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Ensuring Compliance with the EU Carbon Border Adjustment Mechanism

September 3, 2024

Article

Introduction

In October 2023, the Carbon Border Adjustment Mechanism (CBAM) — an emissions trading scheme to reduce carbon emissions — went into effect.

Now in its transitional “pilot” phase for the European Union, the CBAM is set to directly affect EU firms, with an indirect impact on U.S. and global producers who export to the EU. Firms are not only required to provide accurate carbon emissions data and rethink supplier engagement but also to contend with the potential financial and supply chain roadblocks from noncompliance and higher costs.

Many companies doing business in or with the EU will need to be prepared for both the reporting process in the current transitional phase and the shifting trade dynamics the CBAM will have on them. Failure to be sufficiently prepared may lead to a heavy impact on financial performance, damage to reputation, and disruptions to global operations. But building the mechanism to manage and comply now can pay dividends later as other countries enact similar laws or targeted sectors grow.

This article will explore the CBAM, its far-reaching impact, and what your organization needs to know to ensure CBAM compliance.

The CBAM: What It Is, and What to Expect

Enacted in October 2023 as part of the EU’s Fit for 55 package, the CBAM works by placing a price on certain greenhouse gases (GHG) emitted in the production of selected imports. Its goal is to equalize the carbon price between the EU and a given production country, primarily to prevent “carbon leakage” — instances when companies move their production with stringent carbon policies to another more lenient one, thus avoiding taxation.

The goods covered in the pilot phase are:

Iron
Steel
Aluminum
Cement
Fertilizers
Chemicals and Polymers
Electricity and Energy

These products have the highest carbon footprint, encompassing 45% of the EU Emissions Trading System (EU ETS) sectors.

The CBAM is being implemented across three stages:

Stage 1: Transitional Phase

From October 2023 onwards. Pilot product importers must calculate and report emissions.

Stage 2: Pilot Implementation

Starting January 2026, companies must purchase pilot product import permits.

Stage 3: Full Implementation

The CBAM will expand to other product implementations until 2032.

Stage 1: Transitional Phase

During this phase, which extends until December 2025, importers of the pilot phase products listed above are required to calculate and report their emissions to the EU. Businesses will need to measure their current direct and indirect emissions and any carbon tax exposure. Those without a robust data structure to draw from will need to make their estimates, relying on information provided by other non-EU producers.

Stage 2: Pilot Implementation

In the second stage, importers will be required to purchase import permits for the initial list of products to offset their emissions. During this phase:

EU importers must first register with national authorities and purchase CBAM import permits or certificates that would be priced based on the EU’s existing weekly ETS allowances.
Importers will need to declare the amounts of emissions that their imports produce and submit the corresponding number of certificates each year from their permits.
Importers who can prove that the carbon price has already been paid during production (through a domestic carbon tax, for instance) can have the corresponding amount deducted from the total certificates owed.

Stage 3: Full Implementation

Once 2027 rolls in, the CBAM will encompass other products until 2032, when it reaches “full implementation” and applies to all imported products. All importers must then calculate direct and indirect emissions from electricity usage and other factors.

Today, roughly 95% of manufacturing data exists outside of the organization’s immediate ecosystem. While manufacturers may have critical internal information on their employees and operations, external data — which includes information about their suppliers, import-export records, and corporate registries — often lack the recency, quality, and comprehensiveness needed for actionable insights.

Organizations must gain value chain data beyond their own organization to build resilience.

Why Does the CBAM Matter?

The CBAM can critically impact financial performance, reputation, and supply chain operations. Businesses can expect additional taxes, increased legal or regulatory oversight, and potential product shortages. At the same time, failure to comply can lead to brand trust and corporate social responsibility erosion, dissuading foreign firms from working with your organization.

More importantly, firms need to understand the potential financial impact the CBAM can have based on the carbon intensity of a product. The tax amount here is relative and dependent on the carbon content of the imported products. The factors are:

Where the product is produced
Its production methods
The carbon taxes paid by the non-EU producer.

For instance, a steel manufacturer using blast furnaces, which are more carbon-intensive, will encounter a higher cost than a manufacturer using electric arc furnaces. Additionally, firms that are already compliant with EU standards on carbon taxes or pay carbon taxes in the form of state taxes and ETS programs will result in lower CBAM taxes.

The Importance of Data Integrity

The CBAM’s mechanism adds pressure on firms not only to decrease carbon emissions but also to ensure that they are providing their own independently verified embedded emissions data. The most important step for firms at this stage is measuring their direct and indirect emissions and any carbon tax exposure.

Here’s why it’s crucial for businesses to ensure accurate emissions information:

The Default Setting
If any supplier fails to provide its own emissions information, the EU will default to its estimates relying on information supplied by non-EU producers. Default values are based on the emissions of the worst 10% of EU performers or adapted to the performers of the exporters’ region. It’s crucial that businesses avoid the EU’s “default settings,” which will lead to higher taxes and costs.

