The EU Commission is preparing measures to reduce the risk of carbon leakage. A broadening of the Carbon Border Adjustment to downstream products and a compensation for exporters are planned. A linking of the EU’s and UK’s ETS is recommended. And the 2040 climate target could allow CBAM to be more closely linked to international carbon markets.
(Last update on 21/07/2025)
Protection against carbon leakage needed
Alongside a legislative proposal for a European climate target in 2040, on July 2 the EU Commission also announced short-term measures for the further development of the Carbon Border Adjustment Mechanism (CBAM). These are intended to provide more effective protection against carbon leakage.
Carbon leakage refers to the relocation of carbon-intensive industrial production from regions with strict climate policy to places with looser regulation and no carbon costs. Such leakage has negative impacts for the climate and the competitiveness of the European economy.
As highlighted by the EU Competitiveness Compass, energy-intensive sectors face increasing cost pressure. Action plans for the steel & metals and chemical industries aim to align competitiveness with decarbonisation.
In the EU Emissions Trading System (ETS), free allowances for these industries will be phased out between 2026 and 2034. This phase-out increases the risk of carbon leakage. CBAM aims to address these risks by applying the same carbon price to imported goods as to those produced within the EU.
As the first instrument of its kind worldwide, the initial CBAM framework is far from complete. Industry associations such as EUROFER are calling for stronger carbon leakage protection.
While the EU Commission is still working on the implementation rules for the definite phase starting 2026, key changes are underway paving the way for CBAM 2.0.
Following a political deal between EU-Council and Parliament, the overarching CBAM rules will be simplified in Regulation 2023/956. Ahead of the summer break, additional plans for more effective carbon leakage protection were also announced.
New CBAM developments
CBAM 2.0 can strengthen carbon leakage protection through various channels: through the import and export sides, through international carbon markets, and through carbon pricing in third countries.
CBAM extension for EU imports
Currently, CBAM covers over 500 goods from iron & steel and aluminium, as well as fertilizers, electricity, hydrogen and cement – amounting to EUR 89 bn or 4% of EU imports in 2024. These imports represent the highest carbon leakage risks.
However, loopholes remain: most processed goods are currently excluded – so-called downstream products. For example, semi-finished steel products fall under CBAM, but car or machinery parts made from them do not.
To avoid carbon costs, downstream manufacturers could relocate production abroad or EU buyers may circumvent CBAM through re-routing.
To counter such negative impacts, a public consultation is currently exploring how CBAM could be expanded. Two directions are under consideration:
- Vertical: to downstream products made from CBAM-covered goods like iron, steel, or aluminium;
- Horizontal: to additional sectors with high leakage risk, such as polymers or organic chemicals.
While a CBAM review will assess a horizontal extension by end of 2025, the consultation focuses on a vertical extension. The ongoing consultation runs until August 26. Based on the results, a proposal to revise the CBAM Regulation 2023/956 is expected by the end of 2025.
The main challenge in such an extension lies in increasing implementation complexity: Moving down the supply chain, it becomes harder to trace emissions from a large number of upstream products. Also, carbon costs decline in relative value compared to the total product value.
CBAM compensation for EU exports
While CBAM imposes imports with the same carbon costs as in the EU, there is currently no protection for EU exports. Industries like steel, metals and chemicals, face growing disadvantages in global competition.
Without an additional adjustment, carbon leakage could occur through the relocation of carbon-intensive production to non-European sites to serve non-EU markets.
The EU Commission therefore plans to use CBAM revenues to support EU producers at risk of carbon leakage. The first package of the Clean Industrial Deal sets out that such a compensation measure should be:
- Proportional to the phasing-out of free allowances in the ETS;
- Subject to deliverables on long-term decarbonisation;
- Based on objective criteria.
Equal treatment of all products should ensure WTO compatibility. The measure will apply for an initial period and be reviewed in 2027. A legislative proposal is expected alongside the proposal for CBAM extension at the end of 2025.
The Commission is also preparing further analysis of carbon leakage risks. Initial results in the 2023 carbon market report identified the highest risks for aluminium, steel, and fertilizers.
CBAM linking to international carbon markets
The proposal for the EU’s 2040 climate target is also relevant for the future of CBAM. A 90% reduction in emissions by 2040 compared to 1990 will require abatement (excluding carbon capture and storage) of 70-85% of current industrial emissions based on the Commission’s impact assessment.
This means that a large share of emission-intensive processes must either be fully decarbonised or be moved abroad. The EU would then rely more on imports – making CBAM an even more important tool to avoid leakage.
To meet climate targets, ETS caps must also be cut, raising EU ETS prices and volatility. Since the ETS determines CBAM certificate prices, there is a direct impact on carbon costs for EU importers.
To maintain market liquidity, the Commission is proposing opening the ETS to domestic carbon removals. In the 2040 proposal, there is also an opening for high-quality international credits under Article 6 to be considered. In this case, they could also be integrated in the ETS.
With such a move, these carbon credits could be counted as carbon prices already paid to reduce CBAM charges. This would also link CBAM with international carbon markets and increase demand for such credits from industry.
Although such offsetting is often criticised, carbon credits for unabated emissions function as a carbon price on emissions too and thus reduce leakage risks.
CBAM exemptions through interlinked carbon prices
At the same time, CBAM is pushing other countries to price a growing share of their emissions. However, with carbon prices still significantly lower than in the EU ETS, large cost differences persist for now.
To address these gaps, the United Kingdom and the EU are taking first steps. Back in May, both sides agreed to explore linking the EU and UK ETS. Now, the European Commission has issued its recommendation for a Council decision.
As specified in this text, UK imports would become exempt from the EU CBAM. Under Article 2(6) of Regulation 2023/956, third countries are exempt if their emissions trading is fully linked to the EU ETS. In parallel, the UK CBAM would not apply to goods from the EU.
In the long run, fully aligned carbon prices at the regional or even global-level would be the most effective protection against carbon leakage. In such a scenario, CBAM would no longer be needed. Notwithstanding the convergence pressure created by CBAM, globally linked carbon prices remain a long way-off.
CBAM 2.0 increases complexity
Hence, a robust carbon leakage protection is essential: for decarbonization and industrial competitiveness. With the planned CBAM extension, export compensation and potential linkage to global carbon markets, CBAM is evolving.
This creates adjustment needs for businesses:
- EU importers: Preparation for broader product scopes and higher carbon costs to adjust procurement strategies;
- EU exporters: Review eligibility for ETS cost compensation to incorporate these into market strategies;
- Non-EU producers: Reduce emissions in CBAM goods through decarbonisation or prospectively to offset them via carbon credits.
Amid fragmented carbon markets, CBAM 2.0 increases complexity. While compliance risks rise, there is an opening for strategic opportunities too. Companies acting now can strengthen their competitive edge in a world of rising carbon prices.
Sources and further information:
- European Commission: Initiative for Downstream Extension and Anti- Circumvention
- European Commission: Delivering on the Clean Industrial Deal I (Com 2025/378)
- European Commission: Proposal for Amending Regulation 2021/1119 (Com 2025/524)
- European Commission: Recommendation to link UK’s and EU’s ETS (Com 2025/408)
Photo by Guillaume Périgois on Unsplash
