ZEW study questions effectiveness of intensity-based carbon border adjustments

Border carbon adjustments (BCAs) are intended to reduce emissions while protecting domestic industries from competitive disadvantages. However, a new ZEW study using the global steel industry as a case study finds that the design of such mechanisms is crucial. According to the researchers, benchmark-based approaches tied to emissions intensity significantly dilute carbon-price signals. Compared with quantity-based systems, they transmit only around 36% of the CO₂ price required to achieve the same global emissions reductions and lead to greater welfare losses.

Steel industry as a key test case

The study focuses on the steel sector because of its high emissions intensity, global trade exposure and wide range of production technologies.

While integrated blast furnace routes remain highly carbon-intensive, electric arc furnace (EAF) production based on scrap and renewable electricity offers substantially lower emissions. According to the researchers, these differences make steel an ideal sector for evaluating how various border carbon adjustment mechanisms influence investment decisions, trade flows and emissions reductions.

Intensity-based systems weaken carbon-price signals

According to ZEW, benchmark-based border adjustment mechanisms transmit only around 36% of the carbon-price signal required to achieve the same emissions reductions as a quantity-based approach.

The study argues that such systems effectively combine carbon pricing with an implicit production subsidy, reducing incentives for producers to cut emissions.

“Our findings show that the choice of a BCA design is not a technical detail but has fundamental implications for climate action and competitiveness,” said Eunseong Park, researcher in ZEW’s Environmental and Climate Economics Unit.

The analysis suggests that weaker carbon-price signals result in higher trade volumes and lower incentives for structural emissions reductions, while increasing the risk of production shifts to regions with less stringent climate policies.

Carbon leakage risks increase

One of the study’s key findings concerns carbon leakage – the relocation of emissions-intensive production outside regions with carbon pricing.

In a scenario comparable to the European policy environment, the researchers estimate that carbon leakage rises from 16% under a quantity-based system to 36% under an intensity-based approach.

Professor Sebastian Rausch, head of ZEW’s Environmental and Climate Economics Unit, said: “Without a clear domestic CO₂ price incentive such instruments fail to achieve their objective and, above all, shift economic benefits towards domestic industries rather than reducing emissions.”

Supply chains play a crucial role

The study also highlights challenges along global steel supply chains.

If carbon costs are not fully reflected in intermediate products such as pig iron, imports of these products can increase significantly. In the model used by the researchers, pig iron imports into the EU doubled under a benchmark-based system, while prices remained artificially low.

According to the study, this creates incentives to relocate emissions-intensive production stages abroad rather than reducing overall emissions, potentially undermining the environmental objectives of border carbon policies.

Implications for CBAM and future policy

The findings are particularly relevant as policymakers continue to refine carbon border adjustment mechanisms, including the EU’s Carbon Border Adjustment Mechanism (CBAM).

The researchers argue that future border carbon systems should maintain strong and transparent carbon-price signals while avoiding distortions that encourage production relocation or weaken incentives for decarbonisation investments.

The study combines a theoretical equilibrium model with an empirically calibrated analysis of approximately 350 steel plants worldwide, incorporating production technologies, trade flows, supply chains and emissions data to assess the impact of different border carbon adjustment designs.

Source: ZEW, Photo: Fotolia