Europe's Carbon Tariff: A Climate Game-Changer or a Trade War in the Making?

The Looming Tariff

As the European Union's Carbon Border Adjustment Mechanism (CBAM)—the continent's equalizing tariff on imported goods from jurisdictions with a lower price on carbon—entered its transitional phase in October 2023, companies worldwide began confronting its implications. ArcelorMittal Europe, a major multinational steel manufacturer which has previously publicly supported a Carbon Border Adjustment, and invested significantly in decarbonization technologies like hydrogen-based steel production, now faces increasing pressure as its facilities outside the EU must either absorb the cost of the new carbon tariffs or invest heavily in reducing their emissions intensity to remain competitive. 

This scenario is unfolding across industries worldwide as the EU's first-of-its-kind carbon tariff system takes effect. The question remains: Will CBAM successfully drive global emissions reductions, or simply redirect carbon-intensive production to unregulated markets while igniting a new era of trade disputes?

Understanding CBAM and Its Objectives

CBAM combats "carbon leakage"—when industries relocate production to countries with weaker climate regulations to avoid carbon costs, thereby “moving” emissions elsewhere. The mechanism requires importers of carbon-intensive goods—initially covering sectors like cement, iron, steel, aluminum, fertilizers, electricity, and hydrogen—to purchase certificates corresponding to the carbon price had production occurred within the EU's Emissions Trading System (ETS).

After the October 2023 transitional reporting phase, the full implementation will phase out the free emission allowances currently allocated to EU emission-intensive trade-exposed industries under the ETS by 2026. An OECD analysis suggests that the EU ETS reform without CBAM would reduce global emissions by 0.39%, while with CBAM, this increases to 0.54%.

European Industry: Winners and Worries

Winners

European companies that have already invested in cleaner production methods stand to gain a competitive edge. For example, Swedish steelmaker SSAB is pioneering fossil-free steel production using hydrogen through its HYBRIT initiative. CBAM could level the playing field, making their greener products more cost-competitive against imports from regions with lower carbon prices. Similarly, European green technology providers are experiencing increased demand for their solutions. For instance, Ørsted, a Danish renewable energy company, is witnessing greater interest in its offshore wind power solutions as European industries seek to decarbonize their energy supply.

Losers

Conversely, European emission-intensive industries face cost increases and greater burdens than foreign competitors. A Boston Consulting Group (BCG) study suggests that CBAM may disadvantage European manufacturers: they face full carbon costs globally under the domestically enforced ETS (e.g. including scope-2 emissions like electricity), while non-EU firms often don't face these costs. Furthermore, CBAM's limited scope creates loopholes and encourages resource shuffling, generating cost disparities and limiting EU producers' flexibility in managing carbon prices. For example, CBAM does not cover all finished goods and applications, allowing some imports to bypass tariffs by entering as finished products (e.g. car components, white goods).

European industry groups have echoed this. The European Automobile Manufacturers' Association (ACEA) has expressed concerns about the impacts on competitiveness of European car production and potential retaliation from trading partners. Similarly, segments of the chemical industry highlight the lack of consideration for indirect carbon costs (like electricity prices impacted by the ETS), weakening export competitiveness and posing implementation challenges.

Companies Pivoting

European companies are responding to CBAM in various ways. Holcim Limited, a building materials manufacturer, has invested in low-carbon cement and carbon capture technologies across European operations to lower emissions. 

Nevertheless, industry associations like the European Round Table for Industry (ERT) emphasize the need for careful implementation of CBAM to protect European businesses globally.

Global Reactions: A Spectrum of Views

China and India

As major exporters of goods targeted by CBAM, China and India have voiced strong opposition. 

China's Ministry of Ecology and Environment has criticized CBAM as a unilateral measure disguised as climate action. In response, China has proposed green innovation requirements for key industries such as steel, cement, petrochemicals, and chemicals. Chinese steel giants like China Baowu Steel Group are exploring low-carbon steelmaking technologies.

India's Commerce Ministry has been in discussions with the EU, arguing that developing nations shouldn’t face the same emissions reductions obligations as wealthier, industrialized countries. The Centre for Social and Economic Progress forecasts significant impacts on exports in sectors like iron, steel, and aluminum. Going back to this article’s introduction, despite previous support by ArcelorMittal Europe for CBAM, the CEO of its India division claims exports of green steel are not feasible by 2026. 

