The EU wants to introduce a Carbon-Border Adjustment Mechanism (CBAM) to ensure that its efforts to combat climate change are effective, and do not just lead to European heavy industry relocating to jurisdictions with weaker climate rules.
On 17 July the European Commission published its proposal as part of its broader ‘Fit for 55’ climate package. The CBAM now needs to be signed off by the member states and European Parliament – and will inevitably be tweaked along the way.
But even in these early stages, it raises questions for the UK about what impact the CBAM will have on it and how the CBAM will interact with the Northern Ireland Protocol.
But first, what does the EU’s CBAM look like? The Commission wants it to apply to imports of electricity, iron and steel, cement, aluminium and some fertilisers, in the first instance (new products could be added to the list in future).
This would see imported CBAM goods hit with a carbon price equivalent to that imposed when the same or similar products are produced domestically. The EU hopes that doing this will create a level playing field for domestically produced and imported goods.
In practice, it would mean a lot of new bureaucracy for EU importers. Importers of CBAM goods would need to register with a relevant national authority, calculate the amount of CO2 emissions embedded in their imported goods, and purchase CBAM certificates (new carbon certificates that mirror the weekly price of CO2 permits purchased through the EU’s Emissions Trading System).
At the end of each trading year, the registered importer would be required to declare the total amount of CO2 embedded in their imported CBAM goods in the previous year, and surrender the corresponding number of CBAM certificates.
The UK is one of the countries most exposed to the EU’s CBAM, with UK exports of iron and steel and aluminium particularly vulnerable. This exposure poses a problem for the UK and its exporters, as it is not currently listed as exempt from the CBAM regulation.
The European Economic Area countries and Switzerland, in contrast, are exempt from the measure due to them either participating in the EU’s ETS (EEA countries) or having linked their own ETS to the EU’s (Switzerland).
However, a lack of exemption does not necessarily mean that UK exports of CBAM goods to the EU will be subject to an additional charge. EU importers will be able to take into account any carbon price paid in the UK when determining how many CBAM certificates they need to purchase and surrender, and the UK will presumably continue to have a similar (quite possibly higher) domestic carbon price to the EU.
But despite there being little risk of additional direct costs, any EU company buying CBAM goods from the UK would need to jump through additional time consuming, and potentially pricy, bureaucratic hoops to do so.
The UK has a decision to make. If the UK decides to link its own ETS to the EU’s – something that was left an open possibility by the Trade and Co-operation Agreement – then the UK would probably be added to the EU’s exemption list.
A full exemption would benefit UK exporters of CBAM goods, and would help resolve issues related to Northern Ireland.
But at the time of writing the UK government has shown no indication it wants to link its scheme to the EU’s, arguing that doing so could leave the UK with less flexibility to design and shape its own carbon pricing structures.
But as is often the case, Northern Ireland adds an extra dimension to the discussion. CBAM most probably falls within the scope of the Northern Ireland protocol, which means that it would need to be applied either in full or in part in Northern Ireland. (This was acknowledged in an earlier, leaked, draft of the EU’s CBAM regulation, but was stripped out of the final document.)
However, several questions remain unanswered, and it is unclear how the CBAM would operate in Northern Ireland in practice. This is because the domestic carbon price for CBAM goods in Northern Ireland, with the exception of electricity, is set by the UK’s ETS, not the EU’s.
So if CBAM were applied to imports into Northern Ireland it arguably would not be considered an extension of the, EU-derived, domestic carbon price.
This could make applying the EU’s CBAM to imports into Northern Ireland hard to justify in the context of the EU’s WTO obligations, and the need to ensure it does not unfairly discriminate again foreign goods.
EU buyers purchasing CBAM goods from Northern Ireland could of course be required to go through the normal CBAM process. But doing so would create a new regulatory trade barrier between Northern Ireland and Ireland, and undermine the rationale behind the protocol.
An alternative approach would be for the CBAM to only apply to goods imported into Northern Ireland if they were destined for, or at risk of entering, the EU. But such an approach still leaves open the question of what happens to CBAM goods produced in Northern Ireland, which under the protocol can be freely sold into the EU.
Whatever approach is adopted, it will need to be agreed with the UK. Under Article 13 of the protocol for the CBAM regulation to be implemented in Northern Ireland it would require the consent of the UK in the protocol’s Joint Committee.
A failure to agree could increase political tension and lead to a trade dispute, with the EU entitled to take ‘appropriate remedial measures’.
If the EU CBAM does come into force, tensions between the EU and UK will probably increase, as the UK will be impacted both economically and politically.
As well as re-considering linking its ETS to the EU’s, the UK needs to decide whether a CBAM would be appropriate for the UK given its own domestic context and the risk of becoming a future dumping ground for high-carbon goods. At the very least the UK needs to actively engage with the EU and others while their CBAM proposals are still in the early stages.
It is of course still possible that the EU’s CBAM, and carbon-border adjustments in general, prove too complicated to implement in practice, and never see the light of day. But they are looking more likely than ever, and the UK cannot afford to stick its head in the sand.
By Sam Lowe, senior research fellow at the Centre for European Reform and visiting senior research fellow at The Policy Institute, King’s College London.