How can CBAM work?

Note: The English version of this study will be published shortly.

The EU aims to reduce its CO₂ emissions by 55% by 2030 compared with 1990 levels, and by 90% by 2040 relative to 1990. To achieve these ambitious climate targets, the volume of available emission allowances will have to be drastically reduced in the coming years. This will lead to a sharp rise in the price of these emission allowances.

What are the consequences of this price increase?

Despite the increasing electrification of the EU economy, energy prices will rise significantly. Under the current electricity market design, electricity prices increase as long as fossil fuel power plants are still required to cover electricity demand. It is not to be expected that the EU’s trading partners will face similarly high CO₂ prices and energy costs. This may lead to the relocation of energy-intensive companies, accelerated deindustrialisation, and a reduction in the effectiveness of European climate policy with regard to global emissions. A mechanism is therefore required to offset the negative effects of European CO₂ pricing on competitiveness. To this end, the EU has proposed a Carbon Border Adjustment Mechanism (CBAM).

Will this mechanism work?

The proposed CBAM entails high information requirements and therefore considerable administrative costs, which force compromises. So far, it only covers a small number of particularly CO₂-intensive products such as steel, cement and fertilisers. As a result, industries that use these goods as inputs are burdened. In addition, CBAM is applied only to imports, meaning that the competitiveness of exporters is not preserved. Trading partners have also threatened retaliatory tariffs.

What alternatives does the study propose?

• The first proposal envisages a uniform levy on imports combined with a subsidy for exports, thereby exactly offsetting the trade effects of CO₂ pricing. The calculation does not require information on the CO₂ intensity of foreign production. Its advantages lie in lower administrative burdens and the full inclusion of both imports and exports. The disadvantages include the lack of incentives for reducing emissions by foreign producers, persistently high information requirements, and a substantial risk of retaliation by trading partners.
• The second proposal involves the continued allocation of free allowances to CO₂-intensive industries under the EU Emissions Trading System, combined with a levy on the final consumption of the affected goods, regardless of their origin. This approach would be unbureaucratic, WTO-compliant and effective from a climate policy perspective. According to the research team, it would be well suited as a transitional solution.

What exactly speaks in favour of the climate levy proposal?

Simulation results show that this alternative comparatively minimises the production and income losses resulting from higher CO₂ prices in the EU. The researchers recommend that the revenues be used to promote climate-neutral production. It is crucial that CBAM, or a well-designed alternative, is able to fulfil its purpose. If it fails, deindustrialisation could discredit CO₂ pricing as such, likely resulting in more costly and less effective regulation. A well-thought-out CBAM therefore also protects the market-based approach to climate policy in the EU.