It was not so long ago that a European Union carbon border tax to protect domestic industries from international competitors from countries with inferior climate ambitions was seen as a far fetched theory only ivory tower academics and some climate activists promoted. And even most of them recognized it had zero chances of getting close to the legislative table.
And until very recently that was just as well for European multinational companies. They considered any carbon border adjustment mechanism – whether it be in the form of a tax or forcing specified imports into the EU Emissions Trading Scheme – as Pandora's Box and potential trade war trigger that would undermine the multilateral cooperation needed to tackle global warming.
But as the European Commission throttles full steam ahead with its "Fit for 55'' climate package meet 2030 and 2050 CO2 reduction goals, it will include the world's first "Carbon Border Adjustment Mechanism.'' But as it makes it way from a pipe dream to mainstream have all the complexities and risk factors been ironed out?
Hardly. Despite the overwhelming European Parliament support for CBAM resolution in March and the Commission spin expected in July the technical, legal and political issues are as valid as ever.
The core problem with a CBAM revolves around the inexact science of determining a products precise carbon footprint. As an editor of the United Nation's Environment Programme flagship policy magazine Our Planet in the early 1990s I launched debates and seminars dedicated to defining an internationally accepted carbon footprint methodology using Life Cycle Analysis (LCA). The work focused on tracing the production-supply chains, especially in energy intensive industries. This included gauging the increased emissions associated with shipping products around the world over the high seas.
More than 25 years later carbon footprint methodology and LCA is still a work in progress. Blockchain technology is a hopeful new tool to establish a precise, enforceable ledger but as one expert recently told me "we are not there yet.''
There is no better example that illustrates the incertitude surrounding carbon footprint analysis than within the EU. Pay attention to the bitter debate that has divided EU member states and green activists on whether or not wood should continue to qualify as a EU renewable energy resource.
But there are other complicating factors that will spell trouble for an EU CBAM. One includes the large amount of EU member state subsidies for renewable energies. Trade lawyers can debate all sorts of technical issues on whether these subsidies would render the CBAM compatible with the WTO rules. Ultimately the answer is unknown since a CBAM is uncharted WTO territory.
In any case what the WTO might decide is a moot point simply because its dispute settlement process is in a shambles in the aftermath of the Trump Administration wrecking ball. That increases the chances that a CBAM would trigger prompt a wave of retaliatory protectionism that would take the WTO years to adjudicate.
Another key issue concerns energy taxation – or more precise: carbon taxation, which is missing in the EU. That absence has some history. In those heady days of the when the United Nations Climate Change Convention was signed at the Rio de Janeiro summit in 1992 an EU carbon tax was on the table. But even with only 15 EU member states instead of the current 27 it was impossible to get unanimous approval – the U.K. was the chief holdout but there were others happy to hide behind the British. That failed carbon tax effort morphed into what is now the EU Energy Taxation Directive.
By the time it was approved in 2003 it was stripped of all carbon criteria and imposed a minimum level of excise duties. When it was passed former Internal Market Commissioner Frits Bolkestein quipped that it had "more loopholes than Swiss cheese.'' Subsequent attempts to revised the energy taxation directive and re-insert the carbon criteria failed.
The carbon void in the EU energy taxation law is particularly important, especially since transport emissions – a key component in the production-supply chains carbon footprint - have continued to rise since 1990. The trajectory is expected to continue until 2030 according to the European Environment Agency.
The European Commission will try to tackle the transport sector issue, including shipping, by revising the Energy Taxation Directive to re-insert the missing carbon criteria. It will also include transport in the EU Emissions Trading Scheme, a carbon tax substitute policy adopted in the late 1990s to cover EU industrial sectors.
But the ETS also has its loopholes. The big one is free allowances for energy intensive industries. The Commission is expected to end the free allowances in sectors where the CBAM will apply. These include the iron and steel, aluminum, cement, electricity production and fertilizer production sectors. Trade associations are lobbying furiously against the loss of the free allowances for energy intensive sectors.
Whatever energy tax and ETS changes are proposed they must be approved by the Council of Ministers and the European Parliament. That process will take at least two years. If past is prologue the final energy tax legislation and the ETS law will likely illicit another Swiss cheese label.
How the CBAM, targeted for a 2023 launch, is administered and how the revenue is spent are other issues related to WTO compatibility. EU leaders approved the CBAM in 2020 as a new own resource to help the fund the EU budget including the historic 750 billion euro mutualized debt agreement to finance the Next Generation EU Recovery Fund.
The Commission will argue that a majority of the EU member state Next Generation pandemic recovery plans recently are dedicated to climate-related initiatives. But anybody who has ever read a European Court of Auditors report knows that member state funding commitments agreed in the Council and the European Parliament and what happens on the ground can be separate realities.
Red flags about a CBAM have already been raised by some of the EU's leading trade partners. This includes the United States, whose chief climate envoy John Kerry, warned in April that it posed serious challenges for trade and the EU-U.S. relations. Other countries including China, Russia, Turkey, Brazil, India and South Africa have done the same.
Obviously the global warming emergency and the Paris climate agreement to address it require systemic change from all countries. And the Fit for 55 package will call for an unprecedented EU paradigm shift. But is the CBAM a gamble worth taking if it could trigger a trade war in the midst of a pandemic and undermine global cooperation needed to combat climate change?
If carbon footprint analysis was an exact science and subject to an international agreed methodology the answer would be yes. But since it is not, the CBAM will likely pose more risks than rewards if the EU member states and the European Parliament approve it.
