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This article comes from the spring 2020 edition of the FORESIGHT Climate & Energy magazine, which was largely written before, or at the beginning of, the Covid-19 pandemic.
The use of trade mechanisms to spur climate change action in other countries is an approach the EU has increasingly employed since the 2015 Paris Agreement
LEAKAGE CONCERNS
Fears that industry could move out of Europe to countries with less strict emissions reduction regulations have been voiced ever since the EU introduced its Emissions Trading System 15 years ago. The EU is now examining how it can introduce a carbon border tax and use trade as a means to push climate action around the world OPPOSITE EFFECT
There is a danger the EU’s efforts could backfire and do more harm than good in terms of climate action KEY QUOTE
“There is no point in only reducing greenhouse gas emissions at home, if we increase the import of carbon dioxide from abroad” The EU continues to ratchet up its leadership on international climate action, filling a void left by the reticence of major emitting nations such as the US and China. The trading bloc’s latest response to the mounting climate crisis, the European Green Deal, sets out how member states will collectively pursue the EU’s goal to be carbon neutral by 2050 and addresses all sources of emissions: buildings, transport, energy, industry and food supplies. The goal is regarded as ambitious, but as always the devil is in the details. Key to ensuring that all the efforts within Europe’s borders are not undone by businesses simply moving outside the bloc — so-called carbon leakage — is a proposal to introduce a carbon border adjustment. Essentially the proposal is a carbon tariff on goods imported to the EU from regions where similar climate ambitions are lacking. Since the inception of the EU Emissions Trading System (ETS) in 2005, some industries have campaigned furiously for measures to ensure it does not harm their competitiveness. For years, this opposition led to major CO2 polluters being allocated emissions allowances for free to shield them from the full cost of carbon. Despite various reforms aimed at removing the shield, some sectors are still benefitting, such as power generators in certain EU member states who get free allowances to help them modernise. And concerns about carbon leakage continue, with industries and lobbyists increasingly worried about how going carbon neutral could negatively impact European business. Many cite the manufacture in China of most solar panels and batteries as an example of the perceived leakage problem. Manufacturing costs are lower in China, which has bigger reserves of the minerals needed to make these products. “There is no point in only reducing greenhouse gas emissions at home, if we increase the import of CO2 from abroad,” European Commission President Ursula von der Leyen said at the World Economic Forum in Davos in January 2020. “It is not only a climate issue; it is also an issue of fairness. It is a matter of fairness towards our businesses and our workers. We will protect them from unfair competition. One way for doing so is the Carbon Border Adjustment Mechanism. I prefer to encourage our trading partners to work with us for a global level playing field, for the benefit of all of us.” The editorial board of the Financial Times agreed the introduction of such a mechanism was “a necessary step, but it must be taken with care”. TRADE AND CLIMATE The use of trade mechanisms to spur climate change action in other countries is an approach the EU has increasingly employed since the 2015 Paris Agreement. In early 2018, the Commission announced that new free trade agreements would contain strengthened provisions on trade and climate change, including a shared commitment to the implementation of the global agreement and close cooperation in the climate change fight. There is often a disconnect between trade and climate negotiations, says Damien Bruckard, deputy director of trade and investment at the International Chamber of Commerce (ICC), welcoming the focus the EU is bringing to the twin pillars. “We really want to get climate change on the [World Trade Organization’s] agenda,” he says. “Climate change is clearly a global issue. The same governments that have signed the Paris Agreement are also members of the WTO, but do not explicitly talk about climate change there. This important link should be made since trade can help or hinder our efforts to resolve the climate crisis.” For its part, the EU has said that any carbon border levy would be “WTO compliant”. Von der Leyen, in her political guidelines, emphasised that the adjustment mechanism would initially apply to “a number of selected sectors” before being extended. The cement sector is widely mooted to be first in line, but all industry sectors across Europe are waiting to see the full proposal in 2021 and are looking to the French government — which has long called for a border carbon tax — for clues. “It is pretty clear our sector will be one of those being looked at, along with steel,” says Koen Coppenholle, chief executive of the European Cement Association (Cembureau). The French government’s proposal is for the border carbon adjustment to be applied with the same benchmarks used to allocate free allowances under the ETS, with the levy applied