ETS, CBAM and carbon leakage

The European Commission in its memo published on May 2023 answers to this question: “…Isn’t carbon leakage already addressed by the Emissions Trading System?...” in the following way: “… The EU’s Emissions Trading System (ETS) is the world’s first international emissions trading scheme and the EU’s flagship policy to combat climate change. It sets a cap on the amount of greenhouse gas emissions that can be released from industrial installations in certain sectors. Allowances must be bought on the ETS trading market, though a certain number of free allowances is distributed to prevent carbon leakage. That system has been effective in addressing the risk of leakage, but it also dampens the incentive to invest in greener production at home and abroad. The CBAM will progressively become an alternative to this. Under the EU’s revised ETS, however, the number of free allowances for all sectors will decline over time so that the ETS can have maximum impact in fulfilling our ambitious climate goals. Furthermore, for the CBAM sectors, the free allowances will gradually be phased out as from 2026 as the CBAM financial adjustment is phased in according to a gradual schedule.  To complement the ETS, the CBAM will be based on a system of certificates to cover the embedded emissions in products being subsequently imported into the EU. The CBAM departs from the ETS in some limited areas, however, in particular since it is not a ‘cap and trade’ system. Instead, the CBAM certificates mirrors the ETS price. To ensure a level playing field between EU and non-EU businesses, and once the full CBAM regime becomes operational in 2026, the system will adjust to reflect the revised EU ETS, in particular when it comes to the reduction of available free allowances in the sectors covered by the CBAM. This means that the CBAM will only begin to apply to the products covered gradually and in direct proportion to the reduction of free allowances allocated under the ETS for those sectors. Put simply, until they are completely phased out in 2035, the CBAM will apply only to the proportion of emissions that does not benefit from free allowances under the EU ETS, thus ensuring that importers are treated in an even-handed way compared to EU producers…”.