“Unilateral Trade-related Climate Change Measures,” The Journal of World Investment and Trade,...

The Journal of World Investment & Trade 13 (2012) 875–927

© Koninklijke Brill NV, Leiden, 2012 DOI 10.1163/22119000-01306001

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The Journal of

World Investment & Trade

Law Economics Politics

Unilateral Trade-related Climate Change Measures

Rafael Leal-Arcas*Senior Lecturer in Law, Queen Mary University of London

(Centre for Commercial Law Studies), UK Marie Curie Senior Research Fellow,

World Trade Institute, University of [email protected]

AbstractClimate change mitigation has become one of the most relevant topics today, and it will con-tinue for years to come. It is a concern that has implications in economics, law, science, human rights, technology, international relations and ethics, to name but a few fields of knowledge. Climate change is a global problem that knows no geographical barriers. International law is not well equipped to face the challenges of climate change. Global climate is an indivisible public good. International law currently faces the challenge of fragmentation and the need to bring greater coherence to a fragmented system in combating climate change. The aim of this article is to explain the trade implications of climate change mitigation policies by analyzing a couple of areas where the international regimes for trade and climate change mitigation/energy may potentially clash: 1) border carbon adjustments and 2) applying subsidies and simi-lar measures in order to encourage environmentally-friendly technologies. After the introduc-tion, Section 2 provides an analysis on the link between the legal regimes of international trade and climate change. Section 3 compares both regimes and Section 4 offers an overview of uni-lateral trade-related climate change measures. Section 5 examines the main WTO provisions on subsidies and analyzes the WTO cases on subsidies for renewable energy. Section 6 focuses on the inclusion of aviation in the EU Emission Trading Scheme (EU ETS) and the potential expan-sion of the EU ETS to the shipping industry. Section 7 concludes the article.

KeywordsEU emissions trading scheme; trade and climate change; WTO subsidies for renewable energy; trade and energy; energy and climate change; aviation; shipping

1. Introduction

Climate change mitigation has become one of the most relevant topics today, and it will continue for years to come. It is a concern that has implications in

*) The author holds a Ph.D. (European University Institute, Florence), JSM (Stanford Law School), LL.M. (Columbia Law School), and M.Phil. (London School of Economics and Political Science). He’s a member of the Madrid Bar and author of the books Climate Change and International Trade (Edward Elgar Publishing, 2013); International Trade and Investment Law: Multilateral, Regional and Bilateral Governance (Edward Elgar Publishing, 2010); and Theory

876 R. Leal-Arcas / The Journal of World Investment & Trade 13 (2012) 875–927

economics, law, science, human rights, technology, international relations, and ethics, to name but a few fields of knowledge. Climate change is a global problem that knows no geographical barriers. International law is not well equipped to face the challenges of climate change. Global climate is an indivis-ible public good. International law currently faces the challenge of fragmenta-tion and the need to bring greater coherence to a fragmented system in combating climate change.1 One would need to look at various regimes (the World Trade Organization (WTO), the European Union (EU), civil society, the North American Free Trade Agreement) for resolving environmental disputes and for helping with more coherent global environmental governance. It is essential that the international community act quickly and firmly if we wish to avoid irreversible damage with catastrophic consequences.

The aim of this article is to explain the trade implications of climate change mitigation policies by analyzing a couple of areas where the international regimes for trade and climate change mitigation/energy may potentially clash: 1) border carbon adjustments (BCAs)2 and 2) applying subsidies and similar measures in order to encourage environmentally-friendly technologies, as was the case in the China—Wind Power case,3 which will be discussed later.4 After the introduction, Section 2 provides an analysis on the link between the legal regimes of international trade and climate change. Section 3 compares both regimes and Section 4 offers an overview of unilateral trade-related climate change measures. Section 5 examines the main WTO provisions on subsidies and analyzes the WTO cases on subsidies for renewable energy. Section 6

and Practice of EC External Trade Law and Policy (Cameron May, 2008). I am very grateful to Andrew Filis-Yelaghotis for his research assistance.1) On the fragmentation of international law, see the work of the International Law Commission, 58th session, Final Report of the study group on fragmentation, UN Doc. A/CN.4/L.682, and the conclusions of the study group on fragmentation, UN Doc. A/CN.4/L.702, available at http://untreaty.un.org/ilc/guide/1_9.htm. On the specific case of international trade law, see also Leal-Arcas, R. “The Fragmentation of International Trade Law: Is Now the Time for Variable Geometry?” The Journal of World Investment and Trade, Vol. 12, No. 2, 2011, pp. 145-195.2) Cosbey, A. “Border Carbon Adjustment”, International Institute for Sustainable Development, 2008; Persson, S. “Practical Aspects of Border Carbon Adjustment Measures: Using a Trade Facilitation Perspective to Assess Trade Costs”, International Center for Trade and Sustainable Development, Issue Paper 13, November 2010.3) WT/DS419.4) See generally Firger, D. and Gerrard, M. “Climate Change and the WTO: Expected Battleground, Surprising Battles,” Daily Environment Report-BNA, Vol. 2011, No. 133, 12 July 2011; Henschke, L. “Going it alone on climate change. A new challenge to WTO subsidies disciplines: Are subsidies in support of emissions reductions schemes permissible under the WTO,” World Trade Review, 11:1, 27-52, 2012; World Trade Organization, Trade and Climate Change: A Report by the United Nations Environment Program and the World Trade Organization, Geneva: WTO, 2009, pp. 88-129; Charnovitz, S. “Trade and Climate: Potential Conflicts and Synergies” in Aldy, J. et al., Beyond Kyoto: Advancing the International Effort against Climate Change, Pew Center on Global Climate Change, 2003, at 141; Zeller, T. and Bradsher, K. “China’s Push into Wind Worries U.S. Industry,” The New York Times, 15 December 2010.

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focuses on the inclusion of aviation in the EU Emission Trading Scheme (EU ETS) and the potential expansion of the EU ETS to the shipping industry. Section 7 concludes the article.

2. Linking the Legal Regimes of Trade and Climate Change

The connection between the global economy and the environment is undeni-able and very complex.5 Climate and energy challenges increasingly intersect with global economic integration.6 Every business decision carries an environ-mental consequence, and the collective impact of those decisions affects the climate of the entire planet. In international law, environmental law depends upon the fundamentals of public international law, the concept of sovereignty and territoriality of nation-States, as well as the law of international organiza-tions.7 Beyond trade regulation, environmental law closely relates to the law of investment protection, energy law, the law of the sea, and space law.8

Environmental law cannot be separated from social and economic develop-ment under the principle of sustainable development,9 to which the Preamble of the WTO Agreement refers.10 Environmental law, more than any other field, cannot be read in clinical isolation.11 Whether at the national, regional, or international level, it is a paradigm of cross-cutting regulation, influencing

5) See for instance the work of Chambers, B. (ed.) Inter-linkages: The Kyoto Protocol and the International Trade and Investment Regimes, New York: United Nations University Press, 2001. 6) Bacchus, J. “Questions in Search of Answers: Trade, Climate Change, and the Rule of Law,” Keynote Address to the conference on “Climate Change, Trade and Competitiveness: Issues for the WTO,” Geneva, June 2010, available at http://www.gtlaw.com/portalresource/bacchus1. 7) See generally Bodansky, D., Brunnée, J. and Hey, E. (eds.) The Oxford Handbook of International Environmental Law, Oxford University Press, 2007. 8) Cottier, T. and Elsig, M. “Can the Trade Regime Offer Lessons for Reforming the Architecture of the Environmental Regime?” p. 14, preliminary draft, June 2011, available at http://www .environmentalgovernance.org/wp-content/uploads/2011/06/9b.-CottierElsig_A-Discussion -Note_June2011.pdf. Regarding the link between climate change and investment law, see Marshall, F. et al. “Climate Change and International Investment Agreements: Obstacles or Opportunities?,” IISD, 2010, available at http://www.iisd.org/pdf/2009/bali_2_copenhagen _iias.pdf. 9) The UNISDR defines sustainable development as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” See 2009 UNISDR Terminology on Disaster Risk Reduction, Geneva: United Nations International Strategy for Disaster Reduction, p. 29, 2009; Voigt, C. Sustainable Development as a Principle of International Law, Martinus Nijhoff, 2009.10) DiMatteo, L. et al. “The Doha Declaration and Beyond: Giving a Voice to Non-Trade Concerns within the WTO Trade Regime,” Vanderbilt Journal of Transnational Law, Vol. 36, pp. 95-160, 2003.11) Cottier, T. and Elsig, M. “Can the Trade Regime Offer Lessons for Reforming the Architecture of the Environmental Regime?” p. 14, preliminary draft, June 2011, available at http://www .environmentalgovernance.org/wp-content/uploads/2011/06/9b.-CottierElsig_A-Discussion -Note_June2011.pdf.


other fields, and being influenced by other fields of law.12 As argued by Thomas Cottier and Manfred Elsig, its cross-cutting nature also explains why environ-mental law is inherently fragmented and has not so far been placed under the roof and umbrella of a single international organization.13

The interface of trade and climate change14 is increasingly becoming more relevant even if it is not expressly mentioned in the General Agreement on Tariffs and Trade (GATT) or the WTO Agreement.15 Understandably, it would not be reflected in the GATT 1947, as the scientific community had not yet real-ized what was to come in the climate field caused partly by international trade; however, by the time the WTO Agreement was drafted in 1994, there was already much empirical evidence regarding the link between trade and cli-mate change, and yet this link was not addressed. Although there is distrust on both sides, recent scholarly literature tries to bring together these two different but related epistemic communities, i.e., trade and climate change.16 Given that

12) French, R. “The Changing Nature of ‘Environmental Protection’: Recent Developments Regarding Trade and the Environment in the European Union and the World Trade Organization,” 47 Netherlands International Law Review, pp. 1-26, 2000.13) Cottier, T. and Elsig, M. “Can the Trade Regime Offer Lessons for Reforming the Architecture of the Environmental Regime?” p. 14, preliminary draft, June 2011, available at http://www .environmentalgovernance.org/wp-content/uploads/2011/06/9b.-CottierElsig_A-Discussion -Note_June2011.pdf. See also Birnie, P. and Boyle, A. International Law and the Environment, Oxford: Clarendon Press, 1992.14) The ‘trade-and’ expression has been borrowed from Joel Trachtman in Trachtman, J. “Trade and…Problems, Cost-Benefit Analysis and Subsidiarity,” 9(1) European Journal of International Law 32 (1998).15) Barrett, S. ‘Climate Change and International Trade: Lessons on their Linkage from International Environmental Agreements”. Background paper written for the TAIT second con-ference “Climate Change, Trade and Competitiveness: Issues for the WTO’ (Geneva, 16-18 June 2010) available at http://graduateinstitute.ch/ctei/home/events/TAIT_Climate_Conference/TAIT_Papers.html). Condon, B. ‘Climate Change and Unresolved Issues in WTO Law’ J.I.E.L. 12(4), 895-926 (2009); Green, A. ‘Climate Change, Regulatory Policy and the WTO’ J.I.E.L. 8(1), 143-189 (2005); Droge, S., Trabold, H., Biermann, F., Bohm, F. and Brohm, R. ‘National Climate Change Policies and WTO Law: A Case Study of Germany's New Policies’ World T.R. 3(2), 161-187 (2004).16) See for instance UNEP, “Climate and Trade Policies in a Post-2012 World,” 2009; World Economic Forum, “From Collision to Vision: Climate Change and World Trade,” 2010; Pauwelyn, J. (ed.) Global Challenges at the Intersection of Trade, Energy and the Environment, Geneva: Centre for Trade and Economic Integration, 2010; Hufbauer, G., Charnovitz, S. & Kim, J. Global Warming and the World Trading System, Washington, DC: Peterson Institute for International Economics, 2009; Charnovitz, S. “Trade and Climate: Potential Conflicts and Synergies,” in Aldy, J. et al., “Beyond Kyoto: Advancing the international effort against climate change,” Pew Center on Global Climate Change, 2003; Pauwelyn, J. “Testimony before the Subcommittee on Trade of the House Committee on Ways and Means,” 24 March 2009, availa-ble at http://waysandmeans.house.gov/media/pdf/111/pauw.pdf; World Trade Organization, Trade and Climate Change: A Report by the United Nations Environment Program and the World Trade Organization, Geneva: WTO, 2009; Mattoo, A., Subramanian, A., van der Mensbrugghe, D. & He, J. “Reconciling Climate Change and Trade Policy,” Working Paper Series, WP 09-15, Peterson Institute for International Economics, December 2009; Cottier, T., Nartova, O., &


much of the world’s energy needs are likely to largely depend on fossil fuel based sources for the near to mid future, an increase in economic activity and energy consumption in the future, together with an increase in world popula-tion, will lead to higher levels of greenhouse gas (GHG) emissions. This means that there is an inevitable link between international trade and a future global climate change agreement,17 which could lead to a potential conflict between the objectives of the Kyoto Protocol and the WTO rules.18 Moreover, climate change is one of the most relevant international issues facing the world today. The relationship between trade agreements and measures to mitigate the effects of climate change remains a polemic part of the debate.19 It is therefore relevant to explore key legal and economic issues arising from the climate change debate, including the relationship between the WTO Agreement and multilateral environmental agreements (MEAs) that address climate change.20

Free trade can be conceived as pro-environment. It generates resources that can be devoted to environmental protection;21 it increases the efficiency of

Bigdeli, S. (eds.) International Trade Regulation and the Mitigation of Climate Change, Cambridge: Cambridge University Press, 2009; Perez, O. Ecological Sensitivity and Global Legal Pluralism: Rethinking the Trade and Environment Conflict, Hart, 2004; Francioni, F. (ed.) Envi-ronment, Human Rights & International Trade, Hart, 2001; Brack, D., Grubb, M. and Windram, C. International Trade and Climate Change Policies, Earthscan, 2000; Audley, J. Green Politics and Global Trade: NAFTA and the Future of Environmental Politics, Georgetown University Press, 1997; Esty, D. Greening the GATT: Trade, Environment, and the Future, Institute for International Economics, 1994; Sampson, G. & Chambers, W. (eds.) Trade, Environment, and the Millennium, United Nations Press, 2000; Sampson, G. Trade, Environment, and the WTO: The Post-Seattle Agenda, Overseas Development Council, 2000; Epps, T. and Green, A. Reconciling Trade and Climate - How the WTO Can Help Address Climate Change, Cheltenham: Edward Elgar Publishing, 2010; Rao, P.K. International Trade Policies and Climate Change Governance, Springer, 2012.17) Cinnamon Carlarne argues that the WTO should adopt an interpretative clause that pro-vides clear principles for defining the relationship between the WTO and multilateral environ-mental agreements. See Carlarne, C. “The Kyoto Protocol and the WTO: Reconciling Tensions Between Free Trade and Environmental Objectives,” Colorado Journal of International Environmental Law and Policy, Vol. 17, Issue 1, pp. 45-88, 2006. See also Charnovitz, S. “A New WTO Paradigm for Trade and the Environment,” Singapore Year Book of International Law, Vol. 11, pp. 15-40, 2007; Gentile, D. “International Trade and the Environment: What is the Role of the WTO?” Fordham Environmental Law Review, Vol. 20, pp. 197-232, 2009; McNamee, D. “Climate Change, the Kyoto Protocol, and the World Trade Organization: Challenges and Conflicts,” Sustainable Development Law and Policy, Vol. 6, Winter 2006, pp. 41-44.18) See Green, A. “Climate Change, Regulatory Policy and the WTO: How Constraining are Trade Rules?,” Journal of International Economic Law, Vol. 8, Issue 1, pp. 143-189, 2005.19) See for instance Messerlin, P. “Climate and Trade Policies: From Mutual Destruction to Mutual Support,” World Trade Review, Vol. 11, Issue 1, pp. 53-80, 2012.20) John Jackson has studied the link between world trade rules and environmental policies in Jackson, J. “World Trade Rules and Environmental Policies: Congruence or Conflict?” in Bhagwati, J. and Hirsch, M. (eds.) The Uruguay Round and Beyond: Essays in Honor of Arthur Dunkel, University of Michigan Press, 1999, pp. 414-448.21) See generally Lee, M. and Holder, J. Environmental Protection Law and Policy: Text and Materials, Cambridge University Press, 2007.


resource use; by correcting market failures, free trade increases welfare both nationally and globally; free trade encourages the development of climate-friendly technologies and their dissemination; it fosters the multilateral coop-eration needed to address transboundary environmental problems;22 and as per capita income increases, the environment worsens, although up to a point, as illustrated in the environmental Kuznets curve (Figure 1).23 The environ-mental Kuznets curve shows an n-shaped (or an inverted U-shaped) relation-ship between per capita income (GDP) and the quality of the environment. Environmental degradation24 worsens as per capita GDP increases until we reach a turning point, after which the situation gets better. In the view of Steven Horwitz, measures of the quality of the environment do indeed fall in the initial stages of economic growth, but this trend turns around at about US$5,000 per capita GDP, with many measures of environmental damage showing improvement from US$8,000 onwards.25

Moreover, as indicated by Arik Levinson, “pollution often appears first to worsen and later to improve as countries’ incomes grow. Because of its resem-blance to the pattern of inequality and income described by Simon Kuznets, this pattern of pollution and income has been labelled an ‘environmental Kuznets curve’.”26 Levinson goes on to argue that “peak pollution levels occur at different income levels for different pollutants, countries and time periods. This link between income and pollution […] is consistent with either efficient or inefficient growth paths. The evidence does, however, refute the claim that environmental degradation is an inevitable consequence of economic growth.”27 One wonders whether economic growth leads countries to promote a cleaner environment.

In China—Raw Materials,28 the panel report referred to the environmental Kuznets curve, stating:

22) Timbur, M. “International Trade Development – Risks for the Environment?” Economy Transdisciplinarity Cognition, Vol. XIII, Issue 2/2010, pp. 6-22.23) Franklin, R. and Ruth, M. “Growing Up and Cleaning Up: The Environmental Kuznets Curve Redux,” Applied Geography, Vol. 32, Issue 1, pp. 29-39, 2010; Shafik, N. “Economic Development and Environmental Quality: An Economic Analysis,” Oxford Economic Papers 46, pp. 757-773, 1994.24) Environmental degradation can be defined as the reduction of the capacity of the environ-ment to meet social and ecological objectives and needs. See 2009 UNISDR Terminology on Disaster Risk Reduction, Geneva: United Nations International Strategy for Disaster Reduction, p. 14, 2009.25) Horwitz, S. “Free Trade and the Climb Out of Poverty,” The Freeman: Ideas on Liberty, pp. 8-11, at 10, March 2005.26) See Levinson, A. “Environmental Kuznets Curve,” in Durlauf, S. and Blume, L. (eds.) The New Palgrave Dictionary of Economics, 2nd ed., 2008.27) Ibid.28) WT/DS394/R, WT/DS395/R, WT/DS398/R, 5 July 2011.


