Everything you need to know about the Carbon Border Adjustment Mechanism (CBAM)

Since the inception of the European Union Emissions Trading System (EU ETS), one its most common and frequent criticisms has been the risk of reduced industrial competitiveness.
The argument is straightforward: the EU ETS is a mechanism that puts a price on greenhouse gas (GHG) emissions. As a result, industries subject to it must pay for every tonne of GHG they emit—creating an additional cost.
However, the EU ETS applies only within the EU. More precisely, it only covers industrial sites located in the EU, as well as maritime or air journeys involving at least one EU port or airport.

This means that an industrial site in Europe bears a higher cost than one located outside of Europe. Following the logic of this argument, the European site is therefore less competitive than the non-European one. One of the main risks is that the affected industries move their production “elsewhere.” This relocation, caused by carbon pricing, is known as carbon leakage.

Historically, this risk was mitigated because the European Commission granted free allowances to the affected industrial sites. These free allocations, however, are a temporary and imperfect solution: they shield the beneficiary industries from the carbon price—and therefore from the very incentive mechanism that the EU ETS is meant to provide to decarbonize European industry.

To address the risk of carbon leakage and the potential loss of competitiveness, the European Commission designed another mechanism: the Carbon Border Adjustment Mechanism (CBAM). As this new regulatory tool gradually enters into force, free allocations will be phased out.

What is the Carbon Border Adjustment Mechanism?

The Carbon Border Adjustment Mechanism is a new regulatory tool introduced by the European Union. Its goal is to align the economic conditions of production between the EU and non-EU countries.
In other words, it aims to apply to imported products a carbon cost equivalent to what they would have incurred if they had been produced within the European Union.

What are the objectives of the CBAM?

The primary goal of the CBAM is to impose a carbon price on goods imported into Europe, at a level equivalent to the emissions cost applied to goods produced within the EU. This ensures a level playing field—and therefore fair competition—for all economic actors on international markets.

To achieve this, the European Commission designed this new mechanism, which closely resembles a customs duty: it’s a cost applied to imports into the EU. For this reason, some refer to it as a "carbon border tax." However, it is not technically a tax, since the amount charged depends on the carbon pricing in the exporting country. In contrast to a fixed tax, the CBAM is variable.

Understanding the CBAM with an example

Let’s look at an example. Imagine that the price of EU emissions allowances (the carbon price in Europe) is €70 per tonne. Of course, since these allowances are traded continuously on a financial market, the price fluctuates constantly—but let’s assume it’s €70 for simplicity.

Now imagine that producing one tonne of cement results in 100 kg of CO₂ emissions, representing a cost of €7 per tonne.

A European cement producer must pay €7 for their emissions. A producer from Country B, which has no carbon pricing at all, would—other things being equal—be €7 per tonne more competitive. The CBAM is designed to correct this gap.

Now suppose Country C has its own carbon pricing at €50 per tonne. The cement producer in Country C would therefore pay €5 per tonne of cement. In this case, the CBAM would apply only the difference between the EU carbon price and Country C’s carbon price—i.e., €2.

As a result, the producer from Country B pays €7 under the CBAM, and the producer from Country C pays €2. In the end, producers from all three regions face the same emissions-related cost.

Thus, the CBAM represents a cost for exporters to the European Union, which depends on the carbon price in their country of origin as well as, of course, the emissions intensity of their products.

How does the CBAM work?

The Carbon Border Adjustment Mechanism applies only to certain types of so-called "simple" goods—meaning products for which emissions can be relatively easily quantified, which are highly emissions-intensive, and which present a high risk of carbon leakage.

Sectors covered by the CBAM

In its initial phase, the CBAM will apply only to the following sectors, which together account for half of industrial emissions within the European Union:

• Iron & steel
• Cement
• Aluminium
• Nitrogen-based fertilizers
• Hydrogen
• Imported electricity (measured in kWh)

What makes the system more complex is that some semi-processed or processed products are included, while others are excluded. For example, steel bolts and nuts are included, but certain ferrous alloys are not. A finished product such as a car body is also excluded, which creates a potential risk further down the value chain.
Over time, the scope will gradually expand—both to new sectors like refining and chemicals, and to downstream products.

A full list of covered products, categorized by CN code (Combined Nomenclature), is provided by the European Union and included in the annex of the EU CBAM regulation.

Finally, the CBAM targets several greenhouse gases—not just carbon dioxide.

Quantifying emissions in imported goods

The calculation of embedded emissions in covered imported products follows the methodology used in the EU ETS and is detailed in the specific CBAM implementation regulation. Importers are required to provide:

• Data related to the factories, plants, or facilities where the products were manufactured;
• Information on the production methods used, including the specific technologies and parameters of those methods;
• Direct emissions from the production process, expressed in tonnes of CO2-equivalent.

