CBAM: An EU Foreign Climate Policy
Introduction
On 17 July 2021, the European Commission put forward its “Fit for 55” proposal, a series of 13 policy measures to reduce EU greenhouse gas emissions by 55% by 2030 compared to 1990 levels.[1] Included in this package is a proposed Carbon Border Adjustment Mechanism (CBAM).[2] CBAM is a climate measure currently under discussion, which would impose levies on certain carbon-intensive imports into the EU, in order to better incorporate the “true” price of the carbon embedded in products. CBAM is also designed to ensure that EU manufacturers would not be disadvantaged by higher European emissions’ standards legislation. Its purpose is to avoid “carbon leakage”, which is the relocation of industrial production to jurisdictions with weaker climate rules, and simultaneously ensure that EU emissions reductions measures meaningfully contribute to overall global emissions.
While environmental protection measures will undoubtably benefit Ireland, a CBAM could potentially raise complex issues due to Ireland’s significant trading relationships with non-EU partners like the US and UK, taking account of the unique situation of the Northern Ireland Protocol (NIP). The compatibility of a CBAM with the NIP could pose potential political, economic, and regulatory challenges for both IE-NI and NI-GB trade flows.
This blog will explore the purpose of the proposed CBAM regulation and its possible implications for the EU, its partners and for the island of Ireland.
CBAM at Home and Abroad
The Carbon Border Adjustment Mechanism is premised on the purchase of certificates by importers, calculated on the basis of EU Emissions Trading System (ETS) emissions weekly averages, and expressed in euros per tonne of CO2 emitted. The products affected by CBAM would be initially limited to iron, steel, cement, fertiliser, aluminium, and electricity generation when the CBAM provisionally comes into effect in 2026. The timeframe for the introduction of CBAM foresees a transition period (2023-2025), following which CBAM would be gradually expanded to other goods and services while the current system of “free allowances” for European manufacturers to emit carbon under the present ETS is phased out between 2026 and 2035.
In terms of process, the adoption of a CBAM needs a qualified majority of Member States as well as the European Parliament’s consent. The European Parliament would like to see a broader CBAM to include organic chemicals, hydrogen and polymer plastics and a shorter transition period (two years instead of three). This could delay an ultimate agreement if interinstitutional negotiations are reopened.[3]
USA
An EU CBAM for EU-US trade could have relatively minor impacts initially, as only a small percentage of total EU imports from the US would be affected. A proposed US CBAM bill as part of the US budget introduced in July 2021[4] would impose tariffs on aluminium, cement, iron, steel, natural gas, petroleum, and coal imports from 2024 onwards. The US proposal diverges significantly from the EU CBAM as it is based not on carbon pricing, but on domestic compliance costs of emissions reductions for individual sectors calculated at the local, state and federal levels, and it also offers potential exemptions for less-developed countries and similarly ambitious schemes, which the EU CBAM does not.[5] There is scope for EU-US cooperation here, as the Biden Administration has placed climate change and potential carbon border adjustments at the heart of US trade policy,[6] and US Climate Envoy John Kerry has indicated his support for a US CBAM.[7] Whether this proposal would garner sufficient political support remains unclear, but there could be a potential bipartisan agreement on the potential of a carbon border instrument to tackle perceived Chinese trade distortions. CBAMs which clash with one another in terms of their approaches or if perceived as protectionist could potentially violate World Trade Organisation (WTO) regulations, undermine international trade, obstruct international climate cooperation and encourage further protectionist measures.[8]
China
In a joint statement, Brazil, China, India, and South Africa expressed their concerns over the EU’s CBAM and its potential clash with WTO rules and the possible imposition of expensive retrofitting and upgrade costs for domestic industries which export affected goods to the EU.[9]
China is the world’s largest exporter and the EU’s biggest trading partner, as well as its largest supplier of steel and aluminium products. The significant quantity of embedded carbon in Chinese imports exposes Chinese manufacturers and producers to considerable potential disruption from an EU CBAM. While the initial focus of a CBAM would be limited to specific sectors, the high amount of Chinese steel and aluminium exports to the EU could impose significant costs on Chinese producers of up to 6.8% of export value.[10] This could result in possible measures by China to support affected industries, which may be perceived as subsidies under WTO rules and discouraged, or else the reorientation of exports towards less environmentally rigorous destinations subverting the global ambitions of the EU’s CBAM. A robust EU CBAM could provide a baseline for China’s own internal ETS scheme, especially if the EU CBAM is adopted as a global standard.[11] It could also raise the effective price of carbon to be in line with the EU‘s, but could also face significant internal political obstacles in achieving higher environmental standards. In the long-term however, the impact of CBAM may be relatively greater on other countries like Russia, than on China, thus strengthening the competitiveness of Chinese exports in the medium-to-long term.[12]
Russia
A CBAM which targets natural gas imports would have considerable implications for Russia, a major EU energy supplier, which is heavily reliant on hydrocarbon and metallurgic exports.[13] The current EU CBAM proposal could add €1.9bn onto import costs for carbon-intensive Russian products like steel or gas by 2035,[14] with Russia likely to be the country most impacted by a CBAM, though opinions are divided on this.[15] An EU CBAM would likely squeeze Russian agrochemical fertilisers out of EU markets as they would become unprofitable, although Russian steel production could be relatively insulated due to their comparatively low carbon intensity production.[16] Russia is currently formulating its own carbon-reduction frameworks in line with Paris Climate Accord, but it is not yet finalised and its future alignment with an EU CBAM may depend on the geopolitical tensions between Russia and the West and Russian economic priorities.
