Under the EU’s higher climate ambition, the current system of free CO₂ allowances is no longer sustainable to protect against carbon leakage.
The EU will need to start phasing in an alternative system to protect EU energy intensive industries before 2030, though not in all sectors. This new system must protect against leakage and also incentivise industry to start decarbonisation during the coming decade.
A CBAM is the most credible alternative to free allocation.
The proposed “climate club” may have value as a complement to a CBAM, but it is not a credible stand-alone option. Similarly, consumption charges also raise numerous practical and political difficulties that are difficult to resolve, discounting them as a viable alternative to a CBAM.
A cautious and gradual phase-in of a CBAM would accelerate industrial decarbonisation provided that it is accompanied by support for key low-carbon technologies.
It would promote carbon cost pass-through along the value chain, incentivising recycling and the move to lower-carbon materials; it would allow the EU to raise vital funds to finance Carbon Contracts for Difference; and it would help to incentivise cooperative climate action on carbon leakage internationally.
An effective CBAM must also give adequate protection for exporters.
We suggest a two-step approach to this question, including a slightly slower phase-in rate for auctioning prior to 2030, coupled with the prioritisation of decarbonisation support for abatement. This could be followed by a review of the risks to exporters in 2029 based on emerging international action. In a worst-case scenario, a freeze in the phase-down of free allocation to exported production could be considered once CBAM was well established as a policy and risks of retaliation have reduced.
As part of its July 2021 package in support of a 55 percent reduction in greenhouse gas emissions by 2030, the European Commission proposed a Carbon Border Adjustment Mechanism (CBAM). The purpose of the mechanism is to prevent the risk of carbon leakage while free allowances to manufacturing industries are gradually phased out under the revised EU ETS.
The CBAM is controversial. It represents a massive shift in the system of carbon leakage protection. However, if designed correctly, and complemented with a robust package of supporting policies, CBAM could be a key enabler of the industrial transition to low-carbon technologies and a more circular economy.
However, for the CBAM to play this role, we need pragmatic solutions to key design issues. In particular, important issues regarding exporter protection, possibilities of carbon leakage related to resource shuffling, use of revenues, and the transition from free allowances to auctioning. This impulse paper analyses these issues and offers pragmatic and actionable suggestions on how to solve key implementation design questions. It also tries to map out possible interactions between “climate clubs” and CBAM.
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Getting the Transition to CBAM Right
Finding pragmatic solutions to key implementation questions