EU carbon border tax could be next disruptive force in global trade

A tax on carbon emissions tied to imports would cut profits for foreign suppliers of oil, steel, and other goods with large carbon footprints and give companies in cleaner industries a competitive edge, BCG research finds.

A plan that is being considered by the European Commission to tax the carbon emissions attributed to imported goods could create competitive advantages for foreign companies with small greenhouse gas footprints and have financial repercussions for other exporters, adding to the financial strain caused by the COVID-19 crisis. 

The tax could slash the profits that are generated by imported materials, such as crude oil, flat-rolled steel, and wood pulp, by 10% to 65%, and the tax could impact European Union and non-EU producers of such goods as chemicals and machinery, according to new research released by Boston Consulting Group (BCG).

The study found that an EU carbon tax on imports could rewrite the terms of competitive advantage in one of the world’s biggest markets. Higher prices for Russian crude oil, for example, could cause European chemical producers to import more oil from Saudi Arabia, where extraction methods leave a smaller carbon footprint. And steel that is produced in Chinese or Ukrainian mills using blast furnaces would become less competitive in the EU against steel from other countries that is made in more carbon-efficient mills.

The details and timing of the policy are still to be determined and must be approved by legislators. But the article contends that some sort of carbon-pricing mechanism is likely to be imposed on imports and companies should prepare.

A carbon border tax is one of several mechanisms that the European Commission is considering as part of the European Green Deal, a bold initiative to cut greenhouse gas emissions in the EU by 50% over the next decade, compared with the current target of 40%, and make Europe the world’s first climate-neutral continent. 

A carbon tax on imports also has strong support among European manufacturers. Many have been paying for carbon emissions since 2005 under the EU’s Emissions Trading System, and they have wanted a more level playing field against importers, especially those from nations with more lax environmental standards. 

Considering the effects of the tax on competitive advantage and profits, the sectors that would be hit most directly are those that produce refined petroleum products, coke (a key input in steel manufacturing), and mining and quarrying products. 

The tax would reduce the profitability of crude oil shipments to the EU by about 20%, on average, for example, assuming crude oil prices remain in the range of $30 to $40 per barrel. The total profit pool generated by EU imports of wood pulp would shrink by 65%, on average.

Sectors such as basic metals, chemical products, and paper products, while less dependent on trade, would also be directly affected because of their high carbon intensity. The tax would slash the profit pool generated by imported flat-rolled steel products, used by automotive and machinery makers and construction companies, by about 40%, on average.

In terms of commodity steel, Chinese and Ukrainian industries, which mostly produce steel using blast furnaces and basic oxygen furnaces, would be hit much harder, on average, than those of Canada and South Korea, where a greater portion of steel comes from mills using cleaner electric arc furnaces.

Because the costs of the carbon border tax would be felt far downstream in supply chains, it would impact companies in every sector, whether they are European or non-European. Owing to the size of the EU market, the tax is also likely to intensify pressure on companies and governments around the world to take stronger measures to limit emissions. 

Companies in nations with their own carbon-pricing schemes, such as Australia, Canada, and Japan, may be exempt if their governments negotiate new trade pacts with the EU or update existing ones.

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