Evolution of EU Carbon Legislation

On December 13, 2022, the European Parliament and the Council of the EU reached a provisional agreement on the implementation of the EU Carbon Adjustment Mechanism ("CBAM"), the mechanism designed to complement the European Union Emission Trading System ("ETS") by tackling the risk of carbon leakage. 

Under the CBAM, EU importers of goods at high risk of carbon leakage will have to purchase carbon certificates corresponding to the carbon price that would have been paid had the goods been produced under the EU's carbon pricing rules. Goods at high risk of carbon leakage include, in particular, iron, steel, cement, fertilizers, aluminum, electricity, and hydrogen. The emissions price of the imported goods will be calculated on the "embedded emissions" of the goods (i.e., emissions occurring during manufacturing and certain indirect emissions), and the average weekly carbon auction price under the ETS, minus the potential charges paid by the non-EU producer pursuant to the carbon pricing regime in force in the country of production.

In this respect, the provisional agreement of December 13, 2022, clarifies the initial list of goods falling under the CBAM, namely iron, steel and some of their downstream products, cement, aluminum, fertilizers, electricity, and hydrogen. EU institutions also agreed to postpone the entry into effect of the mechanism: The CBAM should start as of October 2023 for a transitional period, the length of which has yet to be determined, during which EU importers will only have to report the embedded emissions of the imported goods. The scope of imported goods should be revised at the end of this period.

A second provisional agreement was reached on December 18, 2022, on the revision of the ETS. This agreement settles key issues such as the increase of emission reduction targets, the creation of an ETS II for buildings and road transports, and the addition of new conditions to benefits from free allowances. In addition, EU institutions agreed upon the timeline for the phasing out of free carbon emission allowances under the ETS (i.e., from 2026-2034). This will directly impact the CBAM: As free allowances in sectors covered by the CBAM will phase out, EU importers will have to start purchasing these certificates from 2027 on for embedded emissions of the goods that no longer benefit from free allowances.

Both agreements are political and remain provisional pending the final adoption of the two regulations and their publication in the Official Journal of the European Union. However, they are key steps in the reform of the EU carbon legislation and implementation of the EU Climate Package aiming at a carbon-neutral European Union by 2050. They also provide insights to companies to prepare for the entry into force of the CBAM reporting obligations and for the upcoming revision of the ETS, designed to reinforce efforts to develop more carbon-neutral supply chains.

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