United States and Canada

The US has an unfavourable view of CBAM, with the International Trade Administration stating, “new EU regulations on carbon emissions create uncertainty and could negatively impact U.S. exporters and cargo operators.” Some studies say that CBAM will only impact 1% or $4 billion of the $350 billion US exports—considerably less than Trump’s recently proposed 25% tariffs, which cover 70% of EU exports. Legislative proposals to replicate the EU's pricing mechanism, such as the Clean Competition Act and the Foreign Pollution Fee Act gained little traction in 2023 and are now likely dead in the water with the Trump administration's very clear antithetical stance on climate action.

Given Canada’s current trade war with the US and efforts to increase trade with the EU, CBAM could benefit Canadian steel production, given its lower carbon intensity. Canada has held consultations for its own CBAM, but there is a strong awareness of the risks of retaliation from major trading partners. The history of tariffs, such as those on steel and aluminum, highlights the potential for trade friction and the importance of aligning carbon and trade policies to avoid negative economic consequences.

Emerging Markets

Developing economies face significant challenges. A study by the United Nations Conference on Trade and Development (UNCTAD) highlighted the potential for reduced export competitiveness and revenue losses for many developing countries. Countries heavily reliant on exporting raw materials and carbon-intensive goods could face significant economic headwinds. South Africa’s energy intensive mining and manufacturing face significant challenges. Other affected countries include Vietnam, Mozambique, Zimbabwe, Cameroon, Nigeria, and Morocco.

The Bigger Question: Will CBAM Actually Cut Global Emissions?

Potential for Success

Well-designed carbon border adjustments could drive global emissions reductions by incentivizing cleaner production processes worldwide. Research suggests that CBAM could indeed lead to a decrease in carbon leakage and encourage the adoption of carbon pricing mechanisms in other countries. 

Early indications include companies in exporting nations setting more ambitious decarbonization targets in anticipation of CBAM, such as Turkish steel producers investing in energy efficiency and exploring cleaner energy sources. The Turkish government has also established mechanisms to support exporters in complying with CBAM requirements. This includes programs to help companies reduce their carbon footprint and improve energy efficiency, recognizing that 40% of Turkey's exports go to the EU.

Risks of Failure

However, the risk of "resource shuffling"—where exporters divert cleaner products to the EU and carbon-intensive ones to other markets—remains a significant concern. Furthermore, effective implementation and verification pose considerable logistical challenges with the European Court of Auditors highlighting potential loopholes requiring robust enforcement mechanisms.

Unintended Consequences

CBAM could trigger retaliatory trade measures, undermining climate action and global economic stability. 

Furthermore, CBAM could widen the gap for developing countries, as Boston University research suggests that border carbon adjustments primarily benefit industrialized countries while imposing disproportionate costs on developing economies.

The Way Forward

Enhanced International Cooperation

Coordination through forums like the G20 and the World Trade Organization is essential for harmonized carbon pricing and to reduce resource reshuffling. For example, the International Monetary Fund has proposed an international carbon price floor among major emitters that could complement border adjustments while ensuring more equitable burden-sharing. Given trade tensions today, CBAM must be perceived as an emissions reduction mechanism, not trade protectionism. 

Support for Clean Tech in Developing Economies

Providing financial and technological assistance to developing countries to support their transition to cleaner production methods is vital for ensuring a just and effective global response to climate change. Initiatives like the EU's Just Energy Transition Partnerships can serve as models for mobilizing investments in decarbonization in emerging economies.

Transparency and Robust Enforcement

Transparent and reliable carbon accounting and verification systems are paramount to prevent circumvention and asymmetrical punishment. Standardized methodologies for emissions reporting, such as those promoted by ISO, can play a crucial role. The EU must also learn from past experiences with its ETS and avoid exemptions and loopholes that could weaken CBAM's effectiveness.

As manufacturers worldwide scramble to adapt to Europe's carbon tariff system, we stand at a critical juncture in climate policy. CBAM represents an unprecedented experiment in using trade levers to drive environmental change. Whether it will be remembered as the catalyst that finally aligned global economic incentives with climate goals—or as the well-intentioned policy that fragmented the international trading system and deepened economic divides—depends largely on how it's implemented and whether it inspires cooperation rather than conflict. The clock is ticking—not only for companies racing to reduce their carbon footprints, but for a planet that can’t afford another failed climate initiative.