IETA CBM0012

 

IETA Response to Environmental Audit Committee’s Call for Evidence on a Carbon Border Adjustment Mechanism

 

About IETA

The International Emissions Trading Association is a non-profit business organization created to advocate for the use of carbon pricing around the world, and to establish a functional international framework for the trading of carbon internationally. IETA’s membership includes leading companies from across the carbon trading cycle; from industrial companies with compliance obligations under various global carbon pricing regimes to traders and banks which act as financial intermediaries in the trading of carbon.

For over two decades, IETA has been heavily engaged in issues around carbon leakage in multiple jurisdictions around the world, including in California, which is the only jurisdiction globally with a Carbon Border Adjustment Mechanism in use.

 

Net-Zero & Carbon Leakage

The UK has legislated for a bold legally binding target of climate neutrality that reaches Net-Zero greenhouse gas emissions by 2050. IETA fully supports this climate neutrality objective, that is in line with the UK’s commitment to global climate action under the Paris Agreement.

In order to reach Net-Zero emissions by 2050, the UK will have to take decisive steps to increase climate ambition. This will include ensuring a carbon price signal across all areas of the economy, and strengthening climate policies including the UK Emissions Trading System (ETS), resulting in higher carbon prices. IETA fully supports this objective, but accepts that this will cause further divergence between UK climate regulations and other jurisdictions, thus increasing the risk of carbon leakage. Unless other jurisdictions work toward a global level playing field in carbon regulation, the faster the UK moves toward Net-Zero, the higher the chance that carbon leakage will occur.

IETA recognises that carbon leakage measures no longer reflect the current situation, nor the future scenarios envisaged by the CCC. In light of the UK’s Net-Zero target, carbon leakage policies will need to be updated and revised to align with this goal.

Carbon Leakage presents a two-fold challenge:

  1. It undermines the UK’s climate objectives and increases the risk that the UK’s decarbonisation can be made ineffective in global terms by GHG emission increases in other jurisdictions.
  2. It reduces the ability of British industry to stay competitive at a time when the UK is rapidly decarbonising, and creates a disadvantage for British companies in other markets.

IETA fully agrees with the need for discussion on this critical issue, which has created a unique chance to revaluate carbon leakage policies. IETA believes the best way of ensuring carbon leakage cannot undermine the UK’s Net-Zero pathway is through recognising the benefits of market-based mechanisms to achieving effective and transparent decarbonisation.

The most efficient way to ensure that carbon leakage does not occur is through international cooperation in the area of carbon markets and carbon pricing. Put simply, the more carbon pricing we have, the less need we have for CBAMs. A global carbon price creating a level playing field for industry must be the long-term goal. CBAMs are technically, politically, and legally complex – the best CBAM is the one that never has to be used. The only way to alleviate those complexities is for the UK to ensure that a CBAM represents the next step in efforts to encourage the proliferation of carbon pricing worldwide. Designing the CBAM as a mechanism to bring other countries with the UK on its journey to Net-Zero, rather than as a protectionist and largely punitive tool, is surely the preferable option.

 

CBAM Mechanism

There are various ways in which the UK could institute a CBAM. IETA believes that the best option is to oblige importers to purchase allowances from a specific pool outside the UK ETS, dedicated to imports, which would mirror the UK ETS price.

This would constitute a separate pool of allowances, not simply another pool of UKAs (UK ETS Allowances), nor a standalone traded ETS. Importers would be obliged to surrender UKA-like allowances which exactly mirror the domestic ETS price and are regulated through ETS rules. Given the well-established efficacy of the UK ETS, a CBAM structure determined by UK ETS prices and rules can provide confidence that this mechanism ensures the same fair and transparent environmental result as the UK ETS, both today and in the future. This would be a similar methodology to the European Commission’s recent CBAM proposal.

This system has clear benefits:

  1. Ensuring that this separate pool is subject to the same price as the UK ETS is much more transparent and flexible than a fixed price. It is also the only way to protect this system from WTO discrimination challenges and ensure compliance with Article III of GATT.
  2. Pre-existing ETS rules are already well understood by British industry.
  3. Such a scheme would be straightforward to fix and isolate in case of problems.

IETA proposes that to ensure this mechanism works as intended, there should be a trial phase for certain sectors. The same should be true for free allocation. If free allocation is to be replaced, it must be done gradually with a phase-in period to avoid the risk of shocks to the UK ETS and serious economic disruption within sectors covered by the CBAM. 