‘We now turn to analyse the second step in China’s argument about the long-term benefits of export restrictions on EPR products, namely that there is a strong link between higher growth and environmental benefits. China argues that “[e]conomic growth, if supported by the adequate regulatory framework, can then be translated into long-term environ-mental protection”. China argues that this relationship is supported by the empirical evi-dence of the so-called “Environmental Kuznets Curve” (EKC). This is an empirical correlation between income per capita and environmental degradation whereby, while at relatively low levels of income pollution increases with income, beyond a certain income level, pollution declines. Reasons for this relationship are hypothesized to include income-driven changes in: (i) the composition of production and/or consumption that moves away from natural resources goods; (ii) the preference for environmental quality; (iii) the development of institutions introducing the proper regulatory measures to address envi-ronmental problems; and/or (iv) the arising economies of scale associated with pollution abatement technologies.’29

‘Parties agree that in general the EKC does not imply a causal relationship from eco-nomic growth to environmental quality. A higher level of wealth can strengthen public demand for a cleaner environment, but unless the government responds with policies that enhance environmental protection, the improvements are unlikely to come. China argues that, even if this is not done automatically, higher levels of income make the link between economic development and environmental protection more likely, and China contends that it has provided evidence of an EKC in China for some of the pollutants at issue in this dispute.’30

‘For the Panel, even if growth makes environmental protection statistically more likely, this does not prove that export restrictions are necessary for environmental gains. For example, to the extent that a higher income per capita generates citizens' preferences for a better quality of environment, income redistribution policies may serve the environ-mental objective just as well as it is claimed that export restrictions do.’31

On the other hand, free trade can also be perceived as anti-environment. For example, there are transport externalities resulting from trade; lowering envi-ronmental standards gives countries a competitive advantage in trade; reduced biodiversity may lead to greater ecological risk; trade allows countries to exceed their domestic regenerative and absorptive limits by importing those capacities from other countries; trade-induced growth may cause environ-mental harm from the unsustainable consumption of natural resources and waste production;32 trade agreements may override environmental regula-tions;33 and trade restrictions should be available as leverage to promote worldwide environmental protection.34

29) Ibid., para. 7.551. (original footnotes omitted).30) Ibid., para. 7.552. (original footnotes omitted).31) Ibid., para. 7.553. (original footnotes omitted).32) Timbur, M. “International Trade Development – Risks for the Environment?” Economy Transdisciplinarity Cognition, Vol. XIII, Issue 2/2010, pp. 6-22; See also Merino Blanco, E. and Razzaque, E. Globalisation and Natural Resources Law: Challenges, Key Issues and Perspectives, Cheltenham: Edward Elgar, 2011.33) McEldowney, J. & McEldowney, S. Environmental Law and Regulation, Oxford University Press, 2002.34) Timbur, M. “International Trade Development – Risks for the Environment?” Economy Transdisciplinarity Cognition, Vol. XIII, Issue 2/2010, pp. 6-22.


Passionate advocates of both free trade and the environment such as James Bacchus argue that “the world needs to lower barriers, and the world also needs to address climate change. We’re just waking to the realization that climate change is a trade issue.”35 Many environmentalists tend to associate liberalized trade with unchecked, environmentally destructive economic growth,36 and many proponents of free trade tend to dismiss environmental-ists’ concerns as irrational and/or a disguised form of protection.37

Today there are serious concerns resulting from the intersection of climate change mitigation policies with trade and competitiveness, including carbon leakage,38 carbon markets, carbon trading,39 climate investment funds,40 and incentives for climate change mitigation. Mathew Cole has found that open trade reduces GHG emissions and energy use in rich countries, while the reverse is true in developing countries.41 As the relationship between cli-mate change and trade becomes clearer, negotiators and advocates working in

35) See interview with James Bacchus, “How Trade Policy Can Save the Planet,” by Steven Andersen, Counsel to Counsel, Fall 2010, pp. 16-17, at 16.36) “No one denies that development is essential for poorer nations. But in the advanced econ-omies, there is mounting evidence that ever-increasing consumption adds little to human hap-piness and may even impede it. More urgently, it is now clear that the ecosystems that sustain our economies are collapsing under the impacts of rising consumption. Unless we can radically lower the environmental impact of economic activity–and there is no evidence to suggest that we can–we will have to devise a path to prosperity that does not rely on continued growth.” Tim Jackson makes a compelling case against continued economic growth in developed nations. Is more economic growth the solution? Will it deliver prosperity and well-being for a global popu-lation projected to reach nine billion by 2050? See Jackson, T. Prosperity without Growth: Economics for a Finite Planet, Earthscan, 2009.37) French, D. “The Changing Nature of ‘Environmental Protection’: Recent Developments Regarding Trade and the Environment in the European Union and the World Trade Organization,” XLVII Netherlands International Law Review (2000), pp. 1-26.38) See for example Fischer, C. “Climate Policy and Emissions Leakage: Comparing the Options,” ENTWINED Issue Brief, 2009/15/09; Parker, L. and Blodgett, J. “’Carbon Leakage’ and Trade: Issues and Approaches,” Congressional Research Service, 19 December 2008; Kuik, O. Climate Change Policies, International Trade and Carbon Leakage, Lambert Academic Publishing, 2010.39) See for instance Howse, R. & Eliason, A. “Carbon Trading and the CDM in WTO Law,” in Stewart, R., Kingsbury, B. and Rudyk, B. (eds.), Climate Finance: Regulatory and Funding Strategies for Climate Change and Global Development, NYU Press, 2009, pp. 254-258; Freestone, D. and Streck, C. (eds.), Legal Aspects of Carbon Trading: Kyoto, Copenhagen, and Beyond, Oxford: Oxford University Press, 2009.40) See for instance Boute, A. “Combating Climate Change through Investment Arbitration,” Fordham International Law Journal, Vol. 35, 2012 (arguing that investment arbitration, which has often been accused of posing a threat to climate change mitigation efforts, could in fact reinforce climate policies).41) Cole, M. “Development, trade, and the environment: How robust is the environmental Kuznets curve?” Environment and Development Economics, Vol. 8, Issue 4, pp. 557-580, 2003; Cole, M. “Does trade liberalization increase national energy use?” Econ. Lett. 92, pp. 108-112, 2006; Cole, M. “Trade, the pollution heaven hypothesis and the environmental Kuznets curve: Examining the linkages,” Ecol. Econ., Vol. 48, pp. 71-81, 2004.


disciplines that have long been free standing are being forced to grapple with the realities of cross-regime coherence as well as potential synergies that can only be realized through collaborative action.

It is clear from the WTO rules and the United Nations Framework Convention on Climate Change (UNFCCC)42 that the trade and environmental regimes do not operate in clinical isolation. Paragraph 31 of the Doha Ministerial Declaration acknowledges the agreement to negotiations on the relationship between existing WTO rules and specific trade obligations set out in multilat-eral environmental agreements.43 Articles 3.5 of the UNFCCC and 2.3 of the Kyoto Protocol provide that measures taken to combat climate change should not constitute a means of arbitrary or unjustifiable discrimination or a disguised restriction on international trade44 and should be implemented so as to minimize adverse effects, including the adverse effects of climate

42) UNFCCC, 9 May 1992, 31 ILM 849.43) WT/MIN(01)/DEC/1, 20 November 2001.44) Article 3.5 of the UNFCCC. Principle 12 of the Rio Declaration on Environment and Development uses the same wording.

Environmental Degradation

Per CapitaIncome

Turning Point

EnvironmentImproves

EnvironmentWorsens

Figure 1: The environmental Kuznets curve. Source: http://alturl.com/kexsi


change,45 effects on international trade, and social, environmental and eco-nomic impacts on other Parties.46 Moreover, the use of trade policy tools in the pursuit of international environmental law also explains why the link between trade and environment has become a prominent issue in WTO litigation.47 The problems of trade and the environment are different, but the tools used in their management are the same: taxes, tariffs, regulations, and subsidies. There is a lot the environmental regime can learn from the WTO system (for instance, the trade policy review mechanism),48 but also from the rest of the UN system (such as the International Labor Organization49 and the Food and Agriculture Organization50).

The interface of WTO and multilateral environmental agreements has been debated for some time.51 International trade could offer the climate change regime the fundamental WTO law principles of non-discrimination such as the most-favored nation principle52 and national treatment.53 Could (or should) this interface of WTO and multilateral environmental agreements be

45) According to Article 1.1 of the UNFCCC, “adverse effects of climate change” means changes in the physical environment or biota resulting from climate change which have significant del-eterious effects on the composition, resilience or productivity of natural and managed ecosys-tems or on the operation of socio-economic systems or on human health and welfare.46) Article 2.3 of the Kyoto Protocol.47) Charnovitz, S. “The WTO’s Environmental Progress,” in Davey, W.J. and Jackson, J. (eds.), The Future of International Economic Law, Oxford: Oxford University Press, pp. 247–268, 2008.48) The aim of the WTO Trade Policy Review Mechanism is the surveillance of the national trade policies of all WTO Members. See http://www.wto.org/english/tratop_e/tpr_e/tpr_e.htm.49) http://www.ilo.org/global/lang--en/index.htm.50) http://www.fao.org/.51) See for instance Hufbauer, G. Kim, J. “The World Trade Organization and Climate Change: Challenges and Options,” Working Paper Series WP09-9, Washington: Peterson Institute of International Economics, 2009; Petersmann, E.-U. “International trade law and international environmental law: environmental taxes and border tax adjustment in WTO law and EC law,” in Reversz, R. et al. (eds.) Environmental Law, the Economy and Sustainable Development: the United States, the European Union and the International Community, Cambridge: Cambridge University Press, 2000, pp. 127-155.52) GATT Article I.53) GATT Article III. In GATT/WTO law, national treatment is the principle of giving others the same treatment as one’s own nationals. In other words, WTO Members must treat domestic and foreign goods, services and/or investors in the same manner for regulatory, tax, and other purposes. The treatment must be either formally identical or formally different, so long as it is no less favorable. The treatment is considered less favorable if it modifies the conditions of competition in favor of the services or services suppliers of the WTO Member. It is also referred to as “non-discriminatory” treatment. GATT Article III “requires that imports be treated no less favourably than the same or similar domestically produced goods once they have passed cus-toms. GATS Article XVII and TRIPS Article 3 also deal with national treatment for services and intellectual property protection.” See “World Trade Organization: 4th Ministerial Conference,” p. 66, 2001. GATS “national treatment” rule (Article XVII) not only prohibits treating foreign firms differently from domestic firms (non-discrimination), but it goes further to prohibit any-thing a government does that modifies the “conditions of competition” in favor of local service


integrated into the WTO agenda? Consensus is frequently fragile, especially when the stakes are high. The Rio Declaration on Environment and Devel-opment emphasizes the view that “environmental measures addressing trans-boundary or global environmental problems should, as far as possible, be based on an international consensus.”54 The failure to arrive at an interna-tional consensus on a solution to climate change suggests that future action may need to go beyond setting new targets for subsequent implementation phases of the Kyoto Protocol and be more along the lines of a new agreement that will also be palatable to the U.S. and major developing country emitters of GHGs. When—or indeed, whether—this will happen is unclear.

3. Comparing the Trade and Climate Regimes

The trade and climate change communities faced a double negative at the beginning of 2010, i.e., no global deal at the 2009 Copenhagen Conference of the Parties to reduce GHG emissions of heat-trapping gases and no concluding deal at the Doha Round of multilateral trade negotiations in the WTO.55 Both multilateral negotiations are highly complex, but also of great importance to all parties involved, whether industrialized or developing countries. Attempts to keep the two multilateral agreements and their respective negotiations apart, hoping to reduce complexities, have not been successful. The two multi-lateral processes could be more directly linked to each other and bridges could be built to reach more ambitious goals in both multilateral fora.56 Furthermore,

suppliers. While GATS proponents say the treaty is geared toward simply ensuring non- discriminatory treatment of domestic service providers and foreign providers, the problem is that the same non-discriminatory regulations—those that apply even-handedly to both foreign and local companies—could still be considered a violation of the national treatment rule. For instance, in the construction sector, the WTO Secretariat has said that even if the same controls on land use, building regulations, and building permits are applied to domestic and foreign service suppliers, “they may be found to be more onerous to foreign suppliers.” See World Trade Organization, “Construction and Related Engineering Services,” S/C/W/38, 8 June 1998, p. 5. Thus, “permits, subsidies, and specific perks, such as road access, that are granted to one service provider, but not another, could be considered a trade barrier for altering the conditions of competition between foreign and domestic service suppliers.” See Public Citizen, “WTO General Agreement on Trade in Services (GATS) Glossary,” GATS “National Treatment” entry.54) Principle 12 of the Rio Declaration on Environment and Development.55) On the WTO, see for instance Cottier, T. & Elsig, M. (eds.) Governing the World Trade Organization: Past, Present and Beyond Doha, New York: Cambridge University Press, 2011; Schwab, S. “After Doha: Why the Negotiations are Doomed and What We Should Do about It,” Foreign Affairs, May/June 2011.56) See the study by Raymond Saner in Saner, R. “International Governance Options to Strengthen WTO and UNFCCC,” CSEND, June 2011.


both regimes are capable of a multilayered governance approach: local, sub-national, national, regional (supra-national) and international.

The relationship between trade and climate change policies requires in-depth analysis with the aim to bring about mutually supportive results both in developing multilateral disciplines on climate and in adapting the interna-tional trading system. Both regimes can offer a system of carrots and sticks. Both the trade and climate change regimes have their own goals and tools. The main goals of the international trading system are trade liberalization, citi-zens’ welfare, economic growth, and the optimal use of the world’s natural resources.57 There is a set of closed and defined trade policy tools (i.e., trade regulation): tariffs (probably the simplest of all), quantitative restrictions, trade remedies, subsidies, norms and standards, process and production methods, intellectual property rights, government procurement,58 services regulation, et cetera, to name but a few. The main goals of the climate change regime, on the other hand, are about environmental protection, sustainable development,59 and the preservation of eco-systems. To achieve these goals, climate change law uses the following policy tools across international law: trade policy tools, funding programs, taxes, permissions, prohibitions, interna-tional standards, and financial instruments.

Drawing lessons from multilateral trade negotiations for climate change depends upon the creation of incentives comparable to the drivers of trade negotiations.60 Among the achievements of the multilateral trading system are the multilateralization of tariff and non-tariff policies and law, progressive trade liberalization both in goods and services, principles of non- discrimination such as the most-favored nation (MFN) treatment61 and national treatment,62 equal conditions of competition, transparency, the rule of law system (i.e., the WTO’s dispute settlement system), and economic growth. This last point has become politically problematic in that developed countries became rich without taking into account the negative repercussions that their growth brought to the environment, whereas developing countries

57) For the case of exhaustible natural resources, see GATT Article XX(g).58) On government procurement, see Arrowsmith, S. and Anderson, R. (ed.) The WTO Regime on Government Procurement: Challenges and Reform, Cambridge University Press, 2011.59) El-Ashry, M. ‘The Law of Energy for Sustainable Development’ I.C.L.Q. 54(4), 1039-1040 (2005); McGoldrick, D. ‘Sustainable Development and Human Rights: An Integrated Conception’ I.C.L.Q. 45(4), 796-818 (1996); Menescal, A. ‘Those Behind the TRIPS Agreement: The Influence of the ICC and the AIPPI on International Intellectual Property Decisions’ I.P.Q. 2, 155-182 (2005).60) Leal-Arcas, R. “A Bottom-up Approach for Climate Change: The Trade Experience,” Asian Journal of Law and Economics, Vol. 2, Issue 4, pp. 1-54, 2011.61) GATT Article I.62) GATT Article III.


today cannot have this luxury, which translates into Nicholas Stern’s predic-tion that climate change would be a break on economic growth.63 At the time when the developed world was becoming rich, economic growth was relatively slow and the beneficiaries were a few million people, whereas today the ben-eficiaries of economic growth are billions of people and economies are grow-ing at 8 per cent or more. This means that economic growth has to be green from the beginning.64

Regarding the modes of negotiations in multilateral trade, WTO negotia-tions are bottom-up, with a tradition of bilateral tariff and services negotia-tions, subject to MFN, and there is a focus on mutually interested WTO Members. In addition, there are also critical mass negotiations,65 such as sec-toral initiatives and plurilateral agreements. Moreover, there are package-deal negotiations, which is the tradition of multilateral trade rounds of negotia-tions. Finally, there are consensus-based negotiations.

There are, however, limits and challenges to the multilateral trading system. For instance, the stalemate of the Doha Round and the proliferation of prefer-ential trade arrangements, the increasingly multi-polar world and the limits of consensus diplomacy, the failure of special and differential treatment and the lack of effective graduation for developing countries, the need for a two-tier approach in negotiations reflecting market access and regulatory tasks, and the need for a legislative response to an efficient dispute settlement system based upon weighted voting.

As for the main differences between the trade and climate change regimes, the trade regime offers a mercantilist approach (i.e., market access and country-based benefits), it is responsive to foreign pressures, it provides reci-procity in terms of political economy, and it is a multilateral system with legal security. The climate change regime, on the other hand, has a public goods approach, with global and regional commons, and is responsive mainly to domestic pressures; it has a strong dependence on funding and technical assis-tance, and has a fragmented treaty system. Moreover, trade regulation is essen-tially (but not exclusively)66 excludable in terms of benefits, there are incentives

63) See generally Stern, N. The Economics of Climate Change: The Stern Review, Cambridge University Press, 2007.64) Fay, M. et al. “Inclusive Green Growth: The Pathway to Sustainable Development,” The World Bank, 2012.65) Critical mass is “the point at which support for negotiating proposition becomes so strong that indifference or opposition by others no longer matters much.” Goode, W. Dictionary of Trade Policy Terms, 4th ed., Cambridge University Press, 2003, p. 87. Patrick Low qualifies the concept a bit further by saying that “a critical mass exits when those prepared to go ahead with an agreement consider the agreement has sufficient support and commitment among the membership.” Low, P. “WTO Decision-Making for the Future,” Staff Working Paper ERSD-2011-05, p. 9, 2011.66) There are plurilateral trade agreements with a most-favor-nation principle approach.


to obtain market access and non-discriminatory treatment, and there is usu-ally political reciprocity. In the climate change regime, however, regulation is essentially non-excludable and there are limited incentives to participate because of the free-riding issue.

