EU’s carbon levy impact on Asia might be less severe than feared, new analysis finds

Key points

The European Union’s carbon levy on high-emission imports might cost its key Asian trading partners less than their governments had feared, according to a new analysis.

Upon factoring in rising EU steel prices, China stands to see the largest decline in Carbon Border Adjustment Mechanism (CBAM) costs, followed by India and South Korea, according to a report from Brussels-based thinktank Sandbag. The three countries are among the largest Asian steel exporters to the EU.

“An important but often overlooked aspect of the CBAM is that it is ramping up in parallel with the gradual phase-out of free allocation under the EU emissions trading system (ETS), which raises the carbon cost borne by EU producers as well. EU market prices are therefore adjusting upwards as both imported and domestic supply become more expensive,” stated the report’s authors.

“Higher EU selling prices allow exporters to recover part of their CBAM costs through higher revenues. If the additional revenues from higher prices exceed the CBAM fees paid, exporters may enjoy a net benefit.”

Based on Sandbag’s simulator tool, South Korea, Taiwan and Japan are also projected to make marginal profits from their long steel and aluminium exports to the EU, even under a business-as-usual scenario.

The EU’s carbon border tax, which kicked in this year, is meant to ensure the bloc’s decarbonisation efforts are not undermined by companies shifting production to countries with weaker climate rules, also known as carbon leakage. It currently covers imports from six sectors: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen.

China has been one of the biggest critics of the carbon levy and has formally raised objections over the fairness of the scheme in World Trade Organisation (WTO) discussions. Alongside other developing countries like Brazil, India, Indonesia, Russia and South Africa, it has argued that the policy is protectionist and risks pushing the cost of decarbonisation onto poorer exporters.

The EU, however, has maintained that the CBAM is compatible with WTO rules and that it will offer funding to developing countries affected by the levy.

Earlier this year, the EU pledged €500m in support of India’s industrial decarbonisation over the next two years. India was also granted a duty-free annual quota of 1.6m metric tonnes of steel exports to the EU, roughly half of its annual shipments to the bloc. 

On the back of these concessions, Sandbag’s latest report projected that the carbon levy India is subjected to could fall even further from €428m to approximately €79m, if exporting companies redirect existing lower-carbon steel to the EU market.

Producers with low-emission steel manufacturing capacities could stand to profit from rising EU steel prices, which could offset any losses from CBAM fees, stated Sandbag. In particular, the report identified ArcelorMittal’s Hazira facility, which can produce up to 8.6m tonnes of low-carbon flat steel, as one of the plants most well-positioned to gain from the EU’s CBAM.

Drop in costs for Asia, but not necessarily emissions

While CBAM costs are likely to decline, it remains uncertain if it will make a dent on global emissions.

An Asian Development Bank study previously found that the carbon tariff is expected to reduce a modest amount of emissions compared to ETS on its own. The EU’s own assessment estimates that CBAM would only lead to a 0.3% cut in emissions for the rest of the world.

But CBAM’s main objective was never to reduce global emissions, Sandbag’s executive director Adrien Assous told Green Central Banking. 

“The CBAM’s objective is often mistaken. According to Article 1 of the CBAM regulation, its objective is to replace the phasing out of free allocation in the EU ETS,” said Assous.

“It is also expected to incentivise emissions reductions in third countries, but the latter is only a desirable side effect. For some people, the CBAM merely aims to decarbonise trade with the EU, which is a total misconception.”

Assous added that the problem with the EU ETS on its own is the free allowances to companies in polluting sectors, which “annihilates the carbon price signal that should trigger emission reductions”.

Last month, the European Commission proposed pushing back the phase-out of free allowances to 2038 from the initial 2034 deadline, when the CBAM would be fully rolled out.

“If you look at statistics from the Commission, blast furnaces have increased their emissions between 2007 and 2022, so the steel sector might as well have been excluded from the ETS,” said Assous. 

“But removing free allocation without CBAM would create a risk of carbon leakage. So the CBAM isn’t just a nice extra layer, it’s an absolute necessity to – at last – get the EU’s carbon market to function.”

Despite their strong criticisms of CBAM, many of the EU’s trade partners in Asia are speeding up the development of domestic carbon pricing schemes to keep revenues at home.

There are currently 40 national and 25 sub-national jurisdictions that have some type of carbon pricing scheme in place, including in China, India, Indonesia, Singapore and South Korea.

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