Addressing carbon leakage ahead of COP26 and MC12

In the wake of the UN Climate Conference, COP26, to be held in Glasgow from 31st October to 12th November, environmental discussions at the WTO continue to gain traction, with several initiatives running concurrently, working to deliver an outcome in time for the WTO 12th Ministerial Conference. Topics of particular interest to Members include the potential launch of negotiations in environmental goods and services, plastic pollution and the circular economy, as well as fossil fuel subsidy reform. In the midst of these discussions, carbon pricing and the EU’s carbon border adjustment mechanism (CBAM) have drawn considerable attention.

During the WTO’s Committee on Trade and Environment in October, the EU provided an update on its CBAM draft proposal, which is an element of its broader Fit for 55 package that seeks to achieve net zero emissions by 2050. With increasing concerns over carbon leakage in the production of goods, the EU’s proposal for CBAM is one approach that is currently being sought to ensure that carbon emissions across a product’s life cycle are reflected in the price. However, the measure has caused concern among Members that putting a price on carbon for imported goods could amount to a form of protectionism and serve as a barrier to trade.

If implemented, CBAM would impose a carbon price on carbon intensive sectors, such as steel, cement and fertilisers. The measure would be gradually introduced, starting in 2023 with three years of no financial adjustment, followed by three years of data collection on embedded emissions in goods imported into the EU. Then, from 2026 to 2035, it would gradually replace free allocation. Essentially, the mechanism is intended to replicate the EU’s emissions trading system (ETS) which applies to domestic goods. Businesses in third countries that have adopted the EU ETS or have a similar scheme which achieves the same carbon price in the EU may qualify for an exemption from CBAM.

The measure, which is open for public feedback until 18th November 2021, has attracted criticism from a number of Members, claiming that CBAM would be inconsistent with WTO rules and could affect the rights of individual Members to determine their own national climate commitments. Further clarity is sought on the EU’s methodology when applying CBAM, whether it would be discriminatory and how the EU would assess emissions reduction methods that exist in other countries. There have also been calls for the scheme to consider common but differentiated responsibilities, a principle formalised under the United Nations Framework Convention on Climate Change which recognises varying levels of responsibilities among countries when addressing climate change.

Discussions in the WTO are currently ongoing in several committees as to the modalities of such a measure and its compatibility with WTO rules. A recent opinion piece by the WTO Director-General, Ngozi Okonjo-Iweala, explores the challenges of carbon leakage and proposes the adoption of a global carbon price as a potential solution, which albeit effective is a long way from being achieved. The outcomes and priorities that will take center stage at COP26 remain to be seen, but in the absence of a common solution to address carbon leakage, multilateral institutions, including the WTO, will occupy a critical role in setting a foundation upon which governments can examine the best approach to be taken to target carbon emissions.