Carbon Emissions, Pricing and Removals
Between ETS, CBAM and Carbon Removals, the framework of legislation being put in place between the EU and UK could mean that not only will companies decarbonise more quickly, but new technologies will also come to the market for those operating in sectors where electrification is not possible.
However, risks abound with reforms to such significant legislation. For example, the EU is committed to phasing out ‘free allowances’ in the ETS market, meaning that all companies will need to pay for their carbon emissions. It is possible there would be a gap in carbon leakage protection, as industry would have to rely solely on the CBAM, without a proper testing phase in place.
The UK has not put in place a commitment to phase-out free allowances, meaning that the cost of production in the UK could be substantially lower for the aluminium, cement, electricity, fertilisers, and iron and steel sectors.
However, the EU has also committed to introducing a CBAM, meaning that UK exporters to the EU would need to pay the difference in price of their embedded emissions, in the event that they cannot demonstrate an equivalent policy in the UK. Given the scale of trade between the UK and EU, this has the potential to have major implications on trade between the two jurisdictions.
Should UK companies need to decarbonise their industry for export to the EU, without being protected from cheaper, more polluting products exported from third countries to the UK, this would undercut business’ ability to retain price competitiveness. Thus, it is essential that the UK produces its own carbon border levy, to protect its manufacturing base against carbon leakage. If such risks can be mitigated, however, with a coherent carbon pricing and CBAM regime in place, this will make a decisive step towards decarbonising European industry, while protecting from carbon leakage.
In short, this developing regulatory framework is one where alignment between the EU and UK is critical. This would ensure that both jurisdictions decarbonise rapidly, while also protecting each other from cheaper, more polluting imports.
The imposition of this new emissions reduction regime, however, comes at one of the most challenging periods in the past 10 years for European industry. With soaring gas and electricity prices, it is critical that both UK and EU policymakers provide for strong carbon leakage protections from third countries, or many companies risk be driven out of business, or out of the European market.