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UK carbon proposals shore up climate policy credibility

Shortly before Christmas the Government announced plans to introduce a levy on the import of carbon-intensive raw materials into the UK by 2027.

Known as the UK Carbon Border Adjustment Mechanism (CBAM), the announcement follows in the wake of the EU’s decision twelve months ago to introduce the world’s first carbon border levy.

Working alongside the UK’s emissions trading scheme (ETS), the UK CBAM is expected to mean that importers must pay a charge equivalent to the difference between the UK’s carbon price (currently trading around €45-50 per tonne), and that payable in the country of origin. The amount charged will depend on the amount of carbon emitted in the production of imported raw materials.

The UK CBAM is expected to cover imports of iron and steel, aluminium, cement, fertiliser, hydrogen, and ceramics and glass into the UK, closely mirroring the raw materials initially expected to be covered by the EU’s CBAM, albeit with some crucial differences. Electricity imports are currently omitted from the UK CBAM, while ceramics and glass are not included in the EU CBAM, at least initially.

The precise list of raw materials in scope (in addition to other factors) will be the subject of consultation in 2024. Under the EU’s carbon border levy all sectors covered by the EU ETS, including the production of oil and refined products, are thought likely to be subject to the EU CBAM by 2030.

One key consideration for North Sea operators in the consultation is the UK Government’s position on these raw materials.

Container ship Marseille Maersk at berth in Felixstowe Docks, Suffolk UK on 7th October 2018. Shutterstock/Anthony Smith Images

Plugging leaks

The UK CBAM is scheduled to launch in 2027, one year later than the EU CBAM comes into force. During the intervening period carbon-intensive raw materials previously imported into the EU could be diverted into the UK, putting downward pressure on prices. Although that could be beneficial to North Sea operators seeking to secure steel to build out infrastructure, it could also reduce the attractiveness of domestic hydrogen production in the UK.

As with the EU CBAM, the full cost of the UK carbon levy is likely to be phased in gradually as free allowances for industrial sectors are phased out. The December announcement confirms that the “UK CBAM will work cohesively with the UK ETS, including free allowances,” adding that the “Authority will also review whether free allocation should be adjusted to reflect any changes to carbon leakage risk for given sectors.”

The consultation on UK free allowances closes on 11 March 2024.

In the long term the CBAM is likely to result in an increase in the cost of imported carbon-intensive raw materials into the UK. Countries that export obligated raw materials to the UK must either introduce a carbon price comparable to the UK, or take action to reduce their production carbon intensity, or some combination of the two. The alternative is that their exports become uncompetitive as global trade becomes progressively constrained by carbon.

Ruth Herbert, head of the UK’s Carbon Capture & Storage Association welcomed the news as a “good starting point for tackling carbon leakage” on the most carbon-intensive products, adding that the mechanism would help UK manufacturers invest in areas such as CCUS without fear of being undercut by producers elsewhere. 

“The details of this policy will need to ensure that exports are not disadvantaged, and that other sectors, such as refining or electricity production can benefit, as many are ideally situated in industrial clusters where they can deploy CCUS,” she added.

Many businesses operating in the UK North Sea will already be wrestling with the requirements of the EU CBAM. The transitional phase which involves collecting data on embodied emissions from importers began on 1 October 2023, and the first filing deadline (31 January 2024) has recently passed. Oil and gas operators wishing to avoid further bureaucratic headaches in the future now have an opportunity to ensure that the EU and UK CBAM’s are aligned by responding to the forthcoming consultation.

New measures aim to prevent UK emission allowance prices from falling too low – and too rapidly – in the event of a surplus allowances. The risk is that the incentive to decarbonise could be weakened if carbon prices fall too low.

ETS volatility

In addition to the UK CBAM announcement, the Government has also invited industry to comment on proposed changes to the UK ETS. Since its launch in May 2021, the UK ETS has been significantly more volatile than its EU counterpart, and over the past twelve months has been plagued by much lower carbon prices.

All five of the proposals detailed in the consultation, which also closes on 11 March 2024, refer to policies that could stabilise the market.

The measures aim to prevent UK emission allowance (UKA) prices from falling too low – and too rapidly – in the event of a surplus of UKAs. The risk here is that the incentive to decarbonise could be weakened if carbon prices fall too low.

On the flipside, the proposals are also aimed at managing excessive volatility to the upside, and controlling for very high prices – the risk being that sharply higher carbon prices could become a burden for industry.

One of the most important proposals is the Supply Adjustment Mechanism (SAM). The consultation document describes it as a “type of market stability policy that predictably amends the supply of allowances in the market in response to certain pre-determined criteria and market conditions”. The draft outline appears to closely mirror the EU’s Market Stability Reserve (MSR) that began operating in 2019.

The design and delivery of the mechanisms will be subject to further consultation in 2024, but overall, the proposals outlined should be commended for injecting some much-needed credibility into the UK’s climate policies.

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