Trade experts positive on EU’s CBAM, despite risk of rich nation-poor nation rift

The world-first carbon-based tariff proposed last week snubbed major EU trade partners and developing countries, but it could still sail through on the winds of legal change.

On 14 July, the European Commission (EC) proposed the tariff as part of the "Fit for 55" package of laws meant to align with the Paris Agreement and recently adopted Climate Law.

The Carbon Border Adjustment Mechanism (CBAM) will impose tariffs on certain imports under as-yet undecided calculations on the carbon emissions the goods represent. It will target listed products from six carbon-intensive sectors: cement, iron, steel, aluminum, fertilizer, and electricity, but might include sectors like chemicals and polymers following data assessments due to be ready by 2026. If adopted, CBAM will require importers of specific goods to register with customs authorities and surrender certificates, with prices that are set weekly, purchased from climate authorities in EU member states.

The CBAM's passage into law depends on European Parliament and Council approval during a possible two-year legislative procedure set out for the Fit for 55 proposals.

"It is really a credible effort, and it's really a historical moment," European Roundtable on Climate Change and Sustainable Transition (ERCST) Executive Director Andrei Marcu said during a 20 July webinar hosted by the nonprofit.

The CBAM has also received support, though with reservations, from the EC's co-legislator, the European Parliament. After its Environment Committee came to the conclusion that the CBAM was a "fantastic opportunity" to address climate change, Parliament gave approval in a non-binding resolution. The CBAM counted on the early support of France, having emerged in 2007 when former President Jacques Chirac highlighted it during a French multi-party environmental debate.

An existing rule in the US state of California taxes electricity imports into the state, which has its own emissions trading system, but the CBAM would be the first example of a national carbon border tariff. "The CBAM is the first climate measure that has potential to profoundly change the rules of world trade," Bixuan (Richard) Wu, a Beijing-based senior partner at Hiways Law Firm, wrote in a recent blog.

In addition to EU due process, the CBAM will face international challenges. World Trade Organization (WTO) rules were not drafted to accommodate climate change policies, so countries slapped with new charges on exports may challenge the CBAM via a WTO dispute settlement case.

Stephen Woolcock, a lecturer in international political economy at the London School of Economics, told Net-Zero Business Daily there are several ways of challenging the CBAM. "If the EU were to introduce the measure, other countries would challenge this, and you then go through a dispute settlement mechanism. The WTO appellate body, if you like 'the international trade court,' would then rule on whether this is complying with the WTO rules," he said.

However, he said it seems likely countries will discuss it in other forums since the US under the Trump administration blocked appointees to the WTO's appellate body. "So, we don't have a functioning appellate body in the WTO at the moment," said Woolcock.

CBAM disputes could be solved through diplomacy, he suggested. "In any case, pushing it to the WTO appellate body would be asking lawyers to find a solution to something that should really be a political debate. It has to be really discussed through the council of the various forums in the WTO to find a solution," he said.

Trade partners pivot to carbon pricing

Under the proposal, countries with their own emissions trading systems could gain levels of exemption from the CBAM, piquing global interest in both carbon border tariffs and emissions trading.

Exemptions for CBAM certificate obligations are in place for non-EU countries in Europe that are in the EU ETS like Liechtenstein, Norway, and Iceland, and also Switzerland because its national emissions trading is linked to the EU ETS. The UK and China may qualify for exemptions if they link their national ETS to the EU ETS; China's power ETS started this week and will soon be the world's largest market for carbon allowances.

Vincente Hurtado Roa, who has a role in CBAM legislation as head of the EC's unit for excise duties, environmental and health taxes and financial taxation, said the heads of wealthy countries at July's G20 meeting were interested in EU-style border mechanisms as more countries set out to enact national carbon pricing mechanisms.

"So, that's why countries like Canada and Japan are already thinking about the introduction of a CBAM. The US, for example, it is also considering this possibility. I've been already in contact with the Australians last week," Roa told the ERCST webinar attendees.

