20
European Affairs Committee
Corrected oral evidence: Dynamic alignment
Tuesday 2 June 2026
11 am
Watch the meeting
Members present: Lord Stirrup (The Chair); Baroness Ashton of Upholland; Lord Barrow; Lord Brennan of Canton; Lord Elliott of Mickle Fell; Lord Jackson of Peterborough; Lord Moynihan of Chelsea; Baroness Smith of Newnham; Lord Tugendhat.
Also present: The Duke of Wellington.
Evidence Session No. 8 Heard in Public Questions 74 - 83
Witnesses
I: Frank Aaskov, Director, Energy and Climate Change Policy, UK Steel; Max Green, Senior Policy Manager, Trade, Make UK; Will Webster, Chair, UK Emissions Trading Group Ltd (ETG), and Head of Regulatory Economics, Centrica.
USE OF THE TRANSCRIPT
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Frank Aaskov, Max Green and Will Webster.
Q74 The Chair: Good morning and welcome to this evidence session of the House of Lords Select Committee on European Affairs, where we are conducting an inquiry into the issue of dynamic alignment. This morning, we are delighted to have as our witnesses Mr Frank Aaskov, who is director of energy and climate change policy at UK Steel; Mr Max Green, who is senior trade and regulation policy manager of Make UK; and, joining us online courtesy of the Tube strike, Mr Will Webster, UK Emissions Trading Group Ltd, and head of regulatory economics at Centrica. A very warm welcome to you all. It is a pleasure to have you all, and we are delighted to have your contributions this morning. We will provide you with a transcript of the evidence for you to correct any errors and omissions afterwards. It is a public session, of course, so what you say is on the record. I just remind you that we are trying to get this done within an hour, so if the questions and the responses could be reasonably concise that would be enormously helpful. Thank you very much.
I will get us started, if I may, with a general question, which is about how the European Union’s carbon border adjustment mechanism is currently being applied to exports from the UK, what difference it is making to your members—your constituents—compared to the pre-CBAM era and what difference it would make if the UK were exempt. In addressing that question, I should be very grateful if you could give us some idea of the scale of the difference. Is it something for which you would sell your soul, or is it something that would be nice to have but it would depend very much on the trade-offs? Mr Aaskov, would you like to start?
Frank Aaskov: Of course. Thank you so much for having me here today. I am very pleased to be here to provide oral evidence. Just before I answer the question, perhaps it is worth defining what a CBAM is and what the intent of the policy is. Fundamentally, it is a carbon tax at the border that is meant to equalise carbon costs between domestic producers and imported products.
The UK Emissions Trading Scheme places a carbon cost on domestic manufacturers, but imported products have not historically faced such cost, and that obviously then negatively impacts domestic producers and drives production abroad. In particular, in the steel industry, which I represent, over 90% of the world’s steel production does not face any comparable carbon costs and, as a result, that does put us at a commercial disadvantage, hence why a CBAM is now being considered—in the EU, it is currently in place, and will be from January next year in the UK. Again for the steel industry specifically, we are very trade intensive; 60% of our production is exported. Of that production, between 70% and 80% has historically gone to the EU. I think last year it was 71% and the year before 78%, so it is within that range. It is our biggest export market and key to our sector.
I would say, looking at how the EU CBAM has been applied, that it has perhaps been a bit of a chaotic start. They had a two-year transition period after which it was implemented, and we had some of the guidance being issued very late—up until a couple of weeks before, even some guidance being issued a couple of weeks after, and there is still some guidance that is outstanding.
In terms of giving you a sense of the scale of this, because we have carbon prices in the UK, really what the EU CBAM is asking us to do now is demonstrate what those carbon costs and our emissions are—ie, it is an admin cost—but also then to pay the difference between them. UK Steel estimates that to be, for a tonne of steel, probably around £10 to £15 per tonne. Just for reference, a tonne of steel, usually, depending on the grade, is about £650, but because of the intense competitiveness of the steel industry, we say that any deal where you can make a difference of £5 or more is usually enough to sway a commercial deal either which way. So it is significant in terms of that.
In particular, as well, EU importers are now increasingly requesting from external suppliers that they deliver on a delivered duty term—ie, where we sign up to paying any kind of CBAM liability, regardless of what it is in future. That increasingly puts a financial barrier on UK steelmakers who are exporting directly to the EU. Not only is there an administrative barrier to trade to our biggest market, there is now also a financial barrier, so it is quite significant for us. We therefore strongly urge the Government to work for mutual exemption between the UK CBAM and the EU CBAM.
