Controversy Abounds Over EU Carbon Border Levy Proposal
28 September 2021
Although the European Commission maintains that its proposal for an EU Carbon Border Adjustment Mechanism (“CBAM”) is instrumental to achieving EU climate goals, without compromising the competitiveness of European industries, it has been reported that key trading partners are highly critical of the scheme. European industries and climate campaigners have also expressed some scepticism.
If the European Commission’s CBAM proposal – which was presented on 14 July this year – is adopted into law, Hong Kong traders will see the CBAM impose an obligation on importers in the EU to pay a levy on the greenhouse gas emissions embedded in certain industrial goods. The CBAM will initially apply only to a selected number of goods which are deemed to be at high risk of carbon leakage, namely, iron and steel, cement, fertiliser, aluminium, and electricity generation.
The Commission’s CBAM proposal forms part of the Fit for 55 package, a collection of initiatives aiming to secure the EU’s goal of a 55% reduction in carbon emissions (compared to 1990 levels) by 2030. The CBAM is specifically designed to reduce carbon leakage, that is, preventing the relocation of European industries to regions where the price of carbon is lower than that in the EU, and reducing the carbon intensity of goods that enter the European market.
The CBAM also provides that the free carbon allowances allocated to European industries under the EU’s Emissions Trading System (“ETS”) will be phased out. The European Commission maintains that the mechanism is therefore WTO compliant and facilitates a competitive transition to lower greenhouse gas emissions in the EU and beyond.
Key trading partners such as mainland China, South Africa, Brazil and India have nevertheless been highly critical of the CBAM. Chinese President Xi Jinping condemned the proposal as a protectionist policy cloaked in environmental concerns. According to thinktank Adelphi, many Chinese stakeholders view the CBAM as contrary to the Paris Agreement and its reliance on voluntary national targets. The Commission denies any incompatibility, arguing that the CBAM is in fact necessary for the EU to reach its commitments under the Paris Agreement. An article published earlier in September estimates that merely 1.8% of Chinese exports to Europe are covered by the proposal. Indeed, thinktank E3G has predicted the impact on mainland China to be relatively small, comparing it to the almost four times higher CBAM bill Russia is estimated to face in 2035. The same source suggests that the main cost of the CBAM will ultimately be borne by European direct consumers.
European industries have also shown resistance to the CBAM proposal. BusinessEurope, the organisation which purports to represent the interests of all-sized enterprises, fears a negative impact on investment prospects for the sectors affected. There are also concerns as to the efficacy of implementation, as the European Steel Association pointed to the possibility for importers to find ways around their obligations through “absorption of costs or source shuffling”.
European thinktanks and environmental groups have given the CBAM a lukewarm welcome, with the Institute for European Environmental Policy and E3G considering the rate of phasing out of free ETS allowances too slow. The adverse effect of the CBAM on developing countries has also been pointed out, with the UN Conference on Trade and Development urging the European Commission to guarantee that the revenue generated be invested into promoting environmentally friendly energy sources in such countries. This is briefly considered in the preamble to the Commission’s proposal, which also encourages future dialogue with third countries on sustainability questions.
The Commission’s Green Deal chief, Frans Timmermans, has stated that the CBAM may not be necessary if trading partners were to make stronger commitments to lower their emissions.
Although the CBAM is relatively unpopular, Hong Kong traders should be aware of the possibility that other large importing jurisdictions may consider similar schemes. The EU’s Economy Commissioner Paolo Gentiloni stated that such discussion is underway “from Canada to the US”. US officials have confirmed that they will monitor the success of the European CBAM model, although any decision-making on the matter is “premature”, according to Climate Envoy John Kerry.
Even when the EU CBAM law is finally adopted, Hong Kong traders in the sectors concerned and others affected by it will benefit from a transition period. From 2023 to 2025, the Commission proposes to set up a reporting system, simply requiring importers to declare the emissions embedded in their goods. From 2026, the CBAM will become fully operational, and importers will be required to buy and surrender a number of carbon certificates corresponding to the difference in price of the carbon emissions associated with the goods between the country of production and the EU.
The CBAM regime will apply to imports of a range of industrial products, namely, iron and steel, cement, fertiliser, aluminium, and electricity generation. Climate thinktanks estimate that the CBAM will apply to about 3.2% of imports into the EU, but that its scope of application may be extended. The CBAM will become applicable to the relevant imports from all third countries, albeit non-EU countries participating in the ETS, and countries whose emissions trading systems are linked to that of the EU, will be exempted.
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