The question therefore is: to what extent can trade measures be used as incentives to foster global environmental governance generally and climate change negotiations specifically? One possibility is by using regional trade agreements with strong climate change chapters to address climate change mitigation. The traditional patterns of policy-making are unlikely to succeed without structural reform in a multi-polar world. Moreover, new approaches to decision-making and graduation67 are essential in order to make the bottom-up approach as well as the critical mass work within a multilateral system. Furthermore, trade and climate change linkages are able to create appro-priate incentives and level playing fields. In addition, the nature of climate change law, which applies a multitude of tools and affects most fields of international law, precludes the idea of a single and exclusive international organization. Cross-cutting linkages could be pooled within an umbrella Interna tional Economic Organization,68 encompassing a multitude of inter-national instruments and organizations, and a shared system of dispute settlement.69

4. An Overview of Unilateral Trade-related Climate Change Measures

There is a shift of climate change policy towards unilateral measures (i.e., bottom-up policies), which calls for enhanced attention of the interfaces of climate change mitigation and trade policy and law, both multilaterally within the WTO and preferentially within bilateral trade agreements.

Trade in a good or service can sometimes be limited through the enforce-ment of domestic regulations and standards. For instance, a country may

67) The notion of graduation has been studied, among others, by Thomas Cottier. See Cottier, T. “From Progressive Liberalization to Progressive Regulation in WTO Law,” Journal of International Economic Law, Vol. 9, Issue 4, pp. 779-821, 2006. See also Jessen, H. WTO-Recht und “Entwicklungslaender”-“Special and Differential Treatment for Developing Countries” im multidi-mensionalen Wandel des Wirthschaftsvoelkerrechts, Berliner Wissenschafts-Verlang, 2006.68) The idea of an International Economic Organization has been suggested by Thomas Cottier in Cottier, T. and Elsig, M. “Can the Trade Regime Offer Lessons for Reforming the Architecture of the Environmental Regime?: A Discussion Note,” p. 17, available at http://www .environmentalgovernance.org/wp-content/uploads/2011/06/9b.-CottierElsig_A-Discussion -Note_June2011.pdf.69) See Auboin, M. (ed.) “Fulfilling the Marrakesh Mandate on Coherence: Ten Years of Cooperation between the WTO, IMF and World Bank,” WTO Discussion Paper No. 13, 2007 (looking at 10 years of cooperation between the three institutions).


impose regulatory controls for products sold or used within the country, which will, in effect, ban imported goods from the domestic market that do not sat-isfy the requirements. Usually, these regulations relate to the safety or environ-mental impacts of the actual product (e.g., pesticide residues on foods,70 air pollution from motor vehicles). Disputes arise when imports face higher standards, although due to the GATT’s national-treatment requirement, this is somewhat rare. A more typical situation giving rise to disputes is when stand-ards that are, on the surface, the same for imports and domestically-produced products, are pronounced as de facto discriminatory or disadvantageous to imports. Standards that aim to regulate a product’s production (i.e., process and production methods or PPMs), as opposed to the characteristics of the final product, are yet more contentious.

Exporting countries have challenged such standards on the grounds that they constitute a ready means of protectionism, and that the importing coun-try is exercising an unacceptable form of extraterritorial regulation of other countries’ activities in their own territory, or in areas beyond its national juris-diction. The fishing standards at the heart of the first two U.S.—Shrimp/Turtle71 cases are an example of regulation addressing PPMs.72 Despite the benefits of PPMs in addressing environmental concerns, they can create a negative eco-nomic effect on the exporting countries, because PPMs can create financial and technological burdens on small producers, particularly developing coun-tries, since they have to adapt their PPMs according to the requirement of importing countries. Moreover, by rejecting the entrance of imported prod-ucts, PPM measures can be used as a protection mechanism for domestic products.

A country not complying with its international obligations may also face the imposition of trade sanctions. For instance, under the Pelly Amendment to the Fishermen’s Protective Act of 196773 (the Pelly Amendment),74 the U.S. President may place trade sanctions on a country that either hurts the

70) On food production, see Freidberg, S. “Supermarkets and Imperial Knowledge,” Cultural Geographies 14(3): 321-342, 2007.71) WT/DS58 and WT/DS61. For an analysis of the Shrimp/Turtle cases, see Trebilcock, M. and Howse, R. The Regulation of International Trade (Routledge, 3 ed., 2005), pp. 528-540. For a legal analysis of the original Panel’s refusal, see Shaffer, G. “The WTO Shrimp-Turtle Case (United States – Import Prohibition of Certain Shrimp and Shrimp Products)”, 93 American Journal of International Law 507, April 1999.72) WT/DS58/AB/R, adopted 6 November 1998, DSR 1998; WT/DS58/AB/RW, adopted 21 November 2001.73) Fishermen’s Protective Act of 1967, 22 U.S.C. §§ 1971-1980 (2002).74) The Pelly Amendment to the Fishermen’s Protective Act was enacted in 1971 to conserve Atlantic salmon. The Pelly Amendment grants the U.S. President discretion to prohibit the importation of fish or fish products originating in a country that is diminishing the effective-ness of an international fishery conservation program.


productiveness of international fisheries or, by engaging in trade or taking (i.e., encompassing both killing and harassment), undermines the work of an international project for protecting endangered or threatened species.75 Sanctions can be designed to create maximum impact, and the President may place an embargo against any product from the offending country (for exam-ple, the U.S. President might threaten Japan with a sanction against tuna imports as a result of Japanese non-compliance with the International Whaling Convention).76 The U.S. has previously threatened countries with such trade sanctions to push for compliance with CITES and the International Whaling Convention.77

If a nation unilaterally limits its GHG emissions, it bears all of the costs of such measures, but most of the benefits accrue to other nations, activating thereby the incentive for these beneficiaries to free ride.78 Moreover, in a world of international free trade and investment, the costs of such measures to the country adopting them are exacerbated by the leakage of investment and eco-nomic activity to jurisdictions that do not have GHG regulation and, accord-ingly, offer lower production costs.79

In order to deal with the competitive disadvantage imposed by investment leakage, a major jurisdiction wishing to adopt a domestic GHG regulatory sys-tem could impose a border tax adjustment on imported goods based on their PPM GHG emissions. If successful, this could lead other major jurisdictions to adopt equivalent regulatory measures. However, such a system would be extremely complex to administer, would trigger protracted WTO challenges, potentially provoke acute trade conflicts, and stimulate powerful resistance.80 Despite talk of border carbon adjustment schemes in Europe and the U.S., it seems unlikely that a major jurisdiction would enforce a unilateral border adjustment system which would harm its consumers or that it would succeed at leading other nations which are part of the Major Economies Forum on

75) Charnovitz, S. “Environmental Trade Sanctions and the GATT: An Analysis of the Pelly Amendment on Foreign Environmental Practices,” 9 Am. U. J. Int’l L. & Pol’y 751 (1994).76) International Convention for the Regulation of Whaling, 161 UNTS 72 (1946).77) Jenkins, L. ‘Trade Sanctions: Effective Enforcement Tools,’ in Cameron, J., Werksman, J. and Roderick, P. (eds.) Improving Compliance with International Environmental Law (1996), pp. 221–228; Charnovitz, S. ‘Environmental Trade Sanctions and the GATT: An Analysis of the Pelly Amendment on Foreign Environmental Practices’ Am. U. J. Int’l L. & Pol’y 751 (1993-1994).78) Stewart, R. et al, “Strategic Analytics for Building a Global Climate Regime Bottom-Up,” p. 3, paper presented at the conference ‘Reaching International Cooperation on Climate Change Mitigation,’ December 21-23, 2011 (unpublished paper; on file with author).79) Ibid.80) For discussion of the trade law issues surrounding this type of response, see Low, P., Marceau, G. and Reinaud, J. “The Interface Between the Trade and Climate Change Regimes: Scoping the Issues,” WTO Staff Working Paper ERSD-2011-1, 2011; Pauwelyn, J. “U.S. Federal Climate Policy and Competitiveness Concerns: The Limits and Options of International Trade Law,” Nicholas Institute for Environmental Policy Solutions, Working Paper 07-02, April 2007.


Energy and Climate (MEF) to adopt significant GHG regulatory limitations in response. Moreover, even if a border adjustment initiative reduced the costs of GHG limitations due to leakage, significant costs would remain: the domestic political cost-benefit analysis might still be unfavorable to significant GHG limitation.

Regarding carbon-related border adjustments from a tax perspective, it is relevant to note that the Report of the GATT Working Party on Border Tax Adjustment of 1970 defines border tax adjustment “as any fiscal measures which put into effect, in whole or in part, the destination principle (i.e. which enable exported products to be relieved of some or all of the tax charged in the exporting country in respect of similar domestic products sold to consum-ers on the home market and which enable imported products sold to con-sumers to be charged with some or all of the tax charged in the importing country in respect of similar domestic products).”81 Although less of an issue now than in the recent past, BCAs and their WTO-compatibility will regain the spotlight in the future as countries implement domestic measures to curb GHG emissions.82 Governments will face pressure from domestic industries to apply BCAs in order to prevent firms in other countries without similar regula-tions from enjoying a competitive advantage. Environmental groups may also push their governments to adopt climate-friendly regulation.83 The U.S. Waxman-Markey bill84 included BCA provisions in its final draft.

5. The WTO and Subsidies for Renewable Energy

This section deals with the main WTO provisions on subsidies and makes ref-erence to disputes at the WTO over subsidies for renewable energy.85 Interrelated links seem to emerge when analyzing climate change, trade, and energy: 1) the interface between climate change and international trade/WTO

81) Report of the GATT Working Party on Border Tax Adjustment, adopted on 2 December 1970, L/3464, para. 4.82) Cosbey, A. “Border Carbon Adjustment,” IISD, 2008; McLure, C. “A Premier on the Legality of Border Adjustments for Carbon Prices: Through a GATT Darkly,” CCLR 4/2011, p. 456.83) Pauwelyn, J. “U.S. Federal Climate Policy and Competitiveness Concerns: The Limits and Options of International Trade Law”, Nicholas Institute for Environmental Policy Solutions, Working Paper 07-02, April 2007.84) H.R. 2454, the American Clean Energy and Security Act (Waxman-Markey). For a summary of the Act, see Larsen, J., Kelly, A., and Heilmayr, R. “WRI Summary of H.R. 2454, the American Clean Energy and Security Act (Waxman-Markey), World Resources Institute, 2009, available at http://pdf.wri.org/wri_summary_of_aces_0731.pdf.85) On renewable energy, see Rubini, L. “Ain’t Wastin’ Time no More: Subsidies for Renewable Energy, The SCM Agreement, Policy Space, and Law Reform,” Journal of International Economic Law, advance access published 25 April 2012; Howse, R. (2009), “World Trade Law and Renewable Energy: The Case of Non-Tariff Barriers,” UNCTAD/DITC/TED/2008/5.


law, discussed earlier; 2) the link between energy and climate change in the context of WTO law/international trade law; and 3) the nexus between energy and international trade law/WTO law.

5.1. Linking Energy and Climate Change

Starting from the premise that climate change mitigation is a global public good, there is a nexus between energy and climate change, which encom-passes a range of issues such as clean energy subsidies,86 carbon taxes,87 and border adjustment for carbon emissions.88 In the absence of a global climate agreement, this last point of border carbon adjustment may be a way forward in tackling climate change. As climate change is one of the most important public policy issues facing countries around the world, countries are adopting various policies in order to address these concerns. Of these, limiting anthro-pogenic (man-made) GHG emissions is a significant mitigation measure.

In the view of Dieter Helm, “since 1900, the global population has more than tripled and the consumption of energy (largely fossil fuels) has increased more than tenfold. Climate change has been caused by the way resources have been consumed, and climate change policy necessitates a substantial change in the allocation of resources.”89 Moreover, according to Kleymeyer, “the energy sec-tor, including energy use and production, accounts for over 50% of global

86) Cosbey, A. “Revenue Energy Subsidies and the WTO: The Wrong Law and the Wrong Venue,” Global Subsidies Initiative, available at http://www.globalsubsidies.org/subsidy-watch/com mentary/renewable-energy-subsidies-and-wto-wrong-law-and-wrong-venue; see also Bigdeli, S., “Incentive Schemes to Promote Renewables and the WTO Law of Subsidies,” in Cottier, T., Nartova, O., and Bigdeli, S. (eds.), International Trade Regulation and the Mitigation of Climate Change, New York: Cambridge University Press, 2009, pp. 155-192; Howse, R. “Climate Mitigation Subsidies and the WTO Legal Framework: A Policy Analysis,” Geneva: International Institute for Sustainable Development, 2010.87) Sindico, F. “Climate Taxes and the WTO: Is the Multilateral Trade Regime a Further Obstacle for Efficient Domestic Climate Policies?” EcoLomic Policy and Law, Vol. 3, No. 7/8, pp. 116-139, 2006.88) Kaufmann, C. and Weber, R. “Carbon-related Border Tax Adjustment: Mitigating Climate Change or Restricting International Trade?” World Trade Review, published online on 16 August 2011; Burniaux, J.-M., Chateau, J. and Duval, R. “Is There a Case for Carbon-Based Border Tax Adjustment?: An Applied General Equilibrium Analysis,” Economics Department Working Papers, No. 794, 2010; Holmes, P., Reilly, T. & Rollo, J. “Border Carbon Adjustments and the Potential for Protectionism,” Climate Policy, Vol. 11, No. 2, 2011, pp. 883-900; Genasci, M. “Border Tax Adjustments and Emissions Trading: The Implications of International Trade Law for Policy Design,” Carbon and Climate Law Review, Vol. 2, No. 1, 2008, pp. 33-42; Ismer, R., and Neuhoff, K., “Border Tax Adjustment: A Feasible Way to Support Stringent Emission Trading,” European Journal of Law and Economics, Vol. 24, 2007, pp. 137-164; de Cendra, J. “Can Emissions Trading Schemes be Coupled with Border Tax Adjustments? An Analysis vis-à-vis WTO Law,” 15 Review of European Community & International Environmental Law, 2006.89) Helm, D., (ed.) Climate-Change Policy (Oxford University Press, 2005), pp. 12-13.


GHGs.”90 Given rapidly rising industrialization in the developing world, and the fact that low-cost energy options are likely to be heavily fossil fuels based for some time to come, GHG emissions are projected to increase and climate change mitigation will remain an urgent issue.91 Furthermore, when dealing with biofuels, it is necessary to find a balance between climate change and energy security concerns.92

Since the use of fossil fuel is one of the major sources of anthropogenic GHG emissions, it is important to promote climate-sensitive energy policy that would help countries increase non-fossil fuel sources in their energy mix. Various alternative energies, in which nuclear and renewable sources play key roles, are being explored and developed by countries as part of their diversifi-cation efforts.93 Major investments in the new and renewable energy sector will be required in order to increase non-fossil energy usage.94

The increased competition for energy resources, climate change and GHG emissions controls, technological advances and limitations have all contrib-uted to a contradictory, fragmented regulatory web. These include the explora-tion of new sources of energy, the transition to greener resources and intelligent grids, the challenges to the security of supply networks, affordability and its links with development and the contested consumption paradigms, the nature and size of energy companies, and the cross-jurisdictional terrain on which they compete.

5.2. Linking Trade and Energy

The presumption is that trade liberalization will increase economic activity and therefore energy consumption.95 All countries require energy resources, but few possess these, and thus trade in energy (primarily oil) is crucial to fulfil

90) Kleymeyer, A.M., “New Rules for the Environmental Imperative: Considerations for the Energy Sector and Interaction with WTO Rules,” in Pauwelyn, J. (ed.) Global Challenges at the Intersection of Trade, Energy and the Environment, Geneva: Centre for Trade and Economic Integration, 2010, p. 63.91) For an estimate of CO2 emissions by country from 1971 to 2008, see International Energy Agency Statistics, CO2 Emissions from Fuel Combustion: Highlights, Paris: OECD/IEA, 2010.92) On biofuels, see the views of Searchinger, T. et al. “Use of U.S. Croplands for Biofuels Increases Greenhouse Gases Through Emissions from Land-Use Change,” Science, Vol. 319, No. 5867, pp. 1238-1240, 2008; Fischer, C., Eggert, H. and Mavroidis, P. “The Law and Economics of Trade in Biofuels,” ENTWINED Issue Brief, 2010/16/09.93) Janardhanan, N. “The new energy order and its impact on the energy policy of Asian coun-tries,” Asian Energy Institute Newsletter, Issue 11, p. 4.94) Sawin, J. et al., “Renewables Global Status Report,” REN21, 2012; McHarg, A. et al. (eds.) Property and the Law in Energy and Natural Resources, Oxford University Press, 2010; Barton, B. et al. (eds.) Regulating Energy and Natural Resources, Oxford University Press, 2006.95) See for example ICTSD, “Linking Trade, Climate Change and Energy,” ICTSD, Geneva, 2006.


global energy needs.96 Internationally, there is more trade in oil than in any-thing else. “Fully half of world trade in services is intensely energy-dependent.”97 Yet, the GATT/WTO has historically not preoccupied itself with energy trade. Very few energy-rich countries saw a need to join the GATT/WTO club, given that the reduction of import restrictions—one of the main goals of the multi-lateral trading system—is not an issue when it comes to energy. Saudi Arabia, the main energy-producing country in the world, only joined the WTO in 2005 and many energy-producing countries are still not WTO Members.98

All forms of energy should be subject to the same rules. Energy may become part of the WTO agenda in the near future.99 Given that current WTO rules are far from addressing all the needs of energy trade today, is it necessary to have a WTO Agreement on trade in energy?100 If so, can and should the Energy Charter Treaty be used as a model? Moreover, since Russia finally joined the WTO on its own in 2012101 (and not as a customs union along with Belarus and Kazakhstan102) and since energy is one of its greatest assets in economic terms, would this be the right time to include energy trade as part of the WTO Agreements? Those energy-rich Middle Eastern countries that are not yet WTO Members, but wish to become WTO Members, will most likely follow Russia.103 These Middle Eastern countries should prioritize the conclusion of

96) Pauwelyn, J. “Global Challenges at the Intersection of Trade, Energy and the Environment: An Introduction,” in Pauwelyn, J. (ed.) Global Challenges at the Intersection of Trade, Energy and the Environment, Geneva: Centre for Trade and Economic Integration, 2010, p. 3.97) Gault, J. “A World of Introduction from the Energy Industry Perspective,” in Pauwelyn, J.