Max Green: Frank gave a very good overview of the CBAM in his points, but, more specifically, our exporters are facing quite a lot of additional burdens, including not only administrative burdens by supplying our EU buyers with information, but also financial burdens from the extra staff costing of doing this. Not only is this impacting in more friction over borders causing slight delays and increased administration on both the UK exporter and the EU importer, but it also has indirect impact on the attractiveness of the UK as a potential supplier to EU businesses. Supply chains are at risk, as EU businesses will start to look at other businesses to supply from, mostly within the EU, to stop having this administrative and financial burden on them.
In terms of the sectors and businesses most affected we have, first, the greatest in the ETS and CBAM-covered sectors and their supply chains, particularly for firms that are highly integrated into the EU value chains and operate on low margins, especially those businesses that already face very high energy costs or supply larger EU manufacturers that pass data and compliance demands down the chain.
SMEs within the UK will face quite large administrative burdens as well. The EU CBAM does have an exemption of 50 tonnes going into that market. However, this is done over all of the suppliers from the EU, not based on one single export from the UK to the EU. So even if you are an SME in the UK and you are supplying a larger manufacturer in the EU, you will be caught up with this CBAM. If the UK were exempt with ETS linkage and through an exemption from the EU CBAM, obviously it would help reduce all of this trade friction, help protect the competitiveness of UK products within the EU, pushing back from that and securing the EU supply chains. It could also increase the attractiveness of the UK as a supplier into the EU over non-EU and non-UK suppliers.
The Chair: Mr Webster, do you have anything to add to that?
Will Webster: Yes, just a couple of things. I will not repeat the analysis that Frank and Max have given because it is the same for all of the sectors affected who are members of the ETG. I will say just a couple of things about practicalities. The exporters will have to start buying the certificates to export into the EU from February 2027 to cover their 2026 exported volumes, and then that will all be settled in September 2027. That is just to give you an idea of the timeline that we are talking about here for the introduction of the scheme.
I will make just one point about the electricity sector, which is a member of the ETG so is part of this. Some of the difficulty will be around when we are exporting electricity, which we do to the continent at periods when wind is high, for example. There is a practical issue about how you attach an emission value to a particular unit of electricity, because this is a fungible commodity that you cannot ring fence and say that that piece of electricity—that electron—was produced with a certain technology. There is an added complication with electricity trade that is on top of the other things that the other witnesses have mentioned.
Q75 Lord Jackson of Peterborough: Just to come back to Mr Green, can I press you a little bit on the evidence that Make UK submitted to the committee? I just press you on two interesting parts—caveats—in the evidence. You talked about the reduction of compliance costs over time, specifically, and you also talked about a caveat if the scheme was designed appropriately. The first question is: what period of time are you looking at for us having an advantageous position? How long will that take? Secondly, what are the different scenarios for the design of the scheme and which is the more advantageous one?
Max Green: To answer your first question around compliance costs and how long it would take, this is more of a longer-term benefit, whereas the carbon pricing of the UK would be more stable in a larger market and that would allow businesses to have that business confidence to invest. With compliance over time, there would be a more stable price to be able to invest and to be compliant. That is a lot longer a time scope. I am sorry; what was your second question?
Lord Jackson of Peterborough: The design of the scheme, because at the moment, you are putting a lot of eggs in this basket. You do not know what the regulatory, policy or legislative framework of any of this is. You are just saying, “Well, it is good because it will reduce bureaucracy”.
Max Green: The design of it is really important. For example, it would be more advantageous if the design looked at a much larger scope, which would look at a much broader range of products within the EU, which we would then have that exemption to. Other things to include are the decision-making that the UK would have in the informal consultation that we would have on that, so that we could be in the room when decisions were made about future ETS reform.
The last point is about the treatment of goods. If the treatment of UK goods were exactly the same as EU ones, then that would help the competitiveness, based on the fact that the UK would become an attractive market again to import these goods under CBAM.
Q76 Lord Brennan of Canton: Apart from its effects in exempting the UK from the EU’s carbon border adjustment mechanism, what are the potential benefits and risks of an emissions trading scheme, a linkage agreement or indeed any of its specific potential terms?
Will Webster: I shall say a bit about the members of the ETG. It was set up as a forum for discussions between industry and government on some of the practical features of emission trading, and it dates back to the early 2000s. Most of our members support the concept of linkage. There are a lot of attractive features to it from the perspective of the businesses that are required to purchase emissions. The UK scheme has been set up efficiently and effectively by the department and the officials, but being in a larger bloc gives you a lot more certainty and reliability about the scheme going forward. It is a larger market, so it is more predictable. Any one company’s purchases or sales of allowances have less impact on the wider market, so you have less risk from the perspective of buying and selling emission certificates.
