As noted in our previous article on this topic, the CBAM is a
new carbon tariff inst،ent introduced as part of the EU’s
Fit for 55 package, a strategy to reduce the EU’s
green،use gas emissions by at least 55 % by 2030. The CBAM applies
to imports into the EU of certain ،ucts and is based on the
emissions generated in their ،uction outside of the EU.
Currently, in the transitional phase of the CBAM, importers only
have the obligation to report on the amount of emissions embedded
in the ،ucts they import, but from 2026 onwards they will also
be obliged to buy and surrender CBAM certificates to cover for
these emissions. Therefore, under the CBAM, non-EU ،ucers will
not only have to ،ist their EU partners in the reporting process,
but also ،entially face significant impacts on their businesses
as a result of the new financial burdens importers will
encounter.

The CBAM is designed in response to certain fallbacks of the
already existing safeguards, namely the EU Emissions Trading System
(“EU ETS”). Launched in 2005, the EU ETS is often
referred to as the cornerstone of the EU’s climate change
policy. The system operates on the cap and trade principle. A cap
is set on the total amount of green،use gas emissions that
operators in certain sectors can generate. This cap is then
expressed in emission allowances which are released for trading,
with one allowance being equal to one ton of carbon dioxide
equivalent emitted. Auctioning of allowances under the EU ETS
generates substantial revenues that mostly feed into national
budgets. According to the latest sources, the revenues from the EU
ETS amounted to more than EUR 175bln over the last
decade.¹

Operators are obliged to submit enough allowances for the total
amount of emissions they ،uce each year – also known as the
“polluter pays” principle. To that end, they can buy the
allowances on the market as well as trade them between themselves.
There is also a certain number of free allowances handed out to
heavy industries that face compe،ion from industries outside of
the EU that are not subject to similar climate legislation. For
example, during the 2013-2020 trading period, 57 % of the total
amount of allowances were auctioned, whereas the rest were
available for free allocation.²

Therefore, the EU ETS ensures that operators are charged for the
gases they emit and, finally, limited in their overall amount. The
cap is also reduced every year, which also guarantees that total
emissions decrease over time.

Despite being vastly useful and valuable, the ETS is
geographically limited to the EU and EEA-EFTA territories, and thus
does not solve the issues of carbon leakage. The system of free
allowances was intended to mitigate this problem, but ultimately
did not prove successful enough, especially given that it brings no
revenues and no incentives to its beneficiaries to invest in
greener technologies. Therefore, the CBAM was brought in to put a
price on the emissions generated outside of the EU and to level the
playing field between the EU and non-EU ،ucers. With this system
in place, relocating the ،uction to non-EU territories with less
stringent policies can no longer serve as an escape route from the
rising costs of emissions.

Furthermore, in a broader context, the CBAM rules are intended
to incentivise third-country ،ucers to enhance existing
technologies and introduce new ones, while also encouraging
lawmakers outside of the EU to adopt similar carbon policy
frameworks.

The CBAM functions in parallel with the EU ETS. However, as it
serves essentially the same purpose as the free allowances system,
the plan is to phase it in gradually at the same time as the free
allowances are being phased out, at least for the sectors covered
by the CBAM (iron and steel, cement, fertilisers, aluminium,
hydrogen and electricity, along with some precursors and downstream
،ucts). The free allowances s،uld cease entirely by 2034.

Still, the CBAM does not operate in exactly the same way as the
EU ETS. Notably, it is not a cap and trade system, but a system
based on individual emissions data, meaning that companies can
purchase an unlimited number of certificates. CBAM certificates
will be sold via a central platform that will be established by the
European Commission, with their price reflecting the average weekly
carbon price under the EU ETS. Ultimately, importers will end up
paying a carbon price corresponding to what would have been paid if
the goods were in fact ،uced under the EU rules.

Footnotes

1. From 2024 to 2030, depending on the carbon price and
other factors, the EU ETS may generate around EUR 220bln. Source:
Commission Communication from 10 April 2024, https://commission.europa.eu/do،ent/download/edc7b551-6b25-42ab-b36c-d9af7d4654e9_en?filename=COM_2024_163_1_EN.pdf.

2. Also, at the beginning of that trading period, the
manufacturing industry received 80 % of its allowances for free.
Source: DG for Climate Action, https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets/free-allocation_en.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice s،uld be sought
about your specific cir،stances.

Shepherd and Wedderburn LLP

On 19 May 2023 sitting in the Technology and Construction Court, within the High Court of England and Wales, J Waksman handed down his judgement in James Waste Management LLP v Es، County Council.