EU GREEN DEAL ON STEEL
EU CLIMATE LEADERSHIP REQUIRES WATERPROOF
CARBON LEAKAGE MEASURES
WHY A CARBON BORDER MEASURE NEEDS TO COMPLEMENT
TEMPORARILY
FREE
ALLOCATION
AND
INDIRECT
COSTS
COMPENSATION IN THE TRANSITION TOWARDS CLIMATE NEUTRALITY
This paper clarifies the reasons why it is appropriate from environmental, economic and legal
perspectives to implement initially a carbon border measure as a complementary provision in
addition to the existing carbon leakage measures.
The EU Green Deal is a landmark for the EU leadership in the international fight to climate change.
The Green Deal proposes to step up substantially not only the long-term climate objectives for 2050
but also the short-term ones for 2030. Considering the current Intended Nationally Determined
Contributions (INDCs) of international partners, this is likely to increase even further the
differences in levels of ambition worldwide. This trend can be assessed by the end of 2020, when
signatories of the Paris Agreement need to submit their final NDCs as well as their mid-century
strategies.
In this context, avoiding the risk of carbon leakage is a pre-condition for preserving both the
environmental integrity of EU climate policy and industrial competitiveness, since it contributes to
reduce emissions at global level while maintaining jobs and investments in Europe. This will also be
instrumental in facilitating the social acceptance of EU leadership in climate ambition.
Due to the market characteristics of the sector, tackling successfully the risk of carbon leakage in
the steel industry is particularly relevant. As recognised in the 2018 Commission Communication “A
clean Planet for All” as well as in the 2015 Impact Assessment accompanying the Commission
proposal on the post 2020 EU ETS Directive, the steel sector is the most exposed among all energy
intensive industries, both in terms of possible impact on output and on investment.
The Green Deal underlines that the risk of carbon leakage can materialise in different forms, “
either
because production is transferred from the EU to other countries with lower ambition for emission
reduction, or because EU products are replaced by more carbon-intensive imports”. As long as there
is no international binding agreement with a global carbon price and equivalent efforts, it is
essential that the EU legislation adopts effective measures that avoid all forms of leakage in the
short term but also in medium term.
While free allocation is designed mainly to address the risk of production relocation, a carbon
border measure can be an effective instrument to address structurally the emissions embedded in
trade. This measure should take into account the carbon intensity and related costs in the EU and
compare them with third countries.
The border measure should be applied for a transition period until breakthrough technologies
reach sufficient market penetration and CO2-lean products represent a critical mass in the market.
It represents a broader contribution to a clean planet, as it is also an effective tool of political
diplomacy to foster climate ambition in third countries so that deeper emission reductions are
delivered globally. Furthermore, it would provide additional revenues to the EU that should be fully
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used for climate measures, in particular for the development and upscaling of industrial
breakthrough technologies.
An effective carbon border measure needs to take into account both direct and indirect costs of
the EU ETS and to create incentives for third countries' competitors to implement similar emission
reductions. As proposed by the Commission, it should apply initially only to few sectors and others
could opt in gradually. In the case of steel, it could initially apply only to steel finished and semi-
finished products such as coils, slabs, plates, bars, billets, etc, and be extended to steel input
materials (scope 3 emissions). A workable solution should preserve also those downstream
products that are primarily based on steel, such as tubes, fasteners and wire drawings. The EU
could adopt “Agreements of Equivalence” with third countries that either join the EU ETS or have
identical CO2 cost constraints for their industry, in which case there will be no border measure.
The effectiveness of the border measure will depend on the details of its design and its ability to
tackle delicate issues such as the risk of absorption and source shifting.
