Where Technical Meets Political: The Complexity of the EU CBAM in Northern Ireland

Abstract

The European Union Carbon Border Adjustment Mechanism will influence UK-EU trade, raising particular issues regarding Northern Ireland (NI). We analyse EU CBAM-related NI issues in four scenarios in terms of whether the UK and the EU link their Emission Trading Schemes (ETS) and whether the UK has an EU-style CBAM. Our research covers direct emissions and indirect emissions (i.e., electricity market), with its importance evidenced by economic data. Relinking the UK and EU ETSs and establishing an EU-style UK CBAM would be the best way to resolve the complications the CBAM creates for NI. The alternative of using the Stormont Brake to prevent the implementation of the EU CBAM in NI would be significantly less satisfactory.

Acknowledgements:

The authors are indebted to L. Alan Winters and Emily Lydgate for their valuable comments. All errors are the authors’ sole responsibility.

Although the UK Government has opened a consultation about setting up a UK CBAM, it has yet to decide whether it will do so. As with the EU CBAM, the potential UK CBAM would aim to prevent carbon leakage. The UK already has an Emissions Trading Scheme, based on the EU scheme, including free allowances. If the UK were to establish a CBAM, it would regulate the cost of carbon emissions embedded in the goods imported by UK importers so that the cost of carbon emissions from these goods would be the same as the cost of carbon emissions from domestic products. Applying the same carbon cost for domestic and imported products would eliminate the incentive for UK producers to outsource or move their production or supply chains to countries with lower carbon costs, thereby preventing carbon leakage in the UK.

It is worth noting that bilateral trade between the UK and the EU will probably not cause carbon leakage in either direction, regardless of whether the UK establishes its own CBAM. With separate ETSs, the price of carbon emissions varies between the EU and the UK. The UK ETS price is currently significantly lower than the EU’s due to the UK’s energy policy.3 However, unless persistent differences between them emerge, EU and UK producers are unlikely to find it worthwhile to change their production and supply chains. From the climate perspective, a UK CBAM’s value is to prevent carbon leakage in the UK market towards countries with very low or zero ETS prices.

However, climate action is not the only reason why the UK should have an EU-style CBAM. After the introduction of the EU CBAM, the UK Government should establish such a CBAM to avoid the spill-over effect of the EU CBAM on the Northern Ireland market. Without it, the border issue between the UK and the EU in Northern Ireland may affect the regular trade flow of non-EU goods (including those from third countries) into Northern Ireland. The UK and the EU announced the Windsor Framework, which has replaced the previous Protocol on Ireland/Northern Ireland (NI Protocol), to create a green lane in which simplified customs procedures and no customs tariffs apply on qualifying goods imported into Northern Ireland (NI) from Great Britain (GB) and third countries. But not all goods can go through the green lane under the Windsor Framework, because those ‘at risk’ of moving into the Republic will have to use the red lane.4 Those destined for Northern Ireland but in the red lane will suffer unnecessary CBAM measures. This impact will be relatively greater on those third-country goods for which the UK duty is less than the EU’s by three percentage points because they must all go through the red lane.5 This effect may cause a trade diversion from those not wanting to pay for the extra cost of customs procedures related to the red lane.

The NI Protocol split the electricity market in Northern Ireland into wholesale and retail parts. Wholesale electricity trading refers to purchasing electricity from generators through auctions by electricity suppliers. Article 9 of the NI Protocol includes Northern Ireland in the EU wholesale electricity single market.6 In other words, because Northern Ireland is part of the EU single wholesale electricity market, its electricity producers must purchase EU (not UK) ETS allowances for the carbon emissions they generate.

According to figures published by the Northern Ireland Statistics and Research Agency for 2021, Northern Ireland exported £148.3 million worth of electricity to the Republic of Ireland (this is all of Northern Ireland’s electricity exports). The exported electricity is on a wholesale basis - namely, electricity retailers in the Republic supplied by electricity generators in Northern Ireland. As noted above, the EU CBAM applies to the sale of wholesale electricity from Northern Ireland to the Republic of Ireland, but effectively at a zero rate because Northern Ireland’s electricity generators have already paid for the carbon emissions of the exported electricity at the price of EU ETS allowances.

