Since 24 February 2022, Ukraine has been valiantly defending itself from despicable, unprovoked and unjustified military aggression. The determined resistance of the Ukrainian people has shown that they share the same values as Europeans, and that in the new geopolitical environment the Ukrainian movement towards joining the EU will be much faster than previously anticipated. In line with this, on 28 February 2022 Ukraine submitted its application to join the EU. On 11 March 2022 during European Council summit held at the Palace of Versailles, the aspirations and the European choice of Ukraine were acknowledged and it was noted that Ukraine’s membership application had been swiftly transmitted to the European Commission, which started its consideration on 21 March 2022. One of the steps towards joining the EU, is for Ukraine to align its environmental legislation with the EU’s, which is at the forefront of international efforts to fight climate change.
On 30 June 2021, the EU Parliament and Council approved, within the framework of the European Green Deal, the European Climate Law, which sets a binding target for EU Member States of achieving climate neutrality by the EU by 2050. As an intermediate step towards climate neutrality, the EU has established that by 2030 its emissions must be cut by at least 55% compared to 1990 levels.
This ambitious aim requires current greenhouse gas emission levels to drop substantially in the next decades and thus increases costs related to the climate policies of various industries, especially for energy-intensive ones. Such increase in costs for various industries may result in an increased risk of so-called “carbon leakage”, which refers to businesses transferring their manufacturing to other countries with laxer emission constraints or to the import into the EU of goods that have been produced in countries with laxer climate policies. This could even result in an increase in global emissions, thus further undermining all of the efforts to reduce greenhouse emissions.
Given this, the EU aims to introduce various mechanisms aimed at combating carbon leakage, and the carbon border adjustment mechanism (CBAM) is one of them.
Although the draft of the CBAM Regulation was presented on 14 July 2021, it is still under consideration and would have to go through the ordinary legislative procedure in the Parliament and Council (consideration is expected to start in the second half of 2022).
CBAM
What is CBAM?
CBAM essentially imposes a charge on imports of goods with a significant carbon footprint, such as cement, iron and steel, aluminium, fertilisers and electricity (Goods) that reflect additional costs that EU domestic industry bears under EU climate policies.
CBAM will apply to imports from all non-EU countries, unless such non-EU country has: (a) implemented the EU emission trading system (ETS) or has unified and linked (have the same goals for reduction of greenhouse gasses emissions) its local ETS with European ETS; and (b) the price paid for emissions by the industry of that country is the same as the one paid by EU industries and the industry of that country has not obtained any reimbursement in connection with emissions charges.
CBAM defines three types of greenhouse gas emissions described in this Picture 1:
Picture 1. Types of emissions under CBAM
As envisaged in the current proposal for the CBAM Regulation, CBAM will apply only to direct greenhouse gas emissions emitted during the production process of the Goods, and it does not cover indirect emissions (including emissions necessary to produce electricity to manufacture the Goods and downstream products using the Goods). Electricity producers can also voluntarily choose to use embedded emissions instead of direct emissions to calculate CBAM charges in the case of electricity (as described in item 3.3 below). However, by the end of the transition period of 2023–2026, the EU Commission will evaluate CBAM and will consider extending its scope to more goods and services, including downstream products (products created from the Goods) and indirect emissions.
CBAM Procedure
CBAM will work as follows (please also see Picture 2 for a brief description of the procedure):
- An EU Company that intends to import Goods into the EU (Importer) will be required to become accredited with the competent authority (to be established once CBAM is implemented) of the EU member state in which it is incorporated in order to import Goods into the EU.
- By 31 May each year, each importer must submit a declaration (CBAM declaration) to the competent authority for the previous year in which, among others, it must state the total quantity of each type of the Goods imported during the preceding calendar year and the total embedded emissions. Where an importer cannot determine the embedded emissions, the CBAM foresees a system of “default values” (the actual values of greenhouse emissions that will be calculated on the basis of the methodologies and guidance established by CBAM) to be applied. The number of CBAM certificates to be acquired by importers of the Goods is determined.
- On the basis of these CBAM declarations, importers will need to buy CBAM certificates annually from the competent authorities of the respective EU Member State to cover the embedded emissions of their imports. The CBAM certificates’ price will be established on the basis of the weekly average price of carbon allowances auctioned by the EU ETS, which has been functioning since 2005. It should be noted that contrary to the EU ETS (under which carbon allowances can be sold back to the EU ETS), unused CBAM certificates cannot be sold to other importers, but can only be surrendered to the competent authority.
- Declarants are required to surrender CBAM certificates depending on the amount of embedded emissions in the Goods imported. Declarants that fail to surrender by 31 May of each year a number of CBAM certificates corresponding to the embedded emissions in their Goods, or which submit false information, will be liable to a penalty equivalent to three times the prior year’s average price for CBAM certificates that the declarant failed to surrender.
Picture 2. CBAM Procedure
It should be noted that CBAM envisages that measures aimed at achieving CO2 reductions taken in the countries of origin of the Goods will impact the number of CBAM certificates to be acquired by an importer of the respective Goods into the EU. In particular, an importer can claim a reduction in the number of necessary CBAM certificates that reflects the carbon price paid in the country of origin of the Goods. However, sufficient proof that the carbon price was paid for the respective emissions must be provided.
