EU and UK set to link carbon markets

In brief

The price is not the point

The UK's carbon price is about £64 a tonne. In Europe, the same tonne costs €86. At current rates, the gap is about €9. It is the narrowest gap in nearly ten months, as expectations of a deal have strengthened.

The market is already closing the gap. So what does the deal add? Recognition. The EU's carbon border adjustment mechanism taxes imports on embodied emissions unless the exporter's carbon price is recognised as equivalent. Linking the two emissions trading systems is that recognition. It aligns both instruments and lets goods move under a single carbon price.

But recognition is the smaller half of it. Linkage is also a commitment device. It removes the option of undercutting your neighbours on carbon, credibly, because the commitment is to progress toward net zero. The UK's CBAM commences in January 2027.^[2] Free allocation is a competitiveness shield, not a permanent exemption. Industry lobbies to keep it. Under the EU's schedule, it phases out for CBAM-covered goods by 2034. Linkage locks the UK into the schedule that removes the cushion altogether. The question is what the UK does once it is paying a European price.

The UK's grid has decarbonised faster than most of Europe's. It has scaled wind and solar, and moved away from coal, closing a chapter of its industrial revolution roots. Its primary energy mix, like most nations, stalls on the decarbonisation journey. About three-quarters is still fossil, with gas doing the heavy lifting for heat and for balancing a renewables-heavy grid. That is the shape of the problem linkage exposes. The easy abatement is done. What remains is heat, transport and industry, where the marginal cost is higher.

But commit to what? A study in Energy, Sustainability and Society this year examined 27 European countries from 1996 to 2014 and asked which policies actually decoupled GDP from emissions. The strongest effect was not the carbon price. Research and development had the largest effect, significant at the 1 per cent level. Carbon pricing was weaker and only marginally significant, and the authors call it "a supporting mechanism rather than the main driver."^[1]

The study has limits. The data stops in 2014, and carbon pricing is coded yes-or-no, so it is not a price level that gets tested. That is precisely what linkage changes.

Which sharpens rather than weakens the case. If the price is a support, linkage is valuable as a support: it stops the UK being the cheapest place in Europe to emit while the harder work happens at a European price rather than a discounted one. The incentive moves toward investment in new technology and scalable alternatives. Carbon pricing alone does not achieve much. The flow of investments toward credible solutions does.

Thus linkage is not a substitute for industrial policy. A European carbon price stops the UK free-riding. It does not build a heat pump supply chain or a grid that can balance renewables with firm, dispatchable low-carbon capacity. Linkage sets the floor. The investment does the work.

The UK is not rejoining Europe. It is accepting a European price — for now.