Carbon Border Adjustment Mechanism (CABM)

The European Union (EU) has recently agreed to the world's first Carbon Border Adjustment Mechanism (CBAM), a tariff on carbon-intensive products such as cement and fertilizer. The purpose of CBAM is to deter carbon-intensive processes and encourage manufacturers to make their processes as "green" as possible. This levy will mirror the EU's carbon market price in order to prevent "carbon leakage," a phenomenon in which the EU's emission reduction efforts are offset by increased emissions outside the EU due to the relocation of production to countries with less ambitious climate policies or through increased imports of carbon-intensive products.

Purpose of CBAM

CBAM is intended to incentivize trading partners to decarbonize their manufacturing industry. It is part of the EU's "Fit for 55 in 2030" package, which aims to reduce greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels, in line with the European Climate Law. Carbon pricing is the primary mechanism the EU uses to encourage industry to decarbonize, and in order to meet its 2050 targets, these prices will need to rise significantly. CBAM extends the concept of carbon pricing to imports for the first time.

Scope of CBAM

CBAM will initially cover several specific products in some of the most carbon-intensive sectors that are at risk of "carbon leakage," including iron and steel (including some downstream products such as nuts and bolts), cement, fertilizers, aluminium, electricity, and hydrogen. The inclusion of hydrogen was recently added because it is mainly produced with coal in non-EU countries. The European Parliament has also indicated its intention to include plastics and chemicals by 2026 and all sectors covered by the EU Emissions Trading System (ETS) by 2030. This means that finished or semi-finished products such as cars could also potentially be included in the future. In addition, indirect emissions (those caused by the production of the energy used in the manufacturing process) may also be included in calculating the carbon content of an imported product "under certain circumstances" (which are still to be clarified).

Context of CBAM

CBAM has become even more relevant now due to rising energy prices in Europe, which make it harder for EU companies to compete against industry abroad. The removal of free allowances under the EU ETS, which will happen over a nine-year period between 2026 and 2034, will also affect certain sectors and pose particular challenges for exports. This is because EU producers will be required to pay their full domestic carbon costs, which industry representatives say will cripple certain sectors.

Concerns about CBAM

Companies and countries outside the EU may raise two main concerns about CBAM. Firstly, they may argue that it places a carbon charge on companies from countries that did not primarily cause climate change. For example, Mozambique's GDP could potentially drop by about 1.5% due to the tariffs on aluminium exports alone, according to the Center for Global Development. Secondly, they may argue that it is a form of protectionism, as it provides an advantage to EU companies over their foreign counterparts.

Comparison to the US approach

The United States has taken a different approach to decarbonization compared to the EU. Rather than pricing carbon, it has decided to subsidize decarbonization through tax credits that support the development of green technologies in the United States through its Inflation Reduction Act. However, many of these tax credits are conditioned on local content requirements, which experts say conflicts with World Trade Organization (WTO) rules and has escalated trade tensions with key US trading partners such as the EU, Japan, and South Korea.

Implications of CBAM

The implementation of CBAM is still being worked out, and it remains to be seen how it will be enforced and how it will affect global trade. It is possible that other countries may adopt similar measures in response to CBAM. Some experts have suggested that if countries do not adopt similar carbon pricing mechanisms, it could lead to an increase in carbon leakage as companies relocate to countries with less stringent regulations. Additionally, it is possible that CBAM could lead to trade disputes and potentially even a trade war if it is perceived as protectionist.

Conclusion

The Carbon Border Adjustment Mechanism (CBAM) is a new levy on carbon-intensive products that the European Union has agreed to implement in order to incentivize trading partners to decarbonize their manufacturing industry and prevent "carbon leakage." While the scope and implementation of CBAM is still being worked out, it has the potential to affect global trade and may lead to trade disputes if it is perceived as protectionist. The EU's decision to adopt CBAM as a means of addressing climate change stands in contrast to the United States' approach, which has focused on subsidizing decarbonization through tax credits. It remains to be seen how CBAM will be enforced and what the implications will be for global trade and the environment.

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