based on the difference between the benchmark — which is derived from an average of the emissions from the most efficient installations in a sector — and actual emissions, explains Coppenholle. “That is the proposal we have been looking at,” he adds, though insists discussions are ongoing. Cembureau wants the carbon adjustment mechanism to be used as a complement, not an alternative, to free allocation. The current EU ETS is in place until to 2030 and it is against this regulatory framework that companies have been planning investments, says Coppenholle. Free allowances address the risk of EU companies relocating outside the bloc, while the cross-border mechanism looks at the carbon footprint of imported products, he points out. STEEL AND CEMENT In the wake of the Green Deal, the European cement industry in January 2020 expressed its ambition to achieve carbon neutrality along the cement and concrete value chain by 2050, with a roadmap due to be published in the first half of the year. “Our industry feels it needs to take up its responsibility towards society, and innovation is at the heart of this,” says Coppenholle. “Keeping the cement industry in Europe means keeping innovation in Europe and jobs in Europe.” While welcoming the European Green Deal, Charles de Lusignan from the European Steel Association (Eurofer) says it will require the steel industry to “completely change” the way it operates. Further, the linear reduction factor in the EU ETS – whereby the emissions cap declines by 2.2% each year from 2021 – means the steel industry will needs to invest in new technologies such as hydrogen energy. De Lusignan warns this spending could push up the cost of steel by 35-100%. Decarbonising steel production will annually require an extra 400 terawatt hours (TWh) of electricity by 2050 — about seven times current grid purchases by the steel industry — of which 234 TWh alone will be needed for the production of 5.5 million tonnes of hydrogen. “We can do these things, but none of them are free — we need to pay for them,” he says. Even with an element of free allocations shielding firms from the full impact of the European carbon price — which jumped to €25 a tonne of CO2 in 2019 — there is still a carbon cost which producers outside Europe do not face and which makes the case for border carbon adjustments, de Lusignan says. Introducing the border tariff does not mean industry can do away with free allocations as it still needs to compete for market share outside Europe, he says. In 2018, the European steel sector exported just shy of 21 million tonnes and imported just over 29 million tonnes. The consensus view is that the EU’s planned border carbon adjustment combined with climate change provisions in all new trade agreements will be aimed at leading other regions to introduce carbon pricing, which in turn would support further renewable energy capacity being built. “We understand it is the intention of the Commission, as soon as it announces the cross-border mechanism, to start negotiations with other countries to discuss CO2 emission reduction plans in their jurisdictions,” says Coppenholle. “It is clear the EU is making this a part of trade discussions and this is positive as it addresses the carbon footprint of imported products.” INTERNATIONAL PUSH BACK The backlash against the EU’s plans has already begun, however, with the US threatening retaliation and a Chinese government advisor warning they could harm otherwise “friendly” cooperation at the UN climate talks. US President Donald Trump – no stranger to slapping tariffs on trade partners for perceived disadvantages to American businesses — is withdrawing the country from the Paris Agreement and his administration is systematically rolling back environmental safeguards across the economy. The withdrawal from the 2015 accord is complete the day after the 2020 presidential election – a fact which some are hoping could see the US staying in after all, should presumptive Democratic candidate Joe Biden be successful. China is set to launch its national ETS later this year, building on regional pilot systems which have been in place since 2013. Initially targeting the power sector — capturing some 1700 entities with emissions of 4.5 billion tonnes of CO2 in 2019, according to analysts Refinitiv — the system will gradually roll out to cover industrials and aviation. China’s efforts on emissions trading are significant. Even when its ETS is applied to just part of the power sector, the 4.5 billion tonnes is more than twice the roughly two billion tonnes of CO2 covered by the EU ETS, still the world’s largest cap-and-trade system. The ICC’s Bruckard maintains that action at the WTO level would be the best “but always the slowest” option. Given that a regional approach is the next best option, the EU’s plans are welcome, he says, mindful they could be seen as protectionist measures in disguise. Ultimately, he takes a pragmatic view of the EU’s intent. “The first policy developed is not going to be foolproof, but we need to get moving now. We are not talking about climate change, we are talking about a climate crisis. We are also seeing a crisis of governance and there is a sense that more needs to be done, but many governments are increasingly up to the challenge.”
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Katie Kouchakji
PHOTO
Yuangeng Zhang