Introduction
In October 2024, the government published its response to the consultation on the Carbon Border Adjustment Mechanism (CBAM), confirming that CBAM will be in effect from 1 January 2027. The consultation, which ran from 21 March 2024 to 13 June 2024, received over 340 responses from industry representatives, trade associations, importers, think tanks, and academics. The introduction of UK CBAM will impact UK businesses with international supply chains, and international businesses who export to the UK.
This article provides an overview of the key elements of UK CBAM and considers the impact on several sectors: construction, energy and utilities, and agriculture, with some suggested actions for businesses and ESG managers.
Background
The purpose of CBAM is to reduce carbon leakage, which is “the movement of production and associated emissions from one country to another due to different levels of decarbonisation effort through carbon pricing and climate regulation”. UK businesses may currently be incentivised to move production to other countries to circumvent costs arising under the UK Emissions Trading Scheme (ETS), which puts a price on certain domestic emissions.
CBAM aims to prevent carbon leakage by imposing a levy on imports into the UK by subjecting certain emissions-intensive sectors to a CBAM rate based on the carbon price gap between the production country and the UK. The aim is to equalise carbon pricing for foreign and domestic goods by imposing a rate on imports which reflects the price if the goods were produced in the UK and were therefore liable under the UK ETS.
The UK ETS Authority (a consortium between the UK, Scottish and Welsh governments and Northern Ireland Department of Agriculture, Environment and Rural Affairs) has conducted consultations to align CBAM with the UK ETS. This includes a proposal to alter the free allocation methodology for stationary sectors to target those at risk of carbon leakage and ensure fair distribution. Another proposed the extension of the Free Allocation period from 2025 to 2026 and starting the second allocation period to 2027.
Scope
The consultation response confirmed that the following sectors will be within the scope of UK CBAM:
- steel
- cement
- aluminium
- fertiliser
- hydrogen
- iron.
The sectoral scope of the UK CBAM will be subject to constant review and additional sectors are likely to be added in the future. This includes the glass and ceramics sectors which are currently excluded.
The remit of CBAM is determined by the scope system which categorises activities based on ownership and control:
- Direct emissions refer to activities that are “owned or controlled by an organisation” such as manufacturing processes (Scope 1);
- Indirect emissions refer to emissions produced by electricity consumed as part of production (Scope 2);
- Precursor emissions are those that are “released as a consequence of an organisation’s actions that occur at sources not owned or controlled by the organisation” (Scope 3).
Emissions falling within scopes 1 and 2 will be liable to CBAM, with some precursor emissions under scope 3 also being covered. A full list of goods and materials within the scope of CBAM can be found in Annex B of the consultation response.
Businesses which spend a minimum of £50,000 on CBAM goods over the course of a year will be within the scope of CBAM. This is a change from the previous suggested minimum registration threshold of £10,000 and has the effect of exempting SMEs due to the disproportionate burden this would place on them.
Requirements
Liability lies with importers of products, who will need to produce CBAM tax returns including essential information, such as the weight of CBAM goods and any effective overseas carbon price. This will be required on an annual basis in 2027, and then quarterly from 2028.
Emissions can be calculated in two ways:
- businesses can use data they have collected; or
- they can choose to use the default value (set per product) where data is not available.
Default emissions values were introduced to ease administrative burdens on businesses, particularly those who have long and complex supply chains and may therefore have difficulties in obtaining the relevant data. The disadvantage of using default values is that they could be higher than the actual emissions produced.
Penalties applicable in cases of non-compliance will include those available under HMRC powers, along with a criminal offence for fraudulent evasion of CBAM. There will be a transitional period prior to the application of penalties, to allow businesses to adjust to the administrative requirements.
Relationship with EU CBAM
EU CBAM, which is already in effect, operates separately to UK CBAM; however, the consultation emphasised that there needs to be international cooperation to combat carbon leakage successfully. This includes working to align UK CBAM with other similar schemes and regulations, including EU CBAM, which is currently more advanced than the UK’s equivalent and is already in its transition stage.
Some of the key differences between EU CBAM and UK CBAM include:
- Mechanism: UK CBAM operates via a levy, while EU CBAM operates via the purchase of ‘CBAM certificates’ in line with ETS prices;
- Sectoral scope: a wider sectoral scope for EU CBAM, which also includes electricity;
- Rates adjustment: on a quarterly basis for UK CBAM, and a weekly basis for EU CBAM;
- Minimum thresholds: for EU CBAM this is calculated with reference to shipments that are 150EUR or more (although an announcement is expected soon which will see an increase in the threshold, meaning smaller businesses will be exempt and bringing the scheme further in line with the UK proposals); for UK CBAM, the minimum threshold is based on the amount of CBAM goods over a 12-month rolling period.
The implications of non-alignment may be significant for certain businesses, resulting in a higher administrative burden due to the need to comply with two different sets of regulations.
Impact on key sectors
Construction
One of the sectors most impacted by the introduction of UK CBAM is construction. This is due to the inclusion of key construction materials, including iron, cement, steel and aluminium, and the reliance on cross-border supply chains and overseas production in this sector. For example, in the first quarter of 2024, 1,719 million GBP worth of iron and steel were imported into the UK. Construction companies are, therefore, likely to face increased costs due to carbon pricing and administrative requirements relating to data collection and compliance.
