Carbon tariff an undesirable response to a flawed system

Viðskiptaráð has submitted comments on the draft bill on a carbon border adjustment mechanism (the Carbon Border Adjustment Mechanism, or CBAM). The proposed bill will transpose Regulation (EU) 2023/956 (CBAM).

The aim of the Regulation is to strengthen the competitiveness of companies covered by the EU Emissions Trading System (hereafter the ETS system) by imposing a charge on the embedded carbon emissions in products with a large carbon footprint (aluminium, steel and iron, hydrogen, electricity and fertiliser). The purpose of the levy is to counter so-called carbon leakage, i.e. carbon-intensive industry relocating to other countries because of tighter climate policy in Europe. Alongside the introduction of the CBAM system, the free allocation of emission allowances to industrial activities covered by the EU Emissions Trading System will gradually be phased out.

A response to the problem with the ETS system

CBAM is a response to the phase-out of the free ETS allowances that local industry has enjoyed to date, and to the impact that phase-out will have on the competitiveness of the industrial activities covered by the system. In Iceland's case, this phase-out will primarily affect the competitiveness of aluminium production, as the cost to aluminium smelters of purchasing ETS allowances is expected to multiply in the coming years, from just under one billion in 2024 to 14 billion in 2030. Changes to the ETS system will therefore have a significantly negative impact on the competitiveness of aluminium production in Iceland.[1]

Looking at the development of aluminium production in Europe, it has contracted by 30% since 2008, and the continent's share of global aluminium production has fallen from 10% in 2000 to 1% in 2025. This decline is explained partly by rising electricity costs, which have increased in part because of the cost to electricity producers of ETS allowances. Given that global aluminium production has not declined in recent years, this trend strongly suggests that European climate and energy policy has already contributed to the carbon leakage that the CBAM tariffs are intended to prevent.

Competitiveness undermined against most of the global market

CBAM is intended to level the competitive position of the companies it covers. It will certainly do so in the European market, where importers will be required to pay a tariff equivalent to the cost of purchasing ETS allowances. CBAM does not, however, correct the diminished competitive position that aluminium smelters and other local industry within Europe will face against competitors outside Europe once the phase-out of free allowances begins and the companies' ETS costs rise.

The competitive position of aluminium smelters here in Iceland relative to competitors outside Europe will be significantly weakened. Companies will either have to pass this cost on in prices, where market conditions allow, or absorb it in the form of lower margins. In both cases, the competitive position of European production relative to production outside the continent is weakened.

Does CBAM belong within the EEA Agreement?

Viðskiptaráð also raises the point that the CBAM regulatory framework is being incorporated into the environmental annex of the EEA Agreement. The Regulation involves a charge on imports of goods to Iceland that is, in essence, a tariff, notwithstanding that the tariff is intended to price the carbon emissions generated in producing the goods. In support of this, Viðskiptaráð refers to the following text in the explanatory notes to the bill: “In addition to the above, it is necessary to adapt so-called EORI numbers, CN codes and rules of origin to the customs systems of Iceland and Norway.”

In Viðskiptaráð's view, this raises a fundamental question as to whether CBAM, despite the Regulation's environmental objectives, in fact constitutes a charge on imports that falls outside the substantive scope of the EEA Agreement. The fact that implementing the system requires adapting the customs systems of Iceland and Norway underscores, in Viðskiptaráð's view, the need for this issue to be examined specifically.

CBAM a sticking plaster on a bigger problem

CBAM only solves part of the competitiveness problem created by the phase-out of free emission allowances within the ETS system. It levels the position of producers within Europe relative to imports from countries outside the continent, but does not improve the competitive position of Icelandic exporters in markets outside Europe.

This is particularly true of Icelandic aluminium production. The ETS costs faced by aluminium smelters will rise significantly regardless of where their products are sold, while CBAM only provides an offset in the European market. Furthermore, implementing CBAM in Iceland will increase the cost of imports from countries outside the EEA.

Viðskiptaráð believes it is essential to examine what options are available to Iceland should a comprehensive assessment conclude that participation in the ETS and CBAM imposes a significant net cost on Icelandic businesses and consumers without a corresponding benefit. This should include an assessment of the legal and economic consequences of Iceland remaining outside both systems.

Outside both systems, Icelandic exports to the EU would incur CBAM costs at the Union's border instead of ETS costs here at home. For exports to other markets, however, ETS costs would fall away, and Iceland would also not impose CBAM costs on imports from third countries.

Iceland's participation in these systems should therefore not be taken for granted. If the ETS and CBAM impose a significant net cost on Icelandic businesses and consumers without a corresponding benefit, the government should thoroughly examine what scope Iceland has to remain outside the systems.

This article was automatically translated from the Icelandic original.