Carbon Border Adjustments  (BCAs) provide an alternative mechanism for reducing the risk of carbon leakage and ensure fair competition. By applying a carbon price on imports reflecting their emissions emitted during the production of the imported product, they level the playing field. However, almost all emissions trading systems have chosen to address competitiveness issues by free allocation of allowances, or by excluding sectors from carbon pricing.

The introduction of BCAs for sectors covered by the EUETS is now receiving renewed attention. In this context, this report aims at informing the early stage of the renewed debate on BCAs in the EU. It sets out an initial overview of the issues that are likely to arise and some possible way forward.

• BCAs may take the form of an obligation on imports to surrender allowances, or a tariff at the border.

• EU producers should not be able to benefit from both free allocation and shielding from BCAs for the same proportion of emissions, because this would over-compensate them and create surplus (windfall) profit.

• BCAs could be phased in as free allowances are phased out, with each mechanism covering a proportion of emissions. This could start in Phase IV of the EU ETS

• It should be possible to design BCAs consistent with WTO rules. As part of this, rules may need to be established to recognise carbon costs already incurred by imports from jurisdictions with their own carbon pricing regimes.

• BCAs are most suitable for emissions-intensive trade exposed bulk commodities. These may include, among others, cement, iron and steel, aluminium, some bulk chemicals, pulp and paper and oil refining. They may also cover electricity

• Unlike free allocation, BCAs can improve incentives to switch to lower carbon products by including the cost of carbon in the market price of products within the EU.

• BCAs can incentivise the introduction of other carbon pricing regimes in other jurisdictions, therefore potentially giving European producers a stronger incentive to remain in Europe, and therefore being a strong safeguard against any possible ‘carbon leakage’.

• BCAs can address barriers to industrial decarbonisation which the EU ETS itself has created, because they price emissions rather than subsidising them, as the current system of free allocation does

• BCAs will ultimately lead to attracting a range of low carbon goods to the EU, creating a market for such products.

• BCAs may raise additional revenue for governments.

• BCAs can, if necessary, continue as caps reduce, eventually to near zero, when allowances become scarcer, making free allocation more difficult. This can help sustain a level playing field for European industry into the long term.

• By reducing the risk of leakage BCAs would make the EUETS more robust to higher EUA prices and thus help enable tighter caps.

• Ensuring compatibility with WTO rules, which may include use of environmental exemption provisions under the Article 20 of the GATT agreement.

• Ensuring cooperation and overcoming opposition from industry and from exporting countries.

• Putting in place significant administrative infrastructure, which is needed to track imports and their embodied carbon content; and

• minimising risks that exporters to the EU try to avoid BCAs or compromise their effectiveness, for example by rerouting production between markets or exporting semi-finished goods.