(ed.) Global Challenges at the Intersection of Trade, Energy and the Environment, Geneva: Centre for Trade and Economic Integration, 2010, p. 9.98) For further details, see Selivanova, Y. (ed.) Regulation of Energy in International Trade Law:

WTO, NAFTA and Energy Charter, Kluwer, 2011; Shih, W. “Energy Security, GATT/WTO, and Regional Agreements,” 49 Nat. Resources J. 433, 2009.99) Marceau, G. “The WTO in the Emerging Energy Governance Debate,” Global Trade and

Customs Journal, Vol. 5, Issue 3, 2010.100) On this point, see the views of Cottier, T. et al. “Energy in WTO law and policy,” in Cottier, T. and Delimatsis, P. (eds.) The Prospects of International Trade Regulation: From Fragmentation to Coherence, New York: Cambridge University Press, 2011, pp. 211-244 (arguing that, since the regulation of energy in international law is highly fragmented and largely incoherent, pertinent issues should be addressed by a future Framework Agreement on Energy in the context of WTO law).101) WTO, “Ministerial Conference Approves Russia’s WTO Membership,” available at 16 December 2011, available at http://www.wto.org/english/news_e/news_e.htm; see also “Russia to Join WTO Alone,” The Moscow Times, 16 April 2010, available at http://www.themoscowtimes .com/business/article/russia-to-join-wto-alone/404038.html.102) International Centre for Trade and Sustainable Development, “Russia Update,” Bridges Monthly, Vol. 13, No. 2, June 2009, available at http://ictsd.net/i/news/bridges/48583/.103) For an analysis on the governance of global energy, see the special issue “Global Energy Governance,” Global Policy, Vol. 2, Issue Supplement s1, September 2011, pp. 1-154; Goldthau, A., J.M. Witte (eds.) Global Energy Governance: The New Rules of the Game, Washington, DC: Brookings Institution Press, 2010.


negotiations to enter the WTO in order to fully integrate into the global trading system and protect their growing interests on world markets. WTO member-ship will certainly help eliminate any discrimination against them in their trade and investment.

5.3. An Overview of the Main WTO Provisions on Subsidies

The WTO’s Agreement on Subsidies and Countervailing Measures (the SCM Agreement) regulates the provision of subsidies by WTO Members. It regulates only those subsidies which are specifically provided to an enterprise, industry, or group of enterprises or industries. This means that only specific subsidies are subject to the SCM Agreement.

Article 1 of the SCM Agreement provides a definition of the term “subsidy” for the purpose of the SCM Agreement. For something to be deemed a subsidy, there must be:

a. A financial contribution by a government or public body,104 in the form of either: a direct transfer of funds (e.g. grants, loans, equity infusion) or potential direct transfers of funds or liabilities (e.g. loan guaran-tees);105 government revenue otherwise due is forgone or not collected, such as tax credits;106 a government provides goods or services other than general infrastructure, or purchases goods;107 or a government makes payments to a funding mechanism or entrusts or directs a pri-vate body to carry out any of the above functions that would normally be vested in the government;108 and

b. A benefit is thereby incurred.109

Article 2 of the SCM Agreement sets out the specificity requirement, providing that only subsidies which are “specific to an enterprise or industry or group of enterprises or industries” are covered by the SCM Agreement. An example of specificity is where the granting authority or legislation explicitly limits access to a subsidy to certain enterprises/industries.110

The SCM Agreement classifies subsidies as falling within three categories: 1) prohibited subsidies,111 2) actionable subsidies,112 and 3) non-actionable

104) Article 1.1(a)(1) of the SCM Agreement.105) Article 1.1(a)(1)(i) of the SCM Agreement.106) Article 1.1(a)(1)(ii) of the SCM Agreement.107) Article 1.1(a)(1)(iii) of the SCM Agreement.108) Article 1.1(a)(1)(iv) of the SCM Agreement.109) Article 1.1(b) of the SCM Agreement.110) Article 2.1(a) of the SCM Agreement.111) Part II of the SCM Agreement.112) Part III of the SCM Agreement.


subsidies.113 However, although the SCM Agreement, as originally entered into force, had non-actionable subsidies as one of three categories of subsidies, this category was provisional for five years until December 1999, with the possibil-ity of extending its application for a further period.114 As of 31 December 1999, no consensus had been reached in the WTO’s SCM Committee for such an extension, which means that non-actionable subsidies have phased out.115

Prohibited subsidies are defined in Article 3 of the SCM Agreement as subsidies that either: are contingent (either in law or in fact)116 upon export performance—this refers to advantages or assistance provided specifically to goods intended for export;117 or are contingent upon the use of domestic over imported goods.118 Prohibited subsidies may not be granted or maintained by WTO Members.119 Article 4 of the SCM Agreement sets out procedures for dispute resolution where a WTO Member wishes to challenge what it believes to be the imposition of a prohibited subsidy by another WTO Member.120

Actionable subsidies are defined in Article 5 of the SCM Agreement as sub-sidies which have “adverse effects to the interests of other Members.” Adverse effects include: “injury to the domestic industry of another Member;”121 nullifi-cation or impairment122 of benefits accruing directly or indirectly to other Members under GATT 1994;123 and/or serious prejudice124 to the interests of another WTO Member.125 Article 6.1 of the SCM Agreement cites circum-stances in which “serious prejudice” shall be deemed to exist, for example,

113) Part IV of the SCM Agreement.114) Article 31 of the SCM Agreement.115) For further explanation of the SCM Agreement, see http://www.wto.org/english/tratop_e/scm_e/subs_e.htm.116) This standard is met when the facts demonstrate that the granting of a subsidy, without having been made legally contingent upon export performance, is in fact tied to actual or antic-ipated exportation or export earnings. The mere fact that a subsidy is granted to enterprises which export shall not for that reason alone be considered to be an export subsidy within the meaning of Article 3 of the SCM Agreement.117) Article 3.1(a) of the SCM Agreement.118) Article 3.1(b) of the SCM Agreement.119) Article 3.2 of the SCM Agreement.120) Article 4.1 of the SCM Agreement.121) Article 5(a) of the SCM Agreement (footnote omitted).122) The term “nullification or impairment” is used in the SCM Agreement in the same sense as it is used in the relevant provisions of GATT 1994, and the existence of such nullification or impairment shall be established in accordance with the practice of application of these provisions.123) Article 5(b) of the SCM Agreement.124) The term “serious prejudice to the interests of another Member” is used in the SCM Agreement in the same sense as it is used in paragraph 1 of Article XVI of GATT 1994, and includes threat of serious prejudice.125) Article 5(c) of the SCM Agreement.


where “the total ad valorem subsidization126 of the product exceed[s] 5 per cent;”127 where the subsidies “cover operating losses sustained by an indus-try;”128 where the subsidies “cover operating losses sustained by an enterprise, other than a one-time measures which are non-recurrent;”129 and “direct for-giveness of debt.”130 Article 6.3 of the SCM Agreement examines negative effects of subsidies in the market and provides a further list of circumstances in which “serious prejudice” may exist, including where: “the effect of the sub-sidy is to displace or impede the imports of a like product of another Member into the market of a subsidizing Member;”131 the “effect of the subsidy is to displace or impede the exports of a like product of another Member from a third country market;”132 “the effect of the subsidy is a significant price under-cutting by the subsidized product as compared with the price of a like product of another Member in the same market […];”133 and/or where “the effect of the subsidy is an increase in the world market share of the subsidizing Member in a particular subsidized primary product or commodity134 as compared to the average share it had during the previous period of three years […].”135 Article 7 of the SCM Agreement sets out procedures for dispute resolution where a WTO Member wishes to challenge what it believes to be the imposition of an actionable subsidy by another WTO Member.

Non-actionable subsidies are defined in Article 8 of the SCM Agreement, which sets out certain instances where, notwithstanding the above provisions, subsidies are non-actionable. These include: where assistance is “for research activities conducted by firms or by higher education or research establish-ments on a contract basis with firms,”136 provided certain conditions set out in Article 8.2(a) are satisfied; “assistance to disadvantaged regions within the ter-ritory of a Member given pursuant to a general framework of regional develop-ment,137 and non-specific (within the meaning of Article 2) within eligible

126) The total ad valorem subsidization shall be calculated in accordance with the provisions of Annex IV [of the SCM Agreement].127) Article 6.1(a) of the SCM Agreement.128) Article 6.1(b) of the SCM Agreement.129) Article 6.1(c) of the SCM Agreement.130) Article 6.1(d) of the SCM Agreement.131) Article 6.3(a) of the SCM Agreement.132) Article 6.3(b) of the SCM Agreement.133) Article 6.3(c) of the SCM Agreement.134) Unless other multilaterally agreed specific rules apply to the trade in the product or com-modity in question.135) Article 6.3(d) of the SCM Agreement.136) Article 8.2(a) of the SCM Agreement.137) A "general framework of regional development" means that regional subsidy programmes are part of an internally consistent and generally applicable regional development policy and that regional development subsidies are not granted in isolated geographical points having no, or virtually no, influence on the development of a region.


regions”138 provided that certain conditions set out in Article 8.2(b) are satis-fied.139 An example is the EU system of Structural Funds under which the wealthier EU Member States finance infrastructure and other investments in economic development and employment in less affluent EU Member States or regions;140 “assistance to promote adaptation of existing facilities141 to new environmental requirements imposed by law and/or regulations which result in greater constraints and financial burden on firms,”142 provided certain con-ditions set out in Article 8.2(c) are satisfied. This last point means that subsi-dies for environmentally efficient technologies are acceptable.

5.4. Subsidies for Renewable Energy

Regarding subsidies, low-carbon technologies are receiving increasing finan-cial support in countries around the world, and their implementation is also on the rise. This is happening as a result of State subsidies, tax incentives, prod-uct labeling, different clean energy regulation requirements, and other meas-ures. An increasingly rising issue, therefore, will be the compatibility of such measures with WTO subsidies and other disciplines (including the GATT and the TBT Agreement).143

Clean energy subsidies have already yielded three high-profile WTO dis-putes: Canada—Certain Measures Affecting the Renewable Energy Generation Sector,144 Canada—Measures Relating to the Feed-in Tariff Program,145 and China—Measures Concerning Wind Power Equipment,146 which was amicably settled in the consultation phase. The resolution of the other two cases (which

138) Article 8.2(b) of the SCM Agreement.139) Aguayo Ayala, F. and Gallagher, K. “Preserving Policy Space for Sustainable Development: The Subsidies Agreement at the WTO,” International Institute for Sustainable Develop-ment, December 2005 (discussing whether there should be exceptions within the SCM Agreement for subsidies consistent with promoting sustainable development).140) See for instance the EU Cohesion Policy for 2007-2013, available at http://ec.europa.eu/regional_policy/sources/docoffic/official/regulation/pdf/2007/publications/guide2007_en.pdf.141) The term “existing facilities” means facilities which have been in operation for at least two years at the time when new environmental requirements are imposed.142) Article 8.2(c) of the SCM Agreement.143) On subsidies and the WTO, see Howse, R. “Climate Mitigation Subsidies and the WTO Legal Framework: A Policy Analysis,” Geneva: International Institute for Sustainable Development, 2010; Howse, R. and Eliason, A. “Countervailing Duties and Subsidies for Climate Mitigation: What is, and what is Not, WTO Compatible?” in Stewart, R., Kingsbury, B. and Rudyk, B. (eds.), Climate Finance: Regulatory and Funding Strategies for Climate Change and Global Development (New York and London: New York University Press, 2009), at pp. 260-266; Peat, D. “The Wrong Rules for the Right Energy: The WTO SCM Agreement and Subsidies for Renewable Energy,” available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1998240.144) WT/DS412.145) WT/DS426.146) WT/DS419.


were combined and heard by the panel as one case) likely will shape important features of international climate policy and the world trading system for years to come.

Let us turn to each one of the WTO disputes.

5.4.1. Canada—Renewable Energy147 and Canada—Feed-In Tariff Program148In Canada—Renewable Energy and Canada—Feed-In Tariff Program, Japan and the EU brought legal actions149 against Canada, in 2010 and 2011 respec-tively, over certain requirements of the feed-in tariff (FIT) program reflected in Ontario’s Green Energy Act, which provides preferential incentives to green energy (solar and wind), but only if it uses components manufactured by local manufacturers. Arguably, the Canadian government has no constitutional powers to prevent Canadian provinces from subsidizing energy, which means that sub-national Canadian subsidies are dealt with at a provincial level. This domestic content requirement oscillates between 25 to 60 per cent, depending on the type and size of the installation (i.e., wind or solar projects below or above 10kW). Feed-in tariffs is a widely used economic policy which consists of accelerating renewable energy deployment by offering long-term contracts to renewable energy producers.150 Canada’s position is that the FIT should be considered legitimate government procurement.

Both Japan and the EU alleged that it appears that the domestic content requirement in the feed-in tariff program is a prohibited subsidy according to Articles 3.1(b) and 3.2 of the SCM Agreement because the subsidy is provided “contingent […] upon the use of domestic over imported goods,”151 i.e., equip-ment for renewable energy generation produced in Ontario over equipment imported from Japan and the EU.

Moreover, both Japan and the EU alleged that the feed-in tariff program vio-lates GATT Article III.3 and III.5 because it accords less favorable treatment to imported renewable energy equipment than to similar equipment made in Ontario. Japan and the EU also claimed that the domestic content require-ments violate GATT Article III.1 because they seem to be “internal quantitative regulations” relating to “the mixture, processing or use” of a specific amount of equipment for clean energy generation facilities which require that the equip-ment for clean energy generation facilities be generated in Ontario, thereby affording “protection to domestic production” of that equipment.

147) WT/DS412.148) WT/DS426.149) WT/DS412/1, 16 September 2010 and WT/DS426/1, 16 August 2011.150) Couture, T. and Gagnon, Y. “An Analysis of Feed-in Tariff Remuneration Models: Implications for Renewable Energy Investment,” Energy Policy, Vol. 38(2), pp. 955-965, 2010.151) Article 3.1(b) of the SCM Agreement.


If Japan and the EU succeed, it could mean lost jobs and a barrier to Ontario’s ambitions to be a clean energy exporter.152 This uncertainty has stalled critical and urgent investments in clean energy infrastructure and other climate-related investments. Despite the urgency, it will still take years to establish a framework to deal with these complex issues.153 The international communi-ty’s aim should be to foster greater international cooperation in an effort to keep investment flowing in the direction of initiatives that help countries develop the infrastructure needed for climate change adaptation and mitigation.154

5.4.1.1. Complaint in the NAFTA ContextAlthough the North American Free Trade Agreement (NAFTA) is a different legal regime from that of the WTO, it is interesting to note that a Texan renew-able energy company, Mesa Power Group,155 announced that they will bring a legal action against Canada in the context of NAFTA regarding Ontario’s FIT program.156 Mesa’s interest in the matter derives from the fact that they had two clean energy projects underway in Ontario. In Mesa’s view, Canada vio-lated several NAFTA Articles, such as Articles 1102, 1103, 1105, and 1106.

NAFTA Article 1102 sets out the most important NAFTA principle, namely the obligation of national treatment157 for investors and their investments “with respect to establishment, expansion, management, conduct, operation, and sale or other disposition of investments.” As defined in an UNCTAD report, national treatment is the “principle whereby a host country extends to foreign investors treatment that is at least as favourable as the treatment that it accords to national investors in like circumstances. In this way the national treatment standard seeks to ensure a degree of competitive equality between national and foreign investors.” It actually means the best treatment provided by a government to any investor or investment, both in the pre- and post-establishment phases.

152) IISD, “IISD convenes meeting at WTO as climate change challenges international trade/investment laws,” 11 October 2011.153) Ibid.154) Wilke, M. “Feed-in Tariffs for Renewable Energy and WTO Subsidy Rules: An Initial Legal Review,” International Centre for Trade and Sustainable Development, Issue Paper No. 4, 2011; Prest, J. “The Future of Feed-in Tariffs: Capacity Caps, Scheme Closures and Looming Grid Parity,” Renewable Energy Law and Policy Review 1/2012, pp. 25-41.155) http://www.mesapowergroup.com/.156) Notice of Intent to Submit a Claim to Arbitration under Section B of Chapter 11 of the North American Free Trade Agreement, available at http://www.international.gc.ca/trade -agreements-accords-commerciaux/assets/pdfs/Mesa_Power_Group_NOI.pdf.157) See UNCTAD, National Treatment, UNCTAD Series on Issues in International Investment Agreements, New York and Geneva, United Nations, 1999, p. 1. For further detail, see Newcombe, A. & Paradell, LL. Law and Practice of Investment Treaties: Standards of Treatment, Alphen aan den Rijn: Kluwer Law International, 2009, chapter 4.


