The Weekly Insight

The Insights

  • The EU’s plan to impose a price on the carbon associated with some industrial imports will have a limited impact on Canada. But broader implementation of border carbon adjustment mechanisms could pose a significant challenge to Canada’s highly trade-exposed economy.
  • While Canada’s domestic carbon pricing regime should help insulate it from new carbon-based trade rules, efforts by countries to use border carbon taxes to punish climate laggards and geopolitical rivals could come with a cost.
  • Canada should push for international cooperation on border carbon levies to protect domestic industry while furthering international progress on climate goals.

The Stakes

Canada won’t get hit hard by the world’s first plan to price carbon at the border, recently proposed by the EU. But more widespread efforts could prove a major challenge, given Canada’s middling performance on emissions and how exposed its industry is to global trade.

The Context

Governments must reconcile bold Net Zero ambitions with the need to stay competitive. Increasingly, many are eyeing border carbon adjustments—pricing the carbon associated with imported goods—to level the playing field between their domestic emitters and those in places with laxer emissions rules. The goals: encouraging other countries to put their own price on carbon; and limiting companies’ incentive to move production out of carbon-pricing countries (known as carbon leakage). Insulating domestic industry from carbon competition lets countries increase the price on industrial emissions, which has thus far remained far below consumer prices in most jurisdictions and hindered progress to Net Zero.

The EU was first out of the gate. Under a plan unveiled last month, first levies would occur in 2026 and would initially target five emissions-heavy sectors: iron and steel, aluminum, cement, fertilizers, and electricity. The plan, which remains subject to EU member-country approval, must first resolve how to treat myriad carbon regulations globally in order to withstand trade challenges.

Other jurisdictions are eyeing similar moves. G7 leaders agreed in June to tackle carbon leakage via trade measures. In the U.S., Democratic lawmakers have proposed including a tax on the imports of heavy emitters in an upcoming budget resolution, although ultimate political support is unclear. In Canada, Budget 2021 announced a consultation process on border carbon adjustments beginning this summer.

Proposals to price carbon at the border come as the U.S., China and some other countries are looking to green their supply chains and strengthen their relative positions in advanced technologies. In this context, there are concerns that border carbon adjustments could be wielded as protectionist weapons.

Our Analysis

Canada’s relatively small share of industrial exports to the EU (about 5% of total industrial product exports) suggests it won’t face a big challenge from the EU’s proposed policy. Energy extraction and mining—two key Canadian industries—aren’t even initially targeted in the EU’s current plan.

But the threat of more widespread border carbon adjustments—especially from the U.S.—could have a significant direct macro impact on Canada’s highly trade-exposed industrial sector. More than half of the economic value created by eight major Canadian industries is exported.

And while Canadian industry is relatively less carbon intensive on average versus the U.S. and many other competitor economies, there is variation among subsectors. Notably, removing the impact of the largely coal-powered U.S. electricity sector leaves remaining U.S. industry better performing on emissions intensity than Canada. Canada provides a significant share of G7 industrial product demand in just a couple of places: energy and mined products. Energy, which comprises half our U.S. industrial exports, is relatively emissions intensive. In mined products, Canada’s emissions intensity is more favourable.

Canada’s carbon pricing framework covers a significant share of industrial emissions, similar to Europe and notably more than the U.S., meaning Canadian industry shouldn’t be overly disadvantaged by new trade rules, in theory.

Emissions intensity ranking (out of above 12 countries)
Average: 5 | Energy: 8 | Mining: 6

However, there remains uncertainty about how countries that do adopt border carbon adjustments would account for foreign carbon regimes and how they will deal with the complexities of cross-border supply chains. That leaves the possibility of countries using border carbon adjustment mechanisms to further domestic interests and to punish (reward) global rivals (allies). And in the longer term, if carbon border taxes ultimately allow other countries to ratchet up carbon pricing more significantly than in Canada, Canada’s emissions-intensive sectors could be disproportionately impacted.

Looking beyond the macro impact, individual firms or products could fare quite differently. For example, Canada’s clean electricity could be a clear winner, while the gas sector is likely more carbon-competitive than bitumen. Canadian mined products may be more emissions intensive than in the U.S., but emissions are better than other U.S. import-competitors, potentially limiting market share losses. Policy design matters too: aluminum is electricity intensive to produce, so Canada’s clean grid makes its lifecycle emissions lower, but only if purchased electricity is captured by border carbon pricing policy. Competitiveness will also depend on how effectively domestic firms are able to invest to reduce their relative carbon intensity.

The Road Ahead

Given the risk that some countries could use border carbon adjustments to disadvantage Canadian industry and amplify trade tensions, the federal government should push for G7 cooperation. It could also leverage the current U.S. administration’s desire to work with allies on key trade issues to proactively co-develop a North American border carbon adjustment mechanism.

As a country that already puts a price on domestic carbon, it’s in Canada’s interest to ensure domestic industry has a level playing field. A border carbon adjustment could do just that, while promoting broader progress towards Net Zero through greater pricing of domestic industrial emissions. Whereas a higher carbon price may challenge domestic industry in the short term, the investment and innovation it requires supports long-term industrial competitiveness in the green economy.

 

About the Authors

Cynthia Leach helps shape the narratives and research agenda around the RBC Economics and Thought Leadership team’s forward-looking economic and policy analysis. She joined the team in 2020. Previously, Cynthia was an executive at Finance Canada, with experience in housing finance policy, current economic analysis and fiscal policy.

Colin Guldimann is an economist at RBC. He works primarily on issues related to the public sector, energy, and climate change. Prior to joining RBC, Colin worked on housing policy and macroeconomic research at the Department of Finance in Ottawa.

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