Supplier Data Impacts EU Pricing
As CBAM pricing is tied to the good’s embedded emissions, inaccuracies in emissions data can lead to miscalculated carbon costs. For example, if a manufacturer overestimates emissions, the importer may surrender excess CBAM certificates, increasing costs and raising steel prices in the market.

Penalty for Failing Reporting Obligations
Failure to fulfill reporting obligations or make genuine efforts to disclose embedded emissions accurately can lead to financial penalties ranging from EUR 10 to EUR 50 for each ton of unreported embedded emissions. Depending on circumstances and the severity of the failure, higher penalties will be applied (failure to report in a duration exceeding six months, for example, will see higher penalties).

Maintaining data integrity will prevent financial penalties and ensure effective carbon pricing. Therefore, it’s essential for firms to ensure robust data assurance and accuracy measures in the supply chain for transparent, efficient, and precise reporting. This also means collaborating closely with importers and auditors. By January 2026, the CBAM will mandatorily require independent verification of CBAM reports.

Crucial Steps for CBAM Reporting and Analysis

The CBAM will have a long-reaching impact on trade and emissions reporting. Still, it’s also an opportunity for firms to begin understanding carbon emission risks in the supply chain and tackling supply chain emissions concerns. That said, for most firms, the first step is to ensure they are ready for CBAM compliance as they work towards addressing CBAM supply chain risks.

Registration and Initial Steps
Firms must first determine if the CBAM’s scope is relevant to their imports and register as an importer with the EU’s CBAM system, if appropriate.
Report Submission
Moving on, firms must prepare the relevant emission report using the approved methodologies to estimate emissions. Until Dec. 30, 2024, companies will have the choice of reporting in three ways:
- Full reporting according to the new CBAM methodology (EU method)
- Reporting based on equivalent third-country national systems
- Reporting based on reference/default values
As of Jan. 1, 2025, only the EU method will be accepted. Under this method, direct and indirect emissions are classified as such:
Direct Emissions: Emissions from the production processes of goods. This includes emissions from heating and cooling during the production process, irrespective of the location where it happens.
Indirect Emissions: Emissions from the production of electricity consumed during the production processes of goods, irrespective of the location of the production of the consumed electricity.
A robust ESG Risk Management Solution that lets you calculate emissions based on the EU method will be critical here.
Data Collection and Compliance
As of July 1, 2024 (Q3), primary data is required for CBAM-relevant products, with limited estimations still allowed. Firms need to gather primary emissions and production data from suppliers for reporting purposes. Note that 80% of carbon emissions come from the value chains organizations are connected to – as such, transparency on multi-tier supply chain becomes crucial. Reliance on manual processes is no longer sufficient.Companies may report estimated emissions for complex goods for up to 20% of the total embedded emissions. As noted above, companies may use any approved methodologies through 2024 but must comply with the EU methodology once 2025 rolls in.
Carbon Emissions Analysis
Firms will need to identify their carbon “hot spots” on a multi-tier chain basis and look at how to address them from a supply chain sourcing strategy approach. Understanding your entire supply chain will help you identify these areas of improvement. If you’re not proactive in your approach to CBAM, you may face higher prices or lose a competitive advantage.
Team Collaboration and Reporting
Mitigating CBAM supply chain risks will require communication and collaboration. Collaborate across teams from sustainability to procurement, tax, finance, supply chain operations and communicate shared objectives, clear responsibilities, and required budget.Firms will also need to report emissions for each supplier and the type of imported goods in scope, as well as include data on the quantity of goods imported and the equivalent carbon price paid abroad. It’s critical to provide a per-product and per-production installation basis.
Supplier Engagement and Data Assurance
Get started on educating and communicating with relevant suppliers, supplier data, and its assurance. Consider contractual changes to support required data gathering. Invest in automation to gather information and calculate the emissions to increase speed, consistency, and accuracy.Set a carbon tax commercial strategy, including cost and tax impacts, effective Jan. 1, 2026. Drive due diligence not just within your firm but across your other business relationships
Strategic Opportunities and Training
Use this as an opportunity to rethink your overall supplier engagement from an ESG and broader relationship management context. This could be an opportunity for joint product innovation.Confirm training, knowledge, and data/solution requirements, including potential synergies available with respect to other regulations such as CSRD.

A Solution to Aid CBAM Compliance

The 1Exiger platform provides companies with all the core capabilities required to deliver CBAM compliance and support planning in a matter of weeks. This is done in the context of broader potential ESG and supply chain risks.

With end-to-end mapping for relevant Combined Nomenclature “CN” product codes (down to raw materials), the ability to calculate product carbon footprint on a mass basis in accordance with EU methodology and certified to ISO 14067:2018 product carbon footprint reporting across the multi-tier supply chain, you’ll be able to mitigate CBAM supply chain and compliance risks.

Contact us to learn more about how Exiger can help your organization ensure CBAM compliance and address any future supply chain challenges from the CBAM.

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