Consultation on UK Carbon Border Adjustment Mechanism ("CBAM")

1.  Introduction

The UK Government launched a Consultation on the introduction of a UK CBAM on 21 March 2024.  The Consultation closes on 13 June 2024.  This follows the announcement, in December 2023, that the UK would implement a UK CBAM similar to the EU CBAM which came into effect on 1 October 2023.

In this update, we summarise the key design features of the proposed UK CBAM and highlight some of the key differences with the EU CBAM.

2.  What is a CBAM?

A CBAM aims to ensure equal treatment of domestic and imported goods by applying a charge to carbon emitted during the production of imported carbon-intensive goods.  This should be broadly equivalent to the costs imposed on UK-based manufacturers in relation to carbon emissions.

CBAMs are challenging to design because they require information on emissions embedded in goods manufactured in countries (including so-called "carbon havens") where accounting for carbon is less advanced than in the EU or UK.  Furthermore, to be consistent with world trade rules, CBAMs must be designed so as not to treat imported goods less favourably than the same goods manufactured domestically.  CBAMs must also take into account any charges already applied to goods in the exporting country, to avoid imported goods being charged twice for the same carbon emissions.

On the latter point, various WTO members have raised concerns about the EU CBAM in the WTO Council and these may lead well to formal proceedings in due course. In view of the design similarities between the EU and UK schemes, challenges to the UK scheme could well be on the horizon.

3.  A word about the EU CBAM

Although the EU CBAM came into force in October 2023, it is operating only a transitional phase until 2026 during which importers of certain goods with the most significant risk of carbon leakage have to report on their embedded emissions.  The first reporting period ended on 31 December 2023 although the deadline for the submission of CBAM reports has been extended to 31 March 2024.  From 2026 onwards, however, importers will have to buy and surrender CBAM certificates equivalent to the carbon emissions embedded in their imports based on a price of certificates determined by reference to the price of EU Emission Trading System ("EU ETS") allowances.  These are the allowances that EU manufacturers would be required to surrender had the goods been manufactured within the EU.

Similarly, as we set out in more detail below, the price importers will pay under the UK CBAM is also linked to the price paid by UK manufacturers under the UK ETS.

The relationship between the EU CBAM and the UK CBAM has at least three important consequences:

• UK-manufactured goods which already face a cost under the UK ETS will from 2026 potentially face further charges under the EU CBAM and, in any event, face further administrative costs arising from the additional reporting obligations associated with the EU CBAM.
• Because the EU CBAM comes into force before the UK CBAM (due from 2027), there is a risk that carbon-intensive products from other countries may be diverted from the EU to the UK to avoid the EU CBAM.  This is an ongoing risk if EU CBAM costs are higher than UK CBAM costs.
• If the UK CBAM scheme requirements diverge from EU CBAM, then costs to UK importers may provide excessive leading to significantly increased costs which are then passed on to UK consumers.

The UK Government ran its initial Consultation on introducing a UK CBAM during 2023.  Whilst the majority of respondents supported the introduction of a UK CBAM, most also wanted to ensure it was fully aligned with the EU CBAM.  We set out below the key differences between the two schemes.

4. UK CBAM – Key Design Features

4.1 Scope

Under the proposals for the UK CBAM goods imported into the UK from 1 January 2027 will be subject to a charge on embedded carbon across seven sectors:

• aluminium
• cement
• ceramics
• fertiliser
• glass
• hydrogen
• iron and steel

The Government considered but decided to exclude scrap aluminium, scrap glass and scrap iron and steel from the scope of the CBAM as the use of scrap products reduces the need for the production of new materials and so has a net environmental benefit.

4.2 Relevant Embedded Emissions

The embodied emissions in respect of which the UK CBAM will be applied cover both direct and indirect emissions (see further below).  The actual emissions associated with the manufacture of products abroad will vary widely depending on the process used and jurisdiction, so the Government is proposing to introduce a dual approach to calculating the emissions associated with imported goods.  That means that the importer will have two options available to them:

• to use default values as determined by the UK Government; or
• to use data on the actual emissions involved.

The second option will require detailed rules to be developed on monitoring and reporting on emissions as well as independent verification.  These are expected to follow in 2024.

4.3 Setting the CBAM rate

The CBAM charge will be applied to particular products within the each of the above sectors and the Consultation sets out the proposed products at Annex A.

The Government intends to apply the UK CBAM charge to direct emissions from the manufacturing process in the exporting country (Scope 1 emissions), indirect emissions from the generation of purchased energy used in the manufacturing process, e.g. electricity, heat, steam, etc. (Scope 2 emissions) and emissions associated with certain "precursor goods" or goods used as an input material in the overseas production of the imported goods (Scope 3 emissions).

Although the emissions intensity of products will vary between jurisdictions, the Government has decided that setting default values by jurisdiction would not be feasible by 2027.  Accordingly, the Government is proposing a default value will be set for each CBAM good in line with global average embodied emissions weighted by the production values of key UK trading partners.

The importer of any in-scope products will be charged the carbon price under the UK ETS less a deduction after accounting for the fact that UK manufacturers benefit from various mitigation schemes, including the allocation of free allowances to certain UK manufacturers and the Energy Intensive Industries Scheme ("EIIS") which grants tax relief to some energy-intensive UK manufacturers such as iron and steel in respect of the energy they consume.  The resulting "effective" carbon price differs between sectors so the Government is proposing to introduce seven UK CBAM rates corresponding with the sectors set out above.

4.4 Adjusting for overseas carbon price

Once the in-principle CBAM liability has been calculated - by multiplying the embodied emission by the CBAM rate for the relevant sector - the liability is then reduced if the embodied CBAM goods were subject to an explicit carbon price overseas (e.g. under the EU ETS) and the importer provides evidence of this.

It should be noted that only the explicit carbon price applied to overseas goods will be taken into account so indirect pricing (e.g. via regulatory policies or fuel duties) is not taken into account.

5.  Liable person and de minimis

Liability for UK CBAM arises at the point at which goods are released into free circulation in the UK (where customs controls apply) or the point at which goods enter the UK where no customs controls apply.

The person liable is the person responsible for goods when they are released into free circulation in the UK where there are customs controls and otherwise the person on whose behalf the goods are imported into the UK.  The liable person is required to register if the total value of a person's UK CBAM goods exceed £10,000 a year.

The charge will be payable at the end of each accounting period.

6. Comparison of UK and EU CBAMs

As mentioned above, a large majority of respondents to the first Consultation on the UK CBAM, some 64%, wanted the UK CBAM to align closely with the EU CBAM in order to avoid unnecessary administration burdens and circumvention (where the importer shifts to a product not covered by one scheme) and passing on increased costs to UK consumers.

The two schemes, however, do differ in some important ways, which are summarised below.

7.  What next?

The UK Consultation is open for responses to 13 June 2024.  Non-UK importers of overseas goods will need to assess the potential impact of the scheme and any indirect consequences of the EU CBAM and UK businesses importing such goods will need to map the potential impact on their business.

Collecting data on actual emissions has proven to be a challenge in respect of the reporting requirements, so non-UK producers will need to invest in emissions data collection management and verification which is capable of addressing both the EU and UK CBAM.

Our team can advise on the design of both CBAMs, WTO-compatibility issues and provide specific advice on the implications of the schemes on particular products and businesses.