Key issues for the coming trade and climate debate

Abstract

Europe’s intended proposal for a Carbon Border Adjustment Mechanism (CBAM) is imminent. It is also controversial. Making this work in a way that is WTO compatible is challenging, particularly if industry in Europe wishes to retain some free allocation under the EU’s Emissions Trading System. This Policy Brief describes some of these challenges, and also takes a closer look at imports of electricity and cement – where they are from and what are their carbon intensities? What would be the costs that a CBAM would impose on these imports, and how do these compare with free allocation to European producers as a method for preventing carbon leakage? The results suggest that the protection that a CBAM might offer against carbon leakage would be limited, while the lost value of free allocation for EU producers may be high. Could reform of free allocation be a substitute for CBAM and stimulate investment in break-through technologies? More extensive consultation with WTO member countries will be necessary on the basis of the legal proposal that the European Commission makes.