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TWN
Info Service on Climate Change (May23/04) The European Union’s Carbon Border Adjustment Mechanism (CBAM) has currently taken Indian and other developing country policy and industry by storm. The UK has predictably joined the bandwagon. Of particular interest is how Indian free trade agreement (FTA) negotiators will navigate CBAM in the ongoing FTA negotiations. CBAM will affect all developing countries who export energy intensive primary goods to EU. However, studies indicate that it will affect smaller economies even more adversely. In particular, economies that are dependant on these exports to EU, could see major macroeconomic challenges in the coming years. Reports suggest that India has opposed this at the World Trade Organization (WTO). CBAM kicks off on 1st October 2023 with carbon emissions reporting requirements on imports at its borders. But the real bang will come in 2026, when the EU actually starts charging massive fees for carbon emissions embedded in products it imports. Fearing that its strict carbon emissions policies will move production to countries with less stringent emissions rules, on 13 December 2022, the EU Parliament and Council, reached an agreement on carbon border taxes. On 16th May 2023, the EU published the adopted Regulation 2023/956 establishing a carbon border adjustment mechanism imposing carbon border taxes. The EU proudly positions this piece of legislation as part of its efforts to reduce emissions globally. Goods imported under fertilisers, cement, steel, energy, and aluminium categories and the now added Hydrogen will have to report carbon emissions in their manufacturing process at the EU border. India’s substantial steel and aluminium exports to EU will be badly affected. In 2021, steel exports (USD 4.1bn), and aluminium (USD 2.7bn) were India’s 5th and 7th largest exports to the EU. Importers of these goods will have to pay an equivalent of carbon emissions embedded in these goods. Weekly auctions of the EU’s Emissions Trading System (ETS) will decide the price. If third country exporters are unable to quantify their exact emissions, a ‘default value’ of their 10% worst performing industries will apply. In case such data is not ‘reliable’ a default value of 5% worst performing EU factories will apply. Let’s look at it just in terms of carbon pricing. The EU’s carbon prices depend on auctions and vary quite significantly, from week to week. In 2022, they varied from € 65.01 to 98.01 per tonne. For a large part of the year, they remained above € 80. EU ETS prices hit € 101 on 21st Feb 2023. Thus, the price of goods for EU’s importers, and by implication for exporters to EU, will constantly vary. Secondly, how and by whom will carbon emissions of worst performing installations be determined? This is default value of emissions in case the exporter cannot report exact emissions. Emissions of worst performing factories will create an unfair and variable cost on which the exporter has scant control. These costs have nothing to do with the price of the commodity, or even with carbon emissions. Auction prices under the EU’s ETS, and emissions intensity of worst performing factories, will effectively decide prices of Indian exports to the EU! Further, CBAM levies also allow for carbon prices paid, if any, locally. They will differ widely for countries, setting up a contest where neither competitiveness, nor carbon footprint will be the decider. If exporters want to avoid getting into the emissions default value trap, exporting countries will have to immediately set up infrastructure to measure, verify and monitor carbon emissions for every single manufacturing plant for CBAM products. Just basic information required by the EU contains 26 columns, including how emissions that are attributable to heating, cooling, manufacturing; embedded emissions in inputs; emissions not associated with goods and much more. The story of course does not end there. A verification system in which EU (or EU accredited) verifiers will verify the correctness of emissions data reported by the exporter will come into play. This is built on a similar exercise which the EU attempted in the civil aviation sector in 2012. Verifiers are instructed to carry out verification with an attitude of ‘professional scepticism’. An extremely complicated verification bureaucracy and compliance costs will be a substantial additional burden that exporters and exporting countries will have to bear. The EU has gone to great lengths to ‘encourage’ its trading partners to reduce carbon emissions embedded in certain manufacturing sectors. The idea is to reduce global carbon emissions. The key emissions source that the EU seeks to tackle is energy, which it imports, and which will be consumed in the manufacture of these products. However, the EU creates a very different landscape in its textual proposals in the India-EU FTA. The export pricing discipline under the Energy and Raw materials chapter specifically forbids any incentives by India to its own industry to consume green energy. If such incentives are given, or ‘measures taken’, energy and raw materials must be sold at the same incentivised price to EU industry. This stance, constraining green energy consumption, is completely at odds with what it professes as a global green leader. Whether the UK has proposed similar provisions is not available in the public domain. But given their extreme regulatory convergence, it is a distinct possibility. In effect, the EU will tax Indian industry exorbitantly on emissions, and also will not allow the Indian government to incentivise its own industry out of its own revenues to use greener energy. In the FTA texts, even domestic price regulation can only be for public policy purposes, should be clearly defined, transparent, non-discriminatory and proportionate! Needless to say, at some future point these terms would be up for interpretation by dispute panel members under the FTA, with no stake in India’s developmental aspirations or concerns. The EU’s proposals also desire to banish any local content requirements for the production of renewable energy. If India wants to empower its own manufacturers in the renewable energy systems once an FTA is signed – banish the thought. Additionally, the EU will not accept any regulation which necessitates forming local partnerships in the production of renewables or even in related value chains. Astonishingly, to report CBAM, the EU requires only local declarants or importers to set up business in EU! If the idea is to promote use of renewable energy in manufacturing by developing countries and especially India, the FTA text proposed by the EU goes into a contradictory direction. Neither CBAM nor the FTA text seem to support any renewable energy push by India. To the contrary, both texts appear to prioritise the EU’s manufacturing industry at the cost of their Indian counterparts. These are lessons for all developing countries who have negotiated or are negotiating an FTA with the EU. Its FTA texts have become progressively more ambitious in a detrimental way for developing countries. The harsh reality of CBAM is likely to expand horizontally. CBAM applies currently only to a few raw materials. However, this has the effect of an inverted duty structure. For instance, steel comprised in a car imported to EU will not have to pay carbon taxes, whereas carbon taxes on steel sheets will make European cars more expensive. If the EU persists with implementation of CBAM, it will have to quickly expand the scope to include more products. This will entail progressively greater impact on developing country exporters. If other countries such as US, Canada and Japan also impose their own CBAMs, the threat to developing country exports will increase exponentially. * The writer is a former Indian Revenue Service officer and has negotiated the India-EU and India-EFTA FTAs in the Department of Commerce of India. She studies the trade-environment intersection at the Geneva Graduate Institute.
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