Trade vs. Fossil-Fuel Reductions

Main obstacles to climate action are in trade agreements
May 1, 2010

Four years ago, Prime Minister Stephen Harper abandoned Canada's Kyoto obligations in favour of his “made in Canada” plan. This option was also later dropped when he decided to align our climate action with that of the United States. 

In the U.S., three bills have made it to Congress or the Senate, but none has yet become law. The Lieberman–Warner bill, introduced in 2003, was defeated in the Senate in 2008. The Waxman-Markey bill was approved by the House of Representatives in 2009, but has yet to be considered in the Senate. And the Boxer-Kerry bill is still under consideration in the Senate.

If any of these bills is eventually passed into law, it will use 2005 as a base year for emission reductions instead of Kyoto’s 1990 base year. In the best-case scenario, U.S. emissions might be brought back to 1990 levels by the year 2020. This would be eight years late and 7% short of what would have been required under Kyoto.

By comparison, the European Union countries are already 7.7% below 1990 levels, and are committed to a 20% reduction by 2020. If lagging countries would agree to join them, the EU nations are willing to commit to a 30% cut in emissions by 2020.

Why can the EU get such results when the U.S. and Canada can’t? What blocks international action when atmospheric CO2 levels are already past the “safe” level on the way to runaway global warming?

The main obstacles may be found in world trade agreements.

The World Trade Organization (WTO)

The WTO's mission is to expand world trade through the reduction of trade barriers and promotion of a level playing field. Its 150 member nations are legally bound to adhere to the Most Favoured Nation (MFN) principle. The WTO website tells us that, “Whatever applies to one member applies to all. This is “so important that it is the first article of the General Agreement on Trade and Tariffs (GATT).” The all-important foundation of the WTO is non-discrimination. A breach of this principle can result in expensive compensation penalties to the offending nation.

In spite of the emphasis on this point, some exceptions do exist, and at least two of them affect climate action.  First, groups of nations are allowed to form free trade blocs, such as North America’s NAFTA and Europe’s European Union (EU). The blocs aren't bound to extend internal preferential treatment to outsiders. Another exception allows, or even requires, special treatment of developing countries and least-developed developing countries (LCCDs).  Both these exceptions affect cap-and-trade programs, the favoured method of controlling greenhouse gas (GHG) emissions.

Canadian lawyer Paul-Erik Veel has looked at cap-and-trade systems vis-à-vis the WTO. His 2009 article, Carbon Tariffs and the WTO: An Evaluation of Feasible Policies, is a must-read for anyone who wishes to understand the market approach to CO2 emissions.

My paper proceeds from Veel’s conclusion that American domestic political constraints on cap-and-trade programs may be fundamentally at odds with WTO legal constraints. Acknowledging a debt to his analysis, this paper proposes that climate action must necessarily be undertaken outside WTO trade agreements, and that a rationing scheme may be the most effective form it can take.

Climate Action

The most successful climate action is found in the EU where, as a free trade bloc, WTO rules can be modified by agreement among its members, facilitating a cap-and trade system. GHG limits on industry can be set within the bloc, but any trade- related attempt to extend them to countries outside the EU can violate WTO rules. Here is a first indication that world trade constraints interfere with wider climate success.

The EU began an emissions trading scheme (ETS) in 2003. By 2009, 40% of EU carbon-intensive industry — over 10,000 facilities — needed emissions permits to operate. This requirement competitively disadvantages EU producers compared with outside producers. This has resulted from a miscalculation. In the wake of Kyoto, the EU expected that other countries would establish their own versions of the ETS, thus avoiding such trade inequities — but that never happened.

In the U.S., the somewhat similar ETS in the 2003 Lieberman–Warner bill was defeated in 2008. U.S. fossil fuels use is now up 17% from 1990 levels, incidentally allowing it to undercut European production costs. Canada’s is up 30%, one of the worst performers under Kyoto. So, having gone it alone for seven years, the EU is now cautiously considering a carbon tariff on imports as a way to protect its low-CO2 producers. Within WTO rules, however, the prospect of carbon tariffs raises a minefield of legal obstacles. In any case, carbon tariffs may have intrinsic trade problems of their own.

