An EU Carbon Border Tax - what might it mean for world trade?

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With companies set to become increasingly responsible for the carbon footprints of their value chains, they must be proactive in measuring and mitigating their CO2, write Boston Consulting Group's Bas Sudmeijer and Tim Figures

Less than two weeks ago, the European Union announced that a significant change in its trade policy is coming.

As part of its newly-announced goal of cutting greenhouse gas emissions by 55 per cent over the next decade, the EU is considering imposing a tax on goods imported into the 27-nation region by 2023 that would reflect the amount of carbon dioxide (CO2) emissions attributed to their production. There is widespread global interest in this innovative move, including from Democratic Party candidate Joe Biden, who has signalled support for a similar scheme in the US if he wins the Presidency.

For countries outside the bloc, but with significant trade flows with it - the 'carbon border tax' plan poses two big questions: will those countries adopt a similar mechanism to put a price on the emissions tied to imports? And will they be able to work with the EU to ensure that trade is adversely affected?

Regardless of how these issues are resolved, UK companies must begin taking action to reduce their greenhouse-gas footprints. There is no doubt as to the commitment of either the EU or the UK in taking tough action on climate change. In fact, the UK has already set itself tougher legally binding targets than the EU, including the requirement to be net zero by 2050. To get there, UK companies will have to not only shrink the carbon footprints of their own operations, but also those of their entire global value chains.

The most pressing question is whether 'third countries' like the UK can work with the EU to ensure their goods are exempt from a future carbon border tax, the details of which are still under consideration. A failure to do so would place industries with high greenhouse-gas footprints - such as automobiles, steel, chemicals, and aerospace - at a significant cost disadvantage in one of their largest export markets. Recent Boston Consulting Group (BCG) analysis shows, for example, that the border tax on a compact family car being imported into the EU would be over €200 at current carbon prices, rising to over €400 by 2025 based on carbon price forecasts.

Technically speaking, it shouldn't be difficult for countries like the UK to make the case for an exemption. Prior to Brexit, the UK was already participating fully in the EU's emissions trading scheme (ETS), and the UK government has committed to continued action on carbon pricing once the UK leaves the EU ETS at the end of the year. Therefore, UK companies have systems in place to measure and report their carbon footprint that are used to factor in carbon costs.

The mechanism for seeking exemption from the carbon border tax, however, is far from clear. But like similar 'equivalence' regimes for financial services and data privacy, it will almost certainly come down to a unilateral decision by the European Union. In practice, these decisions are not purely administrative: they come with conditions attached and can be used by the EU as leverage in wider negotiations with the third country concerned.    

The EU will also be keen to ensure that countries exempt from the carbon border tax are not used as a back door into the bloc for products that have not paid their full carbon costs. If third countries introduce their own border tax along similar lines to the EU's, then that should be easy to address. But if they choose not to go down this road, an exemption will be harder to obtain, and would be likely to come with qualifications designed to avoid this 'carbon leakage'.

And, finally, UK companies in energy-intensive sectors are of course subject to the same broader competitive pressures as those in the EU, as action on climate change ramps up and carbon costs increase. If EU companies are shielded from carbon leakage via the border tax, but their UK competitors are not, then the impact on UK producers in sectors such as steel, chemicals and glass will intensify.

Historically, however, carbon border taxes have faced opposition. One of the main counter arguments - usually made by developing nations - is that such taxes run counter to the principle of 'common but differentiated responsibilities' enshrined in the Paris Agreement. Another is that they contravene World Trade Organisation rules, both on subsidies and the requirement to tax imports from all countries at the same level (the 'most favoured nation' principle).  This shows there is a complex interplay between the rules of the international trading system and the processes and principles set out in the UN Framework Convention on Climate Change.

The Imperative for Acting Now

Whichever carbon-pricing systems are ultimately adopted regarding imports, the time for companies to start taking action to reduce their greenhouse gas footprints is now. Even in industries that are not inherently carbon-intensive themselves, companies will become increasingly responsible for the carbon footprints of their value chains. In many cases, CO2 emissions will become an increasingly important factor to consider when weighing the economics of where to procure everything from finished goods to components, materials, and machinery.

BCG believes that companies must move proactively by taking the following four steps:

  1. Measure exposure: Companies must gain a clear understanding of their carbon footprint and that of their entire supply chain and build a reporting capability that is at least on par with that of their competitors.
  2. Adopt internal carbon pricing: This will help the organisation develop the reflex to consider the cost of carbon in sourcing and operational decisions.
  3. Build a playbook: Companies should develop a set of options and trigger points as the EU scheme - and any other similar schemes - approach implementation. This will enable management to build flexibility into supply chains, understand the abatement curve within the company, and know when to engage specific measures. This is likely to include developing joint plans with key suppliers that may be causing downstream exposure and cost to the company.
  4. Navigate and shape policy: As governments and blocs weigh their own carbon-pricing options on imports, companies should work to shape the timing and operational modalities of the system. They should arm themselves with analysis to help them engage proactively in the public debate and policymaking process.

The movement toward a net zero carbon future in the UK no longer is a question of 'if' but of 'when'. Companies that are most successful in this transition will not only have a competitive advantage at home and in the EU, but also in other markets around the world that are just beginning to go down this path.

 

Bas Sudmeijer is Managing Director and Partner at Boston Consulting Group (BCG), and Tim Figures is BCG's Associate Director for EU & Global Trade and Investment

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