By Antoine Vagneur-Jones
Associate, Energy Transitions Research
The European Union’s answer to the free-rider problem is taking shape. There is a fear that targeting net zero could hurt industrial producers’ cost-competitiveness against imported goods. In response, the bloc proposes to extend CO2 pricing to imports by 2023 through a carbon border adjustment. However, it will be far from straightforward to balance the demands of local industry, trade partners and the World Trade Organization. Our latest white paper breaks down what the policy might look like, and identifies the hurdles that must be jumped for border adjustments to help European industry decarbonize.
1. Knowns and unknowns. Any evaluation of the implications of a carbon border adjustment mechanism (CBAM) would do well to consider what we do and do not know. Four points can be made with a degree of certainty.
2. The Commission is aiming to present essential details on a CBAM by July 2021 and intends it to be in place by 2023 – this is ambitious, and could involve a pared-down launch as a pilot.
3. The scheme will concern sectors covered by the EU Emissions Trading System, or ETS. That rules out hydrogen, battery materials and hydrocarbons (besides refined oil products).
4. Various design options exist, but an expansion of the EU ETS to imports through a separate pool of allowances is preferred by the EU (as opposed to measures such as an import tariff).
5. The scheme seems to be accelerating discussions between trade partners, and their plans to bolster climate policies – action on carbon pricing mechanisms has been linked to the prospect of an EU CBAM.
And yet the unknowns are at least twice that number. Herein lie details that will be clarified upon release of the awaited policy proposal, as well as several challenges facing the scheme.
- Whether the European Parliament and member states will approve a meaningful CBAM.
- How trade partners will react to a CBAM.
- How watertight the scheme will prove with regard to international trade law.
- Which ETS sectors and whether, and to what extent, indirect emissions will be covered.
- The presence of crediting or exemptions for countries where carbon is priced, or that are among the ranks of the least developed.
- How, in calculating adjustments, the scheme will account for proven emissions beyond default intensity benchmarks.
- How to phase out the free allocation of EU carbon allowances in order to avoid double protection. What measures might be taken on indirect compensation, or to protect exports.
- Whether EU industry faces a real risk of carbon leakage – the basis for a CBAM. Plans for a CBAM will likely progress regardless of whether or not this risk is demonstrated, however.
This paper discusses how the EU’s approach has been passive, allowing trade partners to react forcefully to a policy whose implications are unclear. That is understandable for as long as the policy’s details are being hammered out – getting domestic industry onside presents a challenge of similar proportions. Yet it cannot last. The EU must put an emphasis on reaching out to trade partners once its proposal is out. In doing so, it should clarify who will be impacted, exempt and – crucially – why the policy is so vital to achieving the group’s climate goals.