EU’s carbon border levy risks death by a thousand cuts

— By Paola Tamma
July 6, 2021, 6:11 pm | View in your browser

To see a chart about the countries most exposed to an EU carbon borderlevy, view this article in your browser.

This article is part of POLITICO’s Fit For 55 series.

It is fitting that the European Commission is finally set to propose a carbon border tax on France’s national holiday on July 14: Bastille Day.

It was, after all, the French who led the charge for a revolutionary new levy to be imposed at the EU’s ports and border crossings to shield Europe’s industries from cheaper imports made in places with laxer environmental rules.

As with the original Bastille Day at the beginning of the French revolution, however, the big question is now whether everything will descend into a bloody spate of feuding where many of the nobler intentions behind the reform are lost. The biggest danger is that the proposal will be diluted beyond recognition amid a series of compromises to please opponents ranging from trade partners like the U.S. and China, through to Europe’s own domestic industries.

Most worryingly for Brussels, the all-important Germans — rarely fans of revolutionary change — are still wavering on whether a carbon border levy is the best way to protect European companies that feel that they have been put on an uneven playing field by the bloc’s green rules.

The international pressure against the EU is already building to a fever pitch. The proposed tax, a recent draft of which was obtained by POLITICO, has already managed to rile big hitters in global trade, who could take legal action against Brussels at the World Trade Organization.

China’s President Xi Jinping told the the Europeans in April not to let the battle against climate change become an excuse for “trade barriers,” while Australian Trade Minister Dan Tehan told a POLITICO event last week that the EU carbon levy ran “the risk of enhancing protectionism.”

“Of course, this will be disputed in WTO,” Pascal Lamy, a former director general of the WTO, said in an interview. Russia, Canada, Turkey, Qatar and Saudi Arabia have all also raised objections, according to an official in the WTO’s home base in Geneva.

Skepticism from the U.S. is perhaps the single most significant hurdle, with U.S. Trade Representative Katherine Tai refusing to rule out retaliatory tariffs.

The tensions with Washington lay bare the potentially messy battlefield on which carbon levy politics are likely to be played out next. Europe repeatedly insists that it will not apply the tax to countries that have the same level of environmental ambition as the EU does, opening up the prospect that Brussels will agree a scrappy patchwork of bilateral deals with countries to weigh up exemptions for them based on their green agendas.

In the case of the U.S., Europe sounds highly accommodating. Europe’s Green Deal chief Frans Timmermans is signaling that America could avoid being hit by the carbon border tax based on its pledge to go climate neutral by 2050.

“Our partners might use different methods, they might use regulation, they might use taxation, it doesn’t matter what sort of measure you take, if you undertake measures to make sure that you aim for the same goal, which is climate neutrality by 2050, then you can avoid being targeted by a carbon border adjustment mechanism,” Timmermans told his counterpart U.S. Climate Envoy John Kerry at an event held by the European Bank for Reconstruction and Development last month.

Europe’s immediate neighbors may well not be so lucky in winning exemptions from Brussels and fear they are most likely to feel the hardest impact from the EU measure, which will initially target imports of steel, cement, power, aluminum and fertilizers.

“This measure will outweigh all the EU assistance to Ukraine, I mean, technical and humanitarian, everything else,” complained Roman Andarak, acting head of Ukraine’s mission to the EU. The bloc is Kiev’s largest trading partner, to which it exports steel and electricity. The government estimates the EU measure would cost it about €3.5 billion to €4 billion per year. Turkey is also highly concerned.

The Commission has painful memories about how lofty green goals ran slap bang into bare-knuckle Realpolitik, in a similar episode a decade ago. When Brussels wanted to tax airline emissions for all jets departing or landing in Europe, the U.S. and China forced it to backtrack. Washington passed a law banning its companies from complying with the EU’s airline emissions tax, while China simply threatened not to buy Airbus jets.

Germany on the fence

Even within Europe, the measure has failed to win a large fan base.

EU leaders called for the levy as part of a package of new EU revenues that should pay back the bloc’s debt-fuelled, post-coronavirus recovery package. But by raising €2.6 billion in 2030, according to the draft, “the contribution of [a carbon border levy] to paying back the recovery fund will be rather limited,” said a senior EU official — largely losing its appeal. By contrast, the recovery fund is €750 billion, of which more than half (€390 billion) is composed of grants that will have to be repaid by 2058, plus interest on €360 billion of loans to be repaid by EU countries.

