The EU Carbon Border Adjustment Mechanism and its implications for global trade

Dominique Barker: Welcome to The Sustainability Agenda, a podcast series focusing on the evolving complexities of the sustainability landscape with a view on addressing current issues in a concise format to help you navigate and take action. I’m your host, Dominique Barker. Please join me as we explore today’s most pressing matters with special guests that will give you some new perspective and help you make sense of what really matters.

Goda Aglinskaite: We really got a signal from the EU officials and all the Fit for 55 negotiations that have been happening over the past year and a half, that beyond 2026 when CBAM will be in place, the regulator really wants the EU carbon price to increase to send these very strong investment signals.

Dominique Barker: Today, we welcome Goda Aglinskaite. She’s joining us from Amsterdam today. She’s a Carbon Market Analyst with ClearBlue in Amsterdam. Goda focuses on European carbon compliance market, which is the EU emissions trading system. You may also know it as EU ETS. In her role, she assesses market fundamentals and builds carbon pricing models. This involves analyzing the complex EU regulatory environment for policies that can affect the European emissions allowances market. On today’s episode, we’re going to be discussing the EU’s carbon border adjustment mechanism, which is the world’s first and largest carbon border tax. We’re going to explore how and when it will be implemented and what it means for the EU and non-EU companies who do business there and the implications for global trade. Good afternoon Goda, and thank you for joining today’s episode of The Sustainability Agenda.

Goda Aglinskaite: Hi Dominique. I’m glad to be here.

Dominique Barker: So December 2022, the European Union provisionally agreed to the Carbon Border Adjustment Mechanism. I think some people call it CBAM. Can you describe what this is and why it was introduced?

Goda Aglinskaite: Yeah. I would like to start by highlighting that the European Commission introduced Carbon Border Adjustment Mechanism or CBAM as a part of the Fit for 55 proposal which aims to reduce the EU’s emission by 55% by 2030 compared to 1990 levels. And sort of a smaller part of it is the European emissions trading system, EU ETS, and CBAM will be complementing it. The EU ETS covers power sector and heavy industry and with the CBAM will try to limit the competitive disadvantage of the U industry and protect EU from carbon leakage while imposing the same carbon price to some imports as the price applies to the EU industry. So here I think some background is also important. So the energy intensive industries still receive a large share of free allowances in the EU ETS, so around 70 to 80% of their emissions are still covered by free allocation because the EU tries to prevent them from moving their production elsewhere with less stringent climate policies. However, as the EU wants to achieve higher climate goals, they would like to phase out these free allowances. By doing that, they want to give a strong investment signal for the industries to seriously start investing into decarbonization tools. So they introduced CBAM to prevent carbon leakage while they are phasing out these free allowances for heavy industries. So that’s why also, while free allowances will be phased out, CBAM will be slowly phased in at the exact same rate.

Dominique Barker: Okay. And then let’s talk about which sectors are going to be impacted most by the CBAM.

Goda Aglinskaite: Yeah. So the CBAM will apply to iron and steel, aluminium, cement, electricity, fertilizer and hydrogen at first, and then from 2027 it might also apply to organic chemicals and polymers, if the commission evaluates that it is feasible to include these sectors as well. And the reason why these exact sectors and their products are included into CBAM is that their production is highly energy intensive and therefore emits large amounts of CO2, which makes them at risk of carbon leakage.

Dominique Barker: Okay, that makes sense. What will CBAM require companies to do? And maybe you can give a bit of a timeline and how much time they have to implement this and when does this all take place?

Goda Aglinskaite: Yeah. So there will be two periods. The first period will already start on 1st October this year in 2023, and that will be the transitional or data collection period during which EU importers will have to submit quarterly reports demonstrating their CBAM product imports and the emissions embedded in these goods. And then in 2026, the compliance period will kick in, meaning that these emissions will not only have to be reported, but also surrendered with these CBAM certificates. But as said earlier, this will have to be done gradually as CBAM will be phased in in parallel with the free allocation phase out in the EU ETS. So that essentially means that CBAM position will only start being equal to 100% of the verified emissions from 2023 onwards. And before then this CBAM sort of compliance position will be lower. And that means that also this investment signal for CBAM industries to start investing into low carbon technologies will be increasing over time.

Dominique Barker: So then how will these CBAM certificates, I guess that’s what they’ll be called, how will they be different from the EU ETS? The allowances. And so just as a reminder, the EU ETS, we’ve talked about this on the show before, is a cap and trade system. So those allowances are given out to polluters. There’s an incentive to reduce carbon and then sell those allowances. How is the CBAM certificates going to be different and what’s the rationale?

