Carbon border tax: What the EU proposal means for Korea

Industry

Published: 16 Jun. 2021, 19:23 Updated: 01 Sep. 2021, 16:24

Carbon border tax: What the EU proposal means for Korea

Leaders of the world’s wealthiest democracies take part in the G7 summit in Carbis Bay, Cornwall, England, Saturday which included a session on climate change. From left, Italy's Prime Minister Mario Draghi, Australia's Prime Minister Scott Morrison, German Chancellor Angela Merkel, South Africa's President Cyril Ramaphosa, South Korea's President Moon Jae-in, Britain's Prime Minister Boris Johnson, U.S. President Joe Biden, French President Emmanuel Macron, Canada's Prime Minister Justin Trudeau, Japan's Prime Minister Yoshihide Suga and European Council President Charles Michel. [AP/YONHAP]

Leaders of the world’s richest countries stressed the importance of carbon pricing in the goal to reach net-zero emissions at the Group of 7, or G7, summit held last weekend in Cornwall, England.

Global climate response was a key agenda for the G7 summit participants, who in their joint communiqué Sunday recognized the “potential of high integrity carbon markets and carbon pricing to foster cost-efficient reductions in emission levels, drive innovation and enable a transformation to net zero.”

Carbon price refers to the price of carbon traded in the market but also includes carbon tax and subsidies for fossil fuels.

The G7 leaders went onto underline the importance of the “establishment of a fair and efficient carbon pricing trajectory” to accelerate the decarbonization of their economies and to achieve a “net-zero global emissions pathway.”

The joint communiqué, however, avoided direct mention of a looming EU carbon border tax as the European Union is set to propose its ambitious plan to force importers to pay for their emissions next month.

The EU is planning a carbon border adjustment measure (CBAM), or a tariff on imported goods based on their carbon content, as a part of a comprehensive overhaul of its climate and energy legislation set for mid-July.

The EU proposal, setting the world’s first limits on carbon in traded goods, is expected apply to export products, such as steel, and could deal a blow to countries that sell to Europe, including Korea, the United States, Russia and China.

“The EU is leading the fight against climate change,” European Council President Charles Michel tweeted after the G7 summit Sunday. “Carbon pricing matters. We need to address carbon leakage to create global level playing field.”

The leaders of Korea, Australia, South Africa and India were invited as guests to this year's summit, which ran from Friday to Sunday, to join the G7 nations — the United States, Japan, Germany, Britain, France, Italy and Canada — and the European Union.

Countries and businesses are looking to put a price on carbon pollution as a means of bringing down emissions and driving investment into greener options. There are two main types of carbon pricing — an emissions trading systems (ETS), which caps the total level of greenhouse gas emissions and allows industries with low emissions to sell their allowances to larger emitters, and carbon taxes, which sets a tax rate on greenhouse gas emissions or on the carbon content of fossil fuels.

A carbon price gives an economic signal, and businesses can then decide which low-carbon technologies they should adopt, such as investing in technologies that are easy to apply and have the largest mitigation effect.

Korea, which hosted the P4G Seoul Summit last month and aims to become a climate response leader, is in the process of reviewing its own carbon pricing policies, but more immediately, domestic industries will be faced with Europe’s CBAM, which could be implemented as early as 2023.

“Having a carbon price ensures that the lowest cost options to reduce emissions are implemented first and that only very difficult to avoid emissions will use the small remaining carbon budget,” said Georg Zachmann, a senior fellow on energy and climate policy at the Brussels-based economic think tank Bruegel.

“The price signal tells households and companies when it makes sense to change their behavior, deploy low-carbon appliances and invest into developing new technologies: This drastically reduces the cost of decarburization. Hence, decarburization without a carbon price, based only on outright bans and subsidies, is possible, but it would be much more intrusive and expensive.”

EU’s carbon border tax plan

“Europe aims to be the first climate neutral continent by 2050,” Ursula von der Leyen, president of the European Commission, said at the P4G Seoul Summit on May 31. “We have a chance to rebuild for a greener and healthier future, and that is what the European Green Deal is about, our new growth and innovation strategy.”

She added, “My commission will adopt a package of legislation in July which we call Fit for 55. It will detail out our European policies to meet our minus 55 percent target for 2030.”

On July 14, the European Commission is set to present its “Fit for 55” legislative package under Europe’s Green New Deal which will include measures to reduce emissions by at least 55 percent by 2030 compared to 1990 levels.

This includes a revision of the EU ETS and its proposed carbon border adjustment mechanism.

The CBAM involves increased levies on imports of emission-intensive products aimed at reducing the risk of carbon leakage, and according to the commission, they are also intended to encourage EU partners to increase their climate targets by creating a level playing field.

It is expected to keep polluting industries from shifting production outside Europe to avoid the EU emissions limits and then exporting back into Europe, and may encourage other countries to follow suit.

