Climate change presents serious risks to our planet and tackling them requires new methods for managing carbon. One such method is the Carbon Border Adjustment Mechanism (CBAM), which aims to prevent carbon leakage and promote cleaner production techniques globally. This blog is intended to serve as a detailed guide for comprehending and computing CBAM.

What is CBAM?

CBAM also known as Carbon Border Adjustment Mechanism is a policy introduced by the European Union to address climate change. Here's a breakdown of how it works:

• Goal: Reduce carbon emissions and create a level playing field for European businesses.
• Mechanism: Places a fee on imports of certain carbon-intensive goods, like steel and cement.
• Target: The fee aims to account for the carbon emissions generated during production in the exporting country.
• Impact: This discourages producers from moving their operations to countries with weaker environmental regulations (carbon leakage) and incentivizes cleaner production methods globally.

The CBAM is in a transitional phase, with reporting requirements starting in 2023 and full implementation by 2026. However, CBAM is also a complex policy with potential drawbacks like increased administrative burdens for businesses and potential trade disputes.

Key Components of CBAM

1. Scope: CBAM initially applies to a select group of sectors at high risk of carbon leakage, including cement, electricity, fertilizers, iron and steel, and aluminum.
2. Carbon Price: The carbon price is calculated based on the carbon content of the imported goods and the price of EU carbon allowances under the Emissions Trading System (ETS).
3. Reporting Requirements: Importers must report the embedded emissions in their goods and the carbon price paid in the country of origin.

Knowing your CBAM liability

Understanding CBAM liability involves several steps. However, the process of adjusting the carbon price paid to determine the CBAM liability will be mandatory only from its definitive phase in 2026.

1. Determine the Embedded Carbon Emissions: This step involves calculating the total greenhouse gas (GHG) emissions associated with the production of the imported goods. This includes direct emissions from the manufacturing process and indirect emissions from the consumption of electricity and other energy sources.
2. Adjust for Carbon Price Paid: If the country of origin has a carbon pricing mechanism, the importer can subtract the amount already paid for carbon emissions from the total CBAM liability.
3. Apply the EU Carbon Price: The remaining carbon content is then priced based on the current price of EU carbon allowances under the ETS. This is typically expressed in euros per tonne of CO2 equivalent (€/tCO2e).
4. Calculate the CBAM Liability: The final CBAM liability is the product of the remaining carbon content and the EU carbon price.

CBAM Calculation Example

Let’s consider a simplified example:

1. Carbon Content: An importer brings in 1000 tonnes of steel. The production of this steel resulted in 1.8 tonnes of CO2 emissions per tonne of steel, giving a total of 1800 tonnes of CO2.
2. Carbon Price Paid: The country of origin has a carbon price of €20/tCO2e, and the importer has already paid €36,000 (1800 tonnes * €20/tCO2e).
3. EU Carbon Price: The current EU carbon price is €50/tCO2e.
4. Remaining Liability: The importer needs to pay the difference between the EU carbon price and the price already paid: Remaining Liability=1800 tonnes×(€50−€20) per tonne=1800×€30=€54,000\text{Remaining Liability} = 1800 \, \text{tonnes} \times (€50 - €20) \, \text{per tonne} = 1800 \times €30 = €54,000Remaining Liability=1800tonnes×(€50−€20)per tonne=1800×€30=€54,000. Therefore, the importer owes an additional €54,000 under the CBAM.

CBAM Challenges and Future Prospects

While CBAM is a powerful tool for promoting global climate action, it comes with challenges:

• Data Availability: Accurate calculation of carbon content requires detailed data on production processes and energy consumption.
• Trade Relations: CBAM could strain trade relations with countries that perceive it as a protectionist measure.
• Implementation Complexity: Administering CBAM involves complex reporting and verification processes. CBAM represents a crucial step toward achieving global carbon neutrality despite these challenges. By aligning economic incentives with environmental goals, CBAM can drive innovation in cleaner technologies and encourage countries worldwide to adopt more ambitious climate policies.

CBAM represents a major step in the global fight against climate change. By grasping and precisely calculating CBAM, businesses can enhance their ability to deal with the complexities of international trade and contribute to a more sustainable future. As the EU and other regions continue to improve and broaden CBAM, it will be crucial for all stakeholders to stay informed and prepared. Additionally, organizations affected by CBAM regulations should be prepared to submit their quarterly reports by the end of July 2024.

Reference - https://taxation-customs.ec.europa.eu/carbon-border-adjustment-mechanism_en