CBAM Explained | Tunley Environmental

CBAM, or Carbon Border Adjustment Mechanism, is a policy tool designed to tackle carbon leakage and ensure a level playing field for industries that face carbon pricing regulations.

As countries strive to reduce their carbon emissions, new policies and mechanisms are being developed. One such mechanism is the Carbon Border Adjustment Mechanism, commonly known as CBAM. In this comprehensive guide, we will delve into the intricacies of CBAM, understand how it works, and explore its implications and benefits.

An outline of the CBAM regulations:

• The implementation of a UK CBAM by 2027 is underway.
• CBAM liability will be contingent on the greenhouse gas emissions intensity of the imported good and the disparity between the carbon price in the country of origin (if applicable) and the hypothetical carbon price in the UK.
• Importers of goods falling under the scope of the UK CBAM will bear the CBAM liability directly, based on the emissions embodied in the imported products, eliminating the need for the purchase or trading of emissions certificates.
• Additional details regarding the design and execution of the UK CBAM will be open to consultation in 2024.

What is CBAM and how does it work?

CBAM, or Carbon Border Adjustment Mechanism, is a policy tool designed to tackle carbon leakage and ensure a level playing field for industries that face carbon pricing regulations. It aims to address the disparity between domestic industries subject to carbon pricing and their foreign competitors who are not. CBAM works by imposing an additional cost on imported goods based on the carbon content associated with their production.

The rationale behind CBAM is to prevent the relocation of carbon-intensive industries to countries with lax environmental regulations, which can lead to an increase in global carbon emissions. By levying a carbon border tax, CBAM incentivises foreign producers to adopt cleaner technologies and reduce their carbon footprint. This mechanism also protects domestic industries from unfair competition and encourages the adoption of sustainable practices worldwide.

CBAM and the affected emission categories:

CBAM will affect all the following categories:

• Scope 1 emissions relate to direct activities owned or controlled by an organisation. These emissions are directly controlled by those producing the product, for example as part of a manufacturing process or when fuels are combusted onsite.
• Scope 2 emissions relate to an organisation’s consumption of purchased electricity, heat, steam and cooling. Scope 2 represents indirect emissions which are not directly controlled by manufacturers of a product.
• Scope 3 relates to other emissions released as a consequence of an organisation’s actions that occur at sources not owned or controlled by the organisation. Scope 3 represents indirect emissions created upstream or downstream, for example, the transportation by air of finished products by subsequent entities, or the production of precursor goods from another manufacturer in the supply chain.
• The UK CBAM will be applied to Scope 1, Scope 2 and select precursor product emissions embodied in imported products to ensure comparable coverage with the UK Emissions Trading Scheme.
  

Related Insight: The difference between Scopes 1, 2, and 3 emissions

The need for CBAM regulations

The urgency to implement CBAM regulations stems from the growing concern over carbon leakage and the lack of a level playing field in global trade. Carbon leakage refers to the phenomenon where carbon-intensive industries relocate to countries with lower environmental standards, resulting in a net increase in global emissions. Without CBAM regulations, countries with ambitious climate goals may face negative consequences, such as job losses and economic imbalance.

CBAM regulations are essential to ensure that carbon pricing policies do not inadvertently shift emissions from one country to another. By levelling the playing field, CBAM promotes fair competition and encourages global industries to transition towards low-carbon practices. Additionally, CBAM regulations can act as a catalyst for international collaboration on climate action, fostering a sense of shared responsibility among nations.

Implications of CBAM on global trade

The introduction of CBAM will undoubtedly have far-reaching implications on global trade. One of the primary concerns is the potential for trade disputes and conflicts. As countries implement CBAM, tensions may arise if there are disagreements over the calculation of carbon content or the fairness of the additional cost imposed on imports. To mitigate these risks, it is crucial for CBAM regulations to be transparent, predictable, and based on robust scientific methodologies.

