What is the EU Carbon Border Adjustment Mechanism (CBAM)?
The EU's new plan to decarbonise the European economy could have profound impacts for UK exporters.
As part of the large range of policies aiming to decarbonise the European economy, collectively known as the ‘European Green Deal’, the EU is set to introduce a Carbon Border Adjustment Mechanism (CBAM) by the end of 2022.
What is the Carbon Border Adjustment Mechanism?
Currently, carbon emissions from environmentally damaging sectors, such as manufacturing and power generation, inside the EU are monitored and charged through the EU Emissions Trading System (ETS). This limits the level of carbon emissions a firm can legally emit and allows them to ‘buy’ further emissions allowances from other businesses. There is currently no policy that does the same for goods not originating in the EU.
The general aim of the CBAM is to ensure that goods that are imported into the EU are treated in a similar way to those that were produced domestically and to disincentivise ‘carbon leakage’ – where a company transfers part of its production to a country with less strict environmental regulations and then re-imports the finished product.
To do this, EU importers of certain goods will be required to calculate and declare the carbon emissions embedded within their imports from the last year to the CBAM authority. The authority will also sell ‘CBAM certificates’ based on the current price of carbon allowances under the Emissions Trading System. Importers will then be required to use these certificates to ‘pay’ their carbon bill. The hope is that this will make less carbon-intensive imports more attractive.
How does this impact the UK?
According to leaked draft documents for the policy proposal, the CBAM will focus on high carbon-emitting sectors including electricity production, iron, steel and aluminium, cement, and fertilizers.
Because of this, the UK is the second most exposed country to the proposal, primarily due to high levels of ‘iron and steel’ and aluminium exports. This new cost associated with importing carbon-intensive goods could make UK exports distinctly less attractive in their traditional largest market. Analysis by the London School of Economics suggests that up to one-third of the total value of all UK goods exported to the EU could be affected by the policy. The only other country that is predicted to bear a larger overall cost – under modelling by Sam Lowe at the Centre for European Reform – is Russia (below).
As well as the additional cost that this presents to importers of UK goods, calculating the carbon emissions embedded within goods can be incredibly complex, with the carbon emissions throughout the goods’ supply chain needing to be taken into account. If it is not possible for a business to calculate the emissions associated with their goods, then a default figure will be used, based on the emission record of the EU’s 10% worst emitters.
One saving grace is that the draft proposal notes that the total cost of a CBAM charge will be reduced if the country of origin already implements a carbon charging system, similar to the EU’s Emissions Trading System, or a domestic carbon tax. As the UK has now left the ETS, the UK ETS came into force at the end of April 2021 meaning that UK goods would not be charged as heavily. This reduction would be based on how much the domestic system or tax charged for carbon, meaning that imports from the UK may well be more attractive than those from a country with a less ambitious carbon trading system or without one at all e.g. Russia or Turkey.
The CBAM proposal has been approved by the European Parliament, while the European Commission is set to announce further details about the policy and its implementation in July. The policy is set to be first implemented by the end of 2022.