Carbon border tax: Europe's own goal?

The EU's carbon border adjustment mechanism (CBAM) is intended to address the issue of carbon leakage - preventing companies moving to jurisdictions with less stringent emissions rules - and to keep industrial sectors in the EU competitive by charging a carbon levy at its borders. But the inclusion of electricity could trigger several unintended consequences. Listen to a discussion on how the law could significantly affect electricity flows between non-EU and EU countries and impact investment in renewable energy. Could the border tax actually hinder moves to decarbonise Europe?

Host: Snjólfur Richard Sverrisson, Editor-in-Chief, Montel

Guests: Phil Hewitt, Director Montel Analytics; Jean-Paul Harreman, Director Montel Analytics.

Transcript

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 0:06

Hello listeners and welcome to the Montel Weekly podcast, bringing Energy Matters in an informal setting. In this week's pod, we'll discuss a piece of legislation that is causing some concern in Europe's electricity sector. The carbon border adjustment mechanism, often called CBAM, for short. It's a form of carbon border tax. Designed to address carbon leakage IE to prevent companies moving to jurisdictions with less strict emissions rules, and to keep the industrial sector and EU competitive by charging a carbon levy at the borders of the 27 country zone, the law could drastically reduce. Cross border flows between EU and non EU countries and hit investment in renewable energy. Joining me, Richard Sverrisson are Jean-Paul Harreman and Phil Hewitt of Montel Analytics. A warm welcome gentlemen. So Phil, if I can start by asking you what, what is the carbon border adjustment mechanism or CBAM as it's often called? What is it and why was it implemented?

Phil Hewitt, Director Montel Analytics: 1:10

So as you said in your introduction it's, the issue we have is as, as your decarbonize. Essentially, it makes this industry more expensive, which encourages people to offshore production. So by counting the cost of the carbon in, in anything you import, essentially having a tariff on the border, you then should. At least stop industries leaving, or maybe even start repatriating them back to the European Union. It's an approach that's been taken by most modern economies. For example, the UK is also implementing a carbon border adjustment mechanism, but that's only on physical goods. They're not touching electricity. The difference here is that the European Union is actually including import of electricity in their carbon border adjustment mechanism.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 1:56

Why was electricity included? It seems, I can understand why cement or iron and steel or the these sectors, but electricity?

Phil Hewitt, Director Montel Analytics: 2:04

I do not know. You'd have to ask the commission. But I assume it's a good and it's a it's an intangible good, but it's a product that can be moved across borders. The EU decided to include it in its CBAM as I said, the UK just thought it was just a bit too complicated and decided not to do it. And as we'll explore I think in the next, in the coming minutes. Yeah, it is quite complicated.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 2:24

Yeah, it is quite complicated and makes quite a lot of sense to have that kind of exemption of For that, yeah. For that for that good.

Phil Hewitt, Director Montel Analytics: 2:30

So for example there is no tariff on electricity, so when the UK left the single European mar market as part of the Brexit process, there is not actually tariffs charged on electricity. You still have to sign a customs declaration when you move electricity across an interconnector, but it has no, there is no tariff value on that interconnect and on that electricity essentially. There is a border and there is a customs union that, that the UK is exporting into, but there is no, no tariff levied on, on, on electricity. But there will be a tariff levied on the carbon component of that electricity from the beginning of 2026, which is when the EU CBAM goes live.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 3:14

And how will that work? How will it be calculated to are there any details that we, we have, Clarity over it?

Phil Hewitt, Director Montel Analytics: 3:19

So reading the documentation that's coming outta the commission, it's still under consultation. So you could essentially identify where your generation is coming from that you're going to be moving across the border. The problem is that. Is that most electricity that's moved across borders and most modern European electricity markets, the UK and the GB market included, majority of these trades are anonymous. You're trading in an anonymous auction, or you're trading on an anonymous exchange. You don't know where the electricity comes from. Does the electricity come from a nuclear power station? Does it come from a wind farm? Does it come from a gas station? Does it come from a coal station? Who knows?

Jean-Paul Harreman, Director Montel Analytics: 3:58

And I can maybe, yeah. Yeah. And can I add that? We also don't know where the power is going to. So if you want to calculate the difference in carbon intensity of the exporting country and the importing country, since the trades are anonymous the power might flow from the UK to Netherlands or to Belgium or to France, but the markets are coupled. So this power may go anywhere in the coupled market area. So the traceability of what are we comparing with what is very low.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 4:30

Absolutely. That leads to, leads me to my next question really, Jean-Paul I say which countries or regions will it affect the most? Obviously Phil's highlighting that the UK and not being part of the U there are other regions in the European union, such as in Southeastern Europe maybe even Eastern Europe. But it will also have a knock on effect to the, to the UK's neighbors.

