A carbon border adjustment mechanism, or CBAM, puts a cost on the carbon footprint of imports. In effect, it evens up the carbon price of imports with domestic goods produced under a carbon regime.

A CBAM framework could even end ‘carbon leakage’, where manufacturers shift carbon-intensive production to countries with less rigorous standards, relocating their emissions rather than reducing them.

CBAM proponents say the aim is to equalise, not penalise, and encourage cleaner industry across the planet.

A form of CBAM already operates in California and Quebec, with adjustments applied to electricity imports from neighbouring states. On 14 July, the European Commission announced plans for a CBAM in the European Union (EU), and the US, Canada and Japan have discussed similar initiatives.

Will the advent of CBAMs nudge up the carbon price? Common sense says it will, but politics and short-term interests could still play a part.

Experts at the International Monetary Fund calculated that in 2021 the average global carbon price was US$3 per tonne (Sweden’s is highest at about US$139 per tonne) and only about 20% of global emissions are covered by carbon pricing programs. That’s a long way off the US$75 per tonne price they say is needed to reduce carbon emissions by enough to keep global warming to less than 2 degrees Celsius.

How will the EU’s CBAM work?

The European Commission has proposed the EU introduce a CBAM from 2023. It’s part of its broader Fit for 55 package to reduce EU greenhouse gas emissions by 55% by 2030 and become climate neutral by 2050.

The proposed CBAM is planned to apply initially to goods in the cement, iron and steel, aluminium, fertiliser and electricity sectors as they’re considered most at risk of carbon leakage.

EU importers will buy carbon certificates equivalent to the carbon price that would have been paid had the goods been made in the EU. If a non-EU producer can show it has already paid for carbon emissions related to the good, that amount can be fully deducted for the EU importer.

Picture: Iron and steel imports to the EU will attract a CBAM from 2023.

Initially, the CBAM will cover only direct emissions related to the production process (Scope 1 emissions). Indirect emissions from electricity (Scope 2 emissions) will not be covered, although an evaluation in 2026 will assess whether these should be included in the future.

During the transition period from 2023 to 2025, importers will only have to complete carbon reporting requirements. Payments for CBAM certificates aren’t expected to start until 2026 when the definitive system kicks in, and revenue will go to the EU’s budget.

It’s planned that by 31 May each year, the EU importer will declare the quantity of imported goods and their embedded emissions from the previous year. At the same time, it will surrender CBAM certificates corresponding to that amount of greenhouse gas emissions.

Although the transition period starts in 2023, the European Commission is taking a cautious approach, and there will be discussions with stakeholders to clear the way.

CBAMs and free trade agreements

Imposing a carbon border tariff on imports may seem to go against the letter of free trade agreements, especially if it shields domestic producers from foreign competitors. But the EU has managed to thread that needle by imposing an equal carbon price on domestic goods as it does on imports. It also has presented the CBAM as an environmental policy tool rather than a trade mechanism. That may satisfy the World Trade Organization, but it is yet to be tested.

Do carbon prices drive down emissions?

Carbon pricing tends to dominate political discussions about climate change. But when Jessica Green, an associate professor of political science at the University of Toronto, evaluated carbon pricing policies around the world since 1990, what she found was deflating.

Carbon taxes and emissions trading schemes reduced emissions “generally between 0% to 2% per year” she concluded. That’s a long way short of the 45% reduction in carbon emissions by 2030 that scientists say is needed to limit global warming to 1.5°C.

In an interview with This Week in Asia, Green observed that carbon pricing was politically convenient. “Governments can say ‘look, we are doing something. We put a price on carbon.’”

She suggests more effective emissions reduction could come from industrial policy that promoted clean energy.

“We need huge investments in public transportation, electrification and in housing – and those are not going to come from the private sector,” she says.

Ian Parry, a fiscal policy expert with the International Monetary Fund (IMF), is more optimistic on carbon pricing. He writes that a minimum carbon price could be “strikingly effective”.

“A 2030 price floor of US$75 a ton for advanced economies, US$50 for high-income emerging market economies such as China, and US$25 for lower-income emerging markets such as India would keep warming below 2°C with just six participants (Canada, China, European Union, India, United Kingdom, United States) and other G20 countries meeting their Paris pledges.”

An OECD price to rule them all?

Hot on the heels of landing its global minimum company tax rate of 15% in October 2021, the OECD turned its focus to a carbon price. At the G20 Summit in Rome last year, OECD Secretary-General Mathias Cormann raised the idea of international coordination over minimum carbon prices.

“We need a globally more coherent approach which enables countries to lift their ambition and effort to the level required to meet global net zero by 2050, with every country carrying an appropriate and fair share of the burden while avoiding carbon leakage and trade distortions,” he said.

“Carbon prices and equivalent measures need to become significantly more stringent, and globally better coordinated, to properly reflect the cost of emissions to the planet and put us on the path to genuinely meet the Paris Agreement climate goals.”

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