Last week, the European Commission took a major step to implement the climate aspects of its European Green Deal.  It presented a proposal for a European Climate Law and two consultations on its announced Climate Pact and Carbon Border Adjustment Mechanism (“CBAM”).

The European Commission intends to present a proposal for a CBAM by the summer of 2021.  The consultation (currently first as a so-called “feedback period”) on the CBAM is intended to allow stakeholders to give their views on the different aspects of the possible mechanism discussed in the Commission’s Inception Impact Assessment.

The idea of a CBAM has been considered in the EU and elsewhere for many years.  As the argument goes, the need for such an adjustment is based on the reasoning that European trade-exposed energy-intensive industries that are subject to the EU’s Emissions Trading System (“ETS”) and other EU climate standards are at a disadvantage against foreign producers that are not subject to similar emission reduction requirements.  This, in turn, results in foreign producers increasing their emissions despite European industries’ efforts, i.e. so-called “carbon leakage.”

The European Commission’s proposed goal that the EU achieves climate neutrality by 2050 has reinforced the position of those advocating for the need to adopt a CBAM.  Supporters of the CBAM claim that it will ensure that all goods consumed in the EU/EEA, whether imported or produced domestically, are treated the same way and encourage other countries across the world to also decarbonize.  In line with this, in its Communication on an European Green Deal of December 2019, the Commission announced that “should differences in levels of ambition worldwide persist, as the EU increases its climate ambition, the Commission will propose a carbon border adjustment mechanism, for selected sectors, to reduce the risk of carbon leakage. This would ensure that the price of imports reflect more accurately their carbon content.”

In its Inception Impact Assessment, the Commission reiterates this position and states that “[a]s long as many international partners do not share the same climate ambition as the EU, there is a risk of carbon leakage.”  The Inception Impact Assessment also states that the mechanism “would ensure that the price of imports reflect more accurately their carbon content.  The measure would need to be designed to comply with World Trade Organization rules and other international obligations of the EU.”  Not surprisingly, it also states that the mechanism “would be an alternative to the measures that currently address the risk of carbon leakage under the EU ETS.”  Indeed, the introduction of a carbon adjustment mechanism would likely mean that industries covered by the mechanism would no longer benefit from free allowances under the EU ETS.

The Inception Impact Assessment also clarifies that the development of a CBAM would be based on three building blocks: (i) a legal instrument, which could for example include a carbon tax on selected products, a new carbon customs duty or tax on imports, or the extension of the EU ETS to imports; (ii) a methodological approach to evaluate the carbon content and carbon pricing of imported products; and (iii) a possible limitation of the Mechanism to only some industrial sectors (e.g., cement).

The Commission’s consultation on the CBAM raises important climate, international trade, development, and economic issues.  To list but a few:

  • Should the adjustment mechanism target specific industries (g., cement, aluminum, steel, or chemicals), or instead apply horizontally across all industrial production? A prudent approach would be that considered by the Commission and to initially focus on one or two sectors, as pilot projects, such as cement.  Introducing the CBAM from the start to all industrial sectors is likely to increase the risk of legal challenges. Based on the experiences gained with the selected pilot projects, the EU could later decide whether, and under what terms, to extend the CBAM to other sectors.
  • How will the EU be able to develop an objective methodology to calculate the carbon footprint of a product? This is the key question for the viability of the CBAM.  Before adopting any mechanism, it should be clarified how the EU will be able to get reliable and verifiable information on the carbon footprint of the products produced in third countries. There is a major risk that third countries may either not cooperate and not provide any data, or even if they do cooperate, provide data that it is not reliable.  In order to limit the risks of legal challenges, the EU should have a clear idea on how to deal with lack of reliable data from third countries before it takes any steps to introduce the CBAM.

Moreover, even if reliable data can be obtained from third countries, the EU should consider how to deal with situations where two identical or similar products have different levels of carbon footprint due to their different production methods and technologies.  Should the EU in such cases apply a different border tax or levy? And how could such different treatment on identical or similar products be compatible with WTO law?

  • To what extent should the existence of an emissions trading scheme similar to the EU’s ETS in the product’s country-of-origin exempt the imported product from any border adjustment? To which minimum standards should these non-EU emissions trading schemes be subject? As a related question, would there be some kind of “de minimis” level of carbon footprint, below which the border tax would not be applied? Would there be differentiation among WTO countries, g., accepting a higher level of non-actionable “de minimis” level from a defined group of (small or vulnerable) developing countries?
  • What design should the CBAM have to also ensure the EU’s compliance with its international obligations under multilateral environmental agreements that call for “common but differentiated responsibilities” in the fight against climate change?

Interested parties may submit comments until April 1, 2020.