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The trade and climate change debate – considering the US Clean Energy Bill

07 July 2009

There has been significant domestic attention focused on the Select Committee reviewing New Zealand’s Emissions Trading Scheme, which is yet to report back to Parliament after hearing submissions in May 2009.  At the same time, international attention has been focussed on the multilateral discussions (in August 2009 in Bonn and December 2009 in Copenhagen) on a potential successor agreement to the Kyoto Protocol to the UN Framework Convention on Climate Change, setting targets through to 2020.   

While it remains far from clear what these processes will deliver, other countries’ domestic developments have been continuing apace.  The most important new development is the emissions trading legislation passed at the end of June by the US House of Representatives, which President Obama has called an “extraordinary step” and urged the Senate also to approve.  Should it become US law, it will be relevant for New Zealand’s own policy on both climate change (part of our Select Committee’s terms of reference require it to consider the position of the US, at least with respect to timing and implementation issues) and also on trade issues. 

The US legislation, the American Clean Energy and Security Act of 2009 (H.R. 2454, the Clean Energy Bill), was carried by the House on 26 June 2009 by 219 votes to 212.  It introduces an emissions trading (or ‘cap and trade’) scheme.  Despite the clear Democrat majority in the Senate, the controversial nature of the Bill means that its passage in the Senate is far from assured.  From the international trade perspective, a critical provision is section 768, which requires the making of regulations, to apply from 2020:

(A) establishing an international reserve allowance program for the sale, exchange, purchase, transfer, and banking of international reserve allowances for covered goods with respect to the eligible industrial sector;
(B) ensuring that the price for purchasing the international reserve allowances from the United States on a particular day is equivalent to the auction clearing price for emission allowances under section 722 for the most recent emission allowance auction;
(C) establishing a general methodology for calculating the quantity of international reserve allowances that a United States importer of any covered good must submit;
(D) requiring the submission of appropriate amounts of such allowances for covered goods [essentially defined as industrial or manufactured goods] with respect to the eligible industrial sector that enter the customs territory of the United States;

The effect of this appears to be that the US would be able to impose tariffs (through requirements to purchase international emissions allowances) on industrial or manufactured imports from countries and/or importers which do not make the same level of climate change emissions reductions as does the US.  (It should be noted that least developed, and very low emitting, countries are exempted.)  Should this requirement become US law, it would set up a potential confrontation between international trade and climate change regulation.  This has not gone unnoticed.  China has strongly objected that this form of provision would facilitate protectionism and “serves nobody’s interest”.  The editors of the Financial Times opine that the Bill is “careless and creates a gateway for protectionism”.  The editors of the Washington Post suggest it should be deleted and President Obama would appear to agree

Against this controversial backdrop, it is interesting to review the analysis and recommendations of the joint WTO Secretariat and UN Environment Program Report on Trade and Climate Change, released – serendipitously – on same day as the House passed the Clean Energy Bill.  The Report cautiously endorses emissions trading schemes under WTO rules (see pp 103-110). 

It first notes that emissions trading schemes may, but need not necessarily: (a) infringe the non-discrimination principles in the GATT by constituting illegal customs duties rather than permissible border control adjustments imposing a measure equivalent to a national tax (pursuant to Article II.2(a) and Article III); and (b) constitute illegal subsidies under the SCM Agreement, for instance if allowances meeting the WTO definition of a prohibited or actionable subsidy are allocated free of charge.

There are certainly arguments to be made that an emissions trading scheme need be neither discriminatory nor involve illegal subsidies, but such arguments are not straightforward and will depend upon the design of each individual scheme.  As a senior WTO expert testifying before the House Committee on Ways and Means has noted “the devil will be in the details”.  The critical debate is more likely to focus on the secondary question of whether measures required by an emissions trading scheme, should they infringe primary WTO rules, can be justified under Article XX, the general exception provision of the GATT.  On this topic, the Report offers the following general analysis:

The general approach under WTO rules has been to acknowledge that some degree of trade restriction may be necessary to achieve certain policy objectives, as long as a number of carefully crafted conditions are respected. WTO case law has confirmed that WTO rules do not trump environmental requirements. If, for instance, a border measure related to climate change was found to be inconsistent with one of the core provisions of the GATT, justification might nonetheless be sought under the general exceptions to the GATT (i.e. Article XX), provided that two key conditions are met.
First, the measure must fall under at least one of the GATT exceptions, and a connection must be established between the stated goal of the climate change policy and the border measure at issue. It should be noted in this regard that WTO members’ autonomy to determine their own environmental objectives has been reaffirmed by the WTO’s Dispute Settlement Body on a number of occasions (for example, in the US – Gasoline and the Brazil - Retreaded Tyres cases). Although no policies aimed at climate change mitigation have been discussed in the dispute settlement system of the WTO, it has been argued that policies aimed at reducing CO2 emissions could fall under the GATT exceptions, as they are intended to protect human beings from the negative consequences of climate change; and to conserve not only the planet’s climate, but also certain plant and animal species that may disappear as a result of global warming.
Second, the manner in which the measure in question will be applied is important: in particular, the measure must not constitute a “means of arbitrary or unjustifiable discrimination” or a “disguised restriction on international trade”. GATT case law has shown that the implementation of a measure in a way that does not amount to arbitrary or unjustifiable discrimination or to a disguised restriction on international trade has often been the most challenging aspect of the use of GATT exceptions.  

This conclusion is accurate, as far as it goes.  WTO Appellate Body case law permits members to determine their own domestic policy objectives as to matters falling within the list provided in GATT Article XX, which relevantly includes measures “necessary to protect human, animal or plant life or health” (Article XX(b)) and “relating to the conservation of exhaustible natural resources if such measures are made in conjunction with restrictions on domestic production and consumption” (Article XX(g)).  Domestically applicable emissions trading schemes would appear to relate to, at least, the latter provision.  The Appellate Body accords a margin of appreciation to the measures taken to achieve those objectives, with a sliding scale of deference reflecting the relative importance of the interest or values at stake.  This is the case even where, as for Article XX(b), the measure must be “necessary”.  Thus, in the EC-Abestos case (concerning an EU ban on Canadian construction materials containing asbestos), the Appellate Body confirmed that the more vital or important the common interests or values pursued, the easier it would be to accept as “necessary” measures designed to achieve those ends.   Especially relevantly, in the famous US-Shrimp/Turtle cases, the Appellate Body approved the US’s unilateral measures to equalise the rules for foreign imports with its domestic rules (in this case requiring mechanisms to make shrimp harvesting safe for sea turtles).  Carbon equalisation measures would similarly appear to be theoretically permissible. 

It must be said, however, that the case law remains relatively thin, is not totally consistent, and the key difficulty is the second point noted in the Report cited above – that the measure must be applied in a non-discriminatory manner and not constitute a disguised restriction on international trade.  It is unlikely that section 768 (or indeed, the entire Clean Energy Bill), will survive Senate review unscathed, or perhaps at all.  Regardless, the issue of how trade and climate change issues interlock is becoming ever more pertinent. It is also an issue which New Zealand policy-makers will need to address sooner rather than later. 

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