EU Reaches Provisional Agreement On Carbon Import Charge – International Trade & Investment

Key Points

• The co-legislators of the EU recently reached a provisional
  agreement on a regulation for a CBAM.¹




• CBAM will require importers to the EU of covered
  carbon-intensive products to pay a charge for the carbon embedded
  in such products identical to the charge imposed on EU producers
  under the EU ETS.




• If approved, CBAM will apply effective October 1, 2023, subject
  to a transition period during which the obligation of the importer
  would be limited to reporting requirements. The EU will phase-in
  the CBAM charge over a period of nine years, starting in 2026.




• CBAM agreement requires formal approval by ambassadors of the
  EU member states and the European Parliament, which is expected to
  happen during the first quarter of 2023. While the main features of
  the agreement are known, the text is currently undergoing technical
  and legal checks. Although not yet released officially, the draft
  text has been leaked.




• Businesses that import carbon intensive products to the EU, or
  produce such products, should pay close attention to these
  developments, as they could soon face significant reporting
  requirements and—eventually—charges for carbon
  usage.

What is CBAM?

The Carbon Border Adjustment Mechanism (CBAM) is part of the
European Union’s (EU) “Fit for 55” package, a series
of legislative proposals aimed at reducing EU greenhouse gas
emissions by at least 55 percent by 2030 as compared to 1990
levels. It is companion legislation to the EU emissions trading
system (ETS), which imposes charges on high-carbon emitters in the
EU by requiring that producers of these products relinquish carbon
emission certificates to the government equal to the amount of
carbon they release during production.

With CBAM, the EU aims to reduce “carbon leakage,”
which occurs when producers move production from a country with
strict emission constraints (such as the EU ETS) to a country with
less burdensome requirements or when customers increase imports of
carbon-intensive products instead of purchasing domestic products
subject to these emissions standards. The imposition of CBAM
signals a policy shift in the EU in the method used to address
carbon leakage. Under current rules, the EU provides free
allowances to certain EU producers subject to the EU ETS to allow
them to better compete with products produced in jurisdictions
without strict emissions constraints. With the imposition of CBAM,
the EU will impose a tax on imported products made in countries
that impose no or a low carbon charges. The scheme seeks to
equalize the price of carbon paid for EU products under the EU ETS
and the carbon price for imported products.

How will CBAM work?

Under CBAM, importers into the EU of covered products will have
to buy carbon emission certificates for a price that corresponds to
the carbon price an EU producer of the goods would have paid
(through the purchase and submission of carbon emissions
certificates) under the EU ETS. Non-EU producers that have already
paid a price for the carbon used in the production of the imported
goods in a third country may deduct the corresponding cost. This
means that—in principle—exporters in countries that
impose a carbon charge under an ETS, such as Korea and Singapore,
can deduct the corresponding carbon charge from the amount due
under CBAM when importing covered products into the EU. However,
this deduction is not available to imports from countries that do
not impose a carbon charge, such as the United States,²
even if those countries impose other measures to reduce carbon
output such as imposing carbon limits.

CBAM exempts some countries from coverage altogether, including
Switzerland, which has imposed an ETS linked to the EU ETS, and the
European Economic Area (EEA) countries (Norway, Iceland,
Liechtenstein) who participate in the EU ETS. The EU may eventually
conclude agreements with additional third countries that implement
an ETS, exempting covered products from the application of CBAM
reporting requirements or charges. The EU may also consider
specific exemptions for third countries or territories which have
an electricity market integrated with the EU.

The price of CBAM emissions certificates will depend on the
weekly average auction price of EU ETS allowances expressed in euro
per tonne of CO₂ emitted. In other words, the price for
CBAM certificates will mirror the price of EU ETS allowances.

CBAM will gradually replace the free allocation of EU ETS
allowances which are currently granted to the most energy-intensive
EU industries (which comprise 94 percent of industrial
emissions).³

What products will subject to CBAM?

CBAM will initially apply to imports of the following
products:

• Cement




• Iron and steel




• Aluminum




• Fertilizers




• Electricity




• Hydrogen.

In addition, certain precursors and a limited number of
downstream products, such as screws, bolts and similar articles of
iron or steel, will be covered by CBAM.

These sectors and products were selected by the EU because these
industries have high carbon emissions and intensity and also face a
high risk of carbon leakage. In addition, EU legislators determined
that implementing CBAM was feasible from an administrative and
technical perspective for these sectors.

EU legislators intend CBAM to have broad product coverage, and
the list of covered products is expected to expand as the mechanism
evolves. Before 2026, the European Commission will assess possible
expansion of CBAM to other products at risk of carbon leakage,
including organic chemicals and polymers. The goal is to include
all products covered by the EU ETS by 2030, which currently covers
the following sectors and gases:⁴

• Carbon dioxide (CO₂) from




• Electricity and heat generation




• Energy-intensive industry sectors including oil refineries,
  steel works and production of iron, aluminum, metals, cement, lime,
  glass, ceramics, pulp, paper, cardboard, acids and bulk organic
  chemicals




• Commercial aviation within the EEA




• Nitrous oxide (N₂O) from production of nitric,
  adipic and glyoxylic acids and glyoxal




• Perfluorocarbons (PFCs) from production of aluminum.

Under certain conditions, indirect emissions, such as emissions
generated from electricity used for manufacturing, heating or
cooling during the production process will also be used as a basis
for CBAM charges. The Commission will assess the methodology for
indirect emissions before the end of the transition period.

How will emission values be calculated?

CBAM will apply to direct emissions of greenhouse gasses emitted
during the production process of the imported products. The methods
for calculating emission rates will be set out in an annex to the
Regulation.

