Carbon leakage plugged with certificates: the new cbam regulation

1. Introduction

Climate change is one of the biggest challenges facing modern society. The Earth’s average temperature is rising, sea levels are increasing, and extreme weather events are becoming more frequent. Greenhouse gas emissions are a major contributor to this phenomenon. Due to industrialization in recent decades, these emissions have continued to rise. Measures to prevent or mitigate these undesirable consequences are now unavoidable.

To combat climate change, countries frequently consult with one another at the so-called ‘UN climate conferences.’ At the 2015 climate conference, no fewer than 200 countries signed a binding climate agreement to reduce greenhouse gas emissions. The agreement is commonly known as the ‘Paris Agreement’. Its primary is to limit the increase in global average temperature to 2 degrees Celsius above pre-industrial levels.

In order to implement this agreement – which is legally binding on countries worldwide – the European Commission launched its ambitious ‘Green Deal’ in 2019. As part of this initiative the European Union set a target to reduce CO2 emissions by 55% by 2030 compared to 1990 levels. The next step is to achieve full climate neutrality within the EU by 2050. This means that the European Union aims to become the first continent to absorb as much CO2 as it produces by that year.

2. EU ETS System

To achieve these goals, the European Union introduced the EU Emissions Trading System (EU ETS) in 2003. This system, which is mandatory only for the largest ‘CO2 emitters'[1], operates through the allocation of emission allowances. For every tonne of CO2 emitted, a company must surrender one emission allowance. Each year, the European Commission reduces the total number of emission allowances issued, thereby lowering the permissible CO2 emissions within the Union. As a result of market forces, driven by the ability to trade emission allowances, prices for these allowances increase. Companies then face the choice of either purchasing more expensive emission allowances or investing in more sustainable production methods.

3. Direct consequences of the EU ETS System

The European Union’s objectives and the measures implemented under the EU ETS have, in some cases, made it more expensive – and therefore less attractive – for companies to produce goods within the EU. Production costs are increasing, and companies are required to invest substantial amounts in cleaner production methods. This has led to so-called ‘carbon leakage’, where companies move their production to countries outside the European Union, that have no restrictions on CO2 emissions. Outside the Union, production is often cheaper, but CO2 emissions per product are typically higher. In the past, efforts to mitigate this effect included granting certain companies free emission allowances, but these measures have proven to be insufficient in delivering the desired results.

The European Commission has realized that to effectively achieve its 2050 target, it must address the issue of carbon leakage. The existing measures under the EU ETS Directive, which involve granting some EU ETS emission allowances for free to encourage companies maintain production within the EU, have proven to be insufficient. In response, the CBAM was introduced.

4. Partial Entry into Force of the CBAM Regulation on 1 October 2023

On 1 October 2023, part of the CBAM Regulation entered into force. The CBAM Regulation shares several similarities within the EU ETS system. Like the EU ETS, its primary goal is to reduce CO2 emissions, but the focus is now on emissions generated outside the EU. Under the CBAM system, certificates will eventually be issued, and importers of CBAM goods will be required to submit certificates corresponding to the amount of CO2 emitted during production. The CBAM certificates are surrendered based on embedded emissions, which refer to the direct and indirect emissions released during the production of a specific product. As with the EU ETS, each tonne of CO2 emissions corresponds to one CBAM certificate.

The European Commission expects that companies, as a result of the introduction of CBAM, will shift production to more developed countries, where sufficient resources are available to reduce emissions and, consequently the number of CBAM certificates required. However, an unintended consequence of this intervention is that less developed countries may lose income, and as a result their own ability to develop clean production processes could be hindered. To address this, the EU will provide annual financial support (amount yet to be determined) to assist the least developed countries in their efforts to reduce CO2 emissions.

The CBAM Regulation will gradually replace the previous measures addressing CO2 leakage under the EU ETS Directive in the coming period. The full CBAM system will be phased in gradually. From 1 October 2023 to 31 December 2025, there will be a transitional phase during which importers (or their indirect customs representative) will only be required to report emissions. We have dedicated a separate publication to this.

