The New EU Carbon Pricing Framework and Its Impact for Business

In July 2021, the European Commission introduced its climate package of 13 interconnected legislative proposals and revisions—commonly referred to as “Fit for 55”—as part of the European Green Deal. The package is a key enabler for a climate-neutral Europe by 2050 and for reducing emissions from 1990 levels by 55% by 2030. A critical element is the new EU Carbon Border Adjustment Mechanism, CBAM, which will result in a carbon price—similar to a levy on carbon emissions—on certain goods imported into the EU.

On Dec. 13 and Dec. 18, 2022, final trilogue discussions between the European Council, European Parliament, and European Commission concluded, and they reached a provisional agreement. While the agreement may undergo minor amendments before it is finalized, the key elements are now known and businesses are advised to plan before the CBAM enters force in October 2023.

The CBAM in a Nutshell

The CBAM will apply a carbon price to certain goods imported into the EU covering the following categories:

Iron and steel
Cement
Electricity
Fertilizers
Aluminum
Hydrogen
Some precursors and downstream products

The provisional agreement reached on Dec. 13, 2022 confirmed the CBAM will be introduced as of Oct. 1, starting with a transitional phase comprising of quarterly reporting obligations—quantity of goods, quantity of embedded and indirect emissions and any carbon price paid in the country of origin. CBAM reporting and charges will be based on “embedded emissions”—essentially emissions occurring upon manufacture with some indirect emissions also included.

Charges are paid through the purchase and surrender of CBAM certificates and the price of a certificate is equivalent to an EU allowance (one ton of emissions) under the EU Emission Trading System, the ETS. On Dec. 18, 2022, provisional agreement was reached on the reform of the EU ETS, and in turn, the CBAM. Under the agreement, “free allowances”—also known as “free allocation,” whereby allowances are provided to EU businesses in certain industries to discourage moving operations to jurisdictions with less substantive carbon pricing regimes—will be phased out gradually from 2026 to 2034. Accordingly, importers will be required to purchase CBAM certificates to cover the cost of emissions from 2027. CBAM certificates can’t be traded on the EU ETS market.

Where products have been subject to a robust regime of carbon pricing in the country of origin (i.e. a national carbon tax) prior to import, and documentary evidence is available, the price already paid can be reduced from the EU CBAM charges.

Importantly, where importers are unable to provide data on embedded emissions, the European Commission will provide benchmark values. If no reasonable benchmark values can be determined for certain products from a particular origin, “default values” will be published based on the emissions of the highest-emitting EU installations, likely eventually including a mark-up to reflect international emissions intensity.

A New Type of Carbon Pricing Regime

The CBAM represents a landmark step in carbon pricing policy for five key reasons.

Phasing Out of Free Allocation of Allowances

Historically, the impact of the EU’s carbon pricing regime has been weakened by free allocation as described above. The “carbon leakage list,” which defines sectors and subsectors subject to free allocation, covers approximately 94% of EU industrial emissions.

The nature of the CBAM means imports from non-EU countries (except countries of the European Free Trade Association) are charged a carbon price at the border, helping to level the playing field and, in principle, negating the need for free allowances.

A Charge on Scope 3 Emissions of Some Businesses

To date, Scope 3 emissions—indirect emissions in a company’s value chain (other than purchased electricity, heat, and steam)—aren’t directly priced. Instead, existing policy regimes typically focus on direct sources of greenhouse gas emissions (Scope 1), and on power generation (Scope 2 for non-power generating businesses).

In practice, many Scope 1 and Scope 2 emissions aren’t taxed, as not all jurisdictions have carbon pricing regimes, nor are they all implemented in a similar way. The latest edition of the EY Green Tax Tracker indicates a total number of 83 carbon pricing regimes worldwide, with 36 local regimes, and 47 jurisdictional, and with varying prices. Carbon emissions in more than100 nations aren’t currently subject to direct carbon pricing or taxation. Responding to this, the CBAM will apply a charge based on embedded emissions in EU imported goods where they haven’t been taxed already.

However, in the typical scenario where an EU importer isn’t the same entity as the manufacturer of the goods, the greenhouse gas emissions during manufacture are Scope 3 emissions of the EU importer—not Scope 1 or 2.

While the businesses may choose to pass costs up or down the value chain, the EU CBAM means that many EU importers will, for the first time, be charged a carbon price on their Scope 3 emissions—emissions resulting from the activity of a different business.

Potential Impact for Businesses That Have Not Previously Considered Carbon Pricing

To date, only intensive Scope 1 emitters and businesses voluntarily participating in ETS markets have been required to comply with carbon pricing regimes. Businesses without significant Scope 1 emissions footprints have thus typically had little to no exposure to carbon pricing regimes and associated compliance obligations.

The CBAM means businesses across a range of industry sectors will now need to consider the impact of the regime on their operating costs and compliance activities, which will require new internal responsibilities and skills. Businesses newly impacted due to their import footprint will include:

Automotive and aerospace manufacturers (e.g., aluminum, iron, steel);
Chemicals companies (e.g. precursors, fertilizers);
Advanced manufacturing (e.g., aluminum, steel);
Construction companies and material distributors (e.g., cement, aluminum, iron, steel);
Food retail value chain (e.g., aluminum foil).

This list has potential to grow as the European Commission will assess before the end of the transitional period whether to extend the scope to other goods such as polymers and organic chemicals, ultimately including all product categories currently under the EU ETS.