Jean-Paul Harreman, Director Montel Analytics: 4:50

Absolutely. Yes. So the first country that comes to mind is Ireland. Which is in the European Union, but only connected to the UK. So that is, that's the first one, which we'll probably see the worst effects because it's very dependent on renewables. And sometimes it has a shortage of of generation, which forces it to import from the UK. Which then get, gets subjected to to CBAM of course the other neighbors to the uk. Although I have to admit, I'm not completely sure what happens with Norway because it's not eu. But it is in the coupled markets. So that, that is a bit of an unclear one for me. And then indeed in, in in southeastern Europe, we have a few non-EU countries some of which are are structural exporters of of energy. And so we have countries like Bosnia and Serbia that. Import and export a lot of power in the region also to EU countries. So they will also be affected. Yeah. And they are also in Yeah. Coupled markets to an, to a, to an extent. And therefore the traceability of your power flows is very low because it's, I think they're not in core flow based. So it is, yeah, it becomes, it just becomes extremely complicated to label where power comes from and where it goes to. It's just one big copper plate in, in, in essence.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 6:21

E Exactly. We can't, they're all electrons. As well as, the trading being anonymous. But you can't actually trace a certain electron or it certainly that's the nature of electricity as such. But I'll come back to some of the details.'cause I think they are extremely complex. Also quite, quite mind bogglingly, and also the, in terms of the unintended consequences are quite mind boggling. But Phil what's the timeline? It was, I think it was. Past if I'm not mistaken, last year, we are now in a transition period. When does it actually take place?

Phil Hewitt, Director Montel Analytics: 6:51

So the mechanism goes live at the beginning of 2026. At the moment, you're right, we're in a transition phase, so people are having to fill in paperwork. So if we take. So I interact with customers who are trading with the GB market. So they have to identify a customers broker who's set up to be able to provide these CBAM declarations. So of course, all the customers, brokers are all running around going, they're not sure what they have to do. So at the moment, people are having to submit the the declarations and the declarations are submitted quarterly and they have to be complete, completed within the month, at the end of the quarter. So they submit these declarations, but at the moment there's no value attached to. There's no money changing hands. So at the moment it's just a kind of information exercise. What will happen is when the system goes live in 2026, 'cause it's gonna be difficult to track exactly where the electricity has come from, I would've thought the majority are gonna go onto a default arrangement. And this is the average carbon intensity for fossil fuel generation in the country of which is outside the European Union's internal electricity market. So that. For the previous five years, but for two years before. So essentially from year seven to year two. Now as countries like all over Europe are heavily decarbonizing, it's quite a lagging indicator. And the second thing is the GB market is only ever going to really be exporting to Europe when power is cheaper than Europe. And when is power going to be cheaper than Europe when they're using cheaper electric sources of electricity? And what are the cheapest sources of electricity renewables. Therefore, if you look at the numbers that have been quoted in various reports, it's. The carbon intensity number that's going to be used is going to be between 400 let's say around 400 grams per kilowatt hour, or 400 kilograms per ton per megawatt hour. When GB is exporting, typically it's exporting because it's got too much wind or too much or a lot of wind or a lot of solar. It's actual carbon intensity. Is it usually. No more than a hundred grams per kilowatt hour. So essentially the GB market is paying four times the carbon, this, the car, the carbon cost, and the actual realtime generation because of the default arrangements and because it's. Difficult to track and identify where the particular electron that you've picked up on the day ahead exchange or the intraday market has come from.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 9:14

So we're in a transition period at the moment. I sense a lot of work here for these custom brokers. Custom question.

Phil Hewitt, Director Montel Analytics: 9:20

Yes. Yes. And there's also going to have to be some formal identify identification of who is going to be the official keeper of record of the carbon intensity of all of the country and of the European internal energy market. There's gonna be plenty of debate around there. This story is gonna run and run.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 9:38

Absolutely. And if we're going back to 2017, then people, the UK was still burning coal then. So I think it seems, that 2024, the situation or the electricity mix in 24 is very different from what it was in 2017, right?

Phil Hewitt, Director Montel Analytics: 9:49

Yes. There's only one coal station left and that coal station will finish running at the end of this year. So coal exits the GB electricity market on the 1st of October. There will be no more coal burnt. But. Seven years ago we had four or five or even six coal fire generations stations running, and we had a far more carbon intensive generation mix. So yeah, it doesn't quite seem fair.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 10:12

So the UK seems to be very hard hit here. What kind of impact. Can you foresee on flows Jean-Paul, you mentioned, the interconnectors to the Netherlands, to Belgium, France, and also Denmark. Surely and Norway's a bit of a special case here, but how will those flows be impacted?

