Chairman’s Message

Tatsuya Terazawa

Tatsuya Terazawa
Chairman and CEO
The Institute of Energy Economics, Japan

Chairman’s Message
“CBAM vs. International Trade"

Message for April 2024

After a three-month deadline extension, the EU’s CBAM (Carbon Border Adjustment Mechanism) is just about to complete its first quarterly reporting of the transitional period. As CBAM’s full implementation is scheduled for January 1st 2026, I believe it is time to assess its potential impact on international trade and to adopt necessary measures needed to address any negative impacts.

<Main Points>

  • The impact of CBAM on international trade needs to be assessed.
  • CBAM is proliferating in its product coverage and introduction by countries.
  • CBAM could impede economic growth through trade.
  • CBAM could be discriminatory against imports.
  • CBAM could be inconsistent with its objective to address climate change.
  • CBAM does not allow for diversity in approaches to address climate change.
  • CBAM adds to administrative costs of smaller countries and SMEs.
  • New Global discipline for environment related trade measures is required.

  • 1. CBAM could have substantial impact on international trade

     CBAM imposes de-facto import tariffs on specific products, calculated by multiplying the embedded carbon emissions of the imported product by the prevailing EU ETS auction carbon prices. Any carbon prices paid at the country of origin can be deducted from the de-facto import tariffs.
     The rationale of CBAM to prevent carbon leakage is legitimate. But the imposed de-facto tariffs could have substantial adverse impact on international trade. After World War II, the global economy has grown through a dramatic expansion of international trade, primarily led by a series of tariff reduction. The emerging/developing economies greatly benefitted from trade liberalization. I believe that we should assess the impact of CBAM on international trade before it is fully implemented.

    2. The proliferating nature of CBAM could magnify its impact on international trade

     When EU first announced its plan for CBAM, the original five sectors subject to CBAM were iron & steel, cement, aluminum, fertilizers and electricity. But, as expected, the target sectors have already been expanded to include hydrogen and certain down-stream products such as screws and bolts made of iron or steel. It is specifically provided that the list could be further expanded to include organic chemical products, other down-stream products and up-stream precursors.
     As long as there is alleged carbon leakage, EU industries could theoretically demand protection from imports by CBAM and, as a result, CBAM could proliferate to cover an even wider range of sectors. The world could end up with de-facto import tariffs covering many products and that would be in direct opposition to the goal of the past several decades of trade liberalization, as aimed at under GATT/WTO and various FTAs.
     CBAM could also be copied by the trading partners of EU who may wish to protect their own industries as well. Already some countries are discussing the possibility of introducing their own CBAMs; the UK has announced its intention to introduce its own CBAM in 2027. This is another example of the proliferating nature of CBAM.
     Before the full implementation of CBAM, I believe that we need to stop and ask ourselves, “Do we really need to impose de-facto tariffs on screws and bolts to address global warming? What is the impact of screws and bolts on the global climate?” Without such serious questioning and scrutiny, CBAM could proliferate to cover many more sectors and countries.

    3. CBAM could impede economic growth through trade

     International trade has been the economic engine for the world since World War II. In particular, trade liberalization has greatly helped the emerging/developing economies to develop and grow out of poverty.
     But CBAM, with its proliferation, could impede growth of the global economy through trade. As many countries in the Global South may have higher level of carbon contents in their products, they will most probably be subject to higher de-facto tariffs under CBAM and this would certainly impede trade with those countries.
     One of the problems of CBAM is that it will be applied to all countries regardless of their export volume to EU. While it may be justified to target countries with large export volume to avoid significant carbon leakage, the need to put de-facto tariffs on imports from countries with modest volume is less convincing. In fact, 57-79% of the imports by EU of the four major product sectors, i.e. steel, cement, aluminum, fertilizers, are dominated by only 6 exporting countries.
     CBAM has no country-based exceptions other than the exceptions applied to some countries and territories that have adopted EU ETS or an ETS linked to it. Hence CBAM will be applied to imports from countries under reconstruction, including Ukraine. Before the full implementation of CBAM without exceptions, I believe that this aspect of impeding the reconstruction of countries such as Ukraine needs to be seriously considered.

