Analysis-Britain facing race to avoid $1 billion in EU carbon tax costs

By Susanna Twidale and Kate Abnett

LONDON/BRUSSELS (Reuters) - Britain will struggle to link its carbon market to the EU's in just seven months, to avoid UK companies facing the bloc's carbon border tariff and annual bills around 800 million pounds ($1.08 billion) from next year, market experts have said.

Billed as part of a "reset" in relations after Britain's 2016 exit from the European Union, the two sides announced last month they will link their carbon emissions trading systems.

But neither side has set a timeframe or detailed the work that must be done to make this happen before January, when Europe's carbon border tax kicks in.

"It's probably still likely to take many years before linkage takes effect. The earliest is 2028, but it's more likely to be 2029 or even 2030," said Ben Lee, senior emissions analyst at Energy Aspects.

The UK government said a key upside of linking to the EU's carbon market, or emissions trading system (ETS), is to avoid businesses being hit by the EU's carbon border tariff - which, starting next year, will impose fees on the CO2 emissions associated with imports of steel, cement and other goods. The UK government said avoiding these costs would save 800 million pound a year.

But EU officials say to get exempted from the carbon border levy, Britain would need to have linked its carbon market to the EU's.

"Full linkage will take several years given the complexity of the process, purely from a technical perspective," ClearBlue carbon market analyst Yan Qin said, adding that an "optimistic" scenario could see the link forged in 2027.

A spokesperson for the British government said it will seek to agree a carbon market link as soon as is feasible. "We will not provide a running commentary on the progress of negotiations," they said.

A Commission spokesperson said the EU executive would "follow up swiftly" on the agreement, and propose a negotiating mandate to EU countries, to launch talks with Britain on the carbon market link.

TECHNICAL HURDLES

To make a link happen, the UK needs to adjust its national rules for issuing carbon trading permits, bring its emissions permit auctions in line with EU rules, and change its national cap on how much companies covered by the carbon market can emit.

That's not all. The EU and UK schemes are also not yet aligned on how many free CO2 permits they give industries. And the EU carbon market has a special "reserve" which adds or removes permits from the market to help stabilise prices.

Britain's scheme currently lacks a "reserve", though it has a cost containment mechanism that can act as a ceiling on prices, something the EU scheme does not have.

"Resolving the question of a supply adjustment mechanism will likely be one of the technical calibrations that will need to be in place before the two systems can link," said Veyt senior analyst Ingvild Sorhus.

Some businesses argue these issues are technically straightforward to resolve.

"With the right political will, an ETS linking agreement between the EU and UK could be signed within 6 months, and operational by 2028," said Alistair McGirr, Head of Policy and Advocacy at British energy firm SSE.

Industry group Energy UK said linkage negotiations could conclude within a year - but that Britain should seek an exemption from the EU carbon border levy until the link is sealed, in case talks drag into 2026.

"It is a question not of major political roadblocks, but primarily of technical processes ... I'm not saying these are small problems, but they are simply not intractable problems," Energy UK Policy Director Adam Berman said, of the changes needed to allow the link.

The UK plans to launch its own carbon border tariff a year later, in 2027.

Brussels may be in less of a hurry. Britain's carbon market is less than a tenth of the size of the EU's, so a link would see British businesses gain access to a much more liquid market.

The upside for the EU is less clear - although EU officials cite the bloc's aim to expand carbon pricing internationally, to ensure as many countries as possible put a price on greenhouse gas emissions. Companies also say the move would avoiding competitive distortions and reduce costs for both EU and UK consumers.

Pascal Canfin, a French lawmaker in the European Parliament, said the upsides for Britain were more obvious than for the EU.

"It's a political move," said Canfin, of the EU's motivation. "The UK was within [the EU] ETS before. I mean, it's not such a big deal to have it again."

($1 = 0.7387 pounds)

(Reporting by Kate Abnett, Susanna Twidale; editing by David Evans)