With regard to the former, it is important to consider that EU carbon costs are applied to the entire
EU production, while any border measure would likely apply only to the marginal tonnes that third
countries’ producers export to the EU, hence having the possibility to absorb such costs
throughout their entire production. As an example, an EU producer with a total production of 5
million tonnes of steel and an average carbon cost of 10€/tonne will pay €50 million, while a third
country producer with the same total production but exporting to the EU 5% of its production
(250,000 tonnes) would face only costs of €2.5 million, which are much easier to absorb. By doing
so, the EU imports would still set the price at a low level that does not reflect the actual carbon
cost. From the example, it is clear that a measure based on average carbon costs spread over the
entire EU steel production would not align the true costs of EU domestic producers with those of
imports, continuing to erode EU domestic steel producers’ competitiveness and render EU climate
legislation increasingly ineffective.
Source shifting refers to the possibility that a third country producer exports to the EU the low
carbon footprint products while selling products with high embedded emissions in other markets.
This practice, which is prohibited in the Californian ETS, may prove difficult to identify and discipline.
These complex issues need to be fully solved in order to have an effective carbon measure.
Applying full auctioning as soon as the border measures is implemented would expose the whole
EU production to the full carbon costs in the decisive period where breakthrough technologies are
being developed and upscaled. As long as EU imports would be setting the steel price at lower
value, this situation would cause the concrete risk of leaking emissions, jobs and investments to
third countries, hence undermining on one side the environmental integrity of the mechanism and
on the other side the social acceptance of EU leadership in climate policy. This would be
counterproductive for the successful implementation of the Green Deal.
Against this background, and considering all the elements below, it is essential that a carbon border
adjustment is implemented as a complementary measure in addition to existing carbon leakage
provisions in the transition towards climate neutrality:
• A carbon border measure aims to reach the combined environment objectives of the EU policy:
reducing emissions, avoiding carbon leakage and complying with the costs of the cap & trade
system. A complementary border adjustment would not lead to double protection, since
existing carbon leakage measures are already partial and digressive. In fact, even with free
allocation and compensation, EU producers bear carbon costs that are not applied to extra EU
competitors. This divergence will further increase in the future.
• Moreover, EU producers are subject not only to compliance costs for the difference between
their emissions and free allocation and between indirect costs and compensation (i.e. the
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“trade” element of the EU ETS), but also to the full abatement costs that are necessary to
develop the breakthrough technologies required to fulfil the emission reduction targets (i.e.
the “cap” element of the EU ETS). A border adjustment replacing the existing carbon leakage
measures would undermine their financial ability to invest in those technologies.
• While it is important to develop the border adjustment as soon as possible, its implementation
should not lead to abrupt modifications of existing provisions in order to secure legal certainty
for long term investment decisions. In particular, rules on carbon leakage measures for the
period until 2030 have been adopted very recently and should not be modified.
• A carbon border measure implemented as a complementary instrument would also reduce the
direct impact on trade flows and would mitigate trade tensions as it would provide a longer
transition for negotiations with international partners to align climate ambition.
• Similarly, a border measure complementary to free allocation and indirect costs compensation
would decrease the product price impact on downstream sectors within the EU, hence better
preserving the entire value chain.
• As long as it is uncertain whether a border measure may address the environmental and
competitiveness concerns linked to EU exports in third countries, a border measure with full
auctioning for EU producers would burden them with the full carbon costs, thereby
undermining their ability to access export markets.
• If a carbon measure is implemented with full auctioning for some sectors, the legal framework
will lead to significant distortions of competition against other sectors that are still largely
shielded from the carbon costs through free allocation and indirect costs compensation.
• It is clearly possible to design a WTO compliant carbon border measure that complements free
allocation and indirect costs compensation in a transition period, since there is no WTO legal
obligation to reduce or phase out these measures.
While a border adjustment based on the equivalent direct and indirect ETS costs can be an effective
measure in the initial transition phase, a long-term regulatory framework is required for the
advanced transition phase and the post-transition, i.e. when the breakthrough technologies reach
sufficient market penetration and CO2-lean steel represents a critical mass of the market, but
operation costs are still significantly higher than for competitors with CO2-intensive production.
Such framework should be based on the actual CO2 footprint of the product over the entire life-
cycle, requiring the development of a proper accounting system, both at EU level and at the border
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