Carbon border adjustment mechanisms explained: CBAM, trade policy, and decarbonization

The European Union's Carbon Border Adjustment Mechanism began its transitional phase in October 2023 and will start collecting financial levies on January 1, 2026, affecting an estimated EUR 50 billion worth of annual imports across cement, iron and steel, aluminium, fertilizers, electricity, and hydrogen. According to the European Commission, CBAM will cover roughly 50% of emissions in EU Emissions Trading System (ETS) sectors by the time free allowances phase out completely in 2034. The mechanism represents the world's first large-scale carbon border tax and is already reshaping global trade flows: a 2024 UNCTAD analysis found that CBAM-exposed exporters in developing nations face potential revenue losses of $5.3 billion per year, while the World Bank estimates that 18 additional countries are now actively developing or evaluating their own carbon border pricing instruments. For importers, compliance teams, and sustainability leads navigating this new landscape, understanding CBAM's mechanics, timelines, and strategic implications is no longer optional.

Why It Matters

Carbon leakage occurs when companies relocate production to jurisdictions with weaker climate policies, shifting emissions rather than reducing them. The EU ETS, which prices carbon at EUR 65 to 70 per tonne as of early 2026, creates a cost differential that incentivizes such relocation. CBAM addresses this by requiring importers to purchase certificates reflecting the embedded carbon in goods entering the EU, effectively extending the carbon price to foreign producers.

The stakes are substantial. The EU imports approximately 170 million tonnes of CO2 equivalent in embedded emissions through CBAM-covered goods annually, according to European Commission impact assessments. Without border adjustment, every increase in the EU carbon price risks making European manufacturers less competitive while generating no global emissions reduction. CBAM ensures that a tonne of steel produced in Turkey or India faces a comparable carbon cost to one produced in Germany or France.

Beyond preventing carbon leakage, CBAM serves as a diplomatic lever. By imposing costs on carbon-intensive imports, the EU incentivizes trading partners to adopt their own carbon pricing systems. Exporters who already pay a domestic carbon price receive a corresponding deduction on their CBAM obligation, creating a direct financial reward for national climate policy ambition.

Key Concepts

Carbon Leakage and Competitive Distortion

Carbon leakage describes the displacement of emissions from regulated to unregulated jurisdictions. Academic estimates suggest leakage rates of 5% to 25% for energy-intensive trade-exposed sectors under unilateral carbon pricing. The cement, steel, and aluminium industries are particularly vulnerable because their products are globally traded commodities where small cost differences determine market share.

Embedded Emissions

CBAM covers both direct emissions (Scope 1) from production processes and, for certain goods, indirect emissions from purchased electricity (Scope 2). Importers must report actual verified emissions from specific installations where possible. When actual data is unavailable, the EU applies default values based on the average emission intensity of the worst-performing 10% of EU installations for each product category, creating a strong incentive to provide verified data.

CBAM Certificates

From 2026, authorized declarants must surrender CBAM certificates corresponding to the embedded emissions in their imports. Certificate prices track the weekly average EU ETS auction price, ensuring parity between domestic and imported goods. Certificates are purchased through national CBAM registries and cannot be traded on secondary markets, distinguishing them from ETS allowances.

Free Allowance Phase-Out

CBAM's financial obligations scale in tandem with the phase-out of free ETS allowances to EU producers. From 2026 through 2034, free allocations decrease by 2.5% annually in 2026 and 2027, then by 8% to 10% annually from 2028 onward, reaching zero by January 1, 2034. CBAM obligations increase proportionally, avoiding double protection and ensuring WTO compatibility.

How It Works

CBAM implementation proceeds in two distinct phases. The transitional period (October 1, 2023, to December 31, 2025) requires importers to submit quarterly reports detailing embedded emissions in covered goods but imposes no financial obligations. These reports must include the quantity of goods imported, actual direct and (where applicable) indirect emissions per installation, and any carbon price already paid in the country of origin.

