• The adoption of policy measures including a carbon border adjustment mechanism (CBAM), mandatory product standards, and public procurement can address the risk of carbon leakage.
• Adopting such policies would “level the playing field” for British industry helping businesses to compete on the international market.
• Energy Systems Catapult has set out the “broad direction of travel” the government should take between now and 2030 to deliver such policies.

Unchecked carbon leakage risks undermining global efforts to decarbonise and is dampening innovation, says a new report from Energy Systems Catapult.

The report, Addressing Carbon Leakage: Maximising Innovation and Minimising Competitiveness Impacts, finds that implementing policies aimed at tackling carbon leakage can “level the playing field” for British industry such as those in the steel sector.

The UK Government describes carbon leakage as, “the movement of production and associated emissions from one country to another due to different levels of decarbonisation effort through carbon pricing and climate regulation”.

An uncompetitive playing field

British industry pays for its carbon emissions via the UK Emissions Trading Scheme (UK ETS), but for carbon-intensive industries, the playing field is not level. Industry is competing internationally with companies in countries such as India and China where an equivalent carbon price is not paid.

For instance, the spot price of carbon allowances under Britain’s Emissions Trading Scheme are $86 per tonne, whereas in China, carbon allowances are priced at $8.28 per tonne. The policies discussed in the report seek to level the playing field by applying the same carbon requirement on both domestic and international competitors.

Dr Danial Sturge, Practice Manager – Carbon Policy at Energy Systems Catapult, said:

“Carbon leakage will remain a risk while there is a disparity between domestic and international carbon policies and emissions reduction ambition. The government’s emphasis on levelling the competitive playing field by applying policies at the border is a positive step towards both domestic and international decarbonisation”.

Policy measures to mitigate carbon leakage

The report examines three policy measures that together could be used to mitigate against carbon leakage:

• Pricing – A carbon border adjustment mechanism (CBAM) that is applied to some sectors subject to the UK ETS and aligned with the proposed reduction of free allowances.
• Standards – Mandatory product standards could be implemented where voluntary efforts already exist (for example, iron and steel, and cement and concrete).
• Increasing demand – Procurement practices that include carbon requirements for products can support creating a market for low carbon goods.

With no one-size-fits-all approach to minimising the challenges around carbon leakage, we need to consider a suite of policies to address the risk. Such policies should be supported by robust carbon accounting.

This proposal to adopt policies including a CBAM, mandatory product standards, and public procurement, uses and builds on a report Energy Systems Catapult delivered to the Climate Change Committee in 2020, ahead of their Sixth Carbon Budget advice to government.

“The policies we have analysed are not without their challenges”, said Dr Sturge. “The European Union for example reached a political agreement on the implementation of a Carbon Border Adjustment Mechanism only for India and China to challenge such a policy with the World Trade Organisation. We are in uncharted territory and without an approach that is universally consistent, we risk creating a playing field that unevenly benefits international industry, reducing the competitiveness of British industry, and has a negative impact on our climate”.

“The government has an important role in mitigating future carbon leakage risk. This is not just limited to developing the appropriate domestic measures but should also include working alongside international partners. Ultimately, the competitiveness of British industry will remain constrained for as long as there are different levels of global ambition without mitigating domestic policies at the border”.

A new direction of travel

In a bid to hasten the implementation of carbon leakage policies, the report sets out the “broad direction of travel” the Catapult believes should be adopted by government:

• In 2024, structural changes to the UK ETS will be implemented, including changes to the cap to align with Net Zero.
• In 2025, the introduction of emissions reporting system requirements in a limited number of sectors will allow for voluntary product standards and low carbon public procurement to be implemented. This provides an opportunity to test requirements and collect data ahead of implementing mandatory product standards.
• From 2026, reforms to UK ETS free allowances take effect, which sees the beginning of their phasing out. Alongside this sits the introduction of a CBAM, linked to the UK ETS, in a limited number of sectors. The CBAM should expand over time and fully phase in as free allowances completely phase out.
• Late 2020s, product standards become mandatory in a limited number of sectors, before expanding over time. Standards also become more stringent over time.

The Climate Change Committee’s 2023 Progress Report to Parliament reiterates that “the UK must carefully design industrial policy to minimise carbon leakage and incentivise investment in the UK”.