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EU Carbon Border Adjustment Mechanism: Using Trade to Achieve Climate Goals?

About the author: Lin Wei (LL.M Candidate, Class of 2022) is a contributor to Travaux. Her interests focus on international trade and international commercial arbitration. Lin holds an LL.B. degree from the Southwest University of Political Science and Law and is pursuing a master’s degree in international law from the East China University of Political Science and Law. She is a native speaker of Mandarin.

"Who really pays for all this CO2? Understanding the incidence of carbon taxation in the EU" available here.


Introduction


On July 14, 2021, the European Commission adopted and published a proposal for a Carbon Border Adjustment Mechanism (CBAM), which some media reports refer to as a “carbon border tax.” The EU Commission claims CBAM will be a “global solution” that solves climate change as a “global problem.” It will impose a carbon price on selective imports. CBAM aims to minimize “carbon leakage” from the EU to countries with less emissions constraints by aligning the carbon price to be paid on imports into the EU with the price paid under the EU’s Emission Trading System (ETS) for carbon emissions produced within the EU.


The EU has committed to become the first climate-neutral continent by 2050. The CBAM proposal forms part of its target of reducing carbon emissions 55% by 2030. The EU shows courage in introducing this climate policy employing trade measures that has not yet been tried elsewhere. However, there are concerns about the potentially trade-restrictive effects of this legislation and its compliance with WTO rules.


Context: the 2015 Paris Agreement and “Carbon Leakage”


The 2015 Paris Agreement leaves contracting parties to choose their own level of climate goals as nationally-determined contributions (NDCs) that reflect their “highest possible ambition,” and “common but differentiated responsibilities and respective capabilities, in the light of different national circumstances.” This has resulted in asymmetric climate mitigation policies among different countries. Moreover, the Paris Agreement does not provide any enforcement mechanism that would ensure states keep their commitments.


As a result, industries might relocate their power plants, factories, or other heavily polluting facilities to countries with less stringent emission constraints when the EU ETS or other similar carbon pricing rules raise their costs, which could increase their total emissions. To ensure that this trend of “carbon leakage” does not undermine the EU's climate objectives and drive away foreign investments (not explicitly claimed by the EU), the EU introduced CBAM.


As discussed previously, CBAM is a unilateral measure that charges certain products imported from non-EU countries on the basis of their carbon emissions in the production process. It requires importers to buy carbon certificates corresponding to the carbon price that would have been paid had the goods been produced under the EU's carbon pricing rules. The price of the certificates will be calculated depending on the weekly average auction price of EU ETS allowances expressed in € / ton of CO2 emitted.


However, certain third countries who participate in the ETS or have an emission trading system linked to the EU's will be excluded from the mechanism. These include members of the European Economic Area and Switzerland. The EU will revisit the exemptions in 2030 when the “trading partners should have put in place the decarboni[z]ation measures they have committed to, and an emissions trading system equivalent to the EU's.”


Debates under WTO Rules: Discriminatory Trade Restriction?


The EU stated that it has considered and ensured CBAM's WTO compatibility during the drafting stage but without any detailed legal analysis. As a response, some countries like Canada and the US are considering similar proposals. However, BASIC countries (Brazil, South Africa, India, and China) have expressed “grave concerns” regarding the usage of unilateral carbon border adjustment. It argues that these trade barriers are discriminatory and violate the principles of Equity and the UN principle of common but differentiated responsibilities and respective capabilities (CBDR-RC).


To analyze the legal compliance of CBAM, the first step is categorizing it under the General Agreement on Tariffs and Trade (GATT). There are debates on whether the charge imposed via CBAM falls within the concept of “ordinary customs duties” and “other duties or charges” under GATT Article II:1. It provides that a member is bound to impose a certain maximum of tariffs and is barred from charging a value in excess of ordinary custom duties or any other fees mentioned in its schedule of concessions. CBAM charges on imported goods, but on the basis of these items’ Processes or Production Methods (PPMs) instead of value or volume. These fees may not constitute ordinary duties, but can still be designated as “other duties or charges.”


With regards to the non-discriminatory principle under the GATT, the Most Favored Nation (MFN) clause requires the contracting parties to grant the same advantages, favors, privileges, and immunities to all like products originating in or destined for the territories of all other contracting parties (non-discrimination amongst foreign products), and the National Treatment (NT) clause requires contracting parties provide national treatment on internal taxation and regulation to imports from other contracting parties (non-discrimination against foreign products). It is possible that CBAM could violate the MFN principle if it exempts imports from certain countries with equivalent carbon pricing systems. It could also violate the NT rule because imported goods do not benefit from the same free allowance that is granted to local producers.


The last core question is whether discrimination either against MFN or NT obligations can be justified under GATT Article XX as a general exception. Articles XX(b) and (g) are the exceptions relevant to the climate issue. Article XX(b) deals with such measures as may be “necessary for the protection of life or health of humans, animals or plants”; Article XX(g) provides measures “relating to the conservation of exhaustible natural resources if such measures are made effective in conjunction with restrictions on domestic production or consumption”. Even if CBAM qualifies Article XX(b) or (g), it still needs to pass the chapeau test and prove that it is not an arbitrary or unjustifiable measure or a disguised restriction on international trade. There has been only one instance in which a country’s measure has met all of the tests necessary to qualify for an Article XX general exception defense.


Conclusion


When international cooperation on climate protection lacks efficiency and effectiveness, unilateral measures such as CBAM can inspire other states to adopt carbon emission restriction regulations. Meanwhile, according to the report published by the United Nations Conference on Trade and Development (UNCTAD) on CBAM’s potential effects, the EU might need to consider the trade impacts of its new climate change mechanism, especially in developing countries. Furthermore, the compliance issue of CBAM also indicates the need for a reevaluation of the WTO rules before it’s too late to deal with climate change.



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