The European Parliament’s wish list on the Carbon Border Adjustment Mechanism (CBAM)

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On 21 December 2021, the European Parliament’s (EP) Committee on the Environment, Public Health and Food Safety (the Committee) published its Draft Report on the proposal for a Regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism (the Draft Report1 and the CBAM Proposal respectively2).

The Draft Report sets out the Committee’s proposed amendments to the CBAM Proposal. While the Draft Report states that it welcomes the overall approach of the CBAM Proposal, several of the Committee’s amendments change some significant aspects of the CBAM Proposal.

In this publication, we will look at some of those interesting amendments and reflect on the impact they may have on the sectors concerned by the CBAM.

Introduction – what is a CBAM?3

Climate change is a global problem that needs global solutions. Because the level of climate ambition varies throughout jurisdictions, a risk of ‘carbon leakage’ exists. This means that companies based in the EU could move carbon-intensive production abroad, or EU products could be replaced by more carbon-intensive imports. Such carbon leakage can shift emissions outside of the EU and could therefore weaken climate efforts. Although the existing EU Emission Trading System (EU ETS) already provides protection against carbon leakage through free allocation of emission rights, the EU’s ambitious Fit-for-55 targets have rendered this protection insufficient to protect sectors at risk. In order to increase protection against carbon leakage, the European Commission (EC) has therefore adopted a carbon border adjustment mechanism (CBAM). The aim of the CBAM is to equalise the price of carbon between domestic products and imports and ensure that the EU’s climate objectives are not vitiated by production relocating to countries with less ambitious climate policies.4

In practice, under CBAM EU importers will need to buy carbon certificates corresponding to the carbon price that would have been paid, had the goods been produced under the EU’s carbon pricing rules. Conversely, once a non-EU producer can show that they have already paid a price for the carbon used in the production of the imported goods in a third country, the EU importer will be able to fully deduct the corresponding cost. In short, the CBAM will help reduce the risk of carbon leakage by encouraging producers in non-EU countries to green their production processes.5 However, some difficulties concerning the principles and practical implementation of the CBAM still exist - these are discussed at length in this article on A&O’s Countdown to COP26 blog.

CBAMs are already in place in some regions around the world, such as California, where an adjustment is applied to certain imports of electricity. Like the EU, a number of countries such as Canada and Japan are planning similar initiatives.6

The committee’s draft report

Firstly, the Draft Report broadens the scope of the CBAM Proposal to cover organic chemicals, hydrogen and polymers by deleting the proposed Recital 32, which excluded the organic chemicals sector from the CBAM Proposal and adding a reference to hydrogen and polymers into the existing Recital 30 of the CBAM Proposal.7 This means the entire organic chemicals sector would also be subject to the CBAM, which is a significant extension of its scope.

Furthermore, the Committee extends the type of emissions covered by the CBAM Proposal by including indirect emissions (eg emissions generated from electricity used for manufacturing, heating or cooling) in the definition of “embedded emissions” in article 3, (16) of the CBAM Proposal.

In addition, the amendment not only covers the production processes of the goods themselves, but also those of its upstream products.8 This extension may have a significant knock-on effect, potentially involving additional (non-included) sectors in the proposed CBAM by association. It may also influence the carbon price (ie the amount paid in a third country in the form of a tax or emission allowances under a greenhouse gas emissions trading system, calculated on greenhouse gases covered by such a measure and released during the production of goods) seeing as embedded emissions in products imported into the EU will influence the amount of carbon certificates that will be required to import those products.

Additionally, the Committee notes that the implementation pace currently set out in the CBAM Proposal is too gradual to achieve the ambitious EU 2030 objective (ie the net emission reduction target of greenhouse gases of at least 55% by 2030, compared to 1990 levels)9. Therefore, it proposes to shorten the transitional period by one year, ending on 31 December 2024. The Committee also sets out an incremental phase-in of the CBAM factor as an alternative to the free allowances allocated under the EU ETS, so that it becomes compatible with the EU 2030 climate objective.10

The notable exception to this incremental phase-in is the cement sector, for which the Committee excludes certain categories of cement from this phase-in process entirely, because it considers this sector to be less exposed to carbon leakage. This means that the applicable CBAM factor for the cement sector will be 0% (meaning no CBAM mitigation factor would apply at all) from as early as 1 January 2025.

Moreover, the Committee considers that a central CBAM authority would be the most efficient, transparent and cost-effective instrument to ensure the proper implementation of the CBAM Proposal as opposed to a decentralised system with 27 competent national authorities. Practically, the Draft Report suggests that appeal against the decisions of the CBAM authority would be possible with an independent Board of Appeal, made up of three members, appointed by the Council, EP and Commission respectively.11 Decisions of the Board of Appeal could then be appealed with the General Court and ultimately, the Court of Justice.12 This begs the question, considering the caseload before the Court of Justice, whether these additional cases will not add significantly to the current processing times.

Interestingly, while the original article 26 of the CBAM Proposal contained a penalty provision in case declarants failed to surrender the required number of CBAM certificates amounting to the excess emissions penalty of article 16 (3) of the ETS Directive13 (ie EUR 100 for each tonne of carbon dioxide equivalent emitted for which the operator has not surrendered allowances), the amended article 26a changes the calculation method of the penalty to three times the average price of CBAM certificates in the previous year for each CBAM certificate that the authorised declarant did not surrender. Therefore, the Committee’s suggestion for article 26a allows the height of the penalty to fluctuate according to the price of CBAM certificates as opposed to a fixed penalty price depending on the excess amount of carbon dioxide emitted.