Furthermore, CBAM could lead to a reshuffling of global supply chains. Industries that heavily rely on carbon-intensive processes may choose to relocate or invest in cleaner technologies to avoid the carbon border tax. This could result in a redistribution of manufacturing hubs and impact the competitiveness of certain regions. However, it also presents an opportunity for countries to attract investment in sustainable industries and foster innovation in clean technologies.

Addressing carbon leakage with CBAM

One of the primary objectives of CBAM is to address carbon leakage and prevent the relocation of carbon-intensive industries to countries with weaker climate policies. By imposing a carbon border tax, CBAM creates an economic incentive for foreign producers to reduce their carbon emissions. This mechanism levels the playing field and ensures that domestic industries are not at a disadvantage due to higher carbon pricing.

CBAM can also act as a means to encourage other countries to adopt more ambitious climate policies. The fear of facing additional costs at the border may incentivise countries to strengthen their environmental regulations and align with global climate goals. This can contribute to a collective effort in combating climate change and transitioning to a low-carbon economy.

Understanding the UK Carbon Border Adjustment Mechanism

The United Kingdom, in its commitment to achieving net-zero emissions by 2050, has proposed the implementation of a UK Carbon Border Adjustment Mechanism. This mechanism aims to protect UK industries from unfair competition and ensure that imports meet the same carbon standards as domestic production. The UK CBAM will be designed in line with international trade rules and will be implemented in a phased manner.

The UK CBAM will require importers to purchase carbon allowances, similar to the domestic emissions trading scheme. The carbon allowances will be priced based on the carbon content associated with the imported goods' production. This mechanism will incentivise foreign producers to reduce their carbon emissions and align with the UK's climate objectives. The UK CBAM is expected to be a crucial component of the country's climate policy and will contribute to its efforts in achieving a sustainable future.

Benefits of implementing CBAM

The implementation of CBAM offers several benefits for both domestic industries and the global community.

• CBAM ensures a level playing field for domestic industries by preventing carbon leakage and unfair competition from countries with weaker environmental regulations. This promotes investment in cleaner technologies and sustainable practices.
• The regulations incentivise foreign producers to adopt low-carbon practices, eventually leading to a reduction in global emissions. By internalising the carbon cost through the carbon border tax, CBAM encourages industries worldwide to transition towards more sustainable production methods.
• CBAM can foster international collaboration on climate action. The implementation of CBAM by leading economies can encourage other countries to enhance their climate policies and strengthen environmental regulations.

Challenges and criticisms of CBAM

While CBAM presents numerous opportunities, it is not without its challenges and criticisms. One of the primary concerns is the potential for trade conflicts and disputes. CBAM regulations may face scrutiny and resistance from countries that perceive them as protectionist measures or barriers to trade. To address this, it is crucial to establish clear rules and guidelines for the calculation of carbon content and the imposition of the carbon border tax.

Another challenge lies in the complexity of implementing CBAM. Developing robust methodologies for calculating the carbon content of imported goods and ensuring the accuracy and reliability of data can be a daunting task. Additionally, CBAM regulations must be designed to avoid double-counting of emissions and to account for different production processes and supply chain complexities.

How businesses can prepare for CBAM

For businesses operating in industries that may be affected by CBAM, it is crucial to start preparing for its implementation. Firstly, businesses should assess their carbon footprint and identify areas where emissions can be reduced. By adopting and implementing sustainable practices, businesses can become more resilient to potential carbon border taxes and gain a competitive edge in a decarbonising world.

Businesses should stay informed about developments in CBAM regulations and engage with policymakers to ensure their voices are heard. By actively participating in the policy-making process, businesses can help shape CBAM regulations that are fair, transparent, and conducive to sustainable growth.

The Bottom Line

CBAM is a significant step towards achieving a sustainable future, and its successful implementation requires collaboration, transparency, and a shared commitment to combat climate change. Speak to one of our consultants about CBAM to learn more about its implications and how it may affect your business.