The CBAM and the ‘Climate Club’ You Need to Join

Imagine you want to buy a car of any type according to your personal preference (the more efficient the better, of course) and you are hesitating between different options. After assessing your alternatives, it all boils down to two options that are exactly the same in every technical, safety and comfortability feature, even how much you like the looks of both, with the exception that one is around 25% cheaper than the other. Even asking the question about which one you would choose seems unnecessary. However, would your opinion change if I told you that the more expensive option entails processes that reduce the total climate impact of the vehicle by approximately one third?

There are so many different factors involved in this conversation that by the end of this article you will have to think twice about what the underlying question was. To help a bit here, the question is, what’s the CBAM and how will that affect you sitting in Mexico, Colombia, Brazil or in any other country in the Latin American and the Caribbean region (or outside of the European Union for that matter)?

As with most of the more formal, region-wide and innovative climate-related policies, the Carbon Border Adjustment Mechanism (CBAM) started in Europe. Although it’s true that other similar mechanisms (provisions in the ETS of California for specific electricity imports, for example) are in place, the CBAM has a comprehensive description of its characteristics, timeline, potential penalties, calculation methods, and reporting and verification requirements, among many others.

In a nutshell, the CBAM is a mechanism intended to level the field between the domestic products in Europe and what’s imported from everywhere else, in terms of the carbon price put upon the emissions generated during the production process of such goods (both direct and indirect Greenhouse Gas emissions). The underlying idea behind it is twofold. First, the objective is that the carbon price paid by importers on carefully selected merchandise, which are among the most carbon-intensive in the EU and that belong to sectors covered by the EU Emissions Trading Scheme (EU ETS), does not represent a loss of competitiveness to domestic producers in the EU. On the other hand, such a carbon price will hopefully motivate non-EU producers to increase their efforts to reduce the level of emissions of the products they export to the European Union. 

According to the approved regulation on the CBAM, there will be two phases: 1. a transitional phase and, 2. a post transitional or implementation phase. 

• In the first phase, which started in October of 2023 and is planned to conclude in December 2025, the scope of the mechanism comprises six sectors: iron and steel, cement, aluminum, hydrogen, electricity, and fertilizers. In the regulation, every one of these sectors has a list of goods covered by the mechanism, as well as the types of GHGs applicable in each case. 

• It is important to mention that at the end of the transitional phase there will be an intermediate step, which is the review of the initial results of the implementation of the first phase. As part of the review, there could be an expansion of the scope of the mechanism to other goods besides those listed before. 

• In the second phase, for the more permanent implementation of the mechanism, planned to happen from 2026 to 2034, a key change is that authorized declarants for CBAM purposes will have to surrender a number of CBAM certificates equivalent to the emissions embedded in the imported CBAM goods. Furthermore, the regulation becomes stricter in the second phase, for example reducing the number of methodologies authorized for the quantification of embedded emissions.

During the implementation of the mechanism, it is expected to see a gradual phase out of free allowance allocations to sectors covered by the EU ETS that are linked to CBAM goods, seeking to reach a point in which both local products and imported products are covered by the same carbon price.

Even if the CBAM is designed to be compliant with the World Trade Organization’s laws, there are different parties raising concerns such as the risk of discriminatory treatment of products. Nevertheless, could the mechanism be considered discriminatory when the request is that all parties comply with the “pollutant pays principle”? One possible solution to settle this point will come during the review period in 2025 when the conversation can open again to collect feedback from all the involved parties.

The EU’s CBAM is not the only one being considered right now. The UK recently announced its own CBAM, entering into force in 2027. Others analyzing their own are Canada, Australia, and Japan, and it is only a matter of time before others follow.

Another phenomenon to observe is that more jurisdictions will expedite the design and launch of their own carbon pricing schemes, such as a carbon tax or ETS. Since the EU CBAM recognizes the carbon price paid in the country of origin to derive a discount or reduction in the number of CBAM certificates to be delivered, it is becoming increasingly attractive to exporting countries to try to capture those resources as much as possible. More importantly, those same countries will need to make sure there is a reinvestment of such resources to decarbonize their industry to ultimately move toward a competition of the goods with the lowest climate impact instead of one solely based on price.

As indicated in the European Directive on the CBAM, the mechanism is intended to spur international cooperation among countries with carbon pricing instruments, potentially evolving into a global pricing framework. Countries taking part in such cooperation may voluntarily join the Climate Club cited in the Directive, serving as a meeting point to discuss and promote the implementation of climate policies with a level of ambition that will help us to meet the objectives of the Paris Agreement.

As interesting as the CBAM is, there are clear areas to observe during the transitional period. One of those is that the so-called “leakage” the mechanism is trying to address, is not yet fully covered. “Leakage” can be understood as the transfer of operations from countries with more stringent environmental regulations to others with more relaxed regulation in an attempt to reduce costs. For example, specific fertilizers covered by the CBAM will need to cover extra costs when imported to the EU, increasing the market price of this input for agricultural production. However, food imports are not yet covered since food production isn’t covered by the EU ETS either. This could mean that there is a lingering disadvantage for local food producers in the European Union. This also does not mean that there won’t be other instruments in the future imposing a price on the carbon embedded in these types of products, which is something to keep an eye on.

As we have seen so far, although the CBAM (and other complementary instruments) will produce a direct increase in the costs of so-called “CBAM goods” as well as an indirect increase in the price of many other everyday products and discretionary goods, it will also create the necessary price on carbon to help us act much faster than before in our race to zero GHG emissions.

Now that you know how this will affect you, even when you are thousands of miles from the EU, you may now be even more confused than before about which of the car options you would like to go for. My hope is that you will now choose based on the most informed and climate-friendly view – possibly deciding instead to carpool, to use public transport, or to go for a walk more regularly.