What is CBAM? A simple explanation of the EU's carbon border adjustment mechanism

As climate change measures accelerate, the European Union (EU) is introducing the Carbon Border Adjustment Mechanism (CBAM), which is dramatically changing the rules of global business. The EU is establishing a mechanism to impose a "carbon cost" on imports of products with particularly high greenhouse gas (GHG) emission amount, such as steel, aluminum, cement, electrical machinery, and hydrogen.

The aim of this system is to balance carbon reduction efforts within the EU with international fairness, and it requires companies in trading partners, including Japan, to visualize their GHG emission amount and establish accurate reporting systems. The impact on product design and supply chain strategies cannot be ignored.

This article provides an easy-to-understand explanation of the overall system, from the purpose and structure of CBAM and the implementation schedule to the basic measures that Japanese companies should take.

What is CBAM?

overview and Objectives of CBAM

CBAM(Carbon Border Adjustment Mechanism) is a new environmental regulatory framework established by the EU (European Union) that imposes carbon emissions costs on imported highly carbon-intensive products such as steel, aluminum, cement, fertilizer, hydrogen, and electricity. The main purpose of this system is to ensure fairness with the EU emission amount Trading Scheme (EU ETS) and prevent carbon leakage while maintaining carbon reduction efforts within the EU. * 1

Carbon leakage refers to the phenomenon in which stricter regulations in countries with high environmental standards lead companies to move their production location to countries with weaker regulations, resulting in a halt to progress in reducing global greenhouse gas (GHG) emissions.

This mechanism aims to ensure a level playing field by ensuring that EU companies and importers from abroad bear the same carbon costs, and to contribute to promoting global sustainability.

Background to the introduction and the EU's aims

The introduction of CBAM has 2 aims: to strengthen the EU's climate change measures and to ensure economic fairness. The EU has set a goal of reducing GHG emission amount by 55% by 2030 compared to 1990 levels, and to achieve this, it announced a comprehensive package of legal reforms called "Fit for 55" in 2021. *2 CBAM is at the core of this package, and particularly targets high-carbon emission products such as cement, steel, aluminum, fertilizer, hydrogen, and electricity. In addition, CBAM adjusts the carbon emission costs of imported products that cannot be covered by the EU ETS (European emission amount Trading Scheme), thereby leveling the playing field both within and outside the EU.
Through this, the EU aims to raise international environmental standards and encourage other countries to introduce similar carbon pricing systems, thereby accelerating global decarbonization.

The relationship between CBAM and carbon pricing

The CBAM system is based on a complementary relationship with the EU ETS (emission amount Trading Scheme).

The EU ETS imposes costs on carbon emissions based on emissions trading within the EU, but does not apply to imported products, which could lead to imbalances.

To solve this problem, CBAM has introduced a system that applies a carbon price equivalent to the EU ETS to eligible products imported from overseas. This is positioned as part of carbon pricing and is expected to promote global carbon reduction.
As a result, it could put pressure on not only the EU but also its trading partners to reduce carbon emissions, and could also serve as an opportunity for them to consider introducing carbon pricing in their own countries.

Explaining how CBAM works

How carbon emissions costs are calculated

CBAM calculates the carbon emission costs of imported products, and importers cover these costs by purchasing CBAM certificates equivalent to the cost. A carbon price based on the EU emission amount Trading Scheme (EU ETS) is applied to this calculation. Specifically, the cost is calculated based on reported data and standard Emission factor, and then multiplied by the carbon price. This calculation aims to maintain a level competitive environment by requiring importers to pay the same carbon cost as producers within the EU.

For example, for products with high Energy consumption, such as steel or cement, the associated emission amount are calculated specifically and the results are reflected in the carbon cost of the product. This system also plays a role in preventing an increase in greenhouse gas emissions (carbon leakage) caused by companies relocating their production location to countries with lower emission costs.

Products Covered and Importer Obligations

Products subject to CBAM include cement, steel, aluminum, fertilizer, electricity, and hydrogen. These products have been selected as targets of regulation because they emit large amounts of GHG during the Manufacturing process. With the application of CBAM, importers are obligated to purchase CBAM certificates. * 3

Create by Zeroboard based on Annexes to the CBAM Implementing Regulation for the transitional phase

Importers are required to register as "authorized CBAM declarants" and fulfill detailed reporting obligations when importing affected products. * 4

Specifically, detailed reporting of GHGs (greenhouse gases) emitted during the Manufacturing Manufacturing of products is required. Quarterly reporting is required during the transition period from 2023 to 2025, but once the standard is officially implemented, annual reporting will be the norm. Therefore, importers must strengthen cooperation with manufacturers to acquire emission amount data and establish management systems. * 5

System changes under the Omnibus Bill in February 2024

In February 2024, the European Commission introduced an omnibus bill that includes an operational review of the CBAM system, making several important changes to importer obligations and the operation of the system, which aims to clarify and harmonize the system while reducing the reporting and data collection burden.

