Report on the EU Carbon Border Adjustment Mechanism: A review of the EU CBAM’s economic principles, expected impacts and outstanding issues
Share
The views expressed in this report are the views of the authors only and do not necessarily represent the views of Compass Lexecon, its management, its subsidiaries, its affiliates, its employees or its clients.
In a report commissioned by the Naturgy Foundation, a Compass Lexecon team studies the EU’s Carbon Border Adjustment Mechanism (‘CBAM’), the new EU framework to address carbon leakage. The team
reviews the framework’s economic rationale and highlights the economic issues that remain to be addressed to ensure an efficient implementation of the CBAM mechanism.
Situation
In May 2023, the European Union’s (EU) Carbon Border Adjustment Mechanism was introduced. The primary objective of the CBAM is to provide an enhanced framework to address carbon leakage - that is, the risk of relocation of industrial activities in countries outside Europe where there is no carbon price. So far, carbon leakage risks for industrial companies operating in Europe have been mitigated through (i) free allocation of carbon market allowances and (ii) indirect cost compensation for carbon costs. The CBAM is set to replace these two schemes, while continuing to reflect the ‘polluter pays’ principle and providing incentives for producers in third countries who export to the EU to adopt low carbon technologies. Whilst the conceptual principles of CBAM make economic sense, the implementation of such a mechanism raises a number of complex issues and challenges which the report highlights.
Our Role
In this paper, we first set out the economic rationale for introducing a CBAM to address carbon leakage, thereby replacing the current schemes in place.
We then present the roadmap for the implementation phase (2026-2034) of the CBAM framework.
Thirdly, we identify a number of key issues that remain to be addressed to ensure an efficient CBAM framework, particularly in a context where the competitiveness of European industry is at the top of policy makers concerns. These issues mainly relate to the potential impact on trade flows between the EU and its commercial partners and third countries’ climate and economic policies. They include:
- A lack of provisions for exports which could undermine the competitiveness of EU manufacturers in foreign markets;
- The possible reshuffling of trade flows and value chains, which could undermine the CBAM’s effectiveness in limiting global carbon emissions and preventing carbon leakage;
- The current rules for calculating indirect emissions from electricity consumption which may not provide a level-playing field for EU and foreign goods.
Outcome
Our study reveals that whilst the CBAM framework may be based on sound economic principles, the success of the framework will critically depend on some of the implementation rules which are yet to be finalised. In fact, the significant uncertainty on the precise CBAM rules may itself deter investment and contribute to carbon leakage issue.
The team
The Compass Lexecon team was headed by Fabien Roques, and included Florian Bourcier and Simon Malleret.