UK Government intending to establish UK Emissions Trading System (UK ETS) post Brexit

After Brexit, the UK Government intends to establish a UK Emissions Trading System ("UK ETS") as a key part of the plan to achieve the net zero target.

Background

At present, the UK participates in the EU Emissions Trading System ("EU ETS"). This is a cap and trade system which is designed to incentivise individual installations to reduce their greenhouse gas emissions year on year, by setting ever reducing caps on the emissions which each installation is permitted to emit in a given year. Each installation is required to surrender allowances in respect of its measured emissions in the relevant year. Historically many allowances were given to installations for free, but increasingly such allowances must be purchased. Installations which reduce their emissions below the cap will have excess allowances which they are able to sell, providing a further incentive to reduce emissions.

The EU ETS is seen as a key part of EU legislation driving reductions in greenhouse gas emissions from the power sector, industry and flights within the EU.

Up to now, the UK Government had been consulting on options relating to the UK's continued participation or otherwise in the EU ETS following Brexit.

The Political Declaration that was concluded in October 2019 together with the UK Withdrawal Agreement stated that "The Parties should consider cooperation on carbon pricing by linking a United Kingdom national greenhouse gas emissions trading system with the Union's Emissions Trading System".

The publication of this decision paper now gives us a road map on how future UK emissions trading will operate, whether or not a deal is struck with the EU in the exit negotiations.

Latest proposals

The details of the proposals for the UK ETS have recently been published in the consultation decision paper dated 1 June 2020.

The key features of the scheme are as follows, with some key elements yet to be determined:

• Phase I of the system will run from 2021 – 2030
• The UK ETS could operate either as a standalone UK system, or could be linked to the EU ETS in future
• It will apply to energy intensive industries, large power generators and aviation
• There will be a single cap for all participating sectors, which will be set 5% below the UK's notional share of the EU ETS cap for Phase IV of the EU ETS. Based on the proposed design scope, this equates to around 156 million allowances in 2021. This will be reduced annually by 4.2 million allowances, to remain 5% below the UK's notional EU ETS cap.
• The trajectory of the remainder of Phase I will be set following the publication of the Committee on Climate Change's advice on the 6th Carbon Budget (excepted on 9 December 2020), and further consultation
• Some free allowances will be issued, but the majority of allowances will be auctioned. The free allowance allocation will be similar to that applied in Phase IV EU ETS to facilitate a smooth transition for participants
• The UK ETS will introduce a minimum auction reserve price of £15
• A cost containment mechanism will be applied in the first two years of the UK ETS to manage any price spikes, and this mechanism will be reviewed when it becomes clear whether the UK ETS will be linked or stand alone
• There will be exemptions for small emitters and hospitals with emissions lower than 25,000tCO2e per annum, and a net-rated thermal capacity below 35MW
• International credits will not be permitted to be used alongside the UK ETS at first, but this position will be subject to ongoing reviews
• An initial review of operations will be conducted from 2023 to review effectiveness, and there will be a subsequent full review from 2028 to assess whole system performance across Phase I and prepare for Phase II

Uncertainties

From our perspective there are two core uncertainties at this time.

The first is the future relationship of the UK ETS with the EU ETS. While the potential for linkage with the EU ETS (either immediately following the end of the Brexit transition period, or at some point in the future), we can expect the two systems to remain similar, with little scope for the UK to diverge or make radical changes which would prevent the future possibility of linkage, or close off the system from a broader future market.

The second main uncertainty is that it is not clear how the UK ETS and EU ETS will interface in Northern Ireland and with the Irish single energy market (iSEM). While the consultation decision noted that the processes and arrangements for the UK ETS are still in the process of being developed with the participation of Devolved Administrations, these arrangements in particular will need to be clarified.

Conclusions

While this may disappoint some who were hoping for significant innovation in carbon pricing mechanisms to drive energy transition to greener technologies, the similarities and continued broad alignment to EU ETS mechanisms will provide a level of familiarity and stability for participants at this uncertain time.

For further detail on these proposals, please see the full consultation decision paper, which is available here: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/889037/Government_Response_to_Consultation_on_Future_of_UK_Carbon_Pricing.pdf