What You Need to Know
- Key takeaway #1 The CBAM is an important element of the EU's green agenda efforts, and the current transitional period should serve the purpose of learning and improving the CBAM scheme.
- Key takeaway #2 The CBAM provides for a complex set of calculation methodologies with the possibility to use under certain conditions default values or existing emission reporting and monitoring programs.
- Key takeaway #3 Operators of installations are advised to immediately commence working on collecting data for the first CBAM report, due no later than January 31, 2024. Similarly, importers need to learn how to report emissions data, and use the transitional period to check plausibility of the information obtained from operators.
CBAM transitional period started on October 1, 2023
On October 1, 2023, the transitional period of the Carbon Border Adjustment Mechanism (the "CBAM") began. The mechanism is part of the EU's efforts to achieve objectives outlined in its green agenda, in particular to tackle the issue of the relocation of emission-heavy production to countries with less stringent environmental policies. In practical terms, it means that starting from October 1, 2023 until December 31, 2025, emissions on goods in certain sectors should be reported when they are imported into the customs territory of the EU. Subsequently, during the definitive period, the trading in CBAM certificates will be added to the reporting obligations, and, gradually, the existing EU Emission Trading System ("ETS") will be replaced with the CBAM in 2034. In this alert, we discuss certain basic elements of the CBAM as well as certain complex technical aspects of the reporting requirements.
As a first step, it is necessary to determine whether the goods to be imported fall under the scope of the CBAM. Currently, only six sectors are covered: cement, iron and steel, aluminum, fertilizers, electricity and hydrogen. For a more precise customs classification of the goods, one needs to check the EU combined nomenclature ("CN" code) of the goods listed in Annex I to Regulation 2023/956 (the "CBAM Regulation"). If the CN code is included in Annex I, the reporting declarant will need to report emissions of the imported goods. The European Commission (the "Commission") intends to include all products under the CBAM in the future but, at present, it is unclear how and when further inclusions will take place.
The CBAM Regulation 2023/956 uses the definition of authorized CBAM declarants – EU importers or their indirect customs representatives – or indirect customs representatives if the importer is not established in the EU, while Implementing Regulation (EU) 2023/1773 (the "CBAM Transitional Regulation"), which sets the rules of the transitional period, provides for the term "reporting declarant." The reporting declarant is either an importer who lodges a customs declaration for release for free circulation; a person, holding an authorisation to lodge a customs declaration referred to in Article 182(1) of UCC, who declares the importation of goods; or indirect customs representatives in cases of non-EU importers.
During the transitional period, the reporting should be carried out on a quarterly basis, whereas the definitive period imposes annual reporting obligations. The first transitional CBAM report should be submitted no later than January 31, 2024 for the fourth quarter of 2023. Each subsequent quarterly report is to be filed no later than one month after the reporting quarter. The last report for the fourth quarter of 2025 is therefore due by January 31, 2026.
As the complex CBAM enters into its initial period of implementation, the Commission provided for a certain leeway in fulfilling the reporting obligations. As a general rule, the submitted report may be modified up to two months after the end of the relevant reporting quarter. By way of derogation, it will be possible to modify the first two reports until the deadline for the third CBAM report, on July 31, 2024.
Secondly, the competent authorities may, if a justified request is submitted, authorize the correction or resubmission of the report after that deadline but no later than one year after the end of the relevant reporting quarter. If the request is granted, the reporting declarant will have one month to remedy the report.
The CBAM reports are to be submitted via the newly created Transitional CBAM Registry, which may be accessed upon approval by the competent national authorities of the EU Member State of the declarant's establishment. The provisional list of competent authorities, as of October 6, 2023, is available here. According to the Commission's plans, the Transitional Registry is expected to be fully operational by early November 2023.
As the CBAM reporting is an obligation, a penalty may be levied in cases of failure to fulfil the relevant reporting requirements. The imposition of penalties, solely in the form of a fine ranging from 10 to 50 EUR per unreported tonne of emissions, is a prerogative of the EU Member States. To assist the EU Member States with the imposition of penalties, the Commission is empowered to check the reports on the Transitional Registry with regard to compliance requirements during the transitional period and three months after the last transitional report is submitted. The Commission will communicate to the EU Member States of the declarants' establishment, an indicative list of reporting declarants who failed to submit any report, and an "indicative" assessment of reports that are incomplete or incorrect.
