The UK government has confirmed that it will implement its own Emissions Trading Scheme (UK ETS) starting from January 1st, 2021, to replace the EU ETS at the end of the Transition Period. While the UK ETS will initially be a standalone system, the possibility of linking with other schemes, particularly the EU ETS, remains open pending successful trade deal negotiations and a linkage agreement.
Impact on EU and UK Installations:
For EU installations, there will be no immediate change to the EU ETS infrastructure. However, the EU Allowance (EUA) price will be affected by the changing supply/demand dynamics resulting from the introduction of the UK ETS. Companies with UK installations will need to comply with the new UK ETS, opening registry accounts in the UK system and submitting UK Allowances (UKAs) instead of EUAs for compliance from April 2022 onwards. Their requirements for 2020 emissions under the EU ETS remain unaffected.
Risks of the UK ETS Going Alone:
The UK ETS will closely resemble the EU ETS, but there are risks of price spikes due to low liquidity in the smaller system, particularly in the early months and possibly years of the scheme. The lack of early liquidity poses challenges for companies to manage their risks effectively, undermining the purpose of a market-based carbon pricing mechanism. The Redshaw Advisors team has voiced concerns to the UK government regarding the design of the UK ETS and suggested potential improvements. The risk of higher carbon costs for UK emitters compared to their EU counterparts remains a significant concern, although, over time, the UK ETS is expected to be oversupplied, potentially leading to prices hovering around the £15 per UKA floor price unless it links to the EU ETS first.
Managing Risk and Future Outlook:
Currently, UK installations cannot directly hedge UK ETS risk as the market for UKAs will not begin until Q2 2021. In the meantime, EUAs remain the only instrument available for UK installations to hedge future exposure. The expectation is that UKA prices will track EUA prices, as the major UK electricity utilities have already hedged their forward power sales with EUAs. Therefore, short-term prospects for UKAs are bullish, similar to EUAs.
Next Steps and Contacting Redshaw Advisors:
The UK government plans to provide more information and adjust UK ETS legislation in the second half of December, shedding light on what UK installations can expect in the coming years. This includes adjustments to the UK ETS emissions reduction target to align with the recently announced 68% target. Organizations seeking to discuss their UK ETS and/or EU ETS risk management are encouraged to reach out to the Redshaw Advisors team.
Disclaimer: The information provided in this article is based on the current understanding of the UK ETS and its potential implications, but it is subject to change as further details and legislation are released.
