ENVI Rapporteur’s Draft CBAM Report at Odds With Commission Plan on Key Points

The European Commission has proposed a carbon border adjustment mechanism (CBAM) as part of the European Union (EU) Green Deal’s climate provisions—the Fit for 55 package. The CBAM aims to level the playing field between domestic producers—who will see carbon prices rise dramatically under the EU’s emissions trading system (ETS)—and foreign producers, who may not be subject to any carbon price. Importers would be forced to buy allowances based on the embodied carbon in a limited number of basic industrial goods, in the same way domestic producers must purchase emissions allowances under the ETS. This obligation would apply to electricity, as well as basic and semi-processed aluminum, cement, fertilizers, and iron and steel.

The Commission wants the CBAM to come into effect by 2023. Before that can happen, it must agree with the European Parliament and the EU Council on the final shape of the instrument. The latest development in efforts to reach that agreement is the unofficial release of the draft report by the rapporteur of the EU Parliament’s Committee on the Environment, Public Health and Food Safety (ENVI). ENVI, through its final report, will have the most influence of any parliamentary committee on the Parliament’s plenary vote on CBAM, expected by February 28.

There are important differences between the Commission’s proposal and the draft rapporteur’s report, and they highlight some of the thorniest issues to be resolved in finalizing the CBAM. This paper explains six of those differences, assessing what they might mean for the final shape of the instrument and for foreign producers.

ENVI, through its final report, will have the most influence of any parliamentary committee on the Parliament’s plenary vote on CBAM.

The most important differences are proposals to:

• Shorten the timeline for the transition period and for the ramp-up of the CBAM to full effect
• Broaden the scope of product coverage to include basic chemicals, plastics, and hydrogen
• Broaden the scope of emissions covered to include emissions from electricity generation
• Assess the impact of CBAM on exports and make legislative suggestions to address any problems
• Dedicate EU budget resources to assist affected developing countries
• Declare with certainty that the CBAM will not lower its border levies to account for implicit (i.e., regulatory) foreign carbon costs.

The Timeline

The Commission suggested a three-year transition period during which all reporting requirements would be in effect, but no border charges would be assessed. The rapporteur’s report shortens this to two years. In a similar vein, the Commission proposal envisioned the CBAM gradually ramping up in effect over 10 years as free allocation under the ETS ramped down, substituting one protection for the other. The rapporteur proposes ramping up the CBAM protection (and, presumably, ramping down free allocation) to 100% in only four years*. The two changes together would see the full CBAM come into effect in January 2029—seven years sooner than the Commission proposal.

The urgency is undeniable, but the Commission’s longer timeline would allow more time to solve the vexing export challenge and would be less incendiary for affected trading partners.

This would be a significant acceleration, motivated by “the climate emergency and the Union’s own 2030 objective:”** an ambitious 55% reduction over 1990 emission levels. The urgency is undeniable, but the Commission’s longer timeline would allow more time to solve the vexing export challenge (see below) and would be less incendiary for affected trading partners. Seven years is a lot of time to subtract for trading partners that might be considering difficult policy responses such as fostering domestic industrial decarbonization or imposing carbon pricing regimes.

The Coverage

The Commission’s proposal covers electricity and 29 categories of goods in 4 sectors. The rapporteur suggests adding organic chemicals, plastics, and hydrogen.

This would be a massive addition. Plastics alone would add more than 1,000 products to the list. Based on current trade flows, the rapporteur’s recommendation would increase the total value of covered imports from China by roughly five times. It is, however, unlikely that the full value chain for either plastics or organic chemicals would ever be covered per the rapporteur’s recommendations; if coverage is extended, it would likely be more limited to upstream basic materials.

The CBAM should cover these goods if leakage risk is the criterion. But the Commission shied away from including plastics and organic chemicals in the initial coverage, citing technical difficulties given their large and complex downstream value chains and the methodological challenges of allocating emissions to the various different products that come from single installations.

The Commission’s proposal covers electricity and 29 categories of goods in 4 sectors. The rapporteur suggests adding organic chemicals, plastics, and hydrogen. This would be a massive addition.