The full CBAM system will come into effect on 1 January 2026. The issue of free emission allowances under the EU ETS will then gradually be reduced.

5. Goods Subject to CBAM

Not all goods are fall under the CBAM system. The European Commission maintains a list of goods deemed to be at high risk of CO2 leakage. This list will be expanded with additional goods in the coming years. Currently, the list includes cement, electricity, fertilizers, (cast) iron and steel, aluminium and chemicals such as hydrogen. Additionally, indirect emissions resulting from the electricity used in the production of certain products must also be reported. As things currently stand, this concerns indirect emissions from cement, electricity and fertilizers.

A (for now) complete list of products – with their product code (CN) – can be found in Annex I of the CBAM Regulation. Please note that this list is subject to change. It is therefore important to regularly check whether the products you import are subject to CBAM.

6. Price of CBAM Certificates

The price of CBAM certificates will initially – starting in 2026 – be linked to the prices that follow from the EU ETS system. These emission allowances are traded through auctions on the EU ETS market. As a result, the price of a CBAM certificate will be determined based on the weekly average auction price of emission allowances. This allows a CBAM-liable party to benefit from fluctuations in the EU ETS pricing.

As mentioned above, one CBAM certificate represents the emission of 1 tonne of actually emitted CO2. Starting in 2026, it will also possible to use default values, which will only be applied when data on the actual emissions is unavailable.

In the CBAM declaration, a reduction in the number of certificates to be surrendered can be requested if an explicit CO2 levy has already been paid in the country of origin. Additionally, there is still a free allocation of emission allowances under the EU ETS. The number of CBAM certificates will initially be adjusted based on the extent to which these free emission allowances are granted.

7. Authorized Declarant

From 1 January 2026, goods subject to the CBAM Regulation may only be imported into the EU customs territory by authorized declarants. These are declarants must have received a permit from the CBAM authority, an authority that each Member State designates itself. In the Netherlands, the Emission Authority (hereinafter: NEa) will act as the CBAM authority.

Declaration Obligation Permit Holder

The CBAM permit holder who imports CBAM goods must submit an annual CBAM declaration to the CBAM register by 31 May 2027, covering the year 2026. This declaration must include a statement on the quantity of CBAM goods imported in the previous calendar year, the total embedded emissions and copies of verification reports. In the future – when CBAM certificates are actually issued – the permit holder will be required to maintain the necessary number of CBAM certificates available in a central register. The certificates can then be surrendered via the central register, after which the Commission will remove the surrendered certificates from the register.

8. Exceptions

A number of countries and territories are exempt from the CBAM Regulation. For example, these countries use the same guidelines as the European Union or have concluded an agreement (such as the Agreement on the European Economic Area) with the European Union, in which environmental objectives are also regulated. In such cases, a CO2 levy has already been paid. Specifically, this means that the CBAM Regulation does not apply to CBAM goods originating from Iceland, Liechtenstein, Norway and Switzerland. Additionaly, the areas of Büsingen, Helgoland, Livigno, Ceuta and Melilla are also excluded from the CBAM Regulation.

Another exception applies to CBAM goods with a value of less than EUR 150 per consignment, so-called e-commerce goods, as well as goods for military use. It is not necessary to submit a CBAM declaration for the import of these goods.

9. In Conclusion

This contribution was written on the basis of the state of affairs as of 2 November 2023.

Do you regularly bring goods into free circulation that are included in the list of the CBAM Regulation? Then be aware of the reporting obligation that applies to you from 1 October 2023. Are you unsure whether the CBAM Regulation imposes obligations on you, or do you need assistance in determining the consequences and impact of the CBAM system? Please do not hesitate to contact one of our specialists.

While every care has been taken in the preparation of this publication, Customs Knowledge accepts no liability for any errors or omissions, nor for their consequences. This article is not intended as specific advice. Please also refer to the General Terms and Conditions of Customs Knowledge BV.