The UK has finally confirmed that it will be following the EU and introducing its own Carbon Border Adjustment Mechanism (CBAM) to be implemented by 2027.

It published the eagerly awaited outcome of its consultation on this on 18 December. It is also consulting on further changes to the UK Emissions Trading Scheme (ETS). In this article we consider the current position in the UK and future direction for policy in this area.

It published the eagerly awaited outcome of its consultation on this on 18 December. It is also consulting on further changes to the UK Emissions Trading Scheme (ETS). In this article we consider the current position in the UK and future direction for policy in this area.

How did we get here?

The UK launched a consultation in March 2023 on Addressing carbon leakage risk to support decarbonisation (the Consultation) to look at potential policy measures needed to mitigate the risk of carbon leakage. The concern is that the efforts to decarbonise UK industry with the aim of reducing global emissions could be undermined if decarbonisation in the UK leads to “carbon leakage”, i.e. driving businesses and their associated emissions to other countries with lower or no carbon price.

The UK currently has an Emissions Trading Scheme (UK ETS) which places a price on greenhouse gases emitted by domestic producers. The UK ETS works on a “cap-and-trade” principle whereby a cap is set on the total amount of carbon that can be emitted by those in scope, with the cap reducing over time to incentivise decarbonisation. However, the more ambitious the UK’s policies on emissions, the more risk that producers might be tempted to move elsewhere.

The Consultation notes that the UK’s current main measure to mitigate carbon leakage risk is the system of free allocation under the UK ETS. Those operators within the scheme deemed most at risk of carbon leakage are provided with a proportion of UK ETS allowances for free. The idea being that this reduces exposure to the carbon price for those operators. Participants can also buy ETS allowances at auction or on the secondary market which can be traded with other participants, ensuring there are still economic incentives for reducing emissions.

The UK has been reviewing the operation of the UK ETS and consulted on changes to this in 2022. This resulted in the UK ETS Authority announcing in July 2023 that ETS allowances available for purchase from the government would reduce by 45% between 2023 and 2027, whilst the current level of free allowances were guaranteed until 2026. The UK ETS was also extended to cover more sectors, domestic maritime transport from 2026, waste from 2028, with a phasing out of free allowances for the aviation industry in 2026.

A new UK CBAM

The UK has now confirmed that it will introduce a UK CBAM that will apply to imports of iron, steel, aluminium, ceramics and cement from overseas. Interestingly, despite some overlap with the EU CBAM, there is not direct alignment, with hydrogen and electricity being in scope of EU CBAM but not the UK version (and ceramics being in UK but not EU CBAM).

The new UK CBAM will apply “by 2027”. In the EU, the reporting obligations began in October 2023, with the full regime kicking in from 1 January 2026. The UK has not yet specified whether there will be a transitional “reporting only” phase for the UK CBAM. Unlike EU CBAM, the UK version will not involve the purchase or trading of certificates, but rather UK CBAM liability will lie directly with the UK importer.

The amount of the UK levy will depend on both the amount of carbon emitted in the production of the imported good and the gap between the carbon price applied in the country of origin and that applied in the UK. UK CBAM liability will take account of the impact of free allowances and so will apply an effective carbon price to imports which will be “significantly lower” than the headline UK ETS price.

UK CBAM will apply to Scope 1 emissions (direct emissions from producing a product), Scope 2 emissions (indirect emissions eg from the electricity used to power industrial processes) and some upstream Scope 3 emissions (namely those from the production of selected precursor products by other manufacturers in the supply chain which are incorporated into the imported products).

There will be a further consultation in 2024 on the design of the UK CBAM, including questions around the precise list of products in scope.

The Consultation also explored whether it made sense to introduce mandatory product standards (MPS) or voluntary product standards (VPS). MPS would involve product regulations that set upper limits on embodied emissions of industrial products. The government concluded that further evidence and analysis would need to be carried out before implementing MPS given differing views from stakeholders on the likely impact of such measures for specific sectors. VPS, on the other hand, was thought beneficial as this would “help differentiate higher and lower carbon versions of products, empower actors across the supply chain to make informed lower carbon purchasing decisions and could incentivise manufacturers to go further in implementing decarbonisation measures”. The government is therefore going to consult on the detailed proposals for this as part of the wider consultation in 2024. It is also considering options for product labelling to support the effectiveness of VPS. The use of product labels would also be voluntary, but the increased transparency could help consumers choose lower carbon options.

The government is also continuing work on developing an embodied emissions reporting framework – looking at what data would need to be collected and reported and considering whether the reporting would be voluntary or mandatory. The UK, sensibly, will have an eye to other international reporting requirements and UK ETS mechanisms to try to ensure alignment and streamlining of processes where possible.

What next for the UK ETS?

Alongside the announcement of the UK CBAM, the UK also launched new consultations on the UK ETS on 18 December. The Review of Free Allocation looks at how free allowances can be better targeted for stationary installations from 2026 to 2030. The Future Markets policy seeks to ensure the ETS remains fit for purpose, that it continues to offer effective financial incentives driving participants to decarbonise and tackles relevant risks effectively.

Also of interest is the 2023 Review: a stocktake of the UK ETS so far and the paper on “The long-term pathway for UK Emissions Trading Scheme”. These papers confirm that the UK ETS Authority will continue the ETS beyond 2030 until at least 2050. It also confirms that the UK ETS Authority will continue to explore expansion of carbon pricing to more sectors, taking account of the government’s Net Zero Strategy and confirming the proposed expansions announced in July 2023.

What does this mean for business?

It comes as no surprise that the UK has decided to adopt its own CBAM. The UK ETS system replaced the UK’s involvement in the EU ETS and its thinking has been closely aligned with the EU in this area. For those already starting to grapple with the EU CBAM, it will be hoped that the two systems will be closely aligned to minimise compliance costs and administrative burden. Similarly, industry has made it clear that the UK CBAM must integrate effectively with UK ETS processes. Any divergences between the different systems will cause administrative headaches and compliance costs: are the products in scope defined in the same way; are different methodologies used to determine the level of emissions in scope; how will pricing work; what tracking and reporting obligations will there be? And not to forget the impact on the cost of goods and international trade with the UK. 2024 is set to be a significant year for UK policy in this area. We will be keeping an eye on developments in this space.