Green Alliance                            CBM0025

Written submission by Green Alliance

About Green Alliance

Green Alliance is an independent think tank and charity focused on ambitious leadership for the environment. Our work crosses climate, the natural environment and resource use. Since 1979, we have been working with the most influential leaders in business, NGOs and politics to accelerate political action and create transformative policy for a green and prosperous UK.

Responses

1. What are the risks to the UK posed by carbon leakage? How effective is the Government’s current approach to tackling carbon leakage?

It is essential to ensure that UK businesses and sectors who are investing to improve their environmental and climate footprints are not undermined by competition from foreign markets which do not abide by similar environmental standards. High domestic regulatory costs, unless complemented by policy to ensure a level playing field for imported goods, can lead to manufacturing and emissions being offshored.

Most industries have been protected from the full impact of the carbon price introduced by the EU and now UK Emissions Trading System by measures such as the allocation of free permits. However, this has muted policy signals along the supply chain and kept carbon prices low, also limiting investment in low carbon measures by key industry emitters.

Studies have not found evidence of carbon leakage from emissions trading to date.[i]

2. What role could a carbon border adjustment mechanism (CBAM) play in addressing carbon leakage and meeting the UK’s environmental objectives?

Industry is the second largest emitting sector in the UK and to ensure progress towards cutting emissions, significant investment is needed in the next decades to promote energy and resource efficiency, electrification and uptake of deep decarbonisation technologies such as hydrogen and CCUS.

Carbon pricing is an important factor in motivating business investment and a CBAM could enable industry to be exposed to the full price of carbon while limiting the risk of carbon leakage.

Although industry currently has some exposure to carbon pricing because it can sell freely allocated allowances, this is not as clear a signal as an upfront yearly bill for purchasing allowances. A stronger signal would make it easier to justify investment in decarbonisation as well as adhering with the polluter pays principle.

However, there should not be an over-reliance on CBAMs and carbon pricing. Besides their limitations for addressing some sectors and portions of the value chain, as set out in the answers below, experience with the EU ETS has shown that even in the power sectors, where there is no risk of carbon leakage, other measures have been needed to drive investment at pace. Therefore, it is unlikely that a stronger carbon price alone will make the significant capital investments needed in some energy intensive industries financially feasible. Crucially, the signal for domestic decarbonisation will be even weaker if free allocation under the UK ETS is retained alongside a CBAM, as it may be for some time in the EU. Instead, a coherent package of policy measures will be needed, including: R&D support, some level of support for capital spend for major investments and the certainty that there is a profitable market for lower carbon products, which can be stimulated through procurement, product standards and other forms of taxation.

Furthermore, while some of the costs of carbon pricing, and any future CBAM, will be passed on to the end users of products, the degree to which this happens and strength of pricing signal will be very variable. [ii]-[iii] This makes carbon pricing a poor tool for changing consumer behaviour to, for example, ensure the purchase of products with less embedded carbon, let alone where you have wider objectives such as encouraging them to buy longer lasting products. There could also be negative impacts on poorer consumers for some products that should be mitigated. Given that changes in consumption towards use of longer lasting products and lower carbon goods will be a crucial part of achieving net zero, it’s therefore important that further measures beyond CBAMs and carbon pricings are implemented to encourage consumers to switch to more sustainable options, ensuring lower income households are also supported in the transition.

3. Should the Government pursue a unilateral CBAM? If so, why and what form should this take? If not, are there alternative approaches to addressing carbon leakage which the Government should be considering?

There are a number of countries that have discussed the possibility of introducing CBAMs, including the EU (which published its proposal in summer 2021) and the US. This offers the opportunity for the UK to coordinate action, should the government decide to introduce a CBAM. However, there are also concerns that CBAMs could place an unfair burden on developing countries. Addressing these concerns will require extensive international dialogue and coordination. As president of the Glasgow climate conference, and as part of its climate diplomacy more generally, the UK government has promised to support developing countries. This should include helping them adapt and thrive in the coming era of low carbon trade. Mitigating measures could include exemptions or reductions – potentially time limited – for the least developed countries, and increasing support for decarbonisation of industries in exempted countries to invest in low carbon solutions that would ensure they won’t be subject to carbon taxes upon import into the UK and other nations with CBAMs.xli Developing nations should also be helped with the technical and administrative burden of introducing accounting practices for carbon in supply chains and involved in designing accounting mechanisms from the outset rather than simply taking rules from wealthier nations.

Crucially, CBAMs might not always be the most effective tool to promote decarbonisation and avoid carbon leakage. Product standards could provide a much stronger signal and could be designed to take into account wider environmental considerations such as improving resource efficiency, which would help accelerate action on climate change while also helping to address wider environmental impacts. Therefore, we recommend to approach a CBAM on a sector by sector basis, considering whether they provide the most effective tool to limit carbon leakage and support low carbon investment, as well as recognising the they should be implemented as part of a wider package of measures to secure rapid low carbon investment.[iv]

4. If the Government were to introduce a CBAM, which products or sectors should be included and why?

Whilst a CBAM could be a useful tool for some sectors such as energy intensive industries, it would not be appropriate in the area of food and farming. Here a narrow focus on carbon could lead to perverse incentives, for example, rewarding countries that achieve carbon efficiency through highly industrialised systems with poor animal welfare, antimicrobial risk and localised nitrate pollution issues. A more holistic approach would be the development of core environmental standards, which could take the form of import restrictions equivalent to the mandatory regulations applicable to farmers in the UK.

5. What impact might a CBAM have on UK (i) industry, (ii) employment and (iii) consumers?

A CBAM could add to costs for domestic industries if accompanied with the end of free allocation, but this should be balanced against a more level playing field competition wise and more straightforward carbon pricing system. And, as emphasised in our previous answers, it would need to be implemented as part of a wider policy package that would incentivise industry investment.

