7. Border Carbon Adjustments

Border Carbon Adjustments (BCAs), which seek to impose a carbon price on imports, have been discussed for many years.  The EUETS Directive included provisions that allowed for such arrangements to be introduced, although they have not been implemented, and the proposed US Federal cap and trade scheme under the American Clean Energy and Security Bill (Waxman-Markey) made similar provisions, although it was never passed into law.

There was a straightforward idea behind such provisions.  Some countries would introduce carbon pricing, and they would impose a price on imports matching the price to domestic producers.  The price might be levy, or a requirement to buy emissions allowances.  The carbon price on imports would to avoid putting indigenous industries at a competitive disadvantage, and so to prevent leakage of emissions and industry to other jurisdictions without carbon pricing.  This could be accompanied by rebates or exemptions from the carbon price for exports.

There may be challenges to BCAs under the General Agreement on Tariffs and Trade (GATT).  Although the position is not clear cut, it seems that acceptance of BCAs under GATT is likely to require demonstration of environmental benefits[1], so as to qualify for exemptions under Article 20 of GATT.  However, well designed BCAs may be able to withstand such challenges, and the rest of this post assumes that BCAs can be made compatible with GATT.

However despite their potential to prevent leakage and possible compatibility with GATT there has been no comprehensive implementation of BCAs to date.  Instead threats to the competitiveness of emissions intensive trade exposed industry have been addressed by allocating allowances freely to emitters.  (Some modelling compares BCAs with the counterfactual of no measures to address competitiveness, but here I implicitly consider them relative to the counterfactual of benchmarked free allocation of allowances to indigenous industry.)  BCAs are more limited in their application, more complex, and create more problematic incentives than is apparent at first sight.

For most goods and services, emissions are simply not a large enough proportion of costs to justify the tracking of both emissions and the carbon prices paid through complex modern value chains.  The average emissions intensity of world GDP is around a tonne of CO2 for every $2000 of value, so a carbon price of $20/tonne shifts prices by only 1% over the average of the global economy.  Many traded goods are less emissions intensive still.  Even for goods which produce significant emissions from their manufacture are significant, such as cars, the effect can be quite small.  A 10% emissions saving might reduce the price of a £15,000 car by around £15[2], not enough to be much of an influence on purchase decisions.

High administrative costs relative to benefits imply that BCAs are only likely to be applicable to emissions intensive, trade exposed (EITE) commodities.  Indeed, many advocate focussing on EITE commodities, at least as a starting point[3].  This mirrors the position for free allocation of allowances, which tends to be highest for EITE industry. However this inevitably means that BCAs apply to only a small proportion of emissions, as only a small proportion of world emissions are caused by the production of emissions intensive commodities which are subsequently traded internationally.  For example, steel is the largest source of industrial emissions after power generation.  But steel imports to the EU were around 25 million tonnes in 2012[4], with emissions from production of around 50 million tonnes per annum.  A 10% reduction in these emissions would save 5 million tonnes, equivalent from replacing one large coal power station with one burning natural gas.  (Emissions reduction from the steel industry within the EU is incentivised – or at least should be – by the EUETS where benchmarked free allocation of allowances retains the marginal price signal).

The administrative costs around BCAs arise from various sources.  Application of BCAs requires the emissions involved in producing something and the price paid for those emissions (net of any allocation of free allowances) to be tracked, making them much more administratively onerous than simple emissions foot-printing.  Third party certification is likely to be required.  Systems will need to be flexible enough to accommodate not only default parameter values but specific values for individual producers to be legal under GATT[5]Place of origin and transhipment rules will need to be enforced, which is likely to be especially challenging in view of the number of regional pricing schemes in place, with a need, for example, to track goods produced in Oregon (which does not have carbon pricing) but exported via California (which does).

In addition to the administrative costs, substantial political effort is likely to be required to establish BCAs.  Schemes differ, for example in their coverage and the stringency of their caps, and there will usually be no clear cut way of establishing equivalence between the carbon prices paid.  This is likely to result in bilateral negotiations between schemes, with agreements becoming very numerous as the number of schemes increases.  The different levels of jurisdiction at which schemes operate, including national and provincial, is likely to cause political as well as administrative challenges.  Additional political tension may be created by imposing a certain preferred regulatory approach on another country.  For example if a country adopts a regulatory approach to reducing emissions it may claim equivalence with a carbon pricing scheme, but this may be difficult to demonstrate, and so disputes may arise which prove difficult to resolve.   The political difficulties arising from attempts to include aviation in the EUETS do not make it an encouraging precedent for the introduction of BCAs.

