1. What is the Carbon Border Adjustment Mechanism?
In our last article, we mentioned upcoming ESG trends to look out for. One that seems to be at the forefront of conversation for the manufacturing sector is the Carbon Border Adjustment Mechanism (CBAM). CBAM is a tool that is used to put a price on emissions-intensive goods that are imported to a country. The aim is CBAM is to encourage cleaner industrial production in other countries, specifically those not already captured by internal carbon pricing schemes like the EU or UK Emissions Trading Scheme (ETS). It also helps to avoid carbon leakage between countries. Most countries have different emissions reduction policies to help limit climate change, and some are stricter than others. Carbon leakage refers to the movement of production and associated emissions from one country to another, to avoid more stringent climate policies and carbon pricing. By placing a carbon tax on certain imported goods, CBAM will help to ensure that the carbon price of imports is equivalent to the carbon price of domestic production.
The EU was the first political power to implement CBAM in October 2023, with the UK planning to follow suit in 2027. For UK manufacturers that are exporting CBAM-covered goods to the EU, this means they will need to start providing emissions data to their EU customers. Once the UK CBAM is implemented, they will also need to annually declare the emissions embedded in their own imports and purchase corresponding CBAM certificates.
2. How does CBAM work in practice?
The theory behind CBAM seems straightforward, but a lot of manufacturers are interested to know how CBAM works in practice. The first thing to note is that the importer of CBAM-covered goods is responsible for managing the CBAM process. On an annual basis, importers need to declare the quantity of goods imported in the preceding year and their embedded greenhouse gas (GHG) emissions. The importers then have to purchase CBAM certificates to cover every tonne of CO2 equivalent (tCO2e) emitted from the production of imported goods. These certificates are surrendered annually through a CBAM registry.
The cost of the CBAM certificates equates to the carbon price that would have been paid if the goods had been purchased under the country's internal carbon pricing rules. For example, for EU CBAM the price will be based on the weekly average auction price of EU ETS allowances. To give an idea of the cost for one CBAM certificate, the estimated average price of EU ETS allocations for 2024 is €93 per tCO2e (BloomberyNEF, Oct 2023), with an expected range of €100-150 by 2030. This could add significant costs to imported goods, especially for countries that do not have their own internal carbon price.
If importers can prove that a carbon price has already been paid during the production of the imported goods, the corresponding amount can be deducted from the CBAM price. This means that manufacturers in countries that have ETS systems (like the UK) will have lower taxation on exports than manufacturers in countries without internal carbon pricing.
3. EU CBAM - how does it affect UK Manufacturers?
The big question that UK manufacturers are currently asking is, how will EU CBAM affect their businesses? The main impact will be the requirement to report emissions data to their EU customers and the knock-on effect embedded emissions will have on tax that EU customers have to pay. It is important to note that initially CBAM only applies to the following goods and precursors: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen. Any UK manufacturers that are exporting these goods into the EU will be effected by EU CBAM regulation. When fully phased in, CBAM will eventually capture more than 50% of the emissions in EU ETS covered sectors.
The data that is required for CBAM reporting aligns with the requirements of EU ETS, so a full carbon footprint is not required for products. The key emissions data required includes:
- Direct stationary emissions, e.g. natural gas from heating or propane used in furnaces. These emissions need to be attributed to individual products for reporting purposes. Note that mobile emissions sources are not included, e.g. forklifts, telehandlers etc. This section also includes imported heating/cooling e.g. purchased steam.
- Indirect emissions released from the generation of the electricity consumed during the production process. These emissions must also be attributed to individual products.
- Indirect emissions embedded in relevant precursor materials. The "relevant precursors" include any CBAM-covered goods used as input materials in the manufacturing process. These precursors have their own embedded emissions that need to be included in CBAM reporting. This means manufacturers need to monitor and report the quantities of specific input materials. Where manufacturers purchase precursors to produce other CBAM goods, they will also need to obtain data on the embedded emissions from the supplier of these precursors.
For further information on identifying CBAM-covered goods and manufacturer's monitoring and reporting obligations, a guidance document for installation operators outside of the EU has been provided by the European Commission. This can be found on the Taxation and Customers Union website.
4. EU CBAM - timeline for implementation
EU CBAM began its transitional phase in October 2023. During the transitional period, EU importers of CBAM-captured goods have to report GHG emissions embedded in their imports every quarter. The first quarterly reporting period covered October to December 2023 and reports had to be submitted to the CBAM Transitional Registry by 31st January 2024. The last quarterly report of the transitional phase covers October to December 2025. The deadline for report submission will be 31st January 2026. During the transitional phase, no financial payments or adjustments are required from EU importers.
The permanent system enters into force on 1st January 2026. From this date, EU importers will need to annually state the quantity of goods imported in the previous year and their embedded GHG emissions. They will then surrender the corresponding number of CBAM certificates. It will be important for UK manufacturers to tell their EU customers about any carbon tax they pay for their products as a result of UK ETS. This information will ensure that EU importers are not taxed further on products that have already been subject to internal carbon pricing.
5. UK CBAM next steps
The UK government has said that it will implement UK CBAM by 2027. Further details on the design of a UK CBAM will be subject to consultation in 2024. The sectors covered by UK CBAM will include industrial goods imported to the UK from the aluminium, cement, ceramics, fertiliser, glass, hydrogen, iron and steel sectors. For manufacturers in these sectors, it will be important to make sure they are recording their scope 1 & 2 emissions on-site and begin engaging with suppliers that provide precursor materials to gather embedded emissions data.
If any manufacturers need help with either the EU or UK CBAM, there are consultancies like Inspired PLC that can help to calculate direct and indirect emissions (covering Scope 1, 2 & 3) and support with supplier engagement. It will be important for manufacturers to record and report their emissions sooner rather than later to avoid non-compliance further down the line.
