Ambitious policies can prevent carbon leaking offshore as UK industry tackles Net Zero

Published: 9 December 2020

A new independent report produced for the Climate Change Committee suggests the right Government policy can minimise the impact of Net Zero on the competitiveness of UK industry and reduce the offshoring of carbon emissions.

But there is no silver bullet and a wide package of policy measures will be needed, including a market for negative emissions and transitioning from initial subsidies to a set of standards – including at the border – that tighten over time in line with carbon budgets.

Industrial Decarbonisation: Net Zero Carbon Policies to Mitigate Carbon Leakage and Competitiveness Impacts was written by Energy Systems Catapult for the CCC as an input into their Sixth Carbon Budget advice to Government, due out this week. The report says careful policy design can deliver deep decarbonisation, while ensuring energy-intensive, trade-exposed (EITE) industries are not disadvantaged compared to international peers experiencing less-ambitious carbon policies (such as pricing, regulation, subsidies, and standards).

Energy Systems Catapult policy advisor, Dr Danial Sturge, said: “Badly designed Net Zero carbon policies not only have the potential to put UK firms at a competitive disadvantage with their international peers, but could actually cause an increase in global emissions.

“Carbon leakage occurs when emissions are reduced in the UK due to industry moving offshore where it’s cheaper to operate because carbon policies are less ambitious or non-existent. This can lead to a net increase in global emissions. Preventing carbon leakage is a win-win.

“On our way to a Net Zero economy, careful policy design will be required to support British industries, allowing the time and investment for businesses to adapt to the transition.

“The alternative is not only further offshoring of UK emissions and losing green jobs, but there is real risk we let the opportunities of a green industrial revolution slip by.

“The UK can take the lead in developing low carbon markets across manufacturing – from the materials we use to build our homes to the zero carbon cars we drive, from the vast wind turbines that power our economy to the fertilisers we use to grow our food.

“As the Climate Change Committee’s Sixth Carbon Budget advice shows us, there is no room for industry to continue emitting the harmful greenhouse gases like it does today. Industry know this, but there are genuine concerns about the impact of ever stringent climate targets for those that trade on the global market.”

EITE industries are constrained in their ability to pass through carbon policy costs due to actual or potential international competition. Measures aimed at mitigating these concerns are often a trade-off between preserving competitiveness and incentivising emissions reduction. Yet a single carbon policy is unlikely to completely mitigate competitiveness impacts without significantly diluting the incentive to reduce emissions.

Timings and Phasing of Carbon Policies

Energy Systems Catapult evaluation broadly suggests a transition from subsidy-based support in the near-term to the longer-term use of standards, including at the border, to both mitigate carbon leakage and enable deep decarbonisation of industry in line with Net Zero. These should also be considered as part of wider policy packages, including a market for negative emissions.

  • Immediate steps can be taken to realise benefits in the near-term, including continuing to provide direct funding and by improving the methodology for allocation of free allowances under a UK ETS. These can build on existing policies, which is important for business continuity in the context of Brexit and impacts of COVID-19.
  • Alongside these, design and implementation of additional support measures such as low carbon public procurement practices and carbon contracts for difference (i.e. setting a strike price for carbon for a project) can play an important role for beginning to develop low carbon markets.
  • In the interim, a border carbon adjustment mechanism could be developed as part of a longer-term pathway, which could be integrated with a UK ETS and form the basis for wider coverage of standards on producers.
  • Over time, these could be phased down as longer-term policies are fully implemented, including standards on carbon for both purchasers and producers, with border standards eventually used for the latter.
  • The phasing of these will enable industry to adjust, with a UK ETS and the wider set of standards tightening over time in line with carbon budgets.

Recommendations for Policymakers

The following recommendations are intended to provide the direction for an overall approach to industrial decarbonisation that would most effectively mitigate carbon leakage and competitiveness impacts in line with the Climate Change Committee’s Sixth Carbon Budget Pathways:

  1. Study the policy pathways required for industrial sectors, in particular, where competitiveness impacts affect investment decisions, including differences between cluster and non-cluster based firms.
  2. In the near-term, continue to provide support to industry through direct funding and explore alternative policy measures, for example, carbon contracts for difference for low-regret projects.
  3. During Phase I of a UK ETS, implement improvements in the methodology for allocation of free allowances, for example, by using output-based allocation. These should be phased down during the 2020s and potentially replaced with a targeted border carbon adjustment mechanism calibrated to align with the UK ETS price and phased in from 2025.
  4. Explore the use of standards on both producers and purchasers as part of the long-term policy framework to enable industrial decarbonisation. To begin, standards on producers could employ a form of flexible compliance, for example, tradable performance standards. Standards on purchasers could be initiated through a low carbon public procurement programme providing initial demand for low carbon products, before expanding to cover other sectors.
  5. In the long-term, to ensure that the implementation of standards are aligned with Net Zero levels of ambition while mitigating competitiveness impact, explore options to impose standards on producers at the border on imported products.