Mind the carbon price gap

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One of the hopes behind the introduction of CBAM was that it would catalyse climate policy action across Europe's trading partners, accelerating the adoption of direct carbon pricing mechanisms, including carbon taxes and emissions trading schemes.

By lifting all boats towards the prevailing carbon price in Europe, policymakers reasoned that it would reduce the risk of carbon leakage, preserve the competitiveness of European industry, and most importantly, bolster the economic case for decarbonisation around the globe.

More than 20 jurisdictions, including Brazil, Indonesia, and India have responded by developing or launching their own emissions trading schemes or carbon taxes. However, many lower income countries have criticised the EU's approach (which requires imports from all nations to pay the same carbon price) as punitive and distortionary (see Call of duties: Mozambique demonstrates how CBAM could redraw global commodity trade flows).

EU policymakers, such as former top climate official Jos Delbeke, are increasingly concerned about the widening gap between the price of carbon in the EU and that which exists elsewhere in the world. In a post on LinkedIn in February, the Belgian economist indicated that if the gap grew too wide then CBAM's shuffling of trade flows might start to dominate the political narrative:

"It will be useful to avoid too wide a gap between carbon prices in the EU and other major economies, as otherwise unhelpful side-effects such as resource-shuffling or trade diversion may start to dominate the political debate."

So far at least, the public to-and-fro ahead of the EU ETS reform process hasn't specifically compared Europe's carbon price to that prevailing elsewhere in the world. It seems only a matter of time before it becomes a bone of contention for those EU member states and industries aggrieved at the EU's flagship climate policy.

How can we begin to understand the size of this gap, and the potential implications of closing it?