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The EU’s carbon border adjustment mechanism enters its transitional phase on 1 October 2023, meaning that UK businesses exporting to the EU must prepare for the changes.

The EU’s carbon border adjustment mechanism (CBAM) is a policy developed by the EU to prevent ‘carbon leakage’. UK businesses exporting to the EU need to be aware of what data their EU customers will require and how their business may need to evolve to remain competitive.

Background

Carbon leakage occurs when companies move carbon-intensive production abroad to countries where less-stringent climate policies are in place. In effect, locally made goods are replaced with imports, which may be more carbon intensive.

The reason that carbon leakage may occur in the EU is that it has a carbon pricing system. This system, the EU emissions trading scheme (ETS), places a price on the emission of carbon in certain sectors. Businesses in these sectors currently receive ‘free allowances’. This means that they are allowed to emit a certain amount of carbon before they must start paying for it. The ETS free allowances are gradually being phased out to support decarbonisation of EU industry. 

The CBAM will place a price on the carbon emissions of goods imported into the EU to bring the carbon price on those goods in line with goods manufactured within the EU. The intention is that this will stop businesses that are losing their free allowances from shifting production to countries without a carbon pricing system.

How will it work?

The CBAM will initially apply to imports into the EU of certain goods whose production is carbon intensive. This includes:

  • cement;
  • iron and steel;
  • aluminium;
  • fertilisers;
  • electricity; and
  • hydrogen.

It will enter into force on 1 October 2023, but will initially be in a transitional phase. During this phase, importers of goods within scope of the CBAM will have to report greenhouse gas emissions embedded in their imports. However, no financial payments (adjustments) will be necessary.

During the first year of implementation, companies will be able to report emissions in one of three ways:

  • full reporting according to the EU method;
  • reporting based on equivalent third-country national systems; or
  • reporting based on reference values.

The EU method is set out within the implementing regulations for the EU CBAM. From 1 January 2025, it will be the only acceptable method of embedded emissions reporting.

From 1 January 2026, importers will need to declare the quantity of goods imported into the EU in the preceding year and their embedded emissions. The importer will then surrender a corresponding number of CBAM certificates, which will be priced depending on the weekly average auction price of EU ETS allowances. As EU ETS free allowances are phased out between 2026 and 2034, the price of CBAM certificates should increase, thus increasing the incentive for EU businesses to decarbonise their supply chain.

What does this mean for UK businesses?

UK businesses may not themselves be required to report under the EU CBAM (unless they are acting as importer in their own name in the EU). However, UK exporters to the EU will be expected to provide emissions data to allow their EU customers to meet their obligations. 

Exporters to the EU should start considering whether they are able to provide the necessary data. This might include: 

  • commodity codes of goods;
  • country of origin;
  • direct emissions from:
    • fuel combustion;
    • waste gas; and
    • process emissions;
  • indirect emissions from electrical energy consumed.

Although companies will be able to report based on reference values until 1 January 2025, EU businesses may be looking for early reassurance that non-EU suppliers will be able to provide the relevant data in the correct format.

As well as data requirements, the EU CBAM will impose an actual cost on carbon-intensive imports from 1 January 2026. UK businesses should be thinking about how to decarbonise to ensure they remain competitive. 

What’s next?

Although the CBAM will apply to six sectors initially, the intention is that all sectors covered by the EU ETS will be within scope of the CBAM by 2030. For example, the expansion could bring the production of glass or chemicals within scope of the CBAM.

Other countries are also looking to implement CBAMs. The UK government has consulted on introducing a UK CBAM, most likely following a similar timetable to the EU CBAM. More details on the outcome of this consultation are expected in the coming weeks.

Further reading

 

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