Embedded carbon pricing: how to make it work for the world

EU CBAM is the first of a range of anticipated mechanisms that charge import levies based on embedded carbon for specific (emission-intense) products. Introduced as a mechanism to avoid carbon leakage in the EU and to create demand pull for green industrialisation globally, CBAM has caused a lot of noise, concern, and discontent in Africa. This note sets out a principles-based approach that should govern these mechanisms, and their implications for how Africa could engage/ reply to drive the best outcome for Africa.

Why we must put a price on emissions

Putting a price on emissions is necessary to accelerate the green transition – and thus crucial for the future of all life on earth. As long as it remains free to emit and pollute, the world as a whole and vulnerable populations in particular will pay the price for climate change. When it costs money to emit (and avoiding or reducing emissions thus saves money), the business case for climate action solutions will improve, so-called green premiums will reduce, and the transition will accelerate.

One way to put a price on emissions, is to charge for embedded carbon, like CBAM does. To be effective, these mechanisms need to follow certain principles.

Principles for the pricing of embedded carbon

1. Systems like these should maximise the pace and extent of global decarbonisation. Given the urgency to combat climate change, we need both high ambitions, and a high realisation speed – and embedded carbon pricing must create incentives that drive that.
2. Carbon trade measures should NOT result in barriers to market entry that are NOT related to the actual embedded carbon content. After all, these measures are climate measures and should not be used for protectionist industry policy – otherwise, they will probably fail to achieve their climate objective.
3. Humanitarily damaging unintended consequences must be mitigated, to avoid unacceptable damage and costs, and to maximise broad-based support for these measures, even amongst groups that may be negatively impacted by them.

Implications of these principles

Taking these principles to their logical conclusion, results in three clear implications

1. Pricing mechanisms for embedded carbon should not cherry-pick their scope. In particular, emissions from energy/ electricity involved in production (so-called scope 2 emissions) MUST be included, especially for industrial products where they represent a very big part of the associated emissions. For example, over 70% of the emissions embedded in aluminium, are driven by the power used in the processing, but those are currently excluded in the EU CBAM mechanism. If these mechanisms do cherry-pick, they will not maximise pace and extent of decarbonisation – violating principle 1 set out above.
2. Discussions about HOW one can prove compliance, must involve a wide range of actors, including African countries. The design of the data that suppliers will need to hand over, systems, and timelines, needs to be a joint discussion involving a wide range of potential providers of solutions. Even with the right overall scope, details of the proposed mechanism can make or break the potential for new green producers. These details can create barriers to market entry, violating principle 2 set out above.
3. Interventions like these should appropriately recognise different starting points and historic trajectories, which should translate in focused engagement in specific circumstances. Most notably, this calls for:
   • Partnership to accelerate transition for countries with historically low emissions and limited industrial footprint. These partnerships need to help such countries ‘come up to speed’ and contribute their solutions. This may include proactively shaping industrial partnerships, deploying levy revenues towards system build-up, and support for impacted workers. Failure to do so, will lead to implicit barriers to entry, violating principle 2 set out above.
   • Support to mitigate unintended negative consequences that follow directly from the measures. One key example is the need to ensure a ‘just transition’ for workers in emission-intense industries in countries with relatively low levels of industrialisation, great potential for much bigger green industrialisation, and a real, potentially insurmountable transition cost and resistance. This could apply to workers in Mozambique’s current aluminium industry, which is sizeable for Mozambique yet operates in the context that Africa processes less than 2% of its bauxite, exporting the rest as unprocessed bauxite. Failure to provide this kind of support violates principle 3 set out above.

What happens if these principles are not applied?

Embedded carbon pricing tools that do not follow these principles will drive globally inefficient allocation of capital and production capacity and create barriers to market entry. As a result, the distribution of production capacity incentivised by such tools will NOT make the most climate sense. In short, they will fail to realise their climate objectives. They could create incentives for producers to divert export to other regions (e.g., for African producers to export more to China and India than to the EU). They could also give rise to retaliatory measures, such as blanket bans on raw exports, which are not ideal for climate or economic reasons: local processing is not necessarily climate-smart and cost-competitive for all inputs at all locations.

Various stakeholders have argued for exemptions for LMICs, or for alternatives such as a method that prices carbon based on either cumulative historic emissions or national per capita emissions rather than product-related measures. However, those options give emission-intense industries an ‘escape option and incentive’ to move emission-intense production to the lowest-emission locations. That would slow down rather than accelerate global decarbonisation and create a ‘race to the bottom’ rather than a ‘race for green’. Moreover, it would lock low-emission (African) countries out of their leapfrogging potential to become global green manufacturing powerhouses and instead lock them into an emission-intense industrialisation path with high stranded asset risks. It would make these low-emission countries part of the past and of the problem, instead of part of the future and the solution.

Each of these types of responses would be worse for Africa, and for the world.

1. An alternative to pricing, is banning certain levels of GHG emissions. This is how localised pollution tends to be managed. Cities regulating vehicle access based on emission levels, are an example of such a mechanism in GHG emissions. However, carbon pricing is much more widely considered. Compared to banning, pricing has the advantage that it realises financial room to close gaps in green business cases, creating tailwind for new industries and solution providers. Conversely, regulated ceilings may make it harder for new entrants – e.g., African production locations – to come to the table.
2. Another example, are potential incoming shipping levies. IMO is recognising the potential impact of such levies on food price increases and increased food insecurity for vulnerable populations – and they are currently running a study to understand these implications, with various proposals on the table to mitigate these risks.