In Article 1103, the second most important principle of the NAFTA—the most-favored-nation (MFN) principle—is to be found. As defined in an UNCTAD report, MFN treatment in the context of international investment law means that “a host country treats investors from one foreign country no less favourably than investors from any other foreign country.”158

Article 1105 is one of the most original creations of the NAFTA Chapter 11. It provides for treatment in accordance with international law, aiming at setting a minimum standard of treatment for investments of NAFTA investors. The treatment is based on long-standing principles of customary international law.159

NAFTA Article 1106 prohibits the imposition and enforcement of a certain number of specified performance requirements and the use of specified per-formance requirements as conditions attached, including preference for domestic sourcing of goods and restricting domestic sales by tying such sales to export performances. In this case, NAFTA Article 1106 may prohibit the domestic content requirements of Ontario’s FIT.160

5.4.2. China—Wind Power161Although China—Measures Concerning Wind Power Equipment was amicably settled between the U.S. and China, it is nevertheless relevant to discuss the merits of this case. In December 2010, the U.S. filed a complaint against China before the WTO regarding certain measures providing public funds, grants, or awards to enterprises that manufacture wind power equipment.162 The U.S. argued that certain measures undertaken by the Chinese government in

158) See UNCTAD, Most-Favoured-Nation Treatment, UNCTAD Series on Issues in International Investment Agreements, New York and Geneva, United Nations, 1999, p. 1. For further detail, see Newcombe, A. & Paradell, LL. Law and Practice of Investment Treaties: Standards of Treatment, Alphen aan den Rijn: Kluwer Law International, 2009, chapter 5.159) For a detailed discussion of Article 1105 of the NAFTA, see Kinnear, M., Bjorklund, A. & Hannaford, J. Investment Disputes under NAFTA: An Annotated Guide to NAFTA Chapter 11, loose-leaf, Leiden: Kluwer Law International, 2006, at p. 1102; Dumberry, P. “The Quest to Define ‘Fair and Equitable Treatment’ for Investors under International Law: The Case of the NAFTA Chapter 11 Pope & Talbot Awards,” 3 Journal of World Investment 657 (2002); Foy, P. & Deane, R. “Foreign Investment Protection under Investment Treaties: Recent Developments under Chapter 11 of the North American Free Trade Agreement,” (2001) ICSID Rev. 299.160) For a deeper analysis of NAFTA, see Leal-Arcas, R. International Trade and Investment Law: Multilateral, Regional and Bilateral Governance, Cheltenham: Edward Elgar, 2010, pp. 229-236.161) WT/DS419.162) China – Measures Concerning Wind Power Equipment, Request for Consultations by the United States, January 6, 2011, WT/DS419/1; See also Office of the United States Trade Representative, “United States Requests WTO Dispute Settlement Consultations on China’s Subsidies for Wind Power Equipment Manufacturers,” Press Release, December 2010, availa-ble at http://www.ustr.gov/about-us/press-office/press-releases/2010/december/united-states -requests-wto-dispute-settlement-con.


support of its wind power industry are contrary to Article 3 of the SCM Agreement.163 The U.S. complaint was based on a petition that was filed with the Office of the U.S. Trade Representative by the Steelworkers Union in September 2010 pursuant to Section 301 of the Trade Act of 1974.164 In that petition, the Steelworkers Union complained of a wide range of policies under-taken by China to “stimulate and protect its domestic producers of green technology, from wind and solar energy products to advanced batteries and energy-efficient vehicles.”165 Their petition argued that these policies have permitted China to become the dominant global supplier of green technology, and have “drained manufacturing investment from the U.S. to China, trans-ferred valuable technology and research and development activities to China, cost American workers the high-skilled green jobs of the future, and increased the U.S. trade deficit.”166

The Steelworkers petition identified 5 categories of China’s policies that, in their view, are contrary to WTO rules: 1) restrictions on access by foreign nations and firms to critical materials necessary for the manufacture of green technologies.167 These include solar panels, wind turbines, advanced batteries, and energy efficient lighting. According to the petition, “China produces more than 90 percent of the world’s supply of these minerals”168 necessary for the production of these technologies, and “uses a variety of means to restrict exports of these materials to users in the U.S. and other countries;”169 2) the use of subsidies contingent on export or domestic content, such as subsidies for the manufacture and development of green technology that are conditioned on the use of domestic over imported inputs;170 3) discrimination against for-eign firms and goods in bidding out the construction of wind farms and solar power plants;171 4) requirements for foreign companies to transfer technology, even if, when China joined the WTO in 2001, it committed not to ask foreign

163) Article 3 of the SCM Agreement reads:3.1 Except as provided in the Agreement on Agriculture, the following subsidies, within the meaning of Article 1, shall be prohibited:(a) subsidies contingent, in law or in fact, whether solely or as one of several other conditions, upon export performance, including those illustrated in Annex I;(b) subsidies contingent, whether solely or as one of several other conditions, upon the use of domestic over imported goods.3.2 A Member shall neither grant nor maintain subsidies referred to in paragraph 1.164) Petition for Relief under Section 301 of the Trade Act of 1974, as Amended: China’s Policies Affecting Trade and Investment in Green Technology, September 9, 2010, available at http://www.ustr.gov/sites/default/files/09-09-2010%20Petition.pdf.165) Ibid., p. 1.166) Ibid., pp. 1-2.167) Ibid., p. 2.168) Ibid.169) Ibid., pp. 2-3.170) Ibid., p. 3.171) Ibid., pp. 3-4.


firms to transfer technology as a condition of investment agreements with Chinese state-owned enterprises or financial institutions, grant technology licenses to Chinese partners;172 and 5) the provision of domestic subsidies alleged to be trade-distorting, “including in the solar, wind, biomass, geother-mal, hydropower, nuclear, advanced battery, alternative vehicle, and energy-efficient consumer product, sectors.”173

The U.S. complaint addressed only category number 2, that is, the provision of subsidies contingent on export or domestic content.174 It targeted measures which appear in regulations175 that establish a special fund to support the wind power equipment manufacturing sector in China.176 This fund is stated to be for the purpose of “encouraging corporate R&D activities on market demanded products,”177 and it is purported that it will be allocated as “incen-tives instead of subsidies.”178 The U.S. complaint appears to focus, in particular, on the qualifications of wind power manufacturing companies applying for a grant from the fund, which are set out in Article 6(4) of the Appendix of the Management Regulations on Special Fund for Wind Power Manufacturing Sector in China, which requires that “the wind turbine component of blades, gearboxes and generators must be manufactured by Chinese companies or Chinese controlled stock companies. Converters and bearings manufacturing are encouraged.”

The U.S. complaint alleged that the subsidies appear to be “prohibited sub-sidies” according to Article 3 of the SCM Agreement.179 The complaint also alleged breaches of a number of provisions of the SCM Agreement (namely Articles 25.1, 25.2, 25.3, and 25.4) as well as Article XVI.1 of the GATT 1994 requiring the notification of subsidies.180 Moreover, the U.S. also argued that China has breached the terms on which it acceded to the WTO which required translation of measures into one or more of the official languages of the WTO, thereby failing to comply with its obligation under Part I, paragraph 1.2 of its Protocol of Accession.181

172) Ibid., p. 4.173) Ibid., p. 5.174) USTR, “United States Requests WTO Dispute Settlement Consultations on China’s Subsidies for Wind Power Equipment Manufacturers,” available at http://www.ustr.gov/about -us/press-office/press-releases/2010/december/united-states-requests-wto-dispute -settlement-con.175) Ministry of Finance Document [2008] No. 476, “Management Regulations on Special Fund for Wind Power Manufacturing Sector in China,” available at http://www.cresp.org.cn/uploadfiles/2/981/mof_476_eng.pdf.176) Ibid., Appendix, Article 1.177) Ibid., Appendix, Article 2.178) Idem.179) China—Measures Concerning Wind Power Equipment, WT/DS419/1, p. 1.180) Ibid.181) Ibid.


The U.S.-China consultations took place in February 2011, when the Chinese government agreed to put an end to the special fund. The dispute therefore concluded amicably. It is reasonable to say that the U.S. complaint seems rela-tively narrow, given that it dealt only with one of the many policies that the Steelworkers Union brought forward in its petition.

6. EU Emissions Trading Scheme

Given the current UNFCCC treaty impasse, which is likely to persist for the foreseeable future, a radical rethinking of strategy is required. There are difficulties when it comes to developing a single global carbon market with comprehensive coverage of economic sectors and countries. A promising intermediary step between the creation of global carbon market with compre-hensive coverage of economic sectors and countries and the current situation, therefore, could be a sectoral approach to emissions trading. Unilateral, bilat-eral, plurilateral, or regional arrangements could target GHG emissions reductions in specific sectors such as electricity generation, motor vehicles, aviation, shipping, cement and aluminum.

This section deals with two sectors (aviation and shipping) approached uni-laterally by the European Commission with the purpose of reducing GHG emissions. An example of unilateral trade-related climate change measures is the inclusion of aviation in the European Union’s Emission Trading Scheme (EU ETS),182 discussed later in this section. To understand the impact of includ-ing aviation in the EU ETS, it is necessary to provide first an analysis of the EU ETS.

6.1. Overview

The setup of transnational mitigation regimes is a challenging undertaking as is illustrated by the EU ETS.183 The EU ETS184 is the world’s most important GHG emissions trading scheme,185 with an estimated value of EUR 63 billion

182) See http://ec.europa.eu/clima/policies/ets/index_en.htm; see also Ellerman A.D. (2008), The EU Emission Trading Scheme: A Prototype Global System? Discussion Paper 2, Cambridge, Mass: Harvard Project on International Climate Agreements.183) Fujiwara, N. and Georgiev, A. “The EU Emissions Trading Scheme as a Driver for Future Carbon Markets,” Centre for European Policy Studies, 2012.184) Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, OJ L 275/32 (in force since 25 October 2003).185) On the EU emissions trading scheme, see generally Pohlmann, M. “The European Union Emissions Trading Scheme,” in Freestone, D. and Streck, C. (eds.) Legal Aspects of Carbon


of the overall EUR 86 billion value of the global carbon market in 2008,186 and the main regulatory framework for the EU to meet its Kyoto Protocol commit-ments. It is also the world’s first mandatory cap-and-trade program for CO2 emissions,187 albeit the GHG emission caps remain too high.188 Operational since 2005, the ETS’s goal is to cut GHG emissions by one-fifth from 1990 levels by 2020.189 It is the flagship policy covering half of the EU’s carbon emissions, but, as is explained later, could turn intended restrictions on pollution into a trap that commits the EU to increasing carbon emissions for much of the next decade,190 unless changes are swiftly introduced.191

A growing number of countries are integrating cap-and-trade schemes into their national climate policies,192 such as the United States, New Zealand, Australia,193 Canada, and Japan. The EU ETS is the frontrunner in this develop-ment.194 The main features of the EU ETS are: 1) it is a classic cap-and-trade

Trading: Kyoto, Copenhagen, and Beyond, New York: Oxford University Press, 2009, pp. 337-366; Morgera, E., Kulovesi, K. & Mun□oz, M. “The EU’s Climate and Energy Package: Environmental Integration and International Dimensions,” Edinburgh Europa Paper Series, No. 2010/7, 2010; see also Egenhofer, C., Alessi, M., Georgiev, A. & Fujiwara, N. “The EU Emissions Trading System and Climate Policy towards 2050: Real incentives to reduce emissions and drive innovation?” Special Report, Centre for European Policy Studies, 2011 (which addresses the fundamental question of whether the ETS has lived up to its promise to “promote reductions of greenhouse gas emissions in a cost-effective and economically efficient manner,” and if not, what the pros-pects of its doing so are in the future and what additional changes will be required).186) Capoor, K. & Ambrosi, P. “State and Trends of the Carbon Market 2009,” Washington, D.C.: The World Bank, May 2009, pp. 1-2; Nussbaumer, P. “Working of Carbon Market,” 42/30 Economic and Political Weekly, 3081, 28 July 2007.187) Ellerman, A.D. “The EU Emission Trading Scheme: Prototype of a Global System?” Discussion Paper 2008-02, Cambridge, Mass: The Harvard Project on International Climate Agreements, August 2008.188) Egenhofer, C. et al. “The EU Emissions Trading System and Climate Policy towards 2050: Real Incentives to Reduce Emissions and Drive Innovation?” Centre for European Policy Studies, 2011.189) See Cames, M. et al., “Functioning of the ETS and the Flexible Mechanisms,” Brussels: European Parliament, March 2011 (which explains the basic functioning of the EU ETS and how GHG emissions reduction projects outside the EU, the so called Flexible Mechanisms, can be used for compliance under the EU ETS).190) Woerdman, E. et al. “European Emission Trading and the Polluter-pays Principle: Assessing Grandfathering and Over-allocation,” in Faure, M. and Peeters, M. (eds.) Climate Change and European Emissions Trading: Lessons for Theory and Practice, Cheltenham: Edward Elgar, 2008.191) See Sandbag, “Cap or Trap? How the EU ETS Risks Locking-in Carbon Emissions,” September 2010, available at http://sandbag.org.uk/files/sandbag.org.uk/caportrap.pdf.192) Sterk, W. and Mersmann, F. “Domestic Emission Trading Systems in Developing Countries – State of Play and Future Prospects,” JIKO Policy Paper 2/2011, August 2011 (where six developing countries with possible domestic ETS are analysed: Brazil, China, India, Kazakhstan, Mexico, and South Korea).193) See Jotzo, F. and Betz, R. “Linking the Australian Emissions Trading Scheme,” Climate Strategies, March 2009, available at http://www.joanneum.at/climate/linking/CSLinkingAUS .pdf.194) On the linkage between the EU ETS and other emission trading schemes, see Mace, M.J., and Anderson, J. “Legal and Design Issues Arising in Linking the EU ETS with Existing and


system with a highly decentralized implementation mechanism; 2) it is set up in sequential multi-year periods with a declining cap: phase 1 is 2005-2007, phase 2 is 2008-2012, and phase 3 is 2013-2020;195 3) there has been an increase in the percentage of the economy covered by the EU ETS; 4) offset is allowed up to 13 per cent of GHG emissions; and 5) there is a system of free allocation of GHG emissions evolving to almost full auctioning in phase 3.196 The UK was one of the first EU Member States to adopt a domestic GHG emissions trading scheme.197

In the context of GHG emissions trading, free allocation of emissions credits to energy-intensive industries has been considered a means to prevent carbon leakage198 to less regulated markets.199 Free allocation of emissions allow-ances200 may potentially have trade-related ramifications, with respect to the WTO and the Agreement on Subsidies and Countervailing Measures (SCM Agreement).201 New market mechanisms are set in place to allow developing countries to foster products with a low carbon footprint. The issuance of emis-sion credits to host governments may be interpreted as unlawful subsidies under the SCM Agreement. The establishment of the EU ETS can provide meaningful lessons when moving forward with the new market mechanisms

Emerging Emissions Trading Schemes,” 6(2) Journal of Europ. Envi. & Planning Law, 2009, pp. 197-232.195) Enzmann, J., Marr, S. “Moving Towards Phase III: Key Elements of the Review of the EU Emissions Trading Scheme,” 5(2) Journal of European Environmental & Planning Law, pp. 159-181, 2008.196) Weishaar, S. “The European Emissions Trading System: Auctions and their Challenges,” in Faure, M. and Peeters, M. (eds.) Climate Change and European Emissions Trading: Lessons for Theory and Practice, Cheltenham: Edward Elgar, 2008.197) The Greenhouse Gas Emissions Trading Scheme Regulations 2003, S.I. 2003, No. 3311 (31 December 2003), available at http://www.legislation.gov.uk/uksi/2003/3311/contents/made. Further details on the link between the UK ETS and the EU ETS are to be found in the UK report prepared by Angus Johnston for FIDE 2012, available at http://www.ukael.org/ associates_37_1764331037.pdf.198) Veel, P. ‘Carbon Tariffs and The WTO: An Evaluation of Feasible Policies,’ J.I.E.L. 12(3), 749-800 (2009); Bogojevic, S. ‘The EU ETS Directive Revised: Yet Another Stepping Stone’ Env. L. Rev. 11(4), 279-285 (2009); Tabau, A. ‘Non-Compliance Mechanisms: Interaction between the Kyoto Protocol System and the European Union’ E.J.I.L. 21(3), 749-76 (2010); Bourbon-Seclet, C. ‘Legal Aspects of Climate Change in Europe: Is the European Union Emission Trading Scheme Greater than the Sum of the Parts? Part 1’ Journal of Int. Banking Law and Reg. 23(5), 252-266 (2008).199) Ellerman, A.D., Buchner, B., and Carraro, C. “The EU ETS Allocation Process: An Overview,” in Ellerman, A.D., Buchner, B. and Carraro, C. (eds.) Allocation in the European Emissions Trading Scheme: Rights, Rents and Fairness, Cambridge University Press, 2011.200) For a definition of allowance, see Article 3(a) of Directive 2003/87/EC, where “‘[a]llowance’ means an allowance to emit one tonne of carbon dioxide equivalent during a specified period, which shall be valid only for the purposes of meeting the requirements of this Directive and shall be transferable in accordance with the provisions of this Directive.”201) International Emissions Trading Association, “Emissions Trading and the WTO,” available at http://www.ieta.org/index.php?option=com_content&view=article&id=206:emissions-.


for the post-2012 climate governance.202 The decision of leaving many features of the post-2012 new market mechanism to the design of EU Member States led to strong incentives to free-ride the system, which eventually led to the total collapse of the carbon price in the first trading period of the Kyoto Protocol.203 The GATT experience shows that a policy review mechanism can create peer pressure from the international community, which might suffice for a start until a real dispute settlement mechanism can be established.204 Discussion on the establishment of an appellate body for the CDM has shown that the need of increased accountability and the rule of law become always more pressing.205

6.1.1. Achievements of the EU ETSAmong the achievements of the EU ETS are: 1) the pricing of carbon emission credits (CECs), which is the unutilized part of an emitter’s allowance within a trading period that an emitter is permitted to trade within the EU ETS. Under the EU ETS, all GHG emissions by European Economic Area (EEA) emitters must be covered by CECs.206 Where an EEA emitter has exhausted its allow-ance, it is required to purchase CECs, the price of which is set by the market in CECs according to demand and supply. As a consequence of the pricing of CECs, their cost is likely to discourage excessive GHG emissions. Furthermore, there was modest reduction in GHG emissions during 2008;207 and 2) there is a mechanism in place for effecting further GHG emissions reductions as desired.

The European Commission sees the EU ETS as a blueprint for emerging schemes around the world and the nucleus for creating a global carbon market. It aims to establish full bilateral links to other ETS on the condition that these schemes are mandatory,208 are based on absolute caps, and do not

202) Ellerman A.D. (2008), “The EU Emission Trading Scheme: A Prototype Global System?” Discussion Paper 2, Cambridge, Mass: Harvard Project on International Climate Agreements.203) Tuerk, A., Mehling, M., Flachsland, C. and Sterk, W. “Linking Carbon Markets: Concepts, Case Studies and Pathways”, Climate Policy 9 (4), 2009; Van Asselt, H. and Biermann, F. “European Emissions Trading and the International Competitiveness of Energy-intensive Industries: A Legal and Political Evaluation of Possible Supporting Measures,” Energy Policy 35, 2007.204) Bacchus, J. “Questions in Search of Answers: Trade, Climate Change, and the Rule of Law.” Keynote Address to the conference on “Climate Change, Trade and Competitiveness: Issues for the WTO”, Geneva, 16 June 2010, available at http://www.gtlaw.com/portalresource/bacchus1.205) UNFCCC, “Decisions adopted by the Conference of the Parties serving as the meeting of the Parties to the Kyoto Protocol – Further Guidance relating to the Clean Development Mechanism”, FCCC/KP/CMP/2010/12/Add.2 paragraph 18, 2011.206) On the EU ETS carbon price, see Sartor, O. “The EU ETS Carbon Price: To Intervene, or not to Intervene?” Climate Brief, No. 12, February 2012.207) http://europa.eu/rapid/pressReleasesAction.do?reference=IP/09/794.208) On this point, see the analysis of Bazelmans, J. “Linking the EU ETS to Other Emissions Trading Schemes,” in Faure, M. and Peeters, M. (eds.) Climate Change and European Emissions Trading: Lessons for Theory and Practice, Cheltenham: Edward Elgar, 2008.


contain price ceilings for GHG emission allowances.209 This vision includes achieving an OECD-wide carbon market by 2015 as well as the establishment and integration of trading systems in major emerging economies by 2020.

