Now is the time to get serious about Europe’s Carbon Border Adjustment Mechanism

The European manufacturing space is gearing up for a period of significant change. While Europe has been making progress on its overall energy transition for the better part of two decades, we are now seeing it roll out a more comprehensive industrial strategy that will have major effects on its manufacturing sector.

The Carbon Border Adjustment Mechanism (CBAM) is just over two years away from going into force, and European organizations should be deeply focused on preparing their strategy to account for this incoming regulatory environment.

The CBAM will initially be applied to direct greenhouse gas emissions in the electricity, cement, iron & steel, fertilizer, hydrogen, and aluminum sectors. In addition, certain downstream products such as screws will be included, despite low direct emissions, as a way of ensuring the steel industry does not find a way to circumvent regulations.

The indirect emissions from the electricity, cement, iron & steel, fertilizer, hydrogen, and aluminum sectors will also fall under CBAM. This is already quite the list, and with more additions still to be made before 2026, it highlights the importance of companies taking action now.

One of the most surprising inclusions in the new legislature is that of scope 2 emissions – or those related to the production of all energy used. While this greatly complicates compliance for companies, it also ensures the mechanism works as designed – to decarbonize European industry and ensure domestic companies can compete on the global scale.

Many European companies have operations in fossil fuel heavy countries, and the inclusion of these emissions means it is particularly important for them to find new solutions to procure energy to power their operations. In many cases, distributed energy fits the bill to a tee, allowing companies to source cleaner energy without uprooting established manufacturing processes and suppliers.

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Luckily, companies will have a two year runway to adapt their processes, procure clean distributed energy, and ultimately prepare themselves to thrive in a vastly different regulatory environment. Reporting obligations for European companies begins on October 1, 2023, and will run until the end of 2025. They will need to report the quantity of goods imported, total embedded emissions, total indirect emissions as well as the carbon price paid in the country of origin.

This two year transition period will allow for companies to better understand their own supply chains, and identify where they need to make changes before CBAM goes into effect. The companies who utilize this period effectively, will find themselves in a strong position to thrive on the European market when enforcement begins in 2026.

The way CBAM will work, is that international producers will provide the necessary information for verified emissions reports to the importing company. The importer will complete its annual CBAM declaration based off all imports, and will then purchase and submit CBAM certificates to cover their verified emissions. On the other side of the coin, ETS installations producing CBAM goods domestically will continue to report emissions, before purchasing and submitting EU allowances.

One important takeaway here is that CBAM certificates will equal the price of EU allowances under the ETS. In addition, any carbon prices paid outside of the EU will be deducted from the adjustment, ensuring a double levy is not charged. These concessions both ensure the mechanism is fair, and also keep it compliant with WTO regulations.

As the transition period ends and the CBAM goes into effect, energy management will emerge as a key topic for European companies. No longer will procuring the cheapest energy for all operations be the goal, instead ensuring that all operations can be powered with low carbon energy will be the key.

For many, this will see them dipping their toes into the emerging field of distributed energy. Purchasing clean energy to power individual operations abroad will become a key aspect of global businesses operating in Europe, and the benefits will be significant.

As mentioned above, the CBAM will take into account free allowances that are afforded to manufacturers under the ETS. The intention of CBAM is to remove the incentive to manufacture products overseas in a carbon-intensive manner – if the emissions of overseas products are equivalent to those produced in Europe, there will be no CBAM cost applied. This ensures the mechanism is as fair as possible, and does not simply punish producers unnecessarily.

Overall, the CBAM will play an important role in decarbonizing European industry. Companies who take the time now to establish a clean energy mix and to come in compliance with the CBAM will find themselves in a much better position to thrive on the European market once enforcement begins in 2026.

While there are short-term concerns about the economic impacts on export economies in developing countries, the looming impacts of climate change will be far more severe. Once again, Europe is taking an important step to both decarbonize, as well as protect its industry – time will tell who takes advantage of the opportunities ahead.

About the author:

Eren Ergin is the CEO of BECIS and a sustainability professional with over 20 years of experience in clean energy.

In his current role, he drives the global growth of renewable energy as a Service for commercial and industrial clients.