The point about linkage and CBAM that we have just discussed is an important one. If we have several different trading schemes, then CBAM trying to make up the difference between them and even them out is definitely a burden, and that creates a lot of uncertainty for investors in emitting industries. Those are the main reasons why we think it creates a lot more certainty about where the scheme is going.
Lord Brennan of Canton: Obviously your members are in favour of this, but are there any new risks that it creates?
Will Webster: It varies a bit between sectors. As with any kind of scheme where you are going in with another entity, shall we say, there is a discussion about the parameters of the scheme. Schemes always sound simple but then the detail of them has to be sorted out.
I will give you a couple of examples of things that people have flagged in the work we have done. Currently, some emitting industries get a proportion of free allocation. For the EU, that free allocation is based on a benchmark level based on the emissions achieved in that sector across the EU, while for the UK it relates to the sector across the UK. After the schemes were separated, there have been some differences in the way that that benchmark is calculated. Now, the EU benchmark is calculated without any UK data at all, depending on the sector, and I will not attempt to go into how that plays out in practice. You have these differences between the benchmarks that you are supposed to try to achieve, and that affects the amount of free allocation and which sectors get which free allocation. Going from one thing to another creates a set of risks, and then linking back into the original one creates a second set of risks. So across our membership there is an acute awareness of the risks of this type of change, but on balance I think people are in favour of it.
Frank Aaskov: I support Will’s analysis. When we looked at linking, we looked at three benefits. One, as Will pointed to, was the low liquidity and the market being too small. That was pointed out in DESNZ’s own evaluation of the scheme, where it said: “Traders expressed concern about perceived lower liquidity and higher volatility in the UK ETS compared to the EU ETS”. That is a concern as well in terms of price discovery.
I also point to the fact that, prior to exploring linking more formally, most analysts expected UK carbon prices to increase above those in the EU by 2028, partly due to its much tighter cap and smaller market, and that would have cost us in terms of competitiveness. Finally, in terms of the CBAM, there is obviously a huge benefit in linking and removing both those financial and administrative barriers.
I also very much support Will’s comments about the risk of the benchmarks not being included and wider scheme benefits. With everything, there are trade-offs. On balance, our members are in support, but they are very concerned about benchmarks being applied to them that they have had no say in or input into.
Lord Brennan of Canton: Mr Green, anything different to add, or do you just want to endorse what is been said?
Max Green: I endorse what everyone has said: creating that larger liquid carbon market helps to stabilise prices over the long run and to increase business confidence when it comes to investment and compliance costs. Again, there are trade-offs with it, as has already been announced.
Q77 Lord Elliott of Mickle Fell: As you know, energy costs are a huge issue for both consumers and businesses. Would an ETS linkage agreement have an effect on UK energy costs?
Frank Aaskov: We see both positive and negative effects from linking in terms of electricity prices. I believe that Energy UK has set out that, just by having linkage, you would see more efficient trading through the interconnectors in terms of the electricity market—a maximum saving of around 0.75% per year, so a relatively modest effect but still a positive one. At the moment, UK ETS carbon prices are lower than they are in the EU, so in the very short term we expect there to be a negative impact on electricity prices, industrial electricity price included, because that would increase overall power prices. However, again, as I referred to earlier, most analysts had expected UK carbon prices to go above those in the EU by 2028, and at that point you would see a benefit because you would have lower prices by being part of a bigger market. That is our assessment.
Max Green: I am not sure there is much to add from our point of view, except that linkage would mean the stabilisation of carbon prices over the longer term, so any effects on costs would likely come through this indirectly.
Will Webster: Where industries are using gas, not electricity, there probably is not too much additional impact in the sense that you pay the gas price for the gas you use and then the carbon price based on the amount of gas you are burning. That will just depend on whether the UK emission price is higher or lower than the European one, and it has been both over the past few years—sometimes it has been higher and sometimes lower.
In terms of how linkage will help with electricity markets, to give an example, a significant issue on the electricity system is the management of constraints. Sometimes the NESO, the system operator, has to ramp up a thermal plant to deal with the constraint on the GB system. Linking the emission market and the electricity markets in a more efficient way reduces the cost of that, because, instead of ramping up a thermal plant, you can just flow in the required electricity from France, Belgium or somewhere.
