Comment by Dr. Danial Sturge, Carbon Policy Practice Manager at Energy Systems Catapult. 

In the run up to Christmas 2023, the UK government announced the implementation of a Carbon Border Adjustment Mechanism (CBAM) by 2027. By applying a carbon price to imported goods across industrial sectors (including aluminium, cement, ceramics, fertiliser, glass, hydrogen, iron, and steel), a UK CBAM will enhance domestic industry’s ability to decarbonise, improving incentives for innovation, and ensure we continue to lead the way to Net Zero.

Energy Systems Catapult has previously explored the role of different carbon leakage measures, including a CBAM. I’ll be the first to admit that before the EU committed to implementing a carbon price on imported goods, I was pessimistic about ever seeing what is effectively a tax on imports from polluting countries.

The EU leading the way

With the EU having taken the all-important first step, we are pleased to see the UK government following suit.

This is of course, good news for homegrown industry. To date, industry have received subsidies – in the form of free allocation of allowances – via our own carbon market, the UK Emissions Trading Scheme (UK ETS). But this has served to dull the incentive to reduce emissions domestically, while largely mitigating the risk of carbon leakage. Separately and related, government are reviewing free allocation, including interactions with a CBAM; a positive step to join up a complex policy landscape.

Levelling the playing field

A CBAM, on the other hand, levels the playing field, by setting the carbon price experienced by domestic industry to be equal to equivalent products when imported. Ultimately, providing UK industry the incentive to decarbonise, while reducing the risk of losing their competitive edge to other jurisdictions where carbon policy remains nascent or non-existent.

Importantly, it also reduces the exposure that exporters to the EU will face. While technically the EU’s CBAM will be levied on EU importers, the knock-on impacts to producers and exporters here in the UK will be felt eventually. And the risk of this is high because the current carbon price that arises from the UK ETS is around half of the EU’s own emissions trading scheme.

Challenges remain

A key question that remains is whether a UK CBAM will be challenged through the World Trade Organisation (WTO), as we have previously seen for the EU’s version. The EU have sought to overcome this by placing the obligation on EU importers (rather than the producers/exporters of other jurisdictions). The details of a UK CBAM are subject to further consultation in 2024, but if the UK mirrors this, it will go some way to mitigate potential challenges.

It’s all in the detail

Carbon accounting also remains a significant challenge. For example, UK industry still may face an additional administrative burden when reporting emissions for the EU CBAM if they differ from the current requirements of the UK ETS. Government have hinted at developing a new emissions reporting framework that aims to maximise the use of existing data and minimise industry burden, but this is also subject to further consultation later this year. Positively, there is strong support for an independent regulator to verify product embodied emissions, reflecting the work we have been doing as part of the Carbon Regulator project.

But a CBAM is not the only tool available to government. In its earlier consultation, other measures including mandatory product standards were suggested. As we have published before, we have long been proponents of standards for their use in mitigating carbon leakage. While government has said it will continue to explore whether there is a role for mandatory product standards, it does not intend to implement for any specific sectors at this point. It will, however, pursue voluntary product standards, which could later enable mandatory versions.

There are also wider enabling factors that remain to be addressed, including what is taken into account when calculating the CBAM liability. There does appear to be broad consensus that a CBAM should apply a price comparable to the domestic carbon price – tracking the prevailing UK ETS price – and account for discounts.

At this stage, the government have been light on the detail, but the overall sense of direction has been laid out; we will see a UK CBAM, there will be better policy join up across carbon leakage measures (new and old), and carbon accounting sits at the heart of its success. We will be following closely as the details of a UK CBAM are worked out, and as the policy is implemented.