Reflection

Overall, the Committee’s Draft Report contains some amendments that significantly extend the CBAM by including the organic chemicals sector in its scope, as well as including indirect emissions and emissions from upstream products into the definition of “embedded emissions” in the CBAM Proposal. These extensions of the CBAM’s scope may have a significant knock-on effect on non-included sectors as well as the amount of carbon certificates declarants would be required to surrender.

Furthermore, the Committee’s indication that the current pace of implementation as set out in the CBAM Proposal is too slow seems characteristic of the EU’s overall climate ambition as well as its desire to bring the CBAM in sync with the EU ETS and its free allocation rules. The ultimate objective is to ensure the CBAM becomes a fully developed alternative to the free allowances currently allocated to installations at risk of carbon leakage under the EU ETS. Nevertheless, the notable exception to this rule is the cement industry, which the Committee completely cuts out of these benefits, stating as justification that the cement sector has the lowest trade intensity among goods covered by the CBAM and the risk of carbon leakage is therefore correspondingly low. Indeed, certain categories of cement would not benefit from any CBAM factor from as early as 1 January 2025.

The Committee’s suggestions to change the approach toward authorisation of import of products into the single market under the CBAM from a Member State approach through competent national authorities to a single EU-level CBAM authority is remarkable as well. Considering that the import of goods happens at Member State level, one may suggest that national authorities could have a better view on the activities on the ground and the practical and logistical adoption of the future CBAM as opposed to a single authority managing the import goods at all entry points into the single market at once. That being said, an argument in favour of legal certainty and consistency while avoiding the risk of uneven implementation of the CBAM and its implementing measures and delegated acts across Member States and potentially, forum shopping, can also be made.

In addition, a potentially uneven implementation at Member State level could also result in trade distortions if certain national authorities would function more efficiently than others. It appears that the Committee has considered the latter view more convincing by introducing the idea of a single CBAM authority. Furthermore, the appeal process of CBAM authority decisions with an independent Board of Appeal and ultimately, the Court of Justice, does raise some questions concerning the current caseload before the Court and whether the development of the CBAM could be hindered by its relatively long processing times.

Finally, the Committee has also changed the CBAM Proposal’s approach toward the calculation of penalties. Instead of a fixed penalty per tonne of carbon dioxide emitted in excess of carbon certificates surrendered by a declarant, the penalty would now be calculated based on the price of the carbon certificates themselves. Depending on the price of the future carbon certificates, this penalty could be more burdensome than the initial approach set out by the Commission. However, it is still unclear at this point how the carbon certificates will be priced and how heavily those prices may fluctuate in the future.

In conclusion, although it is not certain that the Committee’s amendments will make it into the final CBAM Regulation, it is nevertheless interesting to see how the Committee’s vision differs on some significant points to that of the Commission. Seeing as the CBAM Proposal has been submitted under the ordinary legislative procedure, the amendments will be debated in the EP plenary, after which the EP will vote on the amended CBAM Proposal. If the EP adopts the (amended) CBAM Proposal, it will subsequently be sent to the Council, which can accept the EP’s position (and thus, adopt the legislative act) or amend the EP’s position and then send it back to the EP for a second reading. The vast majority of proposals are adopted during the first reading.14

Conclusion and next steps

If the CBAM Proposal fails to be adopted during the second reading by both the EP and the Council, a Conciliation Committee made up of members of the EP and Council representatives will attempt to reach an agreement on a joint text. If this is the case, the agreed text is sent around to the EP and the Council for a third reading. If both the EP and the Council approve the joint text, the CBAM Proposal will be adopted. If not, the CBAM Proposal will not enter into force and the procedure is ended. The average time for an EC proposal to be adopted on the first reading was just below 18 months in the 2014-2019 legislative period.15 Furthermore, certain Member States (eg France, which holds the presidency of the Council of the European Union since 1 January 2022 until 30 June 2022 and has flagged the adoption of the CBAM as a priority topic) are pushing towards its swift adoption, which may accelerate the legislative process. One thing is certain: this is not the last word on the CBAM Proposal.

1European Parliament, Committee on the Environment, Public Health and Food Safety, Draft Report on the proposal for a Regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism, 21 December 2021, available here (the Draft Report).

2Proposal for a Regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism, 14 July 2021, available here (the CBAM Proposal).

3A&O’s Countdown to COP26 blog already features a deep-dive analysis of the functioning of the CBAM, contributed by Arthur Sauzay. The full article is available here.

4European Commission, “Carbon Border Adjustment Mechanism – Q&A”, 14 July 2021, see here.

5European Commission, “Carbon Border Adjustment Mechanism – Q&A”, 14 July 2021, see here.

6European Commission, “Carbon Border Adjustment Mechanism – Q&A”, 14 July 2021, see here.

7Draft Report, Amendment 13.

8Draft Report, Amendment 33.

9This target was adopted under the EU Climate Law. More information is available here.

10Draft Report, Amendment 105.

11Draft Report, Amendment 94.

12Draft Report, Amendment 96.

13Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a system for greenhouse gas allowance trading within the Union and amending Directive 96/61/EC, available here.

14Source: see here.

15Source: here.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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