EU’s Carbon Border Tax Goes Live, Eliciting Threats from China and Perhaps Soon, the US

Yves here. While you were busy being distracted by Venezuela news, other geo-economic spatting is still underway. For instance, Trump is again threatening to slap more tariffs on India for failing to reduce its Russian oil purchases. But also important but less well reported, perhaps due to the lack of Trump hissy-fitting so far, is the EU carbon border tax. It imposes levies on certain high-carbon-content imports such as cement and steel based on how much more in fossil fuels the exporters was estimated to have used in its fabrication compared to EU producers. This is meant to protect and reward European makers who are subject to these (presumed) higher standards. One can also contend that it reverses the old colonialist practice of using poorer countries to pollute their countries to provide cheap goods to advanced economies, and is a sound move from an environmental perspective.

This article avoid going into details about how these levies are set, but mentions a controversy over Chinese steel, with European manufacturers of the view that the Chinese tax has been set too low. As is so often the case with economic incentives and disincentives, this scheme sounds like a good idea in the abstract. Whether it turns out to be so will depend a lot on design and implementation details.

By Irina Slav, a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry. Originally published at OilPrice

The EU’s carbon border adjustment mechanism launched on January 1 aims to level the playing field for European steel, cement, and power producers by taxing the carbon content of imports from countries with weaker emissions rules.
China has threatened retaliation, calling CBAM unfair and discriminatory.
While CBAM may protect EU industry, it risks higher prices for consumers and escalating trade disputes with major exporters

On Thursday, January 1st, the EU carbon border adjustment mechanism entered into effect with the goal of improving the competitiveness of European goods manufacturers against non-EU companies operating in laxer emissions reduction frameworks. China was the first to threaten retaliation. It won’t be the last.

The carbon border adjustment mechanism, or CBAM for short, was devised to remedy the unintended effects of the world’s most stringent emission-reduction standards for the industrial sphere, namely, sky-high costs that make the end product uncompetitive. This became especially painful for European makers of things such as steel and cement, where the biggest competitor is China—which does not have anything resembling the emission reduction requirements of the EU, so its steel and cement are very cheap, and buyers prefer them.

In other words, in order to boost the competitiveness of European steel and cement manufacturers—and electricity generators, too—the European Union made sure that cheaper imported steel, cement, and electricity are not that cheap anymore. China and India are unhappy about—and there are things they can do that will not help the competitiveness of European businesses.

As soon as the CBAM entered into effect, China’s Ministry of Commerce issued a statement, in which it called the legislation “unfair” and “discriminatory”, Bloomberg reported. “We will resolutely take all necessary measures to respond to any unfair trade restrictions,” the ministry said in its statement.

“CBAM is quite unpopular among major exporters to the EU, but it has already proven to be quite effective in pushing reticent countries towards building or expanding carbon pricing efforts,” one consultant specializing in carbon permit markets, told the Financial Times. “So it’s a major policy shift for the EU to protect its own industry, while at the same time leveraging the carbon pricing idea to third countries.”

China is, in fact, has its own carbon market, has had it since 2021, and it is the biggest carbon market in terms of the volumes of carbon emissions covered by it. With China, it’s not about selling the idea of carbon markets to third countries; it is about competitiveness. And China is not pleased that its competitiveness will be compromised.

In simple terms, the carbon border adjustment mechanism puts a price on the carbon dioxide emissions generated during the production of a good such as cement or steel. The price is based on calculations of the emissions from the respective industries in countries that export to the European Union. The mechanism puts a so-called default emission value for the production of a certain good, and also emission benchmarks, to be used in tandem in a way that is as of yet unclear, but some say it is, in fact, benefiting China.

Politico reported the concerns at the end of last year, citing industrial executives as saying the default values for emissions for certain countries that export to the EU were set too low to be real, including some steel production in China that, according to these estimates, turned out to be lower-emission than steel production in the EU.

“Inconsistencies in the figures of default values and benchmarks would dilute the incentive for cleaner production processes and allow high-emission imports to enter the EU market with insufficient carbon costs,” an industry representative told Politico. “This could result in a CBAM that is not only significantly less effective but most likely counterproductive.”

Meanwhile, Indian steel imports are about to dry up because Indian steel producers appear not to have been included in the “inconsistencies”. India is the world’s second-largest steel producer after China and exports as much as 66% of its output to the European Union.

This is about to drop sharply next year because India’s steel manufacturing is done in blast furnaces fueled with coal, which is incompatible with the European Union’s emission reduction plans. The Reuters report notes steel mills could switch to electric arc furnaces, which have a lower emissions footprint, but such a switch would take time and money.

“Most of the companies are yet figuring out a way to deal with CBAM,” one analyst told Reuters. “In the near term, it is expected to slow down India’s exports to EU,” Ravi Sodah, from Elara Capital, also said.

So, two of the world’s largest exporters of industrial goods, and major suppliers to the European Union specifically, are planning to respond to the CBAM by, at least in one case, curbing exports. This would sure clear up the market for European producers, but it will not be welcome news to consumers of those goods, who would be footing the bill for what is essentially market intervention on the part of the European Union, and a protectionist market intervention, at that. The United States is not going to be happy about it, either, and it will soon make its unhappiness known.