July 2021 Blog

“Duties” on Im­ports for Em­bedded Green House Gas Emiss­ions – EU pro­poses regul­ation esta­bli­shing a Car­bon Bor­der Adjust­ment Mecha­nism

For some time now, the introduction of CO2 duties or a carbon border adjustment mechanism (CBAM) has been discussed in the EU as part of the European Green Deal. The intention is to internalize the externalities of greenhouse gas emissions into the prices on imported goods. On 15 July 2021, the EU Commission presented a proposal for a regulation to introduce a CBAM.

Carbon Border Adjustment Mechanism

The Commission opted against actual CO2 duties that would have worked similar to those in anti-dumping or anti-subsidy regulations. Instead, the proposed Carbon Border Adjustment Mechanism is in part comparable to other border tax adjustments like VAT on imports (Einfuhrumsatzsteuer). The basic principle of this CBAM works as follows: the importer buys so-called CBAM certificates from a Member State and surrenders them to the authorities for all goods subject to the CBAM that it releases for free circulation. A CBAM certificate is required for each tonne of greenhouse gas "embedded" in the imported goods. Unlike emission allowances under the European Emissions Trading System (EU ETS), CBAM certificates do not have to be acquired through an auction. They are "sold" by the Member States to the importers. 

A key intention of the proposal is to prevent imported goods from having a competitive advantage over goods produced within the EU for which the manufacturer had to purchase emission allowances. At the same time, the introduction of the CBAM will allow the EU to end the current free allocation of emission allowances to industries with a high risk of relocation of production. The current draft sets a transition period of 10 years for the introduction of the CBAM and the step-by-step termination of the free allocation of allowances under the EU ETS. The proposed Regulation is intended to enter into force in 2023.

CBAM Certificate Price and Purchase

The price of the CBAM certificates is set by the Commission on a weekly basis. It is based on the average price for emission allowances on the EU’s joint auction platform EEX. This means that importers do not have to participate in the auctions themselves. However, they must ensure that at the end of the levy period, i.e. by 31 May following the end of a calendar year, they possess enough CBAM certificates to offset the greenhouse gas emissions embedded in the imported goods. At the end of each quarter, the number of CBAM certificates in the importer's account must be equal to at least 80% of the embedded greenhouse gases of the goods imported since the beginning of the year.

The final number of CBAM certificates necessary for the imported goods must be determined and surrendered annually by 31 May for the previous calendar year. If an importer has purchased too many CBAM certificates, it may request that these be bought back by the issuing Member State by 30 June of the calendar year following the import. However, the buy-back is to be limited to one third of the total CBAM certificates purchased by the importer.

Exemptions and Offsetting of Foreign CO2 Taxes

For imports from countries participating in the EU emissions trading system (i.e. Iceland, Liechtenstein, Norway, Switzerland), no CBAM certificates will be required. For imports from other countries, importers will be able to apply for a reduction in the amount of CBAM certificates required if and to the extent they already paid a price (e.g. a tax) for the greenhouse gas emissions in the country of origin.

Initially Affected Sectors

The CBAM will not apply immediately to all imports, but will initially be limited to goods for which manufacturers in the EU are currently allocated EU ETS emission allowances free of charge. Other goods are to be included in the CBAM later. Currently, the plan is to apply the CBAM to the following products:

  • Certain cements and cement clinkers
  • Electrical energy
  • Nitric acid and nitrating acids
  • Ammonia
  • Potassium nitrates
  • Certain fertilisers
  • Iron and steel, and certain articles of iron or steel
  • Aluminium, and certain articles of aluminium

Procedure

The procedure will be similar to customs regulations. Goods subject to CBAM may only be declared to the customs authorities for free circulation by "authorised declarants". Unduly declared imports are to be stopped by customs and may not be cleared for free circulation. The customs authorities are also to carry out appropriate controls.

Unless an importer obtains the status of authorised declarant itself, it will have to engage a third party. Authorised declarants must have the necessary financial and administrative capacity. Newly authorised declarants will be required to provide a bank guarantee for the first two years to cover the expected quantity of CBAM certificates required.

Calculation of the "Embedded Emissions”

By 31 May of the year following the import calendar year, a complete declaration must be made for all goods for which CBAM certificates are required. The declarant must calculate and declare the amount of embedded emissions for each imported good individually. The Commission has decided against the proposal to estimate the embedded emissions for each product and determine an average value. Instead, two different procedures are applied depending on the complexity of the production of the goods. For "simple goods", only direct emissions from the production process in the manufacturing plant are considered. For "complex goods" that are produced from several "simple goods", the calculation involves at least two steps. First, the consumables that lead to emissions during the production process of the complex good itself are to be included in the determination of the embedded emissions. Second, all embedded emissions of each "simple" or "complex good" consumed or processed during production of the complex good in question must be added.

Instead of calculating actual emission values, unfavourable default values may be used. However, these default values will be based on the average intensity of emissions in the country of origin. If such data are not available, the emissions of the 10% most polluting EU installations for similar goods will be used as a basis for calculation.

CBAM certificates will also be required for the inward processing procedure. In the case of outward processing, the quantity of CO2 certificates required upon re-importation will be calculated based on the processing operation carried out outside the EU.

Conclusion and Outlook

The EU Commission's goal of preventing what is known as "carbon leakage" and protecting EU businesses from unfair competitive disadvantages resulting from the EU's climate measures is understandable. However, many questions are still open. The EU Commission's proposal gives rise to fears that the introduction of a CBAM will lead to huge bureaucratic burdens. The calculations necessary to avoid the application of the unfavourable default values may be costly and even almost impossible for goods with many individual parts and long supply chains.

The Carbon Border Adjustment Mechanism also raises the question of whether it is compatible with current world trade law. This is because the enormous effort involved in calculating emissions could unjustifiably make imports more expensive. If the present draft becomes law, it will at least subject small and medium-sized importers and especially the procurement departments of these enterprises to huge compliance and bureaucratic costs. The proposed Regulation is therefore unlikely to be compatible with the European Union's goal of maintaining and promoting small and medium-sized enterprises.

Public participation on the present draft regulation runs until 15 November 2021; Link

Lars Hillmann, Lawyer, Hamburg

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