The EU's Carbon Border Adjustment Mechanism Continues to Progress
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Speaking recently, Frans Timmermans, the EU’s Executive Vice President for the European Green Deal, set out the rationale (£) for the measure:
“[i]f there is a serious risk of carbon leakage, if we take the measures to comply with [the 2016 Paris Agreement on climate change] and others don’t, and it leads to a disadvantage to our industries, [the EU] will have no hesitation whatsoever to introduce a carbon border adjustment mechanism.”
Carbon leakage, the risk highlighted by Mr. Timmermans, occurs when there is an increase in greenhouse gas emissions in one part of the world as a result of a carbon emissions reduction measure adopted in another part of the world. While Mr. Timmermans’ statement focused on the threat to industries in the EU (by, for example, those industries having to bear the costs associated with the EU's emissions reduction measures when comparable industrial production in other parts of the world is able to be carried on with less costs in relation to the level of carbon emissions), carbon leakage also has the potential to undercut the efficacy of the EU’s climate change measures by creating an incentive for higher emitting industrial production to move outside of the EU (so-called ‘carbon offshoring’).
The CBAM - which would seek to ensure that the price of products imported into the EU reflects the carbon intensity associated with their manufacture - is intended to address both of these concerns. First, it would protect industrial activity in the EU from imports from countries with more relaxed emissions regimes by raising the costs of those imports (thereby reducing their ability to compete on price with EU-based producers). Second, it would lessen the attractiveness of moving industrial activity to certain countries outside of the EU by reducing the emissions-related cost savings justification for doing so (namely, by raising the cost of those products when they are placed on the EU market).
Indications are that the CBAM will initially be relatively narrow in scope, potentially only targeting a small number of energy-intensive industrial sectors, like electricity generation, cement and steel (although chemicals and fertiliser production have also been mentioned). In addition to being energy-intensive, these sectors are also characterised by substantial international trade flows and are therefore vulnerable to carbon leakage.
Further, these sectors' emissions tend to be concentrated in the production of products ‘upstream’ in the value chain (i.e. at the extraction or initial manufacturing stages) with the result being that the value of embodied carbon as a proportion these products' value tends to be higher than in comparison to semi-finished or finished products (where a lesser proportion of their value results from a carbon-intensive process). Finally, the determination of the embedded emissions in the basic or raw materials associated with these sectors is, while not without significant potential challenges, also easier than for more complex products further down the value chain. This would serve to lower the administrative cost and technical complexity of actually implementing the CBAM while at the same time however, the EU could still be confident that the measure was being applied to products associated with a significant amount of embedded carbon.
Several of the EU’s major trading partners, including the US, have expressed concern about the EU’s plans. For example, John Kerry, US President Joe Biden’s new Special Presidential Envoy for Climate, has stated that a measure like the CBAM should be "a last resort, when you’ve exhausted the possibilities of getting emission reductions and joining in some kind of compact by which everybody is bearing the burden”. It seems clear, however, that the EU regards the CBAM as a means of minimising carbon leakage in a situation in which it is meeting its obligations under an already existing global compact, the Paris Agreement, and going even further.
In terms of the measure's current status, the European Parliament recently adopted a resolution backing the CBAM's introduction. It is anticipated that the European Commission will present a formal legislative proposal on the CBAM in June 2021 and that will include information on the timing for its implementation and its operational mechanics.
There is currently no clarity on whether the UK will follow the EU by introducing its own border adjustment mechanism. The UK government is, however, known to be actively considering how best to price carbon emissions – this could include something similar to the CBAM in addition to measures such as a carbon tax levied on domestic producers.
However, aside from the UK having already committed to relatively ambitious climate change measures, the UK Government will also be conscious of wanting to ensure that UK exports to the EU are not negatively impacted by the CBAM. Whether or not this occurs will depend on the extent to which the UK and EU climate change measures move in tandem in the future – if the UK's exports already have their carbon emissions adequately priced in (for example, as a result of a UK carbon pricing mechanism), it would be difficult for the EU to justify imposing a further pricing measure on those products via the CBAM.
More generally, the accommodation of imports from countries with similar (or higher) climate ambitions is another of the elements which is expected in the Commission's proposal.
Co-authored by Aonghus Heatley a Senior Associate in the Regulatory group.