The lack of alignment with EU CBAM with regards to the inclusion of indirect emissions could lead to a competitive disadvantage in relation to trade as consumers turn to companies in countries with less stringent carbon pricing. This also imposes a greater administrative burden, as UK construction companies will need to comply with two different sets of regulations.
Specific concerns were raised in the consultation in relation to the inclusion of screws and bolts (combined nomenclature code HS 7318) within the scope of CBAM. This has a potentially disproportionate burden compared to the cost of the goods.
The introduction of CBAM may however provide an incentive for companies to invest in new technologies to help with compliance and emissions reduction. Some have described the introduction of UK CBAM as a ‘game-changer for construction’, emphasising the opportunities this provides for investment in sustainable construction. Suggestions for investment include engineered timber, green concrete, and methods of modern construction. Green steel is a key part of the UK government’s steel industry strategy and presents a potential opportunity for the UK to become a market leader in sustainable steel.
Energy and Utilities
A further sector that is likely to feel the impact of UK CBAM is the energy and utilities sector, primarily due to the inclusion of hydrogen within the scope, but also due to the use of materials which are used as a base for renewable energy infrastructure, such as steel in turbines and solar panels.
Similar to the construction sector, concerns have been raised about the inclusion of indirect emissions, specifically the need to take into account the Energy Intensive Industry (EII) scheme, which provides relief for businesses with high energy consumption. The government’s response provided some reassurance that UK CBAM would be aligned with other schemes’ definitions, as far as possible.
Energy UK has emphasised the importance of collaboration between the UK and EU, calling for alignment between the UK and EU ETS rather than having two separate CBAMs, which is currently a less advantageous approach due to the added administrative and compliance burden.
Despite the concerns expressed in the consultation and discussed above, there has been some positive response to UK CBAM from the energy sector, with some suggestions that the renewable energy sector will see higher levels of investment as companies try to reduce their emissions.
Agriculture
This is another area likely to be impacted by UK CBAM, particularly due to the inclusion of fertiliser and the current low levels of UK-based production. This will lead to an increase in production costs due to the need to account for the carbon costs of imports. This will have an impact on the supply chain as farmers aim to find more sustainable sources. The National Farmers Union has expressed “concern that CBAM will push up the cost of fertiliser in the UK at a time when farm bottom lines are already squeezed and farmer confidence is at an all-time low”.
British farmers are concerned that they will face a competitive disadvantage due to the higher costs associated with carbon pricing on imported fertiliser, which may lead to more imports of produce from other countries with lower costs for emissions. Concern is greatest for the arable sector, where fertiliser accounts for 38% of crop-specific expenditure and 12% of total farm costs.
Farmers are likely to be hit by other additional costs stemming indirectly from the introduction of CBAM on other materials, such as steel, aluminium and cement, which are used to construct buildings, build tractors and other heavy machinery, and used for food processing.
Other indirect impacts
Beyond the key sectors discussed above which will feel the most significant impact of UK CBAM, there are other industries that may also be directly or indirectly impacted. This includes healthcare (use of steel in hospital equipment), transport (railway and tramway construction materials included in the scope), and defence (use of steel in aircraft and military vehicles).
Key actions for businesses
Businesses involved in importing goods that are in scope will need to consider how to ensure alignment with UK CBAM ahead of its coming into force on 1 January 2027. The process for measuring and reporting the data can be complex, so it is advised that businesses start planning now to avoid costly mistakes.
Key actions to take may include:
- Assessing which goods and materials will be covered by CBAM and calculating emissions;
- Considering how emissions will be tracked and how data will be collected;
- Conducting an audit of the supply chain and identifying where more sustainable providers can be engaged to reduce emissions and cut costs;
- Investing in innovative and sustainable technologies to bring down carbon pricing costs – the Centre for Sustainability and Excellence has suggested that “CBAM is not just a tax—it’s a catalyst for innovation and a call to action for businesses to align with the global push for sustainability.”
- Engaging with the CBAM industry working group and international working group to voice concerns and have an input.
CBAM and ESG
CBAM should also be taken into consideration by those responsible for ESG reporting due to the way it aligns with the broader goals of ESG, which aim to provide transparency on a company's environmental impact.
Over the next few years, we are likely to see new regulations that will require companies to observe ESG standards across their supply chain. Our report ‘Supply chain ESG disclosure – is your business ready?’ looks to assess the extent to which UK organisations are applying due diligence with regard to their supply chains, and whether they are ready to meet changing global standards in this area.
Our Corporate ESG Disclosure Tool is designed to help businesses stay on top of their mandatory disclosure obligations and consider other voluntary disclosures that could be made to boost their ESG credentials. It is relevant for businesses of all sizes, and can help you identify the key ESG issues that your business may be facing and where real value can be achieved.
Get in touch
For further information or advice on any changes discussed here and how to best prepare for the implementation of UK CBAM, please contact Paul Browne, Head of our International Trade team, or Michael Barlow, Head of our Environment team, who will be happy to help.
This article was written by Michael Barlow and Megan Firth, with input from Victoria Barnes, Lisa Mulholland and Sasha Anisman.