Discussion on the impact of EU carbon border adjustment mechanism (CBAM) for China- EU trade

To achieve the established carbon emission reduction targets, reduce the intensity of carbon leakage, and protect the EU local enterprise market, in December 2022, the amendment to the EU Carbon Border Adjustment Mechanism (CBAM), which covers key industries such as steel, aluminum products, cement, fertilizer, and electricity, was officially released by the EU Parliament decision and will be officially implemented on October 1, 2023. This study tries to discuss its impact for China—EU trade.


Introduction 2.1. CBAM's development
The EU has struggled with the risk of carbon leakage for many years [5][6][7].The EU Emissions Trading System (EU ETS), one of the primary tools for reducing carbon emissions in the EU, covers electricity, industry, aviation, and other sectors.By trading about 40% of the EU's total greenhouse gas emissions, the EU has managed to maintain a high carbon price while being unable to compete with surrounding nations' lower carbon prices, which may lose market share directly or indirectly.One of the ways for EU producers to control costs is to relocate factories outside the EU to take advantage of the lower carbon price and lower production costs, which may lead to the risk of carbon leakage.They then come back into the EU for sales to further their goal of lowering costs and boosting profits.
The CBAM was first proposed by the EU Parliament in the European Green New Deal in December 2019 and started the formulation process in 2020 [2].After years of works, CBAM was approved by the EU's 27 finance ministers on March 15, 2022, during the Economic and Financial Affairs Council Configuration (ECOFIN).This means that CBAM now has the backing of the EU's national finance authorities and has made a significant transition from development to implementation.The Public Health and Food Safety Committee approved the EU's proposal for CBAM, which indicates the EU's resolve and ambition to combat climate change and achieve energy independence.It also expedites the reduction of EU ETS quota supply, expands the market and product participation, and has important ramifications for the carbon trading strategies of nations that depend heavily on the EU as a trading partner [8].
The European Parliament approved an amendment to the original proposal for the creation of CBAM on June 22, 2022.The amendment specifies that the CBAM will have a transitional phase from 2023 to 2026 [9] and that tariffs on steel, cement, aluminum, petrochemicals, and hydrogen will go into effect in 2027.The EU Parliament formally approved the CBAM policy on December 13, 2022, and it will go into effect on October 1, 2023 [10].Now, it has became an EU law [11].

CBAM regulations
The transitional period and the formal period are the two stages in which CBAM will advance.The transition period will begin on October 1, 2023, with the complete CBAM taking effect on January 1, 2027.In accordance with the transitional provisions of CBAM, importers from the EU are only required to report quarterly to the importing national authority the total amount of relevant goods imported, and the implied emissions associated with those imports, as well as any carbon price paid in the country of origin.The light reporting system was first implemented to lessen the load on importers and to avoid severe trade disruptions brought on by policy changes.
Authorized filers will be required to submit a CBAM statement to the National Authority by May 31 of every year once CBAM is fully operational.This statement must include the GHG emissions of imported goods over the previous year as well as the number of CBAM certificates that have been delivered for emissions (1 certificate is equal to 1 ton of CO 2 -equivalent emissions).Notably, the declarant is required to buy CBAM certificates directly from the National Authority and must make sure that at least 80% of the CBAM certificate limit is bought before each quarter.

CBAM calculation method
The CBAM calculation approach follows the common practice around the world of basing carbon levies on CO 2 emissions, which are computed based on fossil fuel usage.To make it more easily understand, this letter directly introduced the calculation principle to show the obligation for the third country.
The obligations that have been met in the third country (exporting country) for these emissions refer to the money paid by the importer in the third country in the form of taxes, fees, or emission allowances under EU-ETS, which is calculated according to the GHG emissions released during the production of the products covered by the policy.
If the exporting country does not have a well-established carbon trading and tax system, it will be unable to benefit from carbon tariff credits and will have to pay higher carbon tariffs as a result.

Analysis of CBAM's impacts on key industries 3.1. A brief overview of key industries' exports
The EU is now China's second-largest export trade partner, maintain the trade cooperation with the EU has a great significance (both shown in figures 1 and 2) [12,13].China's total exports to the EU in 2021 were estimated to be $13.3 billion, aluminum, steel, fertilizer, and cement accounting for 0.85%, 1.72%, 0.01%, and 0.001%, respectively.The impact of CBAM is anticipated to be less significant since the aggregate exports of the cement and fertilizer industries to the EU are lower.
According to Eurofer statistics, the EU steel export size went from a peak of more than 30 million tons to only 16.5 million tons in 2022, a decrease of almost 50% (figure 2).The volume of imports from non-EU nations is increasing and has reached nearly 30 million tons [14].Among them, China's trade with the EU in the steel industry has seen more EU imports than exports, which indicates that the EU market's demand for the Chinese market has outpaced the market's ability to offer it and China's market share has become more important.