Calculations for the emissions will be based on the total
embedded emissions, expressed as tonnes of CO₂e per
megawatt-hour of electricity or, for other goods, such as
CO₂e emissions per tonne of each type of good.

When a CBAM declarant cannot accurately determine actual
emissions, default values will be used. Default values for goods
other than electricity will be set at the average emission
intensity of each exporting country and increased by a
“proportionately designed” mark-up. Default values for
electricity will be set at the CO₂ emission factor in
the third country based on the best data available to the European
Commission.

When will CBAM apply?

Under the provisional agreement, CBAM will be subject to a
transitional implementation period. It will begin in October 2023
only as a reporting obligation, i.e., no charge will be imposed.
From 2026 onwards, CBAM charges will be phased-in over a nine-year
period, as follows:

• 2026: 2.5%




• 2027: 5%




• 2028: 10%




• 2029: 22.5%




• 2030: 48.5%




• 2031: 61%




• 2032: 73.5%




• 2033: 86%




• 2034: 100%.

In parallel, the free allocation of allowances under the EU ETS
will be phased out at the same rate. CBAM will therefore start in
2026 and be fully phased-in by 2034.

Is CBAM WTO compatible?

The EU has stated that it designed CBAM to be compatible with
the World Trade Organization (WTO).⁵ However, WTO
members and others have raised questions about CBAM’s
compliance with the EU’s WTO obligations. WTO rules are
relevant not only to the broader question of whether a carbon
charge may be legitimately imposed on imports into the EU, but also
to the specific elements of the scheme, including the methodologies
for calculating the emissions and the import charge, the collection
methods, any exemptions, any free allowances given to EU industry,
and the reporting requirements, among others. The relevant WTO
rules include:

• MFN obligation: The most favored-nation
  treatment (MFN) obligation in Article I of the WTO General
  Agreement on Tariffs and Trade (“GATT 1994”) requires
  that any advantage granted to the imported products of one WTO
  member must be accorded immediately and unconditionally to the like
  products originating from all other WTO members. If CBAM
  discriminates between “like” products imported from
  different countries, Article I would be violated.




• National treatment obligation: Article III:2
  of the GATT 1994 requires that imported products be treated no less
  favorably than similar domestically produced goods with respect to
  internal taxes. If CBAM charges are considered an internal tax,
  CBAM must not treat imported products worse than the like domestic
  products. The EU may argue that, because EU producers are subject
  to an identical charge under the EU ETS, there is no discrimination
  between domestic and imported products. Further, if CBAM imposes
  more burdensome reporting, bookkeeping or administrative
  requirements on imported products, compared to like domestic
  products, this could violate GATT 1994 Article III:4.




• Tariff commitments: Under Article II of the
  GATT 1994, the EU has committed to a maximum customs duty
  (“bound rate”) on imported products. If CBAM charges are
  viewed as a customs duty, CBAM may be determined to exceed the
  EU’s bound rate. However, Article II:2(a) allows WTO members to
  impose a charge equivalent to an internal tax if certain conditions
  are met. These charges are known as “border adjustments,”
  and the EU may try to raise this provision based on the EU ETS if
  it faces an Article II challenge.




• Obligations related to quantitative
  restrictions: Article XI:1 of the GATT 1994 prohibits
  quantitative import restrictions. CBAM may be inconsistent with
  Article XI if it is viewed as a border restriction, rather than a
  tariff or an internal regulation, that de facto imposes
  quantitative restrictions on imports.




• Obligations related to the administration of trade
  regulations: Article X:3 of the GATT 1994 requires that
  members administer their trade regulations in a fair, reasonable
  and impartial manner. CBAM may be inconsistent with Article X:3 if,
  in practice, it imposes a higher administrative burden on imported
  goods compared to domestic goods.

Even if CBAM violates the EU’s WTO-obligations as described
above, the EU could claim that CBAM is justified under the general
exceptions contained in Article XX of the GATT 1994. Article XX
allows WTO members to apply measures that would otherwise be
inconsistent with the agreement under certain conditions. The EU
would have to show that CBAM is necessary to protect human, animal
or plant life or health, or measures relating to the conservation
of exhaustible natural resources. The EU additionally would have to
establish that CBAM comports with the chapeau of Article
XX; namely, that it is not “arbitrary or unjustifiable
discrimination between countries where the same conditions
prevail” or a “disguised restriction on international
trade.”

Finally, the EU industry has called for an export rebate for EU
producers that export products subject to a charge under the EU
ETS. The CBAM agreement reached by EU legislators does not include
such a mechanism over fears that it would be inconsistent with WTO
rules. However, the European Commission has been tasked with
assessing the risk of carbon leakage for products produced in the
EU and intended for export to non-EU countries. Accordingly, the
Commission will produce a report by 2025 and, if needed, present a
legislative proposal compliant with WTO rules to address this
risk.⁶

Next steps

The CBAM agreement is conditional on a formal approval by the
co-legislators of the EU—the Council of the EU (where EU
governments are represented) and the European Parliament. The text
of the agreement is expected to be formally published in the next
two weeks, with a plenary vote in Parliament in March. If approved,
the new law would come into force 20 days after its publication in
the EU Official Journal.

Footnotes

1. Press Release: Deal reached on new carbon leakage
instrument to raise global climate ambition, European
Parliament

2. There are indications that the EU may be open to
negotiating a separate solution with the United States, exempting
U.S.-origin goods from CBAM.

3. European Commission (2019). Adoption of the Delegated
Decision on the carbon leakage list for 2021-2030.

4.
EU Emissions Trading System (EU ETS), European Commission

5. European Green Deal: Agreement reached on the
Carbon Border Adjustment Mechanism (CBAM), European Commission (13.
Dec, 2022)

6. Climate change: Deal on a more ambitious Emissions
Trading System (ETS), European Parliament (18 December
2022