The main changes are as follows:

• The first purchase of CBAM certificates will be postponed until after February 2027 (however, this will apply to imports from 2026 onwards).
• Introduction of a "di-minimis threshold" that applies to businesses with small import volumes
• Products that have undergone minor processing and assembly (finishing process) are excluded from CBAM.
• Clarification of the rule that emission amount from EU-sourced materials are not subject to reporting (to prevent double counting)
• Flexibility in the requirements for using default values allows for the use of regional average values
• Clarification of requirements for purchasing, retiring, and managing CBAM certificates (in preparation for full implementation from 2026 onwards)

These changes are expected to ease the practical hurdles regarding emission amount reporting and data management for exporting companies outside the EU, including Japan, to a certain extent. However, preparations for complying with the system remain essential, and companies are required to put in place the necessary systems during the transition period.

CBAM implementation schedule

Transition period (October 2023 - December 2025)

The transition period for CBAM will begin on October 1, 2023, and will run until the end of 2025. This will give companies time to adapt to the system, and also allow the EU to make any necessary improvements to the operation of the system as a whole.

During this period, importers of CBAM-covered products will be required to report emission amount, but will not be charged (by purchasing CBAM certificates).
The transition period is also positioned as a preparation period for collecting and reporting data on contained emission amount.

Full application period (from January 2026)

Full implementation of CBAM will begin in January 2026, when actual carbon emissions costs will be imposed. * 6 Companies will be required to purchase and retire CBAM certificates by the end of 5 each year based on their import volume from the previous fiscal year.

Failure to take appropriate measures could result in penalties of up to 100 euros per ton of CO₂, making it extremely important to have accurate data and a well-established management system.

Impact of CBAM implementation

Impact on Industry within the EU

The introduction of CBAM will have a variety of effects on Industry within the EU. First, it is said that EU Manufacturing will be able to compete fairly with cheaper products from outside the EU. In particular, some Energy-intensive Industry such as steel and aluminum have welcomed CBAM, as it will alleviate concerns that cheap imports will threaten their markets.

On the other hand, even within the EU, companies with low production efficiency and businesses with high carbon emission amount are at risk of losing their competitiveness. As high environmental standards are required, these companies will be required to respond quickly, which will increase costs and burden the burden of adapting to the system. In particular, the increasing application of carbon costs based on GHG emission amount under the CBAM regulation could have a significant impact on corporate management strategies.

Reactions and impacts of affected countries

The introduction of CBAM will have wide-ranging economic and policy implications for target countries. As the EU is the first to introduce a mechanism for Settings a carbon price in global supply chains, exporting countries will be required to transparently report carbon emission amount during production. * 7 In order to comply with this reporting obligation, many countries are being asked to establish systems and take technical measures.

Some countries have expressed concerns that the "border adjustment" system could function as a new tariff barrier. Many, particularly developing countries, have pointed out that such a system would have a negative impact on international trade and economic growth. On the other hand, some developed countries with advanced environmental awareness are making efforts to promote exports by aligning CBAM with their own domestic regulations.

Specific impact on Japanese companies

Affected industries

Among Japanese companies, the steel, aluminum, chemical, and power-related industries are likely to be particularly affected by CBAM.
As of 2021, approximately 1.9% of Japan's total exports to the EU are subject to CBAM, and further impacts are expected as the scope of application expands in the future.
Producers of steel, aluminum, and other products exported from Japan to the EU will be forced to improve transparency and reduce their GHG emission amount. In particular, the introduction of reporting obligations will require exporting companies to review their existing processes and accurately understand the carbon emission amount throughout their supply chains.
Furthermore, as carbon costs based on CBAM will affect product prices, Japanese companies will need to review their product designs and production processes to maintain price competitiveness. Japanese companies will also need to accelerate investment in carbon reduction technologies and develop strategies to enhance sustainability by complying with environmental regulations. Long-term carbon emission reduction plans will be crucial for companies in high-carbon-intensive sectors, in particular, to maintain their competitiveness in the EU market.

Specific measures

In order for Japanese companies to comply with CBAM, the following efforts are necessary: * 8

1. Establishing a system for visualizing and reporting carbon emission amount

• Accurately understand GHG emission amount within your company and throughout your supply chain, and report them appropriately to the CBAM Registry.
• We will establish a system to calculate the emission amount of each product and submit them in a form that complies with EU regulations.

2. Investing in low-carbon technologies

• In order to reduce the cost of purchasing CBAM certificates, we will introduce Manufacturing processes that generate less GHG emission amount .
• We will strengthen the development of low-carbon and zero-carbon technologies and the use of renewable Energy.

