Meeting U.S. and global climate goals will require significant actions in the coming decades to decarbonize the industrial sector. Industrial manufacturing activities, including the production of steel, cement, aluminum and fertilizer, represent a significant share of greenhouse gas (GHG) emissions 20% globally and 23% in the U.S.
While progress is being made on emission reduction technologies and processes, political and economic concerns about international competition from trade in these goods with narrow profit margins has hindered adoption of ambitious industrial decarbonization policies. These concerns have led policymakers and industrial leaders in the European Union (EU), U.S. and elsewhere to turn their attention to the intersection of climate and trade policies to advance industrial decarbonization.
The EU has adopted the Carbon Border Adjustment Mechanism (CBAM) that will apply the carbon price its manufactures face under their Emissions Trading System to imported goods as well. Interest in the U.S. for a similar border carbon adjustment is coming from U.S. manufacturers in some industries like steel, which has a lower carbon footprint than many of its overseas competitors.
As possible climate and trade policies are developed and debated, the U.S. should not simply rest on its laurels but look to adopt policies and incentives that will speed the reduction of emissions by domestic manufacturers. Such policies can also help the U.S. integrate with emerging policies and standards around the world. Here we discuss approaches like a low-carbon product standard that would ensure that manufacturers of both domestically-produced and imported goods have strong incentives to decarbonize as soon as possible while also bolstering the competitiveness of clean U.S. manufacturers.
How the EU Carbon Border Adjustment Mechanism Will Work
Under the current Emissions Trading System, companies must turn in allowances to cover their emissions. However, due to concerns over competition and carbon leakage, the EU has provided some free allowances to industrial facilities to help them cover their emissions. As a result, companies are further incentivized to lower their emissions, which lets them sell any unneeded allowances to companies with higher emissions. In practice, however, the free allocations are contributing to slow progress in decarbonization and excess profits.
Starting from 2026, the EU plans to phase out free allocations and implement the CBAM to address carbon leakage concerns. The CBAM will apply a carbon fee on imported goods equivalent to the allowance price domestic EU manufacturers face under the ETS. Companies making goods in the EU and importers will then both face a carbon price on the emissions in their products. While CBAM will go into full effect from 2026, data reporting for imports will start as early as 2023. The EU has also had discussions on implementing a de facto climate club, with imports from countries with comparable carbon pricing systems exempt from the mechanism.
Bipartisan US Interest in Carbon Border Adjustment Policies
Interest in similar border carbon adjustment policies has increased in the U.S., with bipartisan support for distinct and overlapping reasons. Some see these policies as a tool for galvanizing global industrial emission reductions. Some are looking to protect U.S. manufacturers in sectors like steel production that are less carbon intensive than overseas competitors and to bring manufacturing jobs back to the U.S. Another motivation is avoiding the prospect of U.S. goods being subjected to CBAM on exports to Europe. Using trade policies to address GHG emissions associated with traded goods requires estimation of the emissions intensity of those goods — how many tons of GHGs were emitted to produce one unit of the good.
Recognizing the need for better information on the carbon intensity of goods, Senators Chris Coons (D-Del.) and Kevin Cramer (R-N.D.), along with seven additional bipartisan co-sponsors, recently introduced the Providing Reliable, Objective, Verifiable Emissions Intensity and Transparency (PROVE IT) Act that would require a study to determine the average carbon intensity of goods produced in the U.S. and in trading partner countries. If enacted, this bill would provide an important foundation for implementing a carbon border adjustment or similar policy.
Sen. Bill Cassidy (R-La.) is developing a Foreign Pollution Fee that he plans to introduce this summer. His proposal would apply a fee on imported goods that are more carbon intensive than products produced in the U.S. Such an imports-only approach would be a step in the right direction in accounting for the GHG emissions of heavy industry goods. This fee would make it harder for carbon-intensive imports to compete with domestic products or lower-carbon imports but would not provide incentives for domestic manufacturers to reduce the carbon intensity of their products.
