UK Government Announces New Import Carbon Pricing Mechanism | Latham & Watkins LLP

Goods imported into the UK from countries with a lower or no carbon price will face a levy by 2027.

 

On 18 December 2023, the UK government announced a proposal for a new carbon border adjustment mechanism (UK CBAM). The announcement follows extensive consultation earlier this year on possible measures to mitigate carbon leakage risks and aims to support the UK’s decarbonisation efforts.

The UK has made a number of decarbonisation commitments including reaching net zero by 2050. These commitments to decarbonise can be undermined by “carbon leakage”, in which production of goods and associated emissions move from a jurisdiction with more ambitious climate policies (which add costs to carbon-intensive processes) to another jurisdiction with less ambitious policies, resulting in an overall negative impact on the carbon intensity of the processes/goods themselves. The UK CBAM (or other form of carbon tax) seeks to address this issue by aiming to put a fair price on the carbon emitted during the production of certain carbon-intensive goods entering the UK.

UK ETS

Currently the UK’s main measure to mitigate carbon leakage risk is the system of free allocation under the UK Emissions Trading Scheme (UK ETS). The UK ETS puts a price on greenhouse gases emitted by domestic producers, through a “cap-and-trade” system, in which total carbon emissions and allowances under the scheme are capped. To mitigate carbon leakage risks for sectors that UK ETS covers, a proportion of UK ETS allowances are assigned to operators in exposed sectors for free. The government intends the UK CBAM to work alongside the UK ETS to mitigate the risk of carbon leakage.

Alongside the proposal of the UK CBAM, the UK’s ETS regulatory authority is simultaneously consulting on methods to better target free allocations of carbon allowances for industries at most risk of carbon leakage under the UK ETS. It is also setting out plans to ensure the UK ETS market continues to offer an effective financial incentive to drive participants to decarbonise.

For more information on the UK ETS, refer to this Latham blog post.

Details of the UK CBAM

The UK CBAM will be implemented by 2027, and will apply a charge on the carbon emissions embodied in imports from a number of sectors which are carbon-intensive in production:

  • aluminium
  • cement
  • ceramics
  • fertiliser
  • glass
  • hydrogen
  • iron
  • steel

The UK CBAM will be applied to Scope 1, Scope 2, and select precursor product emissions embodied in imported products to ensure comparative coverage with the UK ETS.

The carbon price will adjust for free allowances and other reductions to the carbon price paid domestically, and will account for explicit carbon prices in other jurisdictions.

Comparison to EU CBAM

The EU is in the transitional phase of application for its own CBAM, which runs from 1 October 2023 until 31 December 2025. During this period, relevant importers will only be required to report on emissions subject to the EU CBAM, without paying any financial adjustment. Following the transitional phase, the full EU CBAM will be phased in from 1 January 2026. The EU CBAM has a similar aim and function to the UK CBAM: to mitigate the issue of carbon leakage.

For more information on the transitional phase of application of the EU CBAM, see this Latham blog post.

There have been calls from industry for a UK CBAM to protect trade between the UK and the EU. Further, with the introduction of the EU CBAM, the UK government faces challenges in aligning its own carbon market with the EU’s, to avoid British manufacturers facing levies on their exports under CBAM (as carbon prices in the UK market are significantly lower than those on the EU market).

However, the EU CBAM and UK CBAM measures bear some notable differences:

  • Effective date: The UK CBAM will only come into effect from 2027, whilst the EU CBAM comes into full application from 1 January 2026. This difference in date is a departure from the expected application for the UK CBAM to be aligned with EU policies.
  • Scope of products covered: The EU CBAM does not apply to ceramics and glass, but applies to electricity unlike the UK CBAM.
  • Carbon pricing: As noted above, carbon prices in the UK are currently significantly lower than in the EU. British exports could therefore still face levies under the EU CBAM if the UK does not formally link its carbon pricing to the EU. The government has said it will consult in more detail on the criteria for carbon prices elsewhere in the world to be recognised by the UK CBAM.

Next Steps

The design and delivery of the UK CBAM will be subject to further consultation in 2024, including the precise list of products in scope.

In addition to the UK CBAM, the government also announced its intention to work with industry stakeholders to establish voluntary product standards that businesses could choose to adopt to help promote their low carbon products, and to develop an embodied emissions reporting framework that could help inform future related policies.

Latham & Watkins will continue to monitor developments relating to the UK CBAM, and other climate-related UK and global regulatory updates.

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