How Carbon Border Adjustment Mechanism is Energizing the EU Carbon Market and Industrial Transformation

TL;DR

The paper discusses how the EU's Carbon Border Adjustment Mechanism (CBAM) is strengthening the EU carbon market and promoting industrial transformation by addressing international competitiveness and carbon leakage issues.

Contribution

It introduces the design and potential impact of CBAM as a novel policy tool complementing the EU ETS to enhance carbon pricing and trade fairness.

Findings

CBAM applies carbon costs to imported goods.

CBAM aims to replace free allowances under EU ETS.

CBAM supports the transition to net zero emissions.

Abstract

The global carbon market is fragmented and characterized by limited pricing transparency and empirical evidence, creating challenges for investors and policymakers in identifying carbon management opportunities. The European Union is among several regions that have implemented emissions pricing through an Emissions Trading System (EU ETS). While the EU ETS has contributed to emissions reductions, it has also raised concerns related to international competitiveness and carbon leakage, particularly given the strong integration of EU industries into global value chains. To address these challenges, the European Commission proposed the Carbon Border Adjustment Mechanism (CBAM) in 2021. CBAM is designed to operate alongside the EU ETS by applying a carbon price to selected imported goods, thereby aligning carbon costs between domestic and foreign producers. It will gradually replace existing carbon leakage mitigation measures, including the allocation of free allowances under the EU ETS. The initial scope of CBAM covers electricity, cement, fertilizer, aluminium, iron, and steel. As climate policies intensify under the Paris Agreement, CBAM-like mechanisms are expected to play an increasingly important role in managing carbon-related trade risks and supporting the transition to net zero emissions.