Climate crisis characterized by the rapid pace of global warming is going from bad to worse. Countries around the world are making significant efforts to deal with the crisis, and the European Union (EU) has adopted a variety of institutions and policies ahead of others to foster carbon neutrality. We will find more about the Carbon Border Adjustment Mechanism (CBAM) being implemented by the EU and how the rest of the world including Korea will be affected.
In October, 2018, the 48th Session of the IPCC (Intergovernmental Panel on Climate Change) adopted a Special Report on Global Warming of 1.5℃. The special report recommended that the increase in the global average temperature be limited to 1.5℃ above pre-industrial levels. To achieve the goal, it urges that net zero wherein global net CO2 emissions are balanced to zero needs to be reached by 2050.
Since global discussions on net zero kicked into high gear, the EU has been most proactive in implementing relevant policies. The European Commission having authority to propose legislations announced the European Green Deal strategy in December, 2019, vowing to reach net zero within the EU by 2050.
Then, the European Commission announced a plan to introduce the Carbon Border Adjustment Mechanism (CBAM) in a bid to prevent carbon leakage. Carbon leakage refers to a phenomenon in which industries in countries subject to severe greenhouse gas emissions regulations offshore their production facilities to increase CO2 emission in less-regulated countries. It means that tightening regulations in the EU alone may be less effective than anticipated since EU-based companies may move production facilities to other countries, creating another source of environmental pollution.
To prevent such setbacks, CBAM imposes additional charges on offshore goods. When CBAM goes into force, companies exporting to the EU will be required to pay additional charges in proportion to CO2 emitted by the production process of exported goods. Then, costs of carbon emission will be equalized between production facilities in and out of the EU to facilitate fair competition, prevent carbon leakage in the end, and render EU’s environmental policy more effective.
➀ How it works
Before understanding how CBAM is supposed to work, we need to know about the Emissions Trading Scheme (ETS). ETS allows governments to distribute tradeable carbon emission credits to business sites in their territories first and authorize the business sites to sell surplus credits or buy credits. It was first created by the EU in 2005.
CBAM evens out CO2 emission costs between goods imported to and produced in the EU. Costs are measured against the price of EU-ETS credits. Therefore, imported goods covered by CBAM must pay charges calculated by multiplying the average EU-ETS credit price with their CO2 emissions. Importers are required to declare the amount of CO2 emitted by the production process of imported goods and the amount is multiplied with the average price per EU-ETS unit to arrive at final amount due and payable.
➁ Key items covered under the CBAM
The final objective of the European Commission is to apply CBAM to all imported gods. However, as it is not yet fully ready in terms of systematic preparations, five goods including iron and steel, cement, aluminum, fertilizer and electricity were announced to be subject to the mechanism on a pilot scale. As the final legislation is not finalized, the scope of applicable items may be further expanded. In particular, some in the European Parliament say that the five items proposed by the European Commission are too few. Accordingly, there is a voice advocating the inclusion of plastic, and other materials in the scope of applicable goods.
➂ Enforcement timing
When to enforce CBAM is also a controversial issue. The initial version of the legislative bill announced by the European Commission stipulated that CBAM be put in place by 2023, with a transitional period until 2026 and enforced in full swing in 2026. During the transitional period, affected companies will be obligated to report such data as CO2 emissions amount. With those obligations put in force, an environment supportive of the full CBMA implementation will be fostered. However, as a revised bill accelerating the end of the transitional period has been submitted to the European Parliament, we need to wait and see how the implementation schedule will play out.
When CBAM is in force, companies exporting more to the EU region and emitting more CO2 in production process will suffer greater monetary damage. Iron and steel, and aluminum that are among the five items proposed by the European Commission are anticipated most likely to be impacted, and the damage can grow bigger if plastic and other materials are added to the scope of application as proposed in the revised bill submitted to the European Parliament.
Then, how should businesses adapt themselves? Since the legislation is still in the works, it is hard to develop an exact adaptation strategy. At this stage, the government needs to step forward and incorporate the feedback from businesses on the legislation process as much as possible. Businesses share EU’s commitment to addressing climate crisis, but it is necessary to underscore that non-EU countries and companies are trying to reduce CO2 emissions on their own, too. In fact, several countries are preparing for or operating nation-wide greenhouse gas emissions trading schemes.
In addition, businesses should be aware of the potential impacts of CBAM. Products not included in the five categories named by the EU such as iron and steel, and aluminum may still fall into the expanded coverage of the mechanism in the future. It should be also noted that although indirectly, the impact of CBAM may spread to tier 2 and 3 suppliers.
After CBAM goes into effect, exporting businesses will be required to report and provide CO2 emission amount of their products exported to the EU. Yet, many companies have yet to put an in-house system in place to verify and report CO2 emissions. Therefore, they need to implement a LCA (lifecycle assessment) system in place to quantitatively measure environmental impacts from raw materials to product manufacturing in the initial stage of adaptation to CBAM. Subsequently, they will have to proactively invest in research and development programs for eco-friendly production processes and try to minimize emissions of pollutants. CBAM will pose a liability for businesses in the short run, but it will offer an opportunity for them to preemptively adapt to global environmental standards in the mid-to-long term.