The principal regulatory techniques to reduce carbon emissions are regulat-ing technology, regulating the quantity of GHG emissions, regulating the price for GHG emissions,210 and regulating information.211

Both the Fourth Assessment Report by the Intergovernmental Panel on Climate Change (IPCC)212 and the Stern Review on the Economics of Climate Change make clear the point that establishing a price for GHG emissions is one of the most effective ways to mitigate climate change.213 The ETS is on course to require savings of, at best, a miniscule quantity of 32 million tons of GHG emissions between 2008 and 2012, despite covering 12,000 installations and 1.9 billion tons of GHG emissions annually.214 Regulating a single power station over the same period could have had a greater impact.215 An already

209) NCCR Trade Regulation, “An institutional framework for the global carbon market: options and implications,” available at http://www.nccr-trade.org/wps/wp5/56/. On the EU Commission’s view to amend the EU ETS, see De Cendra de Larragán, J. “Too Much Harmonization?: An Analysis of the Commission’s Proposal to Amend the EU ETS from the Perspective of Legal Principles,” in Faure, M. and Peeters, M. (eds.) Climate Change and European Emissions Trading: Lessons for Theory and Practice, Cheltenham: Edward Elgar, pp. 53-84, 2008.210) Ellerman, A.D. et al. Pricing Carbon: The European Union Emissions Trading Scheme, New York: Cambridge University Press, 2010.211) See generally Chenevière, C., & Nihoul, P., ‘Les Règles Européennes Visant à Lutter Contre le Rechauffement Climatique’, Journal de Droit Européen 17 (159), 2009, pp. 125-131.212) The Intergovernmental Panel on Climate Change is the international corpus of scientists par excellence formed, ultimately, under the auspices of the United Nations. According to its web site, “The Intergovernmental Panel on Climate Change (IPCC) is the leading international body for the assessment of climate change. It was established […] to provide the world with a clear scientific view on the current state of knowledge in climate change and its potential envi-ronmental and socio-economic impacts. The IPCC is a scientific body. It reviews and assesses the most recent scientific, technical and socio-economic information produced worldwide rel-evant to the understanding of climate change.” Available at http://www.ipcc.ch/organization/organization.shtml.213) See “Summary for Policymakers,” in Pachauri, R.K. and Reisinger, A. (eds.), Climate Change 2007: Synthesis Report, Cambridge University Press, 2007, p. 18; Stern, N. The Economics of Climate Change: The Stern Review, Cambridge University Press, 2007, p. 349.214) This estimated figure of 32 million tons saving over five years (2008-2012) assumes a rapid European economic recovery (to 2008 levels by 2011). This means that even if the economy recovers quickly from the 2008 financial crisis, caps will only be 32 million tons lower than the actual emissions in that period. A slower recovery would mean that the caps stayed above the carbon emissions, providing no constraint on emissions.215) Drax power station in the UK is estimated to have a cap on emissions 60 metric tons below its emissions in Phase 2. Caps like those given to Drax add up to an overall cap for large power installations that would have led to 1.1 billion expected savings, a genuine cap on pollution that could have driven GHG emissions reductions and clean energy investment. However, this has been all but cancelled out by extravagant free allocations to heavy industry such as iron and steel, creating a billion more permits than are needed to cover their emissions.


weak cap for this period became a severe over-allocation of pollution permits when the 2008 economic recession caused a sharp drop in production and therefore carbon emissions.216 These lower GHG emissions, far from helping the EU towards a low carbon future, may actually trap it into continued high carbon economy because the ETS allows the huge volume of unused permits to be carried over into the next phase of the scheme that runs from 2013 to 2020.217 These permits would then be available for companies as the economy picks up again from the 2008 economic recession, removing a key driver for investment in low carbon options.218 The ETS in its current form, although a very powerful and effective policy in principle, is in danger of actually hinder-ing a low carbon economy for years to come.219

6.1.2. Possible MeasuresThere are a few ways to resolve these issues and avoid the carbon trap posed by the ETS.220 These involve compensating for the fact that too many permits have been put into the system, and include the following points:

1. increasing the EU carbon reduction target from 20 per cent to 30 per cent by 2020. The EU has already achieved half of the existing target and a higher target would protect momentum towards a low carbon future;221

2. setting caps for the next trading phase (2013-2020) based upon actual GHG emissions and not on the permits allocated, which were too many.222 This would require holding back 1.4 billion tons of permits

216) On the question of who has the right to emit carbon dioxide, see Ellerman, A.D. et al. (eds.) Allocation in the European Emissions Trading Scheme: Rights, Rents and Fairness, New York: Cambridge University Press, 2007.217) Kuik, O. and Oosterhuis, F. “Economic Impacts of the EU ETS: Preliminary Evidence,” in Faure, M. and Peeters, M. (eds.) Climate Change and European Emissions Trading: Lessons for Theory and Practice, Cheltenham: Edward Elgar, 2008.218) Egenhofer, C., Fujiwara, N. and Gialoglou, K. “Business Consequences of the EU Emission Trading Scheme,” CEPS Report, 2005.219) The volume of surplus permits in the trading scheme is now so high that the EU could increase emissions until as late as 2016 when they could reach almost a third higher than 2010 levels. See Sandbag, “EU Emissions trading scheme threats to trap Europe in a high car-bon future,” available at http://www.sandbag.org.uk/blog/2010/sep/10/eu-emissions-trading -scheme-threatens-trap-europe-/.220) See Ellerman, D. & Joskow, P. “The European Union’s Emission Trading System in Perspective,” Pew Center on Global Climate Change, 2008.221) For the specific case of the UK, see Skea, J., Ekins, P. and Winskel, M. (eds.) Energy 2050: Making the Transition to a Secure Low-Carbon Energy System, London: Earthscan, 2010 (which explores in detail the factors which could help or hinder the attainment of the UK’s climate change targets, and how these factors interact with the parallel objective of maintaining a robust and secure energy system).222) Reyes, O. “EU Emissions Trading System: Failing at the Third Attempt,” Carbon Trade Watch, April 2011.


from the scheme from the start, whilst a political decision is reached to cancel the permits permanently. This decision must be reached as quickly as possible;

3. amending the rules of the ETS (through a change in the Directive223) to allow flexibility to respond to large drops in demand such as those caused by the 2008 economic recession, in order to prevent an inunda-tion of permits undermining carbon savings.

These measures face some stiff resistance. While too many permits have been handed out overall, this was not done evenly across those companies covered by the scheme. Some companies received a cap lower than their GHG emissions, but others higher. A few of the latter received an enormous over-allocation of permits, making millions from their sale. These are the ‘carbon fat cats’, led by steel conglomerate ArcelorMittal, and a number of them are lobby-ing hard to keep the ETS broken.224 If the international community manages to lower GHG emissions coming from the steel sector, climate change would largely be under control.

Millions of EU citizens are working hard to reduce their carbon emissions, saving a ton here, half a ton there. The ETS covers 1.9 billion tons annually, including those from electricity production.225 To allow the ETS to fail, provid-ing miniscule carbon savings and allowing some ‘carbon fat cats’ to make huge profits through over-allocated permits, would be a travesty.226

Moreover, since the international negotiations for the creation of a global climate change agreement did not reach a conclusion in Copenhagen in 2009,

223) Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, OJ L275/32, 25 October 2003; this Directive was amended by Directive 2009/29/EC so as to improve and extend the greenhouse gas emission allowance trading scheme of the Community, OJ L140/63, 5 June 2009.224) The surplus permits held by the top 10 ‘carbon fat cats’ in 2009 nearly quadrupled, growing from 33 million permits to 119 million. These would currently be worth roughly €1.7 billion if sold on the carbon market. ArcelorMittal is likely to accrue 102 million more permits than it needs. See Sandbag, “Cap or Trap? How the EU ETS Risks Locking-in Carbon Emissions,” September 2010, available at http://sandbag.org.uk/files/sandbag.org.uk/fatcats2009.pdf, pp. 35-42.225) European Commission, “Investment Needs for Future Adaptation Measures in EU Nuclear Power Plants and Other Electricity Generation Technologies Due to Effects of Climate Change,” March 2011, available at http://ec.europa.eu/energy/nuclear/studies/doc/2011_03_eur24769-en .pdf.226) For an analysis of the ETS from the perspective of the principle of proportionality, see Holwerda, M. “Subsidizing Carbon Capture and Storage Demonstration through the EU ETS New Entrants Reserve: A Proportionality Test,” Carbon and Climate Law Review, No. 3/2010, pp. 228-239.


the provisions of the Emissions Trading Directive on bilateral agreements have become more relevant than ever. International credits from projects or other GHG emission-reducing activities in a third country are eligible for use in the EU ETS only if an agreement has been concluded between the EU and the respective third country.227 Furthermore, the Emissions Trading Directive also stipulates that once an international agreement on climate change has been reached, from 2013 onwards, international credits are disqualified from use within the EU ETS if these credits are generated from projects from third coun-tries that have not ratified the said agreement.228

The Directive mentioned above establishing the EU ETS explicitly empow-ers the European Commission to negotiate linking agreements with Annex B countries that have ratified the Kyoto Protocol.229 For the period beyond 2012, an amendment is foreseen which allows linking agreements to provide for the recognition of GHG emission allowances between the EU ETS and mandatory GHGs trading systems with absolute emissions caps of any other country or regional entity.

EU law does not indicate whether the adoption of linking agreements should be accompanied by the establishment of new institutions entrusted with the regulation and supervision of linked carbon markets. Once the link-ing arrangement enters into force, disputes and irregularities may indeed arise across the link between participants in each emissions trading scheme, thereby necessitating adequate dispute settlement mechanisms, but also raising the question of accountability by both participants and any institution or officials supervising the link’s operation.230 As the implementation of the Kyoto Proto-col’s Clean Development Mechanism shows, these problems, if addressed insufficiently, raise important legitimacy concerns.

The carbon market is still largely unregulated, presenting opportunities for unscrupulous traders to trick customers. As the first phase of the EU ETS dem-onstrated, even where a supranational body acts in a supervisory function, widespread manipulation of the system can take place.231 While the carbon market is seeing explosive growth, particularly in the EU, such growth will not be boundless, particularly if the market is perceived as ineffective in reducing actual GHG emissions. In order for the carbon market to achieve long-term,

227) Directive 2009/29/EC of 23 April 2009, amending Directive 2003/87/EC, Article 11a (5).228) Directive 2009/29/EC of 23 April 2009, amending Directive 2003/87/EC, Article 11a (7).229) Directive 2003/87/EC, para. 17.230) NCCR Trade Regulation, “An institutional framework for the global carbon market: options and implications,” available at http://www.nccr-trade.org/wps/wp5/56/.231) Commission Regulation No. 2216/2004 for a standardized and secured system of registries pursuant to Directive 2003/87/EC was amended in July 2007 by Commission Regulation No. 916/2007 to address problems regarding the registration of emissions under the EU ETS.


sustainable success, it must be regulated, and where the right to increase GHG emissions is being traded across international borders, the potential for affect-ing trade is heightened.232

It is vital to assess what kind of institutions would be needed to supervise linked carbon markets and facilitate a smooth transition to a globally inte-grated carbon market. When exploring options for the improved governance of an integrated carbon market, the question of what could be learned from the trade field comes up. The international trading system, which started with bilateral free-trade agreements, evolved into a comprehensive multilateral regime (i.e., the GATT) and finally resulted in the creation of a powerful new organization, the WTO.233

6.2. Inclusion of Aviation in the EU ETS

Aviation is one of the fastest growing sources of GHG emissions.234 A 1999 report by the IPCC stated that aviation represents 2.5 per cent of global GHG emissions and 13 per cent of all CO2 emissions from the transportation sec-tor.235 Moreover, the CO2 emissions growth rate from aviation is three to four per cent annually and this rate is projected to continue growing at a fast rate given the air traffic growth of around five per cent each year.236 The impact of aviation to climate change is potentially even greater than the numbers men-tioned above, due to the fact that planes also emit nitrogen oxide (NOx), which may initiate the formation of ozone, which itself is a contributor to global warming and is harmful to human health. The impact of NOx emissions on climate change may be up to four times that of CO2 emissions.237

232) Convery, F., Ellerman, D, Perthuis, C. “The European Carbon Market in Action: Lessons from the First Trading Period,” 5(2) Journal of European Environmental & Planning Law, pp. 215-233, 2008.233) NCCR Trade Regulation, “An institutional framework for the global carbon market: options and implications,” available at http://www.nccr-trade.org/wps/wp5/56/. See also Leal-Arcas, R. International Trade and Investment Law: Multilateral, Regional and Bilateral Governance, Elgar 2010, Part 1; Leal-Arcas, R. “Proliferation of Regional Trade Agreements: Complementing or Supplanting Multilateralism?” Chicago Journal of International Law, Vol. 11, No. 2, pp. 597-629, 2011; Leal-Arcas, R. “The Fragmentation of International Trade Law: Is Now the Time for Variable Geometry?” The Journal of World Investment and Trade, Vol. 12, No. 2, 2011, pp. 145-195.234) Gossling, S. and Upham, P. Climate Change and Aviation: Issues, Challenges, and Solutions (Earthscan 2009); Monkelbaan, J. “International Transport, Trade and Climate Change,” ICTSD Information Note Number 17, October 2010; Monkelbaan, J. “International Transport, Climate Change and Trade: What are the Options for Regulating Emissions from Aviation and Shipping and what will be their Impact on Trade?” ICTSD Background Paper, October 2010.235) IPCC, “Aviation and the Global Atmosphere,” p. 6, 1999.236) Baker, T. et al., “Technical Summary,” in Metz, B. et al. (eds.) Climate Change 2007: Mitigation. Contribution of Working Group III to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change, Cambridge and New York: Cambridge University Press, p. 49, 2007.237) IPCC, “Aviation and the Global Atmosphere,” p. 20, 1999.


The EU ETS operates by placing a cap on the total level of permissible GHG emissions within its jurisdictional reach, and by allocating carbon emitting allowances to GHG emitters, namely the operators of emitting installations.238 All emitters within the jurisdictional reach of the ETS must, at the end of a set period, surrender credits for the GHG emissions they had produced during that period.239 The relevant legislation provides for the transfer of unutilized allowances/credits.240 Consequently, should an emitter’s emissions exceed those covered by the allowance/credits that they have been allocated, they would be able to purchase credits/allowances through the ETS at a price set by the market in emission credits under the EU ETS.

So long as the system is policed properly, it is fair to say that, in the long-term, the ETS may discourage further GHG emissions. Furthermore, periodi-cally, the totality of permissible GHG emissions across the jurisdiction of the ETS is incrementally reduced. The EU aviation levy differs from a classic BCA in that it is assessed on physical entry of aircraft, rather than physical entry of goods. In addition, the implementing country is not importing air transport services in any traditional sense of the term. However, its final result and its motivation (i.e., competitiveness concerns for EU carriers) are identical.

The aviation industry is dealt with differently under the EU ETS to static emitting installations. For instance, Article 6 of Directive 2003/87/EC makes clear that allowances issued under Chapter II of that Directive—i.e., in rela-tion to aircraft operators and the aviation industry—are treated differently. Aircraft operators within the scope of the Directive are allocated free allow-ances for 82 per cent of GHG emissions attributed to them.241 They are then required to purchase 15 per cent of GHG emissions attributed to them under the EU ETS auction mechanism.242 The inclusion of aircraft operators from outside the EU who engage EU/EEA territory has met with strong opposition

238) See Article 6(2)(e) of Directive 2003/87/EC, where it is clear that emitters are under “[a]n obligation to surrender allowances equal to the total emissions of the installation in each cal-endar year, as verified in accordance with Article 15, within four months following the end of that year.”239) Ibid.240) See Article 12 of Directive 2003/87/EC, which places a positive duty on Member States to provide for the transferability of allowances.241) The totality of allowances issued to aircraft operators within the scope of Directive 2003/87/EC is based on 97 per cent of the baseline emission figures from 2004 to 2006—rather than on the historic 1990 baseline that is used for the EU’s overall reduction commitment—in order to take into account the growth of the aviation industry between 1990 and 2006. These free allowances are then allocated by “a benchmarking process which measures the activity of each operator in 2010 in terms of the number of passengers and freight that they carry and the total distance traveled.” See Question 5 from the FAQ list on historic aviation emissions and the inclusion of aviation in the EU’s Emission Trading System, available at http://ec.europa.eu/clima/policies/transport/aviation/faq_en.htm.242) See Article 3d.1 of Directive 2008/101/EC.


from many non-EU governments which, under pressure from their aviation industry lobbies, have gone as far as to argue that this unilateral measure on the part of the EU undermines multilateral negotiations under the UNFCCC and its Kyoto Protocol.243

6.2.1. Rationale: Too Little, Too LateGiven the limited progress in the UN climate change negotiations, which are not going far or fast enough to tackle climate change at the required urgency, the EU adopted in 2008 the aviation Directive,244 which provides that from 1 January 2012, airlines using EU airports will have to pay carbon charges for any flights that land or take off in the EU (except for small carriers with very few daily flights, which could be interpreted as a sign of respect of the princi-ple of common but differentiated responsibilities245).246 This policy applies to EU and non-EU airlines (subject to a potential exemption), to passenger and cargo flights, to flights between EU airports, and between EU and non-EU air-ports for the entire length of the incoming or outgoing flight.247 According to the aviation Directive, “for the period from 1 January 2012 to 31 December 2012, the total quantity of allowances to be allocated to aircraft operators shall be equivalent to 97% of the historical aviation emissions.”248 This measure is sus-ceptible of having significant trade effects in the future.