In the US, Senator Chris Coons and Representative Scott Peters introduced a CBAM-style legislative bill in Congress on 19 July. Speaking on the US bill, Roa said that it is based on a carbon price, and so comparing it to the EU's various environmental directives collectively is like comparing "apples with pears."

But government officials in both China and Russia worry about trade barriers under the CBAM. Russia supplies the most fertilizer of any EU importer, according to EC data. It supplies 36% of the total EU imports of fertilizer; 14% of aluminum imports, second behind Norway; and 13% of iron and steel imports, again second on the table, this time behind China. Turkey supplies the most cement, at 37% of EU imports.

Russian officials warned that the CBAM would cost the country's industries, although key calculations were yet to be decided. "The most dangerous thing is that the published regulation does not provide a clear understanding of all the aspects of calculating and verifying the carbon footprint of products. The most important decisions are attributed to the level of by-laws," said Alexander Shokhin, president of the Russian Union of Industrialists and Entrepreneurs, in a 14 July Russian Ministry of Economic Development statement on the CBAM.

While its exports are sure to be impacted, Russia may be exaggerating hurdles when it comes to the carbon accounting for CBAM, given that these calculations are common. "These are very energy-intensive, carbon-intensive processes. A lot of the costs are going to be related to the energy used to produce these products. It is not going to be complicated for them to come up with what the carbon intensity of steel, iron ore, or cement is," said Sujith Kollamthodi, director of policy, strategy, and economics practice with consultancy Ricardo, which provided the EC with analytical support related to the CBAM.

WTO challenge possible

Russia's disapproval of CBAM may not be a barrier to its success. "Russia is not being particularly active in the WTO and has tended to flout the rules, and so I think if it were only in Russia that were holding out, I don't think that's going to block things. I think the developing world opposition, in a sense, has more traction in the WTO," said Woolcock.

CBAM could very well gain the support of other major economies despite forcing them to treat products with more embodied carbon differently, a change from WTO rules. "The US is nervous about this because it's breaking from this established norm of treating the products the same regardless of how polluting the production method is," said Woolcock.

But major nations may see this type of policy as helpful for achieving their own climate-related goals. "It depends on the positions of the key WTO players on this issue of trade and climate change. So, the EU is saying 'We have to adapt the rules, or the rules have to develop, in order to meet the climate change challenge,'" Woolcock said. "I suspect the current administration in the US would go along with that. China is also moving towards more positive positions on climate change, and China also wants to at least maintain the existing multilateral system. Some of the key players, I think, would support it."

Trade disputes on environmental protectionism go back decades, and the US has fallen afoul of these norms. In 1991, the US was found to be in violation of its obligations under the General Agreement on Tariffs and Trade (GATT) after it embargoed imports of tuna from countries, including Mexico, that used nets that were not safe for dolphins, so the US created domestic dolphin-safe product labels.

Prior to the WTO, debates arose when EU and other developed economies raised standards for air and water pollution in the 1970s, said Woolcock. These were mirrored when trade barriers arose targeting labor practices, for example, in sweatshops.

The EC is wary of a trade war with major economies that see the CBAM as a negative. "They still see this as a trade measure, or a barrier to trade. I think it's going to be very important, of course, that we engage with that, some will say to avoid retaliation, possibly. I think that as soon as they know the details of the proposal, they will understand that there is nothing like that. I think that what is more important is to find allies around the world to also use the CBAM as a climate diplomacy tool, and to ensure the rest of the world will team up with the EU to reduce emissions," said Roa.

Markus Gehring, a director of studies at Hughes College and a legal expert at Cambridge University's Centre for European Legal Studies, said in a post on Twitter: "This is a very carefully crafted proposal taking WTO obligations seriously. It will be difficult to convince EU trading partners, but is a logical next step towards the full transition to a zero-carbon economy."