The Wall Street Journal reported earlier this month that according to a draft of the EU legislation, the CBAM proposal would require European importers to buy digital certificates that would cover the carbon content of their imports in certain sectors.

The rules, according to the draft legislation, would apply initially to four heavily polluting industries: steel, aluminum, cement and fertilizer. Other industries would be included over time.

The draft says that the rules could come into effect as early as 2023 and be fully in force in 2025, though EU officials indicate those dates could change in the final proposal.

The proposal would establish a new agency to enforce the rules and certify private companies to be hired by importers to calculate the carbon content of goods produced overseas.

However, importers that source goods from the few countries that already set an explicit price on carbon emissions are expected to be able to deduct those costs from the proposed import tax.

But should countries adopt carbon border taxes, places like Korea that are heavily reliant on exports for the growth of its economy could suffer a severe blow, according to industry observers.

The EU plan has already drawn some backlash from emerging economies as being “discriminatory” and unfair to developing nations.

In April, ministers from Brazil, South Africa, India and China in a joint statement “expressed grave concern regarding the proposal for introducing trade barriers such as unilateral carbon border adjustment.”

The ministers, following a virtual climate change meeting hosted by India, said that a carbon border tax undermines a key principle of the 2015 Paris climate agreement that poorer nations should bear less of the burden for cutting emissions than Europe and other wealthier countries.

As manufacturers in developing countries usually rely on coal-fired energy, they will likely have to pay a significant carbon fee for their exports to the EU.

U.S. President Joe Biden has also advocated mechanisms such as carbon adjustment fees or quotas on carbon-intensive goods from countries failing to meet their climate and environmental obligations but is approaching the idea with caution.

John Kerry, the U.S. climate envoy, said last month during a visit to Berlin that Biden had instructed U.S. officials to examine “what are the consequences, how do you do the pricing, what is the impact,” while also acknowledging the risks of a carbon border tax.

He added, “We do have some concerns about what the downstream impact might be, and we want to understand that fully before jumping on this.”

But Kerry also said in a Financial Times interview in March that the EU’s carbon border tax should be a "last resort,” noting it can have "serious implications for economies, and for relationships, and trade."

Bruegel’s Zachmann said that exporters to Europe will have three possibilities: “First, exporters can pay the European carbon price based on a relatively unfavorable default assessment of the carbon contained in an import product. Second, exporters can certify their exact carbon footprint and hence only pay the European carbon price on this exact amount of embedded carbon. And third, exporter countries — such as South Korea — can introduce an own carbon price system. Then the carbon price paid by imports into Europe will be reduced by the exporter countries carbon price.”

The proposed CBAM, he said, would begin with basic products where carbon emissions are easier to quantify, such as primary steel products.

Impact on Korean industries

Korea declared last October its aim to become carbon neutral by 2050 said recently said it will be revealing more ambitious nationally determined contribution (NDC) targets in November at the 26th Conference of the Parties on Climate Change, or COP26, in Glasgow, Scotland.

Korea was also the first country in Asia to adopt a nationwide ETS and has pledged to continue to support low-carbon technologies.

The Moon Jae-in administration has also pushed its Green New Deal initiative aimed at accelerating the transition towards a low carbon and green economy.

With eyes set on net-zero targets, Korea has plans to adopt a carbon pricing mechanism in accordance with the 2050 Carbon Neutral Strategy Action Plan adopted by the government last December.

According to this plan, the Korean government aims to build a carbon pricing mechanism that could “internalize climate and environmental externalities and encourage economic actors to reduce emissions, with public sector taking leadership towards carbon-neutrality transition.”

The plan describes carbon pricing as “the most cost-effective market mechanism that incentivizes economic actors” to reduce their greenhouse gas emissions.

The Korean government further called for a comprehensive assessment of the “effects of taxation, charges and other pricing tools” to build an effective carbon pricing system and to prevent such a scheme from harming domestic industries’ competitiveness in the international market.

Korean government officials and industry observers have pointed to concerns that if the European Union, the United States and other countries introduce some form of carbon border tax, major domestic industries such as petrochemicals and steel are expected to suffer a significant impact.

The Federation of Korean Industries (FKI) said if the government implements such a tax based on 2019 emission levels of businesses, up to 50 out of the 100 largest enterprises will find their carbon tax payments would exceed operating profits.

The FKI said in March that imposing carbon tax in Korea would result in an additional annual tax burden of up to 36.3 trillion won ($32.4 billion) on the part of Korean companies, or about half of the country’s 2019 tax revenue. It added that the 100 largest emitters will have to bear 89.6 percent of the entire carbon tax, and the tax burdens are likely to be inversely proportional to operating profits.

A report released by Greenpeace Seoul in January found that carbon border taxes from major export countries are likely to incur a levy of $530 million per year.

A carbon border tax is a tariff on carbon emissions attributed to imported goods that have not been carbon-taxed at the source country.

This figure only accounts for major export industries, such as steel, oil, batteries and automobiles that mainly export to the United States, European Union and China.