There is quite a bit of gain from that—Frank referred to the Energy UK study. The gains largely come from the larger market and operational efficiency, rather than thinking about whether the ETS price itself will be higher or lower than otherwise, because sometimes it has been higher and sometimes lower. I do not think you can count on it being structurally different, but the efficiency point definitely applies.
Q78 Lord Moynihan of Chelsea: As an opening question, can you explain how joining Europe’s CBAM affects our own developing CBAM—that is to say, what we charge other countries around the world for the products they export to us that have carbon in them?
Frank Aaskov: By linking emissions trading schemes, we are not linking CBAM schemes. They are still very separate and being developed separately. It is worth bearing in mind that you can have equal carbon pricing but still have very separate applications of how you then deal with imports at the border. Therefore, as a result, the UK is developing its own scheme with its own scheme mechanics, and the EU is taking a different approach to how it is implementing its CBAM.
Lord Moynihan of Chelsea: I am sorry, are you saying that the EU will not require us to charge their CBAM rates at our border with the rest of the world?
Frank Aaskov: Yes, the price would probably be equalised, but how we apply that price and the methodology for using it would be different.
Lord Moynihan of Chelsea: That is all I wanted to establish. Thank you.
My supplementary questions are to Mr Aaskov and Mr Green. All the evidence so far has been about how this CBAM arrangement will help us in our trade with the EU, and you have not yet discussed our trade with the rest of the world, which is of course larger than our trade with the EU. I have a question for Mr Aaskov and one for Mr Green
Mr Aaskov, you have told us that 70% to 80% of your steel goes to the EU, so this is going to help you. But if we are going to have to charge, as you eventually agreed, the same price at the border—our steel industry has shrunk dramatically, we cannot meet our steel needs in this country, it is a very unfortunate thing, we will not talk about why it has happened, but it has—we have to import a lot of steel from the rest of the world and that will all be charged quite a lot more. That means a few things: one is that you have just erected a protectionist barrier, so British Steel has a conflict of interest when it comes to us to say that. You have erected a protectionist barrier against all the steel companies in the rest of the world. The second is that all our manufacturers will be paying more for the steel they import. That cost will go into their products. Am I not right in saying that all those among our population who buy the goods that our manufacturers make will therefore see inflation in those prices, and that those manufacturers who are exporting to the rest of the world will be less competitive, because their products are costing more to make?
Moving to Mr Green, will there not be retaliation by the rest of the world when we up what we are charging them at our border, with this CBAM? If there is retaliation—and by the way, the non-EU global economy is 86% and the EU is 14%, so our manufacturers increasingly want to sell to the rest of the world—does that not mean, again, that our manufacturers will have more difficulty exporting to the rest of the world, unlike in the particularly case of British Steel, which as you say, exports 70% to 80% to the EU? Is that not a severe problem, with our falling inside the protectionist barrier of the EU rather than staying outside it?
Frank Aaskov: Let me come in and talk specifically about the steel industry. I will start by saying that free trade in the steel industry is largely dead—it does not exist—it is about which states can subsidise their steel industry the most. We have seen China massively subsidise its steel industry in every single part of the supply chain up until now, and as their demand has structurally gone down, with their construction bust, China is now exporting its problem to the rest of the world. Therefore, with huge overcapacity, it is undercutting through direct—
Lord Moynihan of Chelsea: Can you answer my question though?
Frank Aaskov: Yes. Coming back to your question, specifically about whether there are retaliatory effects and impact on downstream supply chains, I should say first, on the trade measure, it is not something that the UK is taking unilaterally. We are following what the US, Canada and the EU are all doing because they wish to maintain their steel supply chains.
Lord Moynihan of Chelsea: This will be for every product? Steel, aluminium, fertiliser, and on and on—anything with carbon inside it?
Frank Aaskov: Yes. In terms of retaliation, we have yet to see any retaliatory measures announced. That is particularly because it is not about a protectionist measure; it is about an equalisation of carbon costs, because our domestic industry has already faced these costs while imported products have not. Therefore, you will have a fairly weak case to say that you are unfairly treated if imported products are basically put on the same kind of level as you.
Lord Moynihan of Chelsea: But if they have been put on the same level now, when we go into the EU’s CBAM, they will no longer be, because they will be more expensive.
The Chair: Can I just interject here? These are all very interesting points, but we are looking here at the issue of dynamic alignment with the EU. If we do not have that, we will still have our CBAM.
Frank Aaskov: Yes.
Lord Moynihan of Chelsea: But not nearly so expensive.
The Chair: My understanding, from the evidence we have heard, is that sometimes it is more and sometimes it is less. Is that correct?
Frank Aaskov: Yes, that is correct.