3. Maintaining competitiveness in the EU market

• We will consider whether to pass on the increased costs of complying with CBAM to prices or consider strategies to maintain competitiveness.
• We will strengthen cooperation with business partners within the EU and promote low carbonization throughout the entire supply chain.

Issue regarding CBAM and future responses

Consistency with WTO rules

One of the most prominent Issue in the implementation of CBAM is its compatibility with WTO (World Trade Organization) rules.
The CBAM aims to maintain a level playing field while the EU maintains its domestic environmental policies. However, because it applies a tariff-like mechanism to imported products by adjusting carbon prices, it may be perceived by some target countries and companies as a "non-tariff barrier" or "protectionist regulation."

The WTO-based multilateral trade order has strict rules regarding border adjustment taxes and tariffs, so the focus of debate is likely to be on whether this system has the legitimacy to protect the environment.
In response, the EU continues to emphasize that CBAM will be a major response to the climate crisis and to justify it to the international community.

The impact of global supply chains

In Industry that include the products in question, such as steel, aluminum, cement, fertilizer, hydrogen, and electricity, importers from both developing and developed countries will be required to comply, which may result in increased production costs and a need to review supply systems.
In particular, for global companies that Manufacturing products across multiple countries, assessing carbon emission amount throughout their supply chains and complying with reporting obligations is a major Issue.
In addition, strict implementation of CBAM is expected to bring about changes in the overall market structure, as it may reduce the competitiveness of exports from countries with high carbon emission amount.

Future international collaboration and potential expansion of the system

CBAM began as a unilateral EU initiative, but international cooperation is a future Issue. To create a system for applying carbon pricing on a global scale, cooperation among major trading nations and economic zones is essential. For example, how major exporting countries such as Japan, China, and the United States respond to this system will be a key point.
There are also discussions about expanding the scope of CBAM beyond its current target products. If it is applied to other products and sectors, its impact will be even broader, putting pressure on global trade rules and economic activity toward sustainability.
It is expected that CBAM will continue to evolve from both environmental policy and trade policy perspectives.

summary

As the full-scale implementation of CBAM progresses, the details of the system and related rules will likely become clearer. Accordingly, companies in each country, especially those involved in exports, will need to strategically address carbon costs. CBAM is not simply a trade system; it is an environmental policy aimed at reducing GHG emissions on a global scale. It is therefore essential that all stakeholders fully understand its significance and specific impacts.

For Japanese companies, the key to complying with the CBAM regulations will be to review the products they cover, restructure their export strategies, and take steps to reduce GHG emission amount.
To make the most of the contributions that CBAM can make to environmental improvement, not only will individual companies need to adapt, but Japan as a whole will also need to strengthen its international collaboration.

We provide support tailored to your company's situation, from understanding the CBAM system to practical implementation and tool implementation. Please feel free to Contact us as we will make proposals based on your company's structure and progress.

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<Reference source>

* 1 Explanation of the EU Carbon Border Adjustment Mechanism (CBAM) regulations : https://criepi.denken.or.jp/jp/serc/research/files/290/pdf/23002dp.pdf

* 2 Fit for 55
https://www.consilium.europa.eu/en/policies/fit-for-55/

* 3 Ministry of Industry, Trade and Industry | Carbon Border Adjustment Measures https://www.meti.go.jp/policy/energy_environment/global_warming/cbam/cbam.html

* 4 JETRO | Preparing for the EU Carbon Border Adjustment Mechanism (CBAM) https://www.jetro.go.jp/biz/areareports/special/2023/0801/a48cfe7206a68970.html

* 5 Ministry of Economy, Industry| CBAM Issues and Response Status https://www.meti.go.jp/shingikai/energy_environment/cbam/pdf/001_05_00.pdf

* 6 JETRO | CBAM transition period begins, measures are required for businesses other than importers within the EU 10

* 7 JETRO | Explanation of the EU Carbon Border Adjustment Mechanism (CBAM) (Basics) https://www.jetro.go.jp/ext_images/_Reports/01/b56f3df1fcebeecd/20230036.pdf

* 8- 1 A Clean Industrial Deal for competitiveness and decarbonization in the EU
https://ec.europa.eu/commission/presscorner/detail/en/ip_25_550

* 8- 2 REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL
https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX%3A52021PC0564

* 8- 3 COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS
https://single-market-economy.ec.europa.eu/document/download/7807ca8b-10ce-4ee2-9c11-357afe163190_en

* 8- 4 NRI｜Equilibrium carbon price for future carbon pricing in Japan
https://www.nri.com/en/knowledge/publication/lakyara_202405/files/000026975.pdf

Annexes to the CBAM Implementing Regulation for the transitional phase
https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=OJ%3AJOL_2023_2 28_R_0006#d1e32-113- 1