UK warned against non-linked domestic ETS

The UK should not launch a domestic emissions trading system (ETS) after its departure from the EU unless it is able to link its new scheme to the EU's, industry groups and non-governmental organisations (NGO) have said.

The UK government laid out its options for post-Brexit carbon pricing policy in a consultation that ended last week.

Its preferred option is a UK ETS linked to the EU carbon market. It is also considering a standalone UK ETS or a domestic carbon tax.

But market observers have warned that a standalone UK ETS would face problems, including thin liquidity and volatile prices. Government advisors have previously raised the same concerns.

If the UK exits the EU with a deal in place, it will remain in the EU ETS until the end of 2020, meaning a UK ETS would probably launch in 2021. The UK would leave the EU carbon market immediately under a no-deal Brexit .

‘Number-one priority' Linking to the EU carbon market should be the government's "number-one priority" in developing a post-Brexit scheme, the International Emissions Trading Association (Ieta) said in a consultation response seen by Argus .

The majority of trading in a UK ETS would probably be between power sector firms, which do not receive any free allocation and have to buy all their carbon permits. But UK power sector emissions are expected to continue to fall rapidly in the 2020s, so there might not be enough trading to maintain liquidity.

"A standalone UK market will not be sufficiently deep or liquid to allow genuine price discovery," Ieta said.

The government expects greenhouse gas (GHG) emissions from the power sector to fall by more than a third over 2018-30, as nuclear units and renewables increase their share of electricity generation, and as the UK shuts its remaining coal-fired plants by 2025.

Ieta also urged the UK to ensure its domestic carbon market is linked to the EU's from launch. Any delay could make linkage harder to secure, as the EU turns its attention to other priorities, such as the ETS market stability reserve review in 2021, and its plan to review aviation's inclusion in the carbon market.

Price 'spikes and crashes' NGO Sandbag also urged the government to not launch a standalone UK ETS.

Once the UK coal-fired fleet has closed, industry will be the main lever for short-term changes in emissions. But industry might not be able to cut its emissions, and the closure of a single large industrial facility could wipe out a significant share of UK allowance demand, making it difficult to create a stable carbon price in a domestic ETS, Sandbag said.

This risk has been highlighted this year, as British Steel fell into administration , and will either be bought out or liquidated. The firm's Scunthorpe steelworks made up roughly 4pc of the UK's total EU ETS emissions last year.

"A standalone UK ETS could be vulnerable to carbon price spikes, crashes and generally high levels of volatility," Sandbag said.

The small supply pool in a non-linked UK ETS could also make the system "vulnerable to gaming", Sandbag said.

A UK carbon market would be considerably smaller that the EU system. UK emissions from stationary installations in the EU ETS totalled 129mn t CO2e last year, while total EU ETS stationary emissions were just under 1.7bn t CO2e.

Sandbag and Ieta also agreed that the carbon price in a standalone UK scheme is unlikely to mirror the EU ETS price, which could cause competitive distortions between UK firms and those in the rest of Europe.

The government's fall-back option of a domestic carbon tax would be preferable to a non-linked UK ETS, Sandbag said.

The UK had a domestic carbon market that ran from 2002 until the launch of the EU ETS in 2005.

And there is a precedent for the EU ETS to link with another carbon market. The EU and Switzerland will link their carbon markets in 2020. Negotiations on the linkage began in 2010, but were delayed by policy issues unrelated to carbon trading.

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