IETA does not wish to comment directly on which sectors should be included in a CBAM, but recommends that CBAM coverage starts with industries most at risk of carbon leakage. These are likely to be raw materials, thus simplifying calculations of the carbon intensity of imported products. More sectors could be included in the CBAM at a later date, providing that a robust methodology is able to adequately calculate carbon content. This will be particularly important for semi-finished products - supply chains often extend across multiple different facilities and countries making calculations of carbon content considerably more complex.

 

 

 

Carbon Intensity of Imported Products

IETA believes that it is the importers’ responsibility to disclose the carbon footprint of what they are importing. The question of how to account for the carbon intensity of the product whilst taking into account complex global supply chains and varying carbon pricing regimes, is deeply complex. IETA acknowledges that there will always be a trade-off between accuracy and simplicity in relation to this issue.

Carbon footprinting methodologies exist across several sectors where traceability around carbon content disclosure is assured. IETA strongly encourages the European Commission to look at these pre-existing examples of how to calculate the carbon content of products. For example, in the cement sector, there is already a global standard for measuring carbon intensity (CEN EN 19694-3 1). This globally harmonised standard for calculating emissions derived from clinker and cement production is the foundation of the Getting The Numbers Right Database. This publicly available database lists all emissions (direct and indirect) associated with the global cement industry. Whilst IETA does not wish to advocate for any one methodology, this example illustrates that different sectors already have industry-wide standards which can be used as the basis for the CBAM’s carbon disclosure process.  

Given that the overriding aim of the CBAM must be to encourage global climate ambition, it is critically important to differentiate in a detailed way by products, facilities, and jurisdictions. The methodology must be based on verified emissions data, reflecting the calculation methodology used by the UK for benchmarking. However, if a methodology is used which simply adopts broad jurisdictional or industry-wide averages, there is no incentive for firms to invest and lower the carbon intensity of their products. This would severely undermine the key motivation for implementing a CBAM; driving climate action by providing incentives to other jurisdictions and companies outside the EU to reduce their emissions.

IETA is in favour of strong regulation and transparent standards. If a CBAM is to be introduced, the UK must provide guarantees that importers will follow the MRV model. This would ensure that there is no avoidance of the CBAM by faking the origin of the products and claiming the product has originated from a country with similar carbon pricing standard

 

CBAM & International Climate Policy

Although critical, IETA believes that a CBAM should be viewed as one element in a broader package of climate policies. It will only be effective if complimented by other elements, such as outreach and diplomacy with global trading partners.

A key priority of the CBAM must be to encourage increased global climate ambition. It is IETA’s view that the UK should prioritise negotiations with trading partners likely to be affected, prior to the imposition of a CBAM. These negotiations should work toward helping other jurisdictions reach a level playing field in terms of carbon pricing. The most straightforward way to achieve this is through encouraging other jurisdictions to move toward emissions trading and eventual linkage with the UK ETS. Some jurisdictions already have ETS systems that are mature enough to allow for linkage, others will need more assistance in reaching this point.

Once linkage has been achieved (or an equivalent domestic carbon price put in place), the CBAM must dissolve. This provides a clear incentive for other jurisdictions to fast-track the process of implementing carbon pricing with a similar level of ambition to the UK. This makes the desirable long-term outcome one in which such mechanisms are no longer needed.

If the UK wishes to bring other countries with them on the journey to Net-Zero, IETA is clear that the overarching purpose of the CBAM must be as a climate instrument rather than a resource tool. Revenue generation creates a perverse incentive for a CBAM. Putting a price on carbon is designed to minimise it, not to enable a new revenue stream for policymakers. A clear sign that the CBAM is functioning will come when the volume of imports having to comply with it reduces, meaning that any revenues created from such a policy will necessarily be unsustainable.  

The danger of revenue generation or industrial protectionism driving the design of the mechanism is that it will obscure the two central drivers for this policy – 1. The desire to ensure that the UK can reach Net-Zero without the risk of carbon leakage, 2. The opportunity to encourage key trading partners to match the UK’s level of climate ambition.

 

CBAM & The European Union

In July 2021, the European Commission proposed a CBAM for the European Union. Although it will likely be several years until the implementation of such a mechanism due to the political ratification process, this raises significant questions about the UK’s approach to carbon leakage.

