The EU’s Carbon Tariff: An Overview and Implications

November 1, 2023

The European Union (EU) has initiated the first phase of its Carbon Border Adjustment Mechanism (CBAM), marking a significant policy shift with the introduction of the world’s first carbon tariff. The CBAM primarily targets imports of carbon-intensive products such as iron, steel, cement, aluminum, electricity, fertilizers, and hydrogen. The mechanism aims to address the issue of ‘carbon leakage’, where companies move operations to regions with less stringent emissions regulations, by equalizing the cost of carbon emissions between EU and non-EU producers.

Under this new mechanism, if the carbon intensity of imported materials exceeds that of similar EU products, importers will be required to purchase certificates from the European Emissions Trading System (ETS) to cover the excess emissions. The initial phase, which commenced on October 1, mandates EU importers to start collecting data on embedded emissions of imported products, to be reported by January 31, 2024. Although the tariff payments will not start until 2026, non-compliance in reporting could lead to fines of up to €50 (EUR) per ton of CO2.

The tariff is projected to cover 2.5% of global emissions and could raise over US$80 billion per year by 2040. This policy change presents several challenges for companies, particularly those in certain exporting nations:

Cost of Compliance:

The primary challenge lies in the cost associated with adhering to the new regulations. The obligation to buy certificates could pose a financial burden, particularly for companies from countries where emission reduction costs are high. Countries like China and Ukraine have voiced concerns regarding the high adaptation costs affecting their competitiveness in the EU market.

Data Collection and Reporting:

The requirement for meticulous data collection and reporting on embedded emissions presents an operational challenge. Companies may need to invest in new systems or processes to accurately track and report emissions, which may be technically and financially demanding.

International Trade Relations:

The CBAM has stirred discussions regarding its potential impact on free trade. Although the EU emphasizes that the aim is not trade protection but to protect the EU’s climate ambition, the mechanism could inadvertently affect trade relations between the EU and other nations.

Alignment with Existing Emissions Trading Systems:

Integrating the CBAM with existing ETS’ and other global climate policies will be complex. A harmonized approach is needed to ensure the CBAM operates seamlessly alongside other emission reduction mechanisms.

Legal and Regulatory Hurdles:

Companies may also face legal and regulatory challenges, both within the EU and in their home countries. The novelty of the CBAM may lead to legal challenges and disputes as it begins to take effect.

The CBAM is a significant policy initiative that may serve as a model for other regions in the future. As companies prepare for this new regulatory landscape, understanding and addressing the aforementioned challenges will be crucial for navigating the evolving global trade and regulatory environment. Capturiant’s experienced team can help companies navigate this new regulatory environment.

This article was written by Will Baird (Director, Capturiant) and Catalina Row, (Environmental Consultant, Entoro ESG Advisors).

Disclaimer: This blog post is for informational purposes only and should not be considered as financial or investment advice.

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