Jean-Paul Harreman, Director Montel Analytics: 10:27

Yeah an article published about the impacts of of the CBAM on power flows by for GY net the Danish TSO where they basically said. We will not be able to import power from UK anymore, or we will not import power from UK anymore because the price difference is too big. Which basically defeats the purpose of having an inter interconnector in the first place. The purpose is it flows in two directions. You have the optionality to help each other out. If it be, if it only flows in one direction it, it just cuts the revenues for the operator of the interconnector down. Very significantly. Which I suppose they would've liked to have known. At the time they decided to build the interconnector. It's just gone live what is it, Phil? Half a year ago?

Phil Hewitt, Director Montel Analytics: 11:16

Yes. It went live on the 2020 9th of December. 2023. So literally the Interconnector is shiny and brand new. It's been going from around four months and now it's being hit with this. Yeah. Yes. And now it's potentially, anyway, potentially going to be hit with CBAM. Yes.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 11:29

And what, so that's the impact on the flows. And the other cables will be hit pretty similar, in a similar way.

Jean-Paul Harreman, Director Montel Analytics: 11:36

Yes. Yes. Every country is. Is facing this in a, in its own peculiar ways. In, in, in the Netherlands, for example the grid is heavily congested. The bri net cable has been has been not been allowed to be used to relieve congestion for a while. It's just been reversed. So now people can use bri nets volumes again to relieve the grid's situation in the Netherlands, which is dire, I would say. But if you have to reverse the flow from Netherlands, because we will be exporting to the uk if you have to reverse the flow and then increase your costs. By as much as the CBAM levy will will be, it becomes very expensive to to solve the congestion. And a thousand megawatts of congestion relief is quite significant.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 12:25

And that couldn't effectively just disappear then Jean-Paul,

Jean-Paul Harreman, Director Montel Analytics: 12:28

it it could disappear, but I don't think it will because the problem is so severe that we will need all of the flexibility we can get in Netherlands. What that will do is it will inflate congestion costs and thereby inflate grid fees. And grid fees are one of the major limitations for adding additional flexibility to the Dutch grid. So if you can see.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 12:52

So this is it's snowballing out of control in a sense, in a way in terms of increasing costs and doing the opposite of what is really needed in the country, such as the Netherlands.

Jean-Paul Harreman, Director Montel Analytics: 13:02

Correct yeah. Yeah. So it's not just UK that's being hit, it's also the Netherlands and then. I think in the uk what you also see and it might not be obvious from what we've discussed before, but I think there's also going to be an impact on renewable investments. If you cannot export your excess renewables, do Europe anymore because there's no price difference or Europe. The CBAM causes the export prices to be higher than than local prices in Europe. The only thing that's left is curtailing your renewables, and that yeah, hits the renewable business case as well. So it's also hurting decarbonization, which is. Not the intention of CBAM. I would suppose.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 13:43

No, it's quite the reverse. Phil, that, that's what I was gonna ask you about. And the impact in the uk, which has seen a boom in offshore wind in, in recent years people still planning on building these turbines offshore mainly. What would be the impact on these kind of investments and the renew, the renewable sector generally in the UK?

Phil Hewitt, Director Montel Analytics: 14:04

Yeah, so if we go over the reasons again that we have an interconnector, you're going to have, we have a number of people trading on that interconnector using something called explicit auctions. Those traders will have to factor in the administrative load of now having to handle this cban process. So they're gonna want a little bit more money for that. They're going to factor in the unknown CBAM cost because they don't know at that particular moment maybe what the carbon intensity will be on each side. So there's a potential risk there. So that increases the price. So we then flow less power from GB into those adjacent markets. Because we're flowing less power. It means that when the wind is blowing in the u in gb, because we're building so much offshore wind that power will have nowhere to go. So the price for power in GB will go down. And if that power drops below zero, all the newer wind farms are being built on contract for difference, which actually has a rule in it that if you have more than six hours of consecutive, less than zero price, electricity, the mechanism suspense on that asset, which means that a lot of these offshore wind farms that at the moment have been built on the assumption that they can dump their excess power into Europe. The amount of excess power they're going to be able to dump into Europe is going to decrease dramatically because the price difference to justify the interconnect flowing between Europe. And and GB or for, from to flow from GB to Europe has to be bigger to justify it, which means that there'll be a lot more negative pricing events in, in, in gb, which means that CFD income for those offshore wind farms will go down, which will, which is then an investment risk. So anybody wanting to go into an. Now has got a very complicated model to run to try and work out the impact of CBAM on their running hours, which means that they will require a higher CFD cost. Which increases the cost of decarbonization in GB.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 16:01

As Jean-Paul has said, just rather than actually aiding the decarbonization process, it's making it gonna make it much more difficult in certain jurisdictions.

