Highlight 16/2023 – EU Carbon Border Adjustment Mechanism
Iba’a Hamida, 22 May 2023
As part of the “Fit for 55 in 2030 package”, the European Union’s plan is to reduce greenhouse gas emissions (GHG) by at least 55% by 2030 compared to 1990 levels. To reach that goal, the European Union (EU) will rely on cap-and-trade in the form of the EU Emissions Trading System (EU ETS), which covers emissions from power and heat generation, industrial production, chemical manufacturing, and other sources.
By increasing the price of energy inputs, a carbon price could create a disadvantage for production in the EU relative to production in countries with no carbon pricing policies. Such a disadvantage can undermine the environmental effectiveness of carbon pricing policy by shifting production and emissions to these countries, a process called “leakage.” To prevent this leakage, policymakers have designed mechanisms to level the playing field between domestic producers, who pay a price for GHG emissions, and importers, who do not.
The EU Carbon Border Adjustment Mechanism (CBAM) can be seen as an evolution of existing EU climate policies, such as the Emissions Trading System (ETS) and the Energy Tax Directive. While the ETS imposes a cap on emissions from certain sectors, and companies must purchase allowances to cover their emissions. The Energy Tax Directive sets minimum tax rates for energy products. However, these policies do not apply to imports, which can lead to carbon leakage.
The CBAM is a climate policy tool that has been proposed to help the EU achieve its goals of reducing greenhouse gas emissions while ensuring fairness for European businesses. The CBAM would apply a carbon price to imports of certain goods from countries that do not have equivalent carbon pricing measures, which would effectively level the playing field for European businesses and protect them from carbon leakage. CBAM would address this issue by applying a carbon price to certain imports of goods that have a high carbon footprint, such as cement, fertilizer, and steel. The carbon price would be based on the carbon content of the products, and it would be equivalent to the cost of allowances under the ETS. This would ensure that imports are subject to the same carbon price as domestic producers, creating a level playing field and reducing the risk of carbon leakage. CBAM would also encourage other countries to adopt similar carbon pricing measures, as it would incentivize them to do so to avoid the CBAM.
One potential impact of the CBAM is that it could lead to higher prices for consumers, as businesses pass on the carbon costs to them. However, this could be mitigated by providing support for consumers, such as through targeted rebates or other measures. Another potential impact is that the CBAM could lead to a shift in production to countries with equivalent carbon pricing measures, rather than those with weaker policies. This could help to promote global climate action and reduce emissions globally.
There are also several challenges associated with the implementation of the CBAM. One challenge is that it could be difficult to accurately measure the carbon content of imports, particularly for complex products. Another challenge is that the CBAM could lead to trade disputes with countries that feel unfairly targeted by the mechanism, as it places a carbon charge on companies from countries that did not primarily cause climate change. Mozambique’s GDP, for example, would drop by about 1.5% due to the tariffs on aluminium exports alone. According to the EU, CBAM is designed to be in full compliance with WTO rules and international climate law. However, questions have been raised over the consistency of CBAM with international trade law and environmental principles. Given its innovative nature and global impact, it is likely to be the subject of a legal challenge to the WTO.
In conclusion, the EU Carbon Border Adjustment Mechanism is a policy tool that could help the EU achieve its climate goals by reducing carbon leakage and promoting global climate action. While there are potential challenges associated with its implementation, the CBAM has the potential to create a level playing field for businesses and reduce emissions globally. The EU will need to carefully consider the design and implementation of the CBAM to ensure its effectiveness and fairness while mitigating any negative impacts on consumers.
Iba’a Hamida, Highlight 16/2023 – EU Carbon Border Adjustment Mechanism, 22 May 2023, available at www.meig.ch
The views expressed in the MEIG Highlights are personal to the authors and neither reflect the positions of the MEIG Programme nor those of the University of Geneva.