EU to Impose Carbon Border Tax on Imported Products
January 10, 2023
In December 2022, the European Council and Parliament reached a provisional agreement on a Carbon Border Adjustment Mechanism (CBAM) that will impose a tax on products imported into the EU, beginning with certain “high-carbon” products. The measure is part of an ongoing effort by the EU to prevent “leakage” of carbon-intensive industries to other countries, and to push non-EU countries to reduce their industrial emissions. This alert is based on press releases issued by the Council and the Parliament – the final CBAM text will need to be adopted by those bodies after certain details are finalized.
Industries Targeted. The CBAM will require reporting-only beginning in October 2023, and will focus on the following industry sectors: iron and steel, cement, fertilizers, aluminum, electricity, and hydrogen. It will also cover certain precursors and downstream products related to those industries. The EU has been providing a certain amount of free carbon allowances to those sectors under its Emissions Trading System (ETS) in order to prevent leakage, and the full CBAM phase-in will be coordinated with the phaseout of those free ETS allowances, which will be complete in 2034.
Mechanism. The goal of the CBAM is to equalize the price of carbon paid for products made in the EU and outside the EU. To achieve that goal, companies that import into the EU will be required to purchase CBAM certificates equivalent to the difference between the carbon price paid in the country of production and the price of carbon allowances in the EU. The EU is expressly seeking to “incentivize non-EU countries to increase their climate ambition” by imposing their own carbon taxes. The tax would be calculated based on the Scope 1 and Scope 2 emissions associated with the production of goods, and if the emissions cannot be verified, a default value would be used based on the emission intensity of the 10 percent worst performing EU installations producing those goods.
Timing. The reporting period will extend for three years, until 2026, after which the CBAM will be applied to goods in the initial sectors. The agreement also sets a goal of applying the CBAM to all goods covered by the ETS by 2030.
The CBAM is part of the EU’s “Fit for 55” package, which seeks to reduce greenhouse gas emissions by 55% by 2030. The package includes the ETS as well as measures to increase renewable energy, transition to electric vehicles, increase the use of green aviation and maritime fuels, and improve building energy efficiency.
The CBAM could have significant impacts on companies that manufacture in countries that do not impose carbon costs on industry. The EU has emphasized that its final bill will “be in full compliance with World Trade Organization (WTO) rules”, but given the scope and ambition of the bill, challenges on trade restraint grounds and retaliatory measures are likely. Although similar measures have been proposed in Congress, there are no equivalent initiatives in either the United States or the EU’s other major trading partners, such as India and China.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. John Rousakis, an O’Melveny partner licensed to practice law in New York, Greta Lichtenbaum, an O’Melveny partner licensed to practice law in the District of Columbia, and Eric Rothenberg, an O’Melveny of counsel licensed to practice law in New York and Missouri, John D. Renneisen, an O’Melveny senior counsel licensed to practice law in the District of Columbia, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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