Bi-weekly Newsletter

11 September 2023

Bi-weekly Newsletter

11 September 2023

As EU carbon border levy looms, businesses scramble to get ready

Some businesses and governments are pushing back against a new charge on imports of climate-unfriendly goods ahead of its start date on 1 October.

Dave Keating September 11 2023

In just a few weeks, the world’s first carbon border levy on climate-unfriendly imports is going to take effect across the EU. The Carbon Border Adjustment Mechanism (CBAM), which was voted into law in April, will start a transitional phase on 1 October that will apply to seven products whose production is carbon intensive and are deemed at significant risk of carbon leakage: aluminium, cement, electricity, fertilisers, hydrogen, iron and steel.

Although the levy will begin to apply from October, the bill for companies for what they have imported in its first four months will not come until 31 January. The mechanism is being phased in, with it taking full effect by 2032. The Commission has indicated it will be lenient in the beginning, with the objective being “to serve as a pilot and learning period for all stakeholders” including importers, producers and authorities, “and to collect useful information on embedded emissions to refine the methodology”.

Nevertheless, some companies are raising the alarm that they are not ready and have not had enough time to prepare between the law’s final passage in April and now. The law, first previewed with the unveiling of the EU Green Deal in December 2019, was proposed by the Commission in July 2021. But the details are still now being ironed out. The Commission adopted an implementing regulation on 17 August setting the provisional methodology for calculating embedded emissions – just 45 days before CBAM starts.

Business worries about an EU carbon border levy

Wolfgang Grosse Entrup, head of the German chemical industry association, VCI, said in a post in August on LinkedIn that CBAM is already causing “bureaucratic madness”, and calling for German politicians to “wake up” to the threat posed by CBAM, otherwise Germany will become an “industrial museum”. German industry association BDI has expressed similar concerns, saying CBAM should only be triggered as a “last resort”; in other words, the EU should wait and hold it out as a threat to use only if other countries don’t improve their climate regulations.

The consultancy Deloitte has warned that companies are not prepared. It surveyed 700 companies that import the products that will be affected from 1 October and found that 60% of them are not familiar with CBAM’s requirements. It has urged companies to urgently start carbon accounting now. The situation appears to be most dire for exporters outside the EU. A separate survey by the British Chambers of Commerce found that 84% of British manufacturers don’t know about the new CBAM reporting requirements. William Bain, head of trade policy at the chamber, called it “a serious worry that more than four out of five manufacturers who export have no knowledge of the EU’s new CBAM… It is likely manufacturers that export will have to think about allocating dedicated staff resources just to deal with these reporting requirements.”

There is also concern that foreign companies may simply stop exporting to the EU if they find its carbon border levy too costly or too confusing. There are also open questions about who exactly will need to pay. During the legislative process, the Commission insisted that companies in partner countries like the US and UK would not be significantly affected because they have stringent-enough climate legislation – but that has yet to be determined by the methodology. Even if British and US companies will not end up having to pay, they will still need to submit all the paperwork to prove that they don’t.

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In the past, the EU has caved in to pressure from the US and China when they objected to EU legislation that covered foreign companies, most famously when the EU retroactively cancelled its 2012 law subjecting foreign airlines operating in Europe to paying for their emissions under the EU’s Emissions Trading System (EU ETS).

It is not just the import levy itself companies are worried about; it is also the accompanying loss of free credits for European companies under the ETS. Up until now, European manufacturers have received about half of their emissions allowances for free to protect them against competition from foreign companies that do not face such climate burdens. This was to protect against the risk of “carbon leakage”, where industrial activity would move out of Europe and into laxer regimes to avoid EU climate legislation, with Europe then importing those products.

CBAM is designed to replace that free allowance system, which will be phased out between 2026 and 2034. Companies have complained that this will result in a gap in which free allowances are being phased out but CBAM is not fully phased in (the due date for that is 2032). They worry that the period between 2026 and 2032 will leave them vulnerable to global competition – and there are still fears too that CBAM could be abandoned under pressure from Beijing and Washington or successfully challenged at the World Trade Organization (WTO).

