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Skirting the EU CBAM: Strategies for Avoiding the Carbon Border Adjustment Mechanism.

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In this article we will try to develop how stakeholders and nation states might develop strategies to avoid the EU CBAM. The regulation itself has a built-in mechanism for that.

EU Regulation 2023/956 features built-in safeguards against circumvention, but decision makers anticipate future refinements. This becomes obvious once you read the text of the regulation carefully. Not only does the EU enable future regulation by adopting delegated acts. In a preemptive strike against potential loopholes, the European Union has fortified Regulation 2023/956 with anti-circumvention measures. Yet, the architects of the policy openly concede that it may require further calibration. A full article of the regulation is dedicated to circumvention:

Article 27, Circumvention 1.   The Commission shall take action in accordance with this Article, based on relevant and objective data, to address practices of circumvention of this Regulation.

Suspected practices of circumvention may be reported by a variety of sources, such as the member states themselves and ... anyone:

Article 27, No. 4:   A Member State or any party that has been affected by, or has benefited from, any of the situations referred to in paragraph 2 may notify the Commission if it is confronted with practices of circumvention. Interested parties other than directly affected or benefited parties, such as environmental organisations and non-governmental organisations, which find concrete evidence of practices of circumvention may also notify the Commission.

Exploring strategies for stakeholders and nation states to navigate the EU Carbon Border Adjustment Mechanism (CBAM), it's noteworthy that EU Regulation 2023/956 leaves room for creative compliance approaches. What are those rather strategy-based circumvention measures that may be picked up by interested parties?

The following might be considered:

  1. Enhancing Domestic Carbon Efficiency: Improving a country's carbon efficiency in production processes. This reduces the carbon footprint of exports, making them more competitive under CBAM.

  2. Bilateral Agreements: Engaging in diplomatic negotiations with the EU to seek exemptions or preferential terms for a country's exports.

  3. Diversifying Export Markets: Reducing dependence on the EU market by exploring and strengthening trade relations with other regions.

  4. Challenging Legality: Challenging the CBAM’s compatibility with World Trade Organization (WTO) rules, either directly or through international coalitions.

  5. Adopting Similar Carbon Pricing Mechanisms: Implementing a carbon pricing mechanism domestically that aligns with the EU’s standards can potentially lead to mutual recognition of carbon costs.

We will focus on the last point which appears to be most interesting especially considering active targeted policy measures on a national level. The EU's Carbon Border Adjustment Mechanism (CBAM) addresses carbon pricing mechanisms and their alignment with EU standards in several ways:

  • Equivalent Set of Rules for Imports: The CBAM complements the EU ETS by applying equivalent rules to imports of specific goods, making it an alternative to mechanisms like free allocation of allowances​​.

  • Agreements with Third Countries: The EU may conclude agreements with third countries to account for their carbon pricing mechanisms in the application of CBAM​​.

  • Reduction in CBAM Certificates: An authorized declarant can claim a reduction in the number of CBAM certificates to be surrendered if the carbon price paid in the country of origin is accounted for. This requires keeping records certified by an independent person to demonstrate that the declared emissions were subject to a carbon price in the country of origin without export rebates or other compensations​​.

It is worth breaking down the most important parts and exact phrasing of the the article related to reduction in CBAM Certificates:

  1. Carbon Price Paid in the Country of Origin: Indicates that if the product was subject to a carbon price (like a tax or ETS cost) in its production country, this cost can be recognized under the CBAM. For countries, it incentivizes implementing a carbon pricing mechanism.

  2. Accounted For: This means that the carbon price paid needs to be clearly documented and verifiable.

  3. Records Certified by an Independent Person: Requires third-party verification of compliance, adding an audit-like layer to ensure integrity. This suggests companies need to engage external auditors or certifiers to validate their claims.

  4. Declared Emissions Were Subject to a Carbon Price: The emissions associated with the production of the goods must have been priced in the origin country. This pushes companies and countries to adopt transparent and verifiable carbon pricing measures.

  5. Without Export Rebates or Other Compensations: Ensures that the carbon cost is not offset or reimbursed by the exporting country, maintaining the integrity of the carbon pricing mechanism.

The last point is obviously where things become interesting. While you do have to pay a carbon price and it is mentioned that "other compensations" are a no-no, one could develop a scenario where the subject at least could be argued convincingly in favor of the exporting nation. Let us do a quick case study:

To mitigate a countries' steel export exposure to the EU's CBAM while aligning with WTO rules, on might consider implementing a novel system called "Carbon Credit and Rebate Scheme" (CCRS).

Here is how you might do it:

  1. Establish a Carbon Pricing System: Introduce a carbon tax or an Emissions Trading System (ETS) specific to the steel industry, setting a price per ton of CO2 emitted. Ensure this system's compatibility with EU standards.

  2. Certification and Monitoring: Develop a transparent certification process for steel producers, documenting their emissions and the carbon price paid. Utilize independent auditors to certify these records, ensuring compliance with CBAM requirements.

  3. Rebate Mechanism: Instead of direct export rebates (which could conflict with CBAM rules), establish a system where the carbon tax revenue is reinvested in the steel industry. Create a "Green Fund" that supports initiatives like technology upgrades for emission reductions, renewable energy integration, and efficiency improvements in steel production. This approach aligns with the CBAM's goal of reducing global emissions and avoids the issue of direct rebates.

  4. Technology and Innovation Incentives: Offer additional incentives or tax breaks for steel producers who adopt advanced, low-emission technologies or who achieve significant reductions in their emissions intensity.

  5. International Collaboration: Engage in dialogue with the EU to ensure mutual recognition of the carbon pricing system, aiming for a bilateral agreement that acknowledges the efforts and provides more favorable terms under the CBAM.

  6. Public Reporting and Transparency: Implement a robust system for public reporting of emissions and carbon costs for steel producers. This enhances transparency and aligns with both CBAM and WTO principles.

  7. Stakeholder Engagement: Involve industry stakeholders in the design and implementation of the CCRS to ensure its practicality and effectiveness.

This system balances the need to comply with CBAM requirements, supports the steel industry’s transition to lower emissions, and aligns with WTO rules by avoiding direct export subsidies. The key is the creative use of carbon tax revenues to support the industry's green transition, thus funneling costs back into meaningful emission reduction measures.

Analysis and Interpretation:

  • The regulation incentivizes non-EU countries to adopt similar carbon pricing mechanisms to the EU ETS. This approach aims to create a level playing field, where imports bear equivalent carbon costs as products manufactured within the EU, ensuring fair competition and addressing carbon leakage concerns​​.

  • Establishing a domestic emissions trading system in exporting countries simplifies compliance and exemption from CBAM adjustments. This has led to discussions in various countries, like the United States, about establishing a domestic price on carbon to align with the EU's standards​​.

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