This article covers how carbon pricing impacts trade, the CBAM framework, key compliance steps, and how to manage it through corporate performance management.
When Carbon pricing mechanisms are taking importers by storm. Chief among them is the EU’s Carbon Border Adjustment (CBAM). For the uninitiated, CBAM is the latest installment of global carbon pricing mechanisms that put the polluter pays principle into action. Under CBAM, companies don’t get to sidestep costs by importing cheaper, polluting goods from aboard. CBAM puts carbon costs squarely on the shoulders of the purchasing company, no matter where they’re sourcing from.
Carbon pricing mechanisms, like CBAM, presents many challenges, from data management and emissions calculations to complex reporting requirements. Critical among them will be weighing the cost-benefit of domestic vs. foreign sourcing, which may involve rethinking critical links of the supply chain.
To understand what CBAM will mean for your organization, let’s walk through the regulation and explore its impacts on financial processes.
What you’ll learn
- How carbon pricing is reshaping imports and production
- Understanding the EU’s Carbon Border Adjustment Mechanism (CBAM)
- How CBAM works
- 5 critical steps to prepare for CBAM’s full enforcement
- The best way to manage CBAM: A corporate performance management approach
How carbon pricing is reshaping imports and production
Carbon pricing mechanisms are sweeping the global. As of April 1, 2024, there are 75 carbon pricing instruments in operation worldwide, and in 2023, carbon pricing revenues
reached a record high of $104 billion — according to the World Bank.
What is carbon pricing?
In its simplest terms, carbon pricing puts a price on carbon emissions to make it more expensive to operate businesses that use polluting practices. The end goal of carbon pricing mechanisms is to reduce greenhouse gas emissions by disincentivizing companies using “brown” business practices, making carbon-light alternatives more attractive.
What is the polluter pays principle?
The polluter pays principle is the environmental equivalent of "you break it, you buy it." In essence, whoever causes pollution should bear the costs of preventing,
mitigating, or remedying that pollution. Carbon pricing makes polluters financially responsible for the costs of the high emissions products they produce or use, not society at large.
Types of carbon pricing
Carbon pricing can be explicit or implicit. Explicit carbon pricing puts the price tag right on carbon emissions, whereas implicit pricing encourages reduction without a direct price tag.
Common forms of explicit carbon pricing are:
- Carbon taxes, which impose a fee per ton of emissions. They incentivize emitters to reduce pollution by making it more expensive to pollute.
- Cap-and-trade system, or Emissions Trading System (ETS), which sets an emissions limit. This allows entities to buy or sell permits based on their emissions.
- Carbon border adjustment mechanisms (CBAM), carbon price on imported goods, which we’ll explore at length in this article.
Understanding the EU’s Carbon Border Adjustment Mechanism (CBAM)
CBAM is a global policy tool that places a carbon price on imported goods outside the EU based on the carbon they emit during production. Essentially, CBAM is a tariff levied on goods to ensure EU goods aren’t challenged by cheaper, high-emissions products from aboard.
CBAM has a few goals:
- To encourage cleaner production practices in non-EU countries
- To align emissions standards where differences occur
- To prevent “carbon leakage” by ensuring imported goods face the same carbon price as EU-produced goods.
How do CBAM and the EU’s Emissions Trading System intersect?
CBAM aims to complement and reinforce the EU Emissions Trading System (EU ETS), a cap-and-trade system that limits the amount of carbon emissions domestic companies can produce in the EU. Under the EU Emissions Trading System, companies acquire emissions allowances through grants or purchases. The allowances a company purchases determines the amount of regulated gasses they can emit.
CBAM uses a similar approach, but applies its carbon tax to imports from non-EU countries entering the EU, whereas the EU ETS applies to intra-EU goods.
In summary, CBAM applies to imports, and EU ETS applies domestically.
What is “carbon leakage”?
Carbon leakage is when companies shift production and emissions from a region with strict carbon regulations to a location with more lax rules. CBAM prevents carbon leakage by disincentivizing companies to import cheap, high-emission products from aboard.