For foreign producers, the impact would be a much higher value of covered goods and a commensurate increase in the costs they would bear, given the complexity of the plastics and chemicals value chains.

The Emissions

The Commission had proposed covering only direct emissions—those produced on site under the control of the firm. The rapporteur proposes also covering what he calls indirect emissions—those produced by generating any electricity used.

This makes sense from an environmental perspective, as indirect emissions in many goods dwarf direct emissions. Also, EU producers do pay for their indirect emissions via higher electricity prices, so there is risk of leakage. But producers in some member states are already compensated for indirect costs, protecting them from competitive pressures. Moreover, they worry that covering indirect emissions (and removing the existing compensation) will lead to resource shuffling—which means no production processes actually change, but foreign producers re-orient their “clean” production to be exported to the EU, and their “dirty” production to be sold elsewhere. Foreign producers, of course, see it differently—as an opportunity to profit from low-carbon production.

Exports

It is widely (but not unanimously) accepted that the EU cannot legally refund the costs of the ETS to exporters, as it might be able to do were the ETS a tax. This is a problem for the bloc’s export-oriented sectors, which would lose global market share competing against goods that faced no carbon price.

The rapporteur would mandate a report in 2026 on the CBAM’s impact on exports, with accompanying legislative proposals to deal with any identified risks.

While the Commission proposal does not mention this challenge, the rapporteur would mandate a report in 2026 on the CBAM’s impact on exports, with accompanying legislative proposals to deal with any identified risks. It is not clear what sort of proposals might emerge, but presumably they would somehow involve supporting exporters in proportion to the size of their export streams, which would risk being found to be a prohibited export subsidy under World Trade Organization law.

Developing Countries

The Commission proposes that CBAM revenues would go into its budget to support its green recovery plan. The rapporteur says the funds should be used to cover expenses incurred in administering the CBAM, with the remainder going into the EU budget. But the rapporteur also proposes that the EU commit to increasing development assistance to help “support least-developed countries' efforts towards the decarbonization of their manufacturing industries” (Article 24.a). Those new funds would have to be no less than the amount of revenues raised by the CBAM.

The rapporteur’s proposal is more ambitious and more explicit about a provision that many have declared fundamental to address developing country interests.

Implicit Carbon Prices

Both the Commission and the rapporteur propose crediting foreign producers for carbon prices paid in their home jurisdictions. The Commission says this does not include the cost of regulations—so-called implicit carbon pricing—but only explicit carbon pricing such as carbon taxes or ETS. The rapporteur agrees, but takes care to make that understanding quite explicit.

This is the right choice for many reasons, but it would disappoint countries such as the United States and Australia that are unlikely to adopt carbon pricing any time soon and that hope to convince EU lawmakers to recognize their regulatory efforts.

Next Steps

The ENVI rapporteur’s draft report touches on some of the key challenges in getting the CBAM right. Its divergence from the Commission proposal highlights that, in those areas, there is still deep uncertainty on the final shape of the instrument—design questions that have major implications for EU and foreign producers.

The process of trialogue among the Commission, the Parliament, and the Council will involve each trying to sway the others, so it’s fair to assume that the ENVI rapporteur’s report, like the coming final Parliament position, involves strategic over-asking—aiming higher than what he thinks he can ultimately attain. In general, the rapporteur demands greater ambition and speed in the CBAM than the Commission. This may be in anticipation of a more conservative approach by the Council, which represents member states, some of which will want to delay and weaken the instrument.

The rapporteur demands greater ambition and speed in the CBAM than the Commission.

The EU is the first jurisdiction to attempt something like the CBAM. Trading partners are closely watching the process of negotiation and will try to influence the final outcome to the extent they can. So are other countries thinking of treading down the same path: they will be keenly interested to learn from both the technical and political challenges.

* Based on its relatively low trade intensity, cement would be an exception: it would be subject to full CBAM adjustment immediately at the end of the transition period.

**Page 81 of draft report.