The Chair: There is a separate issue here about whether CBAM makes sense, but that is a CBAM issue, as opposed to a dynamic alignment issue. Have I got that right?
Frank Aaskov: Yes, that is correct.
Lord Moynihan of Chelsea: I want to get evidence on whether that is correct.
Frank Aaskov: For the first two years of the UK ETS history, UK carbon prices were higher. For the last two and a half to three years, UK carbon prices have been lower. As a result, if we linked now, they would go up. Again, some previous analysis would have predicted that that would have happened regardless and therefore, if anything, they would be lower in the longer term. That is our analysis and hence why we have arrived at our conclusion.
The Chair: Could you point us to that analysis, so we can get the figures into the evidence?
Frank Aaskov: Yes, I can provide that separately.
Max Green: Can I come in on the global geopolitical landscape? It is not just in steel, as you rightly pointed out: there is a lot of global protectionism in lots of different products; not just in steel but in aluminium and all these other products. For example, the US section 232 tariffs deal with a wide range of products, including steel, aluminium, copper and other things. Steel is not on its own, all these other products are also impacted, meaning that the retaliation will probably be lower, because we will have to move in the direction of every other market. I know that discussions are happening not just in the US and western countries but also in Australia, India and other countries. We need to make sure that we are in pace with those markets as well.
The Chair: Mr Webster, do you want to add anything?
Will Webster: No, thank you, that covers it from my point of view.
Q79 Lord Tugendhat: Mine is a rather different kind of question. Can you tell me what legal and practical steps would need to be taken before a linked UK-EU ETS came into operation, and how long do you think that might take to set up?
Frank Aaskov: The UK ETS was specific designed to be linked with the EU ETS from the very beginning. It was the then Conservative Government’s preferred option and it was designed to be more or less identical. They have slightly diverged since, but they are relatively minor differences. You are effectively just asking to create an agreement around fungibility—in other words, if I buy a carbon allowance in your market, I can use it in mine, and vice versa. Because the schemes are so aligned already, we do not see that to be prohibitively difficult to do. Where the Swiss agreement took 10 years to negotiate, we do not expect that to be the case this time, partly because the Swiss agreement encased a lot of other aspects around a wider trade agreement, but also because the Swiss scheme had to be changed significantly to comply with. Our earliest estimation is that you could probably link by 2028, again depending on political willingness.
Lord Tugendhat: Will it require legislation?
Frank Aaskov: It is likely that some kind of legislation would be required. Will might be better placed to comment on that.
Will Webster: In summary, there would need to be legislation but probably secondary legislation.
Just to expand on Frank’s point, most of the legislation to set up trading and make the rules of trading are already there, so there is not a great need to reinvent the wheel. The way that the trading system works is that you have to measure your emissions and verify them. You come up with a number and say, “I’ve emitted 100”, and then by a certain date you have to have bought allowances which you then surrender by a certain date and say, “I’ve matched my 100 emissions with my 100 allowances.”
In simple terms, there would need to be some change to the existing rules, saying that you can surrender an EU allowance to cover it and vice versa. That is potentially a relatively simple change around the mechanics of how linkage would work, given that the legislation is already there.
Lord Tugendhat: Do you think we would require any ongoing legislative changes once the system was up and running, or once it is up and running is everything clear?
Will Webster: That is what we have been doing with dynamic alignment. There would be a discussion around what alignment means in practical terms—for example, on the benchmarking point that I was talking about earlier, how you go about doing verification and so on—and what we mean when we say “alignment”. Then, if there was agreement that a clause in a piece of secondary legislation needed to be amended, the UK would go off and do it. Likewise for the countries in the EU; remember that quite a bit of the ETS is done via regulations with direct effect, so that would be done by the EU through its usual processes. Some of that is done at member state level, so member states would do similar things in secondary legislation to make and then enforce the rules. It would be a combination of approaches: a particular issue crops up where additional alignment is needed and then the parties to the agreement go off and either change their national legislation or, in the EU’s case, the EU regulations in order to make that happen.
Max Green: There is a real appetite from industry to get the ETS linkage done quite quickly, due to the fact that once that is done we can then get the exemption for the EU CBAM. With the UK CBAM currently coming into force potentially at the start of next year, that would mean a lot of added bureaucracy for UK importers, so there is an appetite to get it done very quickly. Unfortunately, as Frank has suggested, it is unlikely that that will happen, due to the processes and negotiations, so there will be a temporary period when we are dealing with separate EU and UK CBAMs. It is about getting it done as quickly as possible so that temporary time period will be short.
