Carbon Border Adjustment Mechanism (CBAM) : What are the Implications for Trade & China-EU relations?
This article was originally published in Italian in Panorama on 24th May 2023.
Please note that this is a courtesy translation of the Italian language article originally published in the Panorama Magazine Issue at: https://www.panorama.it/economia/meccanismo-di-adeguamento-del-carbonio-alle-frontiere-cbam-quali-implicazioni-per-le-aziende-europee
On April 18th, 2023, the European Parliament approved the legislation for the implementation of a Carbon Border Adjustment Mechanism (CBAM) as part of the European Union’s (EU) “Fit for 55 in 2030 package”, which is aimed at reducing greenhouse gas (GHG) emissions by 55 percent before 2030.
From this mammoth legislative change, we have the EU & China at an interesting crossroads in the global race for carbon neutrality, but where do China and EU interests intersect on climate action and how will EU/Chinese businesses involved be affected?
The Goals of CBAM
CBAM, according to the official press release of the European Parliament, will be rolled out in phases from 2026 to 2034 and will enable the EU to impose a carbon border tax on specific imports, initially covering six categories of products: iron and steel, cement, aluminium, fertilisers, electricity and hydrogen, as well as indirect emissions under certain conditions.
CBAM incentivizes non-EU countries to increase their climate ambition and to ensure that EU and global climate efforts are not undermined by production being relocated from the EU to countries with less ambitious policies. From both sides of the spectrum, CBAM is ultimately designed for the dual purposes of preventing EU companies from moving their production to places with less stringent climate policies outside the bloc – a scenario known as “carbon leakage” & leveling the playing field between EU firms and overseas competitors on some emissions-intensive products by equalising the carbon prices paid for EU products and for imports.
During a transition period from October 2023 to December 2025, non-EU manufacturers will only be required to report their emissions, providing CBAM certificates pursuant to the emissions in their imports. After that, a levy will be brought in gradually from 2026 to 2034, meaning that EU importers will have to pay for the goods to be imported reflecting the emissions generated in producing them.
CBAM & China
It should be noted that at the time of writing, China’s exports of products likely to be covered under CBAM account for less than 2 percent of its total exports to the EU, worth around €6.5 billion. Recent studies conducted have indicated that China’s aluminum and iron & steel industries would have to pay a combined RMB 2–2.8 billion (€264-€343 million) in carbon border taxes to the EU every year. This would likely mean incurring increased costs, which may be passed on through increased prices.
Therefore, in order to remain competitive and to maintain market share, manufacturers may have to find ways to reduce their product carbon intensity, improving energy efficiency, using lower-carbon fuels, and optimizing production processes, which is a positive step in the right direction in terms of climate control action on both sides of the divide.
CBAM & Trade Implications
Conversely, CBAM has also been subject to a certain level of criticism from China, identified as an indirect trade barrier, as the EU’s continued efforts to promote low-carbon rules and enhance its own industrial competitiveness have been construed as policies that restrict some of China’s most advantageous industries. Chinese government officials have criticized CBAM on a number of fronts, most notably at COP 27, citing the rules as a green tax on developing countries. China has since asked the European Union to justify its incoming carbon border tax at the World Trade Organization (WTO).
China has insisted that CBAM is not compliant with global trading rules & suggested holding multilateral talks on environmental measures. The EU has retorted that CBAM will be compatible with global trading rules, however, should the proposal be accepted, the bloc would likely have to defend CBAM in the WTO courts on the grounds of: legality; environmental goals; impact on trade; compliance with WTO rules; impact on developing countries.
The introduction of the CBAM (which is scheduled to be implemented in October and a cornerstone of the EU’s quest to reach climate neutrality by 2050) has the potential to further foster domestic technological innovation in China, moving firms based in China up in the global value chain, thereby reaping significant economic benefits as well as acting as much needed incentive for lowering carbon emissions.
For companies already in the market or looking to explore exporting to the EU, conducting carbon assessments of the affected products and establishing CBAM responsible business units should be put in place in order for reporting obligations to be met. On the global scale, the US, Canada and the U.K. among others are currently also looking into implementing similar mechanisms in the future, moving forward, international trade and a nation’s competitiveness will be measured by a brand new metric, carbon.
In terms of cohesion between the EU & China, the technological expertise and experience that European companies in China have accumulated working on decarbonisation with government stakeholders, non-governmental organisations (NGOs) and civil society in their home markets puts them in a strong position to contribute to not only reach the net zero targets of the EU (climate neutrality by 2050 by 2035, all new cars and vans registered in the EU are set to be zero emission) but also to China (peak carbon emissions by 2030 as well as carbon neutral by 2060.
As mentioned in the European Chamber publication published last year, Carbon Neutrality: The Role of European Business in China's Race to 2060, China’s success will be predicated on its ability to leverage as much expertise as possible. This will require providing European companies with increased market access and a level playing field on which to operate, so that they can make greater contributions.
A clear mutual benefit in this regard is that China is fertile for both receiving and developing European technologies. As the pace of the research and development (R&D) environment allows companies to commercialise new products faster than they are generally able to in Europe. As the innovation environment is largely less risk averse, there is an added incentive for European companies to further develop their products within the market as well as contributing to the carbon neutral revolution.
Curated by: Atty. Carlo D'Andrea, Vice President of the European Union Chamber of Commerce in China