The Climate Crisis Trade Wars  

The EU’s Net Zero Industry Act is the latest government policy to raise concerns about “green protectionism” and disregard for nature. 

Climate change is a global problem like no other. If just one major polluting country decides not to mitigate its carbon emissions, the catastrophic effects will be worldwide, making international cooperation essential.  

But as countries start to introduce never-before-seen industry and trade policies to catalyse the low-carbon energy transition, governments are coming into conflict over “green protectionism” with some experts warning that climate change will create a new era of trade wars.   

The tension has reached fever pitch with the US Inflation Reduction Act (IRA) rattling political leaders with concerns that its massive financial subsidies for clean energy developers will lure business away from their economies.  

Just this week Canadian Natural Resource Minister Jonathan Wilkinson warned the US against waging a “carbon subsidy war” with its allies in an interview with the Financial Times. He says the IRA’s US$369 billion clean energy package creates an “unlevel playing field” in global trade for Europe and Canada where both will struggle to compete, even with similar efforts underway.  

EU Commission President Ursula von der Leyen also critiqued the IRA in January at the World Economic Forum, when she announced the EU’s answer to it – the Net Zero Industry Act (NZIA).  

“It’s no secret that certain elements of the design of the [IRA] raised a number of concerns in terms of some of the targeted incentives for companies,” she said. China was also namechecked in her speech, with von der Leyen describing “aggressive attempts” to attract EU industrial capacities to the country. 

Legality of EU carbon border tax in question 

But the EU is also under fire for green protectionism with its Carbon Border Adjustment Mechanism (CBAM). It is aimed at levelling the playing field between its producers and those outside the EU by placing a tax on some carbon-intensive imports. This is designed to prevent producers moving their operations outside the EU to avoid its stricter carbon policies.  

China and India have said it will unfairly penalise their economies. Soon-to-be-published research from the African Climate Foundation is reportedly expected to find that the EU CBAM could reduce Africa-to-EU exports by up to 5.7% based on current carbon prices, according to London School of Economics Professor David Luke.   

African Climate Wire also reports that University of Cape Town adjunct Professor Faizel Ismail, who previously served as South Africa’s ambassador to the World Trade Organization (WTO), doubts the legality of the CBAM, and questions whether it violates the WTO rules around the “most favoured nation principle”.  

He also argues that CBAM should be viewed in the wider context of major economies, like the US and China, bolstering green industrial competitiveness. Developing countries need to group together to fight CBAM and related protective measures, says Ismail, predicting that there will be an increase in litigation on climate related issues at the WTO.  

There are already signs that India and China may challenge the EU’s CBAM at the WTO. Last month, at the meeting of the WTO Committee on Trade and Environment (CTE), China proposed it become a platform for discussing how trade policies were increasingly being used to fulfil environmental goals starting with the CBAM at the next meeting in June.

India presented a paper at the meeting outlining its concern on the increasing use of environmental measures as protectionist, including carbon border measures. The EU, perhaps foreseeing this tension, formed the the Coalition of Trade Ministers on Climate in January with 26 partner countries to support ongoing efforts in this area by the WTO.  

The WTO is still to decide on the legality of CBAM, which is set to be phased in by the EU by 2026.  

WTO in support of low-carbon transition  

Alex Child, Head of Research at Carbon Cap Management, says just four years ago something like the CBAM would not be found legal under global trade rules, but this is changing as the climate crisis rises up the global agenda.  

If it’s viewed as a domestic subsidy, “then there’ll be a big issue”, he says, but if it’s framed as having an objective, systematic approach in terms of identifying carbon emissions intensity then this could be seen as not favouring the domestic industry over foreign trading partners.  

“I think the [WTO] will recognise the fact that this [climate change] is a global commons issue. It’s not just for the benefit of a domestic industry. There is a wider societal goal.” 

David McNeil, Head of Responsible Investment Research and Innovation at Insight Investment, agrees, saying the WTO has made public statements alluding to wanting to support the low-carbon transition and not be seen as an impediment to climate action. 

But there will be “a bit of a balancing act” between the WTO principles of non-discrimination and the complexity and novelty of carbon pricing, he adds.  

McNeil also says there will be concerns by exporting countries to the EU on how the measurement of carbon emissions will be carried out and the transparency around this.  

“The EU has a plan to set up a new executive agency to effectively track the emissions content of imports and work with those importers on self-reporting of that data.”  

He notes that there are already challenges in accounting where defaults and estimations can lead to miscalculations.  

“You could, for example, have importers overpaying [a carbon tax] for goods in some circumstances. There is still not sufficient confidence in the accuracy of some of these calculations as accounting for emissions intensity is an emerging field.”  

Another issue will be the scope of CBAM, says McNeil. Currently, CBAM will only apply to direct emissions (Scope 1), but the EU plans to re-evaluate this after the transitional period to 2026.

“We know the bulk of a company’s emissions will be in Scope 2 and 3 (indirect emissions),” says McNeil, who expects the EU will eventually focus on the whole value chain of carbon emissions.

Overall, he thinks the EU’s move is necessary as its longstanding carbon pricing efforts mature. China introduced its carbon markets in 2021, where the carbon price hovered between US$8-$9 metric tonnes of CO2 equivalent (mtCO2e) in 2022, while the EU carbon price was around US$88-$99 mtCO2e over the same period. 

“Political pressure [on the EU] to drive through the cost of carbon more directly to some industries is only going to be feasible with an effective border carbon adjustment, just because of the regulatory asymmetry that we see in other parts of the world,” says McNeil. 

NZIA trade and nature concerns  

As the EU faces pushback on CBAM, its newly announced NZIA could also lead to trade friction, says William Attwell, Director, Climate Risk at Sustainable Fitch.  

Though it doesn’t come with a dedicated package of financial support like the US IRA, he says: “A specific area that could elicit criticism are public procurement provisions, where the regulations say that procuring entities should give a degree of preference to providers to the EU’s ‘security of supply’.” 

The EU’s drive to quickly compete with the US on building its climate industry also risks delayed action on the world’s other major ecological crisis of nature depletion, warns the WWF.  

Camille Maury, Senior Policy Officer at WWF Europe, says that NZIA regulation is being pushed through the EU political system faster than usual and will likely affect political will for upcoming proposed EU laws to protect nature. 

NZIA proposes to reduce the length of time a clean energy manufacturer faces to gain a permit for construction. “This will have an impact of quality on the environmental impact assessment,” says Maury.

If a developer can prove an “overriding public interest” for a project, she says, “it will be automatically granted, and you won’t have to go through the environmental impact assessment”.

She warns that the political imperative to get action through the NZIA going, may weaken equal resolve on the EU’s proposed Nature Restoration Act.  

“We are concerned that it will be more difficult to convince MEPs to vote for strong restoration and get restriction in nature restoration,” she says. 

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