In the global pursuit of climate action, policymakers are continuously exploring innovative strategies to incentivize emissions reductions while ensuring fair competition in international trade. One such strategy gaining traction is the Carbon Border Adjustment Mechanism (CBAM). This mechanism aims to address carbon leakage and level the playing field by imposing tariffs on imports based on their carbon footprint. As nations intensify efforts to mitigate climate change, understanding the intricacies and implications of CBAM becomes increasingly crucial.
What is the Carbon Border Adjustment Mechanism?
The Carbon Border Adjustment Mechanism (CBAM) is a policy tool designed by the European Union to tackle carbon leakage. Carbon leakage occurs when domestic industries relocate to regions with weaker climate regulations. This phenomenon can undermine global efforts to reduce greenhouse gas emissions.
CBAM seeks to mitigate this risk by imposing tariffs on imported goods. These tariffs are proportional to the embedded carbon emissions in their production processes. By internalizing the cost of carbon, CBAM aims to prevent unfair competition. It protects domestic producers subject to stringent emission regulations from foreign competitors operating under less stringent regimes.
CBAM is part of the “Fit for 55 in 2030 package.” This package is the EU’s plan to reduce greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels. It aligns with the European Climate Law and will translate into a 20-35% tax on select imports into the EU starting 1st January 2026. EU has decided to impose this tax from this date on the import of 7 carbon-intensive sectors including:
- Steel products
- Iron and iron ore concentrates
- Cement
- Aluminum products
- Fertiliser
- Hydrogen
- Electrical energy
The implementation of CBAM will roll out in 4 phases:
How Does CBAM Work?
CBAM operates by requiring importers to purchase carbon permits equivalent to the emissions generated in the production of the imported goods. Importers must demonstrate compliance with the emission standards of the importing country. If they do not comply, they must pay a tariff reflecting the difference in carbon pricing between the exporting and importing jurisdictions. This mechanism extends the reach of domestic carbon pricing mechanisms to imported goods. It incentivizes global compliance with emission reduction targets.
The CBAM will be implemented by requiring importers to declare the quantity of goods imported into the EU. They must also declare their embedded Greenhouse Gas (GHG) emissions on an annual basis. To offset these emissions, importers will need to surrender a corresponding number of CBAM certificates. The price of these certificates will be based on the weekly average auction price of EU Emission Trading System (ETS) allowances in €/tonne of CO2 emitted.
Impact of CBAM on India
Many government officials in India have considered the proposed CBAM as “discriminatory” and a “trade barrier.” They believe it would hit not only Indian exports but also those of many other developing nations. The World Trade Organization (WTO) has also raised concerns about the fairness of the EU’s taxation policy. India is already adhering to the Paris climate agreement protocols of becoming carbon neutral by 2070.
In 2022, 27% of India’s exports of iron, steel, and aluminum products worth USD$8.2 billion went to the EU. With this high tax value, the EU’s income is expected to surge by leaps and bounds. However, this will disrupt earnings for major Indian conglomerates like Tata Steel, Steel Authority of India, JSW Steel Group, and Essar Steel India Limited.
To fully grasp the new CBAM tax implications, one only needs to examine India’s exports to the EU in a single year (2022), as shown in the chart below.
Among all these sectors, the steel industry is the toughest to decarbonize and has the highest carbon intensity, responsible for ~ 8% of global emissions.
It could be stated that the impact of the EU’s CBT on India will depend on the carbon intensity of exported products and their substitutes in the EU market. Products with high carbon intensity will face increased charges and low competition. However, if low-carbon alternatives for Indian products are unavailable in the EU market, the outcome of CBAM on Indian exports might be constrained.
Policy Implications and Future Outlook
Conclusion
The Carbon Border Adjustment Mechanism (CBAM) offers a potential pathway to harmonize trade and climate objectives. It does so by internalizing the carbon costs associated with imported goods. While challenges exist in its implementation, CBAM holds promise in incentivizing emissions reductions and leveling the playing field for domestic industries. As policymakers navigate the complexities of global trade and climate governance, CBAM stands as a testament to the evolving intersectionality of economic prosperity and environmental stewardship.
Leave a Reply