EU Carbon Border Adjustment Has Difficult Political Fight, Likely to Hit US Exports

On March 15, France's Finance Minister Bruno Le Maire said, "The agreement in the Council on the Carbon Border Adjustment Mechanism is a victory for European climate policy. It will give us a tool to speed up the decarbonisation of our industry, while protecting it from companies from countries with less ambitious climate goals. It will also incentivize other countries to become more sustainable and emit less."

The Council's proposal sets a 150-euro de minimis for carbon border adjustment. "This measure would reduce administrative complexity, as around one third of consignments to the Union would fall under that category, and their aggregate value and quantity represents a negligible part of greenhouse gas emissions of total imports of such products into the Union," the EU said.

But the Council's agreement did not cover the phase-out of free allowances in Europe's cap-and-trade system to high-carbon sectors, such as steel, "and appropriate solutions on the issue of limiting potential carbon leakage from exports, so that economic efficiency, environmental integrity and WTO compatibility of the CBAM are ensured."

On March 16, Karin Karlsbro, the European parliament's rapporteur, or legislator responsible for getting the CBAM proposal through the committee of international trade, said the bill failed in her committee by one vote because of disagreements over free allowances, export rebates of the cost of carbon for European producers and what would be done with the revenue raised by a CBAM.

The initial proposal only charges exporters of steel, aluminum, fertilizers, electricity and cement a border adjustment for lower climate ambition.

Karlsbro, who spoke on a Peterson Institute for International Economics program March 16, said, "the principles are quite simple, but also politically complicated." She said that including export rebates would not be compatible with World Trade Organization rules, and she said the EU cannot do that.

Karlsbro said it also doesn't make sense from a policy perspective. If European countries get "a rebate of their carbon emissions, why should we ask others to pay [for carbon emissions]? That’s the whole point."

"From my perspective, it's not possible to have free allowances and CBAM," she said, referring to the timing of phasing down those free allowances. She said that the carbon border tax must be designed only to cut carbon emissions, not to put EU industry at an advantage compared to all foreign competitors.

Moderator Cecilia Malmstrom, who used to be the European commissioner for trade, said it's quite rare for a report to be rejected by the trade committee. "This is an indication that it will be quite difficult to agree," she said. Now, the parliament's environment committee is grappling with the bill, and they are considering a shorter transition period and whether more sectors should be targeted, Malmstrom said.

That could include basic chemicals, plastics and hydrogen.

Karlsbro said a vote is planned in June. She said the extremely high prices of energy in Europe, partly as a result of the war in Ukraine, "also make this even more sensitive." She said it's one of the most complicated and controversial measures in the parliament now. If it passes, it will be reconciled in a compromise with what the Council passes.

The Council said it's important to convince other countries to establish similar carbon pricing policies, to create a "climate club." Jeff Schott, a PIIE senior fellow, said that the U.S. wants to be in that climate club, even though it does not have a national cap and trade program or carbon tax.

He said that producers do face costs from regulations on electricity generation, renewable fuel standards in electricity generation, and fuel efficiency standards. But how do you estimate what the cost of those policies are, he asked. Should the cost estimates be across an industry, or applied to an individual production site?

The rapporteur on the environment committee said explicitly that only countries with a price on carbon can be spared CBAM, that environmental regulations such as those in the U.S. do not count.

But the U.S. and the EU are negotiating now on a common standard on carbon intensity in steel, with an eye to lowering barriers to trade in that sector between the EU and the U.S. and raising barriers for steel imports that are not as clean. Schott said that could be constructive, or it could end up protectionist. "I’m not sure if the protectionists have more firepower than the environmentalists," he said.

Karlsbro echoed him. "There are strong forces to design these different measures in a more protectionist way and I think that would be very dangerous," she said. Schott said, "The concern is, as you increase your ambitions in terms of decarbonization, that you maintain political support at home for sustaining the policy and that isn’t so simple, because there are going to be costs. Some things will become more expensive."

Malmstrom said the original list of products would only affect $1 billion of U.S. exports to the EU, out of $260 billion in annual goods. But the CBAM will expand to more sectors over time, she said.

Karlsbro said, "I think it’s so important to stay strong in the principle that trade is something good. We should not punish our trading partners. Our fight is against the emissions, not against any countries, not against any special industry."