Your exports may now face a new EU carbon tax

EU Carbon Border Ajustment Mechanism (CBAM) – what is at stake for UK business?

As part of the EU’s “Fit for 55 package”, which aims to reduce overall EU greenhouse gas emissions by 55% in 2030, the European Commission set out several legislative proposals including the creation of a “carbon border tax” on imports, which would avoid EU based companies being made less competitive (and therefore relocating outside the EU) due to the costs of complying with EU environmental legislation, as well as provide new sources of funding for the EU. The development of this CBAM was done alongside the reform of the EU Emissions Trading System (ETS) as the two are crucially linked through the process of carbon pricing. The EU has now reached a final agreement on these two files this December.

What has been agreed?

The EU CBAM will set up a carbon levy on imports. Originally covering aluminium, steel, iron, cement, fertilisers, and electricity generation, CBAM’s scope has been expanded to hydrogen as well as “precursors” and some downstream products. During the transition period, other sectors for the CBAM to be expanded to will also be assessed, and currently all sectors covered by the ETS are planned to be included by 2030.

The CBAM will oblige EU importers to buy carbon certificates for imported goods, corresponding to the carbon price that would have been paid had the production taken place in the EU and been subject to the average weekly cost of carbon allowances in the EU ETS. The scheme would not in theory apply to them if non-EU producers have paid the same price for emitting when producing that product in their own country. Therefore, third countries will need to have a consistent carbon pricing with the EU one to avoid the levy – however in practice, very few jurisdictions have equivalent levels or costs associated with carbon pricing, even if they have their own ETS, so the truly exempt states can be expected to be limited to those that formally have linked their trading systems with the EU’s (such as Switzerland), at least initially.

The scheme will kick off on 1 October 2023 with a three year transition period with reporting obligations only. As of 2026, the tax will be fully operational. The carbon levy will exist in parallel to the EU ETS but free emission allowances for CBAM sectors will be progressively phased out by 2026 and cut in 2034 to manage the transition for industrial sectors, but also ensure there isn’t a “double protection” effect for European industry in order to comply with WTO rules. As part of the ETS reform however, industry will need to meet conditionality requirements (including mandatory energy audits as well as effective decarbonisation plans) to keep receiving free allowances.

When it comes to exports, Member States will provide support to CBAM sectors through funds raised by the ETS system, but these technical details are still being developed. The European Commission will review the CBAM’s impact on EU exports in 2025, and it will develop further legislation to address potential issues.

Business’ reaction

Together with BusinessEurope, the CBI has encouraged the adoption of a global approach to carbon pricing as a long-term objective. Ahead of the final round of negotiations, BusinessEurope recalled CBAM’s compatibility with WTO, notably when it comes to exports. Reducing free allowances for exports is industry’s main concern as it would undermine European firms’ competitiveness on the global stage and needs to be done in a way that is aligned with realistic decarbonisation pathways, particularly in the context of the current energy crisis.

What does the CBAM mean for the UK

Exporters

UK exporters of CBAM goods to the EU will need to provide a proof of carbon payment that is consistent with the EU carbon price. The UK has its own ETS put in place post-Brexit, so in theory will have a lower cost of compliance (if any at all) than states without one. However should the UK’s carbon price begin to be significantly lower than that of the EU’s, this could change.  Potential extraterritoriality of EU rules (e.g. on ETS maritime) should also be carefully considered.

The only way to definitively and permanently avoid any costs, including administrative burden, is for the UK and EU ETS to be linked, which the CBI will continue to pursue the progress of.

What are the next steps?

• EU institutions will now have to endorse the final version of the text. Once published, the legislative acts will enter into force after 20 days.
• Due to the lack of solution surrounding the Northern Ireland Protocol, there is not much certainty yet on how the new rules will apply to Northern Ireland as the CBAM could create regulatory barrier for companies in Northern Ireland wishing to trade with the Republic of Ireland. At the same time, the UK Government was expected to launch a consultation on an UK CBAM last Autumn which will need to consider how it relates to the EU’s own proposal, but this has been postponed to early 2023. When the consultation is released the CBI will undertake a full process with members to shape our position. If you are in a sector affected by either the EU or potential UK CBAM, please contact Carolina Mazzone, Charley Roberts and Tania Kumar.
• The final structure of the agreement indicates openness from the EU seems to discuss international carbon pricing than it was before, and to explore the possibility of linking its ETS with other markets. This could create opportunities for positive cooperation between the UK and the EU on joint initiatives to address carbon leakage, and the CBI will continue to pursue the chance to link the EU and UK ETS’.
• The CBI’s priority is to ensure that CBAM and EU carbon market remains open to third countries. In the meantime, the CBI welcomes feedback form members on the latest on EU climate and energy law. Get in touch with Carolina Mazzone for more information.