While Northern Ireland’s wholesale electricity market is an integral part of the EU single market, Northern Ireland’s retail electricity market is part of the UK market. The latter involves suppliers directly selling electricity to consumers (producers and households) located in Northern Ireland. Therefore, producers of goods subject to the ETS in Northern Ireland must purchase UK ETS allowances to cover indirect emissions for the electricity they consume in their production processes. When cement, fertiliser and electricity (the three products subject to the EU CBAM indirect emissions charge) enter or have the potential to enter the Republic of Ireland from Northern Ireland, therefore, it would make the most sense for importers in the Republic to purchase EU CBAM credits at a quantity that deducts the indirect emissions costs already paid in the UK, which, as explained above were paid at the EU ETS price. However, it remains unclear how the European Commission will deal with this issue.

The EU will levy CBAM credits on cement, steel, aluminium, fertiliser, retail electricity and hydrogen when these CBAM-targeted goods enter the EU, including via Northern Ireland. Just as Article 5(1) of the NI Protocol requires that goods brought into Northern Ireland from outside the Union, including Great Britain, that risk subsequently entering the EU customs union are subject to EU customs duties, so, too, they will be subject to CBAM-levies.

This section briefly discusses the possible economic significance of this development; the full analysis is available in the Appendix. The calculations are necessarily rather approximate, but they suggest that, from an economic perspective, the issue is not insignificant.

We first estimate Northern Ireland’s exports of regulated products to the EU and the countries adhering to the EU ETS (the EU+ refers to the EU countries plus Iceland, Liechtenstein, Norway and Switzerland), and to the Republic of Ireland - shown in Table 1. Assuming that Northern Ireland has the same shares of regulated products in exports to the EU+ and to the Republic as the UK overall, the export values of regulated products by Standard International Trade Classification (SITC) division can be estimated from the product of Northern Ireland’s total exports in each division, shown in Column 4, and the UK’s shares. Summing the exports of each product in Column 5 (6), Northern Ireland’s total exports of regulated products to the EU+ (to the Republic) are estimated at £348 (£333) million, accounting for approximately 5.8% (10.1%) of Northern Ireland’s total goods exports to the EU+ (to the Republic). This amount is significant.

To estimate how many jobs derive from these regulated exports, we start from Northern Ireland’s employment and gross value added by Standard Industrial Classification (SIC) division. We convert the gross value added to gross output using 2019 UK input-output tables, assuming the UK-wide ratio between gross value added and gross output applies in Northern Ireland. We then allocate the SITC export data in Table 1 to SIC divisions and calculate its ratio to gross output in each division. The number of employee jobs can be calculated by applying the (export/gross output) ratio to the number of employees in each division. The result is given in Table 2. This suggests that around one-quarter (23%) of employees in the industries that produce regulated products in Northern Ireland were linked to exports to the EU+ (to the Republic) in 2021; that implies that around 1100 employees are vulnerable to disruption by the EU CBAM. Almost all of these jobs (1001 out of 1091) are related to exports to the Republic of Ireland.

There are no checkpoints between Northern Ireland and the Republic of Ireland. For customs purposes, goods from outside the EU need to apply EU customs measures at the Northern Ireland border if they risk transferring to the Republic of Ireland. Similarly, these goods will be subject to CBAM measures.

To address the customs issues with imports from GB, the NI Protocol establishes a border between GB and NI on the Irish Sea. The NI Protocol allows the EU to impose customs measures on GB goods that may subsequently enter its market after being exported to Northern Ireland. Article 5(2) of the NI Protocol requires the UK-EU Joint Committee (the Joint Committee) to consider several factors to determine whether non-EU goods entering Northern Ireland would be at risk of subsequently entering the EU market. One of these factors is the incentive for undeclared entry, particularly that resulting from the duties payable under Article 5(1) (i.e., EU customs duties). If the EU considers that GB goods may move to the EU after entering Northern Ireland to circumvent the EU CBAM, the EU could argue for imposing CBAM measures on these goods at the Irish Sea border. The Joint Committee will discuss this issue and the Stormont Brake may be triggered. The latter allows 30 Members of the Legislative Assembly of Northern Ireland to initiate, and the UK Government to adopt, the suspension of new (or amended or replaced) EU Regulations  - regulation added to Annex II of the NI Protocol (now the Windsor Framework).7

Arguably, the Windsor Framework controls the risk of goods from GB  moving to Northern Ireland. The efficacy of this arrangement relies on Northern Ireland’s local regulations and border spot checks, though. UK decision-makers should be alert to possible future disputes. The following analysis takes into account such potential issues and also looks at the impact of the EU CBAM on Northern Ireland’s imports of third-country goods in different scenarios. The situation will vary depending on whether the EU and the UK link their ETS and whether the UK establishes an EU-style CBAM. We examine four scenarios:

1.     The UK and the EU do not link their ETS, and the UK has no CBAM.
2.     The UK and the EU do not link their ETS, and the UK has an EU-style CBAM.
3.     The UK and the EU link their ETS, and the UK has no CBAM.
4.     The UK and the EU link their ETS, and the UK has an EU-style CBAM.