    4. CBAM could be discriminatory against imports

     One of the justifications of CBAM is that the measures applied to imports are equivalent to the measures applied to domestic products. But this claim of the non-discriminatory nature of CBAM must be scrutinized more closely.
     Until the full auctioning of the emission allowances, free allocation of allowances for EU industries will remain in place while being gradually phased out over the period of ten years. On the other hand, de-facto tariffs will be imposed on imports in the target sectors in an “adjusted” manner to reflect this free allocation, but the precise details are not yet clear. Unless EU fully takes into account both the current free allowances and those issued in the past that have been carried over to the present, this could be discriminatory.
     Over the past years, sectors such as the EU steel industry have been provided with substantial free emission allowances. It is explained by EU that an allocation has been made for by-product gas, including blast furnace gas, but it is unclear how much might be considered excessive. It is also not clear to what extent the EU steel industry might have benefited from the allocation of allowances for by-product gas. Considering the magnitude of the allowances which have been allocated freely for the EU steel industry in the past, EU should give a very clear accounting for such questions. Otherwise, the accumulation of free allowances in the past could be considered discriminatory.
     Even for the current CBAM reporting, the obligation for importers is much heavier than for EU domestic products in the transitional period. Importers must report quarterly while EU ETS requires only annual reporting. CBAM requires product by product reporting while ETS is designed for facility(installation)-based reporting. CBAM requires reporting regardless of the size of the company while EU ETS requires reporting only from large emitters. CBAM requires reporting for precursors while this is not necessary for EU ETS.

    5. CBAM could be inconsistent with its objective to address climate change.

     Although the ultimate objective of CBAM is to help reduce the global carbon emissions, the current design of the EU’s (and the UK’s) CBAM could be inconsistent with this objective. If the imports are not already subject to the same level of explicit carbon pricing, de-facto tariffs could be imposed on product imports with less carbon contents than domestic EU/UK products. To serve the ultimate objective of reducing global carbon emissions, such imports should be promoted without imposing de-facto tariffs.
     This apparent inconsistency suggests that CBAM goes beyond the scope of protecting the environment and could be used to protect the EU domestic industries. Logically speaking, imported products with less carbon contents than domestic products should be exempted from the de-facto tariffs of CBAM. If the objective is to avoid carbon leakage, to prevent imported products with higher carbon contents prevailing over domestic products with lower carbon contents, the difference in carbon contents between imported and domestic products should be the basis of the de-facto tariffs and not the whole carbon contents of the imported products. If the difference is zero or minus, no de-facto tariffs should be imposed. If the difference is positive, de-facto tariffs should be calculated by multiplying the difference with the prevailing carbon price.

    6. CBAM does not allow various approaches to reduce GHG emissions

     CBAM allows deductions of explicit carbon price paid at the originating countries. But CBAM does not allow deductions for other various measures put into place in such countries. Tax on energy should increase the cost of imported energy resources and help reduce GHG emissions but CBAM does not account for such effects. Regulations could also help reduce GHG emissions, but CBAM does not take into consideration such policies.
     The G7 Climate, Energy and Environment Ministerial Communique last year made it clear that diverse and wide-ranging climate mitigation policy approaches deployed by each country should be considered in implementing instruments to address carbon leakage. It also stated that, not only explicit carbon pricing, but new regulations and tax policies should be considered in assessing the possibility of avoiding carbon leakage.
     CBAM only recognizes explicit carbon pricing and imposes its EU ETS carbon price levels on imports. As G7 and G20 Summit both recognized last year that there should be various pathways to achieve our common goal, I believe that more diversity and flexibility should be allowed in the implementation of CBAM. EU ETS is not the only way to achieve carbon neutrality.

