This is an extract from a recent report “Global trade in the energy transition: Principles for clean energy supply chains & carbon pricing” by The Energy Transitions Commission.
Carbon pricing is not always the most effective tool to drive decarbonisation. In some sectors, direct regulation or targeted subsidies for technology development may deliver faster and more efficient outcomes. However, there is a strong case for making carbon pricing the central policy instrument in the energy-intensive, so-called hard-to-abate sectors, which together account for approximately 15 GtCO₂ emissions per year, or around 30% of the global energy-related total. These sectors are either inherently international (as with aviation and shipping) or have products which are extensively internationally traded (e.g., steel and chemicals). As a result, it is not possible to proceed with carbon pricing in one country alone without producing adverse effects on relative competitiveness.
Hard-to-abate sectors, the green cost premium, and the need for carbon pricing
Hard-to-abate sectors are those where the technologies and methodologies to decarbonise these sectors do exist but have not yet reached, and may never reach, price parity with their more traditional, carbon-intensive counterparts. These sectors are characterised by the fact that carbon either plays a key role as a material input, is produced as a byproduct, or high fuel density is required for their operation. In these cases, green alternatives to conventional methods are inherently more expensive, and this price gap may persist for the medium-to-long term, or potentially indefinitely.
Two implications follow from these cost considerations:
First, countries can and should impose policies to drive hard-to-abate sector decarbonisation, and they should be confident that the impact on consumer living standards will be very small. Second, decarbonisation of these sectors will not occur without carbon pricing, or regulation with the equivalent effect of a carbon price, to make low carbon production competitive with current high carbon intensive production methods.
The international coordination challenge and the role for CBAM
Given the international nature of several hard-to-abate sectors, achieving effective decarbonisation requires global coordination. These sectors are either actively traded across borders (e.g., steel and chemicals, electricity) or involve inherently international activities (e.g., shipping and aviation).
The ideal solution would be globally agreed carbon prices applied to these specific sectors. In the shipping industry, the International Maritime Organisation (IMO) agreed in March 2025 to introduce a carbon levy of up to $380 per tonne on emissions above a defined intensity threshold which falls gradually over time. While the scheme is estimated to be insufficiently demanding to reduce emissions at the pace defined by the IMO’s previously agreed targets, it is nevertheless a crucial step forward towards internationally agreed carbon pricing, with 63 countries having voted in favour, notably including China, India and Brazil.
In the heavy industry sector, however, there is no international rule-making body with the authority to agree on and enforce a global carbon price. Nor has there been international consensus – particularly among major developing economies – that a meaningful carbon price should be applied globally to these sectors. In this context, countries or blocs that move forward with domestic carbon pricing for heavy industry must implement some form of border carbon adjustment to maintain a level playing field.
Carbon pricing schemes are now in place across 53 countries covering over 20% of global emissions but the EU is the only system which imposes carbon prices sufficiently high to have a material impact on the economics of decarbonisation in the hard-to-abate sectors.
The EU initially sought to address the international competitiveness challenge by providing heavy industry sectors with free allowances within its ETS. But this greatly reduced the incentive for decarbonisation. The EU is therefore now committed to removing the free allowances and instead introducing a CBAM which will see importers face the same carbon price that domestic production faces, with its introduction phased in by the removal of free allowances between 2026–2034.
Until now, however, key aspects of the CBAM have been insufficiently robust to create strong enough incentives for European heavy industry decarbonisation, and final investment decisions on decarbonisation products have been delayed. In March 2025, the EU therefore committed to major strengthening of the CBAM regime which if implemented will create a strong momentum for the heavy industry emission reductions required to meet the EU’s international commitments.
The European ETS and CBAM
The European Union’s Carbon Border Adjustment Mechanism (EU CBAM) was formally adopted in April 2023 as part of the EU’s broader Fit for 55 climate package and was designed to complement the EU Emissions Trading Scheme (ETS), which was established in 2005. The price in the EU ETS is currently around €70 per tCO2 ($80 per tCO2 46) – a price high enough to incentivise decarbonisation of many industrial processes – and is expected to rise further over time. Although it will expand its scope over time, the EU CBAM currently targets the emissions-intensive and trade-exposed sectors – namely iron and steel, cement, aluminium, fertilisers, hydrogen, and electricity. The EU CBAM is being rolled out in two phases to ensure a smooth implementation process:
• Transition phase (until December 2025): Primarily focused on reporting embedded emissions, giving businesses and regulators time to build capacity and develop systems for emissions data collection and verification, without financial obligations.
• Full implementation phase (beginning January 2026): Importers must buy CBAM certificates to cover the carbon price differential between their country of origin and the EU. At the same time, free ETS allowances will be gradually phased down, starting small to avoid market disruption but completely gone by 2034.
Why CBAMs are not protectionist
The economic case for combining country specific carbon prices with a CBAM is clear but it faces resistance from some developing countries, which view it as protectionist and at odds with the principle of “common but differentiated responsibilities” set out in the Kyoto Protocol. Russia has recently challenged the EU’s CBAM at the World Trade Organisation as being “protectionist” in nature. In reality, however, CBAMs are not inherently protectionist, can align with the principle of differentiated responsibilities, and represent one of the only viable tools for developed countries to decarbonise their hard-to-abate sectors while taking accountability for emissions embedded in imports.