Legal challenges

It is not just companies objecting to CBAM. The Polish Government launched a legal challenge against it in August, saying it will present an overwhelming burden on Polish companies. “The introduction of CBAM fees will translate into an increase in the cost of imported products and electricity, as well as products manufactured in Poland for the end user,” Polish Climate and Environment Minister Anna Moskwa said in a statement.

The substance of the EU carbon border levy law was decided by a majority vote of EU countries earlier this year, in which opposition by Poland and Hungary was overcome. Poland is not only challenging the substance of the law based on its effects but also the way it was adopted. Because the laws will affect the economy, they are “primarily of a fiscal nature”, Moskwa said, and therefore the ordinary voting system should not have been used but rather a special legislative procedure that requires unanimous approval by all EU member states.

Were the EU’s high court to agree, the law could be invalidated and sent back to the Council for another vote, at which time Poland and Hungary would veto it. This is why the Commission has been so insistent on not calling the levy a “carbon border tax”, instead using the cumbersome formulation of CBAM. A “tax” would have required unanimous approval, and the EU executive likely expected Poland to veto the proposal.

Read more from this author: Dave Keating

China is making this point to the WTO, saying that CBAM violates international trade principles. In March, Beijing filed a request with the WTO asking the EU to submit justification defending the legality of the instrument – a first step before an expected formal objection. According to the German think tank Adelphi, about 10% of the imports affected will come from China. Other countries expected to be significantly affected include India and Turkey, as well as developing countries in Africa.

The legal challenges, both at EU and global level, could take years to be resolved. “Based on similar actions, it can take two years or more for a judgment [from the European Court of Justice] to be rendered and the contested rules are generally not suspended during that period,” consultancy Ernst & Young has said in a note to clients.

“The action could have significant impact on CBAM and the EU’s Green Deal in the medium-term.” It added, however: “Withdrawal of the CBAM Regulation, in full or part, could jeopardise the EU Commission’s plans for the EU economic zone’s competitiveness among industries that are subject to ETS regulations.

“Given the fast-approaching 31 January 2024 deadline for submitting the first CBAM report covering Q4 2023, businesses need to continue their efforts to prepare for their CBAM compliance obligations,” the consultancy said.

Getting prepared

While the future of the EU's carbon border levy may be uncertain, companies will have no choice but to comply in the meantime. “The CBAM is our landmark tool to put a fair price on the carbon emitted during the production of carbon intensive goods that are entering the EU, and to encourage cleaner industrial production in non-EU countries,” the Commission said in a statement. “The CBAM is designed to be compatible with WTO rules.”

As a first step, EU importers of goods covered by CBAM will need to register with national authorities. They can then purchase CBAM certificates from those authorities, which will be priced based on weekly ETS allowances. The importer will then declare the emissions embedded in their imports and turn over the corresponding number of certificates each year. However, there is one way out of it; if the importers can prove that a carbon price has already been paid during the production of the goods imported from another country – for instance, through a foreign ETS or a carbon tax – that amount can be deducted from the certificates due.

At first, companies will need to report both the imports’ direct and indirect emissions. However, they will not need to pay for indirect emissions until a future date, yet to be determined. During the first year, companies will be allowed flexibility to choose one of three ways to report: using the EU methodology, using an equivalent third country national system or using reference values. However, from 1 January 2025, only the EU method will be accepted.

After the first two years, the Commission will conduct a review of how CBAM has been functioning before the permanent system enters force on 1 January 2026. It is possible the system could be significantly changed before then. Changes could be made to the scope of products covered, for example, including the possibility of expanding it to downstream products more familiar to consumers such as air conditioners or hairdryers.

While the initial period will contain some flexibility, there will be a hefty number of new obligations for importers and exporters dealing with products affected by the EU carbon border levy. With consultancies warning that companies seem ill-prepared, new attention will be needed to ensure compliance.

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