payment.
Certification
In order to pay the tax, EU importers will be required to purchase certificates to cover the cost of the emissions corresponding to their product each year.
The price of the certificates will vary in line with the EU Emissions Trading System (ETS) – another climate tax targeting EU firms’ emissions.
The ‘cap and trade’ system requires companies to cover their emissions by buying ‘allowances’ on the EU carbon market. There are only a fixed number of allowances available per year and this will continue to fall in line with the EU’s climate targets. These allowances can be traded between companies, as needed.
Unlike ETS, certificates will not be tradable although their price will fluctuate, meaning that importing companies will need to make strategic decisions about when to purchase the certificates they’ll use to cover their year’s emissions.
Reaction
While the scope of the legislation has been praised as being a strong commitment to both cutting emissions and meeting climate goals, concerns have been raised about the practicalities of accurately reporting emissions.
Different methodologies are available, and while firms will need to adopt the one that underpins the EU’s ETS scheme by the end of 2024, currently two others are permitted for reporting requirements and these yield different results.
Concerns have also been raised about how effectively the legislation will achieve its climate aims, with some commentators speculating it will only lead to a two-tier system in which high-polluting goods are sent to countries with less restrictions.
Future CBAMs
However, it’s unlikely that CBAM will be the world’s only carbon border tax.
The UK government announced its plans for a CBAM in December, following a consultation on the risks of carbon leakage, scheduled for implementation by 2027.