Carbon Border Adjustment, Trade and Climate Change: Emerging Issues at COP28

The recently concluded 2023 United Nations Climate Change Conference (COP28) in Dubai yielded both positive outcomes and disappointments. On the positive side, parties successfully sealed a deal for a loss and damage fund and increased climate finance commitments and renewable energy production. On the downside, the conference saw a record number of fossil fuel lobbyists, a delayed agreement on the Global Goal on Adaptation, and sorely disappointing negotiations on the Global Stocktake.

What was overlooked at this year’s COP, however, is the World Trade Organization’s (WTO) inaugural participation in co-chairing “Trade Day,” signifying a greater emphasis on interconnection between trade and climate change.

As the only global organisation dealing with trade rules between nations, the WTO is often criticised for failing to facilitate a rise in climate-trade-related disputes. In November this year, the European Union (EU) launched the transitional phase of the Carbon Border Adjustment Mechanism (CBAM) — a policy to speed up global emission goals and tackle the risk of carbon leakage by requiring industries to report their emissions. The leakage occurs when companies based in the EU shift carbon-intensive production to non-EU countries which have less rigorous climate policies. When the policy fully takes off in 2026, EU importers of six commodities — electricity, aluminium, iron and steel, cement, fertilisers, and hydrogen — are expected to pay a carbon levy based on the embedded emissions generated during the production process. The adjustment tariff will be collected in the European jurisdiction for EU importers. Global producers planning to export to the EU must report their emissions and expect additional business costs.

To date, the EU CBAM stands out as the most important climate policy with significant impacts on trade. Various studies have scrutinised the merits and drawbacks, pointing to concerns about its effectiveness in reducing global emissions, potential fragmentation of global trade blocs, impacts on the welfare of developing countries, and technical complexities of implementation within today’s intricate and interconnected supply chains. The WTO, being the sole global trade body equipped with a Dispute Settlement Body to address trade conflicts, has initiated discussions regarding the emergence of “green protectionism” and the perceived unilateral move by the EU.

The WTO’s response to the EU CBAM has been generally ambivalent thus far. In multiple public hearings, WTO representatives affirmed their support for more ambitious climate goals while expressing apprehension about the risk of discrimination and trade frictions associated with such a policy. The WTO, in principle, supports global carbon pricing, provided it is less fragmented. To put it in perspective, global carbon prices currently differ considerably. The EU’s Emissions Trading Scheme (ETS) reached a record high of US$108 per Mt of carbon dioxide (CO₂) in February 2023. In contrast, exporting countries like China, Korea, and Japan, operating under their respective national ETSes, imposed taxes of US$9.20, US$18.75, and US$2.30 per Mt CO₂ emitted, respectively, in 2022. Recently, the WTO has taken a proactive step by launching a task force to determine global carbon prices, aiming to ensure that future carbon adjustments imposed on imports do not unfairly penalise developing countries.

The EU CBAM thus presents an opportunity for ASEAN countries to initiate a more robust domestic carbon tax regime. Collecting carbon taxes domestically is likely to be politically less sensitive than the challenge of facing carbon adjustment tariffs within European jurisdiction.

Various countries have intensified their responses to the EU CBAM. Most notably, China has formally requested the Committee on Trade and Environment at the WTO to facilitate discussions on the EU CBAM. Bilaterally, India and the EU have initiated a dedicated workstream on the CBAM through their joint Trade and Technology Council. Within Southeast Asia, policymakers are navigating diverse responses as they grapple with the potential impacts of this policy.

Indonesia and Malaysia generally have a negative stance toward the EU CBAM, partly influenced by ongoing disputes over palm oil with the EU. Conversely, Singapore exhibits comparatively less concern, as the EU CBAM has limited implications for its current export commodities, mainly organic chemicals and pharmaceutical products, to the EU. Meanwhile, Vietnam and Cambodia have experienced an upward trajectory in trade relations with the EU in recent years. Consequently, policymakers in these countries view complying with EU CBAM as essential to enhancing the global competitiveness of their economies and sustaining the growth of trade with the EU.

The intersection of trade and climate issues is expected to become increasingly significant in the future, mirroring the COP developments and the emergence of the G7 Climate Club. While global policymakers may require an extended duration to address this complex nexus through the WTO, which grapples with the delicate balance between trade liberalisation and climate considerations, industries must be confident in adapting to growing sustainable commitments. This adaptation is essential to avoid both the loss of market access and competitiveness on a global scale.

Southeast Asian countries possess a crucial asset for adapting to the EU CBAM through their increasing commitment to implementing domestic carbon pricing mechanisms. Singapore has successfully implemented a robust carbon tax policy and pathway to raise the carbon price in the future. Indonesia is exploring cap and tax schemes for coal power plants. Additionally, Thailand and Malaysia have established voluntary carbon exchanges, enabling corporations to purchase carbon credits and offset their carbon footprint, thus contributing to nationwide climate mitigation efforts. Without strong standards and safeguards of the integrity of voluntary carbon mechanisms, however, these efforts run the risk of greenwashing.

An often-overlooked aspect of the EU CBAM is that if a non-EU producer can demonstrate that it has paid the price for the carbon used in the production of the goods exported to the EU,  the corresponding cost can be fully deducted for the EU importer. The EU CBAM thus presents an opportunity for ASEAN countries to initiate a more robust domestic carbon tax regime. Collecting carbon taxes domestically is likely to be politically less sensitive than the challenge of facing carbon adjustment tariffs within European jurisdiction. Channelling the collected revenue from carbon tax back to companies to improve their sustainability standards should be considered. This is important to boost their confidence in navigating the rise of green standards in international trade.

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