6.2.2. Legal and Political ReactionsNot surprisingly, the unilateral decision to include aviation in the EU ETS has raised vehement objections, particularly from the U.S., India,249 and China

243) See ICTSD, “India Environment Minister Links EU Aviation Emissions Rule to UN Climate Talks,” Bridges Weekly Trade News Digest, Vol. 16, No. 15, 18 April 2012, where India’s environment minister referred to the inclusion of the aviation industry in the EU’s ETS as a “deal breaker.”244) Directive 2008/101/EC of the European Parliament and of the Council of 19 November 2008 amending Directive 2003/87/EC so as to include aviation activities in the scheme for green-house gas emission allowance trading within the Community (OJ 2009 L 8, p. 3). For a summary of the inclusion of aviation in the EU ETS, see Environmental Defense Fund, “An Overview of Aviation & the European Union Emissions Trading System,” Fact Sheet, June 2011.245) Article 3 of the UNFCCC and Article 10 of the Kyoto Protocol.246) See Article 1 of Directive 2008/101/EC, which amends Article 3 of Directive 2003/87/EC in order to include aviation within the scope of Directive 2003/87/EC. Furthermore, Directive 2008/101/EC amends Annex I of Directive 2003/87/EC to state: “From 1 January 2012 all flights which arrive at or depart from an aerodrome situated in the territory of a Member State to which the Treaty applies shall be included.”247) For an analysis, see Faber, J. and Brinke, L. “The Inclusion of Aviation in the EU Emissions Trading System: An Economic and Environmental Assessment,” ICTSD Issue Paper No. 5, 2011.248) Article 1.4 of Directive 2008/101/EC.249) “India Warns EU over Airline Carbon Tax,” Financial Times, 24 May 2012.


(which has outright refused to comply with the scheme250).251 China has even drafted a climate change law that includes retaliatory approaches to the inclusion of aviation in the EU ETS.252 Developing countries would like to see the discussion on the regulation of airlines’ GHG emissions take place in the context of the UNFCCC as the primary forum to discuss a future civil aviation emissions policy, where their voices can be heard and their concerns can be addressed. Those against the EU policy argue that carriers should only be charged for the portion of the flight within the EU airspace, and not for the entire flight. Moreover, there is a concern that, if such a unilateral decision is replicated in other jurisdictions (in addition to the EU), it may eventually mean different standards to meet GHG emissions requirements in different jurisdictions.

Furthermore, in September 2011, 26 countries gathered in Delhi to debate the inclusion of aviation in the EU ETS.253 This resulted in the New Delhi Declara-tion, which opposes the aviation Directive.254 Based on the New Delhi Declaration, a working paper backed by many Member States of the International Civil Aviation Organization (ICAO), the UN agency dealing with international aviation, stated that the inclusion of aviation in the EU ETS violates the main principle of State sovereignty reflected in Article 1 of the Chicago Convention,255 as delineated by the Convention on International Civil Aviation (known as the Chicago Convention).256 The ICAO working paper further argued that the inclusion of international civil aviation on the EU ETS contravenes articles of the Chicago Convention and its Preamble257 and violates the relevant provi-sions of the UNFCCC.258 The ICAO Council adopted the working paper in November 2011,259 but the working paper was not considered to be a legally

250) Leung, A. and Suhartono, H. ‘China Airlines Won’t Pay EU Carbon Tax,’ Reuters, 6 January 2012.251) The creation of an international aviation emissions agreement has even been suggested by Brian Havel and Gabriel Sanchez “Toward an International Aviation Emissions Agreement,” Harvard Environmental Law Review, Vol. 36, Issue 2, 2012.252) For an analysis of the draft law, see Point Carbon, “China’s draft Climate Change Law Backs Continuation of CDM Projects,” available at http://www.pointcarbon.com/aboutus/ pressroom/pressreleases/1.1889835?date=20120514&sdtc=1.253) Press Information Bureau, Government of India, “International meeting of ICAO Council and Non-EU Member States on Inclusion of Aviation in EU-ETS held,” 30 September 2011, avail-able at http://pib.nic.in/newsite/erelease.aspx?relid=76388.254) http://pib.nic.in/newsite/PrintRelease.aspx?relid=77104.255) ICAO, “Inclusion of International Civil Aviation in the European Union Emissions Trading Scheme (EU ETS) and its Impact,” C-WP/13790, 17 October 2011, para. 2.2.256) Convention on International Civil Aviation, http://www.mcgill.ca/files/iasl/chicago1944a .pdf. The Chicago Convention was designed ‘in order that international civil aviation may be developed in a safe and orderly manner.’ (Chicago Convention, preamble).257) ICAO, “Inclusion of International Civil Aviation in the European Union Emissions Trading Scheme (EU ETS) and its Impact,” C-WP/13790, 17 October 2011, para. 2.1.258) Ibid., para. 2.3.259) ICAO Council, “Summary Minutes of the Second Meeting,” C-MIN 194/2, para. 107.d.


binding document on ICAO members, given that it was not a resolution of the ICAO Council.260 The EU, nevertheless, filed a formal objection to the working paper, arguing that ‘this Council decision is based on a fundamentally flawed and erroneous interpretation of the Chicago Convention”261 and that the avia-tion Directive “does not contain any provision contrary to international law, nor does it infringe any sovereign rights of third countries.”262 The signatory countries to the New Delhi Declaration did not agree on coordinated actions to oppose the EU aviation Directive.

In response to a legal challenge put forth by Air Transport Association of America and Others—first before the High Court of Justice in the UK and then brought before the EU Court of Justice—Advocate General Kokott of the Court of Justice of the EU released an opinion in October 2011, stating that the inclu-sion of aviation in the EU ETS is legal and compatible with all the provisions and principles of international law as well as with the Chicago Convention.263 In her view, the fact that ICAO’s input in the fight to reduce GHG emissions from international aviation has been rather limited should be interpreted to mean that the ICAO should no longer be the sole authority to regulate GHG emissions coming from aviation.264 Furthermore, the EU would like the ICAO to have a stronger position regarding civil aviation-related GHG emissions reduction standards.

Indeed, in 1997 the ICAO was asked to develop policies towards the reduc-tion of GHG emissions coming from international aviation, but its outcome was rather limited. In 2009, ICAO’s Group on International Aviation and Climate Change proposed a plan of action which aims, inter alia, at “a 2 per cent annual fuel efficiency improvement up to year 2050;”265 the “development of a framework for market-based measures, including further elaboration of the guiding principles adopted by the Assembly, and exploration of a global scheme for international aviation;”266 and the development of “a global CO2 Standard for aircraft aiming for 2013;”267 A year later, the Group passed Resolution A37-19, which gets rid of the 2 per cent global annual average fuel

260) Ibid., para. 91.261) European Commission, “EU Reservation to Council Decision on Joint Declaration,” 12 January 2012, available at http://ec.europa.eu/clima/policies/transport/aviation/docs/reservations_20120112_en.pdf.262) Ibid.263) Opinion C-366/10, delivered on 6 October 2011 (not yet published).264) Ibid., paras. 174-206.265) UNFCCC, “ICAO Assembly Resolution on International Aviation and Climate Change,” para. 1.2.1, available at http://www.icao.int/environmental-protection/Documents/STATEMENTS/sbsta-33_Item-6a.pdf.266) Ibid., at para. 1.2.4.267) Ibid., at para. 1.5.


efficiency improvement goal by making it “an aspirational” goal from 2021 to 2050.268

While the Advocate General’s opinion is not binding, the Court of Justice of the EU was expected to follow it. Indeed, in December 2011, the Court ruled that including aviation in the EU ETS is legal and does not violate international law (namely the UNFCCC/Kyoto Protocol or the Chicago Convention) or the Open Skies Agreement between the U.S. on the one hand and the European Community and its Member States on the other.269 In March 2012, Air Transport Association of America decided not to appeal the decision of the Court of Justice of the EU and pressed the Obama administration to bring the case before the ICAO on the grounds that the political process taking place in the ICAO platform would be more likely to achieve a reasonable outcome.270

Analyzing Article 2.2 of the Kyoto Protocol271 in the context of the EU avia-tion Directive, three pertinent questions arise: First, does Article 2.2 of the Kyoto Protocol require Annex I countries to reduce GHG emissions from inter-national aviation, or just to “pursue limitation or reduction of [GHG] emis-sions”? A careful reading of Article 2.2 shows that Article 2.2 requires Annex I countries to “pursue limitation or reduction of emissions” from aviation by working through the ICAO. Second, are States prohibited by Article 2.2 from taking unilateral action on the GHG emissions of international aviation? Nothing explicit in the Kyoto Protocol indicates so. The interpretation of Advocate General Kokott is also that the EU, for instance, is not prohibited from taking unilateral action on the GHG emissions of international avia-tion.272 Third, does Article 2.2 exclude unilateral EU action to regulate outside

268) ICAO Resolution A37-19: Consolidated Statement of Continuing ICAO Policies and Practices Related to Environmental Protection – Climate Change, 2010, para. 4.269) Case C-366/10 (not yet published). For an analysis of both the opinion of the Advocate General and the decision of the Court, see Havel, B. and Mulligan, J. “The Triumph of Politics: Reflections on the Judgment of the Court of Justice of the European Union Validating the Inclusion of Non-EU Airlines in the Emissions Trading Scheme,” Air and Space Law, Vol. 37, No. 1, pp. 3-33, 2012 (concluding “that the integrity of the international aviation system depends upon levels of international cooperation that are inconsistent with the unilateralist, interest-driven readings of legal principle evident in both the Opinion and Judgment.”).270) http://www.airlines.org/Pages/news_3-27-2012.aspx. See also Liu, J. “The Role of ICAO in Regulating the Greenhouse Gas Emissions of Aircraft,” CCLR 4/2011, p. 417; Tunteng, V. (ed.) “Legal Analysis on the Inclusion of Civil Aviation in the European Union Emissions Trading System,” Centre for International Sustainable Development Law, 2012.271) Article 2.2 of the Kyoto Protocol reads:

The Parties included in Annex I shall pursue limitation or reduction of emissions of green-house gases not controlled by the Montreal Protocol from aviation and marine bunker fuels, working through the International Civil Aviation Organization and the International Maritime Organization, respectively.

272) Opinion C-366/10, paras. 174-188.


the ICAO GHG emissions from international civil aviation? This is open to interpretation, as there is nothing written expressly in Article 2.2 regarding GHG emissions reduction emanating from civil aviation outside the ICAO context.

In this respect, the EU aviation Directive inserts a new article regarding third country measures to reduce the climate change impact of aviation, and stipulates that whenever a “third country adopts measures for reducing the climate change impact of flights departing from that country”273 which arrive in EU territory, the European Commission must consider options to provide for the “optimal interaction between the Community scheme and that coun-try’s measures.”274 However, the Directive remains sepulchrally silent when it comes to explaining what would be a measure which has “an environmental effect at least equivalent to that of [the] Directive”275 for the reduction of cli-mate impacts of flights that land in the EU.

The EU has insisted that including only EU airlines will not be effective, as the resulting GHG emissions reduction may well be offset by a growth in GHG emissions by non-EU airlines. Benoît Mayer, in support of the move, points out that there is no economic incentive for the EU in adopting this measure, and that one “should take its environmental motivation duly into account; and mitigating climate change is certainly a legitimate purpose recognized in international law, therefore allowing certain forms of legislation with an extra-territorial effect.”276

Another key legal point is whether the principle of common but differenti-ated responsibilities applies to international aviation GHG emissions. The principle is reflected in Article 10 of the Kyoto Protocol.277 The principle is also found in Article 3 of the UNFCCC and in Principle 7 of the Rio Declaration. The question is whether the principle applies to the ICAO, given that the ICAO does not regulate in the context of the UNFCCC/Kyoto Protocol. Joanne Scott and Lavanya Rajamani, however, while in agreement that the EU’s motives are to be sympathized with, argue that the “aviation decision may not sufficiently reflect or give adequate weight to the principle of Common but Differentiated

273) Directive 2008/101/EC, para. 18.274) Ibid.275) Ibid., preamble, para. 17.276) Mayer, B. ‘A Defense of the EU Emission Trading Scheme in Aviation Activities,’ p. 2, 7 November 2011, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1955817.277) Article 10 of the Kyoto Protocol reads:

All Parties, taking into account their common but differentiated responsibilities and their spe-cific national and regional development priorities, objectives and circumstances, without introducing any new commitments for Parties not included in Annex I, but reaffirming existing commitments […] and continuing to advance the implementation of these commitments in order to achieve sustainable development, […].


Responsibilities and Respective Capabilities (CBDRRC),” which calls for devel-oped countries to take the lead in efforts to mitigate climate change.278 The Arab Air Carriers Organization (AACO) doubts whether the application of the EU aviation Directive on international aviation is legal. AACO would prefer that the control of air transport CO2 emissions be dealt with at the international level by the ICAO. China Air Transport Association (CATA) goes even further to argue that the Directive is a violation of the principle of common but differentiated responsibilities279 and also breaches the Chicago Convention.280

Countries have also reacted against the aviation Directive. In a letter written to European Commission President Barroso, U.S. Secretary of State Clinton and Secretary of Transportation LaHood “strongly object on legal and policy grounds” to the application of the Directive to American airlines.281 In their view, the aviation Directive “is the wrong way to achieve our shared objective of addressing emissions from international aviation. The EU's application of the ETS to […] non-EU States is inconsistent with the legal regime governing inter-national aviation and with ICAO guidance on emissions trading.”282 Moreover, with China refusing to comply283 and with the U.S. House of Representatives having passed a bill that made compliance with the EU aviation Directive illegal for U.S. airlines,284 there is much that hangs in the balance.285

6.2.3. ShortcomingsSince Switzerland is not yet a member of the EU ETS,286 one way for airlines to minimize their financial duties imposed by the aviation Directive is for

278) Scott, J. and Rajamani, L. ‘EU Climate Change Unilateralism: International Aviation in the European Emissions Trading Scheme,’ EJIL, Vol. 23, No. 2, 2012.279) Article 3.1 of the UNFCCC. Benito Müller has analyzed the question of how to operational-ize the principle of common but differentiated responsibilities and respective capabilities as enshrined in Article 3.1 of the UNFCCC by looking at the controversy resulting from the intro-duction of international aviation in the EU ETS. See Müller, B. “From Confrontation to Collaboration? CBDR and the EU ETS aviation dispute with developing countries,” Oxford Energy and Environment Brief, February 2012.280) Statement by CATA on the EU ETS on 10 March 2011.281) Letter dated 16 December 2011 from U.S. Secretary of State Hilary Clinton and U.S. Secretary of Transportation Raymond Lahood.282) Ibid.283) ICTSD, “Beijing bans Airlines from Complying with EU Emissions Scheme,” Vol. 12, No. 2, 6 February 2012; ICTSD, “Tensions over EU Emissions Levy Reach New Highlights as China Tells Airlines not to Comply,” Vol. 16, No. 5, 8 February 2012.284) H.R. 2594 European Union Emissions Trading Scheme Prohibition Act of 2011, 24 October 2011. The aviation Directive case was eventually elevated to the U.S. Senate.285) ICTSD, ‘The Inclusion of Aviation in the EU ETS: Economic and Environmental Consequences,’ Vol. 5, No. 4, November 2011.286) On 20 December 2010, EU environment ministers agreed to start negotiations in 2011 in order to bring Switzerland into the EU ETS. For progress on the negotiations, see Swiss


out-of-the-EU flights to land in Switzerland (or any other non-EU airport near the EU) and, from there, to their final EU destination. For instance, a flight that originally would have flown from Kennedy airport in New York to Frankfurt would have an incentive to change its route so that it would land in Zurich and, from there, to its final EU destination in Frankfurt. Paragraph 16 of the Directive’s preamble clearly stipulates that “emissions from all flights arriving at and departing from Community aerodromes should be included.” This excludes Swiss airports for the time being. It is surprising that the legislator did not contemplate this in the Directive, because allowing flights to land in Switzerland, whose final destination is somewhere in the EU near Switzerland, defeats the environmental goal of reducing CO2 emissions.

The inclusion of aviation in the EU ETS may lead to an all-out trade war.287 In fact, a group of over 20 countries (including China, the U.S., India, and Russia) met in Moscow and argued that the inclusion of international civil aviation in the EU ETS may lead to serious market distortions and unfair competition.288 They perceive the EU policy on aviation as an aggressively unilateral and extra-territorial measure.289 Among the options agreed upon by this group of over 20 countries are barring airlines from participating in the Brussels plan, an action already taken by China; imposing levies or charges on EU airlines as a countermeasure; filing a formal complaint at the ICAO; assess-ing whether the EU ETS is consistent with the WTO Agreements and taking appropriate action;290 and stopping talks with EU carriers on new routes.291

Department of the Environment, Transport, Energy and Communications, “Progress of EU Negotiations,” available at http://www.bafu.admin.ch/emissionshandel/10923/10926/index .html?lang=en. The EU ETS already includes other non-EU European countries such as Norway, Liechtenstein, and Iceland. The decision that extends the inclusion of aviation to these three countries is Decision of the EEA Joint Committee 6/2011 of 1 April 2011 amending Annex XX (Environment) to the EEA Agreement, [2011] OJ L93/35.287) See Meltzer, J. “Climate Change and Trade—The EU Aviation Directive and the WTO,” Journal of International Economic Law, 1-46, fist published online: 2 February 2012. Regarding the impact of the EU ETS on U.S. aviation, see the views of Robert Malina et al. in Malina, R. et al. “The Impact of the European Union Emissions Trading Scheme on US Aviation,” Journal of Air Transport Management, Vol. 19, pp. 36-41, 2012.288) See Joint declaration of the Moscow meeting on inclusion of international civil aviation in the EU ETS, available at http://www.ruaviation.com/docs/1/2012/2/22/50.289) See the views of the South African tourism minister regarding the EU policy in Evans, R. “South Africa urges EU suspend airline carbon scheme,” The Guardian, 21 March 2012.290) On this point, see Bartels, L. “The WTO Legality of the Application of the EU’s Emission Trading System to Aviation,” European Journal of International Law, Vol. 23, No. 2, 2012; see also the views of Henri Nkuepo, who argues that “the negligence of the EU to assess the implications [of including aviation in the EU ETS] for developing and developed countries’ airlines contrib-uted in adopting a discriminatory policy and, therefore, constitutes a violation to the World Trade Organization (WTO) discrimination principles.” See Nkuepo, H. “EU ETS Aviation Discriminates against Developing Countries,” Africa’s Trade Law Newsletter, Issue 7, April 2012.291) See Joint declaration of the Moscow meeting on inclusion of international civil aviation in the EU ETS, available at http://www.ruaviation.com/docs/1/2012/2/22/50.


