The Fit for 55 package: A diplomatic tightrope

The technical challenges of the European Commission’s ‘Fit for 55’ package are only part of the story. Diplomatic tact will be critical in preventing it from undermining the EU’s climate leadership.

A solar power plant in Spain

On 14 July, the European Commission launched a blizzard of draft legislation proposing measures for cutting the bloc’s greenhouse gas emissions by 55 per cent (compared to 1990 levels) by 2030. As a political and economic project, ‘Fit for 55’ is a huge undertaking. It introduces a globally unprecedented carbon border adjustment mechanism (CBAM) for pricing imported carbon. It also includes a major overhaul of the Emissions Trading System (ETS) to extend carbon pricing to shipping, aviation, transport, and buildings; accelerate the development of the renewable energy sector; ban sales of new fossil-fuel cars after 2035; provide social support for EU citizens affected by the green transition; and speed up the modernisation of the building stock. Due to its diplomatic and economic ramifications, the CBAM will largely determine the Fit for 55 package’s long-term impact on global climate policies.

A lack of other options

In theory, given that there is no realistic prospect of a global carbon price, it is a good idea to introduce border adjustments that ensure exporters to the European Union face the same carbon prices as European firms subject to the ETS. In practice, the CBAM has prompted polarised reactions. European industries facing high ETS prices are cautiously supportive; Brazil, India, South Africa, and China (BASIC) have described it as ‘discriminatory’; and civil society organisations have condemned the proposed continuation of free ETS permit allocation to European firms as unfair and contrary to international climate policy norms. The United States has stopped short of opposing the CBAM in principle, but suggested it would be extremely complex to implement.

Given the diplomatic storm the CBAM has already caused, is it still sensible? Yes, probably – if done well. Critics see the measure as trade protectionism in disguise, and they are right to be concerned. But, given the absence of alternative options, it is a viable way to meaningfully price carbon in larger parts of the global economy, and to catalyse innovation in critical sectors. It is true that the scheme will be fiendishly difficult to implement: current proposals pledge to account for both the carbon footprint of imported goods and the implicit carbon price they face (as either a tax or a regulatory standard). It is unclear how this will be done, as the Commission itself admitted in 2018. However, the use of punitive ‘default’ assumptions – where the EU lacks data on a product’s carbon footprint – can help increase transparency in carbon-intensive value chains.

Under current proposals, the CBAM covers five emissions-intensive industries: aluminium, steel, cement, electricity, and fertiliser. The BASICs, particularly China, are all major exporters of aluminium and steel to the EU. Among countries that are the least developed and the most vulnerable to climate change, almost all those that are most exposed to the CBAM are in Africa: Mozambique, Guinea, Sierra Leone, Ghana, and Cameroon (aluminium); Zambia and Zimbabwe (steel); Morocco (electricity); and Algeria and Egypt (fertiliser). Indirect exposure via exports to China may exacerbate these countries’ overall exposure. With many facing severe pandemic-related fiscal challenges and already-high trade barriers, there is a real risk that the CBAM could harm low-income populations unless the EU introduces mitigating measures. Controversially, the documents published by the Commission do not grant exemptions to the least-developed countries (LDCs) or make compensatory financial commitments to the economies that the CBAM would affect most.

A diplomatic minefield

The technical challenges are only part of the story. Diplomatic tact and attention to detail will be critical in preventing the CBAM from undermining the EU’s climate leadership role. The Commission’s words to this effect and a four-year grace period before the measures take effect hint at its awareness of the balance to be struck.

To be workable, the CBAM must comply with World Trade Organisation (WTO) rules. The legal principle of environmental tariffs is well-established in WTO case law. However, to comply with the rules, the Commission may be forced to adjust its plan to grant exemptions or special conditions to LDCs (through de minimis clauses, for instance). Perhaps more critical are the issues raised by combining the CBAM with free ETS permit allocations – which, in effect, give European firms the benefits of both subsidies in the form of free permits and a requirement for their competitors to price carbon at ETS levels. European industries vociferously oppose the abolition of free permit allocations, but this may ultimately be necessary for the CBAM to comply with WTO rules.

Even if the CBAM failed to promote substantial emissions reductions beyond Europe, it would provide cover for the EU to develop some of the core industries of the global green economy.

The use of CBAM revenues presents another diplomatic challenge. The current possibilities include repayment of pandemic-related debt, social support for European communities affected by the low-carbon transition broadly, and greater climate-related financing for third countries affected by the CBAM. Committing CBAM revenues to a mixture of these destinations may help the EU navigate some of the LDC-related effects mentioned above – although any recycling back to third countries would need to be carefully targeted to have any hope of neutralising the CBAM’s potentially negative impact on their national economies. As the loudest supporter of the CBAM and an influential EU voice, France will be under particularly intense pressure to address these issues both by eliminating financing for fossil fuels beyond its borders, and by pressuring French firms with fossil-fuel interests in affected countries to reform or withdraw.

Another challenge for LDCs would come from the EU’s use of default assumptions in cases where the data are not sufficient to assess imports’ carbon intensity. The CBAM assumes that imports correspond to the worst 10 per cent of European firms. This is likely to be unduly punitive to exporters with limited data infrastructure and capacity but cleaner production than their European peers.

Strategic intent

The Commission did not choose the five initial CBAM sectors accidentally. Yes, they play major roles in global emissions, but they are also areas in which EU member states are already making large strategic investments both within their borders and in countries with abundant clean energy resources, as seen in Germanys’ green hydrogen investments in Morocco. Green hydrogen (produced from renewable electricity) and its derivatives, including ammonia, are likely to be vital to the decarbonisation of heavy industry and agriculture alike. The inclusion of electricity also fits into the EU’s push for investment in domestic renewable energy and electric transportation. If managed carefully, this approach could ensure the EU benefits in multiple scenarios: even if the CBAM failed to promote substantial emissions reductions beyond Europe, it would provide cover for the EU to develop some of the core industries of the global green economy.

The big picture

In the short term, the European Parliament should work to clarify and resolve points of contention on the CBAM. At COP26 in November, the EU should coherently articulate its contribution to the grand climate bargain conceived in Paris in 2015. A failure to do so could undermine progress in international negotiations and provide the EU’s opponents with greater political ammunition.

To realise its global potential, the CBAM will need to prod other major economies to take similar measures – in the ultimate test of the ‘Brussels effect’. If the US and the United Kingdom followed suit, exporters would increasingly struggle to find alternative markets and would accelerate their decarbonisation efforts. Decarbonisation is becoming ever more important to countries’ economic interests irrespective of trade and climate considerations. While the CBAM is a bold step, decarbonisation is inevitable for the economies it affects. Whether the EU will be justified in saying ‘thank me later’ is a matter of technical detail and diplomatic skill, but the measure may pay handsomely if handled correctly.

The European Council on Foreign Relations does not take collective positions. ECFR publications only represent the views of its individual authors.

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