The unintended consequences of CBAM on the EU Industrial Strategy

Marking a global first, the European Commission has proposed to introduce legislation for a Carbon Border Adjustment Mechanism (CBAM), as part of its flagship Fit for 55 policy package aimed at achieving the 2050 neutrality target.

Marking a global first, the European Commission has proposed to introduce legislation for a Carbon Border Adjustment Mechanism (CBAM), as part of its flagship Fit for 55 policy package aimed at achieving the 2050 neutrality target.

There is a simple economic logic behind this proposal. As it stands, CBAM aims at compensating the higher manufacturing costs in the EU due to the reduction of free allowance in the ETS. It would achieve this by imposing an import tariff on some carbon intensive raw materials coming into the EU. These include iron and steel, cement, aluminium, fertilisers and electricity.

Popularly acknowledged as a carbon border tax, the primary aim of the measure would be to help reduce carbon emissions and prevent the risk of carbon leakage1, resulting from the EU’s increased climate ambition. The proposed CBAM would also aim to establish a level-playing field for EU raw material producers versus producers based outside of the EU, thereby creating an incentive for the latter to invest in clean technologies. By design, the Mechanism enters the scene in the context of the proposed removal of ETS free allowances, seeking to tackle climate change by putting a price on CO2 emissions. This way, it should also encourage trading partners to reduce their carbon footprint.

However, what the CBAM strives for is rather different from what it delivers. Quite evidently, these changes will increase production costs for all manufacturing companies in the EU relying on the concerned materials to produce their products, including the home appliance industry. In its current form, the EU’s proposed CBAM is in fact only including raw materials, creating this way an incentive for carbon leakage from the EU for all manufacturing industries. That is to say manufacturing companies based in third countries will get a competitive advantage over similar products produced in the EU. In other words, a ‘narrow CBAM’ that applies to raw materials only, would negatively impact the competitiveness of the EU downstream manufacturing industry.

As numbers most often speak louder than words, let’s take the case of a washing machine manufactured in Europe. Its production requires on average 25kg of steel, 4kg cement (as part of concrete) and 3kg aluminium. All materials that will be subject to the CBAM proposal. Under the current ETS system in place, the CO2 price for these materials amounts to 90€/ton CO2. Doing the maths, EU-based home appliance manufacturers will face an increase in the cost of raw materials for the production of one washing machine ranging between 5 up to 10%. The high CO2 price has also had a substantial impact on electricity prices, thus jeopardising the energy competitiveness of European manufacturers. As such, the EU’s proposed CBAM seems not to bring any added value in addressing the issue. In light of the different electricity price-setting mechanism currently in place in the EU, compared to the power mixes abroad, it is in fact very unlikely any adjustment of the actual indirect emission costs may occur.

In this scenario, products that are manufactured abroad and imported into the EU will be more competitive than EU-made ones on the home market of many European companies. At the same time, products that are manufactured in third countries will be more competitive than EU made-ones on global markets, translating into a competitive disadvantage for manufacturing in Europe and triggering a substantial loss of European jobs. As a result, the new emission cap would not only fall short of the very objective of the policy but also drive production and investments outside of Europe, generating significant global environmental impacts. The carbon will simply be emitted elsewhere. Originally thought to address the risk of carbon leakage in the raw materials industry, CBAM as proposed by the EU Commission, would simply move the carbon leakage from the raw materials industry to other downstream industrial sectors, this way jeopardising the entire European economy.

All in all, an international trade regime that builds on innovation should be harnessed to drive the advances needed to reduce net GHG emission. Whilst CBAM is an unworkable answer, the global community poses a vital question: what alternative solution can be tabled to square the circle of industrial competitiveness and climate ambitions? APPLiA, representing the home appliance industry in Europe, a sector that will be heavily affected by the Mechanism, has been at the forefront of the political discussion. Tackling the competitive disadvantage that would stem from ETS additional costs and affect both EU and global markets for EU-based manufacturers, requires an all-encompassing approach.

There is no quick or easy solution here. CBAM alone, even extensively revised, cannot fix the problems it creates. The European Commission should present a legislative proposal two years ahead of the removal of free allowances in ETS, foreseen as from 2026. This would secure the funding pillars of the EU including the competitiveness of all European industries, EU jobs, global sustainability leadership and resilience among others, while also satisfying WTO trade requirements.

 

1The term ”carbon leakage” is used to describe a situation whereby it becomes more interesting to produce products outside the EU, and import products to the EU, meaning the CO2 emissions from the production will occur outside the EU.