News and Analysis • Volume 10 • Number 7 • November 2006

WTO Rules and Sustainable Energy Policies

Interest in multilateral regulation of energy and natural resources policies is increasing as economic growth and the deepening geographical mismatch between demand and production boost international oil and gas trade and prices

Energy is distributed highly unevenly throughout the globe. Sixty-nine percent of known oil reserves are held by members of the Organisation of the Petroleum Exporting Countries (OPEC),1 while Russia, Norway, Mexico and Kazakhstan are the world’s largest non-OPEC net oil exporters. In most major non-OPEC countries governments generally have little control over production levels as oil sectors are owned by private companies,2 which react to demand signals, exploring and extracting more when prices are high.

High prices encourage non-OPEC production of conventional and non-conventional oil.3 They are also likely to have favourable impact on the implementation of policies to reduce air pollution and greenhouse gas (GHG) emissions, and improving energy security. In addition, high prices and technological developments increase opportunities for alternative energy sources.

On the other hand, the sharp drop in oil prices in 1998-1999 led many oil-exporting countries to start economic reforms aimed at diversifying their economies and reducing reliance on oil. Moreover, WTO accession has given an additional push for domestic reforms in energyendowed countries.

Gas resources are more widely spread than oil. Most of these reserves are located in the Middle East (34 percent of the world total), Europe and the former Soviet Union (42 percent of total world reserves). Demand for natural gas is likely to grow significantly as it is projected that, for economic and environmental reasons, gas will become the power industry’s preferred fuel.

Energy-exporting countries often express concern that the high consumption and excise taxes imposed by importing countries on energy products reduce their revenues from finite resources. However, as long as these taxes are applied in a non-discriminatory manner, they are in line with WTO rules.

Energy and the WTO

Specific disciplines on trade in energy did not form part of the original GATT. One of the possible reasons for this is the initial non-participation of energy exporters in the agreement. The issue was also much politicised due to the strategic nature of energy products, and state practices affecting natural resources and energy have been (and remain) sensitive and controversial. Security considerations have largely shaped trade policy in the energy sector.4

During the Uruguay Round, some countries endeavoured to introduce specific disciplines on certain practices of energy-exporting countries, such as dual-pricing and the resulting subsidies, export restrictions/taxes and discriminatory procurement These attempts, however, were not successful because resource-endowed countries were apprehensive of binding rules on trade in natural resources.

Nevertheless, it is commonly accepted that existing WTO rules apply to energy products, although in can be argued that these rules are not optimal for solving some trade-related problems in the energy sector. Traditionally, WTO disciplines have been devised in a manner that addresses import barriers to a larger extent than export barriers. In energy sector, however, export restrictions are the main trade barriers.

Export duties on energy materials and products constitute an important revenue source for energy-exporting countries. Issues related to these countries’ restrictive practices, as well as those of monopoly energy enterprises that often enjoy exclusive rights and privileges, are not substantially addressed in existing multilateral trade rules, nor are transit problems. Moreover, a comprehensive investment framework is lacking.

Could policies to combat climate change fall foul of multilateral trade disciplines?5 Possibly; for instance financial support to producers of renewable energy might be challenged under WTO subsidy rules. The national treatment principle applies to internal taxes and charges, laws and regulations. Internal taxes on imported energy material and products may not be higher than those on ‘like’ goods produced domestically. Technical regulations and standards to promote efficient use of energy must not constitute unnecessary obstacles to trade.

Energy Taxation

Carbon dioxide and energy taxes can be applied directly to fuels, electricity and downstream industries that use energy as input – on the basis of the amount of carbon dioxide emitted or energy consumed in their production.

The question arises whether countries pursuing environmental objectives could discriminate among energy goods on the basis of the eco-friendliness of the technologies used in their production. The answer is not straightforward, and is further complicated if the final products possess identical physical characteristics and have the same enduse, such as electricity generated by nuclear power or renewable sources. In this case, it would be difficult to argue that differently generated types of electricity are not ‘like’ products.

The WTO dispute settlement system has dealt with environmental taxes. The first case concerned an EU challenge of a US tax on automobiles. The measure was introduced to create an incentive to purchase more fuel-efficient cars. Because most cars affected by the measure were European, the EU claimed that the tax was inconsistent with GATT Article III:2 (equal treatment for domestic and imported like products). The panel found, however, that fuel-inefficient imported cars were not ‘like’ fuel-efficient domestic cars. Thus, they could be treated less favourably.

