Carbon leakage can occur if the competitiveness impacts that arise from carbon policies lead to emissions reduction from domestic organisations combined with increases in emissions in other jurisdictions, where carbon policy is either less ambitious or does not exist. This can lead to a net increase in global emissions. Carbon Leakage will remain a risk while there is a disparity between the strength of domestic and international carbon policies.

The UK government’s consultation, ‘Addressing carbon leakage risk to support decarbonisation’, sought views on potential policy measures. Separately, a review of UK ETS free allowances will take place alongside considerations to ensure a clear transition from existing to future carbon leakage mitigation policies.

In this report, which also serves as our response to the government’s consultation, we focus on three carbon policy approaches:

• Pricing – A CBAM that is applied to some sectors subject to the UK ETS and aligned with the proposed reduction of free allowances. It should be designed in a way that facilitates the smooth flow of trade and keeps the administrative burden to a minimum. The price applied by a CBAM should reflect the effective carbon price paid by domestic industry, calculated using the total amount arising from direct and indirect carbon policies less the value of relevant exemptions, compensation, and free allowances.
• Standards – Mandatory product standards could be implemented where there already exists voluntary efforts (for example, iron and steel, and cement and concrete). Determining their intended role alongside other carbon policies, including a potential CBAM, will be an important consideration. Engaging with the British Standards Institution (BSI) could enable improved industry buy-in, and a potential route to their international use through the International Standards Organisation (ISO).
• Increasing demand – Public procurement often constitutes a significant share of national markets for industry supplied goods. Although not sufficient by itself, procurement practices that include carbon requirements for products can support creating a market for low carbon goods.

We also cover the associated carbon accounting and reporting requirements necessary for their operation. A carbon accounting framework that provides an accurate and quantifiable picture of emissions across industry, including on imported goods, will be essential enablers for carbon leakage policy measures.