Communication Is Key: Strengthened Dialogue Between Canadian Exporters And European Union Importers Under New Regulation - International Trade & Investment

The European Union ("EU")'s pathbreaking Carbon Border Adjustment Mechanism ("CBAM") will require Canadian exporters to closely monitor and calculate the amount and cost of carbon embedded in exported goods to their EU importing counterparts. On August 17, 2023, the EU adopted the Implementing Regulation (the "Regulation"), imposing reporting obligations on EU importers of carbon-intensive goods in the six sectors currently covered by the CBAM (iron and steel, aluminum, cement, fertilizer, electricity and hydrogen).¹ The Regulation prescribes new reporting obligations for EU importers that began on October 1, 2023.

Practically speaking, this means that EU importers will likely require Canadian exporters of carbon-intensive goods to implement monitoring methodologies that comply with these new requirements to ensure the importers themselves have the information they need to satisfy their regulatory obligations. Emissions reports will be due quarterly from October 1, 2023, through December 31, 2025 ("Transitional Period"). The purpose of this Transitional Period is to collect emissions data and information on calculation methodologies, and to facilitate a smooth roll out of the CBAM. In 2026, the CBAM will enter its Definitive Phase, in which importers will have to begin paying for CBAM certificates.

New Reporting and Data Collection Responsibilities for Importers and Exporters

Throughout the Transitional Period, and in the subsequent Definitive Phase, EU importers are responsible for reporting the information about the carbon-intensive goods that is needed to determine the magnitude of the border carbon adjustment that would place the imported products on a level playing field with products produced in the EU that are subject to its carbon emissions regulatory and pricing regime.

The required information includes details on the country of origin, the exporting company's name and address, the production routes, and the direct and indirect embedded emissions, alongside other factors.² Exporters are not directly subject to the CBAM. However, they will have to provide the embedded emissions in their exported goods and communicate that data, along with information about their production facilities, to their EU importing counterparties.

The first reporting period will cover emissions released for imported CBAM goods from October 1, 2023, to December 31, 2023, and the first report on such emissions will be due at the end of January 2024. The European Commission has developed an "emissions data communication" template³ to assist exporters in compiling the necessary embedded carbon emissions data. The template is intended to facilitate the information exchange between the importer and exporter. The Commission has included in the template all necessary embedded emissions information that exporters must share for their importers' CBAM reports, as well as recommended information that will provide greater transparency of the shared data.

An electronic database called the CBAM Transitional Registry (the "Registry") will be accessible only to EU importers, the European Commission, and competent authorities (including national authorities, central CBAM authorities and customs authorities). The CBAM Trader Portal (the "Portal") will act as the entry point to the Registry.⁴ The Registry is intended to ease the administrative burden on both importers and exporters as it will allow importers to store information about exporting partners and their embedded emissions, enabling re-use of the information during later reporting periods.

Carbon Pricing Policies in Export Jurisdictions Have a Key Role to Play

The CBAM seeks to ensure that imported products have incurred the same level of carbon costs as comparable EU products. In the EU, the cost is based on the price per unit of emissions under the EU's emission trading system – currently about EUR €82 per tonne.⁵

The CBAM recognizes that some countries have their own carbon pricing systems in place.⁶ Importers must report specific information where exporting jurisdictions have domestic carbon pricing schemes,⁷ including the type of product and carbon price, the country and law providing for the carbon price, and whether there are rebates available, among other factors. Exporters must monitor and communicate to importers the actual price per tonne of CO2 emission that has already been paid by importers. If the price equals or exceeds the EU price, no border carbon adjustment would be payable.

The CBAM and the Regulation stipulate that exporters in jurisdictions with carbon pricing schemes are eligible to receive rebates, reflecting the difference between EU carbon pricing and their home jurisdiction costs so long as they provide specific information required to establish entitlement to the rebate.⁸

Currently, the EU's carbon emissions regime provides free allocations designed to mitigate the risk of "carbon leakage" prior to the CBAM's implementation. Carbon leakage happens when companies move production abroad, often to countries with less stringent environmental policies. However, as the CBAM is introduced, the European Commission will be phasing out the free allocations in line with increasing climate ambition and carbon prices. The phase out also aligns with efforts to level the playing field between EU producers and third-country producers. These allocations will cease entirely in 2026, after the Transitional Period.⁹

Canadian producers and exporters are subject to a domestic carbon pricing regime through the output-based pricing system ("OBPS"). The current price under the OBPS is around CAD $65 per tonne, and in an effort to accelerate a shift towards a low carbon economy, is scheduled to increase annually by CAD $15 per tonne from 2023 to 2030.¹⁰ The OBPS requires specific industries and large emitters to pay a carbon price if they exceed their applicable emissions limit (analogous to the free allocations in the EU). Where a province has enacted a local carbon emissions program, the applicable emissions limits will at least meet the OBPS benchmark, but can be more stringent. Companies that emit less than their regulated limit will in most circumstances earn credits that they can trade with other companies to meet their compliance obligation or bank for future use.¹¹ Canadian exporters will have to comply with the Regulation's reporting requirements for countries with carbon pricing systems to ensure that their importing counterparties can fully benefit from the rebate regime.

Carbon Emissions Data Calculation Methodologies for EU Importers

Since CBAM reporting obligations have commenced quickly, the Regulation provides for temporary alternative monitoring and reporting methods, so long as full and accurate emissions data is maintained.¹² Importantly, these varied reporting methodologies rely on data gathered by exporters.

