In Focus: Canada Exploring Border Carbon Adjustments

Trade Update • August 16, 2021

Following up on a 2021 budget commitment, the Trudeau government recently announced the launch of consultations with the public on border carbon adjustments (BCAs) as part of Canada’s transition to a low-carbon economy. At the same time, the Department of Finance published a background paper outlining various forms such a BCA might take, along with the key environmental, economic, and international trade considerations involved.

What Are Border Carbon Adjustments?

Simply put, BCAs are essentially tariffs applied to imports (or rebates in the case of exports) that aim to “level the playing field” between businesses in countries that have carbon pricing from those in countries that either do not have carbon pricing or apply a lower carbon price. In other words, BCAs aim to ensure that domestic and imported goods reflect a comparable carbon cost.

Another purpose of BCAs is to help prevent “carbon leakage” — the situation where carbon pricing policies may incentivize companies to move production to countries with laxer greenhouse gas emission policies.

BCAs are generally seen as being most relevant to the products made by emissions-intensive trade-exposed (EITE) sectors such as the steel, aluminum, cement, and refined petroleum industries, as they are the most at risk of carbon leakage.

International Developments

While BCAs have been studied for many years, only recently have governments begun seriously considering the implementation of such measures as they look to encourage businesses to reduce emissions while addressing concerns about the competitive effects of carbon pricing.

Last month, the European Union issued a proposal for a carbon border adjustment mechanism (CBAM) on a variety of carbon-intensive imported materials such as steel, aluminum, cement, and fertilizers based on costs the EU already imposes on domestic industry, to be phased in over a 10-year period.

In the U.S., President Biden is said to be “particularly interested” in evaluating the need for such a measure, and earlier this year, the Office of U.S. Trade Representative indicated it would consider a carbon border adjustment to encourage climate action globally while protecting domestic manufacturing. More recently, however, the Biden administration said it was “concerned” about the EU’s proposed CBAM, warning that such measures should only be used as a “last resort” given that they have “serious implications for economies, and for relationships, and trade.”

Also coming on the heels of the EU’s proposal, Sen. Chris Coons (D-DE) and Rep. Scott Peters (D-CA) last month introduced legislation that would tax certain carbon-intensive imports to adjust for regulatory costs faced by U.S. businesses.

Under the proposed FAIR Transition and Competition Act, the average cost to producers of steel, aluminum, cement, iron, and covered fuels of complying with federal, state, and local climate policy in effect at the time would be determined by multiplying that compliance cost by the amount of greenhouse gases emitted in the production process.

Critics have denounced the bill as “mind-bendingly complicated” and warn that it would be exceedingly difficult to implement and would inevitably lead to trade disputes. A key problem is that absent an economy-wide carbon-pricing regime, the U.S. would be required to evaluate the strength of other countries’ climate regulatory regimes in comparison to America’s own complex web of federal, state, and local regulations, which would be the basis for determining an “implicit” domestic carbon price.

Collaboration Needed

The Finance Department’s discussion paper states that “Canada must move forward in collaboration with key trading partners,” making clear that Ottawa is keenly aware of the risky position Canada would be in if the U.S. and other key trading partners opted for unilateral border carbon measures.

“There are different ways countries can take action, and we need to think about how we bring those approaches together,” the Finance report says. “This is why the government wants to engage with key trading partners and other like-minded countries who are taking climate action to better understand their perspectives and plans for BCAs or alternative measures, and ensure there is as much coherence and coordination as possible among different policies and approaches.”

In this regard, a new report published by the International Institute for Sustainable Development just before the EU set out its CBAM proposal, argues that Canada should collaborate with the U.S. and EU to design a set of BCA plans, warning that failing to do so could weaken both domestic industries and Canada’s contribution to tackling climate change. The report urges Ottawa “to figure out how to reconcile its climate ambition with the need to protect the competitiveness of domestic industry and prevent carbon leakage.”

Consultation Process

The initial exploratory phase of consultations now underway involves targeted discussions with the provinces and territories, as well as industry associations representing sectors most directly impacted (i.e. importers and exporters dealing in emission-intensive goods). A limited number of labour and environmental organizations and academics with expertise regarding BCAs will also be engaged.

“The broader Canadian public will be consulted this fall,” according to the government, although how that will play out in light of the upcoming federal election in September remains to be seen.