All you want to know about the EU carbon tax wrangle

What is the EU carbon tax or CBAM?

The Carbon Border Adjustment Mechanism or CBAM is an EU regulation to put a ‘fair’ price on carbon emitted during the production of items identified as carbon-intensive in non-EU countries when they are imported into the bloc. It will be levied in the form of a carbon tax calculated on the basis of the embedded emissions. As EU producers already face a carbon price for their emissions under the EU Emission Trading System (ETS), the CBAM seeks to level the field through a similar price on imports. 

The mechanism is also intended to check carbon leakage, which is a situation where companies operating in a country with strict environment rules relocate to countries with less stringent norms, leading to an increase in emissions. The broader goal of CBAM, as per the EU, is to encourage cleaner production in non-EU countries and to ensure that its own climate objectives are not undermined.

Which are the items covered under CBAM? Which industries in India are likely to be most affected by this? 

The CBAM will initially apply to six items identified by the EU as carbon-intensive and at most significant risk of carbon leakage, namely cement, iron and steel, aluminium, fertilisers, electricity, and hydrogen.

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India is expected to take the biggest hit in its export of iron, steel and aluminium items, with about 27 per cent of it, worth $8.2 billion, going to the EU in 2022, according to research bodies. The metal sector could, therefore, be significantly affected by CBAM. Cement exporters, too, may be affected, but to a lesser extent.

What is the timeline for implementation?

The transitional phase for CBAM has kicked in from October 1, 2023. This will continue till 2025-end. During this period, Indian exporters of the identified items will need to send to the importers information on the total quantity exported, the actual total embedded emissions, and the total embedded indirect emissions in those goods. Based on this, the importer will prepare the CBAM report to be submitted to the EU on a quarterly basis. There will be no financial liabilities in the two-year transition period. Carbon taxes on imports are to be levied from January 1, 2026, if carbon emission compliance cannot be established.

What would be the rate of levy under CBAM? 

The impact of CBAM on India will depend on the carbon intensity of the exported products. The price of the tariff will be calculated by the EU based on the weekly average price of carbon allowances (cost per tonne of carbon dioxide produced) in ETS auctions. On steel and aluminium, it could result in carbon taxes up to 20-35 per cent of tariffs if emission compliance cannot be established, as per estimates by Global Trade Research Initiative. 

What is the EU ETS and how does it work?

The EU ETS is an emissions cap-and-trade system that aims to reduce greenhouse gas (GHG) emissions by setting a limit, or cap, on such emissions for certain sectors of the economy. The cap is reduced annually in line with the EU’s climate target, ensuring that emissions decrease overtime. 

The cap is expressed in emission allowances, where one allowance gives the right to emit one tonne of carbon dioxide equivalent. Each year, companies can use the free allowances to account for their emissions. If the free allowance (the cap) is less than what a company emits, then it would need to buy the remainder from the EU carbon market, where companies with low emissions sell their spare allowances.

Why is India proposing to collect the carbon tax? How will this mechanism work?

The EU has not designed CBAM as a revenue generation exercise for the bloc. The intention behind the CBAM levy is to make the polluting industry pay for the additional carbon it emits. That purpose will not be defeated if India is allowed to collect the levy, as the industry will still have to pay the charges as determined by the EU. India, on the other hand, can use the revenue for purposes such as meeting its climate goals.

If the EU agrees to the proposal, then a mechanism for its implementation would be worked out by the two. One possibility could be that the Indian government collects the CBAM tax from Indian exporters of the carbon-intensive goods once the level of embedded carbon emission is determined through an accredited verifier and the price for it is fixed by the EU through methodologies such as ETS auction price.

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