Recent developments portend important climate-related trade developments in 2024.  In the EU, the Carbon Border Adjustment Mechanism (“CBAM”) to the EU’s Emissions Trading System (“EU ETS”) has entered its transition period, and 2024 will bring additional obligations for importers.  In the UK, HM Treasury recently announced the introduction of its own carbon import tariff regime, which is intended to be implemented by 2027.  The new carbon import tariff regime will work alongside the UK Emissions Trading System (“UK ETS”), further consultations regarding the measure’s scope will occur later this year.

These developments suggest continued acceleration of European trade-related carbon pricing measures in 2024.

EU CBAM: Importers’ obligations ramp up as transition period continues

The transition period of the EU CBAM began on October 1, 2023, and commenced importers’ reporting obligations through the CBAM Transitional Registry.  In sum, from October 1, 2023, until December 31, 2025, embedded emissions on certain imports should be calculated and reported on a quarterly basis.  The deadline for the first transitional CBAM report is January 31, 2024 (for the fourth quarter of 2023), and each subsequent quarterly report must be filed no later than one month after each reporting quarter.  Calculation methods become more complex and precise as the transition period continues.  Additionally, as from December 31, 2024, importers should apply for the status of authorized CBAM declarant.  The purpose of the transitional period is to serve as a “learning period” and collect information to refine the implementation of the CBAM.  Subsequently, during the definitive period—which begins on January 1, 2026—the quarterly reporting is replaced with yearly CBAM declarations covering the total embedded emissions of the goods imported during the preceding year. On this basis, authorized CBAM declarants must surrender the corresponding number of CBAM certificates. This will require importers to purchase certificates tied to the cost of emissions allowances under the EU’s Emissions Trading System (ETS), which give European producers the right to emit one ton of CO2 or CO2 equivalents.

UK CBAM: CBAM 2.0?

In a related development, on 18 December 2023 the UK government announced that, like the EU, it will introduce its own CBAM by 2027.

The UK has for many years operated an emissions trading scheme (the UK ETS) in an effort to drive decarbonisation of domestic production in certain sectors.  However, to date no such carbon price has been applied to imports, which account for 43% of the UK’s consumption emissions.  Instead, companies in certain industry sectors have been granted “free allowances.”  This is similar to the EU ETS, which exempts many domestic producers in certain emissions-intensive, trade-exposed industry sectors from the requirement to purchase emissions allowances.

The UK government has expressed concerns regarding “carbon leakage”, the effect of which will only increase as the UK ETS’s carbon price increases or as the UK ETS’s product scope broadens.  The current system of free allowances under the UK ETS does not fully protect against carbon leakage.  Moreover, certain energy-intensive production has shifted abroad (to imports), and is thus supplied by producers who have no equivalent incentive to clean up production (i.e., with no domestic carbon price in-country of production and no import border tax adjustments).

Sectors

The UK government has stated that in-scope products will fall within the following sectors:

• Aluminium;
• Cement;
• Ceramics;
• Fertiliser;
• Glass;
• Hydrogen;
• Iron; and,
• Steel.  

Interestingly, this differs somewhat from the EU’s equivalent list, which includes electricity but not ceramics and glass.

We understand that consultation will be undertaken in 2024 to consider the precise products to which import charges will be applied.

World Trade Organisation

The purpose of CBAM is notionally environmental, but certain WTO Members have already signalled potential challenges to its WTO consistency. Dispute settlement over the CBAM could address the WTO rules governing, for example, “most favoured nation” and “national treatment” obligations, quantitative restrictions, and the exception for “environmental” measures. Accordingly, ensuring the design of the UK’s CBAM is compatible with its WTO obligations will be both pivotal and challenging.

CBAM & Northern Ireland

The legal position of Northern Ireland is complex.  The EU CBAM notionally falls within the scope of the Northern Ireland Protocol; however, Northern Ireland operates domestically under the UK ETS (other than in respect of electricity).

Current EU proposals indicate that goods produced in Northern Ireland would be subject to the EU’s CBAM (i.e., Northern Ireland would not be EU-aligned).  This approach could pose a regulatory barrier for companies in Northern Ireland wishing to trade with the Republic of Ireland.  This could occur if, for example, there is a difference in either (a) the carbon price across the EU ETS and UK ETS, or (b) the scope of the EU’s CBAM and UK CBAM’s covered products.  Alternatively, the EU may not ask Northern Ireland to apply its CBAM.  This would mean goods could cross into the EU single market via Northern Ireland without paying the EU’s CBAM carbon price.

By contrast, extension of the EU CBAM to Northern Ireland could constitute unfair trade discrimination under WTO rules.  This is because the CBAM would be applied to Northern Ireland even though it is subject to the UK ETS, not the CBAM.

One possible means of reconciling these difficulties would be to integrate the UK and EU emission trading schemes, as contemplated by the EU-UK Trade and Co-Operation Agreement.  However, this could be difficult politically given the composition of the current UK government.

Future

The UK government intends to implement a CBAM, but policymakers have provided limited detail on the proposal.  The EU’s efforts over the last couple of years portend key legal challenges for the UK government. Accordingly, in designing its CBAM, the UK government will need to be conscious of its trade obligations under WTO rules and be mindful of the unique position of Northern Ireland given the Northern Ireland protocol.

Next steps

With these developments in mind, it is important that companies in energy-intensive, trade-exposed industry sectors—particularly with those with significant operations and/or activities in the EU and UK —be prepared to comply with the reporting requirements and other measures entering into force in the coming months.  

The Hogan Lovells trade team has deep expertise and significant experience with these issues, and will continue to provide updates on the latest legal and policy developments.

Authored by Jonathan Stoel, Lourdes Catrain, Warren Maruyama, Aline Doussin, Stephanie Seeuws, Greg Hawkins, and Daniel Shapland.