CBAM advances, but big battles remain

The EU is pushing ahead with plans to introduce a carbon border tax, with member states agreeing on March 15 on what the controversial Carbon Border Adjustment Mechanism (CBAM) should look like. However, the agreement, which sidesteps some of the most contentious issues, comes against a radically changed economic and international policy backdrop.

Announcing his support for the so-called general approach – backed by all Member States except Poland – French Minister for the Economy, Finance and Recovery Bruno Le Maire declared “a victory for politics European climate”. CBAM will “give us a tool to accelerate the decarbonization of our industry, while protecting it from companies in countries with less ambitious climate objectives”.

CBAM aims to protect EU steelmakers against carbon leakage. (Photo by Shutterstock/Norenko Andrei)

As proposed by the European Commission in July 2021, the CBAM will apply to imports of electricity, cement, fertiliser, iron, steel and aluminium. Importers will be required to purchase CBAM certificates corresponding to the emissions embedded in the imported goods. The prices of these certificates will be linked to carbon prices in the European Emissions Trading System (EU ETS), and importers will have to start buying them in 2026, after a transition phase from 2023 to 2025.

Fill gaps

The CBAM is designed to solve the problem of “carbon leakage”. It is the danger that imports from countries without carbon pricing regimes will undermine their European competitors, meaning that production and resulting carbon emissions are shifted from the EU to jurisdictions with more climate regimes. flexible.

Non-EU countries whose companies participate in the EU ETS (i.e. Norway, Iceland and Liechtenstein) or which are linked to the EU ETS (Switzerland) will be exempt. The EU is considering a mechanism by which other countries with equivalent carbon pricing systems could also be exempted. Importers could claim a reduction in the number of certificates surrendered based on any carbon price paid in the domestic market.

The March 15 agreement by the European Council – which includes representatives from all 27 EU member states – contained few surprises, analysts said, but several departures from the Commission’s proposal.

These include centralizing the governance of the CBAM, offering, among other things, a central register of importers covered by the mechanism. This is in line with the draft proposals of the MEP in charge of amendments to European Parliament legislation, Mohammed Chahim, unveiled in January 2022.

It also asks for a minimum threshold of €150, exempting shipments below this value. This threshold would capture around a third of shipments to the EU, the Council said, significantly reducing its administrative complexity.

A wider scope

As regards the scope, the Council’s approach is in line with that of the Commission. However, Chahim wishes to extend it to organic chemistry, hydrogen and polymers. “These products have the right characteristics to be covered by CBAM, and the technical complexities can be overcome”, Chahim wrote on Twitter during the unveiling of the draft report of its Committee on the Environment.

However, the Board dodged decisions on two important elements of the CBAM. The first is the rate at which free allocations to transmitters would be removed. Under existing EU ETS rules, European emitters at risk of carbon leakage receive free carbon allowances. CBAM is expected to render these free quotas useless.

The Commission has proposed to phase out free allowances over a ten-year period until 2035. Parliament’s draft proposal suggests a much more aggressive phase-out that would end by 2028,” Chahim said.

However, the Council argues that the speed of the phase-out is not covered by the CBAM Regulation but is rather determined by the EU ETS Directive. This is currently under review as part of the EU’s ‘Fit for 55’ legislative package, which aims to align climate and energy policy with the EU’s emissions reduction target at the 2030 horizon.

“CBAM is a mechanism against carbon leakage,” says Sanna Markkanen, research program manager at the Cambridge Institute for Sustainability Leadership (CISL). “This is only necessary in the context of the phasing out of free allocation, which is currently the main mechanism for mitigating carbon leakage… So from that point of view, the Council is not addressing the major question around the relationship between CBAM and ETS.”

Lobbyists at work

Pierre Leturcq, senior policy analyst at the Institute for European Environmental Policy (IEEP), notes the intense industry lobbying around the phasing out of free allocation. He argues that continuing to provide free allowances after 2030 means the EU would effectively continue to subsidize its emissions-intensive industry. “That doesn’t make much sense in terms of climate leadership,” he says.

