3 March 2024

CBAM and the Fracture of Global Industrial Trade

Discussed topics

  • Is CBAM really incentivizing third countries to decarbonise, like the EU claims?
  • Dual production streams vs. Complete trade shifts
  • The Chinese case study and its outlook on trade relations with the EU
  • An introduction to two critically different approaches to alleviating commercial disputes: Carbon pricing Integration vs. Segregation
 

What are Dual Product Streams?

Is it possible that some global manufacturers, to comply with CBAM, start producing low-carbon goods exclusively for the EU while maintaining higher-emission production for their domestic market or for exports to countries without such regulations? The practice of splitting production standards into ‘green products’ for markets with carbon pricing mechanisms and ‘dirty products’ for those without is known as a dual product stream. 

 

 

Consequences of dual product streams

The phenomenon of dual product streams presents several consequences for both the economy and the environment, summarized as follows: 

  • Slower adoption of green technologies: The existence of dual product streams may hinder the widespread adoption of green technologies in exporting countries. However, this phenomenon could afford less developed nations additional time to trial new and costly green technology prototypes intended for wealthier markets before these exporting countries implement their own carbon pricing systems, helping the technology to scale. Although for exporting countries, this strategy might result in a more efficient and cost-effective decarbonization strategy in the long run, the near-term introduction of a carbon pricing mechanism in countries outside the EU should not be assumed as certain.
  • Disincentivizing full-scale green investment: Investors require clear signals and certainty to commit to new investments, particularly in capital-intensive industries such as steel, aluminum, or cement. This scenario reminds of a prisoner’s dilemma, where two parties may choose not to cooperate—even when it would be mutually beneficial—due to uncertainty regarding the other’s actions, leading them to maintain the status quo. In the context of green investments, this translates to investors being hesitant to fully invest in clean technologies unless they have confidence that others will do the same. This confidence largely depends on the long-term economic return of green technologies, which in turn relies on the implementation of a carbon pricing mechanism weakening their dirty alternative. The absence of a carbon price, therefore, creates hesitancy among key decision-makers, undermining the urgent push toward climate objectives.
  • Risk of unpredictable climate change outcomes: Climate science underscores the need to cut emissions by roughly 55% by 2030 to avoid the most catastrophic effects of climate change. Delays in action, stemming from government hesitation to set a carbon price and investors’ reluctance to fully commit to green investments, contribute to the creation of dual product streams. This state of stagnation can significantly heighten the risk of rapid global temperature increase and unpredictable weather phenomena.
Global world network communication technology. 3d rendering


Case study: a Chinese outlook for European marginalization

The research conducted by Zhu, J., Zhao, Y., & Zheng, L. (2024) provides essential insights into the effects of the Carbon Border Adjustment Mechanism (CBAM) on Chinese exports. Their simulations indicate a significant reduction in the export of CBAM-affected industrial products to the EU, along with a general decrease in the export volumes to the EU for other goods, too. This trend may suggest a shift towards dual product streams for certain hard-to-replace goods, as Chinese manufacturers aim to maintain access to the EU market. However, it also points to a wider decline in trade flows to the EU, driven by a tendency among Europeans to redirect sourcing towards local producers also for goods not yet affected by the regulation.

 

The study underscores the potential for more pronounced effects on Chinese exports as CBAM expands to cover a broader range of products from 2026, following announcements by the European Commission. This expansion, coupled with the shift to more rigorous emissions calculation methods in 2025—where only the EU’s methodology will be accepted—may significantly alter trade dynamics. This could lead to the emergence of dual product streams as exporters adapt to meet EU standards while striving to maintain their trade relationships. Ultimately, CBAM could prompt a substantial realignment of trade flows away from the EU towards emerging markets, potentially reducing the EU’s prominence in global trade.

 

Abstract map illustration with cartography, world map ,generative artificial intelligence



Global Carbon Pricing as a Trade Tension Mitigator – But under which Form?

It remains premature to predict whether exporting countries will adopt carbon pricing mechanisms and, if so, what forms they might take. The European Union has actively encouraged third countries to establish their own carbon pricing schemes, whether through a carbon tax or an emission trading system (ETS). Notably, under the CBAM framework, importers are allowed to deduct carbon prices paid in third countries, signaling that exporting countries lacking a local carbon tax could consequently experience a loss of potential tax revenue to the EU. It will be in the hands of exporting countries and their industry to decide whether this loss will trigger the creation of a local carbon price or simply redirect trade to other emerging markets.

 

The possibility of fully integrating Emissions Trading Systems (ETS) between the EU and its global trading partners remains a promising prospect, in line with Article 6.2 of the Paris Agreement, with the EU-Swiss agreement serving as a potential model. Such integration offers a significant benefit: countries could exchange Nationally Determined Contributions (NDCs) among themselves, enabling the importing country to offset the entire carbon tax rather than just a fraction of it, especially in the case where an exporting country’s carbon price would have been lower than that of the EU ETS. Also, low-cost decarbonization opportunities would become more attractive globally, which could favor more investments from developed countries into third countries, as carbon emissions would have the same price worldwide, but the cost to abate them would be lower in developing countries. This subject will be further explored in an upcoming blog.

 
 

Conclusion

Achieving such alignment between nations on carbon pricing is realistically a medium to long-term goal, which again puts our climate objectives at risk. The fact that in 2023 we already touched the 1.5°C temperature mark further highlights this danger. Developing countries, also facing numerous other challenges, may find that introducing a new carbon tax could simply serve as fuel for more inflation and public dissatisfaction. Nonetheless, if exporting nations unite to adopt a form of global carbon pricing, preferably an integrated one, it could announce the end of trade disputes related to climate issues, eliminate market exclusions or dual product streams, and possibly mark the beginning of the decline in fossil fuel consumption globally.

 

The future trajectory of carbon pricing mechanisms—whether they will diverge or converge across nations—is still uncertain. Yet, the discussion on this matter is more lively and critical than ever.

 


Source

Hancock, A., & Pfeifer, S. (2024, January 9). How global trade could fragment after the EU’s tax on “dirty” imports. Financial Times. 

https://www.ft.com/content/ca51ebf5-fbb8-4c88-a93d-ded3d6d3bcdd

 

Zhu, J., Zhao, Y., & Zheng, L. (2024). The Impact of the EU Carbon Border Adjustment Mechanism on China’s Exports to the EU. Energies, 17(2), 509. 

https://doi.org/10.3390/en17020509

 

McGrath, M., Poynting, M., Dale, B., & Tauschinski, J. (2023, October 6). World breaches key

1.5C warming mark for record number of days. BBC News

https://www.bbc.com/news/science-environment-66857354

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Nicolas Endress

Nicolas Endress

Founder of ClimEase