CBAM in the Chinese and European eyes: Challenging or supporting carbon pricing policies?

Due to the preoccupation of other more pressing issues at home, China only began to pay more attention to CBAM recently, as evidenced by increasing concerns amongst the Chinese industries over this mechanism.

The Chinese and EU sides expressed a diverse set of opinions regarding the target, legitimacy, and effectiveness of CBAM. While the Chinese perception of this mechanism is relatively negative, the opposite holds true for the EU side.

The EU Carbon Border Adjustment Mechanism (CBAM) is designed to assign a cost to the embedded emissions of products imported to the EU from third countries without equivalent climate measures. The border levy will establish a CBAM certificate, equivalent to one ton of CO2 emissions, that must be surrendered by year’s end corresponding to the total emissions for a specific imported product. These CBAM certificates will closely reflect the price paid for EUAs in the EU ETS. In the event that the jurisdiction from which the product originates has an established, explicit carbon pricing scheme this may be used to reduce the total CBAM obligation by the carbon price already paid.

The EU CBAM was agreed to on 13 December with final details hammered out in the 17 December ‘jumbo trilogues’ for the EU ETS revision. Sectoral coverage will include cement, iron and steel, fertilizers, aluminum, electricity, hydrogen, and some downstream products. The scope of the measure will also extend to indirect emissions (emissions derived from electricity and heat). From October 2023, monitoring, reporting, and verification requirements will be in place for importers. The system for CBAMs will be gradually phased in as free allocation, while the current measure used to counter carbon leakage will be phased out. The timeline for this phase-in/out is as follows:

- 2026 – 2.5% reduction in free allocation

- 2027 – 5% reduction in free allocation

- 2028 – 10% reduction in free allocation

- 2029 – 22.5% reduction in free allocation

- 2030 – 48.5% reduction in free allocation

- 2031 – 61% reduction in free allocation

- 2032 – 73.5% reduction in free allocation

- 2033 – 86% reduction in free allocation

- 2034 – 100% reduction in free allocation

For more information on the outcome of EU ETS revision trilogues, read our analysis 

The EU’s CBAM will be the first of its kind under any jurisdiction. While lauded by many environmental groups, third countries have eyed its development with caution. This article examines CBAM in the context of trade with the EU’s largest trading partner, China.

For more information related to the EU ETS or CBAM please contact henry@greenfact.com.

As part of the EU’s ‘Fit for 55’ package, CBAM first and foremost targets the 2030 achievement of 55% GHG emissions reductions compared to 1990 levels. As a climate policy instrument, CBAM is intended to avoid the rising risk of carbon leakage caused by exporters who seek to benefit from moving their factories to regions with more lax carbon regulations. Following the ‘polluter-pay principle’, CBAM requires exporters in several carbon-intensive industries to report their embedded emissions. Industrial producers who pay no carbon price, or a lower one compared to the EU standard, would need to purchase emission certificates. In parallel, the EU intends to gradually phase out free allowances for its domestic industries. Thereby, a complete drawdown of free allocation will be achieved by 2034.

Subsequently, CBAM offers an effective leakage and competitiveness protection, a significant step forward compared to other existing policy instruments. From the EU perspective, CBAM implementation is seen as a wake-up call for the decarbonization of both EU and non-EU industries, as well as an important action to level the playing field among them. The EU expects that CBAM will play a key role in spurring more ambitious climate action- including providing an impetus to the development of carbon pricing policies in third countries as well as facilitating the constructive negotiations regarding a new global climate deal.

The EU industries’ position in general has rarely deviated from that held by EU leadership regarding the necessity of implementing CBAM. Results of the European Commission’s (EC) public consultation on CBAM illustrate a strong consensus across businesses, including the energy-intensive trade-exposed (EITE) industries, on CBAM introduction. Potential losses in competitiveness due to growingly higher carbon pricing triggers deep leakage concerns amongst the EU industries. In such a dynamic situation, the EU businesses firmly uphold the idea that foreign counterparts should shoulder equal carbon costs and stop relocating their production to countries with less stringent climate regulations.

Nevertheless, there remain diverse voices questioning CBAM design and whether it will serve as panacea to decarbonize the EITE industries. Given the complexity of sectors such as chemicals, some industry practitioners indicate concerns regarding how CBAM should be managed administratively. While there is not uniformity in industry response to CBAMs, many of the underlying grievances are with policy uncertainty and the question of exports. As this measure is the first of its kind, its effectiveness is not clear. Concerns voiced by industries reflect an interest in maintaining competitiveness protection through free allocation while the effectiveness of the new carbon border levy is assessed.

To address the question of exports, voices in European industry, reiterated in the European Parliament’s proposed amendments to the Commission’s proposal, call for export rebates to level the playing field for European-made products exported to third countries. Under the current system, imports to the bloc are exposed to a carbon price through the purchase of CBAM certificates, as are European products under the EU ETS. However, when those products are competing in international markets without robust climate policy, they face a competitive disadvantage. The export rebate provision was not a part of the agreement stemming from the 17 December trilogue, but by 2025 the Commission will assess the need for such a measure.

