UK to face significant financial losses in carbon-intensive traded goods if it fails to keep pace with new EU carbon policy

Posted on 1 Apr 2021 in

A robust carbon pricing framework is needed to support decarbonisation of industry and avoid important UK exports being penalised by the EU’s carbon border adjustment mechanism, according to a new report published today (April 1st) by the Grantham Research Institute on Climate Change and the Environment at the London School of Economics and Political Science.

The paper, What does an EU Carbon Border Adjustment Mechanism mean for the UK? explores how the European Union’s carbon border adjustment mechanism, announced to come into force by the end of 2022, might affect the UK.

A carbon border adjustment mechanism works by imposing a fee on carbon-intensive goods from countries with less stringent climate policy. The policy is gaining traction, in particular following the announcement made by the European Union that a carbon border adjustment mechanism design will be adopted by the end of 2022 to ensure EU companies can compete on a level playing field and avoid carbon leakage.

The paper argues that a failure by the UK to keep pace with the EU’s level of policy stringency for industrial sectors could risk UK exports being penalised by the carbon border adjustment mechanism, entailing an upper bound estimate of €1 billion in financial transfers from the UK to the EU.

“As the EU is the UK’s main trading partner in carbon-intensive goods, regardless of whether the carbon border adjustment mechanism considers only basic materials or broader products, the potential impact is significant. Around one-third of the total value of all UK goods exported to the EU could be affected,” said co-author Josh Burke, Senior Policy Fellow at the Grantham Research Institute on Climate Change and the Environment.

“Maintaining sufficient carbon pricing ambition should be at the heart of any UK climate policy reforms. This will enable greenhouse gases to be reduced in a fair and cost-effective manner and prevent exports from strategically-important energy-intensive UK sectors being penalised by the EU.”

To decarbonise industry, the paper says, there needs to be a strong policy framework that includes a high carbon price and complementary leakage measures. It recommends that the carbon price should rise to £75/tonne in 2030.

“Given strong trade linkages and integrated supply chains with the EU, uncertainty around UK’s post-Brexit climate policy and particularly around anti-carbon-leakage measures further reduces the long-term investment security for carbon-neutral production processes for UK industry,” said co-author Misato Sato, Assistant Professor at the Grantham Research Institute on Climate Change and the Environment.

The paper recommends that, as a priority, measures should be put in place to address uncertainty and enable investors to recover the incremental costs of carbon-neutral investments. It further recommends that the UK consider close multilateral cooperation with the EU on a robust policy package to support industrial decarbonisation, including linking of emissions trading systems, equitable carbon border adjustment mechanism design, the gradual phase-out of free allocation of permits, support for innovation, and carbon contracts for difference.

Policies to address carbon leakage and prevent export sectors from losing global market share should focus on specific sub-sectors and may be differentiated. For example, leakage provisions that are tailored to steel and aluminium would be needed if the UK has a broad, import-only carbon border adjustment mechanism design in conjunction with the EU carbon border adjustment mechanism design. This could include different boundaries for product coverage.

Notes to Editors:

The Centre for Climate Change Economics and Policy (CCCEP) was established in 2008 to advance public and private action on climate change through rigorous, innovative research. The Centre is hosted jointly by the University of Leeds and the London School of Economics and Political Science. It is funded by the UK Economic and Social Research Council.

The Grantham Research Institute on Climate Change and the Environment was established in 2008 at the London School of Economics and Political Science. The Institute brings together international expertise on economics, as well as finance, geography, the environment, international development, and political economy to establish a world-leading centre for policy-relevant research, teaching and training in climate change and the environment. It is funded by the Grantham Foundation for the Protection of the Environment, which also funds the Grantham Institute – Climate Change and the Environment at Imperial College London.