United States: Perkins Coie And Fasken Martineau Lawyers Discuss Trade Issues Linked To Climate Change Regulation

Climate change and trade are inextricably linked. Increasingly, businesses will face cross-border differences in carbon regulation and related trade pressures. 

Today, Canadian and U.S. legislators are pressing forward with policies that will regulate greenhouse gas (GHG) emissions.  Policymakers are trying to achieve a regulatory framework that will have the desired impact on climate change, preserve the competitiveness of domestic industries and manage any negative international trade implications.  These three goals may be difficult or impossible to reconcile.

Recently, Perkins Coie Partners Mike House and Allan Abravanel, and Fasken Martineau Partners Peter Kirby and Marks Sills participated in a panel discussion where they reviewed possible trade issues raised by current and future GHG regulation. This update highlights their discussion.

Our Panelists

Our Interview

Q.  How Can GHG Regulation Impact International Trade?

Kirby:  Domestic GHG policies impose regulatory costs on industry.  These costs may affect the competitiveness of an industry relative to imports from countries that don't impose similar costs on their producers.  While economists agree free trade makes everyone better off on average, the political reality is that domestic producers and unions spend a lot of political capital trying to limit imports that may not face the same costs.  For many domestic manufacturers, the imposition of GHG costs provides a strong argument to "level the playing field" against imports. 

House: That's where the disputes arise – the line between making trade fair by leveling the playing field and imposing unfair costs on foreign producers almost always depends on your perspective.

Abravanel:  Climate change regulation is going to have a big impact.  The production process of some goods, such as oil & gas and cement, directly releases large quantities of GHGs.  It will be costly to control those releases.  Other producers will be indirectly affected because the energy they use will cost more as a result of GHG controls.  If different countries adopt different GHG regulations, production costs around the world for identical goods will vary. 

Sills:  Obviously, there is a big incentive to impose equivalent costs on imported goods  to offset any economic advantage such imported goods may enjoy through lack of regulation in their countries of production.  Governments may try to use various sorts of measures to do that, including tariff and nontariff barriers, subsidies, and domestic tax policy.    

Q.  Won't Free Trade Agreements Prevent That?

Abravanel:  Yes, in theory anyway.  Global free trade agreements like the World Trade Organization [WTO] agreements and regional treaties like the North American Free Trade Agreement [NAFTA] are supposed to provide participants with protection against new trade barriers. 

Kirby:  But while these agreements impose discipline on a country's trade policy, they don't eliminate each country's right to take action in areas such as the environment, health or national security.  Those actions can hurt trade.

Sills: Many of these same international trade agreements that limit governmental discretion to impose discriminatory trade barriers against goods from other countries will permit individual countries, in defined circumstances, to protect their environmental or health  standards.

Kirby:  But the agreements don't give a country an absolute right to impose whatever environmental or health measure it thinks appropriate.  The exceptions require that the measures be nondiscriminatory. 

House: That's right, it is a very difficult balance.  The rulebook for international trade includes a number of exceptions and principles that have been built in over the years to preserve that balance.  What is interesting about climate change regulation from a trade policy perspective is whether it fits within these exceptions.

Q.  Can You Provide Examples Of These Historical Exceptions?

Abravanel:  Some good examples in the area of public health have been in the news over the past year or so.  The United States prohibited the importation of toys and other products containing lead-based materials, for example, because they are illegal to produce in the United States  Various countries have prohibited the importation of foreign meat or other food products in response to various health or food poisoning scares.  Those types of restrictions clearly limit "free trade" but are permitted because of the health and welfare purpose they serve.

Kirby:  An example in the area of environmental protection occurred in the late 90s  when the United States imposed environmental restrictions on U.S. refiners of reformulated gasoline.  At the same time, it attempted to impose trade barriers on imported gasoline, claiming those barriers to be the equivalent of the domestic rules.  Venezuela and Brazil brought a WTO complaint to challenge the imposition of these barriers and won.  The U.S. trade barriers were found to be discriminatory and, therefore, prohibited.  In this case, the trade barriers were not saved by the historical exception for environmental issues.

Sills:  I think the message here is that climate change regulations may be permitted if properly designed to meet WTO standards, but it isn't a sure thing.  Critical issues will include the equivalence and the nondiscriminatory nature of the measures in question. 

House:  Another key question is whether the measure is directed to benefit a specific industry or industries.  Recently, the United States granted substantial renewable energy tax credits to domestic paper companies that reuse black liquor, a thick, dark, combustible liquid generated in the production of paper.  The tax credit benefits companies that combine "renewable" fuels – in this case, the black liquor, with fossil-based fuels – in this case, diesel fuel.  U.S. paper companies are able to qualify for this credit, thereby obtaining a major price advantage against Canadian producers.  The Canadian producers, through the Canadian government, claim this tax credit is an unlawful U.S. subsidy under WTO rules and NAFTA.  Despite the harm caused to Canadian producers, there are strong counterarguments to justify the incentive as part of a much larger, and generally applied, domestic program to encourage renewable energy.

Q.  Many Climate Change Regulations Are Being Proposed At The Sub-National Level As, For Example, By The Members Of The Western Climate Initiative.  Could An Individual State Or Province Take Measures To Reduce GHG Emissions Within Its Borders If The Effect Discriminates Against Imports? 