How Effective can a Carbon Tariff be?

Paul-Erik Veel turns to the Lieberman–Warner bill as the best existing attempt to reconcile climate action with trade law.  Though defeated as legislation, it offers more detail for analysis than the American Clean Energy and Security Act of 2009, recently passed in Congress but not yet in the Senate.

Like the EU system, the Lieberman–Warner bill would use an ETS, but in addition it would impose carbon tariffs on goods from countries that have not taken comparable climate action, and exempt those that have. Small countries and LCCDs would also be exempt, but, critically, not developing countries.

The ETS requires domestic producers to purchase carbon allowances, and these costs are mirrored by carbon tariffs on imports. Determining climate performance and assessing tariffs would fall to a U.S. Commission created under the bill. In Veel’s opinion, some Commission decisions could raise challenges under WTO rules.

Given the wide discretionary powers of the Commission in this bill, the intense political/legal pressures that producers, importers, and trading partners could exert on it might overpower the comparatively distant concept of climate change. In spite of the EU’s stronger commitment to climate success, its corresponding Commission has at times given way to such pressures. One example is recorded in a September 2009 report on its ETS exemptions to placate industries threatening to relocate outside the EU to remain competitive.

Furthermore, carbon allowances under the ETS would be traded internationally on the open market. The idea is that a set amount of CO2 could be emitted globally each year, and the right to emit it would become an internationally traded commodity. In light of recent global financial instability, this setup should alarm the most devoted free market enthusiast.

In 2010, we are two years into a global market meltdown caused by a not dissimilar trading scheme. Real estate values were destabilized through irresponsible derivatives trading in the U.S., which spread to global markets. Carbon derivatives are set to be an extremely hot market. Certainly, there’s a question if trusting the future of global climate to such corruptible market devices is really the best legacy we can leave our descendants.

So the effectiveness of carbon tariffs depends on their legality under a WTO intent on demolishing the same types of trade barriers. They depend on the fortitude of Commissions under relentless pressure to weaken them. And tariffs depend on the integrity of ETS systems entrusted to traders with the common interest of defeating them.

Must Developing Countries Bail Out Developed Countries?

There are provisions in the Lieberman-Warner bill that circumvent the market question, and even exempt entire countries from tariffs conditional on any of 1) their extent of emissions, if smaller than .5% of global emissions, 2) their UN status as an LCCD, 3) their comparable or better (or worse) emissions performance compared to the U.S., 4) their practically demonstrated measures to reach lower emissions in the future, or 5) if the country possesses second party allowances from another country concerning its exports. Any or all of these exemptions could be challenged by other countries (or domestic producers) as violating the WTO MFN non-discrimination principle, and make the U.S. liable for expensive compensation obligations.

In particular, Veel lists international agreements, including WTO agreements, that recognize developed countries’ central role in causing global warming through their industrialization process.  There is corresponding recognition, therefore, that a lesser burden of the remedy should be borne by developing countries. In spite of these precedents in law, developing countries, unlike LCCDs, are treated with no special consideration in the Lieberman-Warner bill. Carbon tariffs against these countries may violate WTO rules against “disguised restriction on international trade.”

But, with cheerleading from Canada, the U.S. insists that developing countries cannot have special treatment when it comes to reducing emissions. This argument is reminiscent of the special pleading heard from banks and financial institutions in 2008. “Too big to fail” is an argument to offload the expense from banks’ mistakes onto taxpayers. In the case of global warming, some of those that profited while causing it now insist that it is everyone’s equal responsibility to clean it up. 

