CBAM is a Key Instrument to Reach the EU’s GHG Reduction Targets

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The EU has green ambitions – but to hit CO2 reduction targets, energy-intensive production from outside the EU must reduce GHG emissions

The European Union has ambitious plans to decrease greenhouse gas (GHG) emissions. Its “Fit for 55” package aims to reduce GHG emissions by at least 55% by 2030, compared to 1990 levels. To meet these reduction goals, the EU is incentivizing companies to lower their carbon footprints.

The EU commission sees this as a mandatory change to meet emissions targets and expects that this kind of measures will propagate to other countries. For example, some carbon-intensive production has been moved to countries outside of Europe that have less strict emissions laws, such as Russia, Turkey, and China. This is known as “carbon leakage.”

The EU ETS is currently the cornerstone of the EU’s climate change strategy – but that’s about to change

The European Union Emissions Trading System (EU ETS) is central to the EU’s current efforts to cost-effectively minimize the use of greenhouse gases (GHG). It’s a cap-and-trade system for EU production that puts a price on GHG emissions from stationary installations.

Essentially, the EU ETS framework limits how much CO2 companies can emit each year. The EU grants free emission quotas to some EU-based industries. This is necessary so that businesses can stay competitive against companies located outside the EU that are not subject to such stringent environmental laws. All companies included in this framework have an emissions allowance that must fully cover the company’s produced emissions. This market mechanism applies to direct GHG emissions, such as carbon dioxide, nitrous oxide, and perfluorocarbons. To remain within this allowance, companies have the option to trade permits that they buy and receive. Failing to do so may lead to heavy fines.

The industries included in the EU ETS accounted for around 36% of the European Economic Area (EEA)’s total emissions in 2020-21. The system encompasses GHGs from power- and carbon-intensive industries, such as the power sector, manufacturing industry, and aviation. Since the EU ETS was introduced in 2005, emissions have been reduced by nearly 35% in the main industries it covers.  

There are also ongoing discussions to extend this ETS framework to EU ETS 2. This would include GHG emissions from fuels used in road transportation, buildings, and certain other industries that are not currently included in the EU ETS.

CBAM is a new, powerful measure that incentivizes greener production in both EU and non-EU countries

Meeting the EU’s climate targets will require stronger measures to reduce emissions. That’s why the EU ETS free allowance system is being replaced with trade measures that will apply to the rest of the world regarding imports—the Carbon Border Adjustment Mechanism (CBAM).

CBAM will be the EU’s main mechanism for incentivizing industries to decarbonize. It is essentially the extension of EU ETS to the rest of the world regarding imports. The most significant change between the EU ETS and CBAM is that that now non-EU countries will be subject to a carbon levy. This levy equalizes the price of carbon between domestic products and imports. It will ultimately replace the free quotas and indirect cost compensation mechanism in place today.

The Carbon Border Adjustment Mechanism measure is still being debated in the EU. While a preliminary agreement on text with the EU Parliament was reached in December 2022, the timeline is unclear.


Energy-intensive industries like electricity, aluminum, and cement are among the first to be affected by new CBAM rules

CBAM deters carbon leakage because non-EU companies that import products to the EU will now have to align with the carbon rules for EU industries. This ensures equal treatment for imported products that did not previously have to follow all of the EU’s strict environmental rules.

How will this work? Starting in 2027 importers in energy-intensive industries, such as electricity, iron, and steel, will have to buy CBAM certificates to cover their embedded GHG emissions. This includes direct and indirect emissions that are embedded in electricity and heat, but does not include all scope 3 emissions. The price of the CBAM certificate is directly correlated to the EU ETS market. The fact that quantity is not capped is just a technical way to avoid speculation on the CBAM certificate and decorrelate the price from the EU ETS price

Electrifying processes, improving energy efficiency, and increasing renewables use reduces CBAM’s costly impact

Now industries – both EU and non-EU — will have to pay for direct and indirect GHG emissions. To avoid CBAM’s potential added costs, companies need to redouble their focus on reducing their carbon footprint.

These emission-reducing actions include:

· Electrifying processes: By electrifying processes and assets, such as industrial heat and motion processes, companies can take a big step toward lowering their carbon footprint without a negative effect on their companies’ operations or production.

· Increasing renewables use: Increasing renewables is a key change that helps companies make a clean energy transition. Improving renewable use is important for reducing CBAM’s financial impact and is also required by EU regulations. One way that companies can decarbonize is by procuring renewable energy using power purchase agreements (PPA). They can also increase renewables use directly through on-site generation, such as solar panels.

· Improving energy efficiency: Improving energy efficiency avoids wasted resources, decreases fossil fuel use, and reduces energy use needs.

How can energy-intensive companies prepare for CBAM?

Energy-intensive companies need a customized decarbonization strategy to prepare their business for these changes. Decarbonization efforts will be supported by technology that drives energy and sustainability programs, increases process electrification, and drives renewable energy use.

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