Importers who are unable to provide this information may instead use a “default” emissions benchmark table made available by the European Commission.

Pricing of Imported Emissions

To comply with the customs duties introduced by the CBAM regulation, importers must purchase CBAM certificates in an amount equivalent to the embedded emissions in their imported goods. The carbon price already paid in the country of origin—converted into euros based on the average exchange rate from the previous year—is deducted from this amount.

CBAM certificates can be purchased on a centralized European platform and must be deposited into the EU’s common registry.
The price of the certificates is set weekly, based on the average closing price of EU emissions allowances (EUAs) at auction during the previous week.

Therefore, the price of EUAs serves as a proxy for the price of CBAM certificates—keeping in mind that EUAs are traded continuously, while CBAM certificate prices are updated weekly.

The Implementation Timeline of the CBAM Regulation

The CBAM regulation, which introduces carbon pricing at the borders of the European Union, was adopted on May 10, 2023. Its implementation begins with a transitional phase, followed by full enforcement starting on January 1, 2026.

The Transitional Phase of the CBAM

From October 1, 2023, to December 31, 2025, a transitional period is in place during which importers (referred to as "reporting declarants") are required to report their embedded emissions at the end of each quarter.
During this phase, there is no obligation to purchase CBAM certificates—only to report emissions.

This transitional period allows the European Commission to refine calculation methodologies, improve verification systems for declarations, test certificate trading mechanisms, and assess potential extensions to the scope of the mechanism.

The Full Implementation Phase of the CBAM

Starting January 1, 2026, annual declarations become mandatory and must be verified by an accredited verifier. Each importer must purchase and surrender CBAM certificates and maintain a minimum balance of certificates in their account at the end of each quarter.

The first annual declaration, covering imports made in 2026, must be submitted by May 2027 at the latest.

The Impact of the CBAM on Climate Finance

The CBAM is an unprecedented regulatory tool with potentially massive consequences. For the first time, it will impose a carbon price—particularly on greenhouse gas emissions such as carbon dioxide—on products manufactured around the world and exported to Europe. This border pricing will generate significant financial flows from foreign manufacturers toward the EU.

Financing Europe’s Energy Transition

One of the main concerns of the EU’s trade partners is that they may end up directly financing Europe’s energy transition—at the expense of their own investment needs. Countries like Canada, South Africa, Brazil, Turkey, and China export tens of millions of tonnes of embedded carbon to Europe via goods such as iron, steel, cement, and fertilizers. This could result in hundreds of millions of euros in annual levies imposed on their companies.

While this represents a major source of revenue for the EU, it also imposes a heavy burden on those countries. In their view, if emissions are to be taxed, the proceeds should benefit the country where the emissions occur—not the European Union.

Accelerating Global Carbon Pricing

As a result, the introduction of the CBAM in Europe has pushed many countries to implement their own emissions trading systems to shield themselves from the mechanism. Indeed, if emissions are already priced in the country of production, they are not subject to a second levy at the EU border.
This is leading to a rapid acceleration in the rollout of emissions pricing systems worldwide—including in Indonesia, Turkey, Brazil, and India.

To address the risk of carbon leakage stemming from the implementation of national ETS schemes, these countries are also starting to consider their own versions of a CBAM.

We are therefore heading toward a system resembling foreign exchange markets—where emissions allowances are specific to each geography (EU, UK, China, India), and cross-border “exchange rates” apply at the boundaries between these regions.

Does the CBAM influence the price of EU carbon allowances?

The price of CBAM certificates is directly linked to the closing auction price of European Union Allowances (EUAs). There is, therefore, a clear relationship between the price of EUAs and the price of CBAM certificates.
But beyond this direct link, the implementation of the CBAM is already triggering a phenomenon known as proxy hedging, which can itself influence EUA prices—starting now.

What is proxy hedging with CBAM certificates?

Proxy hedging refers to an indirect hedging strategy. In this case, entities subject to the CBAM may use EU carbon allowances to hedge against fluctuations in the price of CBAM certificates, since both prices are closely linked. Here’s the reasoning:

• An Indian steel producer knows that starting in 2027, they will be required to purchase CBAM certificates for exports to Europe.
• They also know that the price of those certificates in 2027 will be equivalent to the price of EUAs in 2027.
• If they expect the price of EUAs to rise gradually between now and 2027—a reasonable assumption—they can buy EUAs now to hedge against that increase.
  
  

For example, if EUA prices are €70 today and are expected to reach €80 in 2027, the producer can:

• Buy EUAs today at €70
• Sell them in 2027 for €80
• Use the proceeds to buy CBAM certificates at €80

In this way, the producer uses EUA purchases today as a hedge against the future cost of CBAM compliance.
This hedging activity creates additional demand for EUAs from foreign producers—demand that would not otherwise exist—and can therefore contribute to upward pressure on EUA prices.