20
European Affairs Committee
Corrected oral evidence: Dynamic alignment
Tuesday 2 June 2026
Noon
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. 9 Heard in Public Questions 84 - 91
Witnesses
I: James Low, Associate Director, Energy and Climate, Flint Global; Josh Burke, Distinguished Policy Fellow, Grantham Research Institute on Climate Change and the Environment, LSE.
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11
James Low and Josh Burke.
Q84 The Chair: Welcome back to the public session of the House of Lords Select Committee on European Affairs. We are continuing our inquiry into the issue of dynamic alignment. For the second half of our session today, we are pleased to welcome James Low, associate director for energy and climate at Flint Global, and Josh Burke, distinguished policy fellow of the Grantham Research Institute on Climate Change and the Environment at the London School of Economics. Welcome to you both. We are very grateful to you for coming.
This is a public session. We are being broadcast. There will be a transcript provided to you to correct any errors or omissions you may find.
I will start off with a general question to both of you. To what extent would an emissions trading scheme linkage agreement have significant policy effects in its own right? Would it largely be a technical measure that would follow anyway from the UK’s current decarbonisation and net-zero policies? Which are more determinative: our own or the direction in which the EU might drive us? Mr Low, would you like to start?
James Low: First of all, thank you for inviting me to give evidence today. It is important to note that there are significant policy impacts of this linkage agreement. Obviously, the first among them is the CBAM exemption. The UK Government estimated that that would be £800 million for businesses every year. Energy UK published a report that said it would be around £10 billion over 10 years. That is a significant saving for British businesses that export to the EU.
An additional point is the administrative burden. Lots of these businesses might be small; they might not necessarily have all the resources to deal with the CBAM in an effective way. That is one of the significant impacts.
I would add to that the point about the EU CBAM including electricity. We have significant flows of electricity between us and the EU via our interconnectors. The EU has proposed to include electricity in the scope of its CBAM, and if we do not have a linked ETS, that would mean we would have to pay a carbon price to export electricity to the EU. That would have significant impacts on our electricity flows between the UK and the EU, especially at a time when economies are looking to electrify and integrate more renewable electricity, which naturally is intermittent. Interconnectors will be an increasingly important part of that energy transition, so the EU CBAM is important in that regard as well.
The main other benefit is the greater liquidity and number of allowances. The EU carbon market is just bigger than ours—there are more trades happening and there is more activity—so that should lead to lower price volatility for UK businesses that are in the scope of the ETS agreement. In theory, that should enable businesses in the UK to take more informed investment decisions in their decarbonisation or net-zero transitions as they have a more stable carbon price and are more able to reliably estimate the revenues that that investment will generate.
The Chair: Thank you very much. You said, “in theory”, which we hear a lot of witnesses say. Later on in the question, we will perhaps turn to what is likely in practice.
Josh Burke: Thank you. I agree with a lot of what has just been said. To broaden it out, there are material effects from the linking agreement to the UK’s carbon price. For example, it will be higher than what covered entities will face today. There are implications for industrial competitiveness—not only the CBAM obligations that have already been mentioned but the constitutional arrangements. The governance architecture will materially change in a linked agreement.
Beyond that, there are significant changes to the UK’s market stability mechanisms, which is how you manage supply-and-demand imbalances. When prices spike, what are the measures available for policy-makers to manage that imbalance to mitigate sharp price increases? The UK will likely have to align in some regard to how the EU manages that—at the moment it is different.
There are free allocation rules, so the UK will have to come to some agreement on what that looks like. There is also scope expansion, and maritime and aviation are two sectors that the UK is expanding to on slightly different timelines to what the EU is doing.
Beyond the economic rationale, where there is certainly a positive economic case to link, there are some broader policy implications.
The Chair: Can you expand on the governance architecture that you mentioned?
Josh Burke: Under the Henry VIII powers there is likely to be an acute risk of—
The Chair: Are you talking about parliamentary governance?
Josh Burke: Yes. The dilution of scrutiny.