Business groups are more cautious. On March 9, BusinessEurope Director General Markus Beyrer said: “We must ensure the competitiveness of our businesses by maintaining existing measures, such as free quotas under the EU ETS, at least as long as the new mechanism is in the test phase and has not yet proven its effectiveness.

The Council’s position also opened the door to wider exemptions from the provisions of the CBAM. Its approach calls for cooperation with third countries, in particular “through the parallel establishment of an alliance of countries with carbon pricing instruments or other comparable instruments (“climate club”)”. The provision, intended to “pave the way for global carbon pricing”, was included at the request of Germany, which encourages such international cooperation.

Income Questions

Another controversial issue is the use of revenue generated from the sale of CBAM certificates, which the Commission estimates could amount to around €2 billion per year. These, the Commission said, will be for the management of the mechanism, with any balance going to the general EU coffers.

However, Chahim’s parliamentary bill proposes that 25% of revenues be allocated to international climate finance. That would be important, says Josh Burke, senior policy fellow at the Grantham Research Institute for Climate Change and the Environment, both to help moderate opposition to CBAM among least developed countries, which are at risk of to be excluded from EU markets, and to frame the policy as an environmental measure rather than an economic one. The Council said a decision on the matter would be made by July 1.

Another issue that has been raised is support for EU exporters who will lose their free quotas. The Council noted that the issue must be resolved in a manner that ensures “economic efficiency, environmental integrity and WTO [World Trade Organization] compatibility”.

Leturcq of the IEEP “welcomes the decision of the Council” not to ask for an export rebate. “They would be absolutely inconsistent with WTO rules,” he says. The current position is that the Commission will examine the impacts of CBAM on EU exporters after the mechanism has operated for a few years.

However, there is little clarity on what the Commission could actually do to tackle this problem without breaking WTO rules against export subsidies, says Domien Vangenechten, policy adviser at the E3G think tank. One idea is to increase the size of the EU Innovation Fund and direct some of its resources towards supporting the decarbonisation of export-oriented sectors, although this would offer little relief in the short term. , he said.

Other ideas include maintaining a free allocation of quota to production capacity that can demonstrate that it is heading to export markets, he says. “A challenge is that [such support] is not helpful from an environmental point of view, because it harms the carbon price signal,” he adds.

Diplomatic power

As a number of observers have noted, the CBAM is designed, at least in part, as a tool of diplomacy. In moving the file forward, EU member states recognize “that trade policy and foreign policy go hand in hand,” says Leturcq. He adds that this approach has long been followed by the United States but that it has “always been a major taboo in the European Union”.

However, recent months have changed the context in which a border carbon tax would operate. CISL’s Markkanen notes that Russia would have been hardest hit by CBAM, given the nature of its exports to the EU and its reluctance to introduce domestic carbon pricing. Ukraine, on the other hand, stood to be a beneficiary, given its ability to capture some of the EU’s Russian markets and its growing alignment with the EU, including plans to develop a trading system. rights under its association agreement with the bloc.

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Vangenecht does not see the collapse of trade relations with Russia influencing the development of CBAM legislation. In terms of the intended effect on reducing carbon leakage, “the fact that you don’t have an economic relationship with Russia doesn’t really change that – in fact, it’s basically a very extreme form of CBAM.”

Indeed, Leturcq predicts that the CBAM model will likely be adopted for other EU environmental and social priorities. “CBAM provides an illustration of the complexity [this approach] legally and technically speaking, but also how necessary it is when you increase your own ambition.

The French EU presidency may have claimed victory in reaching a common Council position, but the legislative path from here is uncertain. Several European Parliament committees are debating the amendments, with a plenary vote expected in June or July.

For its part, the Council submits its common approach to an agreement on revisions to the EU ETS. “A lot needs to be reviewed there,” says Vangenechten, including extending emissions trading to buildings and transportation. If all goes as planned, he added, trilogue negotiations – between the Commission, the Council and the European Parliament – ​​could start after the summer break.

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