The report released on Jan. 13, conducted with Ernst & Young Korea, predicted that if Korea’s response to the climate crisis is delayed, the competitiveness of its export industry “may significantly fall.”

The report analyzed the impact on Korea’s major export industry if the United States, China and the EU adopt a carbon border tax.

According to the report, a carbon border tax adopted by the two countries and 27-member bloc would cost the Korean economy a total of nearly 610 billion won by 2023 and 1.87 trillion won by 2030.

In order to effectively respond to the rapidly evolving trade arrangements, the Greenpeace report suggested that Korean industries must decarbonize the electricity grid by expanding power generation through renewable energy; expand investment in new technologies such as green hydrogen and wind power generation; and actively participate in global climate change initiatives for transparent information sharing with investors and stakeholders.

“Essentially, trade will search for ways to flow around the CBAM,” said Zachmann. “The EU therefore would risk not losing its steel industry, but its nail and can industry — and in order to avoid this might decide to also include nails and cans into the border adjustment mechanism. Accordingly, we might never have a definitive list of products but a constant reassessment of the products at risk of leakage.”

He continued, “If, however, the EU remains the only country with a CBAM, there is a significant possibility that trade deviation will arbitrage away any price differential between brown and green products. That would be the case when green products are re-routed to the EU, while brown products are still produced but sold to other markets which have not implemented a CBAM.”

Korea’s response and pre-emptive planning

In a poll released on June 10 conducted jointly by Greenpeace Seoul and Gallup Korea, 66 percent of respondents said that Korean companies are not responding properly to the climate crisis, of which 23 percent were “not responding at all.” Just 34 percent were “responding” to the climate crisis, and 2 percent doing so “very well.”

The poll on Korea’s response to the carbon border tax was conducted on 100 economists from five countries — Korea, the United States, Britain, France and Germany — from April 29 to May 14.

The climate survey addressed concerns that Korea’s biggest conglomerates like Samsung, Hyundai, LG and Posco are not responding as actively to the climate crisis compared to overseas companies, especially amid concerns about the impending introduction of carbon border taxes abroad.

Experts domestically and abroad generally agreed, or some 87 percent of respondents, that Korea should expand its use of renewable energy as soon as possible to reduce the impact of the carbon border tax. Some 68 percent of people were for the implementation of a carbon tax, while 71 percent supported the development of new carbon emission reduction technologies, such as green hydrogen.

Last month, Korean government agencies, including the Ministry of Economy and Finance and Ministry of Environment, requested the Korea Institute of Public Finance to conduct research into how to put a dollar value on carbon emissions.

Analysts said the Moon administration appears to have taken the first steps toward introducing some form of a carbon tax as Korea heads toward its goal of achieving carbon neutrality by 2050.

A report released at the end of May by the KDB Future Strategy Research Institute, a think tank under the state-run Korea Development Bank, also found that an “impact on domestic industries will be inevitable as Korea is an export-dependent country,” adding that “pre-emptive efforts are urgently needed to in collaboration with industries to respond at the state-level to strengthen the industry's decarburization competitiveness.”

Jang Myung-hwa, an analyst with the KDB Future Strategy Research Institute, said, “Should the carbon border adjustment mechanism be enforced, Korea’s leading export industries such as steel, petrochemicals, automobiles and other high-emission sectors are expected to deteriorate in price competitiveness due to an increase in production and export costs.”

She added, “It is expected that the degree of ripple effect of the carbon border tax will differ depending on the response capacity of each country and business; accordingly, the government and industry need to work together to pre-emptively prepare and minimize damages.”

Jeong said there “needs to be an overhaul of the institutionalization of domestic carbon emissions to create a fair competitive environment and to create a virtuous cycle system that properly collects domestic carbon taxes and returns them to businesses, minimizing carbon border tax fees to trading partners.”

She also advised close communication with the EU and related countries and authorities to effectively and pre-emptively respond by actively notifying authorities of the government's decarburization and climate change cooperation efforts.

Zachmann said Korea’s carbon-neutral strategy and emission trading system “are indeed important steps to guide investors in the right direction.”

“Governments should speed up the transition in areas where it is already economic to do so — by tight enough carbon caps in the emission trading system to ensure that coal-fired power plants will run less and less,” he said. “This will provide investors with incentives to deploy exiting alternative technologies. At the same time, governments should support the commercialization of not-yet-competitive low carbon technologies.”

Zachmann noted that countries like Germany and the Netherlands currently experiment with types of carbon price bonuses that pay particularly clean industrial producers for producing clean alternatives to otherwise high carbon products. This can ensure fair competition and innovation and may also “provide domestic producers with a first-mover advantage in global competition.”

He added, “Governments should not bet on running their economic system unchanged until new technologies miraculously arrive — those technologies might only provide value in the countries that master them, because they early on provided a framework for developing them.”

BY SARAH KIM [kim.sarah@joongang.co.kr]