Scenario 1: The UK and the EU do not link their ETS, and the UK has no CBAM, i.e., the status quo.

After Brexit, the UK separated its ETS from the EU’s, so producers in the two regions bear different emissions costs. If the UK ETS price is significantly lower than the EU ETS price for a long time, smugglers may seek to bring goods made in the UK across the Northern Ireland border into the EU market which could cause carbon leakage from the EU. In such a case, the EU would have good reason to impose CBAM measures at the Irish Sea border on goods from GB at risk of moving to the EU market after entering Northern Ireland. It may also wish to explore how to levy the CBAM on regulated goods produced in Northern Ireland and sold in the Republic. The UK ETS price has fallen significantly since March 2023, and EU-UK ETS prices are now further apart than ever.8 This scenario is relevant only in the event of a long-lasting significant difference between EU-UK ETS prices. The fluctuation of EU-UK ETS prices in the short term would be unlikely to generate much carbon leakage in the EU.

Undoubtedly, the EU would need to develop a legal basis to implement CBAM measures on the GB-NI border in the hypothesised case. The CBAM is not an actual customs duty; the difference in carbon price caused by the EU CBAM will not automatically move goods from the green lane to the red lane. The EU CBAM itself is a new regulation; Article 13(4) of the NI Protocol accordingly requests the EU, if it plans to add the CBAM to the NI Protocol, to let the Joint Committee make the decision. Since the Windsor Framework, the Joint Committee can no longer make such a decision without hearing the Northern Ireland Assembly. Presumably, the UK Government would wait for the feedback of the Stormont Assembly. If the Stormont Brake is triggered and finally ratified by the pre-veto scrutiny process (which has yet to be designed by the UK Government), the UK Government could suspend the new EU CBAM rule in Northern Ireland. Thus, the Joint Committee is deprived of the decision-making power. This is based on the Windsor Framework: Paragraphs 65 and 68 discuss the relationship between the Stormont Brake and the Joint Committee, where the two signatories commit that the Joint Committee cannot adopt a new EU rule in Northern Ireland without cross-community support. The only caveat is that the UK Government can exceptionally overturn the decision of suspending the new EU rule in question made through the pre-veto scrutiny process in some circumstances, where it demonstrates that that rule cannot create a regulatory border between  GB and Northern Ireland.9

Nevertheless, implementing the EU CBAM in Northern Ireland will likely create a regulatory border at Northern Ireland ports for GB goods. The impact of CBAM measures on Northern Ireland citizens’ daily lives remains to be examined, though. Northern Ireland citizens may have different feelings about the actual effect. Anyway, once the UK Government adopts the Stormont Brake, Article 13(4) of the NI Protocol allows the EU to take remedial measures (i.e., safeguard measures10). Paragraph 66 of the Windsor Framework also recognises this point.

If the UK has no CBAM at its border, exporters from third countries (those outside GB and the EU) with no carbon pricing could try to export to the UK in order to circumvent the EU CBAM charges. If the EU believes that non-EU goods imported into GB could be smuggled into the EU market via Northern Ireland, the EU would have good reason to impose CBAM measures on these goods at the Irish Sea border. After all, the UK Government cannot ensure that smugglers will not bring these goods to the EU market.

It is worth noting that integrating so-called scope 3 emissions (those embedded in inputs) into the EU CBAM will significantly complicate the current scenario.11 Such an impact merits further analysis, but, we put the issue aside for now because the EU has yet to give a clear plan to extend the EU CBAM to scope 3 emissions.

Scenario 2: The UK and the EU do not link their ETS, and the UK has an EU-style CBAM.

As with the first scenario, if the UK and EU do not link their ETS, the UK and EU would have to negotiate whether to apply CBAM rules to GB domestically produced goods based on subparagraph (d) of the fourth paragraph of Article 5(2) of the NI Protocol. The difference between the second and first scenarios is that the UK is now assumed to have established an EU-style CBAM. In this case, non-EU goods imported into the UK would bear the same emissions costs as those made in the UK, but the EU may still argue for invoking subparagraph (d). As with applying this provision to goods made in GB, the UK and the EU would negotiate whether to impose CBAM measures at the Irish Sea border on third-country goods that may enter the Republic of Ireland via the checkpoint-less Northern Ireland border.