Preservation of a level competitive playing field
If a country introduced a CBAM without introducing a carbon price on the relevant sectors that would clearly be protectionist since it would improve the competitiveness of domestic industry relative to international competition – similar to a direct subsidy. But if a country imposes a carbon price and simultaneously introduces a CBAM at the same price level, it leaves the relative competitive position of domestic and foreign competitors unchanged. Moreover, the explicitly desired objective of the EU’s CBAM is not to raise tariff revenues, but instead to create an incentive for other countries to introduce carbon prices for internationally traded energy intensive sectors.
Common but differentiated responsibilities
The Kyoto Protocol established the principle of “common but differentiated responsibilities” by which all the participating countries shared the responsibility to reduce emissions, but with the pace of emission reductions varying between countries in line both with their level of current and past emissions per capita and their economic capacity to invest to achieve decarbonisation.
The argument is therefore sometimes made that imposing a CBAM on carbon intensive imports from developing countries and thus encouraging/forcing them to accelerate the decarbonisation of their own heavy industrial sectors represents a contradiction of this principle. But this is not the case, since:
• The application of the principle should be and is reflected in the overall pace of emissions reduction to which different countries have committed.
• This slower pace of targeted emissions reduction can be reflected in the pace of reduction in non-traded sectors of the economy without any need for international coordination.
• By contrast, in relation to the internationally traded energy intensive sectors of the economy, permanently different carbon prices in different countries (unless offset by CBAMs) make it impossible for developed countries to achieve the faster pace of reduction towards net-zero emissions which developing countries have quite rightly demanded in international climate negotiations.
Moreover, the impact on developing country consumers of carbon pricing in the hard-to-abate sectors will be very small, thus:
• Demanding that passenger road transport be decarbonised at the same rate in India as in Europe might impose a significant initial cost on Indian consumers.
• But accelerated decarbonisation of heavy industrial sectors in India and China will have a trivial impact on consumer living standards and negligible impact on attainable economic growth, particularly once allowing for the fact that developing countries which impose carbon prices will receive revenue streams which they can use to offset any effects.
Taking responsibility for imported consumption-based emissions
A CBAM is a crucial policy lever that enables richer, developed countries to bear greater responsibility for reducing emissions. It is also the only possible mechanism by which developed countries can take responsibility for imported “consumption-based emissions. Short of outright protectionism aimed at reducing trade volumes, the only effective way to cut these emissions is by decarbonising production in the exporting countries. For developed countries, a CBAM is the only viable tool to incentivise this shift – by encouraging exporting countries to adopt domestic carbon pricing. A developed country that uses a domestic carbon price combined with a CBAM will raise the cost of carbon intensive imports for its consumers. Any resulting carbon prices imposed by developing countries ensure that any resulting revenues accrue to the developing country government, not the developed government. In this way, a CBAM allows developed countries and their consumers to take responsibility for the costs of reducing imported consumption-based emissions.
Developing country response, international measurement standards and use of revenues
CBAMs have a clear role to play in the journey to net-zero. The EU is pioneering their implementation through its strengthened CBAM – crucial to progressing heavy industry decarbonisation in Europe. The ideal response from developing countries would be to introduce carbon prices for the heavy industry sectors of the economy, rising gradually towards European levels, and with the end result of a broadly common carbon price. Some steps in this direction are already occurring: the Chinese ETS has been extended to cover heavy industry sectors, and carbon prices have risen from the initial trivial levels, topping CN¥100 in 2024 (nearly $15) per tonne.
Progress towards wider coverage of carbon pricing in heavy industry sectors could occur as a result of independent national decisions, but it would be desirable to create as much international consensus as possible. Three initiatives, which could be launched at COP30 in Brazil could help build that consensus:
• International discussions, potentially managed by the WTO, to agree on global standards for measurement of carbon intensity of heavy industry production. Advanced work on standards is already in place providing a strong starting point for this discussion.
• Technical assistance if needed for developing countries to develop the emissions data and institutional structures required for effective carbon pricing.
• The allocation of some revenues that will accrue from the EU CBAM (for as long as other countries do not have equivalent carbon prices) to support climate finance flows to lower income countries.
Potential relocation of industry in a net-zero world
Having an internationally agreed carbon pricing for heavy industries – or having the combination of domestic carbon prices with a CBAM – will create a competitive level playing field for international trade. This will remove the danger that heavy industry relocates to avoid carbon prices, and that no true decarbonisation occurs. But once that level playing field is in place, some heavy industry may move to new locations which are cost advantaged in zero emission production because of abundant renewable energy sources.
Energy costs account for a significant share of total production expenses, and regional differences in energy prices could strongly influence locational decisions. For example costs for renewables and round the clock storage in Germany are approximately $130 per MWh for projects commencing in 2030, whereas equivalent costs in India are approximately $90 per MWh. For established industry hubs in areas with high energy costs (e.g., Europe), relocating to regions with newly installed renewable generation could offer significant cost savings.
This will be even more relevant for industries requiring entirely new production processes to achieve climate neutrality. For example, production process for renewable energy-based hydrogen direct reduced iron (DRI) will require new direct reduction plants. In this case, locating the plants in geographies where hydrogen will be cheapest to produce will make the most sense. For countries with high local employment in steel making, this poses a substantial risk – though one possible scenario is that iron-making relocates to areas of cheapest energy input, but steel-making (including through electric arc furnaces) and finishing, which is less energy intensive but accounts for around 2/3 of overall jobs (and value added) remains in existing locations.
Carbon tariffs are not protectionist but countries standing in the way of natural relocation would be.
Access the report here
