The European Parliament on April 18 adopted key pieces of legislation that form the main thrust of the European Union’s (EU) flagship “Fit for 55” climate policy package aimed at cutting greenhouse gas emissions by 55% by 2030 (versus a 1990 baseline).

The deal still needs to be formally ratified by the EU Council in order for it to come into force.

Following two years of fraught negotiations, the Parliament backed a compromise deal late last year between itself, the Council, and the European Commission itself, the Council and the European Commission on plans to revise the EU’s carbon market, set up a carbon tax, and create a Social Climate Fund to compensate vulnerable consumers (GM Dec. 23, 2022).

The revision of the bloc’s carbon market, known as the Emissions Trading System (ETS), is set to phase out free carbon allowances to companies from 2026-2034.

The revision includes fully integrating aviation into the mechanism and extending it to cover shipping emissions. It also compels power generators and heavy polluters to cut their pollution by 62% by 2030 compared to 2005 levels, and compared to a target of 43% under the previous rules.

The deal also puts the EU on track to establish the world’s first carbon border tax, known as the Carbon Border Adjustment Mechanism (CBAM), in a bid to avoid EU companies being undercut by non-EU-based companies with less stringent green policies.

The CBAM, expected to be phased in from 2026-2034, will mandate that importers of goods into the EU pay the difference between the carbon price paid in the country of production and the EU’s ETS price.

As well as levelling the playing field for EU-based producers, the measure also aims to discourage the relocation of plants outside the bloc to bypass ETS costs.

The CBAM measures under the legislation’s initial scope will apply to the fertilizers, cement, iron and steel, aluminium, electricity, and hydrogen sectors.

Bloomberg Intelligence ESG Trade Analyst Clelia Imperiali sees in today’s prices the CBAM adding about €19 billion (approximately $20.8 billion at current exchange rates) to the imported cost of covered goods (about 8% of total EU imports from outside the bloc in 2022), using a core EU carbon-price scenario of €75 per mt.

Imperiali noted that EU energy, construction, and agribusiness companies face more red tape for their non-EU production input from October when reporting obligations start under the new legislation’s transition period.

This will be followed by higher costs from 2026, when the full implementation begins. Importers will need to purchase CBAM certificates linked to ETS allowances.

Fertilizers Europe, the Brussels-based European producers’ organization, was “deeply disappointed” with the EU’s provisional and conditional agreement reached last December on the ETS and CBAM, saying it “fell short of providing a consistent and shielding framework for the EU industrial base and for green investments in Europe” (GM Dec. 23, 2022).

“As a sector with a strong exporting pillar, we are very disappointed to see no export solution in the final compromise. By adding the review clause on possible exports solutions in 2025-2026, policymakers indeed recognized the associated risks for our exports,” it had said.

The organization so far has not made further any comment following the European Parliament’s adoption this week of key elements of the legislation.

The deal agreed to by the European Parliament in its April 18 plenary session also establishes a parallel carbon market – “ETS II” – to levy charges on emissions from road transport and in the course of heating buildings from 2027.

To avoid sparking a political backlash amid fears that the policy would have a disproportionate effect on vulnerable households, legislators also backed a €86.7 billion (approximately $95 billion at current exchange rates) Social Climate Fund to help governments compensate vulnerable households and small businesses affected by higher fuel costs arising from the new measures. The fund will be made available from 2026.

As noted by Imperiali, the first revision of the legislation, due by the end of 2027, is likely to expand the scope to indirect emissions of a group of metals whose direct emissions only will be covered by the initial scope.

She said plastics and chemicals, whose inclusion was also considered during the legislative discussions but did not end up on the final list, may also be among the first sectors the CBAM will expand in the future.

Since the European Commission introduced the CBAM proposal in 2021, several countries, including the US and the UK, have been considering introducing a similar levy.

“We believe the adoption by the EU of the CBAM will trigger a wave of new green trade barriers, especially in countries likely to be hit most by the mechanism,” said Imperiali.