The impact on the steel and aluminium products
According to industry production data from the 2021 Non-ferrous Metals Industry Economic Operation Report [15], China produced 42.75 million tons of aluminum in 2021, including 35.8 million tons of primary aluminum and 6.95 million tons of recycled aluminum.The aluminum industry in China generated CO2 emissions equivalent to 520 million tons, and a carbon emission intensity per unit of product of around 2.61 tons.The General Administration of Customs of China reports that China exported 8.43 million tons of aluminum goods in 2021, up 15.6% from the previous year, including 2.16 million tons to the EU.The export value to the EU was $8.89 billion, accounting for 25.6% of the total amount of such items exported from China.Without considering the free EU ETS permits, aluminum exports to the EU will need to pay an additional 540.25 million euros in carbon taxes, approximately 6.67% of the total exports, according to the EU ETS unit carbon emission price of 95.83 euros per ton for the week of December 13, 2022.
The China Steel Industry Economic Report 2021 [16] reported that China's total steel production is 995 million tons in 2021, with 66.895 million tons and $81.8 billion in total exports of steel, of which 3.18 million tons and $4.38 billion, or 5.4% of exports, are destined to the EU.The average CO 2 emissions per ton of steel produced through the long process in 2021 varied from 2.0 to 2.2 tons in China and 1.9 tons in the EU.Without considering that any free allowances offered to EU producers would also apply to imports, steel exports to the EU would have to pay an additional 609.48-670.43 million euros in carbon taxes, or almost 15.27%-16.80% of total exports (as shown in table 1), based on the EU ETS unit carbon price of 95.83 euros per ton for the week of December 13, 2022.If the EU admit China's transaction fees for carbon emissions from the steel industry, no new carbon tax would be required, further reducing the impact on the export sector.

Indirect impact of EU ETS quota reduction
The average carbon price of the EU ETS, which directly affects total profits, is the fundamental component of the CBAM payment.As the EU ETS goes into its fourth phase, starting in 2021, the annual free allowances for carbon trading have steadily declined.The 2030 overall emissions reduction target is 62% (previous is only 43%) below the 2005 level, and the linear reduction factor has increased to around 4.4% (previous is about 2.2%), which means that the CBAM policy will coincide with the free allowances for a period of time, which may have a complicated impact on enterprises importing into the EU.Long-term trends indicate an upward trend in carbon pricing, which has already been visible over the past two years (as shown in figure 3).It took just two years for the price of carbon to rise by more than 100% (the price of carbon was just under $40 per ton in January 2021, whereas it was over $85 in December 2022).By using the exponential smoothing method, it could be seen that by December 31, 2023, the unit price per ton of carbon is 104.68 euros, the upper limit is 150.79 euros, the lower limit is 58.57euros, and the worst-case scenario will increase the price per ton of carbon by 24% compared with the end of 2022.What is clear is that even if the sector's free allowances are not reduced, companies exporting to the EU will still face the challenge of rising carbon prices.While the profitability of exporters from third countries will decrease significantly, this may likely reduce the willingness to export to EU countries due to the additional transaction costs from reporting requirements, etc.

CBAM policy's multiple goals
The first is that the possibility of carbon leakage can be properly addressed during the policy's formulation and implementation by CBAM payments and other Fit for 55 policies.For instance, in the steel sector, there is huge danger of carbon leakage since in 2022, China exports more steel to the EU than the EU exports to China.Thus, imposing carbon tariffs on steel will not only lessen the amount of carbon emissions that are transferred from outside the EU to its territory but will also stop some multinational corporations from exploiting inconsistencies in national policies to reduce the intensity of carbon leakage at its source.
Second, the policy is crucial to safeguarding the growth of regional businesses.High energy, labor, and raw material costs have been the biggest headaches for EU producers.Thus, the costs of EU products remain high, and the EU's steel products are becoming less competitive on the global market.Take the steel industry as an example, the EU is the second-largest producer of steel in the world, with annual production exceeding 177 million tons and exports representing 11% of global production.However, the EU has one of the highest production costs per ton of steel in the world, at 413-552 euros, or 1.29-1.73times more expensive than China.Local producers may benefit from the CBAM policy dividend to better stabilize their domestic market share, which can further improve the sustainability of the sector's development.Currently, CBAM does not apply to exports from the EU.EU producers would benefit from potential extension of the CBAM policy to cover their exports, allowing them to grow their global market share.
Third, there are fears outside the EU that CBAM could be used to restrict trade flows in an arbitrary manner.While the EU claims that the CBAM regulation is in accordance with the rules of the World Trade Organization, other countries have concern that it constitutes an unjustified trade barrier [17].

