In July 2021, a new Carbon Border Adjustment Mechanism was proposed by the European Commission. The mechanism will impose a levy on imports of specific products so that ambitious climate action does not lead to ‘carbon leakage’ in Europe. The aim of this mechanism is to ensure that reductions in the carbon emissions emitted from Europe contribute to a decline in global emissions, as opposed to pushing carbon-intensive production outside Europe. The European Commission also aims to encourage industry outside the EU, as well as the EU’s international partners, to impose similar carbon prices.
As the EU imposes more stringent environmental and climate policies and while non-EU countries adopt lower climate ambition and more lax policies, it runs the risk of ‘carbon leakage’. ‘Carbon leakage’ refers to EU-based companies moving carbon-intensive production abroad in order to benefit from non-EU countries’ less stringent carbon policies or EU products could be replaced by more carbon-intensive products.
Carbon leakage can undermine EU carbon reduction and climate-related efforts, as it can shift carbon emissions outside of Europe, as opposed to generally reducing such emissions. The Commission’s proposal for a Carbon Border Adjustment Mechanism (CBAM) aims to reduce such carbon leakage while supporting the EU’s carbon reduction goals while remaining World Trade Organization (WTO) compliant.
The CBAM will equalise prices of carbon between domestic products and imports, ensuring that the EU’s climate change efforts are not undermined by companies outsourcing their carbon-intensive production to non-EU countries.
The CBAM was designed in compliance with WTO’s rules. It will work as follows: EU importers will purchase carbon certificates corresponding to the price that they would have paid had their products been produced under EU carbon pricing rules. If a non-EU producer can show that they have paid a price for carbon emissions generated in the production of imported goods in a non-EU country, this cost can be deducted for their EU import. The CBAM will also reduce the risk of carbon leakage by encouraging non-EU producers to green their production processes.
The CBAM will be phased in gradually. The mechanism will apply only to a selected number of goods at high risk of carbon leakage in its initial phase: iron and steel, cement, fertiliser, aluminium and electricity generation. The definitive system aims to be fully operational by 2026 and EU importers will have to declare the quantity of goods and the amount of embedded emissions in the total goods imported into the EU annually in the preceding year. They will also have to provide the corresponding amount of CBAM certificates.