Carbon Border Adjustment Mechanism

Another key legislation which CBAM has to be holistically assessed with, is the reform of the Emissions Trading System (ETS). The reform increases the ambition of the ETS, as greenhouse gas (GHG) emissions in the ETS sectors must be cut by 62% by 2030 compared to 2005-levels. It also phases out free allowances to companies from 2026 until 2034 and creates a separate new ETS II for fuel for road transport and buildings that will put a price on GHG emissions from these sectors in 2027.

The European Parliament also voted to include, for the first time, GHG emissions from the maritime sector in the ETS and agreed to the revision of the ETS for aviation. This will phase out the free allowances to the aviation sector by 2026 and promote the use of sustainable aviation fuels.

In addition, a Social Climate Fund to combat energy poverty was set up which will ensure the climate transition by targeting vulnerable households, micro enterprises, and transport. This Fund will be financed by the auctioning of ETS II allowances and national resources.

When the European Commission proposed the CBAM as part of the Fit-for-55 package, there was still scepticism in Brussels that this proposal would be adopted. However, on 13 December 2022, a political agreement on this act was reached by the European Parliament and the Council. CBAM is here to stay and will phase out the free allowances and compensation regimes under the ETS.

The EU is taking a leading position in combating climate change, with the possible effect that companies in the EU will decide to transfer their companies to countries with less strict regimes. This effect we call 'carbon leakage'. It is particularly carbon-intensive production climate legislation that hits the hardest. CBAM aims at to mitigating such carbon leakage by setting a price on the carbon emitted during the production in non-EU countries of products that are entering the EU and to encourage cleaner industrial production in non-EU states.

The Commission proposed that CBAM would apply to imports of certain goods. During the subsequent negotiations, this scope was modified to include hydrogen among other things. The political agreement sets out that cement, iron and steel, aluminium, fertilisers, electricity, and hydrogen as well as some precursors and limited number of downstream products are within the scope of CBAM. Indirect emissions will also be included to a limited extent.

CBAM will enter into force in its transitional phase as of 1 October 2023.

During the transitional phase, the companies within the scope of CBAM will report GHG emissions embedded in their imports but will not be obligated to make any financial adjustments. This phase is meant to be a learning period where data is collected, allowing traders and importers to adjust to the coming changes. Before the end of the transitional period in 2025, the Commission shall present a report to the European Parliament and the Council regarding the application of CBAM.

Once the permanent system enters into force on 1 January 2026, importers of the products within the CBAM scope will have to declare the quantity of goods imported into the EU in the preceding year and their embedded GHG emissions each year while at the same time surrendering the corresponding number of CBAM certificates. The price of the certificates will be calculated depending on the weekly average auction price of EU ETS allowances expressed in €/tonne of CO2 emitted. The phasing-out of free allocations under the EU ETS will take place in parallel with the phasing-in of CBAM in the period 2026-2034.

National authorities will authorise registration of declarants in the CBAM system, as well as review and verify declarations. They will also be responsible for selling CBAM certificates to importers. In order to import goods covered under the CBAM into the EU, importers must declare by 31 May each year the quantity of goods and the embedded emissions in those goods imported into the EU in the preceding year. At the same time, they must surrender the CBAM certificates they have purchased in advance from the relevant national authorities.

The ETS is the world's first international emissions trading scheme and has been seen at the EU's flagship policy to combat climate change. It sets a cap on the amount of GHG emissions that can be released from industrial installations in certain sectors. Allowances must be bought on the ETS trading market, though a certain number of free allowances is distributed to prevent carbon leakage.

It is important to see the ETS and CBAM together since the CBAM will progressively become an alternative to free allocations and compensation under the ETS regime. To complement the ETS, the CBAM will be based on a system of certificates to cover the embedded emissions in products being subsequently imported into the EU. The CBAM it is not a ‘cap and trade' system. Instead, the CBAM certificates mirrors the ETS price.

When the full CBAM regime becomes operational on 1 January 2026, the system will adjust to reflect the revised EU ETS. CBAM will only begin to apply to the products covered gradually and in direct proportion to the reduction of free allowances allocated under the ETS for those sectors.

The Council and the Parliament also reached a political agreement for a revised ETS regime in December 2022 and the Parliament adopted the revised ETS on 18 April 2023. In its press release the Parliament stated that emissions in the ETS sectors must be cut by 62% by 2030, compared to 2005, which is one percentage point more than proposed by the Commission. In order to reach this reduction, there will be a one-off reduction to the EU-wide quantity of allowances of 90 Mt Co2 equivalents in 2024 and 27 Mt in 2026 in combination with an annual reduction of allowances by 4.3% from 2024-27 and 4.4% from 2028 to 2030.

A separate new ETS II for fuel for road transport and buildings that will put a price on emissions from these sectors will be established by 2027. This is one year later than proposed by the Commission. As requested by Parliament, fuel for other sectors such as manufacturing will also be covered. In addition, ETS II could be postponed until 2028 to protect citizens if energy prices are exceptionally high. Furthermore, a new price stability mechanism will be set-up to ensure that if the price of an allowance in ETS II rises above 45 EUR, 20 million additional allowances will be released.

Parliament also voted to include, for the first time, GHG emissions from the maritime sector in the ETS and agreed to the revision of the ETS for aviation. This will phase out the free allowances to the aviation sector by 2026 and promote the use of sustainable aviation fuels.

Assessing EEA law and Norwegian law, the current ETS Directive 2018/410 of 14 March 2018 is incorporated into the EEA Agreement by Joint Committee Decision 112/2020 in Annex 20. However, parts of the Regulation on the Governance of the Energy Union and Climate Action, 2018/1999 concerning the reporting and the acts as such regarding the Effort Sharing Decision and the LULUCF Regulation, are incorporated into Protocol 31 by Joint Committee Decision 269/2019. Noteworthily, the incorporation of these acts is undertaken not due to their EEA relevance, and the EEA States have in the declaration stated that the reporting is made on a voluntary basis. Nevertheless, the Joint Committee Decision 269/2019 is reflecting the two-pillar system with the EFTA Surveillance Authority mandated with the same tasks as the Commission for the non-ETS sector as well as for the LULUCEF Regulation.

We argue that if it is concluded by the EEA Authorities that CBAM as such is not considered EEA-relevant due to that the EEA States are not part of the customs union nor a harmonised tax regime, we are of the opinion that it is of importance that Norway will adhere to the CBAM since it is so interlinked with the ETS. Moreover, being outside this regime will complicate and lessen the Norwegian participation and rights in the European internal market. It is therefore suggested that Protocol 31 of the EEA Agreement could be reapplied to form a climate legal binding agreement with the EU to reach the set targets for 2030.