Carbon Border Adjustment Mechanism: All You Need To Know

The idea of a carbon border adjustment mechanism, which is the European Union's answer to curbing carbon emissions by companies, has been discussed by experts for years.

Envisioned to curb green emissions in the production process, the scheme, since its announcement, has sparked strong reactions from Brazil, South Africa, India, China, and the United States of America, with the latter even eyeing an exemption.

Here's all you need to know about the EU's carbon border levy:

The European Parliament recently gave a nod to implementing the Carbon Border Adjustment Mechanism. Under it, imports will be taxed according to the amount of carbon emitted in their production when shipments enter the European border.

The EU aims to get to net-zero emissions by 2050, and the CBAM is one of its initiatives towards reducing greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels.

The EU already has systems within its borders to curb carbon emissions, such as allowances that have to be paid by heavy emitters (which act like a carbon tax), but producers outside Europe don’t have to pay this penalty and face little or no regulation.

This presents a situation of 'carbon leakage', where companies based in the EU could move carbon-intensive production to countries where less stringent climate policies are in place or replace EU products with more carbon-intensive imports.

The border tax is meant to offset both the unfair advantage and limit the arbitrage opportunity of shifting production to less stringent jurisdictions.

The CBAM will be implemented gradually and will initially apply only to selected goods that are at high risk of carbon leakage, like iron and steel, cement, fertiliser, aluminium, and electricity.

However, if fully adopted, a reporting obligation would first come into play on Oct. 1, 2023. The plan is to have companies measure the carbon intensity of their production processes and provide statements on it for relevant imports between 2023 and 2025.

Beginning Jan. 1, 2026, companies exporting into the EU will have to purchase CBAM certificates that will bridge the gap between the carbon price paid in the country of production and the price of carbon allowances in the EU Emissions Trading Scheme.

EU importers will start paying a financial adjustment by surrendering the amount of CBAM certificates in proportion to the emissions embedded in their imports.

As CBAM is slowly introduced, the allocation of free allowances under the EU ETS will be phased out. This will happen gradually between 2026 and 2034.

The CBAM will be applicable to goods originating from countries outside its territory, according to PwC International Ltd. This includes EU member states, Iceland, Norway, Liechtenstein, and Switzerland, as well as a number of small territories such as Büsingen, Heligoland, Livigno, Ceuta, and Melilla.

Several countries have long considered enacting legislation that imposes a fee on imported carbon-intensive goods to reach their own climate goals while protecting domestic industry.

Steel and aluminium exporters will be primarily affected by the implementation of the CBAM. While industries like cement, fertiliser, and electricity are also included, they are not major exports from India to the EU.

In 2022, the EU received 27% of India's total exports of iron, steel, and aluminium products, amounting to a value of $8.2 billion, as reported by the Press Trust of India.

According to the Commerce Ministry, the carbon tax approved by the EU would impact 1.8% of India's total exports.

The Indian government is still assessing the monetary impact, as it varies for different production processes, according to the Director General for Foreign Trade.

India plans to file a complaint with the World Trade Organisation over the European Union's carbon border levy, Reuters reported.

The DGFT stated that an inter-ministerial group is coordinating on the issue, discussing the extent to which it can be mitigated, how Indian industries can adapt, and the extent to which mutual recognition of testing and certification can happen.

The initial announcement brought sharp criticism from BASIC (Brazil, South Africa, India, and China) countries, who claimed that the proposal was discriminatory and went against the United Nations principle that recognises that richer countries must provide finance and technology to developing countries to fight climate change.

With the European bloc likely to proceed with the CBAM, the World Economic Forum has hypothesised that other countries could either impose barriers on EU imports in response, negotiate exemptions, challenge the EU CBAM, or adopt their own carbon border taxes.