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Rishi Sunak’s recent adjustments to UK climate targets have had a significant impact on British exporters. Within the next decade, they will be faced with hundreds of millions of pounds in EU carbon border taxes. These revenues, which would have otherwise gone to the Treasury, will now be redirected elsewhere.
The collapse of the UK carbon market is the result of weakened green initiatives by the Conservative government. In recent months, UK emissions prices have fallen to less than half of the EU equivalent, whereas before they were trading at similar levels.
To address this disparity, the EU plans to implement a carbon border tax regime that penalizes countries with lower carbon costs than the bloc. As a result, British exporters to the EU will become liable for the EU tax starting in 2026.
Furthermore, the lower emissions price means that the UK Treasury will generate less revenue from carbon pricing. This change will redirect a portion of companies’ carbon bills from Westminster to Brussels. The EU has earmarked these revenues for investment in renewable industries.
From Sunday onwards, exporters to the EU are required to record carbon emissions embedded in their products as part of the early trial period for the EU’s carbon border adjustment mechanism (CBAM). Under CBAM, countries intending to export to the EU must demonstrate that they have an equivalent carbon price in place or pay penalties to compensate for the difference. The aim is to protect EU industry from countries with less strict emissions markets. The mechanism covers various sectors such as iron, steel, cement, aluminium, fertiliser, hydrogen, and electricity generation. During the trial period, exporters are only obligated to report emissions without paying the levy.
The UK Emissions Trading System (UK ETS) recently hit an all-time low of nearly £33 per tonne. This drop occurred shortly after Rishi Sunak’s speech, in which he announced weaker climate provisions, including the delay of the phaseout of petrol and diesel cars. In contrast, the EU ETS was trading at €82 per tonne (£71.10). Analysts predict that if the gap in carbon prices persists, UK exporters could end up paying hundreds of millions of pounds to the EU by the early 2030s.
The UK energy industry warns that despite low emissions, electricity exports from wind farms, solar plants, and nuclear plants will also be subject to carbon import taxes. Since a significant portion of UK electricity is still generated from burning fossil fuels, the EU will apply a similar portion of the CBAM levy to all UK electricity imports. Differentiating between clean and dirty power sources is challenging for the EU, so the levy will be applied universally. This situation raises concerns that UK wind farms, for example, may not be competitive in the EU market due to higher costs.
CBAM will be phased in starting from 2026 and will reach its full strength by 2034 when free emissions allowances for EU industry are phased out. It is possible that the UK ETS could strengthen relative to the EU ETS in the coming years. Manufacturers may benefit from lower carbon prices in domestic markets and non-EU exports. However, the current weakness in the UK ETS has made proposals to link the two carbon markets challenging.
Prior to the collapse in UK emissions prices, the Office for Budget Responsibility projected that revenues from the UK ETS would reach almost £37 billion between 2022 and 2026. However, the halving of the UK ETS price has significantly reduced these forecasted revenues. Unlike other countries, the UK has not designated the proceeds from the UK ETS for green investments, allowing the Treasury to use them for general expenditure.
The Department for Energy Security and Net Zero highlights that the UK has reduced emissions by 48% since 1990 and that the government has set a clear path to achieve net-zero emissions. The government is committed to reducing the scheme’s emissions cap starting next year, and the price of the UK ETS is determined by the market.
The reduction in UK emissions prices announced in July was smaller than anticipated, and additional carbon allowances were released to industry between 2024 and 2027, which further contributed to the slide in UK ETS prices.
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