Trading Thoughts on the EU’s Carbon Border Adjustment Mechanism

For the first time in its twenty-eight year history, the 2023 United Nations Climate Change Conference, more commonly known as COP28, included an entire day dedicated to the role of international trade policy in addressing climate change. While trade and climate policy have largely been at odds to date, global leaders are more actively leaning on trade policy to decarbonize, including through individual action. In our first in a series of upcoming posts on “Trade & Climate,” we will explore the European Union’s Carbon Border Adjustment Mechanism (CBAM).

Last October, the EU launched the world’s first CBAM. Countries around the world will be watching the EU’s implementation closely, as it taps into trade policy to incentivize other countries to develop climate-friendly policies. This could determine whether we see greater climate cooperation or head faster down the path of trade protectionism.

The EU CBAM will impose a fee at the border on imports of certain high-emitting goods: iron, steel, cement, fertilizers, aluminum, electricity, and hydrogen. This fee will be based on the carbon emitted during production in the country of origin. The goal is to ensure that these goods are subject to the same carbon price that the bloc’s domestic industries pay under the Emissions Trading System (ETS). In doing so, the EU hopes to prevent carbon leakage, which occurs when strict environmental regulations cause industries to move to countries with more lenient standards.

Until 2026, importers will only be required to report on their CBAM exposure, providing them time to establish processes for collecting and reporting relevant data. In 2026, the CBAM will start to take effect as the EU gradually eliminates free allowances under the ETS. By 2034, the free allowances will be gone and the CBAM will be in full force. At that time the European Commission will assess the program and determine whether to expand its scope, potentially to include all sectors currently covered by the ETS.

The global response to the CBAM has been mixed so far. High-emitting countries like India and China have disputed the tariff’s legality under World Trade Organization rules and argued that it violates the “common but differentiated responsibilities” principle established in the Stockholm Declaration and adhered to in the Paris Agreement. The lack of a carveout for least developed countries has stoked fear that the fee will disproportionately impact countries that face the most urgent development needs and the most acute risks of climate change. 

To fully realize its goals, the EU will need to entice other countries to implement similar programs. The United Kingdom announced its own CBAM last December, but the plan is still very much in development and could potentially differ from the EU’s.

Another major hurdle for global CBAM adoption is that domestic carbon taxes are politically fraught in many countries, including the United States, where the Inflation Reduction Act (IRA) avoided punitive measures in favor of tax incentives for clean production. But even the IRA has prompted blowback from trading partners who believe it violates trade rules; and several European countries are now considering their own green industrial policies to compete with the U.S., hinting that unilateral climate policies could accelerate the turn toward trade protectionism.

A patchwork of industrial policies and carbon measures with differing methodologies will create global inefficiencies and challenges, especially for small businesses and economies. The EU instead hopes that its CBAM will be the first step toward a broader global climate strategy. That mission will depend significantly on how the U.S. and other major economies decide to use trade policy to reduce emissions, and whether there will be a concerted effort to collaborate and align policies globally.  

Coming up in our “Trade & Climate” series, we will explore recent U.S. legislative proposals on carbon emissions and border measures, as well as the ongoing U.S.-EU negotiations on a green steel and aluminum initiative.