What is Carbon Border Adjustment Mechanism?

What is Carbon Border Adjustment Mechanism?

The Carbon Border Adjustment Mechanism (CBAM) is a European Union policy instrument that imposes a carbon cost on imports of carbon-intensive goods, equivalent to the price domestic producers pay under the EU Emissions Trading System (ETS). CBAM addresses "carbon leakage"—the risk that production shifts to countries with weaker climate policies, undermining the EU's emissions reductions. The mechanism entered its transitional reporting phase in October 2023, with financial obligations beginning January 2026.

Why It Matters

CBAM represents a fundamental shift in international climate and trade policy. For the first time, a major economy is systematically pricing the carbon embedded in imported goods, creating a de facto global carbon price for products entering the EU market. This has profound implications for exporters in countries without equivalent carbon pricing, particularly in energy-intensive sectors.

The covered sectors—iron and steel, cement, aluminum, fertilizers, electricity, and hydrogen—account for a significant portion of global industrial emissions. Importers must purchase CBAM certificates matching the embedded emissions of their products, minus any carbon price already paid in the country of origin. This levels the competitive playing field between EU producers facing ETS costs and foreign producers previously facing no carbon charges.

The geopolitical ripple effects are substantial. Countries like Turkey, India, China, and Russia—major exporters of CBAM-covered goods to the EU—face strong incentives to implement domestic carbon pricing. If they do, their exporters can deduct those costs from CBAM obligations. This "Brussels effect" may accelerate global carbon pricing adoption more effectively than decades of international negotiations.

Industry response has been mixed. EU producers generally support CBAM as it removes the competitive disadvantage of stringent climate policy. Importers and trading partners have criticized it as protectionism dressed in environmental clothing. The World Trade Organization compatibility of CBAM remains legally untested, though the EU has designed the mechanism to comply with WTO rules by applying equivalent treatment to domestic and imported goods.

How It Works / Key Components

During the transitional phase (October 2023-December 2025), importers must report the embedded emissions of covered goods but face no financial obligations. This allows companies to build measurement and reporting capabilities before the financial mechanism activates.

From January 2026, importers must surrender CBAM certificates corresponding to the embedded emissions of imported goods. Certificate prices will mirror the EU ETS allowance price, calculated as the weekly average auction price. Importers who can demonstrate that a carbon price was already paid in the country of production receive a corresponding reduction in their CBAM obligation, preventing double taxation.

Emissions calculation follows default values initially, with importers incentivized to use actual emissions data for more accurate (and potentially lower) assessments. The methodology covers direct (Scope 1) emissions for most products, with electricity also covering indirect emissions. The European Commission provides default emissions values by country and product category for cases where actual data is unavailable.

Administration is managed through a centralized CBAM registry. Importers must register as authorized CBAM declarants, purchase certificates through a designated platform, and submit annual CBAM declarations detailing quantities imported and associated emissions. Non-compliance carries penalties mirroring the EU ETS—currently €100 per tonne of unreported emissions.

Council Fire's Approach

Council Fire helps companies exposed to CBAM—both EU importers and international exporters—understand their obligations, build emissions measurement systems for covered products, assess financial exposure, and develop compliance strategies that minimize costs while maintaining supply chain competitiveness.

Frequently Asked Questions

Which products are covered by CBAM?

Currently: iron and steel, cement, aluminum, fertilizers, electricity, and hydrogen. The EU plans to expand coverage to all ETS-covered sectors by 2034, which could include chemicals, polymers, and other manufactured goods.

How does CBAM affect non-EU exporters?

Exporters to the EU must provide emissions data for covered products. If their home country has no carbon price, their goods effectively become more expensive in the EU market by the full ETS-equivalent carbon cost. Countries with domestic carbon pricing can offset this impact.

Is CBAM compatible with WTO rules?

The EU designed CBAM to comply with WTO principles by applying equivalent treatment to domestic and foreign producers. However, several WTO members have raised concerns, and no formal dispute has been adjudicated. Legal scholars remain divided on the outcome of a potential challenge.