Importers in every industry should evaluate their imports for CBAM-covered goods. It is likely that the majority of businesses import basic metal parts and components classified in the metals chapters in the EU Customs Tariff. While the CBAM may not constitute a major cost element for the business, compliance requirements need to be arranged, also by small volume importers.

Trade Compliance and Tax Teams Enter the Conversation

Historically, carbon pricing measures such as the EU ETS have often been managed by business functions such as operations or manufacturing. This is primarily driven by the type of data required for compliance purposes, for example manufacturing facility activity-level data and associated emissions. However, unlike ETS regimes, the EU CBAM is heavily linked to trade compliance and indirect tax records.

For example, goods in scope of the regime are defined by customs commodity codes, and non-preferential origin is relevant. Supply chain responsibilities such as “importer of record” (customs declarant) will require to be tracked, alongside tonnages of imported products. The use of different types of customs procedures is also highly relevant. In addition, CBAM legislation provides for cooperation between the CBAM authority and local customs authorities for purposes of compliance and enforcement.

Teams who previously managed carbon pricing will now need input from trade compliance and business stakeholders. Conversely, where carbon pricing hasn’t previously been considered, trade compliance and/or business stakeholders will in practice often be expected to take responsibility for the CBAM.

A New Level of Reporting and Technology Capability Required

In addition to required customs and international trade data points, businesses also will need to calculate and report embedded emissions. While “benchmark” or “default” emissions values potentially can be used, these may be higher than actual emissions.

To effectively calculate and report out, unprecedented levels of visibility over supply chain and emissions data is needed, which will require engagement with multiple stakeholders across the value chain. New technology solutions may be needed to gather and validate information on embedded emissions and carbon prices paid on products earlier in the value chain.

Business Impact will be Substantive and Broad

The CBAM will impact businesses both in the EU and across the globe, from an operational response perspective and in terms of strategic decision-making. Impact may be either direct or indirect and can be broadly categorized as follows:

Cost: Where a business is importing relevant goods into the EU, there will be a direct operating cost implication through the requirement to buy CBAM certificates. Meanwhile, businesses elsewhere in the value chain may find costs passed onto them via pricing changes or contractual arrangement.
Competitiveness: Where a business is selling goods into the EU, their goods may represent higher costs for EU customers than for goods not subject to the CBAM. In the same way, more emissions-intensive manufacturers may be less competitive, as the CBAM will increase cost on goods at EU import.
Compliance: The new regime will drive complex compliance requirements for impacted businesses, including (but not limited to) the need to obtain and monitor emissions data, purchasing and surrendering of certificates, and submission of CBAM declarations.
Structure: Based on commercial terms, the obligations for CBAM compliance can be shifted between the contracting parties in a supply chain. Once the CBAM is implemented, only “authorized declarants” will be qualified to import CBAM-covered products, which may lead to less flexibility on which party can actually import, so that some import structures will need to be reorganized.
Risk: An increased level of risk exposure may be expected for CBAM-covered goods and closer scrutiny of activities occurring throughout the supply chain. Companies need to implement effective levels of risk management.

Considerations for Businesses—Five Key Actions

Now is the time to prepare for upcoming compliance obligations and potential cost burdens. Here are five key actions for effective preparation:

Identify impact: Review your EU import portfolio and the list of goods traded with EU importers to identify whether they fall within the scope of the EU CBAM regime.
Assign responsibility: Where impacts have been identified, determine which function and stakeholders will be responsible and accountable for preparing for the CBAM.
Assess exposure: Responsible parties should identify data points required for EU CBAM compliance and, where possible, model the cost implications for the business or the business’s customers. In addition to identifying areas of financial materiality, relevant stakeholders within the value chain should be identified where coordination of compliance activities is needed.
Plan and implement response: Responsible stakeholders should plan and implement an internationally and functionally coordinated response to the new measures impacting the business. This may include:
- Engaging with external stakeholders for data or operational changes;
- Optimizing supply chains to reduce emissions footprint and cost;
- Developing new internal processes and controls for compliance and monitoring;
- Reporting to internal and external stakeholders on emission, cost, and strategic implications;
- Evaluating infrastructure improvements to reduce release of emission upon manufacture (and throughout the value chain);
- Considering CBAM and carbon pricing measures in the context of mergers and acquisitions and portfolio management; and
- Implementing new IT functionality supporting CBAM management.
Monitor developments: The CBAM likely will evolve over time and isn’t being implemented in isolation. The EU ETS is evolving in parallel and jurisdictions, including the UK, are considering their carbon pricing regimes. Consequently, active monitoring of the global carbon pricing environment is pivotal to ensure that businesses respond to new regimes or changes to existing regimes in a coordinated and timely manner.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Richard J. Albert is EY EMEIA carbon measures lead, based in Leipzig, Germany. He has been with EY since 2007 and is experienced in global trade, customs and excise matters. Alwyn Hopkins is EY UK&I tax and law sustainability strategy and portfolio lead, based in London, UK. He is focused on bringing tax and law knowledge and insights to clients managing sustainable transformation. The views reflected in this article are the views of the authors and do not necessarily reflect the views of the global EY organization or its member firms.

The authors can be contacted at richard.j.albert@de.ey.com; alwyn.hopkins@uk.ey.com

The authors would like to thank Kasia Klaczynska-Lewis, Cathy Koch, Derek Leith and Charlene Glenister for their contributions to this article.