In the Superfund case, brought against the United States by Mexico, Canada and the EU, the panel examined a US tax on petroleum imposed with the objective of financing the clean-up of hazardous waste sites. Although the panel found that some aspects of the US measure were inconsistent with GATT Article III, it recognised the possibility of imposing domestic environmental taxes.

Border Tax Adjustments

When a state with high environmental standards imposes substantial energy taxes, energy-intensive goods produced in the country become less competitive compared to foreign products that are not subject to such regulations. Therefore, the country might choose to refund the taxes to companies upon exportation. The government might also wish to impose additional taxes on imports of products from countries that do not adhere to such a high level of environmental protection.

WTO rules do not clearly define the eligibility of some border tax adjustments. According to the Agreement on Subsidies and Countervailing Measures, prior-stage6 cumulative indirect taxes can be exempted at the border when levied on inputs that are consumed in the production of the exported product, i.e. inputs that are physically incorporated, such as energy, fuels and oil used in the production process.7 The adjustment does not pose a problem when an energy tax on the product itself is levied or reimbursed at the border. Opinions are divided, however, on whether border tax adjustments are permitted under WTO law for taxable inputs that are not physically incorporated in the final product. For instance, it is not clear if a tax on carbon dioxide emissions during the good’s production can be adjusted.

Subsidies

The fact that certain renewable energy sources are not currently commercially viable makes the question of the WTO-compatibility of different support schemes particularly acute.

Such programmes cannot be contingent upon export performance (they would fall under the category of prohibited subsi dies). Subsidies found to be specific to certain enterprises, industries or groups thereof are considered actionable and products benefiting from such subsidies can be countervailed. Alternatively, a WTO Member can request the withdrawal of such subsidies if they cause adverse affects.

Limiting the subsidy to producers of renewable energy could meet the criteria of ‘specificity’. For instance, if a government decided to grant financial support to energy production plants using renewable energies, this programme would be deemed specific, i.e. actionable subsidy.

The question is how to design programmes aimed at attaining environmental objectives without the financial support being considered an actionable subsidy. A possible solution might be to devise objective criteria or conditions governing the eligibility for, and the amount of, a subsidy, make eligibility automatic and carefully monitor compliance. The criteria and conditions should be transparent and clear. For instance, a possible criterium could be a certain level of carbon dioxide emissions during the production. Although it is possible to devise programmes encouraging efficient energy use in general, attempts to directly support renewables industries are more likely than not to fall into the category of actionable subsidies.

Technical Regulations and Standards

Technical regulations and standards are important tools to increase efficient use of energy and reduce GHG emissions.

The Agreement on Technical Barriers to Trade prohibits discrimination through technical regulations. Moreover, technical regulations, standards and conformity assessment procedures should not create unnecessary obstacles to trade or be used as protectionist tools.

The requirement of non-discrimination is applies ‘like products’, but given the ongoing debate on how to determine ‘likeness’, it is not clear whether the methods of energy production could be considered as the basis for legitimate differentiation between goods produced using more or less energy-efficient processes.

Conclusion

WTO rules apply fully to trade in energy products and materials, although they were not specifically designed to tackle energy-related issues. For instance, it is not clear how provisions on the freedom of transit would be interpreted by a WTO panel in case of a dispute. Some traderestrictive practices of energy companies are not covered by WTO rules on state trading enterprises. The implementation of domestic policies related to environmental protection and the reduction of GHG emissions pose some questions in terms of compatibility with WTO rules. Yulia Selivanova is an expert with the Energy Charter Secretariat in Brussels.

ENDNOTES

1 As of January 2005. This includes Canadian non-conventional reserves. Not including Canada, this estimate of OPEC share rises to 84 percent.

2 Mexico is a notable exception; the country’s constitution grants PEMEX, the state oil company, a monopoly over its oil production.

3 Production from Canadian oil sands has increased significantly, as well as production of deep water off-shore fields.

4 Murray Gibbs. 2003. ‘Energy Services, Energy Policies and the Doha Agenda’ in Energy and Environmental Services: Negotiating Objectives and Development Priorities. UNCTAD

5 Art. 3, para. 5 of the UNFCC provides: “Measures taken to combat climate change, including unilateral ones, should not constitute a means of arbitrary or unjustifiable discrimination or a disguised restriction on international trade.” Parties to the Kyoto Protocol “shall strive to implement policies and measures …in such a way as to minimize adverse effects, including… effects on international trade” (Art. 2 of the Protocol).

6 Taxes levied on goods or services used directly or indirectly in making the product.

7 Footnote 61 to the Agreement on Subsidies and Countervailing Measures