Impact of CBAM
The positive outcomes for the EU mostly include: (1) The CBAM will directly minimize carbon leakage from importers or boost the substantial amount of carbon tariffs collected.For instance, the EU would be willing to accept a tariff increase of more than 30 billion RMB on Chinese steel exports to the EU in 2021 alone to reduce or avoid paying taxes, also a direct reduction in carbon transfers of more than 600 tons if Chinese exporters decide to suspend their cooperation [18].(2) Local EU businesses can speed up their transition to a greener economy by utilizing the time between policy release and implementation.As the largest steel producer in the EU, ArcelorMittal proposed adopting the CBAM mechanism as early as 2020 to meet its carbon emission reduction and carbon neutrality targets and implemented several technical and market instruments to promote green and low-carbon transformation, ensuring its continued dominance in the EU.
Naturally, the CBAM policy's execution can also be considered as advancing the position of Chinese industry.On the one hand, the proposed CBAM is helpful for encouraging Chinese export businesses to turn their products into greener ones and forcibly upgrading businesses to go green, and cut greenhouse gas emissions at the source if they hope to maintain and grow the EU market.On the other side, CBAM policy implementation promotes the standardization, institutionalization, and marketization of the industry's green and low-carbon development.With the promotion of the operation of the national carbon emission trading market in recent years, the power industry has gradually begun to embark on the path of green and low-carbon transformation.Although the steel and aluminum products have yet to be included in the carbon emission trading market, it is beneficial to conduct industry-specific carbon emission accounting, prepare for trade, and declare tax avoidance as soon as feasible.
However, the CBAM policy's execution is certain to have negative consequences.First, while the CBAM policy helps China's accelerated maturation in carbon emission accounting and carbon market trading, it also lays the groundwork for risk.The EU, as the policymaker, has complete initiative and interpretation authority over the CBAM policy.When the scope of industries is expanded, by putting additional industries such as autos and electrical appliances in the taxation scope, China's exports to the EU are certain to be stifled to a greater level.To cope with these potential problems, China's carbon emission accounting and carbon market trading must be improved quickly, and effectively account for non-electricity industries, make the accounting process more scientific, reasonable, and in line with the requirements of the drawback is a critical issue.
On the other hand, China's key trading partners, including Europe, the US, the UK, and Japan, have proposed CBAM to tighten restrictions on Chinese exporters.With the EU CBAM policy boots on the ground, the US, Japanese and the UK government have all announced that they would pursue the research and development of a carbon border coordination mechanism as an important means of achieving carbon neutrality in their respective countries by reducing carbon leakage.
Furthermore, because of the epidemic, the Russian-Ukrainian conflict [19], and the impact of the financial crisis, the international political situation is more volatile, and the trading market has yet to fully recover, thus the implementation of CBAM may have a superimposed negative impact on Chinese exporters at this time.

Urgent key issues for CBAM policy
On the policy level, the top priority is to guide industry and enterprises in preparing for the EU carbon tariff system, accelerate the implementation of more targeted carbon emission verification guidelines, and improve the carbon emission trading system and related certification work.As previously stated, the EU, the US, Japan, the UK, and other countries are considering or have already incorporated carbon tariff mechanisms into their next carbon emission reduction and carbon neutral measures, the primary problem to be solved is how to communicate and exchange with all parties to promote the certification of China's carbon emission verification system while minimizing or avoiding the impact of carbon tariffs on the foreign trade industry.
The second aspect is at the industry and enterprise level, where it is crucial to make the most of the EU carbon tariff opportunity to improve green, low-carbon technology, promote endogenous energy, and from an objective standpoint, actively collaborate with the pertinent exporting country provisions.This is also a significant means of showcasing big country enterprises and country craftsmanship.
The third is the international and domestic double-cycle levels.With the global reduction in carbon emissions, the promotion of carbon neutral work, the complexity of the global market, and the release of the EU's CBAM policy as just one of the binding policies, there will be an increase in the number of industries that have to adhere to increasingly strict environmental regulations.Future items will only be low-carbon, sustainable, affordable, high-quality, and expensive.CBAM has emerged as the obvious option to steer the green and low-carbon transformation of industries on the global market with the objectives of carbon emission reduction and carbon neutrality.At the domestic level in China, promoting low-carbon sustainable development is also essential for the country's future growth.