    7. Administrative costs affecting smaller countries and SMEs

     Reporting is required for all the players related to the target sectors regardless of their size or export volume. The only very limited exception is for imports valued at less than 150 Euros. The reporting requirement could be prohibitive to exporters with modest volume or to smaller companies. Smaller countries may find it difficult to provide the necessary information.
     Additionally, if verification bodies are limited to EU organizations and those of the exporting countries are not accredited, unreasonable cost will be incurred. It would be more efficient if mutual recognition of verification bodies could be introduced.
     If different CBAMs require different emissions calculation and verification methodologies, compliance would become even more burdensome.
     In these regards, the G7 Trade Ministers’ Statement last year acknowledged the importance of cooperating to ensure consistency of measurement methodologies and of taking into account of the needs of business, particularly those facing capacity constraints.
     The original deadline to submit the first quarterly report was the end of January this year. The deadline has been extended by three months. As of the end of February, it was reported that less than 10% of German companies have registered to the EU platform. It remains as a big question how many importing companies can actually submit their reports by the extended deadline.
     There is another problem. Many non-European companies have concerns about disclosing their proprietary information to the EU authorities and to their importers. As of this point, it is not clear that sufficient safeguards have been provided by EU to protect such proprietary information.

    8. New Global Discipline for environment related trade measures is required

     I would like to stress again that the objective of trade measures to prevent carbon leakage is legitimate. But at the same time, this has to be balanced against the importance of expanding trade and respecting the long-held principles of trade.
     WTO was established before the rise in the importance of climate change policies. WTO, which includes GATT, does provide exceptions for environment related measures based on GATT Article XX. The discriminatory aspects and/or adverse impacts of CBAM should be taken into account under GATT Article XX in particular its chapeau. But still, there are no specific and detailed rules to govern such measures.
     As we are witnessing the introduction of broad environment related measures, led by CBAM, I believe that it is time to develop a set of principles to govern such measures balancing them with legitimate trade perspectives.
     The members of the G7 have a special responsibility to develop such a set of principles. It was the G7, especially the US and EU, who led the world to growth and prosperity through trade liberalization and the creation of WTO. Changing the WTO rules would require too much time. The G7 can develop a set of principles by themselves to govern climate change related trade measures while balancing the need to continue expanding international trade consistent with long held trade principles.
     The new principles could introduce the concept of “substantiality” in applying environment related trade measures. Such measures should be limited to products with substantial carbon contents, limited to sectors with substantial carbon emissions and be applied to countries with substantial exports. There is a similar precedent to this concept. Anti-dumping duties are limited to cases in which there are “material injury” based on the WTO rules. We can utilize such effective concepts.
     This substantiality concept could exclude many emerging/developing countries from the measures because their exports are generally not extensive. In addition, exceptions could be provided for the least developed countries (LDCs). In fact, WTO allows for exceptions for the least developed countries. This precedent could also be utilized.
     Non-discrimination could be another principle. Non-discrimination has been a key concept in the WTO rules. This could be elaborated more for environment related trade measures.
     Allowance of diversity in the measures to reduce GHG emissions could also be a very important principle. Minimization of administrative burdens, including mutual recognition and acceptance of verification bodies of the exporting countries, avoidance of fragmentation of emissions calculations methodologies, could be a helpful principle.

     I sincerely hope that there could be a constructive integration of legitimate climate change concerns with legitimate trade policy objectives. In the remaining time before the full implementation of CBAM, I sincerely hope that CBAM could be modified and adjusted reflecting the above concerns. I also hope that the G7 members would start discussing the new global discipline to govern environment related measures. The world is about to open the “Pandora’s Box” on broad trade restricting measures to address climate change with the full implementation of CBAM. It is much better to introduce the principles governing such measures before the damages to international trade and to the economic growth opportunity for the Global South are made.