The EU has proposed a carbon border adjustment mechanism as a tool to scale up the EU’s climate ambitions while protecting the competitiveness of domestic producers and minimizing risks of carbon leakage.
While the specific design of the mechanism is being developed, the EU’s trade partners are expressing concerns about its potential impact, including estimating potential losses due to the imposition of carbon price at the border with the EU.
In December 2019, the EU proposed to introduce a carbon border adjustment mechanism (CBAM), a form of carbon pricing on imports into the EU, as part of the European Green Deal. The rationale behind the initiative is an attempt to address the risk that the EU’s efforts to curb greenhouse gas (GHG) emissions will be undermined by a lack of climate ambition in non-EU countries due to so-called “carbon leakage” – a situation when stronger climate policies in one jurisdiction lead to increased GHG emissions in other jurisdictions.
Carbon leakage can occur when industries relocate or stay put and lose market share at home or abroad as a result of competitiveness loss due to increased carbon prices, or because new investment chooses to go to other locations. Currently, imported goods account for about 20% of the EU’s global GHG footprint, and GHG emissions embedded in imports have been growing constantly.
EU’s plans and hopes for a carbon border adjustment mechanism
In early 2021, the European Parliament adopted a resolution (P9_TA(2021)0071), with 444 votes in favor, 70 against, and 181 abstentions, signaling what it would like to see in a World Trade Organization (WTO)-compatible EU carbon border adjustment mechanism. It is based on the own-initiative report of the European Parliament’s Committee on the Environment, Public Health and Food Safety titled, ‘Towards a WTO-Compatible EU Carbon Border Adjustment Mechanism,’ adopted on 5 February 2021. The resolution reiterates the need to raise climate ambition while preventing carbon leakage and ensuring a level playing field between importers and domestic European producers.
In a statement following the vote, Yannick Jadot, Member of the European Parliament (MEP), representing the Greens/European Free Alliance (EFA), highlighted the CBAM as an opportunity to “reconcile climate, industry, employment, resilience, sovereignty and relocation issues.” “We must stop being naive and impose the same carbon price on products, whether they are produced in or outside the EU, to ensure the most polluting sectors also take part in fighting climate change and innovate towards zero carbon,” he said.
In the resolution, MEPs highlight that “trade can be an important tool to promote sustainable development and help fight climate change,” and the EU can act as a “global carbon setter,” considering its consumer market is the second largest in the world.
MEPs further stress that the CBAM must be compatible with WTO rules and EU free trade agreements (FTAs), and “be exclusively designed to advance climate objectives and not be misused as a tool to enhance protectionism, unjustifiable discrimination or restrictions.” Compliance with WTO rules includes similar treatment for importers and domestic producers.
MEPs propose that carbon border adjustment be applied in a mechanism similar to the existing EU emissions trading system (ETS) by establishing a pool of allowances for imports separate from the EU ETS, to be purchased based on a carbon price that mirrors the price of EU allowances. Sectoral coverage, they state, should be the same as under the EU ETS, starting with electricity generation and energy-intensive industries such as cement, steel, aluminum, oil refinery, paper, glass, chemicals, and fertilizer production. As per resolution text, the CBAM should target foreign producers from countries with less ambitus climate policies than in the EU. At the same time, MEPs recognize that special treatment could be granted to least developed countries (LDCs) and small island developing States (SIDS) considering the circumstances of these countries and the potentially negative impact of the CBAM on their development.
The resolution is the European Parliament’s “own initiative,” which reflects its broad position, and represents a way to influence the forthcoming proposal by the European Commission by initiating discussions about the potential design elements of the CBAM. The Commission is expected to release the legislative proposal on the CBAM in the second half of 2021. This will kickstart the process of negotiated approval by the European Council, European Parliament, and the Commission. External consultations will take place as well. As a result, the design of the CBAM, which will be written into EU law, could differ considerably from the initial position of MEPs outlined in the resolution of the European Parliament.
Reactions of EU trade partners
While the specific design of the CBAM is being developed, the EU’s trade partners have already expressed concerns and estimated potential losses due to the imposition of a carbon price on imports at the border with the EU.
John Kerry, US President Joe Biden’s envoy for climate, expressed concerns about the CBAM proposal, including its “serious implications for economies, and for relationships, and trade,” arguing it should be considered only as an option of “last resort” if all other options for reaching solutions for global decarbonization fail.
The CBAM was also the subject of discussion at the meeting of the WTO Committee on Trade and Environment (CTE), held at the end of March. A number of WTO members stressed that the CBAM needs to be designed in a transparent way, and different levels of development should be considered to address trade distortions.
Following the 30th BASIC Ministerial Meeting on Climate Change held on 8 April 2021, ministers from Brazil, South Africa, India, and China “expressed grave concern regarding the proposal for introducing trade barriers, such as unilateral carbon border adjustment, that are discriminatory and against the principles of Equity and [Common but Differentiated Responsibilities and Respective Capabilities]” in a joint statement.
The Russian Federation, another trade partner of the EU, also expressed concerns about “attempts to use the climate agenda to create new barriers.” It estimates losses to Russian steel producers to be between USD 780 million and 800 million per year if a carbon price of EUR 60 per tonne of CO2 is applied to Russian steel exports at the border with the EU.
While the EU’s main trade partners are criticizing plans to impose a carbon border tax, some MEPs and the European Commission officials believe that there is still a chance the CBAM might not be needed – if other countries scale up their climate ambitions to the level of the EU. Under such a scenario, the European Parliament’s resolution argues, the CBAM would become redundant. In particular, Vice-President of the European Commission Frans Timmermans pointed out that “the reason for the carbon border adjustment mechanism disappears” if other countries implement carbon pricing policies.
With various other countries, including Canada and the UK, actively considering including carbon border adjustments as a matter of climate policy, it is likely these measures may become a more prominent feature of climate policies and measures worldwide, affecting global trade flows. Debate around the EU’s proposed measure points to several key issues:
- the need to make sure that a border carbon levy is designed in line with WTO regulations and provisions of the Paris Agreement on climate change;
- the need to ensure that the environmental function of the CBAM is unequivocal; and
- the need to ensure that the mechanism is developed involving the EU’s trade partners in an open dialogue to prevent, to the extent possible, disputes and trade conflicts.
By Yuliia Oharenko, Associate, IISD Energy Program