However, a study shows that airlines could profit from the implementation of the EU ETS.292

India urged its airlines to boycott the EU’s new policy of including aviation in the EU ETS. It also asked Indian airlines not to buy EU carbon credits.293 Interestingly, European airlines and countries have also criticized the plan of including aviation in the EU ETS on the grounds that it could affect the European aviation industry negatively.294 On a letter to the president of the European Commission, French Prime Minister François Fillon said that “it seems absolutely vital that the EU […] deploy every effort necessary to find mutually acceptable solutions with the third-party countries.”295 In response to Fillon’s letter, European Commission President said: “we continue to work very closely with all our international partners in pursuit of an international solution.”296

Moreover, the inclusion of aviation in the EU ETS does not seem to be any-where close to becoming a panacea towards climate change mitigation as things stand at present. According to a study conducted by Merril Lynch, in 2012 the costs of the aviation Directive would translate into €1.50 per passenger for the case of low-budget airlines and €1.73 to €4.35 for per passenger for mainstream airlines.297 Such de minimis figures seem to be far from the climate change mitigation purpose. Rather, the inclusion of aviation in the EU ETS seems to be a political statement by the EU to demonstrate that climate change mitigation is still on the agenda.

6.3. The Shipping Industry

6.3.1. Governance and Environment-related Remit and ActionAccording to the International Maritime Organization (IMO)—a United Nations specialized agency with responsibility for the safety and security of shipping and the prevention of marine pollution by ships—more than 90 per cent of global trade flows engage international shipping.298 This suggests that current levels of global trade flows and, ex fortiori, of global consumption

292) Petsonk, A. “On eve of Moscow meeting, new calculations reveal U.S. airlines could profit from EU can on aviation emissions,” Blog Post, Environmental Defense Fund, 17 February 2012.293) ICTSD, “India Expected to Ask Airlines Not to Comply with EU Emissions Rule,” Bridges Weekly Trade News Digest, Vol. 16, No. 11, 21 March 2012.294) ICTSD, “European Air Industry, Brussels Spar over EU Aviation Emissions Rule,” Bridges Weekly Trade News Digest, Vol. 16, No. 10, 14 March 2012; ICTSD, “Lufthansa Chiefs say EU Aviation Emissions Rule Hinders Competitiveness,” Bridges Trade BioRes, Vol. 12, No. 8, 11 May 2012.295) Letter dated 22 March 2012 from French Prime Minister to the President of the European Commission.296) Sage, A. “France Calls for Retreat on EU Carbon Tax,” The Times, 6 April 2012.297) Merrill Lynch, “Aviation in EU ETS; An Incentive for Efficiency,” September 2008, p. 7.298) See http://www.imo.org/About/Pages/Default.aspx.


would not be possible without the shipping industry, not least because of the competitive pricing of freight transport through this means.299 Shipping—involving over 50,000 vessels, 150 States of registration, and over a million of seafarers from across the globe—is a highly internationalized industry300 for which the international community has set up governance mechanisms such as the IMO.

The 1948 Convention on the International Maritime Organization (IMO Convention)301 sets up the IMO with the express remit, amongst other things, to “encourage and facilitate the general adoption of the highest practicable standards in matters concerning […] prevention and control of marine pollu-tion from ships.”302 To that end, a number of international legal instruments303 have been agreed among the 170 IMO Members, namely: the 1973 Interna-tional Convention for the Prevention of Pollution from Ships as amended by the Protocol of 1978 (MARPOL 73/78),304 and its 1997 Protocol; the 1969 International Convention Relating to Intervention on the High Seas in Cases of Oil Pollution Casualties (INTERVENTION);305 the 1972 Convention on the Prevention of Marine Pollution by Dumping of Wastes and Other Matter (London Convention/LC 1972),306 and its 1996 Protocol (LC Protocol 1996);307 the 1990 International Convention on Oil Pollution Preparedness, Response, and Co-operation (OPRC),308 and its 2000 Protocol on Preparedness, Response

299) See for instance http://www.marisec.org/shippingfacts/worldtrade/the-low-cost-of -transporting-goods-by-sea.php, where it is stated that: “Between 2000 and 2007, the value of world trade grew 12%, whilst total freight costs during this period increased by around half this figure, demonstrating the falling unit costs of transportation, including those of ocean freight. In addition, analysis carried out by UNCTAD suggests that the ratio of the various freight costs to import values continues to decline, and that total freight costs in world trade still represent, on average, less than 6% of the import value (or shelf price) of consumer goods. Although the shipping industry has enjoyed record markets and freight rates in recent years, freight costs for consumer goods have historically represented only a small fraction of the shelf price, and continu-ous improvements in technology and efficiency have helped ensure maritime transport costs remain very competitive. The transport cost element in the shelf price of goods varies from product to product, but is ultimately marginal. For example, transport costs account for only 2% of a television shelf price and only 1.2% of a kilo of coffee.” [emphasis added].300) See “Shipping and World Trade,” available at http://www.marisec.org/shippingfacts/worldtrade/index.php.301) 289 UNTS 48.302) Article 1(a) of the IMO Convention.303) It is interesting to note that “of the 51 treaty instruments IMO has adopted so far, 21 are directly environment-related or 23, if the environmental aspects of the Salvage and Wreck Removal Conventions are included.” See http://www.imo.org/OurWork/Environment/Pages/Default.aspx.304) 1340 UNTS 61; 1988 ATS No. 29; 17 ILM 546 (1978).305) 970 UNTS 211.306) 1046 UNTS 120; ATS 1985 No 16; 11 ILM 1294; UKTS 43 (1976).307) 2006 ATS 11.308) 1891 UNTS 51 / UKTS No. 84 (1999) Cm 4542 / 30 ILM 733 (1990).


and Co-operation to Pollution Incidents by Hazardous and Noxious Substances (2000 OPRC-HNS);309 the 2001 International Convention on the Control of Harmful Anti-fouling Systems on Ships (AFS);310 the 2004 International Convention for the Control and Management of Ships’ Ballast Water and Sediments (BWM 2004/Ballast Water Convention);311 and the 2009 Hong Kong International Convention for the Safe and Environmentally Sound Recycling of Ships.312 Furthermore, there are other IMO Conventions that touch upon pollution; however, these relate to questions of liability and compensation for damage.313

According to the International Chamber of Shipping, “shipping is the least environmentally damaging form of commercial transport and, compared with land-based industry, is a comparatively minor contributor to marine pollution from human activities. There has been a substantial reduction in marine pollution over the last 15 years […] despite a massive increase in world seaborne trade.”314 It goes on to state that 1990 UN figures indicate that maritime trans-port causes no more than 12 per cent of total maritime pollution, whilst 77 per cent of maritime pollution is caused by land-based discharge, atmospheric inputs, dumping, and oil exploration and production.315 It supplements these findings by stating that these figures are likely to be outdated and that the current contribution of maritime transport to maritime pollution is possibly less than 10 per cent.316 When compared to road and air transport, shipping transport, and generally the shipping industry, is the least polluting means of transporting goods. For instance, at worst, a cargo vessel emits 21 grams of CO2 per ton-km, while a truck emits 50 grams per ton-km, and a freight airplane emits 540 grams per ton-km. In that respect, shipping is the greenest form of commercial transport amongst those compared; however, given that 90 per cent of global trade in goods is transported through shipping, it is a significant

309) [2003] ATNIF 9.310) [2008] ATS 15 / AFS/CONF/26.311) IMO Doc. BWM/CONF/36 (not yet in force).312) Not yet in force.313) Namely, the 1969 International Convention on Civil Liability for Oil Pollution Damage; the 1992 Protocol to the International Convention on the Establishment of an International Fund for Compensation for Oil Pollution Damage; the 1971 Convention relating to Civil Liability in the Field of Maritime Carriage of Nuclear Material; the 1976 Convention on Limitation of Liability for Maritime Claims; the 2001, International Convention on Civil Liability for Bunker Oil Pollution Damage, and the 2007 Nairobi International Convention on the Removal of Wrecks. Furthermore, for a list of IMO Conventions, see http://www.imo.org/About/Conventions/ListOfConventions/Pages/Default.aspx.314) See http://www.marisec.org/shippingfacts/environmental/.315) http://www.marisec.org/shippingfacts/environmental/small-contribution-to-overall -marine-pollution.php.316) Ibid.


contributor to the world’s total GHG emissions by causing around 3 per cent of total CO2 emissions.317

Furthermore, between 1992 and 2008, the volume of global trade trans-ported by sea rose from 17,500 billion ton miles318 to around 32,700 billion ton miles.319 This 85 per cent increase over 16 years was not met with an increase in marine transport-related pollution, despite this increase in trade volume been largely attributable to the transportation of petroleum-related commodities.320 This is cited as an achievement due to the introduction of environmentally-minded practices, pursuant to, amongst other things, the IMO Conventions discussed above.321

The international shipping industry purports to be “closely involved in global discussions on ships’ CO2 emissions,”322 and to have worked to develop proposals for the UNFCCC that will develop further the post-Kyoto regime. In relation to the position of the shipping industry on climate change and its efforts to reduce its CO2 emissions, the shipping industry argues that it may be possible to reduce its CO2 emissions by 15 to 20 per cent over 2007 emission figures by 2020.323 However, it considers itself the ‘servant of world trade’ and its efforts to reduce GHG emission levels are being largely contingent on the projected growth of the population and of the world economy between now and 2050.324

In relation to reducing the CO2 emissions of the shipping industry, the IMO, and more specifically its Marine Environment Protection Committee, has put together a bundle of measures which, amongst other things, include an index system, analogous to that used to rate vehicles and electrical appliances, to classify new vessels according to their energy efficiency; a template for a Ship Energy Efficiency Management Plan for vessels, new and old alike, to monitor and improve performance in relation to CO2 emissions; and ideas in relation to possible economic tools to encourage GHG emissions reduction.325

317) See http://www.marisec.org/shippingfacts/environmental/atmospheric-pollution.php.318) Ton miles are “a measure of aggregate tanker traffic calculated by multiplying voyage dis-tance by volume carried for each voyage. They are a useful way of measuring overall tanker demand.” See http://omrpublic.iea.org/glossary_pop.asp?GLOSSARY_ID=79.319) See http://www.marisec.org/shippingfacts/environmental/reduction-in-marine -pollution.php.320) Ibid.321) For further details on the link between transport by sea and climate change, see Asariotis, R. and Benamara, H. (eds.) Maritime Transport and the Climate Change Challenge, Earthscan, 2012.322) http://www.marisec.org/shippingfacts/environmental/atmospheric-pollution.php.323) http://www.shippingandco2.org/industrymeasures.htm.324) http://www.shippingandco2.org/reducingco2.htm.325) International Chamber of Shipping, “Shipping, World Trade and the Reduction of CO2 Emissions.”


6.3.2. Potential Expansion of the EU ETS to ShippingThere are talks that the European Commission should expand its ETS to other fields.326 The European Commission has now turned its gaze to the shipping industry.327 It has not acted so far, as it had hoped that the IMO—which has purportedly been seized of the matter for quite some time—would have taken more robust action to manage the GHG emissions of the shipping industry. According to the European Commission, GHG emissions from the shipping industry are “a large and growing source of greenhouse gases (mainly CO2) that are causing climate change. Shipping greenhouse [gas] emissions, cur-rently approximately 900 million tones [sic] per year globally, are expected to more than double by 2050 in the absence of action.”328 It considers it essential for the international community to reduce 1990 levels of GHG emissions by at least 50 per cent by 2050 in its attempt to contain global warming increase to no more than 2 degrees Celsius. It considers current efforts of the shipping industry through the IMO to have been insufficient to the extent that “if the IMO and UNFCCC processes fail to include emissions from shipping into reduction commitments,”329 the EU may move to include the shipping indus-try under the current GHG reduction commitment regime of the EU.330

326) See for instance Nash, D. et al. “Europe’s next economy: The benefits of and barriers to the low-carbon transition,” Institute for Public Policy Research, 2012 (who suggest that the EU should expand its ETS to include imported energy-intensive goods and that ‘serious consideration should be given to extending the ETS into imported goods from energy-intensive sectors if binding emissions commitments for 2020 are not agreed by 2015’).327) See Directive 2009/29/EC, chapeau, para. 3, which states that: “The European Council of March 2007 made a firm commitment to reduce the overall greenhouse gas emissions of the Community by at least 20 % below 1990 levels by 2020, and by 30 % provided that other devel-oped countries commit themselves to comparable emission reductions and economically more advanced developing countries contribute adequately according to their responsibilities and respective capabilities. By 2050, global greenhouse gas emissions should be reduced by at least 50 % below their 1990 levels. All sectors of the economy should contribute to achieving these emission reductions, including international maritime shipping and aviation. Aviation is contributing to these reductions through its inclusion in the Community scheme. In the event that no international agreement which includes international maritime emissions in its reduction targets through the International Maritime Organization has been approved by the Member States or no such agreement through the UNFCCC has been approved by the Community by 31 December 2011, the Commission should make a proposal to include interna-tional maritime emissions according to harmonized modalities in the Community reduction commitment, with the aim of the proposed act entering into force by 2013. Such a proposal should minimize any negative impact on the Community’s competitiveness while taking into account the potential environmental benefits.”328) See http://ec.europa.eu/clima/policies/transport/shipping/index_en.htm.329) Ibid.330) Others have also proposed the application of a carbon price to shipping emissions in order to both reduce GHG emissions and raise funds for climate change mitigation and adaptation. See Gore, T. and Lutes, M., “Out of the Bunker: Time for a Fair Deal on Shipping Emissions,” Oxfam/WWF Briefing Note, 2011.


Based on a public consultation in early 2012 on whether to include maritime transport emissions in the EU’s GHG reduction commitment, as of April 2012 there had been no firm plans to extend the EU ETS per se to the shipping indus-try.331 None of the questions contained in the consultation questionnaire made a specific reference to the possibility of the inclusion of the shipping industry in the EU ETS. That said, an important accompanying policy docu-ment refers to the term ‘EU ETS’ on 65 occasions.332 What is more, the poten-tial inclusion of the shipping industry into the EU ETS must have received serious consideration by European Commission policy officials, given that an entire annex—namely Annex B—to the aforementioned policy document provides a legal analysis of its potential inclusion under the EU ETS.333 Broadly, the accompanying policy document and its annex suggest that a unilateral measure on the part of the EU to extend the EU ETS or to set up a specific ETS in relation to maritime pollution would, on balance, be permissible so long as it conforms with the EU’s international obligations under existing legal instru-ments, including the WTO Agreement and the United Nations Convention on the Law of the Sea. It highlights the bases on which objections may be raised by third parties and the counterarguments the EU may advance.334

In May 2012, the EU Council and the European Parliament reached an agree-ment whereby tougher limits were given on the sulphur content of marine fuels used by ships in order “to provide a high level of protection for human health and the environment.”335 This new Directive amends Directive 1999/32/EC regarding the sulphur content of marine fuels. The aim of the new Directive is to considerably reduce emissions from shipping resulting from the combus-tion of marine fuels with a high sulphur content, since they contribute to air pollution.336

331) The public consultation ran from 19 January 2012 to 12 April 2012. See http://ec.europa.eu/clima/consultations/0014/index_en.htm for details.332) See Faber, J. et al. “Technical Support for European Action to Reducing Greenhouse Gas Emissions from International Maritime Transport,” December 2009, available at http://ec .europa.eu/clima/policies/transport/shipping/docs/ghg_ships_report_en.pdf. See for instance p. 16 of this report, where it is suggested that there ought not to be discrimination between sectors included under the EU ETS, as well as p. 113 onwards and, particularly, the section entitled ‘5.4 Broad evaluation of policies identified,’ where there is an initial legal analysis of a move to include shipping industry emissions in the EU ETS.333) See Annex B to the report, which contains a legal analysis of EU competences to regulate international shipping emissions. Available at http://ec.europa.eu/environment/air/transport/pdf/ghg_ships_annexes.pdf.334) Ibid., pp. 16-17.335) Council of the European Union, “Council and the European Parliament reach a provisional agreement on the sulphur content of marine fuels,” 23 May 2012, 10034/12, Presse 208.336) Ibid.


7. Conclusion

Avoiding the linkage between trade and climate change is not possible. From an economic, environmental, and political point of view, these two areas are inextricably linked, and therefore the international community must find a mechanism to continue to lower barriers to trade while also combating or mit-igating the effects of climate change. Pragmatism should be the crucial ele-ment in moving the climate agenda forward: flexibility over rigidity and practical results over utopian ideals.

Given the difficulties of moving climate change negotiations forward, coun-tries are utilizing alternatives to a classical top-down approach in climate change policy-making. Evidence of this phenomenon is bottom-up policies such as low-carbon technologies receiving increasing financial support in countries around the world, and the inclusion of aviation in the EU ETS. Other UNFCCC parties are slowly introducing similar mechanisms to the EU’s unilat-eral decision to include aviation in the EU ETS: Australia intends to have in place a cap-and-trade system by 2015, and Korea and China are considering the creation of a cap-and-trade system. However, not every country agrees with the EU’s unilateral decision to include aviation as part of the EU ETS. As a reac-tion to, and rejection of, the EU’s polemic unilateral decision to tackle climate change, other parties to the UNFCCC such as the U.S. are now suggesting a global cap-and-trade regime.

Undoubtedly, the EU is being more pro-active than any other UNFCCC party when it comes to finding ways and means to reduce GHG emissions. By even considering the potential expansion of the EU ETS to the shipping industry, it demonstrates to have a preventive approach to climate change mitigation. However, its unilateral trade-related climate change measures have not so far been well received. The inclusion of aviation in the EU ETS will not mitigate the climate change problem unless other UNFCCC parties join the EU’s unilat-eral efforts for the benefit of the whole international community in the fight against climate change. In the absence of an international climate change agreement fair for all, countries may act unilaterally by having their own cap-and-trade system and by providing tax incentives to mitigate climate change.

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