Starting January 1, 2026, the definitive phase begins. Importers must register as authorized CBAM declarants with their national competent authority, submit annual CBAM declarations by May 31 each year (covering the previous calendar year), and surrender the corresponding number of CBAM certificates. The number of certificates equals the volume of embedded emissions minus any deduction for carbon prices paid abroad. For example, if an importer brings 10,000 tonnes of steel with embedded emissions of 1.8 tonnes of CO2 per tonne, and the exporting country charges a carbon price of EUR 20 per tonne, the declarant must purchase certificates for 18,000 tonnes of CO2 at the EU ETS price minus the EUR 20 already paid.

The six covered sectors were selected based on carbon intensity and trade exposure:

Sector	Key Products	Estimated EU Import Emissions (Mt CO2/yr)
Iron and steel	Flat products, long products, pipes, fasteners	52
Cement	Clinker, Portland cement, aluminous cement	14
Aluminium	Unwrought aluminium, bars, wire, foil	17
Fertilizers	Urea, ammonium nitrate, mixed fertilizers	12
Electricity	Direct power imports via interconnectors	68
Hydrogen	Grey, blue, and green hydrogen	7

What's Working

The transitional reporting phase has delivered significant data visibility. By the end of 2024, more than 11,000 importers had registered with the CBAM Transitional Registry, and the European Commission received over 4.6 million product-level emissions reports covering the first year of data collection. This unprecedented dataset is already enabling better-informed trade and climate policy decisions.

Trading partner responses confirm CBAM's diplomatic leverage. Turkey accelerated the launch of its own ETS in 2025, explicitly citing CBAM exposure as a primary motivation. The United Kingdom finalized its own Carbon Border Adjustment Mechanism (UK CBAM) taking effect January 1, 2027, with similar sector coverage. India's Bureau of Energy Efficiency launched a Carbon Credit Trading Scheme in 2024, partially motivated by shielding Indian exporters from CBAM costs. Australia, Canada, and Japan have each published formal assessments of carbon border adjustment feasibility.

Major industrial exporters are adapting proactively. Tata Steel, one of Europe's largest steel importers from India, invested EUR 300 million in a hydrogen-based direct reduced iron pilot at its IJmuiden plant in the Netherlands, aiming to cut steelmaking emissions by 30% before the definitive CBAM phase begins. ArcelorMittal committed USD 1.7 billion toward decarbonizing its European operations, with projects in Ghent (Belgium) and Hamburg (Germany) deploying direct reduced iron technology paired with carbon capture. CEMEX, the Mexican cement multinational, launched its Vertua line of low-carbon cements across European markets, achieving 40% lower CO2 intensity per tonne and positioning the company ahead of CBAM cost escalation.

What Isn't Working

Data quality and verification present persistent challenges. The European Commission acknowledged in its 2024 review that a significant share of transitional reports relied on default emission values rather than actual installation-level data, particularly for imports from countries without established monitoring, reporting, and verification (MRV) infrastructure. Without accurate data, CBAM risks penalizing compliant producers and rewarding those who avoid reporting.

Small and medium-sized importers face disproportionate compliance burdens. A 2025 survey by Eurocommerce found that 62% of SME importers rated CBAM compliance as "very difficult" or "extremely difficult," citing complex verification requirements, limited technical expertise, and the cost of engaging accredited verifiers. The administrative overhead of tracking installation-level emissions across global supply chains may exceed the capacity of smaller firms.

Developing country exporters face structural disadvantages. Many nations in sub-Saharan Africa, Southeast Asia, and Latin America lack the MRV systems needed to generate verified emissions data, meaning their exporters default to penalty-level emission values. UNCTAD estimates that Mozambique's aluminium exports to the EU could face CBAM costs equivalent to 6% of export value, straining economies that contribute minimally to global emissions. While the EU has pledged technical assistance, deployment of MRV capacity-building programs has lagged behind the mechanism's timeline.

