- The EU applies a carbon price to its heavy industry through its Emissions Trading System (EU ETS). To prevent carbon leakage – the flight of carbon-intensive industry away from the EU and towards countries with looser environmental regulation – the EU so far has opted to largely exempt its heavy industry from the ETS carbon price.
- The introduction of the Carbon Border Adjustment Mechanism (CBAM) changes the EU’s strategy by applying carbon pricing both to domestic production and to foreign producers who sell in the EU, which allows it to level the playing field. CBAM applies to importers of a subset of goods from outside the EU: iron and steel, cement, aluminium, fertilisers, electricity and hydrogen.
- CBAM has already been imposing carbon accounting and reporting duties on these goods since October 2023. These are administratively burdensome, but one year after their introduction, CBAM has not had visible impacts on trade flows. Producers are absorbing these administrative costs, and they continue to trade with the EU. At the same time, CBAM has already encouraged other countries to implement their own carbon price systems or adjustment mechanisms.
- Starting in 2026, importers of CBAM goods will have to pay a carbon price aligned with the EU ETS one. This will push foreign producers to focus on limited exports of ‘cleaner’, lower-carbon products towards the EU, redirecting more carbon intensive ones elsewhere. Emissions would not decrease immediately and global markets of CBAM goods may split between low-carbon and high-carbon goods – at least until the former become more competitive globally. But in the longer term, there will be more momentum to decarbonise production of CBAM goods, leading to cleaner exports towards the EU and generally lower industrial emissions.
- CBAM is a climate policy tool with trade implications. This hybrid nature has irked many of the EU’s trade partners: their main criticism is that CBAM is discriminatory, privileging countries that choose carbon pricing over other decarbonisation policies. It also imposes a relatively heavier cost on producers with more carbon-intensive processes, which tend to be in developing countries. Some countries, including China and India, have threatened to file WTO complaints against CBAM, though the EU remains adamant that the policy is WTO-compliant.
- The countries most affected by CBAM will be those countries that export a high volume of carbon intensive goods to the EU and do not apply a domestic carbon price. Many are large economies, mostly in the high- or middle-income category: China, Russia, Türkiye, the UK, the US. These countries have the means to adapt to CBAM – implementing or strengthening their own carbon pricing system (like China, Türkiye and the UK), subsidising industrial decarbonisation (like the US has been doing with the Inflation Reduction Act) or merely absorbing the loss (in the case of Russia).
- However, there are also large economies that will be affected by CBAM and may need additional EU support in adapting their industry to a net zero future – such as India, Vietnam, Brazil and Ukraine. And while smaller lower-income countries make up a smaller share of overall EU imports, CBAM-affected goods may be important sectors for their economy – as in the case of Mozambique or Zimbabwe.
- The EU should listen to developing countries and reconsider ways to lessen CBAM’s impact on them. It should make use of CBAM revenues to fund policies for technology transfer and decarbonisation support for least developed and developing countries. Additionally, the EU should reconsider exempting from CBAM (at least temporarily) least developed countries, as well as Ukraine, which is under attack from Russia.
- The EU needs to engage with its trade partners to support countries that want to adopt carbon pricing systems, helping them design and implement such systems. Countries that have carbon pricing in place, such as the UK, should seek bilateral deals with the EU to be exempted from CBAM and avoid its red tape. This may require those countries to negotiate with the EU to link their emissions trading systems with the EU ETS.
- The EU cannot simply focus on clean industrial policy at home and not lead the industrial revolution abroad: the Commission should make concrete support for industrial decarbonisation, from financial support to technology transfer, a key part of its climate diplomacy and external investment strategy.
About the author:
Elisabetta Cornago is a senior research fellow at the Centre for European Reform, where she works on EU energy and climate policy from an economics perspective.
Aslak Berg is a research fellow at the Centre for European Reform focusing on trade policy, international economics, regulatory policy and regional integration.