Carbon markets and carbon pricing systems are becoming increasingly relevant, as governments recognise the potential benefits of market-based mechanisms in achieving decarbonisation objectives.
The European Union Emissions Trading Scheme (EU ETS), the flagship tool for achieving the EU decarbonisation goals, has proven the effectiveness of such mechanisms as a policy instrument. The EU ETS, as part of the EU fit for 55 package, is now expanding in scope and reach, incorporating the maritime transport sector under the existing system and extending to the buildings and road transport sectors under a separate system, ETS 2. Other jurisdictions, such as the UK, are following this example and implementing market-based mechanisms of their own.
Recent developments may see a further expansion of carbon pricing mechanisms to new jurisdictions. The newly implemented EU Carbon Border Adjustment Mechanism (CBAM), effective from 1st October 2023, will impose a carbon price on imports into the EU for specific carbon-intensive products, including cement, iron & steel, aluminium, fertilisers, electricity, and hydrogen. This measure is intended to create a level playing field, by aligning the cost of carbon for imported products, with that imposed on the equivalent domestic production within the EU,
The UK is also planning to follow this new EU policy measure, with the introduction of the UK CBAM. This is expected to include the aforementioned carbon-intensive imports, but also extend the scope to include ceramics and glass.
The existence of CBAMs may lead to the emergence of new national and regional carbon pricing systems. Importers of impacted products into the EU can reduce the obligation to pay the EU carbon price if they can show that an equivalent carbon price has already been paid in the exporting country. It is perhaps likely, therefore, that governments of exporting countries, exposed to CBAMs, will prefer that the revenue from the imposition of a carbon price should remain within their own “coffers”, rather than being paid out to a foreign jurisdiction. They may conclude that a domestic carbon pricing system of their own would be advantageous.
For the EU CBAM to be effective, it needs to mirror the regulations imposed on EU emitters. Under the EU ETS, impacted installations are exempted from the obligation to purchase European Union Allowances (EUAs) if they can show that the carbon emitted has been captured and permanently stored in line with the EU CCS Directive. This creates a significant economic incentive for CCS within the EU, particularly where the carbon price is above or near to €100/t, as it was for some time during 2023. A similar incentive must be there for imports covered by the CBAM, providing an exemption from CBAM where fossil carbon is captured and permanently stored in the exporting country.
Countries and companies that can produce low carbon products, either through improved technology or efficiency, or through capturing the associated carbon emissions and permanently storing them via Carbon Capture and Storage (CCS), should be at a significant advantage in the emerging world of carbon markets, either through benefitting from an exemption to a compliance system as mentioned above, through the possible generation of carbon credits for potential sale into the voluntary carbon market, or through creation of low carbon products and monetisation of the associated green premium.
If you would like to understand more about carbon markets, the Carbon Border Adjustment Mechanism and their implications for business, please contact Michael Fulton at Energex Partners mfulton@energex.partners.