UK
The deep economic, political, and cultural interlinkages between the UK and Ireland pose significant challenges for the effective implementation of CBAM. The inclusion of the UK under an EU CBAM/ETS scheme could positively impact exports of steel, aluminium, and fertilisers, but may be politically untenable if the UK is committed to regulatory divergence from the EU post-Brexit.
For Ireland, one of the key questions is whether a CBAM regulation would fall under the aegis of the NIP and whether potential CBAM levies would be imposed on imports which enter the Single Market via Northern Ireland. If so, this raises the question as to whether they would they be collected by the EU or by the British Government on the EU’s behalf. At present, only electricity generation in Northern Ireland falls under the EU’s ETS, as part of the all-island Single Energy Market (SEM), while all other goods and products are covered by the UK’s own ETS.[17]
The potential extension of EU ETS and CBAM measures to imports entering Northern Ireland would preserve the open border between Ireland and Northern Ireland and avoid CBAM regulations, but it could pose legal and political challenges for the NIP, particularly if it were to introduce additional regulatory barriers between Northern Ireland and Great Britain.
As indicated above, if a CBAM were to be implemented within Northern Ireland as part of the UK, the European Union would need the assent and permission of the UK Government to implement it and to collect levies raised or else rely on UK authorities to administer, monitor, and implement CBAM provisions on the EU’s behalf and ensure that CBAM-subject goods produced in Northern Ireland are not subsequently sold into the Single Market. These concerns could be alleviated by UK ETS alignment with the EU, but this will likely pose significant political challenges within the current UK Government and the Northern Ireland Assembly. The UK Government is currently discussing its own potential CBAM, but how closely this would align with the EU’s CBAM and whether exporters would need to purchase permits to offset differences in carbon pricing between the two remains to be seen.[18]
The Future of CBAM
CBAM has been identified as a key priority for the French Presidency of the Council of the EU, and the subsequent Czech and Swedish presidencies. They hope that CBAM will address carbon leakage and increase the political and “social acceptability” of the climate transition measures CBAM provides for citizens and firms.[19] How CBAM will work in practice remains to be determined, and other issues such as whether there will be a central EU CBAM authority, or 27 national authorities, remains to be decided between the European Parliament and Member States.
CBAM also forms a key part of the EU’s broader strategic autonomy agenda as an instrument to project and promote European regulatory power beyond the EU’s borders and to underpin the EU as a world leader tackling climate change. These ambitions could face significant opposition from several countries which may perceive CBAM as a protectionist measure aimed against them and their industries, like China, Russia, or potentially, a future US administration. It could also lead to significant restructuring of global supply-chains as a response to CBAM measures and foster economic and trade divergences between those adhering to CBAM provisions and those are unable or unwilling to do so. However, as long as the carbon regulatory regimes put in place by other jurisdictions are seen as approximately equivalent to EU standards, a rough alignment of measures may be acceptable.
Looking at CBAM through a foreign policy lens, it seems that the Irish Government, and in particular, the Department of Foreign Affairs, may have some diplomatic footwork to do with its trade partners both within and outside the EU in advance of the introduction of CBAM to forge a permissive consensus and ensure a smooth transition. For its part, the EU is keen to work together with like-minded partners to find a solution to the climate crisis and to address global greenhouse emissions. Although price rises and political challenges are likely, the green transition is of major economic and geopolitical importance for the Union. Hence, the EU is likely to be proactive on promoting this agenda, even if a robust CBAM could have profound impacts on the EU’s trading partners and for the island of Ireland.
[4] GAI21718 (senate.gov)
[6] Online PDF 2021 Trade Policy Agenda and 2020 Annual Report.pdf (ustr.gov)
[7] https://www.euractiv.com/section/emissions-trading-scheme/interview/john-kerry-carbon-border-tariffs-are-a-legitimate-idea-to-have-on-the-table/
[8] Divergent climate change policies among countries could spark a trade war. The WTO should step in. | PIIE
[9] Joint Statement issued at the conclusion of the 30th BASIC Ministerial Meeting on Climate Change hosted by India on 8th April 2021 | South African Government (www.gov.za)
[10] 20210610 PolicyPaperCBAM China_Final.pdf (adelphi.de)
[11] Why China should fear the EU's carbon border tax - Nikkei Asia
[12] EU's planned carbon border tax to impact Russia the most -study | Reuters
[13] EU Border Carbon Tax: a Challenge for the Russian Economy — ECONS.ONLINE
[14] EU carbon border tax to cost Russia billions (euobserver.com)
[15] E3G-Sandbag-CBAM-Paper-Eng.pdf (netdna-ssl.com) p.45
[16] Carbon challenge to Russian exporters (bcg.com)