Unpacking Regulations: Navigating the EU's CBAM, Upshots from the First Reporting Periods

By setting the first carbon border tax of its kind, the EU intends to level the playing field between EU and third-country manufacturers of energy-intensive products. Despite significant technical issues causing delays, the CBAM is not stopping and is pushing countries to introduce similar fees. As the EU Carbon Border Adjustment Mechanism (CBAM) plunges importers and suppliers into new carbon emissions reporting requirements, Jules Cordillot comes back to the origins of CBAM and takes stock of the first reporting periods. 

The origins of CBAM: carbon leakage and failures of the ETS 

Carbon pricing is widely seen as a key driver to achieve emissions reduction. In 2005, the EU set the largest emission trading system around the world, through a “cap and trade” system. Contrary to a carbon tax where a public authority determines a specific price to pay for pollution, a ceiling (cap) is set on the maximum amount of emissions that can be emitted. The cap is split into individual allowances, each representing the right to emit one ton of CO2eq. With carbon emission quotas, covered companies are allocated credits which they could then sell or buy according to their needs. The EU ETS has proven effective in reducing the greenhouse gas emissions of the electricity sector. However, the tool has failed to trigger the decarbonization of EU energy-intensive industries, which receive free allowances. Greenhouse gas emissions from the industrial sector have remained largely flat between 2013 and 2019. 

.

Source: E3G and Jacques Delors Institute – Policy Brief

.

Downsides of the ETS – free CO2 quotas 

Much has been written about the French "swindle of the century" when France imposed a Value Added Tax (VAT) on CO2 quotas, leading to the misappropriation of hundreds of millions of euros from 2006 to 2009. This fraudulent activity has also had repercussions across various EU Member States, notably Denmark and the Netherlands. This resulted in losses of approximately 5 billion euros for several national tax revenues. Beyond this fraud, one of the downsides of the ETS lies in the free CO2 quotas. The primary objective of providing free quotas to the most polluting industries was to prevent "carbon leakage", which refers to the potential relocation of activities outside the EU in response to increasingly stringent environmental regulations. According to E3G and the Jacques Delors Institute, from 2005 to 2020 industrial sectors were allocated approximately 10.4 billion free allowances valued at over €138 billion. However, over the same period, those sectors’ cumulative emissions only amounted to approximately 9.1bn tons, meaning they received approximately 1.3bn allowances more than necessary.   

Recently, it was pointed out that the system, which was originally designed for a specific purpose, was diverted to become a means of generating profits for its beneficiaries, who are primarily cement and steel manufacturers. According to Carbon Market Watch, industries involved in the EU ETS garnered additional profits ranging from €16.7 to 29.1 billion across the fifteen most energy-intensive sectors in nineteen EU countries. These profits have primarily been funded by consumers, who have experienced higher electricity costs and increased prices for goods in European markets. In essence, the 'polluter pays principle' has largely remained theoretical, with Europe's most polluting industries receiving billions of euros in subsidies through the EU ETS. 

No more free lunch: CBAM gradual introduction to replace free CO2 quotas 

Because the climate clock is ticking, the EU adopted new energy and climate goals (-55% emissions cut by 2030, and climate neutrality by 2050), and a reform of the ETS was approved with the goal of cutting emissions of the sector covered by the trading system, of 62% by 2030 (against 43% under previous rules). Such a reform could put energy-intensive sectors at a higher risk of carbon leakage. Hence, the EU also adopted the first carbon border tax of its kind: the Carbon Border Adjustment Mechanism. Within the EU ETS reform, free allowances for companies will be phased out from 2026 until the end of 2033, in parallel to phasing in the CBAM.  

Under CBAM, companies will first have to report emissions associated with imported products (aluminum, iron, steel, cement, fertilizers, hydrogen, electricity), and then buy and surrender certificates every year, starting 1st January 2026, to cover those emissions. Importers will initially have to pay for only 2.5% of embedded emissions for 2026, and this rate will gradually increase to 100% of grey emissions by 2034. By doing so, the CBAM ensures World Trade Organization (WTO) compatibility as it applies the same carbon price on imported goods as on domestic EU producers. Importers had to report emissions for the first two quarters respectively October-December 2023 and January-March 2024. As the deadline for the second reporting period just ended (31 April 2024), here are the five upshots to have in mind:   

First upshot – Ownership: Assigning internal responsibility has been a headache for many companies, as business functions were reluctant to take ownership of EU CBAM which often “fell between the cracks.” While CBAM is a customs and tax issue, it requires the involvement of procurement and purchasing departments as they deal directly with suppliers, brokers, and distributors. 

Second upshot - Data gaps & quality: Many businesses have been struggling to obtain the necessary data elements, even for the reduced data sets, as the EU allows default values to be applied until 31 July 2024. CBAM is primarily a data project that requires a centralized platform to collect import data at the first stage. While software can assist in automating calculation and reporting, it will not be sufficient when suppliers need to calculate emissions following the CBAM methodology, which is similar to the ETS methodology but includes scope 2 and some scope 3 emissions. 

Third upshot – Suppliers activation: Acquiring data from suppliers is one of the major challenges for importers. This is because suppliers may not have the same ability to track emissions as equivalent companies do in Europe. Additionally, some suppliers may be unwilling to fulfill ESG (Environmental, Social, and Governance) data requirements. Finally, importers, traders, and brokers may hesitate to request data due to the risk of disrupting business operations. To comply with CBAM regulations, importers will need to engage significantly with their suppliers. While importers are responsible for reporting CBAM, suppliers must monitor and calculate emissions embedded in the covered products. 

Fourth upshot – CBAM level-playing field ambition is working: Although some countries have expressed their intention to challenge the Carbon Border Adjustment Mechanism (CBAM) at the World Trade Organization (WTO), it has indirectly led to other countries introducing similar carbon fees. Turkey, one of the countries most affected by the CBAM, has announced the launch of an ETS that will come into effect in the second half of 2024. In early February, China issued new regulations that aim to improve the regulation of carbon trading, prevent emissions data fraud, and expand the scope of carbon trading to new sectors such as cement and aluminum by the end of 2025.  

Fifth upshot – Despite technical issues, CBAM is not stopping: To register on the CBAM transitional registry, companies must register in their own country through "National Competent Authorities" like the French "Douanes". However, during the first reporting period, importers faced errors and logistical issues in publishing their reports. According to data collected by Germany's emissions trading authority, fewer than 10% of the 20,000 companies in Germany expected to report emissions did so by the 31st of January 2024 deadline. Though most of the bugs have been fixed now, it is worth noting that the EU has not indicated any intention to postpone the date when importers will have to collect actual emissions data from suppliers. However, many industrial and business trade associations will most likely support an extension of those default values for the 2024 reporting year.

Reach out to Schneider Electric's Sustainability Business to equip your organization for CBAM reporting. Collaborate with us to engage your suppliers and collect emissions data from CBAM-covered products, ensuring a smooth transition and proactive compliance. 

Contributor:

Jules Cordillot, Senior Sustainability Consultant