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The Carbon Border Adjustment Mechanism

The European Union's (EU) Carbon Border Adjustment Mechanism (CBAM) came into force on 16 May 2023. The CBAM aims to target carbon leakage, which the European Commission defines as occurring when industries transfer polluting production to countries with less strict climate policies. The CBAM will cover the import of goods from all non-EU countries. However, certain third countries that participate in the EU's Emissions Trading System (ETS) will be excluded from the mechanism.

This new regulation will enter into application in its transitional phase from 1 October 2023 and the permanent system will enter into force on 1 January 2026. During the transitional phase, the CBAM will focus on 6 (six) sectors at high risk of carbon leakage, i.e., cement, iron and steel, aluminum, fertilizer, hydrogen and electricity. In this phase, a reporting system will apply and importers in the recognized sectors will have to report emissions in covered goods but will start paying financial adjustment only in 2026.

Once the permanent system is in operation, the CBAM will require European Union (EU) importers to buy CBAM certificates for goods which are covered by the CBAM. EU importers will have to declare the quantity of goods and the embedded emissions in the goods imported into the EU in the preceding year by 31 May each year and surrender the number of CBAM certificates corresponding to the embedded greenhouse gas emissions. Notably, where a carbon price has already been paid during production of the imported goods and can be proved by the third country producers, the corresponding amount could be deducted – this is where the existing carbon/environmental price schemes in India assume importance.

CBAM and Emissions Trading System

The EU's ETS is a 'cap and trade' international emissions trading scheme which sets a cap on the greenhouse gas emission that industrial installations in certain sectors can release and allows the trading of permits between companies above or below the limits to meet the set targets. The CBAM is envisioned as an alternative that will further encourage investment in green production within and outside the EU and complement the ETS system. In effect, the CBAM will require importing companies to buy CBAM certificates to make up for the difference in carbon price paid in the country of production and the carbon price in the EU, thus ensuring 'equal treatment' and avoiding carbon leakage.

Effect on Indian Players

The CBAM will have major consequences for many Indian exporters. According to the Global Trade Research Initiative, 27% of India's iron, steel and aluminum exports, totaling $8.2 billion in 2022 went to the EU. The CBAM will thus be a substantial levy once it enters into full force, and it is expected that it could potentially lead to an increase of 20-35 percent in the landed cost for exports in the selected categories. Apart from a likely and significant financial impact, it also necessitates a serious introspection of the environmental regime in India and whether India imposes a 'carbon price' that could be proven to allow for deduction under the CBAM system during import.

Furthermore, the Ministry of Environment, Forest and Climate Change has recently notified Green Credit Programme Implementation Rules, 2023 to create a market-based mechanism to incentivize environment positive actions through the issuance of 'Green Credits' to individuals, cooperatives, private sectors, industries, organizations, etc. However, none of these steps operate in the exact same manner as the EU ETS 'cap and trade mechanism' and therefore, the EU may not readily accept the same as explicit carbon price mechanisms eligible for deduction under the CBAM.

However, the recently proposed Carbon Credit Trading Scheme (CCTS) in India (which is at a draft proposal stage), proposed under Section 14AA of the Energy Conservation Amendment Act 2022, may be a stronger candidate in this context since it potentially meets the requirements as it would be a 'cap and trade' scheme exactly like the EU ETS.

The CCTS is envisioned to set up a domestic carbon credit trading scheme and the draft CCTS issued by the Ministry of Power envisions both voluntary and compulsory elements. In light of the implementation of CBAM, it is imperative that the final contours of CCTS is designed in a manner that the CCTS would be considered an equivalent emissions trading system so as to allow Indian importers to seek exemptions from additional carbon levies under CBAM on their exports to EU.

Source: 

https://www.mondaq.com/india/climate-change/1336766/interplay-of-indias-carbon-pricing-schemes-with-european-union-carbon-border-tax---impact-on-indian-exporters