Written by 5:36 pm EU Investment

How will the EU’s carbon tariff work?

Climate policy is redrawing the blueprint of global trade, putting up new walls between the markets for high-carbon and low-carbon manufactured goods.

On Dec. 13, the European Union settled on a long-negotiated policy to levy import tariffs on steel, cement, fertilizer, iron, aluminum, and electricity, based on the volume of carbon emissions created during their manufacture in exporting countries.

The “carbon border adjustment mechanism” (CBAM) is meant to protect the competitiveness of European manufacturers. Once the price of carbon emission permits in Europe—some of which are now doled out for free—begins to rise, companies will face increasing pressure to decarbonize. The tariff, in effect, effectively imposes Europe’s carbon price on countries that don’t have their own. In this way, EU policymakers hope to prevent high-carbon industries from simply relocating outside the EU. Known as “carbon leakage,” this effect would not only damage the European economy but, from a planetary perspective, render the EU carbon price pointless.

If it were to kick in overnight, the CBAM would cause consumer prices to spike in Europe and wreak havoc on high-carbon manufacturers from South Korea to South Africa. But with a lead time of more than a decade before it is fully implemented, the impact on consumers and on most exporting countries may be hardly noticeable.

“If this thing works the way it should, the CBAM should have very minimal impact by the time it’s functioning,” said Aaron Cosbey, a trade economist at the International Institute for Sustainable Development, a Canadian think tank. “But you still have to put it in place to get that effect.”

How the EU’s carbon tariff will work

For a three-year phase-in period starting in October 2023, importers in Europe will only be required to report the emissions of specific products: how much CO2 was produced in China to make a particular ton of steel, for example. This step will require importers to wring data out of exporters that today often goes unreported. And it will require exporters to pay carbon accountants to gather that data, if they don’t already. Exporters with ready access to such carbon data will have a leg up over their competitors in winning contracts with European importers. The audits of importers’ carbon statements , though, will be an ongoing challenge for EU regulatorsone that doesn’t yet have a foolproof solution.

After that, the tariff will kick in: Importers will be required to buy permits from the EU that match their reported emissions, at the price set by the European cap-and-trade market. At first, only some emissions will be covered, but by 2035, all the emissions generated by imported products will have to be matched with permits. If the exporting country has its own carbon price—China, for example—that can be counted against the tariff.

Estimating the total tariff bill requires some tricky assumptions about the future carbon permit price and rates of improvements to manufacturers’ carbon efficiency. A 2021 analysis by the European climate think tank Sandbag offered some projections for China, a relatively high-carbon manufacturing economy. At the current carbon price of €90 per ton, CBAM charges levied on imports from China by 2035 could amount to about $772 million. That’s not chump change, but the sum is dwarfed by China’s total exports to the EU in 2021: $472 billion.

There will be two main effects of this tariff, Cosbey said. One is that lower-emission versions of certain products—Chinese steel made with hydropower rather than coal power, for example—will be routed to the EU, with everything else saved for domestic consumption or export to less picky markets.

The other is that the policy will induce more countries to invest in low-carbon power and industrial R&D, implement their own carbon prices, and take other steps to help their companies avoid the tariff. (The US, for instance, may be nudged to follow through on plans to create carbon tariffs of its own.) Over the next decade, low-carbon manufacturing is certain to become much cheaper as technology becomes more efficient and the price of low-carbon power falls. The threat of the tariff, in other words, could spur the investments needed to avoid it.

Should Africa get a waiver from the EU’s carbon tariff?

But while that type of investment may be manageable for the US, South Korea, and other wealthy exporters, it will be more challenging for developing countries. In Africa, for example, Algeria and Egypt are big fertilizer exporters to the EU, and Mozambique is a major exporter of aluminum. In Mozambique’s case, the CBAM could cost the country 1.6% of its GDP, according to the Center for Global Development.

“Imposing costs on those exporters seems to violate the basic UN climate principle of common but differentiated responsibilities,” Cosbey said, referring to a common refrain in climate geopolitics that developed countries can’t ask for emissions cuts in developing countries without helping to pay for them.

Those countries are sure to push for a more equitable approach as details of the CBAM are hammered out (and potentially litigated in the World Trade Organization) in the years to come. One solution would be for the EU to redirect some CBAM revenue to developing countries to support low-carbon technology or the bureaucracy needed to establish a local carbon price (along with delivering on other forms of climate finance). Other solutions, said Faten Aggad, a senior advisor at a think tank called the African Climate Foundation, would be a temporary waiver for developing countries—and for African countries to quickly implement the African Continental Free Trade Area, so that the European market becomes less important.

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