ESC recommendations on Carbon Border Adjustment Mechanism
CO2 financial mechanism at the external borders of the European Union
Published 18th October 2021
European Shippers’ Council represents importers and exporters throughout Europe. We are committed to join efforts with European institutions and other organisations to combat climate change. The European Commission recently presented the Fit for 55 package, which includes a wide range of measures to achieve the reduction target of 55 per cent in CO2 emissions by 2035. The package contains 13 legislative proposals, including a CO2 tax at the external borders of the European Union (EU).
CARBON BORDER ADJUSTMENT MECHANISM AS NEW INSTRUMENT TO COMBAT CARBON LEAKAGE
To combat carbon leakage, which until now has been regulated in the ETS itself, a new instrument is being developed: Carbon Border Adjustment Mechanism (CBAM). Given the im-portance of combating carbon leakage for the climate, economy, and employment, we think this is a good development. The CBAM is being introduced in the most emission-intensive sec-tors. The purpose behind the mechanism is to better reflect the cost of ‘the CO2 footprint’ of products in the price of imported goods. In addition, a goal is to (also) create incentives (out-side the EU) that would stimulate the reduction of carbon emissions. A border mechanism, such as the CBAM, can be an effective way to protect European industry from carbon leakage if done correctly and in a well-designed way. However, this measure also poses risks to a level playing field and may lead to reduced investment. This needs to be properly monitored.
Fit for 55 also includes a plan to phase out free emission allowances within the ETS. To safe-guard the international competitive position of EU-based entrepreneurs, the instrument of a CO2 mechanism at the borders of the EU has been devised for six specific energy-intensive sectors. The EC estimates that the effect on shifts of location in the production chain will be limited, and, thus, the risk of carbon leakage. At the same time the institution states that this may change as carbon prices rise. The effect of the CBAM instrument on the choice of production locations of manufacturers that work with these products is, therefore, unknown.
ESC CONCERNS AND RECOMMENDATIONS
European shippers strongly recommend the European Commission to monitor closely and undertake additional investigation of the potential undesirable scenarios that may evolve. These concern carbon leakage and the competitive position of European companies on the global market. ESC also advises to check the new instrument on the WTO compliance and stay engaged in a dialogue with other partners regarding the implementation of the CBAM. Here are ESC concerns and recommendations:
a. Potential shifts of production from inside to outside the EU
A CBAM may result in producers choosing to process the materials (into an intermediate or final product) outside the EU resulting in carbon leakage). And only then they would import the products into the EU. It should be investigated how this effect can be avoided.
b. Importing with a diversion
It may also lead to shifts in the import components of production to third countries such as the UK (which is likely to be excluded from CBAM due to having its own ETS system). This should be monitored.
c. Reduced export competition
EU-based producers and traders working with materials covered by the ETS or CBAM lose their free emission allowances and have to innovate to make their production processes more sustainable. They are faced with cost price increases. This makes their products relatively expensive compared to non-European products, which weakens their competitive position outside the internal market. This must be carefully monitored during the transition period and, if necessary, export subsidies must be considered.
d. Risks of non-compliance with WTO rules
It is still unclear whether the CBAM is WTO-compliant, but this is crucial. Therefore, we pro-pose that the EU requests an opinion from the WTO. A logical consequence would be that the development and introduction of the CBAM instrument would only go ahead if there is no conflict with WTO rules. If the CBAM cannot be pushed through, an alternative means of protection must be found, or the system of free emission rights must remain in place.
e. Trade disputes and legal uncertainty
The CBAM may lead to political backlash from the EU’s international trading partners and possibly to trade disputes. It is, therefore, important that the Commission engages and stays engaged in a dialogue with trading partners, bilaterally and in multilateral organisations, prior to the final establishment of the mechanism. This should avoid trade disputes and legal uncertainty. Above all, it is important that the CBAM does not lead to discriminatory behaviour and subsequent retaliation.
f. CBAM revenues as resources for greening
The revenues from the CBAM must be used to stimulate the transition, promote innovation, and combat energy poverty.
ESC is supporting the European Commission in its efforts to achieve the reduction target of 55 per cent in CO2 emissions by 2035. As this is a complex process and will impact the whole EU economy, all the actions and the introduction of new mechanisms should be carefully considered, and potential risks eliminated in time.