What does the EU’s carbon border tax mean for Australia?
The EU’s Carbon Border Adjustment Mechanism (CBAM) has received strong support from the EU Parliament as a practical solution to so-called “carbon leakage”; situations where European businesses have avoided climate policy related costs by relocating production lines to jurisdictions with laxer emissions constraints. The policy will see imports from climate laggards charged with a European carbon price that is currently sitting at around A$90/ton of carbon emission equivalents (CO2e).
Significant trading partners of Australia are also considering similar policies. The UK, Japan and Canada are all contemplating carbon tariffs so that tougher domestic carbon prices don’t negatively impact local competitiveness. US President Joe Biden’s election commitment to impose a “carbon adjustment fee against countries that are failing to meet their climate and environmental obligations” has also recently received backing from the US Democrats.
The Coalition has failed to replace the carbon tax scheme it repealed in 2014 with a substantial alternative, so Australian exports to the EU are likely to be affected by the incoming tariff. Although the EU’s CBAM is expected to have limited direct impact on Australian exports, it could prompt a rise in retaliatory or similar tariffs that would dampen international trade and activity. A suppressed international market could significantly affect Australia’s export-led economy.
What do we know about the EU’s CBAM?
Implementing the CBAM will involve ascertaining the amount of CO2e emitted in the production of a given import, and to what extent foreign governments had already taxed those emissions. The policy will impose a reporting system on importers from 2023 before financial adjustments are expected to be enforced no later than 2026.
Products covered by the CBAM will be priced by the EU’s Emissions Trading System (ETS). The EU ETS is a market-based carbon trading scheme whereby one carbon allowance gives the holder the right to emit one ton of CO2e. Data from the International Carbon Action Partnership (ICAP) show that the ETS climbed to almost A$90/ton of CO2e emissions on 30 June 2021 (see Figure 1).
Figure 1. EU ETS Contract in AUD, 25 March 2008 to 30 June 2021
Source: ICAP
Fitch Ratings report that the main driver behind the EU ETS’ value surge has been the tightening of the emissions regulations alongside a reduction in the number of free allowances. Fitch Ratings expects these trends to continue, with EU lawmakers set on strict 2050 emissions targets that will see the share of free carbon allowances decrease to at least 75% by 2025 from 80% in May 2021.
A$90/ton of CO2e emissions is more than triple what Australia’s carbon price was before it was repealed in 2014, following industry uproar at the policy’s effect on businesses. And according to a Reuters Industry Survey, the EU ETS is expected to rise further.
CBAM legal texts indicate that the border tax is projected to bring in A$15.8 billion a year by the time taxes have been increased to full capacity in 2030. The specifics of the CBAM are not yet known, but carbon-intensive goods such as steel, cement, electricity, fertilizer, and iron have been earmarked by EU lawmakers as primary targets.
CBAM developments come at a time when Australian diplomats are on the cusp of negotiating a new trade deal with Europe. In recognition of Australia’s perceived lack of action against climate change, Pascal Canfin, elected chairman of the EU Parliament’s Environment Committee, recently cautioned that:
Australia has to understand that we are really serious… we will not ratify a trade deal if there is no concrete additional climate action from Australia.
The EU’s preference for climate action over trade represents a fork in the road for Australia: cut the emissions or lose exports.
What does this mean for Australia?
There appears to be general agreement that the EU’s CBAM will have limited impact on Australian export revenue. According to Tennant Reed, climate policy expert at the Australian Industry Group, Australia will be largely unaffected by an EU carbon tariff in the short term because few Australian goods compete directly with local industries that are covered by the EU ETS.
Furthermore, accounting techniques around carbon emissions do not appear to affect Australia’s largest export to Europe, metallurgical coal. Specifically, the EU scheme is not expected to cover “fugitive” methane emissions (i.e., emissions released during coal mining), and emissions emitted from coal is expected to be counted in the location where it is burned, not the location where it was mined. Therefore, the fact that Australia produces and exports significant amounts of coal won’t affect Australian emissions figures much.
The Australia Institute (TAI) agrees that carbon tax exposed goods only make up a small portion of the whole economy. In total, Australia’s emissions intensive exports (i.e., primary metal products, bulk chemical products, paper products, and basic metal products) were worth $23.4 billion, or 5% of total export value, in 2019-20 (see Figure 2).