Woolcock agreed. "The EU is being very careful. But that doesn't mean to say that other countries are not going to have different interpretations of the WTO provisions. So, this gets into the very legal debate about how you interpret the WTO provisions and how much scope there is. And then this, as I say, is the legal discussion that's been going on for decades," he said.

Aaron Cosbey, a development economist with a think tank, the International Institute for Sustainable Development (IISD), was confident that WTO rules would change to accommodate the EU measure. "The question is, is the interpretation of WTO law changing? Law itself will not change. I think anybody familiar with trade policy will tell you that," he told ERCST webinar attendees.

Those deciding WTO disputes should rule in favor of the CBAM, he said, given the urgent need to act on climate change. "The interpretation of the law changes over time. And those that interpret that law are sensitive to the realities of evolving international priorities, [they] are sensitive to the fact that climate change is probably the biggest challenge we face: an existential challenge at the international level. So, we can certainly see if a good effort is taken to respect WTO law, I expect we will see strong desire on the part of those interpreting that law to find the measure in question in accordance with that law," said Cosbey.

Recent legal decisions in EU countries, for example, the February ruling of the Administrative Court of Paris in France and the April ruling of the Constitutional Court in Germany, reveal a trend towards better climate change protections under law.

"Two questions are worth asking. Will the next decade be WTO's decade? Will the next decade be carbon neutrality's decade? These two questions shed light on […] the rules of the game of the future," wrote Wu.

Developing states left behind, for now

An even more pressing question is how the EU CBAM will impact on developing countries that rely on EU states as buyers of their imports.

Developed nations would fare better than developing nations in a world with the CBAM, as the gap in income between them widens, leaving the richer nations with more and the poorer nations with less, according to a United Nations Conference on Trade and Development (UNCTAD) report.

Developing countries hit will likely include EU aluminum importers Mozambique, Guinea, Sierra Leone, Ghana, and Cameroon; steel importers Zimbabwe and Zambia; electricity importer Morocco; and fertilizer importers Algeria, Egypt, and Trinidad and Tobago, according to EU-funded sustainability think tank Institute for European Environmental Policy (IEEP).

These and other developing states with linked supply chains will be negatively impacted by the CBAM, but exempting them "would create confusion on the very nature of CBAM," said IEEP.

Because the EU uses the CBAM for compliance with the Paris Agreement, this aspect of the measure could cause a backlash against global climate efforts. CBAM disputes might "divert significant political energy and attention from other aspects of international climate policy in the leadup to and aftermath of COP26, and—at worst—undermine the trust that is essential to securing the strong multilateral agreements needed," according to the IEEP.

In fact, that's the direction that Russia seems to be going, based on a statement by Russian Minister of Economic Development Maxim Reshetnikov, who argued that the CBAM conflicted with the Paris Agreement. "The Paris Agreement guarantees countries the right to independently determine the most effective methods for combating climate change," he said in the statement.

Cosbey believes the CBAM is not a nail in the coffin of the Paris Agreement, even if it is discussed at COP26. "On the question of whether we see a conflict with the spirit of Paris Agreement in this EU CBAM proposal? Personally, I don't. I think there are some design elements here which are helpful in terms of asking for actual data, in terms of nonpunitive default for GHG intensity," he said.

The impacts on developing countries may be fixed, for example, by directing a share of CBAM revenues to them, he said, adding: "I would like to have seen revenue sharing effected to a much greater extent, and I think it's going to be."

Part of the CBAM's purpose is addressing the EU's past role as a major polluter, Cosbey continued. "But the ultimate question is, does it respect the principle of 'Common but Differentiated Responsibility,' which says that those that have been most responsible for climate change in the past and those with the most means for addressing it should take a leadership position, and should be out in front," said Cosbey.

The principle from the United Nations Framework Convention on Climate Change meant countries in the EU are obliged to create something like a CBAM, he said.

Posted 21 July 2021 by Cristina Brooks, Senior Journalist, Climate and Sustainability