Serbia: Diving into the CBAM Regulation: how does it function alongside the EU ETS?

The CBAM is designed in response to certain fallbacks of the already existing safeguards, namely the EU Emissions Trading System ("EU ETS"). Launched in 2005, the EU ETS is often referred to as the cornerstone of the EU's climate change policy. The system operates on the cap and trade principle. A cap is set on the total amount of greenhouse gas emissions that operators in certain sectors can generate. This cap is then expressed in emission allowances which are released for trading, with one allowance being equal to one ton of carbon dioxide equivalent emitted. Auctioning of allowances under the EU ETS generates substantial revenues that mostly feed into national budgets. According to the latest sources, the revenues from the EU ETS amounted to more than EUR 175bln over the last decade.[1]

Operators are obliged to submit enough allowances for the total amount of emissions they produce each year - also known as the "polluter pays" principle. To that end, they can buy the allowances on the market as well as trade them between themselves. There is also a certain number of free allowances handed out to heavy industries that face competition from industries outside of the EU that are not subject to similar climate legislation. For example, during the 2013-2020 trading period, 57 % of the total amount of allowances were auctioned, whereas the rest were available for free allocation.[2]

Therefore, the EU ETS ensures that operators are charged for the gases they emit and, finally, limited in their overall amount. The cap is also reduced every year, which also guarantees that total emissions decrease over time.

Despite being vastly useful and valuable, the ETS is geographically limited to the EU and EEA-EFTA territories, and thus does not solve the issues of carbon leakage. The system of free allowances was intended to mitigate this problem, but ultimately did not prove successful enough, especially given that it brings no revenues and no incentives to its beneficiaries to invest in greener technologies. Therefore, the CBAM was brought in to put a price on the emissions generated outside of the EU and to level the playing field between the EU and non-EU producers. With this system in place, relocating the production to non-EU territories with less stringent policies can no longer serve as an escape route from the rising costs of emissions.   

Furthermore, in a broader context, the CBAM rules are intended to incentivise third-country producers to enhance existing technologies and introduce new ones, while also encouraging lawmakers outside of the EU to adopt similar carbon policy frameworks.

The CBAM functions in parallel with the EU ETS. However, as it serves essentially the same purpose as the free allowances system, the plan is to phase it in gradually at the same time as the free allowances are being phased out, at least for the sectors covered by the CBAM (iron and steel, cement, fertilisers, aluminium, hydrogen and electricity, along with some precursors and downstream products). The free allowances should cease entirely by 2034.

Still, the CBAM does not operate in exactly the same way as the EU ETS. Notably, it is not a cap and trade system, but a system based on individual emissions data, meaning that companies can purchase an unlimited number of certificates. CBAM certificates will be sold via a central platform that will be established by the European Commission, with their price reflecting the average weekly carbon price under the EU ETS. Ultimately, importers will end up paying a carbon price corresponding to what would have been paid if the goods were in fact produced under the EU rules.

In the upcoming articles we will delve into the specifics of the reporting obligation, calculation methods as well as the criticism and potential challenges of the CBAM Regulation. Stay tuned!

[1] From 2024 to 2030, depending on the carbon price and other factors, the EU ETS may generate around EUR 220bln. Source: Commission Communication from 10 April 2024, https://commission.europa.eu/document/download/edc7b551-6b25-42ab-b36c-d9af7d4654e9_en?filename=COM_2024_163_1_EN.pdf.

[2] Also, at the beginning of that trading period, the manufacturing industry received 80 % of its allowances for free. Source: DG for Climate Action, https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets/free-allocation_en.