On the 13th of December, a provisional agreement was reached to create the EU Carbon Border Adjustment Mechanism (CBAM). The CBAM puts an emissions tariff on imports of goods with a high risk of carbon leakage from countries which are not members of the EU Emissions Trading System (ETS).
The agreement is provisional, which means it is still to be adopted by the European Council and the European Parliament. Some details might change in the course of the negotiation and after the transition period ends in 2026.
In this article, you will learn about the ETS, the CBAM’s goal, scope, and obligations, as well as the role of digital solutions in compliance:.
Why do we need CBAM?
The EU aims to reduce emissions by at least 55% by 2030 and become climate neutral by 2050. To reach these goals, the EU has created a variety of climate change measures. One of the most prominent initiatives is the EU Emission Trading System (ETS).
Interested to know about corporate net zero commitments in addition to policy measures? Read our extensive overview of Scope 1, 2, 3 emissions.
The CBAM was created to address some of the disadvantages of the ETS. So, to understand the rationale behind the CBAM, it is important to first comprehend what the ETS is.
Explaining the ETS
The ETS creates a carbon market by using a cap & trade system. A limit on the amount of emissions an organisation can produce is imposed with allowances. Companies below or above these limits trade these allowances. This trade, in turn, defines the market price of carbon.
Currently, the ETS covers CO2 produced from:
- Electricity and heat generation and
- Energy-intensive industries, including
- Oil refineries
- Production of iron, aluminium, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids, and bulk organic chemicals
- Commercial aviation within the European Economic Area
Watch the video to further understand the concept.
An ideal example of an emissions trading system
In a perfect world, carbon markets would be global, and emissions trading can happen between richer countries with high costs for polluting and poorer countries with more affordable emissions reduction measures. Such a global distribution is estimated to reduce the price of fulfilling the Paris agreement by 79%. Another important advantage of a global scheme is that it restricts polluters from moving to jurisdictions not covered by the carbon markets. The ETS, however, is a regional scheme and suffers from discrepancies in coverage across countries.
Loopholes of the EU ETS: CBAM as a solution
The regional nature of ETS gives rise to ‘carbon leakage’ - when it is cheaper to source goods from a region with less regulation or when EU companies move abroad for more lenient climate standards1.
Ultimately, carbon leakage undermines many climate change initiatives, and this is the issue that the CBAM aims to address. The CBAM equalises the price of carbon paid abroad for foreign products and in the EU by putting a tariff on emissions embedded in goods produced outside the ETS.
What is the scope of the CBAM?
The CBAM applies to goods produced in non-EU countries. This includes:
- Goods wholly produced outside the EU
- Goods that underwent their last, substantial production phase outside the EU (in case production involves more than one country)
The CBAM aims to gradually affect the import of all goods covered by the ETS by 20306.
From October 1st 2023 to 2026, there will be a transition period, where the CBAM obligations will be limited to reporting and will apply to goods with high chances of carbon leakage6
- Iron and steel
- Some downstream products containing iron and steel (such as screws and bolts)
- Some chemical elements (hydrogen and precursors)
Starting in 2026, the transition period will end, and importers will start paying adjustments. The European Commission will evaluate other high-risk products to be added to the CBAM. Such products might include organic chemicals and polymers and downstream goods. The Commission will also look into including indirect emissions to the requirements.
Around 2030-2032, the mechanism is expected to be fully implemented. At this point, all goods covered by the ETS will be included in the CBAM.
What are the obligations of the CBAM?
The CBAM forces importing companies to purchase CBAM certificates to pay the difference between the carbon price in the country of production and in the EU1. The costs will not apply if the importer will be able to prove that the producer has paid a corresponding price in a non-EU country7.
Cost of the tariff
With the CBAM certificates, importers will have to pay the same amount per tonne of CO2 emitted as if the goods had been made in the EU. The price of the certificate will be defined by the weekly average auction costs of emission allowances under the ETS.
The CBAM certificates include the price of the goods’ embedded emissions but what exactly are these emissions?
Definition of ‘embedded emissions’
The regulation defines embedded emissions as the direct greenhouse gas emissions from the manufacturing of goods, calculated according to methods set out in Annex III of the CBAM regulation1. Direct emissions are those generated from activities a manufacturer owns or controls.
The European Commission is considering adding indirect emissions to the embedded emissions to be calculated6. The authorities will look into methodologies to include additional emission types after the end of the transition period in 2026.
Read our blog about direct and indirect emissions as defined by the Greenhouse Gas Protocol.
Obligations for importers
To pay the difference in carbon prices for embedded emissions between a third country and the countries covered by the EU ETC, the importers will have to:
- Register with the national authorities before importing the goods. The application should include such information as certification by a tax authority, declaration of honour, and volume of imported goods.
- Declare the number of imported goods and their embedded emissions annually (by the 31st of May of the year preceding the import). The declaration should include data on the number of goods, total embedded emissions, and total amount of CBAM certificates.
- Attain the necessary amount of CBAM certificates. The certificates should offset the declared embedded emissions
- Maintain the compliance documentation
At the same time, to ensure the fulfilment of obligations by importers, the EU will assign CBAM authorities. These representatives will:
- Authorise registration in the CBAM system and assign to each authorised declarant a unique CBAM account number
- Review import declarations
- Sell CBAM certificates
- Establish a national registry of declarants containing the data regarding the CBAM certificates
- Cancel or re-purchase the extra certificates from importers by June 30th each year
Calculation of embedded emissions, however, is a significant undertaking and requires large-scale data management efforts, but several digital solutions can assist with compliance.
How digital solutions support compliance with the CBAM
According to the regulation, the embedded emissions of goods outside of the EU have to be declared before being imported8. Due to the complex nature of modern supply chains, this might bring challenges associated with the inaccessibility of information, confidentiality concerns, errors, and lack of scalability. The issue will become more prominent when the European Commission adds indirect emissions which demand wide-scale data exchange between supply chain actors.
Digital traceability solutions make the emissions accounting process for the CBAM easier.
- First, they enable companies to track products throughout their lifecycle, giving a full overview of the product's history. Different traceability solutions have various specialisations: some are supply chain agnostic, while others focus on certain groups of goods. The product’s history usually includes the composition, origin of materials and parts, the processing history, the distribution and location of the product after delivery, as well as its quality and safety.
- Second, digital traceability tools collect the data necessary for emissions calculations. From a single place, firms can generate product life cycle emission reports to be integrated into the CBAM declarations and other corporate accounts fuss-free.
- Third, digital systems establish a scalable information exchange system and eliminate the need to share emissions data manually through numerous files and surveys.
Want to better understand what ‘traceability’ is? Read our article about the 2 levels of supply chain visibility.
One of the digital solutions available is Circularise’s Digital Product Passports. The software can trace the history of the product, including its emissions. Each physical good gets assigned a passport that moves through the whole supply chain, with key information about the product added to the record at each step. Compared to other traceability tools, Circularise’s software comes with an added layer of confidentiality. Using its proprietary encryption technology called Smart Questioning, supply chain actors can share key insights about the manufacturing process, without revealing any sensitive data. The tool also does not allow a centralised party to tamper with the record. This is key in supporting indirect suppliers to share emissions information.
Read more about Circularise’s Digital Product Passports for suppliers and manufacturers or brands and Original Equipment Manufacturers (OEMs).
Circularise is the leading software platform that provides end-to-end traceability for complex industrial supply chains. We offer two traceability solutions: MassBalancer to automate mass balance bookkeeping and Digital Product Passports for end-to-end batch traceability.