What is carbon leakage?
Carbon leakage can occur when different jurisdictions implement different levels of carbon pricing and regulation. When this happens, economic activity can move to a jurisdiction with weaker policies around reducing carbon emissions, resulting in carbon emissions shifting from one country to another. The objective of decarbonisation efforts is to reduce global emissions. Carbon leakage undermines this objective.
The consultation seeks views on three potential policies to minimise carbon leakage:
- a carbon border adjustment mechanism (CBAM);
- mandatory product standards and policies. These would prohibit products entering the UK market that breached an upper limit for carbon emissions produced during production. This would apply to UK produced and imported products; and
- emissions reporting requirements to increase demand for low carbon products. These could include voluntary product standards, product labelling, prioritising low carbon products in public procurement guidelines and encouraging the private sector to do the same.
What are CBAMs?
CBAMs introduce a carbon price on certain imported products that reflects both the carbon emitted during production, and any difference between the carbon price in the country of origin and the carbon price that would have occurred if the product was produced in the UK.
The EU is in the process of introducing a CBAM. The pilot will be launched from 1 October 2023 and other major economies such as Canada are considering similar policies.
Currently the main policy to tackle carbon leakage is free allocations of UK Emissions Trading Scheme (ETS) allowances. This allows industries at risk of carbon leakage to emit carbon emissions at no direct cost. However, from 2026 these will be phased out with only those industries most at risk of carbon leakage continuing to receive them. The policies consulted on will be in addition to the changes to the allocation of free ETS allowances.
Which sectors are affected?
A UK CBAM would be targeted at the sectors the Government considers at risk of carbon leakage:
- Iron and steel
- Non-ferrous metals
- Non-metallic minerals
- Paper & pulp
- Power generation
The Government will, however, consider other sectors if robust evidence is provided to justify their designation as at risk of carbon leakage.
When will the measures be introduced?
The consultation helpfully summarises the timeline for proposed new measures, with the earliest date for a potential UK CBAM being 2026.
A key component of any CBAM would be a reporting framework to collect data on embodied emissions of products manufactured in or imported to the UK. The Government recognises the complexities of this and suggests aligning as far as possible with international reporting frameworks. The consultation states that 2025 would be the earliest date for the introduction of an emissions reporting system in a limited number of sectors, the first stage in the introduction of a CBAM. This would be followed by the introduction of a CBAM for those limited sectors in 2026 to coincide with the phasing out of free ETS allowances.
What do I need to do?
Those sectors identified by the Government as most at risk of carbon leakage should consider the impact of a possible CBAM in the context of the proposed EU CBAM. The Government is particularly interested in evidence on:
- whether the sectors at risk of carbon leakage are correct;
- how emissions should be measured;
- what emissions should be included in CBAM;
- how the price of emissions should be measured; and
- the implementation timetable.
Affected businesses are strongly advised to engage with the consultation process to ensure their views are reflected in future policy development. Given the phase out of free UK ETS allowances affected businesses could become more exposed to foreign competition in the absence of policies in this consultation. We can discuss the consultation, identify your risk of carbon leakage, and provide you with advice if you think your business will be impacted by the EU CBAM pilot staring on 1 October.
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By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.
Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. You should always seek appropriate tax advice before making decisions. HMRC Tax Year 2023/24.