Jean-Paul Harreman, Director Montel Analytics: 16:10

Yeah. Yeah.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 16:11

And. But were these investors, were they aware of this when they made these investments?

Phil Hewitt, Director Montel Analytics: 16:16

I doubt it. And it takes a very long time to build an offshore wind farm. So typically it's takes you between five and 10 years to get to a decision to actually maybe go and enter an auction and then it's gonna take you five years to build the plant. So there are wind farms that have planning, have got a contract now with the government are on the six hour rule, which means that they're negative prices more than six hours. They don't get paid who are already in the process, already in the pipeline to be built. And now they're at risk from CBAM.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 16:48

And what are you hearing from companies in GB? Are they aware of this or is this is gonna come as a bit of a surprise?

Phil Hewitt, Director Montel Analytics: 16:54

I don't think everybody's quite aware of what's, what the impact is going to be. If the interconnectors weren't aware and they have a foot in each camp, so to speak. Then an offshore wind fund developer who is only interested in the GB market is going to be in for a bit of a shock. So I think a lot of offshore wind developers are going to start to think, ah, we didn't see this coming.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 17:14

And these are companies as well that operate in both sides of the interconnector often, aren't they as well?

Phil Hewitt, Director Montel Analytics: 17:19

Yes. Yeah. So big investors like Ted and and Stat Oil. Sorry, Equinor.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 17:24

Yeah. Yeah, absolutely. I. But TSOs have been aware, haven't they? Or you mentioned any gnet, the Danish, TSO. What about tenet or other continental TSOs? Are they also aware of the potential consequences of this measure?

Jean-Paul Harreman, Director Montel Analytics: 17:39

I don't think we've seen any any comments from other TSOs so far, but yeah, this is slowly sinking in. I think we are we're at the start of of. Very turbulent period. And I think there will be a very strong lobby to try and get an exemption for electricity because it's just very difficult. So you can't track the origin you can't track the destination. Even if you would make an abstraction and say, okay so we have a net import or a net export from a certain country. What would you define as export? So let's take an example. Netherlands is exporting a thousand megawatts into uk and then at some point one of the TSOs decides actually we can't really support this. We need the power on our side of the interconnector to balance the grid or something else is happening and they stop the flow, which means zero flow. Actually, the initial situation was a thousand megawatts export into the uk. Is this now UK actually exporting that 1000 that was initially imported, or is it. Yeah. Bringing the exports exactly to zero. What is it? Because the one position was done on a day ahead market, and in inter day there's another trade being sort of trade being done to reverse it. And then you also have for example, days where administratively Netherlands is exporting 1200 megawatts into uk and someone is administratively. Exporting 200 megawatts from the UK into the Netherlands. How does that work? I don't think it's completely specified. It is not. It's not two crates of beer go across the border. They come from a high decarbonization sorry, a high carbon country. So we put a tax on it. It's just something you can't see. You don't know how much it is. You don't know where it comes from. You don't know where it's going. How are you going to tax it?

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 19:44

Exactly. Yeah. No, it makes makes it highly conscious. But also Phil, when we were talking earlier about this you mentioned if it's a very cold day in France and France is very reliant then on, on the UK for imports if there is some wind, but, or, in these sort kind of situations it all get, it also gets quite complicated, doesn't it?