However, some challenges may arise where there are several competing products for a similar market, with some products covered by a CBAM and some not. This could be the case in construction for example, where steel might be subject to a CBAM, while cement might not be. This issue would be less of a risk if a product-based approach was taken, adopting for example embedded carbon standards for buildings that could be met with any mix of materials, without exposing one to higher carbon pricing.

There could be a positive impact on employment in the UK if industrial jobs are retained as a result of lower international competition. Furthermore, CBAMs could support the move towards a circular economy, by incentivising domestic investment in product repair, remanufacturing and recycling. Green Alliance estimates that scaling up circular economy activities could deliver 472,000 jobs by 2035 across the UK.[v]

As mentioned above, the degree to which carbon costs are passed on to consumers is variable and will continue to be so with a CBAM in place. This has the advantage of keeping costs for poorer consumers down but could be seen as a missed opportunity to create markets for lower carbon products and services. Where there are impacts on consumers these need to be managed to avoid undue impact on poorer households. Product standards could also push up costs but would allow a more calibrated approach, for instance ensuring that consumers can save money. The ecodesign standards for energy related products are designed in this way ensuring that any increase in upfront costs are mitigated by cheaper running costs.

6. What risks would need to be managed when designing and implementing a CBAM?

Risks of harm to developing nations need to be addressed as discussed in our previous answers and below.

There is also the risk of reciprocal measures from other trading partners. From that perspective, it will be useful to watch the EU experience of introducing a CBAM and learn from that, ensuring there is extensive international dialogue around effective implementation of CBAMs.

7. What wider opportunities and benefits might arise from introducing a CBAM?

Besides supporting domestic decarbonisation, a CBAM or equivalent measures, e.g. product standards, could help to address the UK’s consumption emissions. These have fallen much more slowly than territorial emissions but are equally the UK’s responsibility. However, there may be limitations to the effectiveness of CBAMs in achieving this, as e.g. a lack of accurate data on the embodied carbon of imported goods may force CBAMs to be imposed based on average emissions of a country’s production, which might either disincentivise single producers from investing in low carbon solutions, or might place a significant burden on individual businesses to prove their goods have lower embodied carbon. Calculating the embedded carbon content of a product can be expensive and difficult, especially if inputs are sourced from many different countries.[vi]

Therefore, as with driving domestic investment in low carbon solutions, for CBAMs to effectively support action to tackle consumption emissions, they would need to be complemented by other measures that stimulate investment in low carbon and resource efficient solutions along global supply chains.

There could also be an opportunity for the UK to work with trading partners around the introduction of a CBAM or equivalent to support them to decarbonise.

Finally, better metrics and measures of embedded carbon, which would need to be developed to support implementation of a CBAM (or product standards), and how it flows through our economy will allow more targeted policy design in future. It would also place much needed emphasis on the need to tackle resource consumption and step up ambition on resource efficiency.

8. How might a CBAM interact with the UK’s international obligations, including on trade and the environment?

To be consistent with WTO rules, a CBAM can only be applied to sectors where domestic producers are subject to a carbon price. Additionally, the rationale for a CBAM must be environmental, rather than economic. The latter would not be considered legitimate under WTO rules, being a fiscal or protectionist measure.

Finally, as president of the Glasgow climate conference, and as part of its climate diplomacy more generally, the UK government has promised to support developing countries. This should include helping them adapt and thrive in the coming era of low carbon trade. Therefore, given the potential negative impacts of a poorly design CBAM, the UK needs to carefully consider and mitigate impacts on developing countries.

9. Should the CBAM design include any special regard, e.g. for developing countries or small and medium-sized enterprises? If so, which circumstances should be given special regard, and what impact might this have? If not, why not?

As we mentioned in our previous answers, any CBAM must be carefully designed so as not to unfairly disadvantage developing countries and should be supplementary to effective measures and finance to help facilitate their transition to greener economies.

Some developing countries, such as Bangladesh, rely heavily on the UK for exports though make up a relatively small fraction of total UK imports. Applying a CBAM to imports from these countries could have a negative effect on developing economies and only a small impact on carbon imported into the UK. The UK Generalised Scheme of Preferences currently grants tariff and quota free access to countries on the UN’s Least Developed Countries list, for all goods other than arms and ammunition. These countries could also be exempted from a CBAM to reflect the principle of ‘common but differentiated responsibilities and respective capabilities’ when tackling climate change, a principle that guides international climate negotiations. The UK could retain the right to safeguard against carbon leakage, should this become an issue. As countries develop and are no longer included in the UN’s LDC list, they could face a CBAM on their exports.

As the primary purpose of the CBAM is to prevent carbon leakage, a decision to exempt LDCs would need to be justified on environmental grounds to remain WTO compliant.

Should responsibility for complying with the CBAM fall upon importers, smaller businesses are likely to face a disproportionate burden, having fewer resources available for extra administrative work. The government could support smaller businesses with funding, to pay for third party certification bodies to carry out compliance work.

10. What practical and administrative challenges might arise when designing and implementing a CBAM? How might these be addressed?

A CBAM relies on accurate data on the carbon intensity of imported products. Where a lack of data exists, an emissions factor may be applied which relates to the average carbon intensity of a country’s production but care must be taken to not give undue advantage or disadvantage to domestic producers. This could also undermine the effectiveness of the CBAM, giving no incentive for carbon-intensive producers to improve their production.

A CBAM will also need to consider rules of origin for any origin-based criteria.

Caterina Brandmayr

Head of climate policy, Green Alliance

October 2021