EU’s ‘Fit for 55 Package’ and Pricing of Carbon: why should the developing countries be wary of it?

James J. Nedumpara & Sathiabama. S

The European Union’s long-awaited and controversial carbon pricing proposal is officially published. The carbon ‘tax’ is part of the carbon border adjustment mechanism (CBAM) and an integral element of the European Green Deal. The CBAM is adopted as part of the ‘Fit for 55 Package’—policies fit for reducing net greenhouse gas emissions in Europe by at least 55% compared to 1990 levels by 2030. The stated objective of the CBAM is to prevent carbon leakage and achieve carbon neutrality by penalizing carbon emissions in select carbon-intensive sectors. As noted, the EU is keen to prevent its industries from moving to third countries, where the climate change and environmental regulations could be lax or less strict. The EU also considers that international trade would support global efforts to achieve sustainable development goals.

Pigouvian taxes (taxes that address a negative externality, named after renowned British Economist Pigou) or similar measures to curb carbon emission is not new. However, the more significant issue is whether such a carbon pricing scheme would be imposed on cross-border trade by disregarding all considerations relating to development, equity, global cooperation, and the principle of ‘common but differentiated responsibilities and respective capabilities. The CBAM is not the European Union’s first initiative against carbon emissions.

The European Emissions Trading System (ETS), introduced in the backdrop of the United Nations Framework Convention on Climate Change (UNFCC), sought to put a price on carbon emissions. The ETS functioned based on ‘cap-and-trade, or fixed maximum amount of carbon emissions, with an allocation of specified free allowances. The CBAM will substitute the ETS in selected sectors, while the ETS will continue in some form. In this opinion piece, we reflect upon the WTO compatibility of the CBAM and its impacts on developing countries like India.

Design and structure of the measure

According to the legislative proposal, initially, the CBAM would cover only listed sectors—electricity, iron and steel, cement, aluminum, and some fertilizers. This limited coverage may get extended to the other sectors of the EU ETS, too, A carbon price, determined by the EU ETS system of auctions, would be imposed on the imports of goods. Importers will be charged based on the actual emissions embedded in the senses. By creating a new CBAM authority, the CBAM regulation would require the importers to obtain the authority’s authorization and CBAM certificates in electronic formats. The CBAM certificates would be sold by the competent authority of each Member state to the authorized declarants in that Member state at a price determined by the Commission.

The carbon price of the certificates will be calculated depending on the weekly average auction price of the EU ETS allowances expressed in € / tonne of CO2 emitted. Once implemented, the importer will have to report the actual emissions embedded in the product and surrender a corresponding number of CBAM certificates by May 31 each year. During the transitional period, i.e., from 2023 to 2025, the importers will report the embedded emissions without paying any duty, while the free allowances under the EU ETS will be phased out. Gradually, the CBAM would be phased in from 2026. If a carbon price is paid in the country of origin, the corresponding cost can be fully deducted for that import.

Although the structure of CBAM looks even-handed and is linked to the carbon emitted in the production process, the measure’s impact can fall disproportionately on developing countries whose industries are still dependent on carbon-intensive technology. The CBAM also has implications for the EU’s international law commitments.

Harmony with the WTO rules

Among the several controversies, the central question for the international community is: will the new CBAM legally conform to international rules, especially the WTO rules? A carbon pricing mechanism based on the ’embedded carbon’ is structurally incompatible with WTO’s non-discrimination rules. Based on conventional WTO jurisprudence, a distinction based on non-product-related processes and production means is legally questionable. This is at least the position from the landmark Tuna-Dolphin dispute of the early 1990s under the GATT. Interestingly, the emitted carbon does not travel along with the imported product; it is left behind in the place of manufacture. Accepting the EU CBAM assumptions could allow the much-contested social clauses to gain legitimacy under the WTO rules.

EU President von der Leyen has also underlined that ‘carbon must have its price – because nature cannot pay the price anymore’. Considering the WTO rules and the EU’s international obligations, applying the EU ETS by imposing the carbon price on imports, in selected sectors, based on actual emissions from third-country producers is likely to rise further. Although the CBAM promises to provide a level playing field, applying the measure uniformly to all the third countries, irrespective of their national circumstances, raises the question of non-discrimination, equity, and fairness considerations.

Impacts on emerging developing economies like India

It is pertinent to note that the joint statement made by Brazil, South Africa, India, and China at the 30th BASIC Ministerial Meeting on Climate Change raised concerns about this measure. They expressed grave concern at the proposal of a unilateral CBAM, which can fundamentally affect the competitiveness of developing countries. The additional cost of CBAM could negatively affect exporters and consumers, especially from developing countries. Also, a European roundtable on climate change and sustainable transition report observed that the most affected industries by the EU CBAM included Colombia’s cement industry, China’s plastics sector, North African fertilizer, and South American pulp exports.

In short, while the EU’s CBAM can be termed as a measure that furthers the goals of the 2015 Paris Agreement, the unilateral nature of the steps combined with its potentially detrimental effects on developing and resource-constrained countries indicates that this measure is not motivated by climate change considerations alone.