Figure 2. Australian exports of emissions-intensive commodities
Source: ABS
Where export destination data is available, it appears that only about 1% (A$234 million) of the total value of emissions intensive commodities went to EU countries. That said, TAI warns that if carbon tariffs are erected in other jurisdictions, then Australian primary metals producers, which accounted for 87% of total carbon tax exposed goods, may be at risk.
Although the direct effect on Australian exports may be limited, Sky News is reporting that Australia could be indirectly impacted by the CBAM. For instance, cheap but polluting steel produced in China made with large amounts of Australian metallurgical coal is likely to be hit with sizable carbon tariffs. If demand for Chinese coal decreases, then so too will demand for Australian coal.
Data from the Department of Industry, Science, Energy and Resources shows that Chinese Taipei, China, Japan, and South Korea were the biggest export destinations for Australian thermal coal in 2018-19 and 2019-20 (see Figure 3).
Figure 3. Thermal coal exports (Mt) by Australia
Analysis from the United Nations Conference on Trade and Development (UNCTAD) shows that South Korea, China, and Japan exported around $3 billion, $2.5 billion, and $0.5 billion worth of iron and steel to the EU in 2019, respectively. If EU demand for iron and steel from these economies weakens due to the CBAM, demand for Australian thermal coal will likely follow suit.
Are there any issues with the CBAM?
Despite strong support from within the EU Parliament, border taxes may fall short of World Trade Organization (WTO) measures designed to prevent trade discrimination. Ventilating the Coalition Government’s perspective on the CBAM, Australian Minister for Trade Dan Tehan pushed back against the carbon border tax at POLITICO Live’s Competitive Europe Summit, saying:
A carbon border adjustment mechanism … runs the risk of enhancing protectionism. And that, I think, would be detrimental to global growth and to free trade globally.
EU Officials are keenly aware of WTO regulations, as evidenced in the European Parliamentary report Towards a WTO-compatible EU carbon border adjustment mechanism, and argue that the CBAM is non-discriminatory and non-protectionist.
The WTO has not released any official positions on the carbon border tax, but EU delegation teams are expected to engage directly with the WTO to assess the legal and technical feasibility of different forms of the CBAM closer to the implementation date. Due to the novelty of the CBAM, however, it is difficult to know how long the WTO settlement process will take and which way its decision will go.
The Centre for European Reform is also concerned that a blanket tariff placed on imports risks unfairly penalising the exports of developing countries that do not have the infrastructure or resources to quickly and feasibly decarbonise. EU Officials are aware of the issues posed by the CBAM on developing countries and are in favour of granting special treatment to Least Developed Countries and Small Island Developing States where tariffs may impede economic development.
Another perspective held by many Europe-based industry groups showcase a commitment to 2050 emissions neutrality goals paired with anxiety about the effects of higher input materials prices on industry competitiveness and innovative capacity.
For instance, in a recently released position paper, the European Automobile Manufacturers’ Association (ACEA) warns that the CBAM may adversely affect the EU automobile sector which has a “global sourcing strategy that depends fundamentally on an economic policy allowing for open and fair trade”. Even the European Cement Association (CEMBUREAU), which the CBAM is intended to protect, highlighted the importance of a “pragmatic approach [toward the CBAM’s design]… to avoid distortions on the internal market” in a statement that is otherwise highly supportive of the carbon border tax.
These concerns were quantified in a study produced by DIW Berlin, a German think-tank, which estimated that a price of £75 per tonne of CO2e would leave up to 25% of the EU’s manufacturing sector vulnerable to being undercut by overseas manufacturers not subject to the CBAM – i.e., 25% of the EU’s manufacturing sector would be susceptible to carbon leakage!
Therefore, although widely supported, there is a common understanding across industries of the potentially disadvantageous effects of “protecting” domestic businesses through CBAM trade restrictions.
Conclusion
Ultimately, it looks like Australia could be subject to a carbon price to some extent even if it doesn’t implement one domestically. For goods included in the CBAM, particularly in the primary metals industry, carbon border taxes may represent an incentive to decarbonise carbon-intensive production methods. However, Australia may remain largely unaffected by the CBAM given favourable carbon accounting methods that do not directly impact significant areas of existing trade with the EU.
But with the likes of the UK, US, Japan, and Canada also considering carbon border taxes, Australia’s economic competitiveness is likely to be challenged if export products and production methods remain unchanged.
This article was prepared by Adept Economics Research Officer Ben Scott and Director Gene Tunny. If you have any questions or comments please get in touch with us: contact@adepteconomics.com.au