Circumvention risks are emerging. Analysts at Carbon Tracker have identified "resource shuffling," where producers route lower-carbon output to CBAM-regulated markets while directing higher-carbon output elsewhere, as a potential loophole. Similarly, transshipment through non-covered countries or slight processing to change product classification could undermine the mechanism's effectiveness. The European Commission has acknowledged these risks and is evaluating anti-circumvention provisions for the 2025 to 2026 review period.

WTO compatibility remains contested. India, South Africa, and China have raised formal concerns at the WTO Committee on Trade and Environment, arguing that CBAM constitutes a disguised trade barrier. While legal analyses by the European Commission and independent scholars such as those at the Graduate Institute Geneva suggest CBAM can be defended under GATT Article XX (general exceptions for environmental protection), no formal WTO dispute has been adjudicated, leaving legal uncertainty.

Key Players

Regulatory Authorities

• European Commission DG TAXUD - Administers the CBAM framework, transitional registry, and certificate pricing.
• EU Member State Competent Authorities - Handle national-level declarant registration, verification oversight, and enforcement.
• UK Government (HMRC) - Implementing the UK CBAM effective January 2027 with parallel sector coverage.

Major Affected Exporters

• Tata Steel - India-headquartered steelmaker with major EU import exposure; investing in hydrogen-based decarbonization.
• ArcelorMittal - World's second-largest steelmaker; EUR 10 billion decarbonization roadmap across European plants.
• CEMEX - Mexican cement producer developing low-carbon product lines to reduce CBAM exposure.
• Norsk Hydro - Norwegian aluminium producer leveraging renewable-powered smelting for lower embedded emissions.

Advisory and Compliance Providers

• Sphera - Lifecycle assessment and emissions data management for CBAM reporting.
• Watershed - Enterprise carbon accounting platform supporting CBAM-related Scope 1 and 2 quantification.
• PwC and Deloitte - Big Four firms offering CBAM readiness assessments and compliance services.

Key Investors and Funders

• European Investment Bank - Financing decarbonization projects that reduce CBAM exposure for EU trading partners.
• World Bank Carbon Pricing Leadership Coalition - Supporting developing countries in building carbon pricing and MRV capacity.

Sector-Specific KPI Benchmarks

KPI	Sector	Low Performer	Median	Best in Class	Source
CO2 intensity (t CO2/t product)	Steel (BOF route)	2.3	1.85	1.4	World Steel Association, 2025
CO2 intensity (t CO2/t product)	Cement (clinker)	0.95	0.83	0.59	GCCA Roadmap, 2024
CO2 intensity (t CO2/t product)	Primary aluminium	18.0	12.5	2.0 (hydro-powered)	International Aluminium Institute, 2025
CBAM reporting accuracy (%)	All sectors	<50% actual data	70% actual data	>95% actual data	European Commission, 2024
Carbon price paid at origin (EUR/t)	All sectors	0 (no carbon price)	8	65+ (EU ETS parity)	World Bank Carbon Pricing Dashboard, 2025

Action Checklist

• Identify all imports falling under CBAM's six covered product categories using Combined Nomenclature (CN) codes listed in Annex I of the CBAM Regulation
• Register as an authorized CBAM declarant with the relevant national competent authority before the May 31, 2026 deadline for the first annual declaration
• Establish data collection workflows with non-EU suppliers to obtain installation-level direct emissions data, avoiding reliance on penalty-level default values
• Map carbon prices already paid in countries of origin to maximize deductions on CBAM certificate obligations
• Engage accredited verifiers early, as verification capacity is expected to be constrained in the initial years of the definitive phase
• Evaluate supply chain diversification options, prioritizing suppliers in countries with operational carbon pricing systems that qualify for CBAM deductions
• Monitor the European Commission's planned 2025 to 2026 review for potential scope expansion to downstream products, organic chemicals, and polymers
• Benchmark your imported goods' embedded emissions against sector KPIs to identify high-exposure products and prioritize decarbonization engagement with suppliers

FAQ

Q: Which products are covered by CBAM? A: CBAM covers six sectors: iron and steel, cement, aluminium, fertilizers, electricity, and hydrogen. Within each sector, specific product categories are defined by CN codes in Annex I of the CBAM Regulation (EU) 2023/956. The European Commission is evaluating expanding coverage to downstream products, polymers, and organic chemicals in future reviews.

