Ambitious post-Brexit UK emissions trading scheme set to launch in May

The new UK emissions trading scheme (ETS), which will run until 2030, will begin in May, and is set to be “a cornerstone of the government's pledge to become a net-zero economy by 2050”, according to the Financial Times.

The announcement comes after a consultation on UK carbon pricing, which has been necessitated by the UK’s exit from the European Union, meaning the EU ETS is no longer applicable. This affects over 1000 businesses, who will need to get up to speed with the new compliance arrangements.

This is the official line:

“The 4 governments of the UK have established the scheme to increase the climate ambition of the UK’s carbon pricing policy, whilst also protecting the competitiveness of UK businesses.”

The hope, of course, is that the new scheme provides continuity for those involved. Moreover, it is predicated upon the government’s pledge that auction volumes (which are explained below) will reduce the number of allowances for polluting by 5% compared to the EU system that it is replacing. It’s based on the EU scheme, in order to facilitate a smooth transition. In addition, the intention is to expand the scope of the UK ETS to include two-thirds of the UK’s emissions which currently fall outside of the remit of the EU ETS. The EU itself is also expanding its scheme to include sectors not currently covered, namely maritime. Analysts think the UK will follow suit.

Photo: Pixabay

How does it work?

As with the scheme it’s replacing, it works on what is known as a ‘cap and trade’ principle, which is where a cap is set on the total amount of particular greenhouse gases that can be emitted by the relevant sectors. This sets a limit on how much carbon can be emitted. The idea is that the cap will decrease over time, which will then make an important contribution to the Net Zero 2050 target. The cap works by giving participants free allowances, with an option to buy more at auction or on the secondary market as required.

Intercontinental Exchange, the US Fortune 500 company that will handle the carbon trading platform, has said that 83 million UK allowances will be sold this year in fortnightly auctions. Given that UK companies had continued to buy EU allowances to hedge their bets since the UK left the EU scheme, the expectation is that they’ll try and sell these and replace them will the new allowances, which will cause a flurry of activity on the market.

What analysts are assuming is that the UK allowances will not be priced below their EU equivalents in the initial period, which should lead to a cost of around £35 a tonne.

Who is involved?

It applies to energy intensive industries, the power generation sector and aviation. It is worth quoting the government document at length:

“It covers activities involving combustion of fuels in installations with a total rated thermal input exceeding 20MW (except in installations for the incineration of hazardous or municipal waste).

The aviation routes covered by the UK ETS will include UK domestic flights, flights between the UK and Gibraltar, and flights departing the UK to European Economic Area states conducted by all included aircraft operators, regardless of nationality.

If you carry out an activity covered by the UK ETS, you will need a greenhouse gas emissions permit.”

There are further permits and plans that may be required in particular circumstances.

What are the potential stumbling blocks?

The UK power sector has requested clarification regarding if the new scheme will be linked to the EU one that it is replacing, with some analysts predicting instability in the UK energy market until there is transparency regarding the future relationship between the schemes.  Furthermore, Shane Tomlinson, deputy CEO at E3G, a climate think tank, said this:

“How the EU-UK trade agreement is implemented will be very critical to determining its success because it opens up as many questions as it answers in a lot of places, particularly in relation to energy.”

What we do know is the EU-UK Trade Agreement struck at Christmas holds both parties to maintain their climate change obligations and, like in other areas, there is scope for rebalancing measures if either side reneges on its commitments.  In theory at least, this should ensure a race to the top rather than the bottom.

Yet there are unanswered questions. It could be argued that once a party goes it alone, as the UK is doing post-Brexit, then some divergence will be inevitable. In that context, Alexander Stafford, a Conservative MP and member of the Parliament’s business, energy and industrial strategy select committee, has emphasised the importance of getting it right from the outset:

“It is worth bearing in mind that the more the UK diverges, the harder linkage will become, so early action is crucial. Negotiations must begin as soon as possible to ensure that the 2021 compliance year is covered by a linked UK-EU ETS.”

Of course, the divergence at present is going in the right direction, as discussed above. A final word from environment journal:

“The UK has been a self-proclaimed ‘pioneer’ in emissions trading since 2002 and looks set to continue playing a leading role. There are compelling arguments for global collaboration, however, the UK also has ability to shape its own autonomous emissions trading future. It has developed a framework which can be refined and will likely provide sufficient flexibility to remain at the forefront of this evolving industry.”

We will see how this all pans out in the years to come, but the signs are good, at present.