The Regulation contemplates two available methods to determine embedded emissions: a calculations-based method and a measurements-based method:

The calculations-based method determines emissions from source streams based on activity data gathered from measurements and calculation factors, either from laboratory analyses or standard values.¹³ Source streams are a specific fuel type, raw material, or product that either contain carbon or generate carbon emissions during production.¹⁴ Activity data refers to data from the materials consumed or produced by a carbon-emitting process.¹⁵
The measurements-based method involves continuously¹⁶ measuring the concentration of carbon emitted in the site-specific composed mixed gases at exported production facilities.

Where an eligible monitoring, reporting, and verification system is already established for the purpose of a carbon pricing scheme or compulsory emission monitoring scheme ("EMS") in the exporting jurisdiction, there are three alternative methodologies contemplated under the Regulation.¹⁷ Importers can use data collected within any of these systems by their exporting counterparties to fulfill their reporting requirements during the Transitional Period:

The first is a carbon pricing scheme, which generally refers to any pricing mechanism charged to the source emitting carbon.
The second is a compulsory EMS which monitors, analyze, and quantifies the amount of carbon emitted over a specified period.
The third is an EMS with verification by an accredited verifier, which uses a third-party individual who has been verified in accordance with CBAM Regulations¹⁸ to issue a verification report, confirming the data obtained by the EMS.

Penalties for Non-compliance During the Transitional Period

The Regulation prescribes penalties for importers that do not take the necessary steps to comply with their CBAM obligations, including where a quarterly report is incorrect or incomplete, and for failure to remedy such reporting inaccuracies.¹⁹ The penalties range between EUR €10 and EUR €50 per tonne of unreported emissions.²⁰ While Canadian exporters are not directly subject to the penalty regime in the Regulation, they will still want to accurately communicate their embedded emissions to avoid their importing counterparties being penalized. It is likely that importers will seek representations and warranties, cooperation covenants and indemnification provisions in supply agreements that effectively transfer these responsibilities and risks in large part to the exporters.

Key Takeaways

While there is no formal reporting onus on Canadian exporters, the Regulation effectively creates a parallel expectation that they will closely monitor and communicate the production cycle, embedded emissions, and carbon costs of their carbon-intensive goods to their EU importers.²¹ Canadian exporters should be aware of their EU counterparties' reporting obligations to provide full and complete emissions reports. Also, Canadian exporters should ensure they understand how their OBPS or provincial carbon emissions regime obligations in Canada may interact with the EU regime to obtain maximum available rebates under the CBAM and the Regulation. Depending on market dynamics, the CBAM could be relatively advantageous for Canadian companies that are competing in Europe with goods exported from the US, China, or numerous other countries that have no or lower carbon regulatory costs than Canada.

Footnotes

1. For more information on the CBAM, please refer to McMillan's bulletin The EU's New Carbon Border Adjustment Mechanism in Action: Impacts on Canada and Beyond.

2. Regulation (EU) 2023/956 at article 3(2).

3. The European Commission, Guidance Document on CBAM Implementation for Imports of Goods into the EU, at Information Required for Transitional Period at page 76.

4. Regulation (EU) 2023/956 at article 22.

5. The price of emissions allowances in the EU and UK, Ember. Online.

6. Almost 40 countries worldwide have some form of domestic carbon pricing system in place including Australia, South Africa, Argentina, Brazil and New Zealand in addition to Canada. The United States does not currently have a federal carbon pricing scheme, although some states have implemented carbon-pricing mechanisms or cap-and-trade programs including California, Connecticut, New Hampshire, New York, Washington and other Northeast states. China has a national carbon emissions cap and trade market that sets a limit on the amount of carbon emitted for each unit of power generated.

7. Regulation (EU) 2023/956 at article 7.

8. Regulation (EU) 2023/956 at article 7.

9. The European Commission, Guidance Document on CBAM Implementation for Imports of Goods into the EU, at Information Required for Transitional Period at page 18.

10. "The federal carbon pollution pricing benchmark" Government of Canada. Online.

11. For more information on the OBPS, please refer to McMillan's bulletin Transition to Emissions Performance Standards (EPS) Program Underway for Greenhouse Gas Emitters in Ontario.

12. Regulation (EU) 2023/956 at articles 4(2) and 4(3).

13. Regulation (EU) 2023/956 at article 4(1)(a).

14. As previously defined by the European Commission in Regulation (EU) 2018/2066 at article 3(4). See also Regulation (EU) 2018/2066 at article 21.

15. As previously defined by the European Commission in Regulation (EU) 2018/2066 at article 3(1).

16. As previously defined by the European Commission in Regulation (EU) 2018/2066 at article 3(40); note: "continuously" refers to using periodic measurements to determine the value of a quantity.

17. Regulation (EU) 2023/956 at article 4(2). See generally the CBAM description in our previous bulletin.

18. See also: Regulation (EU) 765/2008 and Regulation (EU) 2018/2067.

19. Regulation (EU) 2023/956 at article 16(1).

20. Regulation (EU) 2023/956 at article 16(2).

21. See also: the European Commission has published three guidance documents for EU importers and non-EU installation operators on the practical implementation of the Regulation. These guidance documents contain provisional methodology for calculating embedded emissions: Carbon Border Adjustment Mechanism.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.