Post-Brexit politics seen as an obstacle to cooperation on carbon pricing mechanisms.
A “half-hearted” Carbon Border Adjustment Mechanism (CBAM) isn’t the answer to the UK’s decarbonisation goals, and its effectiveness will depend on politically “difficult” alignment between the UK and EU’s Emissions Trading Schemes (ETS).
According to Richard Folland, Head of Policy and Engagement at financial think tank Carbon Tracker, the UK government’s plans for a UK CBAM, announced in December following a consultation, are welcome but insufficient.
“Within the wider context [of UK climate policy rollbacks], the UK CBAM is a piece of good news,” Folland told ESG Investor.
“But the real answer for businesses and investors is for the UK ETS to link to the EU ETS,” he said.
The UK ETS was split off from the EU ETS following the UK’s decision to leave the European Union, and emissions permits now trade at a lower price than on the larger market.
“British businesses, exporters and importers are all deeply integrated with the overall European market – why should we do things differently here?”
An ETS sets a cap on the amount of CO2 emissions that can be emitted by companies operating in the region, but also issues free allowances that are distributed among industries impacted by the scheme as they endeavour to transition to more sustainable practices.
In Europe, these free allowances are being phased out over time and will be replaced by a CBAM, which will equalise the price of carbon between domestic products and imports to prevent ‘carbon leakage’, an increase of emissions outside of the region in question.
The UK’s CBAM will be applied to Scope 1, 2 and some third-party emissions produced by imports including iron, steel, aluminium, ceramics, cement from 2027.
The UK government decided to implement a UK CBAM in order to reduce carbon leakage risk, and has further recognised that the mechanism is an important part of “delivering the energy transformation needed to achieve net zero”.
Details as to the criteria for interaction with carbon prices elsewhere in the world, the phase-in timeline of the CBAM, and the full scope of the mechanism, are to be determined following consultations this year.
“A question mark also remains over how the UK plans to phase out free allowances,” added Folland.
The UK ETS Authority is currently committed to maintaining current levels of free allocation for industrial sectors until 2026.
Folland said that the UK could have been “a bit bolder” by introducing mandatory standards for carbon-intensive products to demonstrate greater ambition and send a positive signal to investors, businesses and other governments.
Instead, the proposed mechanism “conveys a rather half-hearted approach to the CBAM overall”, Folland said, which is reflective of the “ongoing political uncertainty” surrounding climate-related policies UK investors have faced over the latter half of 2023.
With the UK CBAM coming into force from 2027 – and, as of yet, no new details on how it will be implemented, including transitional arrangements – Folland is concerned that the UK is falling further behind the EU.
The EU CBAM is currently in its three-year transitional period, with EU importers only required to report their emissions without paying the carbon levy. It will enter into full force 1 January 2026, meaning the UK risks a flood of high-emission products.
“The UK ETS is not as ambitious as the EU’s, and that is reflected in the respective carbon prices,” Folland added. “This has a knock-on effect for elements of the CBAM.”
The bloc’s ETS was first introduced in 2005 to cover around 40% of EU emissions; the bloc has since upped the ambition of the scheme to cover over 60% of emissions and has introduced ETS 2, which will operate as a separate market for other industries including road transport and maritime.
To address this disparity, Folland suggested that “the UK could operate in much the same way as Switzerland”.
Switzerland and the EU have had an agreement since 2020 to link their respective ETS’, mutually recognising the emission allowances of each scheme, meaning that anyone obliged to participate in either ETS can use emission allowances from both to cover relevant CO2 emissions.
“While the Conservative government is in charge, however, it’s difficult to see the UK getting closer to cooperation with the EU,” Folland admitted.
Alongside the UK CBAM announcement in December, the UK ETS Authority launched two consultations on proposed changes to the UK ETS and its free allowances to ensure it continues to support progress to net zero across the UK. Both are open to feedback until March.
Despite the UK and EU differences on carbon pricing, Folland from Carbon Tracker said it should form a crucial part of global climate policy to realise the goals of the Paris Agreement.
“While the US has decided to incentivise and build up the clean energy sector through the Inflation Reduction Act, the EU ETS, in particular, has an established track record of taking emissions off the table,” he said.
“The argument for carbon pricing comes from that track record, and the number of countries and regions that have since also decided that carbon pricing can be an effective policy tool to tackle climate change.”