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The Carbon Border Adjustment Mechanism:Collaboration or Confrontation? 1
Miki Yanagi, Hiroko Nakamura, Soichi MorimotoSenior Researcher
The Institute of Energy Economics, Japan

Key developments
1. EC announces plans to establish a carbon border adjustment mechanism
On July 14, 2021, the European Commission (EC), the executive arm of the EuropeanUnion (EU), published a proposal 2 for a regulation to establish the world’s first carbon
border adjustment mechanism (CBAM). CBAM is a mechanism under which countries
that bear the carbon costs for taking strict climate measures to impose taxes, surcharges,
and emission permits purchase duties on imported goods from countries that do not takesuch measures, thereby adjusting the differences in such costs. The purpose of this paper
is to offer a summary of the EC’s CBAM regulation proposal brief and its implications
for Japan.
The EC’s proposed CBAM designates products of iron and steel, cement, aluminum,fertilizers, and imported electricity as target products. The revenue generated by theCBAM is estimated to amount to 2.1 billion euros in 2030 and will source theNextGenerationEU, a more than 800 billion euro temporary recovery fund for repairing
the economic damage caused by COVID-19. According to IEEJ estimates based on
Combined Nomenclature (‘CN’) goods codes using Eurostat, imports from Russia,
Ukraine, Turkey, and China are expected to be subject to CBAM.

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The report was updated based on the IEEJ reporting material dated July 27,2021.

2 European Commission(2021) “Proposal for a regulation of the European parliament and of

the council establishing a carbon border adjustment mechanism” 2021/0214 (COD), Brussels,
14.7.2021..
https://eur-lex.europa.eu/legal-content/en/TXT/?uri=CELEX%3A52021PC0564

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Figure: EU imports goods share estimation based on EC regulation proposal, in2019(Source) Based on Eurostat (“Extra-EU imports since 2010 by country of origin andcountry of consignment, by HS2-4-6 and CN8 (DS-059071)”), the author’s estimations(Note) In the statistics, the U.K. is included in the EU. The graph covers the top fiveimport partner countries, as well as Japan, the US and China.
2. A “transitional period” will start in 2023 through 2025
CBAM will impose obligations to report the embedded emissions of the imported product,
which includes not only direct emissions from the manufacturing process but also indirectemissions from electricity and heat. The carbon price due in the country of origin should
be reported as well. The reports must be submitted to authorities quarterly. The
methodology for measuring emissions will be prescribed in an implementing act to bedetermined, and the EC will continue to engage in dialog with third countries on thedetailed design of the system during the transitional period. The EC will submit anassessment report on the measurement of indirect emissions and other topics to theEuropean Parliament and the European Council before the transitional period ends.

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3. CBAM is scheduled for implementation in 2026
The obligation to pay the carbon price for imported products through CBAM certificateswill begin in 2026, according to the EC proposal. A CBAM certificate is a certificate
corresponding to one tonne of embedded emission in goods. Importers (termed“declarants” in the proposal) will thereafter be required to pay for the embedded carbon
emissions of their products with CBAM certificates, whose prices will mirror the EUEmission Trading System (EU-ETS) price. Carbon emissions will initially be calculated
for only direct emissions, such as those from fuels consumed in manufacturing plants.
However, based on assessment results by the EC during the transitional period, theCBAM could eventually be expanded to include indirect emissions associated withpurchased electricity, heat etc. Furthermore, the proposal states that the CBAM will allow
carbon prices that have been paid in the country of origin to be deducted; however, thiswill basically apply only to explicit carbon taxes and explicit carbon prices used inemissions trading.
From 2026, CBAM will be rolled out in stages, in step with the phasing-out of freeemission allowances, which have served as a carbon leakage countermeasure under theEU-ETS. In 2035, free allowances will be suspended completely, and CBAM will be fully
implemented.
4. Next steps and implications for Japan 3
The European Parliament and the European Council will conduct deliberations based on
the EC’s proposal. At present, prospects for final approval of the proposal and the actual
design of the system, if approved, remain unclear. Japan’s exports of the target products
to the EU are miniscule; and therefore, the impact on Japan will be limited even if theproposal is passed. However, Japanese companies may be affected if products from
Russia, China, and other economies that are shut out of the EU flow into Asian markets.
Attention must also be paid to the risk that CBAM may hamper free trade and exacerbate
the North-South divide.
On the other hand, it is desirable, from a trade perspective, to standardize the methodology
for measuring emissions for each product, and Japan should play an active role indeveloping such standards. It is also essential to confirm whether the proposal isconsistent with WTO rules. This includes monitoring for any arbitrary or unjustifiable
discrimination, including using the proceeds from auctioning free allowances to provide
technological support such as CCS technologies to targeted sectors, in effect,
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A METI study group has also made references to CBAM:
METI, Japan, “Interim report of a study group on ideal economic and other approaches for achieving worldwide
carbon neutrality” https://www.meti.go.jp/press/2021/08/20210825002/20210825002-1.pdf

