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The carbon threat to Ukrainian exports to the EU

18/ 09/ 2020
  Stanislav Zinchenko. CEO of GMK Center. Export costs of Ukrainian companies supplying their products to the EU might increase to €566.3 million. The Ukrainian media space pays only scarce attention to environmental issues, especially when it comes to industrial ecology. The public environmental policy is badly structured and needs modernization. However, we live in the 21st century that brings significant changes worldwide, and environmental policy has become an integral part of geopolitics and international trade. What is CBA?. The EU has been discussing a possibility of introducing the so called carbon border adjustment mechanism in the recent year. CBA is a tax that will be imposed on carbon-intensive products imported to the EU depending on the volumes of CO2 emitted in the process of their manufacture. The CBA introduction is provided for by the European Green Deal presented back in December 2019. The European Commission proposes to introduce CBA by 2023 at the latest. CBA pursues two main goals: Prevent movement of carbon-intensive production to jurisdictions with less strict environmental standards (carbon leakage), thus facilitating CO2 emissions reduction at the global scale. Ensure that European producers and importers have equal conditions for competition (European producers pay for their CO2 emissions under the EU emissions trading system, while importers pay no such fees, which gives them an advantage). Many specialists believe that CBA is a special fiscal instrument that will increase the EU revenues at the expense of exporters, on the one hand, and a new form of protectionism to safeguard the EU own markets, on the other. According to the estimations of the European Commission itself, annual CBA revenues will amount to around €5–14 billion. Impact on Ukraine. Why is it important to us? Because the EU is Ukraine’s key trade partner. In 2015–2019, the share of the EU in the structure of Ukraine’s exports increased from 34.1% to 41.5%. In monetary terms, Ukraine’s exports in the same period increased from $13 billion to $20.8 billion. The new trade restrictions that are being created by CBA are barriers to increasing of Ukraine’s both exports to the EU and domestic production. Unless our government joins the negotiations and manages to arrange an efficient dialogue with the EU partners, Ukraine will suffer from a drop of currency earnings and budget revenues, as well as decrease in employment and household incomes. That is the issue is crucial, but Ukraine is demonstrating little discussion about ways of mitigating the negative impact of CBA on its exports. No estimations of the potential effect of CBA for Ukraine have been made. So, our GMK Center team did the math and shared our forecast to initiate a dialogue about what Ukraine can do to protect its exports. Export, by the way, is an important component of the Ukrainian economy which is highly internationalized. In 2019, for instance, the share of exports in Ukraine’s GDP reached 32.6%. In 2019, Ukraine’s exports to the EU amounted to €21.1 billion, one third of the amount being a potential subject to CBA. The following are examples of carbon-intensive groups of commodities: pig iron, steel semi-finished products, rolled products; pipes, metalware and other articles of ferrous metals; ores; chemical products; fertilizers; plastics and polymers; electricity. How much?. Almost all Ukrainian export commodities are more carbon-intensive than their European analogues. In such conditions, Ukrainian exports turn out to be a good target in terms of CBA taxation. The procedure for its calculation and collection is now only at the stage of discussion. Various options are possible. For example, taxation of producer-specific direct CO2 emissions. In this case, the amount of CBA depends on the actual volume of emissions produced by the exporter, and the market price of the greenhouse gas emissions allowances at the time of the product delivery. Another option might be taxation of the difference between the country-specific sector-average direct CO2 emissions and the same in the EU. Taxation of both direct and indirect CO2 emissions is not impossible either. Indirect emissions may include energy-related CO2 emissions or CO2 emissions of all the suppliers in the production chain. GMK Center’s estimations build on the following assumptions: only direct CO2 emissions are taxed; the price of CO2 emissions allowances is taken as the projected €22.2 per ton; major carbon-intensive groups of products are taken as taxable items (iron ore concentrate, pellets, pig iron, steel semi-finished products, rolled products, ferroalloys, welded pipes, carbamide, plastic). According to our estimations, export costs of Ukrainian companies supplying their products to the EU might increase to €566.3 million per annum as a result of CBA introduction. Almost 94% of that amount be will a burden of steelmaking and power companies. Is it possible not to pay? We are partners after all. What are the possible ways to mitigate the CBA impact on Ukrainian exports? First of all, it’s accession to the European Green Deal. Two solutions are possible here: 1.A dialogue on exempting Ukraine from CBA as Ukraine signed a free trade agreement with the EU. In the opinion of many experts, this format is unlikely to be a success as the EU has similar agreements with many other countries which negates the effect of the CBA concept as such. Still, there’s always a chance, and a dialogue is worth trying! Moreover, the assumption that Ukraine may be exempted from CBA under the Association Agreement implies that Ukraine is supposed to fulfill the same emissions commitments as the EU companies. And this might bring in other risks for our exporters. 2.The EU is now discussing the idea of complete or partial cancellation of CBA for economies that will follow the same decarbonization policy as the EU. This idea may take the form of agreements of equivalence that will determine the conditions of decarbonization for non-EU countries. In that case, Ukraine may hope for special, less strict, conditions of decarbonization and CBA. In the process of accession to the European Green Deal, different starting points of Ukrainian and European companies should be taken into account. Environmental projects of European companies have been receiving support from the European Commission in the form of grants, subsidies, interest refunds in the recent 10 to 20 years. Ukrainian companies, first of all, implemented environmental projects with no available government instruments of financial support. Secondly, they had and have no such access to financial resources as their European competitors. Therefore, the deadlines for achieving carbon neutrality should be extended for Ukraine in comparison to European producers. In addition, accession to the European Green Deal should open access for Ukrainian companies to financial resources provided by European funds. Another opportunity for mitigating the CBA impact on Ukrainian exports would be exempting Ukraine as a developing economy. The EU is indeed discussing the idea of exempting companies from developing countries from CBA, as this tax threatens their sustainable development. Ukraine is a developing economy based on the following criteria: according to the IMF, Ukraine ranks 112th in the world in the GDP per capita index (when adjusted by purchasing power parity); among all European countries, Ukraine ranks 2nd in the UN Human Development Index, preceded only by Moldova; according to Growth from Knowledge, Ukraine is the poorest country in Europe; in the World Economic Forum’s Global Competitiveness Report, Ukraine ranks 58th out of 141 world economies; in the Legatum Prosperity Index, Ukraine ranks 96th out of 167 countries; in the Index of Economic Freedom, Ukraine ranks 134th out of 180 countries. So, we can count on leniency. Whatever option is chosen, the dialogue should be started right away. The EU is already overrunning Ukraine in terms of decarbonization. This gap will only be expanding in the future, thus putting barriers to access of Ukrainian products to European markets. All these and many other topics will be discussed on 17 September during the roundtable on introducing the carbon border adjustment mechanism organized by the European Business Association and the European Roundtable on Climate Change and Sustainable Transition (ERCST).
Stanislav Zinchenko CEO of GMK Center
Export costs of Ukrainian companies supplying their products to the EU might increase to €566.3 million.

