What are the UK’s ETS and CBAM, and why should we align them with the EU’s equivalent schemes?
In the lead up to the Election, Labour explored plans to align the UK’s carbon regime with the EU’s if they were to win the Election.
Now that they are in power, and their EU ‘reset’ is off to a promising start, we look into the current carbon border tax situation in the UK, the problems that exist with it and why it is so important that the Government follows through with their plans for EU alignment.
What is the UK ETS?
To reduce the emission of carbon dioxide, and keep up with climate change commitments, the UK applies a carbon tax on certain domestic products based on the amount of carbon dioxide emitted during the manufacturing process.
Pricing is determined by the UK Emissions Trading Scheme (ETS) which was set up in January 2021 to replace the EU Emissions Trading System, which the UK left following Brexit.
What are the problems with the UK’s ETS?
Emissions trading schemes like the UK’s, often lead to ‘carbon leakage’; a phenomenon where countries with stringent carbon rules, like the UK, end up exporting their carbon usage by relying on imports from other jurisdictions where they face less stringent regulations, or none at all.
The result is that while the UK ETS scheme reduces carbon dioxide emissions domestically, this reduction is often compensated or nullified by emission increases in other jurisdictions with less stringent regulations. The overall volume of carbon emissions pumped into the atmosphere does not therefore go down.
What is a CBAM?
A Carbon Border Adjustment Mechanism (CBAM) is a mechanism implemented by governments to address the problem of carbon leakage.
This is done by applying a charge to the carbon emitted during the production of imported carbon-intensive goods. These fees cover the difference between the emission fees in the country of production and fees under domestic carbon pricing schemes, meaning that imported goods face an overall comparable price to those goods produced in-country.
The EU was the first to announce a CBAM. It is currently in a transition period, and is expected to be fully operational from 1 January 2026.
In response to the EU’s plans, industry leaders and trade bodies throughout the UK called on the UK Government to implement a similar tax. Indeed, in the UK Trade and Business Commission’s report Trading our Way to Prosperity, published in May 2023, it is recommended that the UK Government design and implement a carbon border adjustment mechanism and that it linked the UK ETS with the EU ETS.
In December 2023, the UK Government finally announced that it would be bringing in its own CBAM to support the UK’s decarbonisation drive, but that it wouldn’t be in place until 2027, a full year after the EU CBAM.
What are the benefits of having a UK CBAM?
The UK CBAM should discourage UK-based importers from buying goods that have been produced in a carbon-intensive way. This allows UK manufacturers to remain competitive, as it will prevent them from being undercut on price by foreign rivals whose governments impose less stringent levies on businesses that emit a lot of carbon, or do not impose levies at all.
It should also encourage UK manufacturers to work towards decarbonising production.
Those exporting to the UK may also be incentivised to change their production methods in order to meet UK decarbonisation criteria and remain competitive suppliers. In this way, a UK CBAM will hopefully affect carbon usage beyond the UK’s borders too.
Are the EU and UK carbon border tax schemes aligned?
The UK CBAM will be similar to the EU’s CBAM but they will not be aligned.
The UK’s ETS is also not currently aligned with the EU Emissions Trading System.
What problems arise if the UK’s and EU’s schemes are not aligned?
While the introduction of a UK CBAM has been welcomed, the Government has been criticised for failing to align the UK CBAM with the EU’s in terms of start date but also more widely in areas like pricing, which would mean linking ETS schemes, and administration.
Divergent timings
Because the UK’s CBAM is due to come into force in 2027 — a year after the EU’s version — industry is concerned that the UK risks becoming a temporary dumping ground for carbon intensive goods such as iron, steel, cement and fertiliser as global rivals seek to avoid paying the EU’s CBAM.
Divergent pricing and administrative systems
The cost burden of duplicative reporting requirements - and of managing differing pricing schemes - runs the risk of slowing down and significantly decreasing trade in goods between the UK and EU.
The UK is likely to lose out far more here, with the possibility of some EU manufacturers deciding that exporting to the UK is not worth the extra cost. Meanwhile, UK manufacturers who are tied to the EU as their largest export market are unlikely to find alternatives and will have to somehow navigate the costs and administrative requirements of divergent systems. These costs will probably be passed on to UK consumers.
Note, the UK’s carbon price is at present lower than the EU’s under their respective carbon pricing schemes, which means British exporters to the EU could end up paying hundreds of millions of pounds extra to make up the difference.
What has the UK Government said about linking the UK and EU schemes?
It was reported in June that Labour were exploring how to realign the UK’s carbon regime with the EU’s if they were to win the Election.
Since Labour came to power, however, there has been no update on plans to align the two schemes.
What is Best for Britain campaigning for?
As recommended by the UKTBC, Best for Britain campaigns for the full alignment of both the UK CBAM and ETS schemes with the EU’s equivalent schemes.
Unless both schemes are fully aligned, trade friction will not be reduced.
This article first appeared on Best for Britain