The Chair: We will come to that later. I thought for a moment you were talking about industrial governance.
Q85 Baroness Ashton of Upholland: As a committee, we are looking at different provisions that are highly technical in many places, so I wonder if you can help us out. What are the most significant potential provisions in an ETS linkage agreement that we ought to look out for when it is published? Where would you say, “Whatever you do, please make sure that you have looked at these provisions carefully”?
James Low: When I first read the Common Understanding document, three main things stood out to me. The first was alignment on international aviation. Currently, the UK ETS applies a carbon price for flights within the UK and from the UK to the European Economic Area. It does not apply to flights going to Dubai or Singapore—longer-haul flights—but it was a specific inclusion in the Common Understanding document that we should align on scope with the EU in terms of international aviation. So, if the EU then decides to expand the scope of its ETS to international aviation, we would have to do so as well. Obviously, at a time when there are challenges around the Middle East with regard to jet fuel, you can see how adding a carbon price to long-haul flights is going to be politically challenging in the UK—although you could also argue that it removes an existing distortion as well, because short-haul flights are exposed to this carbon price but long-haul flights are not.
The EU does not currently include international aviation in its ETS; there is an exemption while there is a trial period of an international carbon pricing scheme on aviation called CORSIA, but that carbon price is much lower than the ETS would be. That is definitely one thing.
The joint governance mechanism is really important as well: what provisions are there in principle for the UK to raise issues over dynamic alignment or seek dialogue with the EU on those issues; and whether or not either party can walk away from the agreement.
Timing is an interesting one as well. There is a wide-ranging review of the EU ETS going on at the moment, looking at things like carbon removals, international aviation and the future trajectory of the cap, so there is a lot outstanding and a lot that could change over the next year or so with regard to the EU ETS. How the agreement is timed and the timing of implementation, in addition to how the agreement takes into account the current policy uncertainty with regard to the EU ETS, will be an interesting one to watch out for.
Josh Burke: I would just add that it is really important to scrutinise the definition of dynamic alignment and understand what precisely triggers alignment obligations. That is really important; perhaps the agreement should specify it. One thing we have been looking at is tiered approaches that reserve the highest domestic scrutiny for certain types of legislative changes. Beyond that, on the non-adoption mechanism and its consequences, I really want to understand a bit more about what a proportionate consequence structure looks like. Without that, dynamic alignment becomes automatic, in effect, so that is something I really want to understand.
Beyond that, we have talked about the cap and the UK’s sovereignty with regard to having the ability to set its own cap, and then also the transitional arrangements. I would want to see a defined transitional period before full market integration—beyond what James said, basically.
Baroness Ashton of Upholland: That is quite a lot of additions. Can you just help us a bit? When you said, “the definition of dynamic alignment”, how long is a piece of string, really? Are there any pointers within that at which we should look?
Josh Burke: Yes. As one example, the UK and the EU are both looking to integrate carbon dioxide removal methods into their respective compliance markets. The EU and the UK have slightly different views on which eligible technologies can be integrated. The EU has specified only permanent removal technologies—those that sequester carbon into geological storage—and the UK has potentially opened the door to things that store carbon for hundreds of years in trees. So there is a fundamental mismatch there. The EU might say, “Okay, we don’t want those in our ETS”, and the UK might have to follow suit. We do not know what that will look like yet, but that is an example.
Baroness Ashton of Upholland: Thank you; that is really helpful.
The Chair: That is very interesting, but is not the more significant issue not that, per se? Presumably, that will be sorted out in negotiation, but, should the UK—or, indeed, the EU—come up with some new technology that fundamentally changes things in a similar way to what you have just described, and the other side does not, what happens then?
Josh Burke: That was just one example. As you said, there is a couple of different ways this could go. What I did not mention were the things around how the cap should be structured, the free allocation provisions or the things that might disproportionately undermine the competitiveness of one jurisdiction vis-à-vis another. These are the kinds of things where we might want to see dynamic alignment with the EU in order to prevent a distortion of trade.