The Ukrainian media space pays only scarce attention to environmental issues, especially when it comes to industrial ecology. The public environmental policy is badly structured and needs modernization. However, we live in the 21st century that brings significant changes worldwide, and environmental policy has become an integral part of geopolitics and international trade.

What is CBA?

The EU has been discussing a possibility of introducing the so called carbon border adjustment mechanism in the recent year. CBA is a tax that will be imposed on carbon-intensive products imported to the EU depending on the volumes of CO2 emitted in the process of their manufacture. The CBA introduction is provided for by the European Green Deal presented back in December 2019. The European Commission proposes to introduce CBA by 2023 at the latest.

CBA pursues two main goals:

  1. Prevent movement of carbon-intensive production to jurisdictions with less strict environmental standards (carbon leakage), thus facilitating CO2 emissions reduction at the global scale.
  2. Ensure that European producers and importers have equal conditions for competition (European producers pay for their CO2 emissions under the EU emissions trading system, while importers pay no such fees, which gives them an advantage).

Many specialists believe that CBA is a special fiscal instrument that will increase the EU revenues at the expense of exporters, on the one hand, and a new form of protectionism to safeguard the EU own markets, on the other. According to the estimations of the European Commission itself, annual CBA revenues will amount to around €5–14 billion.

Impact on Ukraine

Why is it important to us? Because the EU is Ukraine’s key trade partner. In 2015–2019, the share of the EU in the structure of Ukraine’s exports increased from 34.1% to 41.5%. In monetary terms, Ukraine’s exports in the same period increased from $13 billion to $20.8 billion.

The new trade restrictions that are being created by CBA are barriers to increasing of Ukraine’s both exports to the EU and domestic production. Unless our government joins the negotiations and manages to arrange an efficient dialogue with the EU partners, Ukraine will suffer from a drop of currency earnings and budget revenues, as well as decrease in employment and household incomes.

That is the issue is crucial, but Ukraine is demonstrating little discussion about ways of mitigating the negative impact of CBA on its exports. No estimations of the potential effect of CBA for Ukraine have been made. So, our GMK Center team did the math and shared our forecast to initiate a dialogue about what Ukraine can do to protect its exports. Export, by the way, is an important component of the Ukrainian economy which is highly internationalized. In 2019, for instance, the share of exports in Ukraine’s GDP reached 32.6%.

