On July 14, 2021, the European Commission published a proposal for a regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism (“CBAM”).
CBAM is a new form of carbon pricing. It would apply to a subset of products whose production in the EU is already subject to the EU Emissions Trading System (ETS). When the selected products are imported from non-EU countries, their importers should purchase a CBAM certificate (at a price derived from the EU ETS auction) for each tonne of CO2 (equivalent) considered to have been emitted in their production, net of any price. carbon has been paid for on those emissions in their home country. CBAM aims to discourage EU companies from shifting production to (or sourcing key primary products from) countries with less ambitious climate change (carbon leakage) policies and to encourage global move towards net zero carbon emissions by 2050, in line with the 2015 Paris Agreement COP21 targets.
The main questions raised by the CBAM are:
CBAM is part of the Commission’s “Fit for 55” legislative package on EU climate and energy policy, which aims to support the implementation of the European Green Deal. The EU is now committed to becoming the first climate neutral continent in the world by 2050, and it has increased its greenhouse gas (GHG) emission reduction target for 2030 from the current 40% to 55% emissions from 1990.
The “Fit for 55” package sets out the measures that Member States must take to achieve the new 55% GHG target and the Green Deal strategies at national level. The package consists of the partial revision of eight existing European laws and five new legislative proposals, including the CBAM.
The CBAM would initially apply to imports of goods falling into five categories, defined by reference to CN codes: iron and steel, aluminum, cement, ammonia and certain fertilizers, and electricity. Among the products covered by the EU ETS to which the CBAM would not initially apply are organic chemicals, refined products, ferrous scrap, ferroalloys and other fertilizers.
The CBAM would apply to imports of the selected products from all countries, unless they are part of or linked to the EU ETS. In the first place, it means Norway, Switzerland, Iceland and Liechtenstein.
In the EU ETS, the obligation to surrender an EU quota per tCO2 (equivalent) emitted falls on the operators of the installations manufacturing the products concerned. Under the CBAM, registered importers (“authorized registrants”) would be required to purchase certificates regarding emissions produced by facilities where they were manufactured outside the EU – whether direct (e.g. , in the case of steel, emissions from blast furnaces) or indirect (from the production of electricity that feeds the installation).
Declarants are so called because they would have to make an annual declaration, no later than May 31 of each year, of the goods subject to CBAM that they imported, the emissions incorporated in these goods and the number of CBAM certificates that they have imported. ‘they are required to render (total emissions minus carbon price paid in the country of origin). They would purchase the CBAM certificates from the competent national authority (NCA) that each member state would be required to establish in order to administer the CBAM on its territory.
The unit purchase price of CBAM certificates would be equivalent to the average price of the EUA auctions of the previous week. In this way, imports would (at least in theory) be subject to the same carbon costs as EU producers. In addition to ensuring that they have the necessary number of certificates available in their accounts in the national register maintained by the NCA, registrants would be required to keep a balance of at least 80% of the certificates they are held. to return according to their imports. in the year to date.
Unlike the EU ETS, there appears to be no provision for secondary trading of certificates. They would be bought from the ANC and could be resold to it at the price paid if the declarant ends up with more certificates than he needs to pay his annual obligation, but only up to a third of the total he needs. bought the previous year. Any other excess certificate would simply be canceled.
In addition, unlike the EU ETS, where a significant proportion of EU allowances are allocated free of charge, all CBAM certificates would have to be purchased at the prevailing rate. Indeed, since the EU ETS free allocation scheme is designed to fight carbon leakage, it will be phased out.
Although the proposed regulation (in particular in its annexes) goes into some detail (for example, concerning the methods for calculating integrated emissions, in Annex III), it leaves a number of areas for the Commission to develop. in the implementation and delegation of acts.
All importers of products falling under the CBAM will need an authorization to import products covered by the CBAM and will need to register with the ANC for this purpose. Only verifiers accredited by the CBAM authority will be authorized to assess the carbon content of products.
The basis for calculating carbon pricing for imports should be parallel to EU ETS valuation rules
The proposal contains formulas for the calculation or determination of carbon content by reference to the emissions embodied in imports of tangible goods (steel, aluminum, cement, fertilizers) and electricity.