Scenario 3: The UK and the EU link their ETS, and the UK has no CBAM.

If the UK and EU were to link their ETSs, producers in both places would bear the same emission costs. In this scenario, under EU CBAM rules that exempt goods imported from countries that participate in or link their ETSs to the EU’s, EU importers would not be required to pay CBAM credits for imports of products made in the UK. But customs requirements and procedures would still apply as they do now. Circumventing the EU CBAM levies would be impossible in this case. Hence, the EU has no reason to argue for extending the application scope of the EU CBAM to GB domestically produced goods by invoking subparagraph (d) of the fourth paragraph of Article 5(2) of the Northern Ireland Protocol.12 In other words, even if the EU considers that somebody may smuggle GB domestically produced goods into the EU market via Northern Ireland, it cannot impose CBAM measures on these goods at the Irish Sea border.

As with the first scenario, since the UK has not established its own CBAM and the price of goods from most countries does not include similar emission costs to EU ones, the EU would also have good reasons to impose CBAM measures at the Irish Sea border on third country goods entering Northern Ireland via GB.

Scenario 4: The UK and the EU link their ETSs, and the UK has an EU-style CBAM.

The difference between the fourth and third scenarios is that, in the fourth, the UK is assumed to have established its own CBAM which mirrors that of the EU. In this case, the price of goods imported into the UK will contain the same emissions costs as UK products. In addition, as the UK and EU have linked their ETS and, by extension, their CBAMs, non-EU goods imported into the UK will bear identical emissions costs to EU ones. As with the third scenario, there is no legitimate reason for the EU to invoke subparagraph (d) of the fourth paragraph of Article 5(2) of the NI Protocol to apply the EU CBAM to goods made in the UK. What is more, there is also no legitimate reason for the EU to invoke subparagraph (d) of the fourth paragraph of Article 5(2) of the NI Protocol to apply CBAM measures to non-EU goods imported into the UK because these goods bear the same emission costs as EU ones. Therefore, in the fourth scenario, the EU should not extend the application scope of the EU CBAM to non-EU goods destined for Northern Ireland, either for goods from GB or from third countries. Assuming that the UK CBAM mirrors the EU CBAM in its sectoral coverage, this option will best facilitate seamless trade in Northern Ireland.

In sum, analysis of these options reveals that relinking the UK-EU ETSs and establishing a UK CBAM that mirrors the EU CBAM is the ideal solution to the Northern Ireland issue.

The Windsor Framework’s Stormont Brake provides a suboptimal solution to resolving potential CBAM-related trade friction in Northern Ireland. The Windsor Framework allows 30 Members of the Legislative Assembly (MLAs) from two or more political parties of Northern Ireland to sign a petition to initiate the Stormont Brake. If the pre-veto scrutiny process confirms eligibility for activating the Stormont Brake, the UK Government can implement the Brake to suspend immediately the EU CBAM measures targeting non-EU goods (i.e., GB and third-country goods) destined for Northern Ireland.

One may be concerned about the applicability of the Stormont Brake in this case, which relies on identifying new EU rules. The EU and the UK agreed and declared the Windsor Framework before the promulgation of the final EU CBAM regulation. The EU CBAM rules are, therefore, new for the UK as a whole. In any case, it is defendable that any EU orders extending the scope of its CBAM rules to those goods qualified for the green lane will essentially change the previous EU regulation and constitute a new rule.

Launching the Stormont Brake includes a pre-veto scrutiny process, which the UK Government needs to establish through consultations with all stakeholders. The UK Government said that the pre-veto scrutiny process would be similar to a consultation procedure, where all stakeholders examine whether new EU rules severely affect Northern Ireland citizens’ daily lives and if there is a severe effect, trigger Stormont Brake. In the CITP Briefing Paper on the Stormont Brake, Zhao proposed that the UK Government could create a third-party dispute settlement system (i.e., an ad-hoc arbitration tribunal) for the pre-veto scrutiny. We believe that this ad-hoc arbitral tribunal could review the compliance conditions for the activation of the Stormont Brake with due regard to the impact that its use may have on the prevention of carbon leakage. The ad-hoc arbitration tribunal could follow the proportionality principle. This principle, widely used in national court judgements and international arbitration, requires that a decision should secure a legal value with minimal prejudice to the conflicting one.13 In this way, an ad-hoc arbitration tribunal could find a balance between supporting the UK’s international reputation and ensuring Northern Ireland citizens’ well-being, thus appropriately addressing the conflicting interests.