Overview
On April 22, 2021, President Biden will host a virtual summit with 40 world leaders to discuss the global climate change crisis. The "Leaders Summit on Climate" is intended to catalyze more ambitious emissions-reduction efforts by the world's major economies. The United States intends to lead by example with a new 2030 emissions target as its Nationally Determined Contribution (NDC) under the Paris Agreement.
The decision to convene a summit on climate change is one of many signals sent by the Biden Administration over the past few months that the U.S. approach to climate change is shifting dramatically, both at home and abroad. The Biden Administration has made clear that climate change must be part of decision-making across the entire government, including with respect to trade policy. Stronger enforcement of the environmental standards in U.S. FTAs, the integration of climate change into government procurement decisions, and strengthening U.S. supply chains for electric vehicles are all part of this shift. The United States is also pushing climate cooperation bilaterally. It recently entered into a "Competitiveness and Resilience (CoRe) Partnership" with Japan that focuses on the development and deployment of clean-energy technologies. The United States and China also recently released a Joint Statement "Addressing the Climate Crisis" that acknowledges their shared commitment to implementing the Paris Agreement.
One of the trade-related climate policies currently under consideration by the United States is "carbon border adjustments". President Biden included carbon adjustments in his campaign plan and USTR referenced the possibility of imposing "carbon border adjustments" in its recently announced 2021 Trade Policy Agenda. Carbon border adjustments charge a fee on imported goods based on the carbon intensity of their production process in order to reduce the incentive to relocate carbon-intensive production to jurisdictions that have not yet addressed the need for carbon emitters to internalize emission costs, commonly referred to as "carbon leakage". They also serve to level the playing field for domestic industries that would otherwise face competition from cheaper, more carbon-intensive imports. By raising costs on imports, carbon adjustments may also incentivize other countries to adopt similar carbon pricing policies. Carbon adjustments may also rebate the cost of a domestic carbon fee on exports to help them compete in international markets.
Carbon border adjustments are highly controversial for a number of reasons, both practical and legal. On the practical side, accurately measuring carbon emissions is a huge challenge. There are well established methodologies for estimating emissions for certain primary goods such as steel and aluminum, but estimating the carbon footprint of finished products presents significant challenges. Difficult choices would need to be made in structuring any carbon border adjustment. For example, would emissions be calculated on a product-specific basis to ensure each company is charged according to its particular emissions, or would benchmarks be developed and if so, based on what data? Would the same benchmark apply to producers that use relatively cleaner technologies to manufacture the same product? How would reported emissions from foreign producers be verified? What if a producer is already subject to a carbon fee in their home country? Should their exports be charged a reduced fee? Should certain countries be exempt altogether, e.g., developing countries? How should the revenue collected from a border fee be used? Should U.S. exports be eligible for rebates?
All of these practical choices in turn raise complex legal questions under the WTO covered agreements. The consistency of these measures with WTO rules concerning border adjustments has not been tested and there is considerable room for debate. It is also unclear whether these measures would be found justified under any of the potentially applicable WTO exceptions.
There has also been speculation that the Biden Administration could impose carbon tariffs under Section 232 of the Tariff Act. A carbon tariff could similarly target imports based on the carbon-intensity of their production process, but imposed as a standalone measure, without an underlying domestic carbon pricing regime for internationalizing carbon costs, it would not constitute a carbon border adjustment. This would further complicate the already challenging methodological and legal issues.
The unilateral imposition of carbon border adjustments or carbon tariffs poses risks for global cooperation on climate change. If only one or a handful of countries implement these measures, it may provoke retaliatory measures by trading partners rather than incentivize more ambitious, coordinated climate action. Special Presidential Envoy for Climate John Kerry has indicated that carbon border adjustments should be viewed as a “last resort”. Nevertheless, it remains possible that the United States will take action targeting carbon-intensive imports. A carbon border adjustment is included in the carbon fee legislation recently proposed by some Democrats. And carbon tariffs may gain traction if the legislative process moves too slowly.
The European Union has advanced considerably further toward a carbon border adjustment than the United States, with a proposal from the EU Commission expected in June. One option on the table for the EU carbon border adjustment mechanism (CBAM) is extending the EU Emissions Trading Scheme (ETS) to importers in the form of a requirement to purchase emissions allowances. This could raise costs for emissions-intensive imports significantly. On top of buying sufficient emissions allowances to cover emissions associated with the production of their products, companies may need to adopt highly technical emissions tracking and estimation methodologies. EU producers that have participated in the EU ETS are well-practiced at monitoring and reporting their emissions. Producers in other countries may have no experience with this and face a steep and costly learning curve.
If the EU CBAM proposal is ultimately approved, the United States and other countries will be under increasing pressure to act, whether by imposing their own carbon border adjustments, pursuing legal challenges, or imposing retaliatory measures. In addition to the EU, Canada already has a federal carbon pricing regime in place (recently upheld as constitutional by the Supreme Court of Canada) and has indicated that it is exploring carbon border adjustments. Other countries such as Australia, Brazil, India, South Africa, and China have voiced opposition to carbon border adjustments, arguing that these measures are protectionist, have the potential to spark trade conflicts and disrupt international cooperation on climate change, and would harm developing countries that have less capacity to reduce emissions and depend heavily on emissions-intensive exports.
It's too early to rule out a coordinated approach among countries on carbon border adjustments and other trade-climate issues entirely. There are multiple opportunities scheduled over the course of this year following the Leaders Summit for countries to negotiate some kind agreement on whether and how to deploy trade policy to complement domestic climate polices and encourage more ambitious international action, including the G7 Summit, the UN Climate Conference (COP26), and the WTO Ministerial. But the uneven levels of climate ambition and exposure among countries will make reaching any kind of broad agreement on carbon border adjustments in particular extremely challenging.
In light of the lack of international consensus and pending unilateral action, companies should begin preparing to navigate multiple, potentially divergent trade-climate regimes. Given the amount of time it may take to develop the capacity to accurately measure emissions and comply with new regulations, it is not too early for companies to start evaluating their potential exposure to trade-climate policies, developing strategies to mitigate costs and capitalize on opportunities, and considering how to engage with policymakers across the rapidly expanding list of trade-climate issues.