Q86 Lord Barrow: We have got into this area but I am going to come back to the here and now then go to the future, if I may. Can you characterise, in your view, how much the UK and EU ETSs are aligned? To what extent is there divergence? What changes would have to be made to the UK scheme as it stands at the moment, presuming that we are mirroring, in order to align it? Start there, then I will move on.
Josh Burke: By and large, if we start at the highest level, in terms of ambition, I would say that they are broadly aligned. They both have high levels of ambition and high levels of policy stringency, so, at that level, they are aligned. On some of the technical details, they have slightly different things. In terms of fundamental mismatches around the way in which policymakers can intervene in the market to manage price spikes, the UK has a different approach to the EU there. That is one thing on which they are misaligned. They are also misaligned, although it is not the ETS specifically, on the timelines for the CBAM, which is an adjacent policy: one starts in 2026, and another starts in 2027. The sectoral scope of the CBAM is also different.
Beyond that, on the broad sectors, the UK ETS and the EU ETS are broadly equivalent. The EU ETS2 is coming into force, although that has been delayed. The UK does not have an equivalent, although that is outside the scope of this initial linking agreement. The UK has a more stringent cap than the EU’s, for example. By and large, the technical differences are manageable, so, if the politics and the negotiations can be overcome, the linking can be done on a technical level.
James Low: I do not have much to add to that; obviously, I agree with all of it. Over the past few years, the politics have been the most challenging thing. These technical barriers can be overcome if there is a strong enough political will to do so, and this Government appear to be taking that approach.
Lord Barrow: If we look at the review currently under way with the EU, would you say that it is creating a direction of travel on the EU side that creates more divergence? Or does it still stay within that technical sphere, if I can put it that way?
James Low: It stays within the technical sphere. The EU’s ETS review was statutory: it had planned this review. Although there are a lot of other external factors, including electricity price pressures in Europe and the UK, which are driving the review and may influence the direction, I think that both countries are in a largely similar place on the pace of transition and the pace of decarbonisation, as well as facing some political pressures around those. They are largely headed in the same direction overall, so it should not have significant implications.
Josh Burke: The geopolitical pressure caused by the current conflicts have impacted politics in the EU in a more intense way than we have seen in the UK. There has been an intense lobbying effort and political pressure put on policymakers to try to find ways of reducing the price faced by polluters in the EU. One of the policy options that has been pushed is to allow companies to buy carbon credits from international jurisdictions, which are cheaper—and, arguably, jurisdictions that have poorer governance—and allow those to be used as part of their compliance obligations[1]. The UK has taken a more stringent view and said, “That is not something we are looking at at the moment”, so the political pressure is manifesting in slightly different ways in the respective jurisdictions—more so, perhaps, to dilute the policy efficacy at the EU level, relative to the UK.
Lord Barrow: If we look into a future where we have linkage, one of the earlier witnesses talked about the importance of the UK being able to influence decision-making in the EU. What do you think is the most effective way in which the UK could do that? How realistic is that as an aspiration? You can bring in arbitration and break clauses as well if you want, but I am thinking primarily about policy influence.
James Low: To be honest, given that we are now outside the EU, the more formal channels will be more limited—that is the reality. That said, there are lots of informal channels that can be made. There is nothing stopping UK Government officials speaking to EU Commission officials about the policy that they are working on and the direction they are going in. You can have secondments between the two jurisdictions, so UK Government officials go and live and work in Brussels and vice versa. That helps to embed that kind of policy influence in both directions. There is the UK Mission to the EU as well, so there are organisations set up, but the formal institutions that we used to be part of, the formal channels, are less available to us.
Josh Burke: One worry, although it is not a big worry, is that the UK is outside the formal decision-making process. That said, a lot of the decisions are made at the technical level, and the UK can participate in technical working groups, which has proven to be a very effective channel, for example, with Norway and the EEA in negotiations. There is also the Joint Committee and industry coalition building. Beyond that, there is maybe a strategic use of non-adoption mechanisms that the UK could potentially use as leverage in some of the negotiations. So, there are a number of channels that the UK can look to influence decisions through.
