Australian businesses risk having to pay an expensive levy to export goods to the European Union based on the intensity of greenhouse gas (GHG) emissions used in making and shipping products.
The European Parliament's environment committee recently endorsed the proposed Carbon Border Adjustment Mechanism (CBAM), which would initially apply a carbon cost to products sold into the EU including steel, cement, chemicals and fertilisers, eventually extending to all commodities and products covered by the EU's carbon market.
The CBAM has strong implications for Australian exporters to the EU because it would force exporters to buy carbon permits at prices similar to those of the EU's Emissions Trading Scheme, with research firm RepuTex noting that European Union Allowances (EUAs) are currently trading at a record-high of €38.56 (A$60), with prices forecast to significantly increase to 2030.
While some call CBAM a carbon tariff, the EU says it is aimed at leveling the playing field for European-based industrial emitting companies, which are reducing their GHG emissions to meet compliance targets. This could make it compliant with the current rules under the World Trade Organisation.
A CBAM would need to show that carbon pricing for the raw material or product is equally applied to EU producers or third party exporters to EU, said Andrew Hedges, a partner at Norton Rose Fulbright who specialises in carbon markets. For example, sellers of steel to EU industries will need to account for carbon pricing in their final price to European customers.
"The design of any EU CBAM is still very much open, but it is possible it will lead to increased prices for customers in the EU," Hedges said. "That said, it will act as an incentive to reduce emissions."
Hedges also noted that if a non-EU exporter sold into the EU and their product was more efficient in terms of GHG emissions, they may be able to sell at a potentially lower price than more GHG intensive producers, which would be an advantage.
Critically, according to the CBAM proposal, countries (or sub regions such as states) will be able to avoid the carbon levy should they implement a carbon trading system similar to the EU ETS, and/or put in place an equivalent price on emissions.
The move highlights the fact that Australia is a global outlier in terms of targets and commitments on climate change, and how dependent Australian businesses are on strong multilateral trade relationships between Australia and its trading partners.
It also significantly ups the ante on the Morrison government to commit to more ambitious climate targets.
The return of the US to the Paris Agreement process plus China's commitment to net zero carbon emissions in its economy by 2060 means that approximately 70% of all of Australia's trade will be with countries that have committed to decarbonization by mid-century, noted Emma Herd, CEO of the Investor Group on Climate Change (IGCC).
"The thing that has escalated so quickly here is the fast-evolving climate policies that we see across a number of jurisdictions, which have set the target dates to become carbon neutral," said Andrew Petersen, CEO of the Business Council for Sustainable Development Australia (BCSDA). "Using carbon taxes and other forms of market-based measures, they come into their own because they're part of a suite of regulation standards and now subsidies that will enable the jurisdictions to get where they want to get to.
"Because of that, one of the interesting debates that will emerge not just in this country, but elsewhere is the role of the CBAM and the role that it plays as part of the carbon toolbox."
By proposing a GHG emissions levy, the European Union is de facto setting a global carbon price.
"Institutions like the EU are saying one way or another, we will get a carbon emissions price built into your product," said Professor Mark Howden, director of the Climate Change Institute at the Australian National University. "Either it happens externally or it happens via internal policy, but they will establish a level playing field for things that are for sale within their jurisdiction."
CBAM will potentially apply a lifecycle calculation on products being sold into the EU, Howden said.
"Lifecyle analysis tries to document the GHG emissions that are built into the product through the value chain, both in the design and impacts on products, through to subsequent transport and processing," Howden said. "The whole of life footprint would be the way that a CBAM would be most effective in the sense of the best job of identifying the real emissions associated with those products."
Lifecycle analysis presents challenges in terms of gathering data and making sure that emissions aren't double counted through the value chain and production cycle, Howden noted.
An emissions levy can also be challenging in that it represents a unilateral approach, as opposed to a negotiated, multi-lateral agreement to a common carbon price or reductions targets such as those under the Paris Climate Agreement.
"It strikes me that a much better solution would be to agree on essentially a global approach to pricing carbon," Howden said. "You can see why the EU is keen, it means they can take aggressive approach to climate action while seeking to protect their own industries from disadvantage.
"What it does is that it demonstrates global leadership and moral leadership, which also has a whole range of advantages in terms of diplomatic clout and green credentials for product coming into the EU."
The proposed CBAM and Australia's ongoing negotiation of free trade agreements with the EU and the post-Brexit United Kingdom both highlight the fact that Australia tends to perform more strongly in a multi-lateral and globalized economic system, and Australian businesses are exposed to risk if countries pursue unilateral trade policies.
"The danger always in on a country of Australia's size is that it ends up being the price taker," said Jason Collins, CEO, European Australian Business Council and chair, European Business Organisations. "that's always a risk and particularly when you have, for example, a US administration that is about transactional deals and putting to one side the international system for working things out, such as the WTO and various other bodies.
"That's why the Australian government, and Europe, which arguably has been the real champion of the international system and the international trade policy agenda have been so consumed with defending that system."
The challenge for Australian business is that there is a perception gap between Australia's federal climate commitments versus the actions that business and investors are taking on the ground, Collins said.
"Most of this is business and industry led," Collins said. "It is led by specific groups setting ambitious targets by a corporate community, and investor groups, whether that be the individual adoption of ESG targets, reporting and commitments.
"An important message to our European partners is that there si a lot that's going on, particularly in renewable energy, which is a massive and very positive story in Australia."
Petersen reinforced Collins view that the Commonwealth government needs to set a clear pathway for decarbonisation of the Australian economy.
"There's so much more momentum in financial and trade and markets that it's very difficult to unpick that and we could end up with business suffering as a result of that," Petersen said. "What we're now seeing is the EU carbon clock starting to tick for Australian companies. They're going to have to look at how to prepare for some mechanism that will be a barrier to carbon intensive products and services, and we need to take action or risk being caught up in the fracturing of the world trade system, which as an exporting country we can't afford to get involved in."