China is the world’s largest exporting country, and concurrently the most crucial trading partner of the EU. According to data from 

, in 2021, China was the bloc’s largest and third-largest trade partner in terms of imports and exports respectively. The total traded goods of both sides in 2021, worth roughly EUR 696 b, accounting for 16% of all 

. Following the fast-growing trend of EU-China trade during the last decade, it is predicted that their trade will continue to increase significantly in the future. The high emission intensity of China’s exports compared to EU products has led to growing concerns regarding Chinese acceptance of CBAM.

During the past two years, the Chinese government has been preoccupied by other more pressing concerns, notably the US-China trade conflict, COVID-19 pandemic, the introduction of the national carbon market, the 14th Five Year Plan, as well as the dual climate commitments of reaching emissions peak before 2030 and achieving carbon neutrality by 2060. It was, therefore, just recently that Chinese leadership began to devote more attention to the EU’s impending carbon levy. Against the backdrop of unknown specifics of this mechanism, during the Leaders’ Summit on Climate and the 30th BASIC Ministerial Meeting on Climate Change in April 2021, the Chinese side expressed concerns over the risk of trade restrictions, as well as the unilateral nature of the EU climate regulations. From the Chinese government’s perspective, the implementation of CBAM would violate the non-discrimination principles of the WTO, claiming it imposes an extra cost on foreign imported products and establishes a disguised trade barrier. Simultaneously, China believes that the EU CBAM is imposes a levy on products from developing countries and demands that those countries take more ambitious climate action than their voluntary NDCs. Therefore, this mechanism is contradictory to the spirit of the Common but Differentiated Responsibility (CBDR) and Nationally Determined Contributions (NDCs) articulated in the Paris Agreement. Like other countries, including Russia and the UK, China is keeping a watchful eye on whether different EU actors may use CBAM to pursue different aims, rather than tackling climate change. Indeed, some EU member states have already proposed to use the revenue to pay their COVID-19 pandemic recovery loan while several European industry sectors 

to be an additional measure to the current free allocation system.

from 2021 indicates the low readiness of Chinese industries to respond to CBAM. Only 30% of the respondents answered that they had a moderate or good understanding of CBAM while around 25% of them were not sure about the impacts of it on their business. There are two main reasons for such results. Firstly, many industry representatives believe that as long as they participate in China’s national ETS, they will be exempt from CBAM, or the Chinese government will take action in protecting the domestic industries, which was indeed the case during the 

 in 2012. Secondly, despite having just reached agreement on CBAMs, EU institutions have yet to release the final legislative text, making planning visibility more difficult for Chinese industries. Recently, the discussions on CBAM have become more prominent. Like other Chinese stakeholders, Chinese industries broadly consider this mechanism to be a heavy carbon tariff on their exported products - a protectionist move. The fact that CBAM would initially only cover some carbon-intensive industry sectors such as cement, iron, and steel, where EU industries seem to be less competitive, again raises doubts amongst Chinese counterparts about the primary target of CBAM. Across Chinese businesses, there exists a prevailing opinion that the central government should hasten the scope expansion of the national ETS as to prevent domestic industries from being hit hard by CBAM. Currently, Baowu Group, the biggest steel enterprise in China, together with other members of the China Iron and Steel Association (CISA), were tasked by the Ministry of Ecology and Environment (MEE) to prepare drafts for emissions accounting and reporting, a move considered to be crucial in preparation of broadening the national ETS sectoral coverage.

It remains to be seen whether the EU’s CBAM will deliver its ambitious climate impacts. When designed and managed properly, it is promising that the EU CBAM will convey a higher quality price signal, thereby improving the visibility of carbon pricing policies in countries beyond EU borders. At home, this mechanism will help address existing concerns amongst domestic industries over carbon leakage and product competitiveness of the EITE sectors.

At the same time, due to growing trade tensions and fear of protectionisms, the EU CBAM has unsurprisingly been faced with distrust. In such a dynamic context, insufficient clarity on the use of CBAM revenue will further undermine already fragile trust amongst countries. China will continue to be an important trading partner for the EU. Thus, the EU will pay a close attention to China’s response to CBAM, as well as to further development of the Chinese ETS. So far, both sides have yet to hold official discussions with a specific focus on CBAM. The top political agendahas been occupied by other more pressing issues such as EU-China ETS cooperation, and the operation of China’s national carbon market. This perceived lack of official exchange between both sides has been translated into a relatively negative reaction from China towards CBAM.

To reduce China’s resistance and smooth the path for putting increasingly ambitious climate policies on the table, the EU needs to actively engage with China on the issue of compliance. Specifically, it must address the risk that China may respond to this mechanism with retaliatory measures. Despite its initial negative reactions, the Chinese perception of CBAM is not necessarily fixed. China’s ultimate position will largely depend on its communication with the EU, the rigidity of CBAM, the development of its own carbon pricing policies, and notably, the EU’s recognition of these policies.

For more information related to the article please contact mai@greenfact.com.

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