Phil Hewitt, Director Montel Analytics: 20:01

It, it does. So we, so France has got plenty of generation most of the time, but. But their domestic demand is very temperature sensitive. So on a very cold day, France doesn't have enough generation. So it will then essentially cash the chips that it's been sending lots of generations GB all the way through the summer. And it's saying, now guys, I need you to send some back. And this puts the GB market under stress.'cause Britain is now going to return the favor and export back into France. But now that cost of that. Import back into France is gonna be significantly more than it would've been because you've got the carbon border adjustment mechanism. So essentially France has been dumping cheap power without any taxation into gb, and now GB is going to be sending the power back to France, but it's going to be heavily taxed. With the CBAM. So the people who are paying at the end will be French consumers because they'll be buying expensive British power inflated by taxes. Because of, 'cause of the CBAM. So it doesn't quite make sense to me. And one of the kind of underlying and kind of policy if you're trying to create a policy where you are trying to stop importing goods from countries that are essentially taking advantage of Europe's desire to decarbonize. Because climate change is a real threat. And you have another country which is deciding to not decarbonize and take advantage by building factories and transferring those jobs from Europe to that country, which is the reason why you have a CBAM. But then if you actually look at what GB is a trailblazer in decarbonization. It's a Petri dish. It's fully aligned with the European Union. It's signed in the in the Trading Corporation agreement, the commitment to zero carbon. If anything, it's trying to decarbonize faster than the European Union. And yet it's being punished. Do you think a kind of a punitive measure then? I dunno whether it's a punitive measure. I think it's just badly thought through. I think it's badly thought through. Because surely ultimately you use taxation to drive behavior. And if the behavior. Is fully aligned with your behavior. Why do you need to tax it? It doesn't really seem sensible for me. It's is it an issue of fairness? I think ultimately, as Jean-Paul described with the situation with the Netherlands and I've just described with the situation with France, you are actually going to be piling costs onto onto European consumers. For no real benefit because you are not discouraged, you're not GB can't. But it actually, and if anything, the result is that GB will decarbonize slower.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 22:34

So yeah, you're increasing costs and hampering the road to decarbonization. It makes very little sense. And also potentially, as you mentioned Jean-Paul in the earlier that. You're deterring investments as well into green energy because people with the countries that really need to change their energy mix to cleaner, greener aversion. You, you mentioned Serbian, Bosnia-Hercegovina surely these countries, they're gonna think twice about investing renewables or into wind.

Jean-Paul Harreman, Director Montel Analytics: 23:01

Yes. I would think so. If you, if your renewable investments are not, or renew renewable generation is not taken into account for CBAM. It's just gonna reduce the revenue for your renewables because you, the amounts of times you can export your excess renewables or yeah, it will just decrease. So why would you, yeah. Why would you do it? Just out of idealism? But to be honest. I don't think the poor half of the countries in Europe should be on that side of the coin. I think if anything they should be helped.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 23:37

Absolutely. What happens next do you think, Phil? Do you think, do you expect to see a lot of lobbying and a lot of pressure put on the commission to potentially exempt electricity or exempt the uk? Do you think these are likely paths going forward?

Phil Hewitt, Director Montel Analytics: 23:51

I think that might happen. I think that the, all the different TSOs, so majority of the time when you build an interconnector is built by A TSO because they have access to cheaper finance and their, and they're experienced in building cables. So the transmission system operators will be lobbying extensively, I would've thought, to remove the CBAM from electricity. And it makes sense as I think as we've rehearsed in, in this podcast. And it's a function of Brexit, of course as a lot of these things are. And the country that always gets hammered by Brexit is Ireland. So if we look at the single electricity market of Ireland at the moment, it's a market which is actually one of the few markets in Europe that's actually growing demand year on year 'cause of the build out of data centers because of its permissive tax regime and historical links with with the us. Irish demand is growing, and Ireland at the moment is dependent on GB for when it when the wind doesn't blow. The capacity mechanism in Ireland will build new generation, but that's three years ahead. So Ireland is in, is potentially going to be exposed to extremely high prices when it needs. Emergency power from Britain over the Interconnectors because of CBAM. So again, Irish consumers who are already paying some of the highest electricity prices in Europe will be paying even higher electricity prices.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 25:05

Doesn't exactly make sense, but but to put it mildly. But Jean-Paul, if I can close by asking you, do you expect it to be implemented in 2026 as it stands today? The legislation?

Jean-Paul Harreman, Director Montel Analytics: 25:18

That's an interesting question. I would go back and look at other other implementations of of European legislation. So most recent example is European Harmonization of Balancing Markets which is. Constantly being delayed. We've seen countries delaying by three years, by five years, by several months conditionally exceeding to the process if certain changes are made. It would not surprise me if if CBAM would go a similar route. And yeah, as you said, I would expect extensive lobbying, not just from TSOs, but I would as the realization sinks in that this is going to affect more people then anyone initially thought I would expect more. Yeah, more pressure coming from different, different ranges of the electricity market.

Snjólfur Richard Sverrisson, Editor-in-Chief, Montel: 26:10

And I'm sure this is a subject matter that you guys will be watching very closely. And and us at Montel News, we will certainly be reporting all the ebbs and flows of where we take us, where the path goes forward. So Jean-Paul and Phil, thank you very much for being guests on the Montel Weekly podcast.