Trilogue agreement on “EU climate toll” (CBAM): core problems remain unsolved

By levying a kind of "EU climate toll" on certain goods imported into the EU, the aim is to compensate European companies for competitive disadvantages due to climate-related additional costs of the EU Emissions Trading Scheme (EU ETS). This is to be achieved by requiring companies importing into the EU to purchase so-called "CBAM certificates" in order to pay the difference between the lower or not-existent CO₂ price in the country of production and the allowance price in the EU ETS (see cepPolicy Brief 5/2022). The CBAM is to be introduced from October 2023 - in a transitional period only with the obligation to report the required CBAM allowances - and will cover the following products: Iron and steel, cement, fertilisers, aluminium, electricity and hydrogen, as well as some intermediate products and a limited number of downstream products. Indirect CO₂ emissions would also be covered in a "well-circumscribed manner".

To avoid double protection of EU industry, the length of the transition period and the full implementation of the CBAM will be linked to the planned phase-out of free allowances under the EU ETS. This has yet to be agreed as part of the ongoing negotiations on the EU ETS. Measures to prevent the relocation of production and CO₂ emissions ("carbon leakage") in exports are still unresolved.

cep assessment:

European Parliament rapporteur Mohammed Chahim mistakenly praised the proposed CBAM as "[...] an alternative to our current carbon leakage measures, which will allow us to apply the polluter pays principle to our own industry." This fails to recognise that EU emissions trading does not aim to implement the polluter pays principle. Rather, it aims to reduce CO₂ emissions both effectively and as cheaply as possible. So instead of forcing all industrial plants to make the same CO₂ reductions every year in lockstep at unnecessarily high costs, only the total amount of emission reductions is determined by the decreasing amount of allowances. Then, through emissions trading, companies can arrange among themselves who will provide the CO₂ reduction at the lowest cost. This principle also works with the granting of free allowances. For a company will always decarbonise if its CO₂ avoidance costs are lower than the ETS-allowance price. Emissions trading already provides the same incentives for companies to decarbonise as after the introduction of the CBAM, when all allowances must be purchased. This is because those who are allocated free allowances can sell their allowances and thus finance the decarbonisation investment if the allowance price is correspondingly high. Otherwise, however, the free allowance protects them from foreign competition, which has to bear no or lower CO₂ costs.

Therefore, the need to introduce a CBAM as a replacement for free allowances to protect against carbon leakage is mere window-dressing. Moreover, a CBAM can only inaccurately reflect the CO₂ emissions "embedded" in products or prevent manipulation. Therefore, as carbon leakage protection, it does not offer a complete replacement for the expiring free allowances (see cepStudy of 13 July 2021). Especially for the export sector, even after the provisional trilogue agreement that has now been reached, there is still no functioning solution in sight that would also be compatible with the rules of the World Trade Organisation (WTO). There is still a danger that the export sector will be left without a solution and ultimately suffer massive competitive disadvantages on the world markets. Moreover, there are serious fears that the EU will provoke trade conflicts with its CBAM. Even the alleged WTO compatibility of the CBAM is disputed, and corresponding lawsuits are considered a "complete nightmare" by some WTO staff. It may also block the path to an international climate club, as is now being sought by the G7 countries. A climate club with a minimum CO₂ price would not be compatible with a fluctuating price for emission allowances and CBAM certificates and would lead to carbon leakage not only to non-members but also to club members with the lower minimum price.

There are better ways to achieve the desired climate targets while maintaining the competitiveness of European industry and encouraging other countries to step up their climate protection efforts (for more on this see "Why the EU Should Abandon Its Unilateral 'Carbon Toll'", Common Ground of Europe from 16 November 2022). We can only hope that someone will pull the emergency brake and modify the EU's CBAM plans accordingly.

Dr. Martin Menner

cep Expert EU Climate Policy