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compensating for the free allowances they would have earned, and thus subsidizing
domestic products while imposing charges only on imported goods.
5. Developments in the United States
Under these circumstances, at the margin of the G20 Finance Ministers meeting in July
2021, Secretary of the Treasury Janet Yellen commented as follows, questioning the EC
CBAM proposal, which focuses only on explicit carbon prices: “It is important that anycarbon border adjustment system focus on the degree to which a country’s climate
policies reduce emissions (and hence carbon content), rather than focus only on explicit
carbon pricing.” 4However, the situation is not so simple. During the election campaign, President Biden
made reference to applying a carbon adjustment fee at the border in conjunction withregulatory measures on domestic manufacturers (“Democratic Platform” 5 ). Meyer &Tucker (2020) also point out the possibility of introducing carbon border adjustments onnational security grounds based on Section 232 of the 1962 Trade Expansion Act 6.
Meanwhile, there were moves by Congress Democrats in connection with carbon borderadjustments that deserved attention. These include a proposal by Senator Coons andRepresentative Peters on a carbon border adjustment mechanism that includes implicit
carbon prices that are linked with standards or regulations, to be applied to iron and steel,cement, aluminum (and products containing at least 50% of these materials), as well as
oil, gas, coal, and other fossil fuels (July 2021 7). In August, a “carbon polluter importfee” was included in the 3.5 trillion-dollar budget resolution introduced by Senator Coonsand Representative Peters. Although the reconciliation legislation was expected to be
based on their bill, the carbon border adjustment mechanism has been excluded from the"Build Back Better Framework" 8 (October 2021).

4 “Remarks from Secretary of the Treasury Janet L. Yellen at the G20 Finance Ministers and Central

Bank Governors Meeting’s High Level Symposium on International Tax”,U.S. Department of thetresurery, July 9, 2021
https://home.treasury.gov/news/press-releases/jy0266
5The 2020 Democratic Party Platform said, “We will apply a carbon adjustment fee at the border to products fromcountries that fail to live up to their commitments under the Paris Climate Agreement, because we won’t let polluters
undermine American competitiveness.”.
6 Meyer & Tucker (2021) “Trump’s Trade Strategy Points the Way to a U.S. Carbon Tariff”, August 24, 2020.
https://www.lawfareblog.com/trumps-trade-strategy-points-way-us-carbon-tariff7 H.R. 4524,S. 2378,
7 H.R. 4524,S. 2378,
https://www.congress.gov/117/bills/hr4534/BILLS-117hr4534ih.pdf
https://www.congress.gov/117/bills/s2378/BILLS-117s2378is.pdf
8The Whitehouse, “The Build Back Better Framework, President Biden’s plan to rebuild the middle
class”
https://www.whitehouse.gov/build-back-better/
https://rules.house.gov/sites/democrats.rules.house.gov/files/Section-by-Section-117HR5376RHRCP117-17_0.pd

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6. Conclusion and implications
A trial run of the carbon border adjustment mechanism is being pursued mainly in the EU
as the world’s first such effort. Future challenges include verification in terms ofinternational trade law, including consistency with WTO rules.
(1) The EC’s CBAM proposal seeks dialog and international cooperation with non-EUcountries during the 2023–2025 transitional period It is strategically important forJapan to become actively engaged in dialog with Europe and to collaborate withrelevant non-EU countries.
(2) Furthermore, the development of methodology will be the world’s first attempt tocalculate all the emissions embodied in products. Establishing the methodology will
be a technical challenge.
(3) From 2026, when the mechanism is gradually implemented, it will be important toverify that the system is compatible with WTO/GATT rules, and thus does notdiscriminate between countries in and outside the EU. The most important discussion
point is whether the obligations imposed are equivalent for both the EU companies
that are subject to the EU-ETS and the non-EU companies that will be required topurchase CBAM certificates and to comply with reporting obligations. In addition,
to avoid trade frictions, the international community is urged to actively engage anddiscuss CBAM in the meetings offered in various forums such as the EU, G20, etc.

Contact:report@tky.ieej.or.jp

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