Climate change has become one of the defining challenges of our time, prompting governments and institutions around the world to implement bold initiatives to reduce greenhouse gas (GHG) emissions. One of the most notable measures is the European Union’s (EU) Carbon Border Adjustment Mechanism (CBAM), which aims to curb carbon emissions from imports. If you're not familiar with the complexities of CBAM, don’t worry—this article is designed to help you understand what it is, why it's necessary, and how it impacts businesses and consumers alike.

What is CBAM?

The Carbon Border Adjustment Mechanism (CBAM) is a policy tool created by the European Union to align with its ambitious climate goals. The EU has set a target to reduce its greenhouse gas emissions by at least 55% by 2030 and aims to achieve climate neutrality by 2050. CBAM plays a key role in helping the EU reach these targets by addressing a significant issue called carbon leakage.

Carbon leakage occurs when businesses move their production to countries with less stringent climate regulations to avoid the costs associated with carbon emissions in more regulated markets like the EU. This shift undermines global efforts to combat climate change, as it can lead to higher emissions in regions with weaker environmental policies. CBAM aims to tackle this issue by ensuring that the cost of carbon is factored into imported goods, making them comparable to the carbon costs of goods produced within the EU.

How Does CBAM Work?

CBAM operates alongside the EU’s Emission Trading System (EU ETS), a carbon-pricing system where companies within the EU are required to pay for every tonne of carbon dioxide (CO2) they emit. While EU-based companies pay for their emissions through the EU ETS, companies outside the EU have not been subject to similar carbon costs—until now.

Under CBAM, importers bringing goods into the EU will have to report the embedded emissions in their products and, over time, buy CBAM certificates to cover those emissions. This ensures that the price of imported goods reflects the carbon costs associated with their production, effectively leveling the playing field between EU-based companies and international exporters.

Phases of CBAM Implementation

CBAM is being introduced in two phases:

1. Transitional Phase (October 2023 - December 2025)

During this initial phase, importers are required to report the carbon emissions embedded in the goods they bring into the EU. However, they do not need to pay for these emissions immediately. The goal of this phase is to give businesses time to adjust to the new requirements and ensure that the reporting mechanisms are effective before financial obligations are introduced.

Importers must submit quarterly reports on the embedded emissions in their imports, including both direct emissions (emissions generated during production) and indirect emissions (emissions from the electricity used in production). Non-compliance with reporting requirements may result in penalties during this phase, but there will be no financial payments associated with carbon emissions just yet.

2. Definitive Phase (Starting January 2026)

From January 2026, the CBAM mechanism becomes fully operational. Importers will now have to purchase CBAM certificates to cover the embedded carbon emissions in the goods they import. The price of these certificates will be tied to the weekly auction prices of the EU ETS, meaning that the cost of CBAM certificates will fluctuate in line with the price of carbon within the EU.

The definitive phase will involve a gradual ramp-up of financial obligations. By 2034, CBAM will cover 100% of the embedded emissions in the goods imported into the EU. At this point, importers will need to buy certificates for all the carbon emissions associated with their goods.

What Sectors are Covered by CBAM?

Not every sector is immediately affected by CBAM. Instead, the mechanism focuses on emission-intensive industries that are most susceptible to carbon leakage. These include:

• Cement
• Iron and Steel
• Aluminium
• Fertilizers
• Electricity
• Hydrogen

Within these sectors, CBAM covers not only the primary materials but also certain precursors and downstream products. For example, in the iron and steel sector, it includes products like pig iron, steel in various forms, and other related materials.

The Importance of CBAM in the Fight Against Climate Change

CBAM is one of the EU’s most important tools in its fight against climate change. By ensuring that imported goods face the same carbon costs as goods produced within the EU, the policy prevents companies from bypassing EU regulations by moving production to countries with more lenient environmental policies.

Moreover, CBAM encourages other countries to implement stricter carbon-pricing mechanisms. By imposing costs on carbon emissions from imports, the EU is indirectly incentivizing its trading partners to introduce similar policies, as they would otherwise lose competitiveness when exporting to the EU. In this way, CBAM serves as a catalyst for broader global climate action.

How Will CBAM Affect Businesses?

Businesses, especially those involved in the industries covered by CBAM, will face new challenges as the mechanism rolls out. Companies that export goods to the EU will need to adapt to the new carbon pricing requirements. This might involve:

• Reporting Obligations: During the transitional phase, businesses must track and report the embedded emissions in their products. This could require new data collection systems and an understanding of the emissions generated throughout the supply chain.

• Purchasing CBAM Certificates: Once the definitive phase begins, importers will need to budget for the purchase of CBAM certificates to cover the emissions embedded in their products.

• Adjusting Production: In some cases, companies may find it more cost-effective to reduce the carbon emissions associated with their production rather than paying for CBAM certificates. This could lead to investment in greener technologies and production methods.

What Does This Mean for Consumers?

Consumers are unlikely to see the effects of CBAM immediately. However, as businesses begin to factor in the cost of carbon emissions in their imports, some of these costs may be passed down the supply chain, potentially leading to higher prices for certain goods. For instance, goods like steel or aluminum that are critical in manufacturing may become more expensive.

On the other hand, CBAM could also drive innovation and competition in green technologies. As more companies look for ways to reduce their carbon footprint and avoid paying for CBAM certificates, we could see faster adoption of sustainable practices, which could ultimately lead to better products and services for consumers.

Challenges and Criticisms of CBAM

While CBAM has been praised for its role in tackling carbon leakage and promoting global climate action, it is not without its critics. Some of the key challenges include:

• Trade Tensions: Some countries have raised concerns that CBAM could lead to trade disputes, as it imposes costs on their exports to the EU. These countries argue that CBAM acts as a form of protectionism under the guise of environmental policy.

• Complexity: CBAM introduces a new layer of complexity for businesses, particularly in terms of reporting and compliance. Smaller companies, especially those in developing countries, may struggle to meet these new requirements.

• Impact on Developing Countries: There are concerns that CBAM could disproportionately affect developing countries, which may lack the resources to comply with the EU’s carbon pricing policies. This could lead to reduced access to the European market for some exporters.

The Future of CBAM

Despite these challenges, CBAM represents a significant step forward in global efforts to address climate change. As the mechanism becomes fully operational in the coming years, it will be closely watched by policymakers, businesses, and environmental advocates alike. In the longer term, CBAM could serve as a model for other regions to implement similar measures, contributing to a more comprehensive global approach to reducing carbon emissions.

the transitional phase starting in 2023 to full coverage of emissions by 2034.

The Carbon Border Adjustment Mechanism (CBAM) is a groundbreaking policy that ensures the EU’s carbon pricing system is applied to imported goods, preventing carbon leakage and promoting fair competition. While it presents challenges for businesses and may influence trade dynamics, CBAM is essential in the EU’s fight against climate change and serves as a powerful incentive for countries around the world to adopt more stringent environmental policies.

As CBAM is rolled out, its full impact will become clearer, but one thing is certain: businesses, policymakers, and consumers alike will need to pay close attention to this transformative policy and its implications for the global economy.