In 2019, Ukraine’s exports to the EU amounted to €21.1 billion, one third of the amount being a potential subject to CBA. The following are examples of carbon-intensive groups of commodities:

  • pig iron, steel semi-finished products, rolled products;
  • pipes, metalware and other articles of ferrous metals;
  • ores;
  • chemical products;
  • fertilizers;
  • plastics and polymers;
  • electricity.

How much?

Almost all Ukrainian export commodities are more carbon-intensive than their European analogues. In such conditions, Ukrainian exports turn out to be a good target in terms of CBA taxation. The procedure for its calculation and collection is now only at the stage of discussion. Various options are possible. For example, taxation of producer-specific direct CO2 emissions. In this case, the amount of CBA depends on the actual volume of emissions produced by the exporter, and the market price of the greenhouse gas emissions allowances at the time of the product delivery.

Another option might be taxation of the difference between the country-specific sector-average direct CO2 emissions and the same in the EU. Taxation of both direct and indirect CO2 emissions is not impossible either. Indirect emissions may include energy-related CO2 emissions or CO2 emissions of all the suppliers in the production chain.

GMK Center’s estimations build on the following assumptions:

  • only direct CO2 emissions are taxed;
  • the price of CO2 emissions allowances is taken as the projected €22.2 per ton;
  • major carbon-intensive groups of products are taken as taxable items (iron ore concentrate, pellets, pig iron, steel semi-finished products, rolled products, ferroalloys, welded pipes, carbamide, plastic).

According to our estimations, export costs of Ukrainian companies supplying their products to the EU might increase to €566.3 million per annum as a result of CBA introduction. Almost 94% of that amount be will a burden of steelmaking and power companies.

Is it possible not to pay? We are partners after all

What are the possible ways to mitigate the CBA impact on Ukrainian exports? First of all, it’s accession to the European Green Deal. Two solutions are possible here:

1.A dialogue on exempting Ukraine from CBA as Ukraine signed a free trade agreement with the EU. In the opinion of many experts, this format is unlikely to be a success as the EU has similar agreements with many other countries which negates the effect of the CBA concept as such. Still, there’s always a chance, and a dialogue is worth trying!

Moreover, the assumption that Ukraine may be exempted from CBA under the Association Agreement implies that Ukraine is supposed to fulfill the same emissions commitments as the EU companies. And this might bring in other risks for our exporters.

2.The EU is now discussing the idea of complete or partial cancellation of CBA for economies that will follow the same decarbonization policy as the EU. This idea may take the form of agreements of equivalence that will determine the conditions of decarbonization for non-EU countries. In that case, Ukraine may hope for special, less strict, conditions of decarbonization and CBA.

In the process of accession to the European Green Deal, different starting points of Ukrainian and European companies should be taken into account. Environmental projects of European companies have been receiving support from the European Commission in the form of grants, subsidies, interest refunds in the recent 10 to 20 years.

Ukrainian companies, first of all, implemented environmental projects with no available government instruments of financial support. Secondly, they had and have no such access to financial resources as their European competitors.

Therefore, the deadlines for achieving carbon neutrality should be extended for Ukraine in comparison to European producers. In addition, accession to the European Green Deal should open access for Ukrainian companies to financial resources provided by European funds.

Another opportunity for mitigating the CBA impact on Ukrainian exports would be exempting Ukraine as a developing economy. The EU is indeed discussing the idea of exempting companies from developing countries from CBA, as this tax threatens their sustainable development.

Ukraine is a developing economy based on the following criteria:

  • according to the IMF, Ukraine ranks 112th in the world in the GDP per capita index (when adjusted by purchasing power parity);
  • among all European countries, Ukraine ranks 2nd in the UN Human Development Index, preceded only by Moldova;
  • according to Growth from Knowledge, Ukraine is the poorest country in Europe;
  • in the World Economic Forum’s Global Competitiveness Report, Ukraine ranks 58th out of 141 world economies;
  • in the Legatum Prosperity Index, Ukraine ranks 96th out of 167 countries;
  • in the Index of Economic Freedom, Ukraine ranks 134th out of 180 countries.

So, we can count on leniency.

Whatever option is chosen, the dialogue should be started right away. The EU is already overrunning Ukraine in terms of decarbonization. This gap will only be expanding in the future, thus putting barriers to access of Ukrainian products to European markets.

All these and many other topics will be discussed on 17 September during the roundtable on introducing the carbon border adjustment mechanism organized by the European Business Association and the European Roundtable on Climate Change and Sustainable Transition (ERCST).

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