The emissions taken into account in calculating the carbon content cover direct emissions from processes (scope I) and indirect emissions resulting from the use of electricity (scope II).
- In the case of tangible property:
- Actual emissions should be calculated at the facility level using a formula in Annex III, which divides the total emissions attributed to the production of the tangible good in question by the volume of that good.
- If actual emissions cannot be determined, default values will be used. These will be determined on the basis of the 10% worst performing installations in the EU.
- In the case of electricity:
- The calculation of actual emissions will be the exception rather than the rule and subject to strict cumulative criteria that will not apply to imports from countries that are not interconnected and capable of physically exchanging electricity with the EU.
- The ‘specific defaults’ will be calculated on the basis of the ‘best available data’ at the Commission regarding the (average) tonnes of CO2 emitted per MWh from pricing sources in the third country, group of third countries or the region. region within a third country (borrowing from its practice in the context of trade defense instruments such as anti-dumping investigations). Where such information is not available, “alternative default values” will be used, based on the average CO2 intensity of electricity produced from fossil fuels in the EU.
Calendar with tentative dates for the EU CBAM legislative process and its implementation
The ‘Fit for 55’ package will now go through the ordinary legislative procedure whereby the proposed regulation text can be amended by the European Parliament or the Council, provided that the other agrees, and that the Commission actually accepts them. . This procedure, known as a trilogue, will involve negotiations between the European Parliament, Council Member States and the European Commission on any proposed amendment or new provision. It normally takes around 18 months before the final text of the regulation is adopted and EU-27 member states are required to apply it in their national legal orders.
Perhaps one of the most controversial features of the proposal is its provision for a transitional period to cover the three-year period from January 1, 2023 to December 31, 2025. During this period, the CBAM will only apply in as a quarterly reporting obligation. – delivery of CBAM certificates to be purchased from the ANC will not be required. The impact assessment of the Commission proposal contains an estimate that CBAM will initially involve 1,000 operators carrying out 239,000 import transactions on an annual basis from 510 production sites outside the EU, from so the need for a “warm-up” period is understandable, but some will see this as an unnecessarily slow start.
The most important provisions (concerning for example the return of CBAM certificates) will not come into force until January 1, 2026.
International trade law issues for companies and governments arising from the impact on carbon leakage, free allowances and export refunds
In its own own-initiative resolution of March 2021, the European Parliament supported the introduction of a CBAM, provided that it is compatible with WTO rules and EU free trade agreements in not being discriminatory or constituting a disguised restriction on international trade (see link to Dentons alert).
CBAM is likely to be controversial with many EU trade partners in the WTO and their exporters who have already criticized the continued use by member states of free allocations, albeit for a limited period. Likewise, certain Member States and their industries affected by the CBAM proposal are likely to challenge the abolition of export refunds relating to carbon allowance payments when they consider that their exports are disadvantaged on world markets.
Recently, EU industries such as aluminum producers have challenged the Commission’s expectation that the proposed mechanism would support the EU’s green targets, in particular to better tackle the inherent GHG emissions of the EU. EU industry and international trade, while being non-discriminatory and striving for a level playing field globally. Indeed, they believe carbon leakage will be encouraged rather than reduced, with more GHG sensitive products imported from countries with lower carbon emission control standards. The Commission’s impact assessment reflects a concern about the “reshuffle of resources”, and the proposal focuses entirely on what might be called primary products, rather than more “downstream” products produced at from these products. While this would give the Commission the power to combat “circumvention practices”, there is no guarantee that the CBAM, even if it survives a legal challenge, will actually achieve its objectives.
The European Parliament will probably support the Commission’s wish that the revenue generated by the CBAM be used as part of a basket of own resources (i.e. funds that belong to the EU and can be spent by EU) to strengthen support for Green Deal objectives within the EU budget, and to help poorer households with transport and housing. Again, this may encourage non-EU countries and exporters to challenge possible illegal subsidies under the WTO Subsidies Agreement, depending on who the actual beneficiaries are, or aid from the WTO. ‘Illegal state of the EU if the financial support is actually provided by the member states.