Within an overall attempt to satisfy WTO requirements, the exclusion of developing countries is notably inconsistent with established WTO practice. China is a developing country.  It happens to be a major political problem in the U.S. that, as such, China was exempted from Kyoto climate action. Here, legal and political factors are at odds, and with little hope of reconciliation.

Can Carbon Tariffs be both Legal and Effective under WTO Rules?

The proposed mechanism by which carbon tariffs would be implemented is the “border tax adjustment.” This WTO-approved tariff method is normally intended to equalize various expenses, or lack thereof, in the exporting country with similar kinds of producer costs in the importing country. So far, the WTO can give no guidance in applying adjustments to CO2 emissions. There are strong arguments that could make border tax adjustments on CO2 emissions a violation of the rules. The resulting liability risk might in itself discourage or delay the use of carbon tariffs.

Even so, Veel concludes that arguments in support of carbon tariffs might in the end prevail. He suggests they would probably not succeed through an attempt to balance trade expenses, but rather to protect exhaustible natural resources. Importing countries could argue that “an atmosphere without excessive amounts of CO2 can be characterized as an exhaustible natural resource.” GATT Article XX(g), concerning more conventional understandings of resource conservation, might successfully be interpreted in this way. But even if carbon tariffs can be justified under the WTO, they might not work as expected.

Veel cites the case that, as an end product, high-CO2 steel produced using coal is indistinguishable from low-CO2 steel produced using cleaner energy. Both steels must be deemed “like” products under WTO non-discrimination rules, regardless of the energy used in production. As such, a carbon tariff on the high-CO2 imported steel cannot exceed the American producer’s cheap low-CO2 allowances. Besides removing the exporter’s incentive to reduce CO2 emissions, since he already qualifies for the low tariff no matter what energy he uses, this provision would actually be an incentive to higher emissions. Countries like China would choose cheaper coal over cleaner energies, making their steel cheaper to produce and cheaper for buyers to import.

Carbon Leakage

It is scenarios like steel production that lead to “carbon leakage.” American steel producers would be motivated to relocate, perhaps to China’s industrial free zones, to avoid the American ETS requirements, just as other U.S. industries have relocated to avoid high U.S. labour costs. Then shipping that high-CO2 steel back to U.S. markets would add significant transport-related CO2 emissions, further subverting the intent of climate legislation. Steel is just one example among many that would cause ETS-driven factory relocations.

Carbon leakage is an existing problem. As noted above, the EU has had to make concessions to industries on the verge of relocation to escape the EU’s ETS.

Can Climate Action Work Through the WTO?

As Thomas Jefferson said, “Money and not morality is the principle of commerce and commercial nations.” Under the WTO structure, if climate action depends on trade mechanisms, commercial interests will be threatened. Traders and affected nations will naturally look for ways to fight or circumvent climate-related restrictions.

Regardless of the special pleading of developed nations, all humankind must do what it can to solve the climate problem, no matter who caused it. But attempting to manoeuvre through the trade-oriented WTO to achieve what can best be described as a socialist goal — climate action for the common good — is clearly a project at odds with itself, and probably doomed to failure.

After his detailed analysis, Veel is no more optimistic.  He concludes, “Thus, despite the undeniable need for states to take action to combat global warming, reaching a multilateral solution to this problem should be a first-best solution.” Again, this has already been clearly demonstrated by the only success so far – that in the EU. It is essentially a multilateral solution, but one restricted to a small portion of the globe.

What Would a Global Multilateral Solution Look Like?

It may be concluded from the above discussion that the first imperative in a multilateral solution is that it must exempt itself from WTO influence. This is not to say that the WTO lacks merit in its trade-related endeavours, rather that, 1) it is an unsuitable framework for cooperative multilateral climate action; 2) a multilateral solution is likely to require trade actions to express its own influence which would conflict with the WTO rules; and 3) the WTO already has rules binding on all countries whose actions affect the climate. To the extent those rules are allowed to apply, they are likely to impede climate action.

