The European Parliament and European Council voted in favor of implementing the Carbon Border Adjustment Mechanism (CBAM) after reaching a provisional agreement on the CBAM in December 2022. Several countries and the European Union (EU) have long considered enacting legislation that imposes a fee on imported carbon-intensive goods to reach their own climate goals while protecting domestic industry. Carbon border adjustment mechanisms seek to accomplish this goal by imposing a carbon fee on imports of certain products manufactured in countries without equivalent greenhouse gas (GHG) reduction mechanisms for the relevant product or sector. The EU CBAM will apply to imports of certain products from the U.S. and other countries with less stringent GHG reduction programs than those imposed within the EU, such as the EU Emissions Trading System (EU ETS).

Key Takeaways

• The European Parliament and European Council formally approved the CBAM. It is one piece of the EU’s “Fit for 55 in 2030 Package,” which includes reforms to the EU ETS and the creation of an EU Social Climate Fund.
• Over the past several years, U.S. lawmakers have floated similar CBAM mechanisms. These could resurface following the implementation of a CBAM program in the EU or other major trade partners.
• The CBAM will enter into force on October 1, 2023.
• Beginning in 2026, the importation of covered products into the EU—including from the U.S.—will be subject to CBAM requirements.
• Additional CBAM requirements will be phased in gradually between 2026 until 2034 at the same speed as the free allowances in the EU ETS are phased out.

European Union Carbon Border Adjustment Mechanism

The CBAM will work in tandem with the EU ETS to reduce greenhouse gas emissions by targeting imports of carbon-intensive products. It is one of several EU programs dedicated to reducing greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels and achieving climate neutrality within the EU by 2050.

The CBAM will initially cover the following products and sectors: iron and steel, cement, fertilizers, aluminum, electricity, hydrogen, and certain precursors to these goods. After a transition period, the European Commission will determine whether to expand the scope of the CBAM to include other goods, such as organic chemicals and polymers, with an initial focus on carbon-intensive goods. The long-term goal is for CBAM to cover all products and sectors covered by the EU ETS by 2030. The EU ETS currently encompasses:

• Carbon dioxide (CO2) emitted in relation to:
  • electric power generation and heat generation,
  • energy-intensive industry sectors, including oil refineries, steel works, metals production, cement, lime, glass, ceramics, pulp/paper/cardboard, acids, and bulk organic chemicals;
  • aviation within the EU;
• Nitrous oxide from the production of nitric, adipic, and glyoxylic acids and glyoxal (which are used as raw ingredients in a range of other products); and
• Perfluorocarbon emissions from the production of aluminum.

Companies importing covered products into the EU will have to purchase sufficient CBAM certificates if they exceed EU emissions standards to account for the difference between (i) the carbon price paid in the country of production (if any) and (ii) the price of carbon allowances in the EU ETS. The price of the CBAM certificate will vary depending on the price of European Emission Allowances.

The final text of the CBAM will be published in the Official Journal of the European Union, and the CBAM will enter into force on October 1, 2023. For the first three years, producers will only be required to report the emissions of their products. Beginning in 2026, producers must purchase CBAM certificates at a price set by the EU ETS. The CBAM requirements will be phased in gradually between 2026 and 2034 at the same speed as the free allowances in the EU ETS are being phased out.

The CBAM intends to encourage producers to reduce their greenhouse gas emissions in manufacturing. Producers who trade with the EU can reduce their emissions, either voluntarily or under governmental programs, or pay the price of CBAM certificates. The CBAM applies equally to all covered goods imported into the EU, designed to prevent carbon leakage (i.e., when producers relocate their practices to countries with less stringent environmental policies).

U.S. Carbon Border Adjustment Developments

Formal implementation and adoption of the EU CBAM may trigger discussions of establishing a CBAM for the U.S. – a development that was gaining traction among U.S. lawmakers last year. In December 2022, before the passage of the EU provisional agreement on the CBAM, the Biden Administration, through the Office of the U.S. Trade Representative, sent a “concept paper” to the EU, proposing a trade agreement that would create a global “club” of countries seeking to reduce carbon emissions. The paper proposes imposing tariffs on metals with higher carbon emissions, such as steel and aluminum, from countries outside the club. These efforts intend to encourage trade in metals produced with less carbon emissions.

In addition to efforts from President Biden, Congress also has considered several bills in the recent past aimed at creating a carbon border adjustment for the United States, sometimes in tandem with a national carbon pricing scheme. While past bills failed to gain bipartisan support during the prior legislative session, discussions continue regarding introducing a U.S. carbon border adjustment mechanism. As these new mechanisms unfold, B&D continues to track and provide advice on national and global developments related to carbon border adjustment developments.

Beveridge & Diamond’s Air and Climate Change practice group helps private and municipal clients navigate all aspects of carbon markets and climate change initiatives, including state and federal regulatory programs, obligations arising under international agreements, private governance, and sustainability initiatives. For more information, contact the authors.