Factory emitting carbon emissions with the ambition of reduction through CBAM

The United Kingdom is set to introduce a pioneering environmental policy in 2027 with the introduction of a carbon import levy targeting carbon-intensive products.

Announced by the government, this measure is a strategic endeavour to align international trade with the nation’s ambitious climate objectives. Here, we provide an in-depth analysis of the upcoming levy and its broader implications.

 

Key Aspects of the Carbon Levy

The carbon border adjustment mechanism (CBAM) is a significant policy shift, poised to transform the landscape of importation and manufacturing in the UK. This mechanism is particularly targeted at sectors known for their high carbon emissions, establishing a new framework in how these industries operate and trade.

The CBAM will impact imports in carbon-intensive sectors such as iron, steel, aluminium, fertiliser, hydrogen, ceramics, glass, and cement. These sectors are chosen due to their significant contribution to global carbon emissions. The selection of these sectors is based on their environmental footprint and the potential for carbon leakage, where production might shift to countries with more lenient environmental regulations.

The levy is calculated based on the carbon emissions produced during the manufacturing of imported goods. This approach considers the entire supply chain, from raw material extraction to production. The mechanism is designed to quantify the carbon cost more accurately and impose a levy that reflects the true environmental impact of these goods. It aims to bridge the gap between carbon prices in the country of origin and those faced by UK producers. This disparity often results in unfair competition where domestically produced goods are at a disadvantage due to stricter environmental regulations.

 

Primary Objectives and Goals

Finance Minister Jeremy Hunt has emphasised the necessity of this levy to ensure parity in carbon costs for imported goods in sectors like steel and ceramics, compared to those produced within the UK. This parity is vital to prevent the undermining of the UK’s environmental policies by imports from countries with lower carbon costs. A key goal of the CBAM is to contribute effectively to global emission reduction. By imposing this levy, the UK aims to discourage carbon leakage, ensuring that its decarbonisation efforts do not inadvertently result in increased emissions in other parts of the world. The levy is also seen as a tool to incentivise other countries to strengthen their environmental policies, creating a ripple effect in global carbon emission reduction efforts.

 

Detailed Overview of the UK’s Emissions Trading System (ETS)

The UK’s Emissions Trading System (ETS), inaugurated in 2021, is a cornerstone of the country’s climate policy, instrumental in its journey towards achieving Net Zero emissions by 2050. This system is an integral part of the UK’s strategy to reduce greenhouse gas emissions and plays a critical role in incentivising sustainable practices in various sectors.

Mechanism of the ETS

The ETS works on a ‘cap-and-trade’ principle. It sets a cap on the total amount of certain greenhouse gases that can be emitted by installations covered by the system. Within this cap, companies receive or buy emission allowances which they can trade with one another as needed.

Each allowance gives the holder the right to emit one tonne of CO2 (or its greenhouse gas equivalent). The cap on allowances reduces over time, thus decreasing the total emissions allowed and helping the UK meet its climate targets.

Comparison with EU and China’s ETS and Industry and International Perspectives

The UK’s Emissions Trading System (ETS), while modelled on the EU’s framework, diverges significantly following the UK’s departure from the EU. The UK has established an independent ETS, tailored to its specific environmental targets and needs. This divergence is evident in several aspects, including the sectors covered under the scheme, the caps set for emissions, and the carbon pricing. Notably, the UK’s carbon price under its ETS has generally been higher than that of China’s, indicating a more robust approach to carbon reduction.

In parallel, the EU has already initiated a similar system to the UK’s proposed carbon levy, with plans to start imposing CO2 emissions tariffs on imports by 2026. This move by the EU is viewed as a significant step in managing carbon emissions at an international level. However, there are concerns about the timing of the UK’s levy implementation. The UK’s mechanism is set to be introduced a year after the EU’s, which could potentially affect trade dynamics and the competitiveness of UK industries.