As the UK’s largest trading partner, an EU CBAM is likely to affect the UK in several ways:

  1. British companies exporting to the EU will be obliged to submit detailed assessments of the carbon footprint of their products, and prove that they have paid a carbon price in the UK.
  2. If the UK carbon price (UK ETS) is lower than the EU carbon price (EU ETS), British companies exporting to the EU will be obliged to pay the difference. This revenue will be collected by the EU, not the UK.
  3. If the UK carbon price (UK ETS) is higher than the EU carbon price (EU ETS), British companies will be at a competitive disadvantage in the EU, their largest export market. 
  4. As the CBAM falls under the scope of the Northern Ireland Protocol, the UK Government will need to discuss with the EU how the CBAM might be applied in Northern Ireland. Current EU proposals indicate that goods produced in Northern Ireland would be subject to the EU’s CBAM, which would constitute a significant regulatory barrier for companies in Northern Ireland wishing to trade with the Republic of Ireland.[1]
  5. The imposition of a UK CBAM will not rectify any of the issues mentioned above.

There is one policy solution that would both negate the issues mentioned above, and allow the UK to collaborate with the EU on international solutions to carbon leakage – linking the UK ETS to the EU ETS.  Linkage of emissions trading systems is not a new phenomenon; several ETS linkages exist across the world, and the UK has already committed to giving ‘serious consideration’ to linkage as part of the UK-EU Trade and Cooperation Agreement.[2] UK-EU ETS linkage was the strong recommendation of a recent report from the LSE Grantham Institute, and from over 40 major industry bodies in a recent letter to the Prime Minister.[3] [4] A linked UK-EU ETS would ensure a level playing field in carbon pricing between the two jurisdictions. In practice, this would mean that the impact of a UK CBAM would be enhanced by limiting carbon leakage across a significantly larger market.

Linkage of the UK ETS to EU ETS would simplify the UK-EU carbon leakage relationship in a several ways:

  1. British companies will no longer be obliged to submit detailed carbon-related documentation in order to export into the EU. The EU’s CBAM proposal makes clear that any jurisdiction which links their ETS to the EU ETS will be exempt from all CBAM related disclosures.
  2. Given that the UK ETS and EU ETS prices would converge, there would be no competitive disadvantage for British companies nor revenues being paid by British companies to the EU.
  3. This carbon price convergence would ensure that no carbon-related regulatory barrier exists for UK companies in Northern Ireland exporting to the Republic of Ireland.

Whilst the UK could implement a CBAM without linking the UK ETS to EU ETS, it would cause significant regulatory issues, and would mean passing up the opportunity for a stronger response to carbon leakage. Carbon leakage is fundamentally an international problem, and solutions like ETS linkage which create a level playing field for carbon pricing across multiple jurisdictions, are the way to ensure one country’s carbon leakage protection doesn’t simply lead to higher emissions elsewhere. IETA firmly believes that transforming the UK ETS from a domestic tool to an international multilateral mechanism, with the scope to link with multiple different jurisdictions in the future, is the best way to address carbon leakage. This is an international solution for a global problem.

Conclusion

Carbon leakage is a clear threat to the UK’s target of reaching Net-Zero by 2050. The imposition of a CBAM has the capacity to address carbon leakage, safeguard the competitiveness of British industry, and encourage global climate ambition. To achieve these goals and remain compliant under WTO law, the CBAM must be designed as a market-based mechanism. IETA’s preferred option is the establishment of a separate pool of allowances for imports that mirror the UK ETS price and are regulated through UK ETS rules.

The overall objective should be that by creating a global level playing field in carbon pricing, a CBAM is no longer required.  By helping other jurisdictions to institute carbon pricing regimes that match levels of climate ambition in the UK, and working toward linkages that reduce the cost burden of trading for industry, Net-Zero can be achieved both cheaper and faster. 

October 2021


[1] Sam Lowe (Centre for European Reform), Aug 2021: CBAM – What might a EU Carbon Border Adjustment Mechanism mean for the UK? https://ukandeu.ac.uk/eu-cbam-uk/

[2] UK-EU Trade & Cooperation Agreement, Dec 2020: Article 392.6 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/982648/TS_8.2021_UK_EU_EAEC_Trade_and_Cooperation_Agreement.pdf

[3] Josh Burke et al (LSE Grantham Institute), Apr 2021: What does an EU Carbon Border Adjustment Mechanism mean for the UK? https://www.lse.ac.uk/granthaminstitute/wp-content/uploads/2021/04/What-does-an-EU-Carbon-Border-Adjustment-Mechanism-mean-for-the-UK_FULL-REPORT.pdf

[4] 42 Industry Bodies, Apr 2021: The Importance of Linking the UK ETS with the EU ETS https://www.ieta.org/resources/EU/2021%20UK-EU%20Linkage%20Joint%20Letter/UK-EU%20ETS%20Linkage%20Joint%20Letter%20(UK).pdf