The UK government confirmed late on Monday the 1st June 2020 its aim to establish a domestic carbon market from 1st January 2021 that will run in parallel with Phase IV of the EU Emissions Trading Scheme (EU ETS) (2021-2030). Such a UK Emissions Trading Scheme (UK ETS) may be linked to the current EU ETS, however if this cannot be achieved then it will stand alone or, over time, be linked to other carbon markets around the world. The new UK ETS is be designed to create a seamless transition from the current EU ETS that regulates the carbon emissions of around 1,000 UK installations representing about 10% of EU ETS covered emissions. While the UK recognises that there is a case for establishing carbon pricing in other sectors, there are no plans to widen the scope of the UK ETS despite only around 30% of the UK’s emissions covered by the scheme. However, scope widening will be considered during the first review of the scheme, to be implemented no later than 2026.
The proposed UK ETS has the following features, some of them additional to the current EU ETS, as follows:
- Free allocation will continue in line with current EU ETS rules
- Auctioning will continue in a similar proportion to that under the EU ETS
- No use of offsets will be allowed
- There will be a £15/tonne floor price (additional to the EU ETS)
- There will be a pressure release mechanism similar to the EU ETS’s but modified in the first few years to try to keep price rises contained to double the average of the previous 2 years (additional to the EU ETS)
- Linkage with the EU ETS is desired, if it is in the interest of both parties, but if there is no linkage EUAs will not be a valid currency in the UK ETS
- The UK’s carbon reduction ambition will be greater than the EU’s current plans, with a 5% increase in the targeted reduction by 2030. Carbon Pulse reports that this will result in a linear reduction factor of 2.69% compared to the EU ETS’s 2.2% during Phase IV (additional to the EU ETS).
The UK government will keep its contingency plan of a carbon tax as an alternative should it not have the UK ETS ready by 1st January 2021. The £18/tonne levy on power generators, additional to UK ETS obligations, is expected to remain in place.
A standalone UK ETS risks a liquidity crunch with all the low hanging emissions reduction fruits having already been picked in the UK by a huge move away from coal fired power generation in recent years in favour of gas. A link to the EU ETS would alleviate this pressure but this could take several years to agree and implement. On the plus side, auctioned volumes, relative to emissions, should be more generous than in the rest of the EU. The main danger for a UK ETS is that the power utilities, keen to hedge several years ahead of actual production, will soak up any spare UK Allowances (“UKAs”) and more. This will cause prices to spike. At the same time they can be expected to sell any EU Allowance hedges that they continue to hold which will mean that, in the absence of linkage, the UK ETS can be expected to price above the EU ETS for at least the first year or two of operation. The soft price “cap” of double the average price of the last 2 years is cold comfort considering that this will only result in the release of additional UKAs when the price goes north of €45 (based on current prices) for a period of 3 months. It seems that restrictions on speculative holdings are likely to be needed to head off the more extreme price disparities, but there is no suggestion, so far, that this is planned.
By implementing a UK ETS the UK government has the opportunity to make improvements to the process of free allocation and it said that it would begin a full review of possible future changes to the process in the coming months. But for now it will stick to the EU ETS’s rules including the exemption rules (i.e. hospital opt-outs and 35MW thermal limits) in a bid to facilitate an easy and rapid link-up with the EU ETS.
For more information on how the UK ETS will affect you please contact us through the usual channels. To get the latest updates on the EU and UK’s thinking in relation to carbon markets, join us at Carbon Fast Forward Online on 18th June 2020.