Dr. Goran Dominioni (Dublin City University)
The European Union (EU) Emission Trading Scheme (ETS), is considered by many the flagship EU climate policy. The EU ETS has undergone many reforms in almost 20 years of its existence. In the latest round of reforms adopted in 2023, one of the main novelties is the gradual phase-out of free allocation of EU ETS allowances. This change is significant because it ends a climate-harmful practice that has resulted in windfall profits for regulated entities in the past. This move also comes at a potential risk.
While detrimental in many ways, free allocation helped to address risks of policy-induced carbon leakage, that is, the displacement of greenhouse gas (GHG) emissions to third countries due to an increase in the cost of emitting GHGs in the EU. Carbon leakage risks are problematic because they can hamper the climate ambition of the EU — a jurisdiction that many expect to take the lead in addressing climate change in line with the Paris Agreement.
The EU has adopted the Carbon Border Adjustment Mechanism (CBAM) to address potential risks of carbon leakage. CBAM imposes a price on GHG emissions embedded in products imported into the EU in sectors deemed at risk of carbon leakage and having a significant climate impact. By imposing this price, the EU aims to level the playing field between domestic producers and exporters to the EU. Furthermore, the instrument can potentially increase climate action in trading partner countries.
In particular, CBAM can incentivize the governments of trading partner countries to support domestic producers that export to the EU to reduce GHG emissions (e.g., through subsidies). In addition, governments in third countries may be incentivized to implement carbon taxes or ETSs in their own jurisdictions, as these prices are credited for under CBAM, and thereby collect revenues that would otherwise accrue to EU countries.
In a recent article, Dan Esty and I have argued that this regulation could be improved by extending the comparison of the stringency of climate policies in the EU and trading partner countries to instruments that are not explicit carbon pricing mechanisms. This would be beneficial both from a climate and a political perspective. From a climate perspective, it would allow countries that do not have the political space or the technical capacity to implement a carbon tax or an emission trading scheme to implement additional climate policies and see them credited for in the border carbon adjustment mechanism. This can stimulate great climate action in trading partner countries, especially those struggling to implement explicit carbon pricing mechanisms, such as the US (at the federal level). From a political perspective, extending the comparison to other GHG policies can reduce opposition from trading partners.
Indeed, while less than 50 countries have an explicit carbon pricing instrument in place worldwide, virtually all countries have implemented policies that increase the marginal cost of emitting GHGs, such as gasoline and fuel taxes. Recognizing their policy efforts could smoothen opposition, potentially avoiding risks of trade disputes.
Goran Dominioni is an Assistant Professor in Law at the DCU School of Law and Government. His primary research interests are Carbon Pricing, International Maritime Transport, and Climate Change Law.
The views expressed in this blog post are the position of the author and not necessarily those of the Brexit Institute blog.