The U.S. currently imports only a small proportion of the heavy industry products it consumes. For example, 25% of steel and 15% of cement products are imported annually. Therefore, a policy covering both domestic goods and imports would more effectively scale decarbonization across hard-to-abate sectors in the U.S.
The Clean Competition Act (CCA), introduced in 2022 by Sen. Sheldon Whitehouse (D-R.I.), and expected to be reintroduced this year would apply a carbon intensity charge to both domestically produced and imported goods if their emissions intensity exceeded a certain benchmark and directing revenues to support decarbonization in affected industries. By applying the emission reduction incentives equally on domestic manufacturers and imports and providing funds for decarbonization, the CCA could drive deep industrial decarbonization in the U.S.
Comparing Trade Approaches to Decarbonize Industry
The CCA would come close to implementing a low-carbon product standard, which WRI explored for the cement and steel industries. Under a low-carbon product standard, companies would be rewarded for how far below the emissions benchmark their products were. Let’s walk through how each would provide incentives to decarbonize U.S. manufacturing.
Clean Competition Act
Under the CCA, a carbon intensity charge would be applied equally to domestically-produced and imported goods. The charge would be proportional to the degree to which the products’ carbon intensity exceeded the benchmark, and would be calculated as follows:
(carbon intensity of product – carbon intensity benchmark) x (weight of goods) x (carbon price)
The starting point for the benchmark under CCA would be the U.S. industry average for that good and would decline over time, requiring the charge to be paid for more goods unless the industry decarbonizes at the same rate. The carbon price would also increase over time. This combination would provide a very strong incentive for both domestic and international manufacturers to reduce their emissions intensity and has the potential to be considered part of an international climate-club pact.
In addition, the revenue raised under the fee would be directed in part to a domestic competitive grant program to help existing facilities reduce their emissions and new facilities to be built with best-in-class carbon intensity. Additional funds would be directed to the U.S. State Department for multilateral assistance for climate and clean energy programs overseas. In addition of scaling industrial decarbonization, this type of a combined domestic and import goods fee would likely be needed to satisfy the EU that the U.S. has a comparable carbon pricing system and should be exempt from CBAM.
Low-Carbon Product Standard
A low-carbon product standard would provide incentives for manufacturers to reduce a product’s carbon intensity by setting an emissions intensity benchmark that decreases over time. One version of a low-carbon product standard would have products with emissions intensities below the benchmark earn credits, while those with higher emissions intensities would owe credits. The credits would be tradeable, so companies could buy and sell the emissions credits. An alternative approach would implement a fee-bate, where rebates would be paid to those who earned credits and a fee would be paid by those who owed them. With tradeable credits, the market would set the carbon price, while in a fee-bate system the government would establish the level of the fee/rebate.
A low-carbon product standard would create a strong additional layer of incentive for companies to make investments in significantly lowering their emissions. Rather than just avoiding a fee by beating the benchmark under the CCA, with a low-carbon product standard, companies would earn money based on how far below the benchmark they were. This approach would provide strong financial incentives for both existing facilities and new entrants to invest in innovative technologies and processes that not just meet but significantly beat the benchmarks.
What are the Prospects for a Climate and Trade Policy in the US?
As the U.S. implements the Bipartisan Infrastructure Law and Inflation Reduction Act, significant funding and policies are being deployed to decarbonize the industrial sector. Different policy measures can play complementary roles at different stages of development and deployment of low-carbon technologies and processes.
One area of potential bipartisan agreement on Capitol Hill is the use of trade policy to protect clean U.S. industries facing competition from more carbon-intensive industries overseas, though significant work will be required to craft legislation that can garner sufficient support to become law.
As policymakers look for ways to ensure that low-carbon U.S. manufacturers aren’t outcompeted by high-carbon imports, the U.S. should not simply rest on its current relatively clean manufacturing practices. Ambitious policies that combine trade and climate action and apply to all products sold are needed to deepen the reach of decarbonization, maximize market penetration across the sector and provide industrial decarbonization at the scale that it needs.
Note: A version of this article appeared as an op-ed by the authors in The Hill in April 2023.