Q: How are CBAM certificate prices determined? A: Certificate prices are calculated as the weekly average of EU ETS auction closing prices. As of early 2026, this translates to approximately EUR 65 to 70 per tonne of CO2. Prices fluctuate with the ETS market. Importers can deduct any carbon price already effectively paid in the country of origin, provided documentation is verified.

Q: What happens if an importer cannot obtain actual emissions data from their supplier? A: When actual installation-level data is unavailable, the EU applies default emission values. During the transitional phase, importers could use country-specific or UN Comtrade-based averages. From 2026, default values are set at the emission intensity of the worst-performing 10% of EU installations for each product, creating a significant cost penalty and strong incentive to obtain actual data.

Q: Does CBAM apply to goods from countries with their own carbon pricing? A: Yes, but importers receive a deduction. If a carbon price has been effectively paid in the country of origin (whether through a carbon tax, ETS, or equivalent instrument), the corresponding amount per tonne of CO2 is subtracted from the CBAM certificate obligation. This ensures no double charging and rewards countries that implement carbon pricing.

Q: Is CBAM compatible with WTO rules? A: The EU designed CBAM to comply with WTO obligations, particularly under GATT Article XX(b) and (g), which permit trade measures necessary to protect human, animal, or plant life and relating to conservation of exhaustible natural resources. Several developing countries have raised concerns, but no formal WTO dispute panel has been convened as of early 2026. Legal scholars remain divided, though the prevailing view among trade law experts is that CBAM can be defended if implemented in a non-discriminatory manner.

Q: How does CBAM relate to the phase-out of free EU ETS allowances? A: CBAM and free allowance phase-out are linked by design. As free allowances to EU producers decrease (reaching zero by 2034), CBAM obligations on importers increase proportionally. This ensures that EU manufacturers and foreign exporters face equivalent carbon costs over time, maintaining competitive neutrality while strengthening the overall carbon price signal.

Sources

• European Commission. (2023). "Regulation (EU) 2023/956 establishing a Carbon Border Adjustment Mechanism." Official Journal of the European Union. https://eur-lex.europa.eu/eli/reg/2023/956/oj
• UNCTAD. (2024). "A European Union Carbon Border Adjustment Mechanism: Implications for developing countries." https://unctad.org/publication/european-union-carbon-border-adjustment-mechanism-implications-developing-countries
• World Bank. (2025). "State and Trends of Carbon Pricing 2025." https://openknowledge.worldbank.org/handle/10986/41543
• European Commission DG TAXUD. (2024). "CBAM Transitional Period: Implementation Report." https://taxation-customs.ec.europa.eu/carbon-border-adjustment-mechanism_en
• Carbon Tracker Initiative. (2025). "CBAM and Carbon Leakage: Risks and Opportunities." https://carbontracker.org/reports/
• Marcu, A. et al. (2024). "Border Carbon Adjustments in the EU: Legal, Economic and Political Challenges." European Roundtable on Climate Change and Sustainable Transition. https://ercst.org/border-carbon-adjustments/
• International Aluminium Institute. (2025). "Greenhouse Gas Emissions Intensity: Primary Aluminium." https://international-aluminium.org/statistics/greenhouse-gas-emissions-intensity-primary-aluminium/
• Global Cement and Concrete Association. (2024). "GCCA 2050 Cement and Concrete Industry Roadmap for Net Zero Concrete." https://gccassociation.org/concretefuture/