James Low: The Swiss linkage agreement has provision for the Joint Committee to establish working groups and sub-committees underneath that, so if that is in the linkage agreement, we can invest in that and develop those working-level institutions.
Lord Barrow: And you would welcome that in the agreement?
James Low: I think so. It seems sensible.
Q87 The Duke of Wellington: What you have both been describing is very interesting, but doing some of these calculations of different prices sounds quite complicated. Do you think we have sufficient resources, in central government and the devolved Administrations, capable of entering into these sort of discussions and calculations, and therefore to make the link actually work in practice?
James Low: Notwithstanding setting up new working groups through this linkage agreement, so outside of that, the Government probably have sufficient resources, although they might need to create some new institutions. My understanding of the way the team is set up currently, since the UK ETS is a devolved policy, is that there are representatives of the Welsh Government, the Scottish Government and the Northern Ireland Government, while the UK Government lead policy development in general. Within that, I think there is sufficient resource. They might need to reorientate themselves a bit more, looking at what is going on in the EU, interacting with the EU, thinking about that and embedding it in the process that the UK ETS authority currently goes through as it develops policy, but overall, I think they have sufficient resources.
The Duke of Wellington: Do you agree?
Josh Burke: I agree, by and large. The establishment of new bodies or groups would be a helpful accompaniment to this. A dedicated EU alignment unit within DESNZ, for example, or the reinstatement of the European Scrutiny Committee would help in this regard.
Q88 Baroness Smith of Newnham: I am going to turn to Mr Burke first, because he has already begun to touch on the issue that I want to ask about, which is parliamentary scrutiny. You mentioned Henry VIII powers. I am wondering—obviously this is something for this committee as we are thinking about our report, since we have to make recommendations to the House as a whole—what you think are the key requirements for a system of parliamentary scrutiny of dynamic alignment on the ETS linkage agreement.
Josh Burke: The worry is that there is asymmetry in the speed at which changes at the EU level can be adopted at the UK level. I see Henry VIII powers as an operationalisation of dynamic alignment and by and large that is a good thing, in that it can keep pace effectively without the changes being slowed down throughout the parliamentary process. However, there is a need for scrutiny of certain changes.
As I mentioned earlier, I see three different tiers. Tier 1 is the technical implementing measures: registry, technical standards and benchmark calculations are quite technical things that could be pushed through without much scrutiny, they are technocratic decisions. I describe tier 2 as significant design changes: quite technical things like revisions to free allocation benchmarks and changes to linear reduction factors. At a minimum, they would need some kind of debate, accompanied by an impact assessment. Then tier 3 is fundamental architectural changes—changes to the scope, changes to the cap and things that are inconsistent with the Climate Change Act. Those are the types of things that would need genuine parliamentary debate and committee scrutiny. I would break it down into those three tiers.
Baroness Smith of Newnham: Would it be sensible to do something like reinstating the European Scrutiny Committee of the House of Commons? Obviously, the House of Lords European Affairs Committee has a role to play, as does the House of Lords generally, but the Commons is the primary legislative body.
Josh Burke: Yes, I agree. Re-establishing that would be a good thing.
Lord Jackson of Peterborough: You agree that bringing back the European Scrutiny Committee to the Commons would be good?
Josh Burke: Yes.
Lord Jackson of Peterborough: Okay. That is clear. Thank you.
Q89 The Chair: I wonder if you could help us understand one or two issues that seem to be quite complex. First, on the point about parliamentary scrutiny, talking about dynamic alignment rather than specific sectoral agreements, if the UK signs up to dynamic alignment, then that is what it means—within those defined areas of EU law, if they change something, we have to change as well and incorporate it into our domestic law. We would have agreed to do that, so it seems entirely reasonable to do it through secondary legislation, because the primary legislation gave the Government the power to do that.
