The Carbon Border Adjustment Mechanism: ensuring fairness

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©NLMK, 2020.

This article is part of our special report The EU’s carbon border adjustment mechanism.

I want Europe to be a global advocate for fairness’, said President von der Leyen in her State of the Union address in September. But how do we design fairness into the Carbon Border Adjustment Mechanism (CBAM)?

The CBAM is an incredibly ambitious project, and as ‘fairness’ is often in the eyes of the beholder, how can we actually ensure we ‘level the playing field in a WTO-compatible way’, as the President argued in the same speech?

Ben De Vos is the CEO of NLMK International.

Our CBAM conundrum

The NLMK Group is an international steel producer, with over 52.000 employees worldwide. In Europe, we employ around 2.000 people directly, with manufacturing plants in Belgium, Denmark, France and Italy, and thousands indirectly – our contractors, service companies, suppliers, etc. Our business model primarily consists of producing semi-finished steel products (slabs) at our facilities in Russia, close to raw material deposits. We then ship these slabs to our sites in Europe, to transform them into finished products closer to our customers, including for the car, construction and offshore wind industries – last summer we supplied the steel needed for a next-generation floating offshore wind farm off the coast of Portugal. We not just employ people – we also add value in the EU: from 30% to 100% depending on the product, contributing to EU GDP and to EU exports abroad.

This all means we’re an EU importer, a local producer and an investor. What’s more: a recent assessment of our emissions – using the European methodology – showed that NLMK’s CO2 footprint is lower than the average of EU integrated producers and closer to EU best-in-class benchmarks. 

Making sure then the CBAM is fair – meaning that it ensures equal treatment of EU and foreign producers – will be crucial for the viability of the CBAM (including its WTO-compatibility), but also of particular importance to NLMK given our business model embedded in a global supply chain, and our CO2 footprint achievements to boot. 

An IAM for the CBAM: choosing a ‘superior policy option’ over ‘one size fits all’ 

We don’t have all the answers, so we asked two leading experts from MIT (at the Center for Energy and Environmental Policy Research) and the University of Cambridge (at the Energy Policy Research Group) to help us figure out what ‘fairness’ across borders could look like for the CBAM.

Their conclusions from this investigation can be found in a recently released study, in which the researchers propose a so-called individual adjustment mechanism (IAM) within the CBAM: a ‘superior policy option’, with significant economic, climate and legal benefits, and implementable in practice, building on the existing emissions reporting methodology & process. Such a mechanism would allow producers from outside the EU to demonstrate their actual carbon intensity relative to an established default value. 

For a combination of reasons, the Commission when designing the CBAM may consider a ‘default’ or benchmark value to determine the carbon intensity of imports – the scope of such a value could be EU-based or even global, and based on a ‘worst in class’ vs. ‘best in class’ criterion as outlined in the paper. Regardless, such a ‘one size fits all’ approach would run counter to the stated main objective of the CBAM – ‘fighting climate change by avoiding carbon leakage’: cleaner producers would get charged the same amount as higher-carbon producers – in direct contradiction to the legal principle that ‘the polluter should pay’. In addition, this approach also increases the risk of violating international trade law and of incurring international retaliation, as the CBAM’s justification on environmental grounds would be shakier.

Not reinventing the wheel: how the IAM would work

The CBAM with an IAM would allow producers to demonstrate their actual carbon intensity compared to the default value. It would be a voluntary mechanism, giving the option to EU importers to use the IAM, and allow for any foreign producer to be rewarded for their individual decarbonization efforts compared to more carbon-intensive importers or local producers.

To do so, importers would have to provide information documenting the actual emissions associated with production of the imported goods. This process would be the same as the one for domestic good under the EU ETS, following the established monitoring, verification and reporting (MRV) of emissions as part of an annual compliance cycle, including independent third-party verification.

The closing argument: the benefits of the IAM, alternatives & the next steps

Infographic: The EU Carbon Border Adjustment Mechanism.

Figure 1: ‘one size fits all’ vs. ‘Individual Adjustment Mechanism’

To conclude, there are major benefits to including an IAM as part of the CBAM: 

  1. It will provide a stronger economic incentive for foreign producers to reduce their carbon intensity, improving the prospects of the CBAM to reduce global CO2 emissions effectively
  2. Second, the IAM improves the CBAM’s chances of being compatible with WTO rules and non-discriminatory, supported by past case law as described in the study
  3. Third, it would level the playing field for low-carbon and relatively more expensive products vis-à-vis CO2-intensive goods, which are usually manufactured with lower costs. Opening the market for ‘greener’ products would promote the EU’s environmental goals and would further drive a change in the consumption patterns. 

As the Commission is now analysing the responses to the CBAM consultation, they will have to make several major decisions in the near future, including which policy instrument to use, and which sectors will be covered. To avoid unintended effects, including for downstream sectors which might witness an increase in production costs and thus be exposed to additional competition from abroad, the Commission might consider targeting a carbon charge at the consumption level as a priority option. 

If the final choice is for an EU Carbon Border Adjustment Mechanism, we would firmly argue that it needs to have an Individual Adjustment Mechanism – only then will it be effective in combating global climate change and be WTO-compatible. Then the EU can also claim to be a global advocate for fairness.

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