Comment: Carole Ferguson of Industry Tracker says the niche border tax planned by the EU to help its emissions trading scheme operate more effectively could have positive impacts on carbon pricing beyond its borders
Global carbon markets that put a price on carbon are a key lever for pricing in and tackling climate change. They were also a key discussion point at COP26, with proponents including Angela Merkel through to Prince Charles. But many still felt that not enough progress was made.
There was simultaneously a climate policy slowly working its way through the echelons of the EU, and quietly discussed at the summit, which could provide the backdoor to a global carbon price: the carbon border adjustment mechanism (CBAM).
Our research on the European steel sector found that current trajectories would see the industry exceed its carbon budget in 2035
After years of negotiations to address how carbon credits can be traded between countries, some progress was made at COP26, with a new structure for how these credits can be accounted for. However, a number of areas still need to be addressed to improve quality and transparency in generated carbon credits. It is clear we are still a long way off a truly global carbon trading scheme, and time is not on our side.
Indeed, for many of the high-emitting sectors that would be regulated by these carbon schemes, and incentivised to cut emissions, they are nearing the end of their carbon budgets and will soon be in breach. Our research on the European steel sector, for example, found that current trajectories and use of business-as-usual technologies would see the industry exceed its carbon budget in 2035, threatening the EU’s ambition to reach net zero by 2050.
If you compare the carbon markets established globally since the Kyoto protocol, from the U.S., to the EU, to China, the approaches are different while the pricing and the success of implementation fundamentally varied. The U.S. doesn’t even have a national approach or a consistent price within the country itself. How likely is it, therefore, that we can splice and dice these together and achieve global agreement and cooperation in time? Especially given that countries and regions are still announcing and working to different climate goals, as well as timescales to deliver on these.
And even the EU Emissions Trading Scheme, which is commonly thought to be the most progressive of the schemes, hasn’t been functioning properly, with the supply and demand part of the equation not working. Instead of letting the price move, based on how much emissions need to be reduced, high-emitting companies have been given free allowances, which have effectively removed the cost of emitting and taken away the incentive to decarbonise.
This practice, known as “grandfathering”, sounds counter-intuitive, and in many ways it is, but there is logic behind it. For globally traded sectors, such as steel, European companies would have been killed off if they were being penalised by high carbon prices, whilst competing with international companies not operating under high carbon prices and able to “dump” their products into Europe without penalty. This has supressed demand for trading permits and weakened the carbon price in the EU.
In this context, the CBAM, being proposed by the EU, could be our best bet and should be a key priority for the EU, and also globally.
This mechanism would regulate domestic carbon intensive production and tackle the longstanding issue of carbon leakage, which is where production shifts to countries with less stringent climate policies.
While the EU parliament has endorsed the CBAM, its smooth implementation and effectiveness remains a concern
Combined with the more ambitious targets of the EU’s next trading period to 2030, it would also stimulate the EU ETS to start functioning more as a market, boosting the price, and reflecting the actual emissions cuts required by heavy industry. What’s more, the taxes generated from the CBAM – estimated to be in the range of €5 to €14bn a year, depending on its design and scope – would provide significant capital to be allocated towards activities and investments that could drive the transition to net zero.
While the EU parliament has endorsed the CBAM, its smooth implementation and effectiveness remains a concern. The EU wants it to be consistent with WTO rules, which brings some complexities, and more lobbying could take place by trading partners negatively impacted by the CBAM, as well as companies within the EU ETS that are reluctant to let go of free allowances.
It is also not clear whether other countries such as the U.S. will adopt the same approach. The CBAM is due to kick off in 2023/24, and the detail is still being ironed out. But it would represent a significant regulatory step forward and could be ground-breaking for the decarbonisation of high-emitting sectors not only in the EU, and also globally.
By levelling the playing field for imports and exports, and mirroring the carbon prices within the EU emissions trading scheme for those operating outside of it, this niche border tax could have a significant impact worldwide. If successful, it could end up creating a form of global carbon market at a time when this could not be more needed.
Carole Ferguson is managing director and co-founder of Industry Tracker, the climate research house for investors.