EU's ecological "weapon": how the world will be encouraged to reduce carbon emissions
How will the EU set import duties based on carbon emissions in the exporting country?
This question was one of the most discussed aspects of the European Green Deal. And it's not surprising, because the carbon border adjustment mechanism (CBAM) was only being formalized, and until recently, no one knew exactly what it would be.
Will it be an additional import payment/tax, or will it be an internal tax? Will it involve buying emission allowances? Which goods will it definitely apply to? When will it be applied?
One thing was clear: if the technologies of most Ukrainian manufacturers are fundamentally incomparable to European ones in terms of environmental friendliness, then CBAM will inevitably significantly affect Ukrainian imports.
Even before the official text of the draft regulatory act on CBAM appeared, Ukrainian manufacturers began to calculate potential losses. For example, according to GMK center, the losses of metallurgists from the introduction of CBAM will amount to approximately 155-200 million euros annually.
On July 14, an extraordinary event occurred: the EU finally published the draft Regulation establishing the procedure for administering CBAM. Looking ahead, it should be noted that the CBAM project is not final. It will still be considered by the European Parliament and the Council of the European Union. However, it is obvious that the core of the document will definitely remain.
So let's try to understand what awaits Ukrainian exports in the near future.
Compulsion to reduce emissions
CBAM is designed to globally reduce greenhouse gas emissions from the production of goods in third countries, as the application of CBAM will encourage exporters to decarbonize, implement new technologies, which in turn should reduce environmental risks associated with carbon leakage.
In simple terms, the production of specific types of goods involves corresponding greenhouse gas emissions, these emissions are effectively included in the composition of a specific product (embedded emissions), and each such product contains a certain amount of tons of CO2. It is to such goods that CBAM will apply upon import to encourage more environmentally friendly production outside the EU.
A similar mechanism is already applied to manufacturers in EU member states, who are issued permits under the European Union Emissions Trading System (ETS).
According to the published draft Regulation, CBAM initially applies to cement, electricity, fertilizers (including ammonia, nitrogen and complex fertilizers), iron, steel and aluminum products. At the same time, the project provides for a further expansion of the list of products to which CBAM will apply after the transitional period based on the results of the mechanism's effectiveness assessment in 2026.
The first stage of CBAM implementation is planned from January 1, 2023. It will last until the end of 2025.
During the transitional period, declarants will be obliged to submit quarterly information (the so-called CBAM report) on the total amount of included direct and indirect emissions for each type of goods subject to CBAM regulation, as well as information on the carbon tax paid in the country of origin (if applicable).
After the transitional period (from January 1, 2026), product imports will only be possible by authorized declarants who will declare imports annually by May 31. The CBAM declaration will contain information on the actual volumes of imported goods and the corresponding included direct and indirect emissions, calculated according to a separate methodology.
According to the calculations of such emissions, declarants will have to submit the required number of CBAM certificates to the authorized body. The declared information regarding emissions may be verified by authorized bodies.
A CBAM certificate will be an electronic certificate corresponding to one tonne of emissions included in the product. A certain number of CBAM certificates will be accounted for under the unique account number of the CBAM declarant in national registries.
National registries will be established in each EU member state by an authorized national body, which will authorize declarants (importers) at their place of registration and sell CBAM certificates.
Currently, the draft Regulation does not contain a clearly established value for one CBAM certificate. It is assumed that this value will be calculated by the European Commission based on the average price at ETS auctions within the EU Emissions Trading System for each calendar week.
The corresponding prices for CBAM certificates will be published on the European Commission's website. For information, currently, ETS allowance prices at auctions are 52 euros/t CO2.
Exceptions for Ukraine
Can Ukraine count on preferential terms?
The current CBAM draft provides for the possibility of reducing the price of CBAM certificates if a carbon tax is paid in the country of origin. CBAM also provides for the possibility of concluding separate agreements on the exclusion of states from the application of CBAM if their policies and measures reflect comparable carbon emission control regimes (adequate carbon taxation, etc.).
For example, Ukraine, due to the targeted development of alternative energy sources, can count on the exclusion of CBAM application to electricity originating from Ukraine. CBAM contains separate provisions regarding electricity, which Ukraine could seemingly meet.
Another question is the compliance of CBAM with WTO rules and the Association Agreement between the EU and Ukraine.
It can be preliminarily noted that the CBAM project de jure does not contain direct violations of WTO law and the Association Agreement with the EU, in particular:
1) national treatment, as it provides for comparable regimes for national producers and producers from third countries;
2) most-favored-nation treatment, as the CBAM project provides for the possibility of excluding third countries from the application of CBAM, given that Iceland, Liechtenstein, Norway, and Switzerland are already excluded in the current project.
And the accompanying documents to the project themselves contain many references to environmental and climate goals and statements of full compliance with the WTO.
However, we believe that it is currently difficult to draw final conclusions about whether CBAM is "legal." It is quite likely that de facto violations may arise during the practical application of CBAM.
First of all, it is currently impossible to definitively state the nature of CBAM. Yes, it seems to be a payment for certificates, but is it not a hidden import payment/duty? If so, will the cumulative effect of the new duty and the ordinary import duty not exceed the bound rate agreed for the EU, in accordance with Article II of GATT (at least for certain goods)?
Will there be a violation of the national treatment principle? For example, if national EU producers receive benefits under the European Union Emissions Trading System (ETS) compared to the CBAM regime for exporters.
Currently, many EU producers receive free ETS allowances, and it is planned that at least until 2030, some producers will continue to receive such allowances for free.
So, if Ukrainian producers are forced to buy ETS allowances, then in essence there will be a violation of the national treatment principle, as the EU will discriminate against importers compared to domestic producers.
Will there be a violation of the most-favored-nation treatment due to the exclusion of certain states from the application of CBAM?
Questions remain open as to how the list of countries to which CBAM will not apply will be determined, whether the criteria will be sufficiently transparent, and so on.
Similar questions will arise in the context of the Association Agreement. The only point is that under the Agreement, Ukraine is obliged to implement EU climate change policies, so within Kyiv's current course, there is a chance that by 2026 Ukraine will implement a number of norms that will allow Ukrainian exporters not to incur additional administrative costs for CBAM.
Action Plan for Ukraine
How to survive the launch of CBAM as painlessly as possible?
First of all, Ukrainian producers should already assess their embedded emissions in accordance with the CBAM calculation methodology provided in Annex 3 to the CBAM project. After assessing the volume of their emissions, it is worth thinking about how to modernize production.
However, the efforts of business alone will clearly not be enough.
It is very important that our government continues negotiations with the EU and still tries to bargain for longer transition periods for Ukraine, because it is obvious that Ukraine will not have time to modernize its industry in five years.
It is also necessary to negotiate for the EU to participate in relevant financing programs for such modernization, as is the case, for example, in the Economic and Investment Plan for the Western Balkans (such a plan was agreed precisely for the implementation of the Green Deal).
Additionally, Ukraine needs to accelerate the implementation of the provisions of the Association Agreement regarding climate initiatives in order to try to take advantage of exceptions from CBAM in the future.
Well, and of course, it is necessary to monitor how CBAM will be applied in practice. If there are grounds, it can be challenged in the WTO and under the Association Agreement.
And if any WTO member does this earlier, it will definitely be necessary to join the dispute as a third party.