Trade becomes a new tactic for curbing emissions
Steel is one of the great paradoxes of the energy transition. It is essential for low-carbon energy technologies: the weight of a wind turbine is typically about 70% steel, for example. But steel production is also a massive contributor to global greenhouse gas emissions. It accounts for about 7% of total carbon dioxide emissions from energy use.
A new trade agreement between the US and the EU attempts to start to resolve that paradox. The two economies have agreed to negotiate the “world’s first carbon-based sectoral arrangement”, covering trade in steel and aluminium, to reward metal produced with lower emissions. The Biden administration said the deal would “drive investment in green steel production in the United States, Europe, and around the world, ensuring a competitive US steel industry for decades to come.”
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So far, all the two sides have is an agreement to agree. The new sectoral arrangement is scheduled to be completed by 2024, and in the meantime there is an interim deal that eases the burden of tariffs on EU steel and aluminium in the US, while lifting tariffs that the EU had imposed on a range of US products.
The hype is justified, even so. As the world moves towards a lower-carbon future, with different economies moving at different speeds, international trade in energy-intensive goods will become increasingly contentious. If countries with low costs and high emissions can sell freely into countries with high costs and low emissions, production will shift to those higher-emitting economies. To prevent that, several economies have been looking at proposals for carbon border adjustment mechanisms (CBAMs): import duties based on products’ associated emissions, intended to level the playing-field between imports and domestic producers that have been paying a price on carbon.
The EU is pressing ahead with plans for its CBAM. Joshua Firestone, a principal economist with Wood Mackenzie’s fiscal service, wrote in a new note this week that one economy’s implementation of a CBAM “may trigger a domino effect for carbon fees in many other countries, including the accelerated adoption of carbon charges or higher carbon prices”.
The US-EU steel and aluminium trade deal looks like the first of those dominoes to fall. The Biden administration says the US and the EU will “work to restrict access to their markets for dirty steel and limit access to countries that dump steel in our markets,” while inviting into the agreement “any interested country that wishes to join and meets criteria for restoring market orientation and reducing trade in high-carbon steel and aluminum products.”
Steel producers that want to drive down emissions have a number of options available to them. In a world on course to limit global warming to 1.5 °C, implying a fall of 93% in emissions from steel production by 2050, the industry would have to change radically, cutting conventional blast furnace production by about 85%, nearly doubling the use of scrap, and capturing about 60% of the residual emissions. Those changes would be “immensely tough to achieve, with significant hurdles to overcome”, a recent Wood Mackenzie note warned. But import duties linked to emissions are part of a policy framework that could shift the industry towards that pathway.
Wood Mackenzie’s Mingming Zhang suggests that the US-EU agreement could create a “two-speed steel industry”, with innovative producers exploring investment in low-carbon technologies and setting the stage for further expansion and productivity gains, while the others suffer shrinking market share and falling profitability.
However, administering this pioneering emissions-based tariff system will not be easy. Governments will have to watch carefully to be sure that steelmakers are not trying to circumvent the rules, says Cicero Machado, Wood Mackenzie’s principal analyst for steel in the Americas. And given that EU imports into the US are much greater than US imports into the EU, this is likely to be a more pressing issue for the US government. “Rules of origin are going to be very important,” Machado says. “The US is going to have to be sure that all the steel it imports on preferential terms is melted and poured in the EU.”
The administrative burden created by a CBAM is one reason why some have opposed them. John Kerry, President Joe Biden’s climate envoy, has also sounded sceptical, suggesting that they should be “a last resort”, implemented only if more co-operative efforts to drive down emissions had failed. But with the steel and aluminium agreement, the US and the EU are taking a first tentative step in that direction. There is a good chance that further steps will follow.
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