Kirby:  The general rule is that each country is responsible for the acts of sub-national entities like states or provinces.  There are many examples in which state and provincial measures have been challenged as violative of trade agreements.  A province or state can legislate in its areas of jurisdiction to limit GHG emissions, but is subject to challenge if its rules discriminate against imports.  A nondiscriminatory carbon tax imposed on all goods sold in the state would likely be acceptable under applicable trade agreements, but a tax only on foreign-origin goods would not.  So long as provincial or state rules are not discriminatory as a matter of law or fact, they would likely be acceptable.

Sometimes a measure might seem non-discriminatory but is discriminatory in practice.  Consider a carbon tax based on each product's GHG emissions over its entire life cycle.  Such a tax might be deemed discriminatory against imported goods, because the carbon footprint of goods imported over long distances will include GHG emissions resulting from the transportation required to bring these goods to local markets.  Even GHG regulations that indirectly favor local producers may violate trade law.

Q.  What Can A Business Do If It Encounters A Trade Barrier?

Sills:  International trade agreements do not create private rights.  The most effective way for private business to resolve international trade issues is to work through industry groups and persuade government agencies to take up the issue at the international level.  The EU ban on importation of genetically modified organisms [GMOs] was recently resolved after a series of WTO panel decisions and continuing negotiations between the EU Commission and both the U.S. and Canadian governments.

House:  A disadvantaged domestic producer could also seek its own domestic subsidy to combat another country's trade barrier and preserve its competitive position relative to producers in that other country.  But as we have seen, certain domestic subsidies can run afoul of multi-lateral anti-subsidy agreements if the domestic subsidy is too specific to a particular industry.

Abravanel:  There's an example in the Waxman-Markey Bill (HR 2454), which passed the U.S. House of Representatives on June 26.  The House version provides free emission allowances to industries that must compete with goods from foreign nations that do not similarly regulate GHG emissions.  The effect in trade terms would be to relieve certain domestic industries from some of the costs of compliance with the U.S. GHG regulations.  This program of free emission allowances might survive a trade challenge, if it were perceived to permit domestic industries to compete more effectively against producers of goods in countries without climate controls.  If, however, it were perceived as subsidizing competition with goods of countries imposing climate controls of some sort, it could very well be invalidated. 

House:  It is not certain the Waxman-Markey provision would limit exemptions only as necessary to compensate for goods produced in countries without climate controls.  Furthermore, the legislation's imposition of border measures after 2020, which would require importers to buy carbon permits for imports from countries unlikely to take action to fight climate change, could make the law vulnerable to a successful challenge at the WTO (particularly as the current bill sharply limits presidential discretion to exempt such measures in particular circumstances).

Q.  What About Offsets?  Could Defensible Trade Barriers Be Erected To Protect Domestic Offsets Relative To Imports?

Abravanel:  Just to be clear, cap-and-trade programs are often designed to permit an entity subject to a cap to meet all or part of its obligation with an "offset," which is a verified third-party carbon reduction that comes from a sector that is not capped.  The relationship between offsets and trade law is very complicated because what is permitted under trade law always depends on the unique history of each restriction and how it is applied in each circumstance.  There is even a question of how an offset should be characterized – is an offset a good, a service or something else entirely?  The answer to this question of characterization determines the trade rules that would apply.

Kirby:  A country could decide to recognize domestic GHG reductions only as offset credits, just as governments usually grant tax credits only for domestic investments.  It could be argued that a refusal to recognize all foreign reductions as offsets (a complete prohibition on trading of nondomestic offsets) is more likely to survive international scrutiny than any hybrid scheme where some, but not all, foreign reductions are recognized.  A country that prohibits all foreign trading in a commodity can rightly claim to be treating all foreign companies and all foreign countries alike.

House:  Perhaps "trade" in offsets is really about mutual recognition of certification or verification agencies and standards between countries.  The United States would have an interest in ensuring the integrity of any credits purchased by U.S. companies for domestic use.  This implies that the United States would have to approve or accept a determination by a foreign agency regarding qualification of an offset credit.  Since it would be impossible to have an international carbon market without an international agreement that addresses some of these trade issues, we expect many of these issues to be defined before 2012 and the replacement of the Kyoto Protocol. 

Q.  Can We Expect Trade Disputes In The Future?

Kirby:  Domestic manufacturers will demand protection from any policy that gives importers an economic advantage.  On the other hand, U.S. or Canadian climate change measures that affect imported goods negatively will be closely scrutinized for compliance with U.S. or Canadian trade obligations.  Unless climate change policy is neutral in terms of its trade impact, there will always be the possibility of disputes over implementation.  This may explain why several groups argue that a simple carbon tax is a better option than a cap-and-trade program.

House:  Of course, trade laws and remedies available under multi-lateral trade agreements are not perfectly suited to address all situations that involve real barriers to trade.  We have seen many instances in which governments have enacted measures that restrict trade but these measures have, nevertheless, prevailed when challenged.  Industry can't rely on trade agreements and domestic trade law remedies alone to achieve a level playing field.  It's important for industry to be vigilant and proactive in addressing protectionist proposals or broad policy measures that may have unintended trade impacts.  Forming an effective strategy early, in consultation with legal experts, can help nip those threats in the bud and avoid the very difficult job of reversing damaging trade restrictions.

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