Establishing Rules Against Climate Change in the EU: A Fair Game?

Aug. 5, 2021, 8:01 AM

The European Commission (EC) presented its long-awaited proposal for a regulation on a carbon border adjustment mechanism (CBAM) on July 14. This will require importers to pay for the embedded greenhouse gas (GHG) emissions of covered goods imported into the European Union.

CBAM is part of the so-called “Fit for 55” package of regulatory and policy proposals intended to ensure that the EU reduces its GHG emissions by 55% by 2030 (over 1990 levels), to achieve climate neutrality by 2050.

This package will impose a significant burden on the EU domestic industry, when compared to that of competitors in third countries. For example, the Fit for 55 packages will require industrial installations covered by the EU’s cap-and-trade system, the emissions trading system (ETS), to reduce their emissions by 61% by 2030 over 2005 levels.

The EC’s proposal for a CBAM is intended to level the playing field for the EU domestic industry and to address the problem of “carbon leakage.” Indeed, one of its main objectives is to limit the risk of EU-based production losing out to third country producers that are subject to less stringent climate change mitigation efforts. To address this, the mechanism would be closely linked to the ETS.

For example, the CBAM proposal only covers sectors that are at risk of carbon leakage and that are subject to the ETS—it would apply fully, from 2026, to imports of cement, fertilizers, steel, iron, aluminium, and electricity. The proposal also links the CBAM price that importers must pay to the weekly average price of the ETS allowances, while adjusting for importers to account for any free allowances granted to EU domestic competitors under the ETS.

International Climate Change Diplomacy

The proposed CBAM, however, is also intended as a tool of international climate change diplomacy. The proposal tries to “encourage” countries around the world to commit to and implement GHG reduction efforts comparable to those of the EU.

To achieve this, the proposal would empower the EC to exclude third countries from the CBAM if they are fully integrated into the ETS or conclude an agreement with the EU linking their cap-and-trade system with that of the ETS.

Similarly, the CBAM proposal allows to make discounts to importers for the “carbon price” paid in the goods’ country of origin. This carbon price could be the amount paid in the third country in respect of the goods, in the form of an emissions tax or allowances under an emissions trading system.

In effect, with its CBAM proposal, the EC is trying to position the EU as a leader in international climate change diplomacy by using basic tit-for-tat concepts, much as in traditional (unfair) trade legislation. This strategy might be successful with close neighboring countries for whom the EU is the largest trading partner, such as Ukraine or Turkey, but it is unclear whether it will have the same effect on large actors, such as the U.S. or China.

A Three-Step Mechanism

In practical terms, the CBAM sets up a three-step mechanism. First, only registered importers defined as “authorized declarants” would be entitled to import covered goods into the EU. These authorized declarants would be liable for any failure to comply with the obligations of the CBAM.

Second, authorized declarants would be required to purchase “CBAM certificates” to cover the embedded emissions of any covered goods they import. This will require authorized declarants to keep track of the volume of covered goods they import in a calendar year. A certificate would correspond to emissions of one ton of CO2 equivalent, and its price would be based on the weekly average price of an ETS allowance.

Third, by May 31 of each year, authorized declarants would be required to submit a “CBAM Declaration.” This would refer to the goods imported in the previous calendar year and their embedded emissions and be accompanied by sufficient CBAM certificates to cover them.

But Is it Fair?

On its face, the CBAM proposal seems to go to great lengths to ensure that it is compatible with the World Trade Organization’s rules on non-discrimination and exceptions for environmental and human health protection. Much will depend, however, on the final wording of the CBAM and on how the EC will use many of the regulatory powers that the proposal grants it.

The more substantial question is whether the CBAM proposal and its implementation will be fair on trade partners and take sufficient account of the principle of “common but differentiated responsibilities.”

The EC will have to work hard to engage with third countries and less developed countries to accommodate their specific circumstances. The EU should also dedicate a significant part of the CBAM revenues to financing climate change mitigation efforts and adaptation in less-developed countries. There is no reason why an average EU citizen should be entitled to produce more GHG emissions than one in a less developed country, and the EU has a historical responsibility for the climate change that the world is already suffering.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

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Cándido García Molyneux co-chairs Covington’s Environmental Practice Group in Brussels, specializing in regulatory, policy, and strategic advice on EU environmental and product safety legislation.

Lasse Luecke is a trainee with Covington in Brussels.

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