On July 14, the European Commission launched a storm of bills proposing measures to reduce the bloc’s greenhouse gas emissions by 55% (from 1990 levels) by 2030. As a project politically and economically, “Fit for 55” is a huge undertaking. It introduces an unprecedented carbon border adjustment mechanism (CBAM) for the pricing of imported carbon. It also includes a major overhaul of the Emissions Trading System (ETS) to extend carbon pricing to shipping, aviation, transport and buildings; accelerate the development of the renewable energy sector; ban sales of new fossil-fueled cars after 2035; provide social support to EU citizens affected by the green transition; and accelerate the modernization of the building stock. Due to its diplomatic and economic ramifications, the CBAM will largely determine the long-term impact of the Fit for 55 package on global climate policies.
Lack of other options
In theory, given that there is no realistic prospect of a global carbon price, it is a good idea to introduce border adjustments that ensure that exporters to the European Union face the same carbon price than European companies subject to the ETS. In practice, the CBAM has elicited polarized reactions. European industries facing high ETS prices are cautiously favorable; Brazil, India, South Africa and China (BASIC) called it “discriminatory”; and civil society organizations have condemned the proposed continuation of the free allocation of ETS permits to European companies as unfair and contrary to international standards of climate policy. The United States does not oppose CBAM in principle, but suggested it would be extremely complex to implement.
Considering the diplomatic storm that the CBAM has already caused, is this still reasonable? Yes probably – if it is well done. Critics see the measure as trade protectionism in disguise, and they are right to be concerned. But, given the lack of alternative options, it is a viable way to significantly price carbon in larger parts of the global economy and catalyze innovation in critical sectors. It is true that the diet will be devilishly difficult to implement: the current proposals undertake to take into account both the carbon footprint of imported goods and the implicit carbon price they face (as a tax or regulatory standard). It is not clear how this will be done, as the Commission itself admitted in 2018. However, the use of punitive ‘default’ assumptions – when the EU lacks data on the footprint product carbon – can help increase transparency in carbon-intensive value chains.
Under current proposals, CBAM covers five emissions-intensive industries: aluminum, steel, cement, electricity and fertilizers. BASICs, particularly China, are all major exporters of aluminum and steel to the EU. Among the least developed countries and most vulnerable to climate change, almost all of those most exposed to CBAM are in Africa: Mozambique, Guinea, Sierra Leone, Ghana and Cameroon (aluminum); Zambia and Zimbabwe (steel); Morocco (electricity); and Algeria and Egypt (fertilizer). Indirect exposure via exports to China may exacerbate the overall exposure of these countries. With many people facing serious fiscal challenges from the pandemic and already high trade barriers, there is a real risk that CBAM could harm low-income populations unless the EU introduces policy measures. mitigation. Controversially, the documents published by the Commission do not grant exemptions to the least developed countries (LDCs) or make compensatory financial commitments to the economies that the CBAM would affect the most.
A diplomatic minefield
Technical challenges are only part of the story. Diplomatic tact and attention to detail will be essential to prevent CBAM from undermining the EU’s leadership role on climate. The Commission’s comments to this effect and a four-year grace period before the measures come into force suggest that it is aware of the balance to be struck.
To function, the CBAM must comply with the rules of the World Trade Organization (WTO). The legal principle of environmental tariffs is well established in WTO jurisprudence. However, in order to comply with the rules, the Commission may be forced to adapt its plan for granting exemptions or special conditions to LDCs (e.g. de minimis clauses, for example). Perhaps more critical are the issues raised by combining CBAM with free ETS permit allocations – which, in effect, give European companies the benefits of both free permit grants and an obligation for their businesses. competitors to price carbon at ETS levels. European industries vehemently oppose the abolition of free allocation of permits, but it may ultimately be necessary for the CBAM to comply with WTO rules.
Use of CBAM revenues presents another diplomatic challenge. Current possibilities include repayment of pandemic-related debt, social support for European communities affected by the broader low-carbon transition and greater climate-related funding for third countries affected by CBAM. Committing CBAM revenue to a mix of these destinations can help the EU overcome some of the LDC-related effects mentioned above – although any recycling to third countries should be carefully targeted to have any hope of neutralizing the potentially negative impact of CBAM on their national economies. As a strong supporter of CBAM and an influential voice of the EU, France will be under particularly intense pressure to address these issues both by eliminating fossil fuel financing beyond its borders and by putting pressure on them. French companies with fossil fuel interests in affected countries to reform or withdraw.
Another challenge for LDCs would come from the EU’s use of default assumptions in cases where there is insufficient data to assess the carbon intensity of imports. CBAM assumes imports are the worst 10 percent of European companies. This is likely to be unduly punitive for exporters with limited infrastructure and data capacity but cleaner production than their European counterparts.
The Commission did not choose the initial five sectors of the CBAM by chance. Yes, they play a major role in global emissions, but these are also areas in which EU Member States are already making significant strategic investments both within their borders and in countries with abundant clean energy resources, as shown by German investments in green hydrogen in Morocco. Green hydrogen (produced from renewable electricity) and its derivatives, including ammonia, are likely to be essential for the decarbonisation of heavy industry and agriculture. The inclusion of electricity is also part of the EU’s desire to invest in domestic renewable energies and electric transport. If managed carefully, this approach could secure EU benefits in multiple scenarios: even if the CBAM failed to promote substantial emission reductions beyond Europe, it would provide the EU. EU a cover to develop some of the key industries of the global green economy.
The big picture
In the short term, the European Parliament should focus on clarifying and resolving contentious points on CBAM. At COP26 in November, the EU is expected to coherently articulate its contribution to the grand climate deal conceived in Paris in 2015. Failure to do so could undermine the progress of international negotiations and provide opponents of the EU with more political ammunition.
To realize its global potential, the CBAM will need to encourage other major economies to take similar action – by the ultimate test of the “Brussels effect”. If the US and UK followed suit, exporters would find it increasingly difficult to find alternative markets and accelerate their decarbonization efforts. Decarbonization is becoming increasingly important for the economic interests of countries, regardless of trade and climate considerations. If the CBAM is a bold step, decarbonization is inevitable for the savings it affects. Whether the EU will be justified in saying ‘thank you later’ is a matter of technical detail and diplomatic skill, but the measure can pay off very much if handled properly.
The European Council on Foreign Relations does not take collective positions. ECFR publications represent the opinions of its individual authors only.