To reconcile the values driving trade with those concerned with climate action, it seems there is no space for these two endeavours to operate on the same plane. There must be a separation of powers, as with the judiciary, the legislative, and the executive branches of governments.  Climate action must be organized on a separate tier if there is to be no dual sacrifice of its requirements and of the contributions the WTO has made toward rationalizing world trade.

The Climate Alliance (CA) Solution

The 150 member nations of the WTO, or initially a faction within the membership, could form a Climate Alliance (CA) whose charter exempted its members from WTO obligations in specific climate-related actions.

Indeed, the core membership of such an alliance would logically be the EU nations, since they are now cornered between WTO rules and the requirements of their own ETS.

As an alliance, any repercussions arising from conflicting WTO obligations would be absorbed equally by all CA members. However, such a delineated political bloc premised on specific climate objectives would probably never be legally challenged because the formation of an alliance of states would alter the arena from the legal to the political.

Non-climate-related WTO membership obligations would continue undisturbed. Trading within the CA would continue to be based on WTO agreements. CA trading with outside nations would necessarily involve carbon-based discrimination on imports, although there would be no reason for outgoing trade to be affected in any way. If outside retaliation were contemplated, here again it’s doubtful an “anti-climate alliance” could attract members.

Although this arrangement would allow a core EU-based CA to open its doors to new membership based on subscription to its established ETS, this may not be the optimum means of attracting new members. The ETS works best among closely related parties, such as in an established union, where many diverse policies are held in common.

Carbon Rationing vs. the ETS

Fossil fuel rationing would work equally well in any country, and would eliminate the need for an international ETS except to accommodate nations outside the CA.

Membership in the CA would be based on a nation’s agreement to maintain a national schedule of fossil fuel use, regulated at fuel entry points into its national energy system. Each nation’s level of rationing could take into account its economic and technological development, similar to what has already been recognized in agreements concerning developing countries. Certainly, no nation could be exempt from at least some level of rationing.

The Mechanics of Fossil Fuel Rationing

CO2 emissions are directly related to fossil fuel use, and this makes rationing an ideal control mechanism. The U.S. Energy Information Administration (EIA) tells us that 81% of anthropogenic GHGs are fossil-fuel-related emissions. That reveals a useful fact about climate action: if you reduce fossil fuel supply by a given percentage, then you reduce emissions by almost the same percentage. It’s a linear relationship.

This means the CA could prescribe and monitor emissions precisely. For example, in the case where a nation’s fossil fuel supply is reduced by 10%, its anthropogenic GHG emissions will be diminished by 8.1%. And so it follows that rationing a nation’s fossil fuel supply is a certain way to reduce and know its GHGs by exactly predictable amounts. If the goal is to reduce emissions by a certain percentage by 2030, a calculated schedule of supply will yield that exact level of emissions reduction by that date. This is much simpler and more accurate than the present method of accumulating the reported emissions from every consumption point in a country — an extremely onerous and imprecise process vulnerable to under-reporting.

Ease of execution makes rationing appealing.  Administratively, rationing a nation’s fossil fuel supply is not complicated. There are only two pathways for fossil fuel supply into any country’s energy system: from imports or from domestic production facilities. Each supply point is already routinely monitored by government agencies for statistical and taxation reasons in most countries. Therefore, any desired level of fossil fuel entering a nation's energy system can be known and regulated. It would be a minor administration burden on even the poorest of nations.

From the CA’s point of view, administration would also be easy. Shipping records are easily available for monitoring imports, and production facilities can be monitored and spot- checked in a variety of ways beyond the country’s reporting requirement. In any case, membership in the CA would necessarily involve the CA’s right to corroborate fossil fuel usage reporting. International agreements on nuclear materials have similar requirements, and the nuclear threat to human security has by now been exceeded by that of climate change.