Lord Tugendhat: And one hopes that, once the system is up and running, there will not have to be continual minor changes.
Max Green: That is the hope, yes, although it is the EU that will have those decision-making powers on ETS reform, not us.
Q80 Lord Jackson of Peterborough: First of all, I concede that you might struggle with this because it is about parliamentary oversight and I know that is not really your area. However, it should be noted that this was not in the Labour Party manifesto, so they have no mandate to push forward with this policy. In the manner of contrived obscurity that this Government are moving on these policies, there is no mention of governance or regulatory regime issues. That being said, and looking at the different models of Switzerland and Norway, how can Parliament have proper scrutiny and oversight of dynamic alignment as regards a proposed ETS linkage agreement?
Frank Aaskov: I refer you to some of the evidence you received earlier in this committee from the Swiss and Norwegian ambassadors about the systems they have set up. They referred to a consultation system, which is quite refined, where they have involved all institutions in the various processes. The CBI also referred to setting up a mechanism to systematically scrutinise it. From an industry point of view, we have a strong interest in Parliament and the Government as a whole being very active in scrutinising the changes that are made to the ETS and ensuring that UK industry’s concerns are heard and taken into account, but we would probably defer to experts who can refer to how to do that best. Both the Swiss and Norwegian ambassadors set out how they have implemented that, so I would probably point to that evidence.
Lord Jackson of Peterborough: On a specific point, would your members be happy that their shareholder funds went to an EU innovation fund?
Frank Aaskov: Not to be too political, I am mindful that if we do not link then—as does not happen at the moment when we export steel to the EU—we would pay a CBAM cost, and that would be going into the EU budget. If we link instead, we keep those revenues at home with UK Treasury.
Max Green: I emphasise that parliamentary scrutiny is essential to ensure democratic oversight and increased business confidence for the sectors that are impacted by EU alignment. In this case, we want to make sure that industry in the UK is heard, so we would like a bit of consultation and engagement with Parliament before any kind of changes.
Although scrutiny is important, there are other things that Parliament should be doing in terms of the ongoing reform and ETS linkage in the EU, such as an early notification of relevant EU regulatory changes—a mechanism that allowed us to get early warning from the EU of regulation changes, so that we could pass that on to industry. We would like a clear government explanation of the rationale for and impacts of ETS linkage and changing regulations, as well as clear business guidance so that UK businesses, especially SMEs, can follow the guidance quickly and be able to trade with the EU with, hopefully, less friction.
Will Webster: Industrial competitiveness is a crucial issue where parliamentary scrutiny is rightful and needed in order to look at what any Government are doing for the future of industry in this country. There is a set of issues around that; a reasonably big one is energy prices and so on, but that is not the only issue. There are things like workforce, wider trade policy and all of that. The particular issue of the emissions trading scheme and linkage is then a subset of that.
I think the view of our members is that we would like to see elected officials looking widely at how the Government are dealing with the wider question of industrial competitiveness, of which this is a part. That is where our members would see parliamentary scrutiny coming in, with this issue being an element of how that is developing.
Q81 The Chair: There are a couple of issues that I want to tease out a bit further. Not least, I want to make sure that we have clearly understood. The EU and the UK are both going to have carbon border adjustment mechanisms. If they agree on the level of that carbon border adjustment mechanism—give or take a little bit—then linking them does not seem to be an issue. The issue, it seems to me, is if there is a fundamental disagreement. Bear in mind that on the one hand we are dealing with a large regulatory authority in the EU, and on the other hand we are dealing with the UK. If the EU were to impose certain rules and conditions in its pursuit of net zero, for example, that drove up the cost of producing steel and other products significantly, and therefore it raised the carbon border adjustment mechanism materially, but in the UK we did not believe that was the route to follow, we would then have to impose a carbon border adjustment mechanism that was inflated significantly above the level that we would otherwise impose. First of all, is that true?
Frank Aaskov: Let me answer that question first. In theory, if you have linked your carbon schemes, you would never have a difference in carbon price. Therefore, in theory the CBAM would apply the same costs at the border, so that scenario would not apply in reality. However, because we have two different CBAMs—two different ways of calculating the CBAM value—it could, in effect, still be the case. UK Steel has concerns that the UK scheme will charge a lower cost than the EU CBAM will. Therefore, it will be easier to export high-emission steel to the UK market than to the EU, simply because of how specifically you calculate those emissions in the end. I apologise if that is a bit confusing; I am happy to take you through that separately or to provide evidence on that.
The Chair: It would be very helpful if you could put that in writing, because it seems to me that this is the crux of the issue. Whether or not you have a CBAM is an entirely separate policy debate; this is about the linking of the two. From what I understand, linking the two would create problems if there were that kind of divergence.