France is the leading voice in favor, and rallied support from eight other EU countries — Austria, the Czech Republic, Denmark, Lithuania, Luxembourg, the Netherlands, Slovakia and Spain. But it remains to be seen whether French backing will be sufficient to pull the measure through the Council — where it needs the backing of a qualified majority of EU countries.

Crucially, Germany — Europe’s largest exporter — is ambivalent about it, advocating caution above all. German industry is worried that such a levy would increase the price of its key exports — cars and machinery — which are intensive users of steel. “Having a carbon price as an incentive has a cost effect – it comes with competitiveness issues,” said Carsten Rolle, head of energy and climate policy at Germany’s business confederation BDI.

In a document detailing Germany’s stance on the bloc’s climate policies, Berlin writes that “all opportunities and risks potentially associated with the carbon border adjustment mechanism or alternative approaches should be carefully identified and weighed against one another,” highlighting especially “compatibility with WTO law, practicability, compatibility with international climate agreements, impacts on developing countries and the signaling effect for trade policy” as potential issues. That’s hardly rapturous support from the German camp.

“What they fear is retaliation against EU exports based on carbon. And it happens that the carbon content of Germany’s exports is on average, very high, very high,” said Lamy.

As a way of avoiding all-out trade wars, Berlin has pitched “an international climate club on which we will cooperate with the U.S. and our most important trading partners and coordinate our climate policies and international policy measures,” German Finance Minister Olaf Scholz told reporters last month.

That is a deliberately vague counter plan from the Germans and the Americans aren’t too sure what it means either. U.S. trade chief Tai said this overture to co-operate in a climate club was “really interesting” but “would benefit from further elaboration.”

Fundamentally, however, what Scholz is talking about is simply miles from the core plan that Brussels and Paris have in mind: the U.S. has no federal carbon price, China is in the process of setting up its own carbon market, but for now the prices are low and the coverage limited. If the EU were to exempt the world’s two largest emitters from its scheme, in the attempt to avoid a new trade war, it would defeat the purpose of the levy, and land the EU in uncertain legal waters.

Fears from business

Industry has broadly welcomed the idea of a tax to prevent unfair competition from dirty rivals, but is trying to add in a bundle of caveats. The central fear hinges on what happens to existing perks to address carbon leakage — the risk of EU industry decamping to places with looser environmental rules — once it is introduced.

Currently, EU installations get a free quota of emissions under the bloc’s Emissions Trading System — a cap-and-trade carbon market — according to their efficiency. The number of allowances allocated for free is gradually decreasing, just as the carbon price has increased tenfold in under four years, breaching the key threshold of €50 per ton of carbon dioxide earlier this year.

“With the increasing carbon price … it’s clear that the costs will become unbearable for the industry. We need a type of additional instrument to prevent carbon leakage from the industry,” said Axel Eggert, director general at Eurofer, the European steel lobby. 

Europe’s steel industry only wants to be part of the experimental phase of the carbon border levy if it gets to keep free allowances throughout this decade, as the sector bosses wrote in a letter to Commissioners

The cement industry is on the same page: “Free allowances need to be there till 2030 in full force,” said Koen Coppenholle, chief executive of European cement association Cembureau.

They have already applied lobbying pressure to the Parliament, getting MEPs to change their stance on the levy at the last minute to ensure that gratuities are maintained in full.

That’s a no-go for the Commission, which said in a draft that a border levy would be “alternative” to the free emission quotas. As far as Brussels sees it, companies shouldn’t be protected at the border and get a cash windfall.

Instead, the Commission is thinking of a transition period during which the carbon border levy is introduced and free allowances are gradually removed. “The possible solution is a phase-in-phase-out mechanism in which the two things coexist for a while but without overcompensating the beneficiaries. This is key to WTO compatibility,” said the senior EU official, adding that this is one of the issues currently being debated in the Commission. The draft limits itself to saying that the obligation to buy import certificates shall “reflect the extent to which EU ETS allowances are allocated free of charge” and that the Commission will set out in secondary legislation “the calculation methodology for the reduction.”

What is clear is that industry will fight tooth and nail to keep as much as it can for as long as it can: “It’s a political question, whether we still receive free allocation or not. Purely political, it’s not technical,” said steel industry lobbyist Eggert.

Kalina Oroschakoff and Jakob Hanke Vela contributed reporting.