Carbon Leakage under Rationing

Carbon leakage is a profound problem when an ETS is used to control carbon in a WTO structure. Nations do not want to lose their industries, and they will make emissions concessions to keep them. But, from within a CA, there would be little incentive for high-carbon industries to relocate outside. By remaining within the CA, those producers would be protected from outside competition by CA-endorsed carbon tariffs beyond the reach of WTO law. 

Outside markets would have no more reason to tax goods from within the CA than they would if they originated from another location to which the industry might relocate. In fact, relocating would only cause a producer the probable loss of CA markets.

Why Nations Would Enrol in the CA

Membership in the CA would offer the applicant nation the advantage of open CA markets exempt from carbon tariffs, albeit with the requirement of acceding to a rationing regime. 

Deciding an appropriate level of rationing for any country would be the key to negotiating its membership within the CA. As noted above, there are already agreements in place that have dealt with similar questions that cite economic development, existing climate action, and other factors, and these could be used to indicate an appropriate rationing assessment.

An alliance implies emphasis on cooperation in an effort toward mutual benefit. Each new member would bring new trading goods, new resources, and additional support, strengthening the CA and moving it closer to its goal.

The CA could establish timelines designed to show benefits of early membership that would not be offered to late-comers. Of course, it would be increased membership that would be sought by the CA, and, since equality among members would attract and keep them, threatened penalties would probably be forgiven or eased after new member agreements were reached.

Domestic Political Reactions

Under a rationed national supply, governments would find it no more difficult to apportion limited energy allotments to their industries and consumers than through an ETS. In fact, the ETS would remain a reasonable way to regulate domestic allotments. But the allotment problem would be somewhat easier when the government would operate within a known fossil fuel budget. In fact, all sectors of society would appreciate that they operate within a finite fossil fuel supply.

Importantly, governments would escape domestic political criticism; they could point to the external authority as the arbiter of carbon restrictions in a community of nations.  There would also be CA benefits to justify membership.

Of course, alternative and renewable forms of energy would not be rationed. With limited fossil fuel available, there would be an enormous competitive advantage to those who chose to pursue the unlimited energy available through alternative technologies. Besides being a profitable industry itself, clean energy technology would become an important metric of international competitiveness and responsible behaviour.

Obstacles to a Rationing System

The rationing solution would leave some international obstacles outstanding. Developed countries would still enjoy their in-place infrastructures built through the extensive use of fossil fuels, while developing countries would continue to argue their right to a fair share of development through unrestrained fossil fuel use.

In a global climate crisis, any effective solution will necessarily disallow a nation’s aspirations to achieve economic parity through increased fossil fuel use. These aspirations conflict with emission reduction goals, and in the long term they are in no nation’s interests.

Developed nations would be more capable of developing alternative energy, and would therefore be subject to tighter rationing.

In any case, a more genuinely fair objective will be to honour each nation’s obligation to provide for its citizens’ basic human needs and comforts through adequate energy use.  To this end, criteria could be formulated to equalize world per capita fossil fuel use within the constraints of reducing overall emissions. These criteria might allow developing countries a higher fossil fuel use while requiring developed countries to proportionately reduce their use, both under rationing provisions within a carbon reduction schedule. A goal of global per capita fossil fuel equity might not soon be fully realized, but at least a determined progression toward it would be recognized as fair.

Greater International Democracy

To the extent that an alliance implies cooperation and democratic principles, with numerous nations interacting, there would be a tendency toward fairness among nations’ energy use. This should result in a true levelling of the playing field. Since the main objective would be controlling climate change, a political structure such as is found in the UN, with powerful nations wielding extra influence and even veto power, would not be justified. But those nations staying outside the alliance for too long, even powerful nations, would risk sacrificing eventual influence within the CA according to their normal weight. This would be an added incentive to enrol, and that in turn would bring other countries in.


            (Garth Woodworth—[email protected]—is a freelance writer who lives in Victoria. He will be glad to provide detailed sources and references for this article to anyone wishing to obtain them.)