CBAM: The EU’s game changer for sustainable trade

The European Union is poised to implement a revolutionary system for addressing carbon emissions which aims to sharply curtail greenhouse gases in the EU while leveling the playing field with their less environmentally ambitious trading partners.

The EU may not possess an intimidating military but when it comes to regulatory clout, the union is a superpower. Rules drawn up in Brussels affect producers of goods and services in every corner of the world. Exporters to the EU are impacted by regulations developed thousands of miles away.

Senior EU officials are about to put the finishing touches on the so-called Carbon Border Adjustment Mechanism program (CBAM), which was proposed by the EU Commission in 2021 as part of the Union’s “Fit for 55” program to slash carbon emissions by 55 percent by 2030 in line with United Nations’ targets. European-based companies fret that — absent fees at the borders — they will be at a competitive disadvantage as they struggle to meet stringent EU requirements that manufacturers based in other regions may not encounter.

Companies outside the 447-million-person EU market, including those in the United States, worry they face swingeing tariffs. Moreover, they question whether this measure would be compliant with international trade rules set in the World Trade Organization.

CBAM targets five industrial sectors: iron & steel, electricity, fertilizers, cement and aluminum. Some in the EU would like to see the coverage expanded — to cover chemicals for instance — but few think this would be agreed to this week. The current timetable calls for importers’ reporting requirements to start in 2023 and end in 2026. Full implementation is currently slated for Jan. 1, 2027 — and would be phased in until 2032.

It’s a complex process which will work, in its initial stages, in tandem with the EU’s Emissions Trading System, a cap-and-trade system in which overall emissions for the year are “capped” and companies are given free “allowances,” with each allowance permitting them to emit one metric ton of carbon emissions over the course of the year. The companies subject to this system include power and heat generators and the aviation industry. According to the EU Commission, the executive branch of the union, emissions in covered sectors have fallen 42.8 percent since the system was introduced in 2005.

Cleaner companies may not require the full allotment of permits and can sell surplus allowances on exchanges across Europe. The exchange prices will be the “default” price that will help the EU determine what the border charge will be, although the EU has also developed a methodology based on actual emissions that is a more precise measure of the extent to which a producer emits greenhouse gases.

Under CBAM, the number of free allowances will be sharply reduced — and eventually scrapped — driving up the price of carbon. As the free allowances are phased out, EU-based businesses will bear this increasing cost of carbon.

Currently, there are no global rules for carbon pricing or for the application of border measures. This complicates the EU’s task of assessing border charges. Under CBAM, companies which pay no carbon tax at home would be hit with the full carbon market price.  Where there is a carbon pricing system and emissions taxes are applied, those duties will be deducted from the price the EU will charge at the border. The United States has no national carbon pricing system.

According to the World Bank, there are 70 different pricing schemes around the world, with 47 national jurisdictions covered and 36 subnational schemes in place including in California, Massachusetts and Oregon.

These schemes vary wildly in terms of scope and pricing. For instance, carbon is priced $98.99 in the United Kingdom but only $1.08 per ton in Kazakhstan. Were the system in place today with carbon currently trading in the European Union at 87.56 euros ($92.17) exports of affected products from China (where the carbon price is the equivalent of 1.16 euros) or Australian (20.8 euros) would pay duties of 86.4 euros and 66.76 euros respectively.

For CBAM to comply with WTO rules, any tax on foreign producers must not exceed that which is levied on domestic producers. EU officials are adamant that CBAM will comply with WTO rules. They point out that WTO rules provide wide scope for the implementation of environmental measures.

CBAM is, they argue, based on market principles, is calibrated, dynamic and quantifiable. Importers can provide the Commission with information on the production methods used to make the products they are importing and if they consistently brandish their green credentials, they can qualify as an authorized operator eligible to use streamlined processes at the border. Brussels will not discriminate between domestic and foreign producers and the Commission has, to this point, resisted pressure from business to provide rebates for goods that are exported.

This said, there is an acknowledgement that trade will be impacted, especially trade from developing countries. According to estimates I’ve heard, imports into the EU would, by 2030, fall 11 percent below where they would have been absent the CBAM measures. Such a result would doubtless trigger a strong response.

CBAM represents an immense, good-faith effort by the EU to address the seminal challenge of our day. EU officials have gone to considerable lengths to consult with trading partners. But they acknowledge the unilateral nature of the program and concede that an intergovernmental approach would be far more effective. Rules or guidelines negotiated in the WTO, the OECD or the World Bank would offer greater clarity and transparency and may help to avoid conflict. Unfortunately, at present, no such rules exist.

Keith Rockwell is a Global Fellow at the Wilson Center; he previously served as the chief spokesman for the World Trade Organization (WTO).

NOTE: This post has been updated from the original to correct the final word in the name of the CBAM program.