Goda Aglinskaite: Indeed. So CBAM certificate will be tied to the EU ETS allowance price. They’re called EUAs. So the CBAM certificate price will be determined by the weekly average EUA carbon auction price. And the rationale behind tying these prices together is again to level this playing field and protect EU industries competitiveness and to do that also in case the carbon price has already been paid for these imports in the originating country, that price will be deducted from the CBAM position. So for instance, in the EU today we have a 90 year old carbon price and if an aluminium producer already paid that price, paid $30, let’s say in the US, then when importing into the EU only the difference will have to be paid. And these certificates are not interchangeable CBAM certificates or EUAs. They’re simply tied together by the price. And also there are some different design properties. For instance EU allowances, they do not have any banking rules and or holding limits, whereas these CBAM certificates will have a two year expiry.

Dominique Barker: Okay. And maybe just to simplify it for everyone. So the CBAM, what Europe is trying to do is as companies in high emitting industries decarbonize, they don’t want cheap goods to come in that are carbon intensive. And so it’s a way to protect the industries and to ensure that it’s all on a level playing field. Begs the question, what does this mean for the EU importers? So, for example, Canadian exporters, what does it mean for those who are exporting to Europe and importing from the Europe perspective and for non-EU exporters selling into the EU markets? What can companies do to prepare?

Goda Aglinskaite: So we see sort of two ways that the importers can prepare for CBAM. So first of all, they can prepare for the process itself of how CBAM will be carried out so they can assess their trade flows, implement internal processes to assess the volumes of their imports of CBAM covered products, as well as start collecting data for the embedded emissions. But what we also see as a very important task for them to do now is to set up a risk management strategy to prepare for facing these large additional costs that will be increasing significantly and they will be increasing not only as CBAM position as being phased in until 2034, but also as the EU carbon price is projected to increase significantly. And we really got this signal from the EU officials and all the Fit for 55 negotiations that have been happening over the past year and a half, that beyond 2026 when CBAM will be in place, the regulator really wants the EU carbon price to increase to send these very strong investment signals.

Dominique Barker: And again, you said that the price today is €90 per tonne and so projecting an increase from there? Okay.

Goda Aglinskaite: Exactly.

Dominique Barker: Okay. And so this sounds like there will be an impact on global trade. Care to make a comment on how CBAM could transform global trade?

Goda Aglinskaite: This question, of course, has been very much at the centre of the attention during all this CBAM negotiations, and the EU has received a lot of complaints from its international trading partners. Essentially, according to the WTO rules, countries cannot be subsidizing their own exports to provide them with this competitive edge in the international markets. So in this case, the EU tried to solve this problem by gradually phasing in CBAM at the exact same rate as their phasing out free allowances for their same industry. On the other hand, of course, the carbon cost associated with imports of these raw materials for manufacturing will likely be added to the cost of final goods, which might again decrease competitiveness of the goods produced within the EU in the global market. And that has been again a headache for all the EU officials during the negotiations. And the current version does not include any protection for the EU exports. But the European Commission will have to carry out the assessment on how to support these EU experts and once again, how to do that in line with the WTO rules. And the last point I want to make here is that together with CBAM, EU really wanted to encourage this global climate ambition and for now CBAM is not even formally approved yet. It’s at the very last stages, but it still needs a few formal votes. But we have already seen that it did encourage this global climate ambition. So since the initial proposal, we’ve seen that China has introduced a cap and trade system. Turkey started implementing carbon pricing policies. So we do think that EU has sent this very clear signal and we do expect to continue seeing more and more carbon pricing policies being introduced all around the globe.

Dominique Barker: And when you said that there’s still a couple of votes left in order to pass this, what’s the timing on that?

Goda Aglinskaite: So for now, it’s not fully clear. But today we actually saw the vote of the parliamentary committee and now the European Parliament will likely vote during the plenary session in April. And after that the member states, so the European Council will have to vote as well. So hopefully we will see that in around May and the policy will finally turn into law around June. That is our estimation.

Dominique Barker: Great. Well, obviously, this will have a large impact on those companies that export into Europe. And so your explanation is a really good intro into some changes that are likely to happen. Goda, thank you so much for taking the time to join our show today and thank you very much to our listeners for listening in.

Goda Aglinskaite: Thank you, Dominique.

Dominique Barker: Please join us next time as we tackle some of sustainability’s biggest questions, providing different perspectives to help you move forward. I’m your host, Dominique Barker, and this is The Sustainability Agenda.

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