Proactive responses to EU CBAM
Start by actively participating in consultations on global carbon policy.The government, businesses, and industry associations actively work to strengthen their docking and communication with the EU government and the relevant departments, improve mutual communication at the policy level, fully explain the history, methodology, and key components of the development of China's carbon emission verification system and carbon emission trading system, and gain a thorough understanding of the pertinent work that the EU will undertake in the next step.To provide an effective response on a technical level, to show the reliability, availability, and applicability of China's carbon emission verification system as well as other information related comprehensively, methodically, and scientifically to the EU carbon tariff determination, to improve international certification of the trading system in the carbon trading system, and to ensure the accuracy and credibility of the data.
Second, take two precautions to ward off negative elements.Even though China's government is working more quickly to promote carbon emissions and carbon neutrality, it is still crucial to be ready for the worst in case the EU CBAM rejects China's carbon emissions accounting and carbon market trading data, which will have an impact on various industries.For instance, the China Metallurgical Industry Planning and Research Institute [20] estimates that the total cost of China's iron and steel industry exposure to the EU CBAM might range from 200 million to 400 million U.S dollars annually.According to prof.Duan's analysis [21], the spectrum of goods covered by CBAM accounts for 4.8% of all exports to Europe, with an annual cost increase of 305 million USD based on a unit carbon emission price of 52 USD without considering free EU ETS credits.The study by the CICC Global Institute [22].was analyzed, and it was discovered that the value of China's exports to the EU will drop by around 6.9% if the unit price of carbon emissions is set at 50.8 USD per ton.These analyses indicate that there are two key factors that determine how much Chinese exports to the EU will trade, which is roughly in line with this paper's conclusion.On the one hand, if the EU market is lost because of the CBAM policy, the relationship between the scope covered by CBAM and carbon tax is obviously inversely proportional; the larger the scope, the more carbon tax paid; and on the other hand, in the EU ETS free quota tightening, the carbon emission unit price has been fluctuating up.
Thirdly, if the EU market is lost because of the CBAM policy, it won't have a particularly significant effect on China's international commerce in the near term.However, if other countries decide to follow the policy, the international trade sector may experience a round of export winter periods.

Conclusion
The EU CBAM policy, which uses carbon tariffs as a regulatory tool and the EU ETS as a basis for valuation to reduce and avoid the risk of carbon leakage, objectively achieves the goal of preventing carbon leakage while also defending the growth and market of local businesses.After the CBAM policy is put into effect, steel and aluminum cargo from China to the EU will have to pay an additional 540.2 and 609.48-670.43 million euros in carbon taxes.Future effects on the steel and aluminum industries will worsen if the price of carbon in the EU ETS rises more.
The release of the EU CBAM policy has various effects.For the EU, the CBAM policy can directly decrease importers' carbon leakage or enhance the high carbon tariffs levied, and it can also indirectly encourage the greening of local businesses and industries in the EU and boost their market share.To maintain and grow the EU market for China, CBAM compels Chinese exporters to utilize higher quality green, and low-carbon energy and manufacturing materials.It also accelerates the low-carbon, green transformation of the entire production process to cut GHG emissions at the source.Additionally, the policy supports the standardization, institutionalization, and marketization of China's relevant industries' green and low-carbon development.The CBAM strategy, however, also has a lot of detrimental effects on China.China's major trading partners, including the US, the UK, and Japan, have also suggested carbon border coordination mechanisms to further strengthen the restrictions on Chinese exporters.As the policymaker, the EU has complete initiative and interpretation power over the CBAM policy, and this creates a more complex environment and challenges for China's international trade.
China must be adequately equipped at the policy, industry, and business levels, as well as the 'The dual circulation strategy' 5 levels.On the one hand, policymakers should do a good job of guiding policy, expediting carbon emission verification, and strengthening the carbon emission trading system and certification work.On the other hand, industry companies need to boost internal motivation, take the lead in implementing green and low-carbon transformations, and support CBAM's declaration effort.Additionally, the development of China's domestic recycling market is given a chance by the changes in the global market, and fostering the green, lowcarbon, sustainable development of all sectors of society and industry is also a crucial step for future social progress.To achieve this, the government, businesses, and industry associations are advised to actively participate in international carbon policy discussions and disseminate China's carbon accounting and trading regulations while also being ready on both sides to prevent the EU from using the CBAM policy to harm China's international trade.

Figure 1 .
Figure 1.Key industries of China's exports to the EU.Notes: Thistableshows the size of four industries (aluminum, iron and steel, fertilizer, cement) and their total proportion.These four sectors account for 2.58% of China's total exports to the EU.

Figure 2 .
Figure 2. EU and non-EU countries, China's steel industry import and export data.

Table 1 .
Free tax and fees share table.