The report is considered to be incomplete if not all of the compulsory elements are reported, and incorrect if the submitted data does not meet the reporting requirements under the Transitional Regulation, or the data is wrong, or no sufficient reasons were provided to justify the use of other reporting methodologies not stipulated in the Transitional Regulation.
In circumstances when the report is not submitted or it is incomplete/incorrect, the national competent authorities must initiate a review and assess the indicative information submitted by the Commission within three months from the time of the Commission communication. With regard to incorrect or incomplete reports, a correction procedure may be initiated to obtain additional information from the reporting declarants.
Overall, the level of penalties remains largely to be seen and it will depend on the extent of unreported information, readiness to remedy any shortcomings, previous reporting behavior, the level of cooperation and appreciating voluntary measures to prevent further irregularities.
Methods of reporting
It becomes evident from the outset that close cooperation is required between the reporting declarant and the supplier for collecting and reporting CBAM information. The supplier operator monitors and collects emissions data at its installation, transmits the information to the related or unrelated EU importer, who then completes and submits the CBAM report. It is of paramount importance that the operator employs a renowned, reliable, engineering firm to calculate emissions from the start of the production cycle.
Compliance seems to be more complex for unrelated importers, as they are responsible for the accuracy of information but their capabilities to verify information provided by operators are limited. What if their suppliers refuse to provide CBAM data or are unable to do so in a reliable fashion? In order to relieve such insurmountable burdens upon reporting declarants, the Commission envisaged a temporary use of alternate methods for calculating emissions.
First, for a limited period until December 31, 2024, reporting declarants are allowed to use certain monitoring and reporting methodologies if they have a similar coverage and accuracy compared to the standard methodologies offered by the Commission in the Transitional Regulation, the so called 'EU method.' In particular, the following methodologies:
- a carbon pricing scheme where the installation is located;
- a compulsory emission monitoring scheme where the installation is located; or
- an emission monitoring scheme at the installation which may include verification by an accredited verifier.
Secondly, if reporting declarants do not possess all the required information to complete the CBAM reports, they may use alternative methods to determine emissions, including default values (not yet) published by the Commission, or other default values, until July 31, 2024. It is compulsory to specify the calculation method used.
In addition, it will be possible that calculations of up to 20% of total emissions of complex goods are based on estimates provided by the installations' operators. Complex goods are goods other than simple goods, which are in its turn defined as goods produced only from inputs (precursors) and fuels having zero embedded emissions.
The EU method of calculating direct emissions, which will become a default way of determining emissions in the definitive period, is therefore comprised of the calculation-based and measurement-based approaches. The choice between the two, or a combination of both, should favor a methodology that gives the most accurate and reliable results, except where sector-specific requirements require the use of a particular methodology.
Under the calculation-based approach, emissions may be determined by the standard or mass-balance method. Firstly, emissions are calculated on the basis of quantities of all consumed fuels and inputs multiplied by corresponding factors, notably the emission factor, the conversion factor and the oxidation factor. Under this scenario, it is necessary to measure emissions from fuel combustion as well as emissions from the production process. If biomass is used, it may be zero-rated if certain criteria of the EU's Renewable Energy Directive 2018/2001are met, or deducted from fuel emissions when mixing biomass with fossil fuels. Under the mass balance approach, considering the difficulty of calculating emissions of individual inputs, no differentiation between fuel and process materials is made. Emissions are calculated on the basis of carbon content of each material entering the installation as an input and leaving it as an output. It is possible to use a combination of the mass balance method and the standard method for different parts of the installation.
The measurement-based approach requires the use of the so-called Continuous Emission Measurement System ("CEMS") installed at a suitable measurement point. It is obligatory to use this methodology for the determination of N2O emissions. It is necessary to use measuring instruments with the lowest uncertainty, without incurring unreasonable costs, which are fit for the applicable environment. Annual emissions are determined as the sum of all hourly values of the measured greenhouse gas concentration multiplied by the hourly values of the flue gas flow, where the hourly values shall be averages of all individual measurement results of the respective operating hour. CEMS requires the measurement of greenhouse gas concentration and volumetric flow of the gas stream where the measurement takes place. CO2emissions from biomass that meet the EU Renewable Energy Directive 2018/2001 standards may be subtracted under certain conditions. The measurement-based approach necessitates the corroboration of emissions against annual emission calculations.
In addition to direct emissions, operators need to report net measurable heat, waste gas energy and emissions and indirect emissions.