However, as always with these things, it is about what people did not understand or envisage when they passed the primary legislation. There are some clear instances. For example, if the scope of the EU legislation that is caught up within a particular area of dynamic alignment starts to expand. I am not an expert but I imagine that there are ways to do that in an incremental fashion that are not immediately apparent. Rather than just saying, “We are going to add this new law to the group”, presumably there would be a mechanism that would need to agree that. How do we watch out for that? Let us deal with that point first, because the second one that I am going to raise is on a rather different issue.
James Low: My understanding of the European partnership Bill, which was in the King’s Speech, is essentially that it is to enable that to happen—to be able to transpose treaties into law without needing a new Act of Parliament every time. I was reading about it and it says that the treaty itself and what is in scope of any agreement with the EU should be subject to parliamentary approval, presumably scrutinised to a greater extent than secondary legislation might be, and I think that is right. I probably agree with what Josh has suggested about tiers or perhaps having some kind of materiality threshold, so that if a change affects the UK to a certain extent, UK businesses and stakeholders are consulted and that change is subject to parliamentary approval. I would support that.
The Chair: So this is a key point to look for in the forthcoming Bill—not just that you have a piece of primary legislation that gives you the power to do everything by secondary legislation, but that there are mechanisms for ongoing supervision to ensure that something is not slipped in there that really should require primary legislation.
James Low: Yes, I think so. I agree.
Q90 The Chair: That is very helpful, thank you. The second point is that the problem here with regard to linking emissions trading schemes, it seems, is if there should be a substantial divergence between what the UK and the EU would set as a carbon price were they not linked, because then we would basically be following the EU’s price, irrespective of the fact that we would set a different one, and that could get to a material level.
First, how likely is that to happen? I go back to the point that I made earlier about one side introducing some new technical solution that fundamentally changes the calculation. And if it is going to happen and we are linked, how do we deal with it?
Josh Burke: Sorry, is the question about what happens if the prices are on different trajectories, where the EU is higher than the UK?
The Chair: Assuming that we are linked, so we have a common price, but something happens that means that if we were not linked, the prices would be substantially different.
Josh Burke: In a linked scheme, the UK entities would have access to whatever technology there is in the EU, if that allows allowances to be traded because a company has been able to abate. The economic rationale for linking is that you enhance the abatement options: you can abate where it is cheapest, depending on where the technology is. In a linked scheme, the UK would benefit from any technological innovation at the EU level regardless.
The Chair: I am sorry, we are obviously just hypothesising here, I know, but I think one has to think about these things in advance. It seems to me conceivable that there is a technology that one side employs but the other side believes should not be employed. I cannot say what that might be, but that could result in substantially different pricing mechanisms if you were separate. So, let me go back to the second half of my question, which was how would we deal with it. Is this something where we would definitely want to see a brake mechanism?
Josh Burke: I would slightly tweak the framing and imagine that it was not necessarily a technology but a policy intervention that could materially change. So, the UK or EU could introduce surplus allowances, which lowers the price, or pull allowances out, which increases the price. That way, you would get a price divergence. I think that is a more likely situation. In reality, I do not think that is a likely outcome, in that the UK will have to mirror the kinds of provisions that the EU has. So, even if those provisions—which in the UK are called the supply adjustment mechanism[2] and at EU level they call it the market stability reserve—have different names and operate in different ways, the UK version would have to find a way of mirroring what the EU is doing, to make sure that the price difference is not realised, because that could lead to competitive advantage. The policy changes that could create divergence in prices are, I think, unlikely to materialise, because in reality the UK would do what the EU does.
The Chair: It is unlikely, but not impossible, so I come back to the question of whether it is important in this arrangement to have a brake mechanism?
James Low: It is difficult to foresee a break mechanism being in place and able to be exercised on the basis that one body can walk away from the agreement purely because it thinks it is losing competitiveness because it thinks its carbon price would be cheaper. It is difficult to foresee this agreement leading to that sort of clause. The principle of dynamic alignment is that it is designed to prevent a situation where one body would see, in the counterfactual, a substantially lower price or a competitive advantage. Dynamic alignment is principally there to prevent that.