From an industry perspective, key stakeholders such as UK Steel’s Director General, Gareth Stace, has emphasised the importance of the UK’s domestic measures. The implementation of the UK’s carbon levy is seen as crucial to prevent a potential influx of high-emission products into the UK market, which could occur following the activation of the EU’s system.

Internationally, the responses to these carbon levies have been mixed. China’s top climate envoy, Xie Zhenhua, has urged nations to refrain from adopting unilateral measures like the EU’s levy. Such appeals highlight the complexities and challenges in achieving a globally coordinated response to carbon emissions and underscore the need for harmonisation in environmental policies across different regions.

These developments indicate a growing international focus on carbon management through trade mechanisms and emissions trading systems. They also reflect the evolving landscape of international trade, where environmental considerations are becoming increasingly integral to trade policies and agreements.

Comparative Market Prices: A Closer Look at the UK and China’s ETS

The carbon pricing under the Emissions Trading Systems (ETS) in the UK and China highlights a significant disparity, reflecting differing approaches and commitments to carbon reduction.

UK’s ETS Pricing: The UK’s ETS, a key part of its strategy to reduce greenhouse gas emissions, has set its carbon price at approximately 36.60 pounds per metric ton. This price point is indicative of the UK’s aggressive stance on tackling climate change and its commitment to achieving Net Zero emissions by 2050. The higher carbon price in the UK serves as an economic signal, incentivising businesses to invest in cleaner, more sustainable technologies and practices to reduce their carbon footprint.

China’s ETS Pricing: In contrast, China’s ETS trades carbon at around 71.60 yuan per ton. When converted, this equates to approximately 8.40 pounds (considering the exchange rate of 1 pound to 8.52 yuan as of the latest figures). This price is significantly lower than that of the UK’s ETS. The lower carbon price in China may reflect different stages in economic development, policy priorities, and approaches to climate change mitigation. It may also be indicative of the broader scale of industrial activity in China and the balancing act between economic growth and environmental sustainability.

Implications of the Price Disparity

This stark contrast in carbon pricing between the UK and China has several implications. For businesses operating internationally, it creates a complex landscape where carbon costs can vary dramatically depending on the region of operation. The disparity also raises questions about the effectiveness of carbon pricing as a tool for global emission reduction, especially considering the varying economic contexts and climate policies of different countries. For policy-makers, this poses a challenge in harmonising international efforts to combat climate change, as countries navigate their economic realities while trying to align with global environmental targets.

The difference in carbon pricing between the UK and China is a microcosm of a global challenge in implementing effective carbon pricing mechanisms. It underscores the need for international collaboration and dialogue to find a balanced approach that accommodates different economic and environmental contexts. Such variations also highlight the importance of understanding regional market dynamics for businesses and investors looking to adapt to the emerging realities of a carbon-constrained world.

Future Outlook

The introduction of the UK’s carbon import levy in 2027 marks a critical step in harmonising trade policies with climate goals. This move reflects a growing trend towards using economic tools to promote global environmental responsibility. While the policy aims to establish a level playing field for UK producers, its effectiveness and impact on global trade and emission reduction efforts will hinge on its implementation and global response.

 

How We Can Help

McGrady Clarke is well-positioned to assist businesses in navigating the complexities of the UK’s new carbon levy. Our expertise can help organisations:

  • Assess the Impact: We offer thorough assessments to determine how the CBAM will affect your business operations and international trade activities.
  • Strategic Planning: Our team can assist in developing strategies to mitigate the financial impact of the levy, optimising supply chains, and sourcing strategies to reduce the carbon footprint.
  • Compliance and Reporting: We provide guidance on compliance with the new regulations and support in accurate carbon reporting, essential for adhering to the levy requirements.
  • Sustainability Initiatives: McGrady Clarke can help businesses implement sustainable practices and technologies that not only comply with the levy but also advance broader environmental objectives.

Contact us today to discuss how we can help your organisation with the upcoming changes.