Introduction
The Carbon Border Adjustment Mechanism (CBAM) is a policy tool designed to equalise the price of carbon between domestically produced products and imported products to ensure a jurisdiction’s climate objectives are not undermined by production relocating to countries with less ambitious climate change policies. The embedded emissions of goods exposed to this regime will be required to be measured, reported, verified, and finally offset against the relevant instrument.
In light of a recent consultation response from the UK Government regarding the introduction of the UK CBAM from 2027, Redshaw Advisors analyses the key differences between the EU CBAM and the UK CBAM. We bring attention to critical developments to help our viewers navigate the changing dynamics of the CBAM.
Overview of the EU CBAM
The EU CBAM aims to combat carbon leakage, supporting the EU Green Deal and net-zero targets while encouraging global climate action. The EU CBAM covers carbon intensive sectors like iron and steel, cement, aluminium, fertilisers, electricity, and hydrogen. Starting with a transitional phase (2023–2025), only emissions measuring and reporting for the embedded emissions of exposed goods will be required. Full implementation in 2026 will mandate importers to not only report emissions but also purchase CBAM certificates reflecting the embedded emissions in CBAM-covered imported goods. Adjustments will be made for countries where carbon pricing exists, ensuring fairness.
Overview of the UK CBAM
Similar to the EU's CBAM, the UK version seeks to impose a carbon price on imported goods, particularly those from carbon-intensive sectors like iron and steel, cement, aluminium, fertilisers, and hydrogen, ensuring that foreign products are subject to the same carbon costs as domestically produced goods. The key difference however is that the UK CBAM is a tax-based mechanism whereas the EU CBAM is a market-based mechanism. The UK CBAM would also allow for adjustments based on carbon pricing already applied in the exporting country.
Key differences between the UK and EU CBAM
| Aspect | EU CBAM | UK CBAM |
|---|---|---|
| Mechanism | Market-based mechanism. | Tax-based mechanism. |
| Implementation | Transitional phase started on 1st October 2023. Definitive phase from 1st January 2026. | No transitional phase. Full implementation to be introduced on 1st January 2027. |
| Reporting period | Scheduled quarterly in the transition phase, changing to annual intervals in the definitive phase in starting 2026. | The first reporting period will be conducted on an annual basis. From 2028 and onwards, accounting periods will be shifted to quarterly basis. |
| Sectoral scope | Iron & steel, cement, fertilisers, aluminium, electricity and hydrogen. Likely to expand. | Iron & steel, cement, fertilisers, aluminium, hydrogen. Initially excludes glass and ceramics. Likely to expand. |
| Emissions coverage | Direct and indirect emissions (Scope 1 & 2) and select precursor product emissions. | Direct and indirect emissions (Scope 1 & 2) and select precursor product emissions. |
| Phasing out of free allowances | EUAs phase out will be in direct proportion to CBAM phase-in. | UKA phase out will be independent of the UK CBAM. |
| Penalties | Penalty for the definitive period amounts to €100 per tonne CO2e, in addition to purchasing certificates for the unreported emissions. | The UK government is minded to adopt the penalty points system recently introduced for VAT. The UK government also intends to introduce a general penalty, for any offenses that are specific to CBAM. |
| Exemptions | Consignments of low value, no more than €150 in an accounting period. Goods used for military purposes Products already subject to the EU ETS. | Consignment of less than £50,000 in a 12-month rolling period. Goods already subject to the UK ETS. |
Implementation and timeline
Introduced on 1st October 2023, the EU CBAM commenced with a transitional phase implementing quarterly reporting periods. During the transition period, which is set to end on 31st December 2025, no CBAM certificates need to be surrendered. Following the transition period, the definitive period starts, and reporting and accounting periods are shifted to annual basis. Importers are expected to surrender CBAM certificates equivalent to the embedded emissions in the imported CBAM covered product in this phase.
On the other hand, the UK CBAM does not have a transition phase and will directly move to a definitive phase from the 1st January 2027. This implies that importers are required to pay the applicable tax directly from the mechanism's inception. The first accounting period of the UK CBAM spans a whole year (ending on the 31st December 2027), however importers will have until the 31st May 2027 for submitting the first CBAM return and payment covering the first accounting period. Following the first accounting period, the UK CBAM will adopt quarterly accounting periods from 2028.
Sectoral differences
There is little difference in the sectoral scope of both mechanisms apart from the exemption of electricity from UK CBAM. The reason for this is that the UK relies heavily on imported electricity from the EU, and since electricity is already covered under the EU ETS, the threat of carbon leakage from electricity is minimal for the UK. The UK Government initially intended to include glass and ceramics in the sectoral scope of the UK CBAM. However, the Government later determined that these sectors are generally less exposed to carbon leakage risk and raised feasibility concerns in the response to their second consultation. As a result, glass and ceramics were dropped from the initial sectors covered under the UK CBAM. Both the UK CBAM and EU CBAM remain open to potential changes in their sectoral scope in the future.
Emissions covered
Emissions covered under both schemes are identical to ensure synergy among both the mechanisms. Both the UK and EU CBAM allow default values, but importers are cautioned that these may lead to higher CBAM costs because of the defensive values in place.
CBAM rate and costs
The EU CBAM rate and the UK CBAM rate are quite similar in theory. Both rates adjust for free allowances, and are referenced against the emissions allowance prices in their respective emissions trading systems. However, the UK government decided to set a distinct CBAM rate for each sector covered under the UK CBAM. The UK government will set this rate each quarter, also factoring in the Carbon Price Support (CPS) rate, a subsidy to ease higher domestic electricity costs due to the UK ETS.
The EU CBAM certificate price is pegged to the weekly average EUA auction price, while the UK CBAM rate is referenced to the average quarterly price of UKAs. As a result, the UK CBAM rate will be updated once every quarter, whereas EU CBAM certificate costs will likely be more volatile.
Administrative approach
One key lesson from the initial quarters of EU CBAM was the significant reporting challenges, particularly around the complexity of measuring and reporting emissions. To avoid such complexities, the UK is working on implementing a simpler, more streamlined tax-based system.
The EU Commission has yet to release CBAM benchmarks, which will be developed from a combination of EU ETS benchmarks, taking into account country-specific emissions intensity and, in some cases, installation-specific data. In contrast, the UK CBAM bypasses benchmarks entirely, relying on emissions intensity to determine default values.
The UK government raised the minimum threshold for compliance from £10,000 to £50,000 over a rolling 12-month period to reduce complications for Small to Medium Enterprises (SMEs).
Considering all these disparities, Redshaw Advisors is of the opinion that at this stage it may be comparatively easier to comply with the UK CBAM.
Implications and recommendation for businesses
Both the EU CBAM and the UK CBAM are complex mechanisms and require meticulous care and attention throughout the compliance procedure. Redshaw Advisors suggests companies at risk from the mechanisms to equip themselves with knowledge and prepare ahead of time for compliance. Both the mechanisms are expected to incur significant costs moving ahead, but they also offer opportunities for hedging.
Get in touch to discuss your CBAM hedging strategies and we will arrange a free consultation session to discuss your CBAM exposure.
