Green Energy Trade Shift: implications of the new EU CBAM norms

As part of EU’s trade policy for green energy, the CBAM seeks to strike a balance between the carbon pricing norms that apply to goods imported into EU and the goods produced domestically in EU.

In brief

• The EU’s carbon adjustment mechanism will initially cover in its ambit certain goods whose production is carbon intensive and is at high risk of carbon leakage: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen.
• With the CBAM's enforcement on the horizon and regulatory requirements set to kick in from October 1, 2023, it is important for India to evaluate its trade approaches and make necessary preparations.

In the quest to plug carbon emissions leakage, the European Union’s (EU) carbon border adjustment mechanism (CBAM) is the latest addition to the green energy practices adopted around the world. Essentially, the benefit of this measure is to encourage green energy imports. The CBAM came into force on 17 May 2023¹. A transitional period of the CBAM will commence from 1 October 2023 and last through the year 2025². The first reporting period for importers will end on 31 January 2024³. The obligation for importers under CBAM, which is being referred to as the world’s first carbon border tax, to pay a charge in respect of their imports will enter into force on 1 January 2026⁴.

As part of EU’s trade policy for green energy, the CBAM seeks to strike a balance between the carbon pricing norms that apply to goods imported into EU and the goods produced domestically in EU. While the latter are subjected to the existing EU Emissions Trading System (ETS), in the former category the importers will be required to pay for the greenhouse gas (GHG) emissions embedded in certain carbon-intensive products by purchasing CBAM certificates. The price of CBAM certificates will be pegged to the price of emission allowances (European Union Allowances / EUA) auctioned under the ETS⁵,  calculated based on the weekly average auction price of EUA expressed in €/tonne of CO2 emitted⁶. 

CBAM will be phased in between 2026 to 2034 while the EU ETS free allowances (cap) will be gradually reduced⁷. During this period of 2026-2034, CBAM will apply only to the proportion of emissions that does not benefit from free allowances under the EU ETS⁸.

The CBAM system will mirror the EU ETS and will work as follows: 

• CBAM will be applied on the actual declared carbon content embedded in the goods imported in the EU, according to a formula that will reflect the effects of the EU ETS on the production of similar goods in the EU⁹. 
• From 2026 EU importers will buy CBAM certificates corresponding to the carbon price that would have been paid had the goods been produced under the EU's carbon pricing rules¹⁰.
• Conversely, if a non-EU producer has already paid a carbon price in a third country on the embedded emissions for the production of the imported goods, the corresponding cost can be fully deducted from the CBAM obligation¹¹.

Scope of the CBAM

The CBAM aims to level the playing field for EU’s domestic as well as imported products by ensuring that the imported products also incur comparable CO2 costs and prevent domestic businesses from shifting their production plants / operations to non-EU countries¹².

The EU’s carbon adjustment mechanism will initially cover in its ambit certain goods whose production is carbon intensive and is at high risk of carbon leakage: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen¹³. By the end of the transition phase, a review report will be prepared of the CBAM's functioning¹⁴. The report will also assess the inclusion of other goods produced in sectors covered by the EU ETS in the scope of the CBAM mechanism, such as certain downstream products¹⁵,  which will be included by 2030¹⁶.

CBAM and trade policy issues 

The EU has claimed that the CBAM has been designed to be compatible with the World Trade Organization (WTO) and its other international obligations and simply seeks to place EU based producers at par with the non-EU producers in terms of the carbon cost embedded in the covered products. At a preliminary level this seems questionable due to the trade implications of CBAM. Hitherto, border measures allowed under the WTO have been agnostic of the production process or method (PPM) adopted in its manufacture. For example, whether cotton is grown organically or using chemical fertilisers, the customs duty is the same. With CBAM this long held principle is being changed as the same product depending on the production process (i.e., its carbon intensity) will face differential taxation.