Frank Aaskov: Yes. Let me try again and see if I can make it a bit clearer. The CBAM and the ETS are inherently separate schemes but they are nevertheless connected. The ETS sets a carbon price, and that would be the same in both markets. Then both the UK and the EU are separately asking, “How do we apply that price at the border? How do we calculate an equivalent price at the border?”
The Chair: Sorry, just to clarify, it is the same carbon price if the systems are linked.
Frank Aaskov: Yes.
The Chair: But what if they are not linked?
Frank Aaskov: The ETSs would be linked and therefore the carbon price is similar.
The Chair: What I am asking is: what if the ETSs were not linked and the EU were to put a substantially different price on carbon from the UK?
Frank Aaskov: That is effectively what is happening at the moment and will happen until we can link. At the moment, when the UK applies a CBAM—this is what Max referred to earlier—there will be administrative and financial barriers both ways. When you export products from the UK to the EU, we would face a CBAM administrative and financial burden. When the EU exports products from the EU to the UK, there will be, as a minimum, an administrative burden—and perhaps a financial burden too, depending on what the carbon prices were.
The Chair: If we linked—
Frank Aaskov: That would disappear.
The Chair: It would disappear. But if we linked and if EU regulations meant that the EU would set a much higher price for carbon than we would otherwise have set, then we would be applying that, through a CBAM, to our imports, which would drive up the costs.
Frank Aaskov: If, for example, there were a structural change to the EU carbon market that also impacted our carbon price, because they were linked, that would mean that the CBAM cost at the border would also be higher.
The Chair: I am trying to get to Lord Moynihan’s point here. The risk is a significant divergence from the price that we would set for carbon were we not linked?
Frank Aaskov: That is correct, yes.
The Chair: Is that a very real risk? Is it a very big risk?
Frank Aaskov: From our point of view—again looking at both, given the risks you highlighted earlier and that were highlighted over here earlier—we do not see this as just having benefits. There are also costs and disadvantages to this, and we very much recognise them. When you have dynamic alignment, how much input do you have into it? We have to look at what other partners of the EU, Switzerland and Norway, think about how they engage with it. I think the evidence you heard from those ambassadors was that they were quite happy with the process, but they also recognised the slightly different strengths of the two partners.
However, we have to bear in mind that the Swiss and the Norwegian economies are smaller than that of the UK. It would not be up to us to comment on how the power dynamics would be between the UK and the EU, but we are mindful of them. On balance, we still think that it would be beneficial to link, because of the benefits outweighing the risks.
The Chair: By the way, Mr Aaskov and I are having this conversation, but others should leap in if they wish to.
That brings me to the second point I wanted to tease out. Throughout this, there is the sense that, “Well, this looks great to us in principle but, of course, it depends on how it works in practice”. That includes the design—the point raised by Lord Jackson—and our ability to influence any decisions down the road. I am not trying to put words in your mouth, I am just trying to make sure that we have understood this correctly: it seems to me that another key risk is that, if the system goes in a direction that we do not like, we do not actually have any real influence over it. Do you see that as a key risk?
Frank Aaskov: That is why we would hope that, in any kind of agreement, there would be some kind of arbitration system or resolution mechanism for dealing with that. When there was consultation or consideration of this, there was also reference to a break clause; I think the Swiss have one for six months. If there were to be substantial disagreement, that would allow us to delink. I think the Swiss can give six months’ notice. For the UK—correct me if I am wrong, Will—when ETG was writing a report on this, I think the preference was for a 12-month break clause, so that we have the option of simply opting out and delinking if there were substantial divergence in thinking and strategic direction.
The Chair: You would want to see that?
Frank Aaskov: Yes, 100%.
Q82 Lord Jackson of Peterborough: I have just a quick technical question. Have any of the groups worked together to get data? Obviously, they are relying on the Government’s analysis, which is very modest in terms of the impact on GDP. Have you done your own research on likely benefits or disbenefits of different schemes?
Will Webster: I will have to get back to you on the point that Frank just mentioned; I do not have the information to hand. We at the ETG have done a qualitative piece of work, which we provided to officials and summarised in our evidence. That is looking to get views from different industries that are emitters about what they see as the priority and where they see the potential issues coming up. We can certainly do that.
