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Climate crisis: EU’s carbon border levy ‘going to happen’, despite threat of challenges

Katie KouchakjiMonday 11 October 2021

Even before the European Commission published its long-trailed carbon border adjustment mechanism (CBAM) proposal in July, overseas opposition to the plan was brewing and exporters were nervous. The proposal – which still needs to progress through the European policymaking machine before implementation – was met with the expected outcries from Russia and China, and with nerves in Australia.

Under the proposal, a carbon levy would be applied to imports into the EU of products from pre-determined sectors. Importers will buy CBAM certificates, priced in accordance with EU Emissions Trading System (ETS) allowances. If they can prove that a carbon price was paid during the production of the imported goods, a corresponding amount will be deducted off the cost. Initially, from 2023, importers will have to report on the emissions embedded in their goods and from 2026 the levy will apply.

‘The CBAM will equalise the price of carbon between domestic products and imports and ensure that the EU’s climate objectives are not undermined by production relocating to countries with less ambitious policies,’ states the Commission’s website. ‘It also aims to encourage industry outside the EU and our international partners to take steps in the same direction.’

‘How much this is going to bite when it’s fully implemented in 2026 comes down to how quickly the EU phases out free allocations to covered sectors,’ says Andrew Hedges, a London-based partner at Norton Rose Fulbright.

To begin with, the covered sectors are iron and steel, cement, fertiliser, aluminium and electricity generation. Aside from the latter, these sectors currently receive a portion of their EU ETS allowances for free to help them compete internationally with rivals not subject to carbon pricing. ‘It’s going to be a long hard road for European policymakers – they’ve been trying to phase out free allocations as long as I’ve been working on carbon, which is about 15 years,’ Hedges says.

However, Carbon Market Watch, an NGO, has criticised the proposal for enabling the continuation of free EU ETS allowances beyond 2030. ‘A CBAM that opens the door to free allowances beyond 2030 is worse than having no CBAM at all,’ says Agnese Ruggiero, a policy officer at the organisation. ‘Such an exemption would let large polluters completely off the hook and send a very negative signal internationally.’

‘This is going to happen, this is not something that is going to be defeated by industry lobbying, or for example Russia or China,’ says Yves Melin, Publications Officer of the IBA International Trade and Customs Law Committee and a partner at Reed Smith in Brussels.

There is now general agreement in the EU that there needs to be a carbon price on goods consumed in the bloc, even imported ones. This idea was ‘anathema five years ago’, Melin says. ‘CBAM is the perfect solution to achieve carbon neutrality, provided it’s applied in a non-discriminatory way.’

‘It’s a typical European Commission proposal that doesn’t make anyone happy – but it’s a good starting point,’ says Domien Vangenechten, a policy advisor at think-tank E3G in Brussels, who notes that the EU wants carbon leakage and climate risk to be addressed. He adds that the proposal has taken account of international pushback over the past 18 months, evidenced by the inclusion of a negotiating period, a gradual phase-in and its application only to limited sectors, for example.

This is going to happen, this is not something that is going to be defeated by industry lobbying, or for example Russia or China

Yves Melin
Publications Officer, IBA International Trade and Customs Law Committee

The sectors covered, however, imply that ultimately ‘there will be a CBAM on everything’, says Melin, due to the raw materials embedded in products and the carbon emitted to manufacture them. ‘If only raw materials are covered, manufacturing of intermediary or finished goods is going to move out of the EU. So the ultimate scope of this is really broad,’ explains Melin.

In early September, Gerassimos Thomas, Director General in the Taxation and Customs Union department at the European Commission, told a Parliamentary hearing that the levy’s scope would be expanded after 2030, in terms of sectors and products covered.

Melin acknowledges criticism that the CBAM will be too complex to administer, but counters that the EU is used to devising and enforcing complex rules, and that EU importers already report extensive supply chain and manufacturing data when claiming preferential origin when they want to be exempt from duties under the EU’s many trade agreements.

Melin says that third countries may seek to challenge the proposal at the World Trade Organization (WTO), but that Article XX of the General Agreement on Tariffs and Trade – which minimises barriers to trade – allows exceptions on the grounds of environmental protection, and the WTO dispute settlement mechanism is a long process anyway.

‘There is a long history of WTO trade disputes attacking trade policy with an environmental bent – and succeeding,’ says Hedges. ‘That said, the Commission did do some analysis around that, they’re live to it, and you can see in some of the design elements that they’re mindful of it.’

Already, others may be following in Europe’s footsteps. US lawmakers have proposed the FAIR Transition and Competition Act to similarly apply a border tax to goods produced in countries which are not taking steps to cut their emissions. The legislation is in committee at the time of writing.

The governments of Canada and Japan are considering introducing such a mechanism and the UK government is facing calls to follow suit.

‘There was a concern a year ago that the EU would do this unilaterally, [and the] threat of a broad coalition [would] oppose it,’ says Vangenechten. ‘I still feel that is possible […] but you do see some momentum,’ such as Canada’s consultation on a CBAM-type policy and a G20 statement, issued in July, endorsing carbon pricing.

In New Zealand, a CBAM is unlikely given the size of the country and the complexity involved, says Mark Baker-Jones, a director at advisory Te Whakahaere. And the price discrepancy between the Pacific nation’s ETS and the EU’s – with EU ETS prices nearly double New Zealand’s as of early September – presents a liability for exporters. ‘We need to think about which of our products can survive at [a carbon price of] NZ$80,’ says Baker-Jones. ‘There is pressure to stop subsidising big emitters.’

For both New Zealand and Australia, agricultural goods account for a large share of their exports to the EU. As such, they won’t be subject to the CBAM in its current form. But there are also ‘huge opportunities’, says Scott Wyatt, an advisor at the Delegation of the European Union to Australia, such as in feedstocks to lower livestock emissions. ‘It’s very much on the EU’s agenda,’ he said on a webinar hosted by the Carbon Market Institute in August.

‘Across my client base, I don’t see a single client not engaged on the energy transition and what it means for them,’ says Hedges. ‘Everyone is alive to it and pushing to it, but there is still a very big hurdle of “Christ, this is going to be expensive”.’

Image: Creativa Images C / Shutterstock.com

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