Carbon Border Adjustment Mechanism (CBAM)

The Carbon Border Adjustment Mechanism (CBAM), which would impose a carbon tax on imports of goods created using non-green or environmentally unsustainable technologies, will be implemented by the European Union (EU) starting in October 2023. Read here to know more.

As a global issue, climate change requires global solutions.

There is a possibility of so-called “carbon leakage” when the EU increases its climate ambition and as long as less rigorous climate policies are prevalent in many non-EU nations.

When businesses located in the EU relocate carbon-intensive production to nations with laxer climate regulations than the EU, or when EU products are replaced by more carbon-intensive imports, carbon leakage occurs.

Carbon Border Adjustment Mechanism (CBAM)

The EU has agreed to the world’s first Carbon Border Adjustment Mechanism (CBAM), a measure aimed at preventing “carbon leakage”.

• CBAM will initially cover several specific products in some of the most carbon-intensive sectors.
• CBAM, which some argue violates international trade rules, also aims to incentivize trading partners to decarbonize.
• CBAM extends the concept of carbon pricing to imports for the first time.

Carbon Border Adjustment Mechanism (CBAM) is a tariff on carbon-intensive products, such as cement or fertilizer. While CBAM’s implementation is still being worked out, we at least know the scheme’s scope.

The new levy is to deter carbon-intensive processes and encourage manufacturers to “green” as much of their processes as possible.

• The levy would mirror the EU’s carbon market price to prevent “carbon leakage”.
• That’s when the EU’s emission reduction efforts are offset by increased emissions outside the bloc through relocation of production to non-EU countries with less ambitious climate policies, or offset through increased imports of carbon-intensive products.
• Companies in countries with a domestic carbon pricing regime equivalent to the EU’s will be able to export to the EU without buying CBAM certificates.

CBAM will initially cover several specific products in some of the most carbon-intensive sectors at risk of “carbon leakage”:

• iron and steel (including some downstream products such as nuts and bolts)
• cement
• fertilizers
• aluminum
• electricity
• hydrogen (which was recently added because it is mainly produced with coal in non-EU countries).

CBAM is part of the “Fit for 55 in 2030 package”, the EU’s plan to reduce greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels, in line with the European Climate Law.

The EU’s primary mechanism for incentivizing industry to decarbonize is through carbon pricing and to meet its 2050 targets; these prices will need to rise substantially.

India and Carbon Border Adjustment Mechanism

CBAM has been criticized as a trade-restrictive policy, especially by developing countries like India, which has set a target of becoming carbon neutral by 2070.

India has expressed concerns about CBAM at various international forums, including the World Trade Organization (WTO), emphasizing the importance of non-discriminatory treatment for the same products and warning that such measures could lead to protectionist practices.

• India’s exports of energy-intensive goods including steel, aluminum, cement, and fertilizers are anticipated to suffer significantly from the EU’s adoption of the CBAM.
• In the EU market, Indian exporters are expected to see increased pricing, less competitiveness, and decreased demand for their products.
• Implementing the CBAM is expected to pose a significant challenge to India’s metal sector. In 2022, 27 percent of India’s exports of iron, steel, and aluminum products went to the EU.
• Starting January 1, 2026, the EU will begin collecting carbon tax on each consignment of steel and aluminum, which will result in Indian firms paying an amount equivalent to 20-35 percent of tariffs.

The impact of CBAM on India will depend on the carbon intensity of the exported products and their substitutes in the EU market.

If there are no low-carbon substitutes for Indian products in the EU market, then the impact of CBAM on Indian exports may be limited.

• India has to put in place a carbon pricing mechanism, develop low-carbon technology, and maintain its competitiveness in the global market while reducing the effects of CBAM.
• This will assist Indian companies in adhering to CBAM rules and lowering the carbon intensity of their products. India must also re-evaluate its export strategy and find new markets for its goods to maintain their competitiveness in the face of CBAM’s effects on the EU market.

Steps Taken by India

The Indian government is also considering several measures to address the potential impact of the EU’s carbon border tax:

• Negotiating with the EU: Talks with the EU to provide a discount or exemption for Indian manufacturing. The intention is to prevent unfairly taxing Indian businesses for their emissions.
• Developing a carbon pricing mechanism: Developing a national carbon pricing system to incentivize businesses to cut their emissions. This will increase the competitiveness of Indian enterprises and assist India’s policies in complying with the EU’s carbon reduction targets.
• Promoting renewable energy: Encouraging renewable energy sources to cut carbon emissions, such as solar and wind power. To assist the Indian industry in switching to greener energy sources, the government intends to continue investing in renewable energy infrastructure.
• Investing in carbon capture technology: Investigating how carbon capture and storage (CCS) technology may be used to lower emissions of carbon from manufacturing operations. Before they are discharged into the environment, this technology collects carbon emissions and stores them below.

Global Concerns

Companies and countries outside the EU may raise two concerns over CBAM:

• It places a carbon charge on companies from countries that did not primarily cause climate change.
• According to the EU, CBAM is designed to be in full compliance with WTO rules and international climate law.
• However, questions have been raised over the consistency of CBAM with international trade law and environmental principles.
• Given its innovative nature and global impact, it is likely to be the subject of a legal challenge to the WTO.

The trade tensions that measure such as the EU CBAM and the US Inflation Reduction Act can cause are also being raised.

• Given the very different ways the EU and the United States have chosen to incentivize decarbonization, finding equivalence between the two blocs will be challenging.

Way forward

India’s manufacturing industry is expected to be significantly affected by the EU’s new carbon border tax, especially companies that export products to the EU.

The Indian government is taking proactive steps to ensure the country’s manufacturing industry remains competitive by reducing carbon emissions and promoting renewable energy sources.

• India is also laying the foundation for the creation of a carbon market. In this regard, the Ministry of Power published a draft of the Carbon Credits Trading Scheme (CCTS) on March 27, 2023.
• The draft comprehensively outlines the institutional framework and operational mechanisms that will govern the forthcoming carbon credit market in India.

Under the provisional agreement, CBAM will begin to operate from October 2023 onwards. Initially, a simplified CBAM would apply with importers obliged to collect and report carbon data.

• From 2026 onwards, the full CBAM will kick in and the levy linked to the EU’s carbon market price will be payable.
• If companies cannot provide emissions data or their data are regarded by the EU as unacceptable, they will face punitive default values for emissions.
• According to the European Commission, several countries, including Canada and Japan, are planning initiatives like CBAM.

The world needs to find a way to square the need to take climate action with the fundamental principles that underpin the global trading system. The year 2023 will be critical in working through how best to do this.

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-­Article written by Swathi Satish