My reflection is that there are short-term and long-term issues. In the longer term, the UK and the EU economies are of course all different but they have a lot of similarities. If we are thinking about how to decarbonise an economy, there will be similarities between them. I would say that, over the long term, you would not necessarily expect to see a lot of misalignment—that kind of disbenefit should play out over time to work its way through—but we may get short-term issues for particular topics or sectors. Where a break clause may usefully come in is if we see a particular impact somewhere that makes us say, “Hang on, it is going to take a while for this to correct itself. We cannot go on like this for another few years”. So having a break clause is really important from the perspective of looking at individual short to medium-term impacts.[1]
The Chair: If you would let us have that piece of analysis you mentioned, that would be helpful.
Q83 Lord Moynihan of Chelsea: I have a quick question. I invite our witnesses to comment on my understanding that, right now, we do not charge for CBAM—of course, if we had another Government, we might never charge for CBAM—but that the current Government are planning a CBAM, and under current plans, to take steel as an example, it would be around £30 a tonne did we not have the reset. The EU’s CBAM is about £65 a tonne, a little more than double what we apparently, in my amateur understanding, were going to charge. Could we have a comment on that?
Frank Aaskov: I am happy to comment on that. Again, this is about how you design the specific CBAM and how you apply that carbon price, even if it is similar, at the border. Our concern at the moment is that the UK is taking a very soft, very lenient approach to that, meaning that we may apply significantly lower prices at the border than the EU does.
There is no requirement, in my understanding, under linking the emissions trading schemes, then also to link or equalise the CBAM, so you may still have different applications of that similar carbon pricing practice.
The Chair: So could we still charge lower rates than the EU charges?
Frank Aaskov: Yes. Just to give a clear example, the way the CBAM works is that you can come in with your actual emissions and say you have monitored them and had them verified by a third party from your site. Then, you have to pay for those emissions associated with this product you are exporting to the UK market, and you have to pay the carbon price. That carbon price is similar to the UK carbon price. If you do not have those emission values, because you simply do not have them and you operate in a jurisdiction where that does not apply, you can use default values—namely, basic values that the Government have provided. The UK and the EU have set those.
At the moment, we are waiting for the UK ones, but our expectations are that they will be different. So, even though you have a similar carbon price, the EU may estimate a steel product coming in from, let us say, Indonesia, to be much more carbon intensive than the UK does. So even though they pay the same carbon price, one product is estimated to be lower carbon by one CBAM than the other CBAM. Therefore, even though the price of the carbon is the same, the actual amount of carbon is estimated to be different in the two CBAMs. That is how it could be slightly different.
From our point of view, we would wish them to be aligned. We do not wish for high-emission products to come to the UK whereas the EU is keeping all the low-emission ones.
The Chair: That is clearly understood.
Lord Moynihan of Chelsea: Can I just say to him that my question was not answered on the numbers?
Frank Aaskov: Apologies.
Lord Moynihan of Chelsea: I also find it impossible to understand how it can be asserted that the EU would accept us charging a lower CBAM if we were linked in, because we could then, in theory, sell lots of goods into the EU, having paid less for them than the manufacturers. I find it terribly difficult to understand the assertion—if it is £30 versus £65—that we will continue to charge £30 a tonne and the EU will charge £65, particularly knowing how the EU operates.
Frank Aaskov: I would agree.
Lord Moynihan of Chelsea: Thank you, that is fine.
Frank Aaskov: I support the view and the assessment. I see that as a risk in terms of linking as well. If we have an inferior CBAM, how would the UK recognise the mutual exemption of our CBAM, if it does not similarly apply the carbon price in practice? Therefore, from our point of view, we would wish to align the CBAM to make sure there would not be that difference.
The Chair: I think that is a technicality that we will watch down the road. Could you address the issue of the £30 versus £65?
Frank Aaskov: The Government have not published their data on this or provided this, so this is our internal estimation. We have yet to be told otherwise, but our estimation, with those caveats, is that for the UK it would be around £30 per tonne, whereas for the EU is about £150—so a significantly higher price per tonne. Again, we do not have the final data from the UK yet in terms of how they would apply, so that is just based on the evidence available at this point. Over the summer or in September, we may get the final costs confirmed by the UK Government.
The Duke of Wellington: Does Mr Webster agree with those figures—those steel numbers?
Will Webster: I do not have the information here, so I am not able to comment.
The Chair: That is something to which people will pay a lot of attention over the coming months. Meanwhile, our time is up, and we have tried your patience for long enough. Thank you very much—it has been a most helpful and useful discussion. With that, I suspend the public session.
[1] Following the session, the witness wished to further clarify that on “Q81and Q82 - On the preference for a 12-month break clause, most respondents to the research undertaken by the ETG thought that 1-2 years was appropriate”.