Lord Jackson of Peterborough: Previous industry witnesses were not able to show that they had tested the accuracy of the Government’s proposals. They have done a qualitative analysis, which is, I assume, basically a focus group of their members, but they have not done a quantitative analysis. Have either of you, as policy or academic experts, tested the methodology that the Government are using? They are saying that there will be a 0.1% increase in GDP in the next 10 years. Have you had an opportunity to test that? Do you think they are using a robust methodology?
Josh Burke: I cannot speak to the 0.1% but we at LSE conducted two different studies. One looked at the economic benefits of linking and showed that a linked agreement would reduce transaction costs for industry, because finding a counterparty is easier because there are more of them, so the transactional cost for any polluter goes down. That much is true and quantitative.
We also looked at the implications of the CBAM and came up with a very similar figure to what the Government have used. I have seen it, but I am not sure what the underlying source is in the government document. They say £800 million is saved from the UK not being exposed to the CBAM. Our modelling said £0.8 billion to £1.1 billion is saved from the UK not being exposed to the CBAM. So, our estimates come out broadly the same.
James Low: I have nothing to add to that.
Q91 The Chair: I will turn to another issue on which certainly I was left a bit confused and maybe others were too. It is possible that we will have an ETS linkage and a common carbon price with the EU, but that we will apply it differently in our carbon border adjustment mechanism from the EU, as we do now. Is that something that could possibly continue after an ETS linkage? For example, if we charged a third party a lower assumed price than the EU did, because it did not have all the measurement mechanisms, would we not be in danger of feeding into the EU products from that country without it paying the charge that the EU thinks is appropriate? How does that work?
James Low: The CBAM should be related to the carbon price experienced in the domestic country. If we had a common carbon price with the EU, I would expect a CBAM payment coming from a third country to face the same cost. I would just say that the UK CBAM and the EU CBAM differ in their scopes. There are certain goods that are not in scope of the UK CBAM but are in scope of the EU’s. That is one difference.
The Chair: Would they have to be aligned as part of this?
James Low: As part of this ETS linkage agreement, there is not a requirement for both—
The Chair: So, we could import a good from a third party at a lower price than they would be able to feed it into the EU, and then we would be able to feed it into the EU?
James Low: I believe so, yes.
The Chair: That is a bit strange, because in all the Brexit negotiations on trading goods, that third party sourcing was a crucial issue. This is what has left me a bit confused on how it works. I am sure it is just that I do not understand it, but I wonder if you can help.
James Low: That would be quite a significant loophole, which I imagine the EU would be alive to and would look to close, and there would be some kind of chain of where that good has been and where it has come from.
The Chair: That is very bureaucratic, and the only alternative, as far as I can see at the moment, would be for us to adopt the same carbon border adjustment mechanism and apply it in the same way as the EU.
Josh Burke: I cannot speak to the detail you have just mentioned, but I foresee a situation where the UK has phase 1 of the UK CBAM that runs to, say, 2030, and by 2030 the UK says, “Why are we duplicating efforts? It makes more sense to harmonise the respective schemes”, and there is a phase 2 and by 2030 the two schemes are aligned. I think that would make a lot of sense to most people.
The Chair: It seems logical anyway, whether or not you agree with it. Are there any further questions?
Well, thank you very much indeed. You have helped us enormously on some quite tricky technical issues, and I think that we are managing to get our minds around them a bit better than we were. You have highlighted some important pluses and minuses of this whole proposed arrangement, so we are enormously grateful to you for coming, particularly on a day like today, with the challenges. With that, I draw the public session to a close.
[1] The witness later clarified that he should have said “net zero/decarbonisation obligations” rather than “compliance obligations”.
[2] The witness later clarified that he should have said “the cost containment mechanism”, not “the supply adjustment mechanism”.