Even if the administrative systems can be made cost effective, and the political challenges can be overcome, the incentives created by BCAs are problematic.  They do not put the incentive for reducing emissions where the control is, usually in the manufacture.  Instead they rely on flow back of incentives through the value chain, which inevitably leads to dilution of effectiveness of the incentive – although this is less so for emissions intensive commodities with relatively short value chains than other goods, which is another reason for focussing on these.  There are also potential problems with bypass by moving down the value chain.  For example, if BCAs are imposed on steel imports, the exporting country may move into the production of semi-finished goods, which bypass the BCAs but lead to a loss of economic activity from the jurisdiction imposing BCAs.

The most serious problem with incentives created by BCAs seems to be “resource shuffling”, the switching around of resource flows in a way that reduces or avoids payment of BCAs, while not reducing emissions from manufacture, and increasing transport costs and associated emissions.   For example, if the EU is currently importing high carbon production, and the USA has its own low carbon production, BCAs in the EU may simply to lead to the low carbon US production flowing to the EU (to obtain the benefit of the competitive advantage it now enjoys), while the high carbon production previously going to the EU instead is shipped to the USA.  The only effect on emissions is the increase from the extra shipping involved.

For these reasons BCAs tend to work best for emission intensive commodities in certain well defined circumstances.  They may be applicable when free allocation of allowances is inappropriate, as in the power sector (where imports are not sufficient to limit price rises by generators within the scheme and so free allocation is likely to create windfall gains).  They may also work where the price signal to consumers to substitute less emissions-intensive goods is an important abatement mechanism, which may be the case for cement.

Applications of BCAs to date are all for electricity imports.  California and Quebec both have a requirement to surrender allowances for imported electricity.  Indeed the requirement for electricity exports from the north-eastern USA to Quebec is the only instance of an implemented BCA across national frontiers.  Similarly in the Beijing emissions trading scheme consumers are likely to be required to surrender allowances for imported power.  However, such measured are not universal for carbon prices in the power sector.  RGGI does not have any requirements for imported power, nor does the UK carbon price support levy.

Those schemes that are in place illustrate some of the difficulties with BCAs.  California has provisions in place to guard against resource shuffling but they have yet to be tested.  Achieving similar rules across multiple commodities for multiple carbon pricing regimes across countries with separate legal systems appears likely to be vastly more complex and difficult.

BCAs for cement have also received serious consideration in California.  Process emissions from cement are hard to reduce, and the best way of reducing them is to use less cement.  The price signal on consumers is therefore valuable, and a good reason for at least considering BCAs for this commodity.

Despite these instances of applicability, BCAs increasingly seem like an idea designed for a world very different from that now emerging.  They were expected to apply mainly at the border of developed countries, imposing carbon pricing to prevent leakage to developing countries.  However carbon pricing coverage in developed countries is both more diverse in design, more varied in price, and less comprehensive than was envisaged, while some developing and middle income countries are moving towards their own carbon pricing.  BCAs are simply not well suited towards this more complicated emerging reality.

In view of their many difficulties BCAs seem likely to be restricted to a few special cases, where they may have a valuable role to play.  The substantial administrative effort and political will needed for widespread adoption of BCAs is much better directed elsewhere.  In particular there is much that can be done, and is being done, to help the spread of carbon pricing, and this is where the priority should lie.

Adam Whitmore – 3rd July 2013

[1] Some specific issues around GATT are well considered Carbon Leakage Measures and Border Tax Adjustments under WTO Law,   Joost Pauwelyn, 2012 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2026879  A good overview of general issues around BCAs is provided by A Guide for the Concerned: Guidance on the elaboration and implementation of border carbon adjustment,  Cosbey at al. (2012) http://www.iisd.org/publications/pub.aspx?pno=1716

[2] E.g. 10 tCO2/car of emissions from manufacture, 10% saving of these, $23/tonne carbon price is £15/vehicle.  The main point here is that the available reduction in emissions for one manufacturer versus another (assumed for illustration to be 10%) is much less than the total emissions from manufacture – zero emissions production is not practically feasible.  Estimates of emissions from manufacture vary greatly and by size of car, how wide the scope of the footprinting is and so forth.  The 10tCO2 figure is roughly indicative for a moderate sized car costing £15,000.  See for example, slightly lower estimates from the Carbon Trust http://www.carbontrust.com/media/38401/ctc792-international-carbon-flows-automotive.pdf,  and Argonne National Laboratory http://www.bartlett.ucl.ac.uk/energy/news/documents/don_hillebrand.pdf

[5] My understanding is that precedent in this comes from two cases, around shrimp netting and turtles, and around reformulated gasoline

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