Indirect emissions are emissions resulting from the production of electricity that was consumed during the production process multiplied by the emission factor. It concerns not only indirect emissions resulting from the production process but also from any relevant precursors. The Commission envisaged the use of default values but it is also possible to use actual data under certain circumstances, i.e. when operators produce electricity at their installation, or where electricity is received from a source with a direct technical link and all the relevant data is available, or where the electricity is received from an electricity producer under a power purchase agreement. If the electricity is obtained from the electricity grid, it is possible to use either the default emission factor provided by the Commission, or any other emission factor of the country of origin's electricity grid based on publicly available data representing either the average emission factor or the CO2emission factor.
Both direct and indirect emissions from consumed precursors should be determined to calculate the total emissions of complex goods, in cases where precursors are indicated in the production processes of Section 3 of Annex II to the CBAM Transitional Regulation. However, if the production and use of a precursor are covered by the same production process, only the quantity of additional precursors used and obtained from other installations or from other production processes need to be considered.
Attribution of emissions to goods
In order to determine the specific embedded emissions of goods, it is necessary to determine total emissions at the installation, which are then attributed to emissions of the production process(es). Then, embedded emissions of precursors should be added, and the overall result divided by the quantity of goods produced per each production process. The CBAM defines this as the "activity level".
It should also be noted that the CBAM is narrower than the total carbon footprint of products as the CBAM excludes emissions relating to mining of raw materials, transportation and other upstream processes, as well as the distribution of products and end-of-life, including recycling, re-use and waste disposal.
As CBAM compliance requires monitoring and subsequently providing large volumes of data, operators of installations need to establish proper monitoring methodology documentation. This includes information on the monitoring methods and production data for their installation and the overall production processes. Gathering such data consistently and solidly is necessary to implement the basic CBAM monitoring principles: completeness, consistency and comparability, transparency, accuracy, integrity, cost-effectiveness and continuous improvement.
As mentioned herein, it is possible to use, until the end of 2024, other eligible monitoring and reporting methodologies, such as the carbon pricing scheme, the compulsory emission monitoring scheme, or the emission monitoring scheme. These may include verification by an accredited verifier. Operators should verify these methodologies prior to use.
Further, the CBAM Transitional Regulation requires not only to need to outline the method of determination of emissions under the CBAM methodologies, but also to justify why it is not technically feasible to use a specific determination methodology, or why following a specific determination methodology would result in unreasonable costs for an operator. The CBAM Transitional Regulation provides for a requirement to conduct regular checks at least yearly, during which such claims may be re-assessed.
By introducing the principles of technical feasibility and reasonableness of costs, the Commission attempts to relieve the burden in determining emissions, based on the principle of the best available data source. Where a cost/benefit analysis shows that the improvement cost exceeds the benefit of data accuracy, it is possible to choose a less costly monitoring approach or equipment. Costs under 2,000 EUR per year will not be accepted as unreasonable.
Reporting carbon price
During the transitional phase, reporting declarants may provide information about any carbon price that was paid in a country of origin of goods for the embedded emissions. Currently, it is only a reporting requirement, while in the definitive phase it will be necessary to indicate any paid carbon price to obtain a rebate for the CBAM financial burden. The carbon price, including for precursors, is attributed to CBAM goods under the same methodology for determining specific embedded emissions.
Over the next two transitional period years, the Commission plans to closely monitor the CBAM implementation. At the end of the transitional period, a report must be presented to the European Parliament and the Council of the EU on the various aspects of the CBAM implementation, including the awaited extension of the CBAM scope to additional products and adjustments to calculation methodologies. Any scope extension to other products in the value chain must be presented in a separate report at least one year before the end of the transitional period. This is, therefore, a space to be closely monitored.
Even though the transitional period may be regarded as a "learning period", importers should not underestimate the real risk of penalties from 10 to 50 EUR per unreported tonne of emissions for failures to fulfil reporting obligations. It is unknown at this stage how actively EU Member States will enforce the CBAM implementation, at least during the transitional period. Moreover, enforcement levels may vary among the 27 EU Member States. Under any perspective, it is clear that the transitional period obligations should be taken seriously by both operators and importers from the outset. Beyond compliance needs, acting professionally on CBAM is also necessary in order to embed the Commission's methodological requirements in daily operations, adjust them where warranted, and build in-house institutional and operational knowledge.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.