Third-country carbon pricing under the EU CBAM

In October 2023, the EU introduced a Carbon Border Adjustment Mechanism (CBAM) imposing a carbon price on imports of selected goods to the EU market. One question that arises for the  implementation of the new instrument is how third-country carbon prices can be recognised and deducted from CBAM payments. The discussion paper presents two possible approaches: One that recognises carbon costs that are actually incurred, and another that uses carbon price averages of the country of origin. The first, the actual payment approach, simplifies the questions of how to account for free allocation of allowances or tax rebates, and how to deal with subnational systems. It puts the responsibility of providing evidence on the CBAM declarants who have an interest in achieving the recognition of their carbon costs incurred under a third-country instrument, while the other approach, the average price approach, assigns more responsibilities to the EU.   

The discussion paper raises conceptual considerations and open questions regarding the  technicalities of recognising third-country carbon prices, such as the treatment of multi-product installations or upstream carbon pricing instruments. It discusses challenges that are specific to the processes of cap-and-trade systems, tradable performance standards, and carbon taxes. The complexity of the issue, as analysed in this paper, implies that the EU will need a fair amount of pragmatism in designing the recognition procedure, keeping the regulatory burden manageable while at the same time effectively preventing carbon leakage.