MEP Mohammed Chahim, the rapporteur of the Carbon Border Adjustment Mechanism (CBAM) Regulation in the Environment Committee at the European Parliament, is in charge of drafting a report that includes proposed changes to the European Commission legislative proposal. The draft report was published in December 2021 and will be used to inform and influence the final CBAM text that will be voted on by the Environment Committee in May this year.
To shed some light on the key changes proposed by MEP Chahim, we have compiled a short explainer including suggestions and recommendations.
For a short explanation of CBAM, see our FAQ.
1. Phase-out timing of free allowances and phase-in of CBAM
The draft report includes a faster time for the phase-out of free allowances to CBAM sectors. MEP Chahim suggests ending free allowances for CBAM sectors in 2028, with the exception of the cement sector that would see its free allowances end in 2025.
While this timeline is faster than that proposed by the European Commission, it still allows the CBAM and free allowances to partially coexist, albeit for a reduced period.
As clearly stated by MEP Chahim in his justification text to his amendments to the EC proposal: “the CBAM is a carbon leakage measure”. Thus, the CBAM should be an alternative to carbon leakage protection measures and therefore it should entirely replace them from the year the mechanism enters into force.
Keeping free allocation any longer is an ineffective and wasteful use of public resources. This would further delay the enforcement of the polluter pays principle and thereby create little incentive to decarbonise industrial production in the CBAM sectors. The allocation of free allowances represents a market failure that has created virtually no incentive for EU industry to reduce their emissions.
The draft report also fails to address the need to end indirect cost compensation in CBAM sectors. As an alternative to carbon leakage protection, the CBAM should cover direct and indirect emissions and therefore replace both carbon leakage protection measures: free allowances and indirect cost compensation.
→ Remove the CBAM factor and mandate full auctioning as early as possible, not only for the cement sector.
Full auctioning will ensure the application of the polluter pays principle, and will make the EU ETS more effective. It will also ensure that industrial sectors contribute to investments in climate action measures and will provide much-needed funds for member states to increase their climate mitigation efforts. No exception to the polluter pays principle also means a simpler CBAM and better chances that it will be considered WTO-compatible and non-discriminatory towards third countries.
2. Extension of CBAM scope
The draft report includes an extension of CBAM to additional sectors, in particular chemicals and plastic production, as well as hydrogen production.
→ To better and fully address all high-emitting sectors, the CBAM should also include upstream emissions that occur in the production of plastic. These would include refineries, steam crackers and monomer production.
The inclusion of these sectors would properly address all emissions occurring in the production of plastic and could hugely contribute to reducing them. Moreover, revenues generated through the phase-out of free allowances for these sectors could be more beneficially directed to clean innovative processes, circularity, recycling and material substitution.
3. Supporting Least Developed Countries (LDCs)
The draft report better addresses Least Developed Countries as it mentions financial support for the decarbonisation of their industry through reinforcing the share of the EU budget dedicated to climate spending.
This financial support could additionally contribute to the diplomatic underpinnings of the CBAM and increase acceptability in partner countries, whilst leading to concrete emission reductions.
→The specific mention of Least Developed Countries is a step in the right direction to addressing the specific needs of these countries to develop and to be supported in their efforts to decarbonise their economies. However, the provisions concerning these countries should be stronger and assign a specific and defined share of CBAM revenues to support LDCs.
4. Use of CBAM revenues
With regards to the use of CBAM revenues, the draft report distinguishes between two sources of revenues and assigns them to different purposes.
First, the revenues generated through the sale of CBAM certificates should be accrued to the EU budget and used to cover the costs of the centralised CBAM Authority. Any remaining budget should be assigned to the EU budget.
To support the decarbonisation of least developed countries, the draft report also introduces a provision whereby revenues equivalent to those of the sale of CBAM certificates should be used to provide financial support to least developed countries (LDCs). This means that member states will need to increase climate spending in the EU budget to ensure that at least an equivalent amount to CBAM certificate sale is used to support LDCs.
While this addition goes in the right direction, the proposal still supports the CBAM revenues to become EU owned resources.
In order to allocate financial resources to LDCs, MEP Chahim suggests a soft earmarking of these revenues in the EU budget.
This clause could be made stronger by avoiding channeling CBAM certificates revenues to the EU budget and simply allocating the entirety of these revenues to support vulnerable countries, giving special attention to LDCs.
→ CBAM is an international climate policy tool, so its revenues should be channeled towards climate action and returned to the most vulnerable countries in the form of international climate finance. Furthermore, allocating CBAM revenues to the EU’s budget would raise legal challenges under the WTO and could strengthen partner countries’ perception that the CBAM is a protectionist and fiscal measure. This should be avoided.
Secondly, according to the draft report, the revenues generated by auctioning allowances that are no longer given fo free to industries covered by CBAM should be split: 50% should be made available to fund innovative low-carbon technologies through the Innovation Fund, and 50% should be transferred to the EU budget to repay the debt generated under the EU Covid-19 recovery package.
→The auctioning revenues generated by the reduction of free allowances in CBAM sectors should be entirely reinvested in the Innovation Fund. The auctioning of all pollution permits will generate substantial revenues and transferring these to the Innovation Fund will strongly support green investments and the uptake of cleaner production processes.
If instead half of the auctioned allowances are transferred to the Union budget to repay for the Covid recovery package, there would not be any guarantee that these revenues would be used for climate mitigation in the EU. The recovery package provides resources for a variety of different objectives, not only climate mitigation and most member states are already lagging much behind the 37% climate spending objective in their Recovery Plans.
5. Export rebates
A highly debated issue, MEP Chahim’s draft report suggests a compromise solution for exports in the CBAM regulation. He suggests a 3 year period where exports of goods from the EU are monitored by the European Commission. If at the end of that period, the Commission concludes that EU exports are negatively affected by CBAM, then it can propose legislation to eliminate such effects and risk.
→ This suggestion risks compromising the integrity of the CBAM regulation and creating problems with WTO even if at a later stage. Export rebates are not deemed compatible with WTO rules and would largely amount to subsidies for EU industry. The European Commission’s proposal did not include rebates on exports and this position should be maintained in the final CBAM regulation.