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EU’s carbon border tax moving (too?) fast

The EU’s carbon border adjustment mechanism now picking up speed in the European Parliament will have ripple effects worldwide – some of which could be unintended and counter-intuitive, businesses warn.

By Dave Keating

If you can’t beat them, join them. That seems to be the attitude of some of the EU’s trade partners when it comes to the carbon border adjustment mechanism (CBAM), a charge on goods imported from countries with laxer climate regulation proposed by the European Commission last year. In March 2021, shortly before the EU’s CBAM was unveiled, US climate envoy John Kerry warned against the EU adopting such a measure, saying it has “serious implications for economies, and for relationships, and trade” and should be a last resort. Fast-forward a year, and the US is now considering its own CBAM, as is the UK.

A US carbon border tax is looking more likely after a Republican Senator took the unexpected – and these days unheard of – step in May 2022 of endorsing a plan from the Democrats. According to Politico, North Dakota Senator Kevin Cramer said he would support the carbon border tax plan put forward by Democrats in October 2021 if it could be coordinated with other wealthy countries.

The European Parliament’s environment committee, chaired by French MEP Pascal Canfin (centre), adopted its position on the EU’s proposed Carbon Border Adjustment Mechanism in May. (Photo courtesy of the European Parliament)

“I see this as a carbon club type of opportunity as much as anything,” he said at an event in Washington D.C. in May, using the language of Germany, which currently holds the presidency of the G7, and aims to have all G7 countries sign up. According to a recent report by the Climate Leadership Council, a bipartisan advocacy group pushing for market-driven climate solutions, if all G7 countries adopted a carbon border tax it could cut global greenhouse gas emissions by 5.5%.

Meanwhile, the UK is preparing to develop a CBAM identical to the EU’s, with the exact same name. It is a remarkable turnaround from last year when even the mention of such an idea was taboo at the COP26 summit in Glasgow. It is controversial for many developing countries, particularly China and India, which would be hit hard by any such levy. Both Beijing and Delhi are lobbying intensely against the EU – or any G7 country – adopting this approach. Turkey and Russia would also be heavily impacted, according to Energy Monitor analysis (although the latter is not a major concern for the EU given the circumstances).

Taking the EU CBAM global

Both developed and developing countries have a single message for EU legislators right now: slow down. They do not want the EU moving ahead with its CBAM unilaterally without international coordination. “Every time a European leader comes in, I do sort of plead with them, ‘Help us catch up. Let’s reconcile something together before you move forward too quickly,’” Senator Cramer said. The UK, Canada and Japan have issued similar messages.

The EU has been burned before by these partners, however. In 2012, the US demanded that the EU remove international aviation from the EU’s Emissions Trading System (ETS), promising that it would quickly find a global solution to reduce aviation emissions at the International Civil Aviation Organization (ICAO). A decade later, no such solution has come, and international aviation remains exempt from the EU ETS.

The EU was badly burned because it had started developing the bulk of its ETS in 2008, when both Republican and Democratic presidential nominees were promising a US ETS. That plan was abandoned by US President Barack Obama after it was defeated by Congressional Republicans, and the EU was left holding the ball with no major international system to link to. Europeans are well aware that passing any legislation in the US now is almost impossible.

“If we wait for the Americans, we may be waiting forever,” said one European Parliament source involved in the discussions. On 17 May, the Parliament’s environment committee went ahead with a vote supporting the CBAM. A plenary vote on the issue in the full Parliament may take place next week. Ahead of that vote, the Parliament's second and third-largest groups, the Liberals and the Socialists, have reached a deal to include a green export rebate, which would give free allowances for exports if a company has invested in green technology. So far this hasn't been supported by the Parliament's largest group, the conservative EPP.

The Parliament wants to move forward quickly with this file, but adopting an EU CBAM without international coordination could push potential climate allies into the status of enemies in a trade war – jeopardising future climate cooperation. Right from the start, the EU CBAM will need to apply to every country in order to be compatible with World Trade Organization (WTO) rules. No country can be automatically exempt. Imports will have their carbon footprint assessed by experts for the European Commission, and if it is equal or below that of an equivalent product made in the EU, no levy will be applied.

But how do you assess a carbon footprint, especially for a country like the US that has no national price on carbon (because it never adopted an ETS)? One solution floated by the Commission is to count both explicit carbon prices like an ETS and implicit prices like regulations and taxes paid at home.

However, even this would not help goods from developing countries that are unlikely to have climate regulation similar to the EU or US in the near future.

Unintended consequences

There is likely no version of the EU CBAM that India and China will be OK with; however, getting an agreement among the G7 is not an unattainable goal. But it is not just foreign governments that are urging the EU to slow down. European businesses say the legislation is moving too fast for something so complex.

Markus Beyrer, director-general of the Brussels-based industry association BusinessEurope, says the Parliament’s environment committee adopted its position too quickly and risks undermining the competitiveness of European businesses rather than safeguarding it, which is the main purpose of the CBAM. He is particularly worried about the committee’s endorsement of the Commission’s plan to phase out free allowances in the ETS. The Commission’s reasoning is that the CBAM will make up for any potential competitiveness problem that the free allowances were meant to abate.

“By rushing from free allocation… to CBAM, placing a disproportionate burden on industry, and making the benchmarks unrealistically stringent, producers and employees all along the value chain would suffer,” he says. “There would likely be a gap in carbon leakage protection, as we would have to rely solely on the CBAM, without a proper testing phase in place.”

He is particularly concerned that the CBAM only covers imports and not exports. If export-dependent EU manufacturers lose their free allowances, they will face higher costs without any direct benefit from the CBAM. This could mean their goods are replaced in the global market by products with a higher carbon intensity.

Aylin Shawkat, a project manager for industry at the Berlin-based climate think tank Agora Energiewende, says this is not an illegitimate concern. “As the CBAM is phased in and free allocations phased out, producers on the domestic [EU] market will increasingly face the carbon price of the ETS,” she said at a recent event in Brussels. “The problem is these are internationally-traded products… so they face intense competition from other producers and there is little ability to pass on these costs.

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“EU products are in general less carbon intensive than products from other markets," she added. “So if [they] are replaced internationally by others then we have an overall increase in carbon intensity internationally, and hence we have carbon leakage.”

The effect of such a distortion would be minimised, of course, if the entire G7 agreed to implement CBAMs, but this will take time. Maria Spyraki, a centre-right MEP from Greece who is working on the CBAM legislation in the European Parliament’s industry committee, said at the same event that her committee is urging a more cautious and slower approach than its environment counterpart.

“In the industry committee we are proposing the extension of the transition period by one year, from 2026 to 2027 – after which the CBAM will take effect,” she said. That may not be a huge amount of extra time, but she says it could make a crucial difference, especially when combined with a reserve fund of allowances designed to deal with unintended consequences. “We are trying to provide a safety mechanism, a temporary CBAM reserve, in order to provide stability and predictability, and a kind of support to companies until we have a fully implemented mechanism in terms of WTO.”

In the Council of EU national governments, the upper chamber of the EU’s legislature, recent discussions on the CBAM proposal resulted in a new phrase referencing international climate alliances. That may be a sign the Council is preparing to put the brakes on the CBAM to wait for the rest of the G7 to catch up – and give European businesses more time to adjust to the loss of free allowances. If that’s the case, it will prompt worries that the CBAM is being put on hold for a G7 solution that will never come, just as pricing aviation emissions was put on hold for an ICAO solution that never came. Lawmakers have to decide whether getting the ball rolling is worth the risk of some potentially damaging unintended consequences.

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