Carbon border adjustment: a powerful tool if paired with a just energy transition

By Randolph Bell, Director, Atlantic Council Global Energy Center; Richard Morningstar Chair for Global Energy Security and Elena Benaim, Intern, Atlantic Council Global Energy Centre  

Carbon border adjustment (CBA) policies are gaining momentum on both sides of the Atlantic. They were proposed as a key element in the European Green Deal and as part of US Democratic presidential nominee Joe Biden’s climate plan. But how do they work? Carbon border adjustment mechanisms tax imported goods based on their carbon footprint with the aim of limiting emissions leakage and levelling the playing field for domestic industries that produce goods with lower greenhouse gas emission footprints than imports that may be cheaper but have higher greenhouse gas footprints.

There are a number of technical challenges to overcome in implementing a carbon border adjustment policy, including whether to peg it to a domestic price on carbon, which sectors to apply the tax, and how to ensure accurate and transparent data on embodied carbon. But one major concern is that the policy could have negative consequences for the economies of developing countries by cutting their export revenue and/or impeding the development of new export-oriented industries. Developing countries might argue that the policy runs counter to the Paris Agreement’s bottom-up, nationally determined contributions, and could push them to cut emissions more than what they pledged. Carbon border adjustment could also run afoul of the Common But Differentiated Responsibility (CBDR) principle that developing countries do not share the same responsibility as developed countries in addressing climate and environmental issues.

This criticism, however, paints with an overly broad brush. Carbon border adjustments would have a highly varied impact on developing countries, and the impact will depend a great deal on how the policy is designed; for instance, an exemption for very poor countries is conceivable. But broadly speaking, a carbon border adjustment will be positive for some developing countries, will impact others negatively, and some will see little or no effect. Just as the energy transition will ultimately produce winners (countries with good solar and wind resources and/or critical minerals) and losers (coal miners and oil-producing countries), so too would a carbon border adjustment. The obligation of developed countries, then, is to accompany it with fair transition policies that support countries and individuals who would otherwise stand to be harmed by a carbon border adjustment or lose in the energy transition more broadly.

How an exporting country would be impacted by a carbon border adjustment policy depends on three factors: first, the level of fossil fuel intensity of its industries; second, the percentage of GDP generated by exports to the carbon border adjustment jurisdiction; and third, the share of emission-intensive products in its exports. In practical terms, carbon border adjustments would not significantly impact the many developing economies that do not currently export meaningful quantities of the carbon-intensive goods that would be subject to the tax, like steel, cement, coke (fuel), and petroleum products. For example, 92.3% of exports from East African Community (EAC) countries are primary products, 81% of which are agricultural products and 7.8% fishery products. These products are exempted from the European Emissions Trading System, and the UN Food and Agriculture Organisation has noted that applying a carbon border adjustment to food and agricultural products would be “extremely challenging.” At present, then, EAC countries would be minimally impacted by a carbon border adjustment.

However, a carbon border adjustment could shape the development path of these countries going forward. While this is no small issue, with the cost of clean energy dropping dramatically, the right support from developed countries could help these countries leapfrog those with legacy assets and become clean export centres. For countries that export energy-intensive goods, the impact will be uneven and vary country to country based on the emissions intensity of the goods they export. Some could actually benefit from the policy, though of course others would be harmed.

Steel provides a good case study for country-level variation in the greenhouse gas intensity of production. Steel is carbon-intensive, and the EU imports a very high percentage of it. Chinese and Ukrainian steel manufacturers primarily use blast furnaces and basic oxygen furnaces, while Turkish companies mainly use electric arc furnaces. The furnace type is one of the main factors in the emissions-intensity of steel, with blast furnaces and basic oxygen furnaces emitting about 2 metric tons of CO2 equivalent per metric ton of steel produced, and electric arc furnaces emitting 1 metric ton of CO2 equivalent per metric ton of steel produced. If the EU were to impose a carbon border adjustment on steel, Chinese and Ukrainian steel imports would be subject to higher import taxes in comparison with Turkish steel. While Chinese and Ukrainian industries would be hurt, it could also spur changes to lower the emissions footprint of their industries. 

The textile industry, while not discussed as one of the initial sectors the EU is considering for its carbon border adjustment, has received significant recent criticism for its greenhouse gas footprint, which is about 10% of global emissions. It is entirely feasible that textiles could be included in a future carbon border adjustment if the initial policy is successful, with potentially telling results. Bangladesh’s largest trading partner is the EU, representing 58% of its total exports in 2019, and 90% of these exports were clothing. Vietnam is also a major EU trading partner with textiles representing a significant percentage of its exports to the EU. The emissions intensity of the Vietnamese power sector is a little more than double that of Bangladesh, primarily because natural gas dominates Bangladesh’s power generation while Vietnam has a much higher percentage of coal in its generation mix. By this measure, textiles produced in Bangladesh would be taxed at a lower level than Vietnamese goods. Not only would a carbon border adjustment tax on textiles reshape trade patterns, but it could also nudge Vietnam towards a cleaner development path, at a moment when it is already considering moving to a cleaner energy mix.

Carbon border adjustment policies will reshape global trade, but they need to be viewed in context, as one tool in the energy transition that is already transforming the global economic and geopolitical landscape. A poorly designed carbon border adjustment policy could, for instance, encourage developing economies to pool together to create their own carbon border adjustment policy based on per capita emissions, which would clearly disadvantage the developed world. This risk further highlights the responsibility that developed countries have to assist developing countries in the energy transition and more broadly support clean growth in the developing world. A carbon border adjustment mechanism could support a more just transition through the deployment of revenues to developing countries. This proactive approach to a fair transition might our best option to move forward to a more just and sustainable future.