CBAM implementation
It is intended that CBAM will gradually enter into force between 2023 and 2026:
- Transitional implementation: After 1 January 2023, importers will be required to report on a quarterly basis the actual embedded emissions in imported Goods, detailing direct emissions and indirect emissions, as well as any carbon price paid abroad (i.e. not paying CBAM charges).
- Full implementation: CBAM will become fully operational in 2026. Thus, after 1 January 2026, importers of Goods will have to declare annually the quantity of Goods and the amount of embedded emissions in the total amount of Goods they imported into the EU in the preceding year, and pay the CBAM charges for the embedded emissions.
Impact on the Ukrainian energy sector
Ukrainian electricity exports that may potentially be subject to CBAM
Exports of Goods from Ukraine to the EU that may be subject to CBAM potentially amount to EUR 2.9 billion. In 2019, imports into the EU of Ukrainian Goods that may be subject to CBAM amounted to 6% of all imports of Goods that may be subject to CBAM in the EU from the whole world (please see Picture 3 below).
Picture 3. Share of Ukrainian Goods that may be subject to CBAM in the total volume of CBAM Goods that may be subject to CBAM imported into the EU from the whole world
Electricity is among the Goods that may be subject to CBAM, and the total exports of electricity in 2020 (which was previously possible only from Burshtyn Island and certain generating blocks of Dobrotvirska CHPP, the parts of the Ukrainian energy system that were synchronised with ENTSO-E) that may be subject to CBAM amounted to approximately EUR 281 million. It should be noted that since 16 March 2022, the entire Ukrainian energy system has been synchronised with ENTSO-E and thus exports of electricity to the EU that may be subject to CBAM can be significantly higher.
As the level of CBAM charges is tied to the amounts of greenhouse gas emissions generated during the production of the Goods, CBAM has the potential to have a significant impact on Ukrainian electricity exports to the EU, due to the high carbon intensity (the amount of carbon emissions necessary to generate 1 MWh) of electricity generation in Ukraine, which is twice as high as the carbon intensity of electricity generation in the EU (please see Picture 4 below which provides an approximate status of carbon intensity in the production of the Goods).
Picture 4. Comparison of the carbon intensity in the production of the Goods that may be subject to CBAM
Exemptions from CBAM that may apply to Ukraine
General grounds for exemption from CBAM
As a contracting party to the Association Agreement with the EU and a Member of the Energy Community, Ukraine is in general committed to decarbonisation processes that should eventually result in the adoption of carbon pricing mechanisms similar or equivalent to the EU ETS or in its participation in the EU ETS. As a result, Ukraine can be exempted from CBAM on general grounds, if it complies with its obligations envisaged by the Association Agreement with the EU and by the Energy Community.
Specific CBAM exemption in relation to electricity
In addition to the abovementioned general grounds for the exemption of Ukrainian Goods from CBAM, there is also special exemption procedure from CBAM that may apply to electricity, if the following conditions are met:
- Ukraine’s electricity market is integrated with the EU internal market for electricity through market coupling and it has not been possible to find a technical solution for the application of the CBAM to the importation of electricity into the EU from Ukraine;
- it is not possible to find a technical solution for the application of CBAM to the import of electricity into the EU;
- Ukraine has prepared and submitted a roadmap to the EU Commission, which contains a timetable to adopt measures to implement climate neutrality by 2050 and to demonstrate substantial progress towards the alignment of domestic legislation with the EU in the field of climate action, including towards carbon pricing at an equivalent level as the EU;
- Ukraine will finalise the implementation of an emissions trading system for electricity, with a price equivalent to the EU ETS.
Please also note that Ukraine may lose this exemption status in the event of the following:
- if the EU Commission has reasons to consider that Ukraine has not shown sufficient progress to comply with one of the requirements listed above, or if Ukraine has taken action incompatible with the objectives set out in the EU climate and environmental legislation;
- if Ukraine takes steps contrary to its decarbonisation objectives, such as providing public support for the establishment of new generation capacity that emits more than 550g of CO2 of fossil fuel origin per kWh of electricity.
Furthermore, the EU will in any case in 2030 revisit any exemptions granted before 2030, thus making Ukrainian electricity subject to CBAM if it does not comply with the general grounds for exemption from CBAM by this time.
Methods of calculating potential CBAM charges on Ukrainian electricity exports
CBAM charges for imports of electricity to the EU will be calculated on the basis of CO2 emissions under one of the two following methods:
Impact on Ukrainian energy sector
CBAM will affect Ukrainian electricity exports to Europe unless Ukraine either qualifies for one of the two possible exceptions from CBAM (as described in item 3.2 above).
Otherwise, electricity exporters will be required to pay CBAM charges and only if CBAM charges will be calculated on the basis of actual values of CO2 embedded emissions (Method 2 above) will the export of electricity from Ukraine to the EU remain economically viable. The calculation of CBAM charges under the two methods described in item 3.3 above will impact Ukrainian electricity exports as follows:
- Method 1. In Method 1, electricity exports to the EU might not be economically viable, as CBAM charges will increase the price of electricity exported to the EU by approximately 1.5-2.5 times.
- Method 2. Method 2 will create opportunities to export Ukrainian electricity generated from sources with low carbon emissions, such as renewables, nuclear and highly manoeuvrable capacities using natural gas.
