In 2019 the UK Government launched a carbon pricing consultation and they have since confirmed their intention to establish a UK Emissions Trading System (UK ETS) from 1st January 2021. The UK ETS will replace the incumbent European Union Emissions Trading System (EU ETS) at the end of the Brexit transition period, as either a standalone system or linked with the EU ETS if it is “in both parties’ best interest to do so”. A UK carbon tax remains the fallback approach should a UK ETS not be ready by 1st January 2021.

Mirror image

The proposed UK ETS will largely be a mirror image of the EU ETS to ensure a smooth transition. The same Monitoring, Reporting and Verification rules will be applied as those agreed for Phase IV of the EU ETS. In addition, free allocation rules will remain the same, utilising the data collected for Phase IV of the EU ETS to determine the benchmarks to be used. For this reason, we have named the carbon credits, that will be issued under the scheme, UK Allowances (UKAs). Other similarities between the systems include:

  • Auctioning will continue in the same proportion as the EU ETS
  • Offset use will not be allowed
  • Cost Containment Mechanisms will be in place but with tighter rules for the first two years of the UK ETS

Increased ambition

Despite the similarities between the two systems, there are some significant differences. The UK has set a cap for its ETS of 45% below 1990 levels, this is 5% more ambitious than the current EU ETS cap to help ensure that the UK is on target to meets its carbon neutral commitments by 2050. It is expected that the EU Green Deal will increase the EU’s emissions reduction commitments also, but as it stands, the UK’s ETS cap will be 5% lower than it would have been under the EU ETS.

In addition, the UK ETS will have an auction floor price of £15 per tonne. The price floor will provide UK installations with minimum allowance price certainty and will help drive investment in lower emissions technology. The floor price is likely to rise over time. Because the floor price is only applied to the clearing price of UKA auctions, and not to the market as a whole, the price of a UKA in the secondary market could fall below £15 per tonne. However, it would be very difficult, if not impossible, for it to remain below for an extended period of time.

Although the Cost Containment Mechanisms, that would see additional auction volumes should the UKA price remain at elevated levels for a period of time, are similar to those already employed by the EU ETS, the rules will be tighter for the first two years of the UK ETS. If the price for 3 months is more than double that of the preceding two years the UK government may choose to intervene and release additional supply.

According to BEIS, the UK government department responsible for the EU ETS and proposed UK ETS, development of the system is well underway. The new registry and MRV systems are expected to be ready in good time for 1st January 2021.

Next steps for the UK ETS

With the UK still in a transition period and trying to negotiate a trade deal with the EU there remains much uncertainty for UK installations and the carbon pricing mechanism they will face post-Brexit. Whilst a UK ETS, linked or not, is the UK government’s preference they still intend to launch a consultation on a fallback mechanism: a UK carbon tax.

The timeline to get a UK ETS up and running by 1st January 2021 is tight but achievable. The possibility of it being able to link to the EU ETS in that timeframe is much harder to call. Environmental legislation, including a link between the UK ETS and the EU ETS, is likely to be a prisoner to any trade deal that may or may not materialise. Given how long it took for the EU ETS to be linked to the Swiss ETS (around 7 years) a link to the UK ETS by 1st January 2021 seems optimistic, but there’s also not much to do, as the 2 ETSs are so similar and based on the same original set of rules. A link between the systems is also essential to avoid the liquidity and price volatility concerns at the start of the UK ETS that Redshaw Advisors have raised with BEIS directly

If you would like to know more about how to manage your risks under the UK ETS or about its potential impact on the EU ETS and on EUA prices, please get in touch with the Redshaw Advisors team on +44 (0) 203 637 1055.