UK rejects widened scope for ETS

A UK emissions trading system (ETS) will initially apply to the same industries covered by the EU ETS, although the inclusion of additional sectors will be considered in a later review, the country's Department for Business, Energy and Industrial Strategy (Beis) has said.

The UK is due to exit the EU ETS at the end of this year, coinciding with the end of the Brexit transition period and the beginning of Phase 4 of the EU ETS (2021-30). The UK government has indicated it intends to set up its own ETS as a replacement, either linked to the EU ETS or operating as a standalone mechanism.

This system, whose first phase would also run over 2021-30, would apply to energy-intensive industry, power generation and aviation in line with the scope of the EU ETS, the government's response to a consultation on the mechanism's design shows. It rejected calls from government advisory body the Committee on Climate Change (CCC) to include agriculture and land use in the scheme, as well as suggestions for carbon pricing to be applied to municipal waste incinerators.

But the government will consider extending the scope as part of its first review of the system, it said. Two reviews will take place during the first phase of the UK ETS — the first in 2023 for implementation in 2026, and the second in 2028 for implementation in 2031. This is one less review than was initially put forward in the consultation.

As with the EU ETS, a UK scheme would introduce carbon allowances to the market through auctions. And a system of free allocations "similar to that of Phase 4" would be used "to safeguard competitiveness in the UK ETS and reduce the risk of carbon leakage", whereby firms relocate to avoid carbon costs. This would equate to 58mn allowances in 2021, the government said.

Aviation compliance under the UK ETS would apply to domestic flights, as well as UK-Gibraltar, UK-European Economic Area and UK-Switzerland routes. This is similar to the scope of the EU ETS, which covers intra-EU flights only.

Divergence from the EU ETS

But not all aspects of the UK's design for an ETS are directly aligned to the existing EU ETS scheme.

The cap on total greenhouse gases that can be emitted under the scheme, for example, will be set 5pc lower than the UK's notional share of the Phase 4 cap, at about 156mn allowances for 2021. This is designed to ensure that the country's climate goals are met, the government said.

Additionally, the government will consult again on the potential lowering of the cap in the context of CCC advice on the Sixth Carbon Budget, expected in December, to align it with carbon neutrality goals by January 2024 at the latest. The UK has a legally binding target to reach net-zero emissions by 2050.

In the case of a standalone ETS, auctions would include a transitional auction reserve price of £15 to safeguard the value of UK carbon allowances during the move to the new scheme. This echoes calls from the CCC to include a carbon floor price in the UK ETS to avoid extreme price volatility.

And international credits will not be permitted under a UK ETS, as time does not permit the necessary standard setting and acceptance testing required for their inclusion. This differs slightly from the EU ETS, where a limited quantity of certified emissions reduction credits may be used for compliance.

But the UK may revise its position on this if necessary in the context of aligning the system to the UN's International Civil Aviation Organization's Carbon Offsetting and Reduction Scheme for International Aviation (Corsia), which is due to start up next year, the government said.

Linking to the EU system

The overarching similarities between the design of the UK ETS and Phase 4 of the EU ETS mean that the two systems should be compatible were they to be linked, the government said.

A large proportion of respondents to the consultation indicated a preference for any UK ETS to be linked to the EU ETS, although whether this will be the case depends on the outcome of Brexit negotiations.

The UK has said it remains open to linking a domestic ETS to the EU's system, "if it suited both sides' interests". If the UK were to go ahead with a scheme not linked to the EU ETS, the market would likely encounter liquidity issues owing to its limited size. The closure of any industrial facility, for example, would immediately remove a sizeable share of market demand, a concern raised by environmental think-tank Sandbag last year.

The government also intends to consult on the design of a potential carbon tax later this year, which could be implemented as a back-up option if plans to set up a domestic ETS were to fall through.

"Given inherent uncertainty, it is sensible to have a fallback carbon pricing option; therefore, the UK government will also consult on a carbon emissions tax that, if needed, will ensure a carbon price remains in place in all scenarios," the government said.

The UK must now put legislation for the UK ETS forward in the four legislatures. The government is "on track" to implement the scheme on 1 January 2021, it said.

"This new scheme will provide a smooth transition for businesses while reducing our contribution to climate change, crucial as we work towards net-zero emissions by 2050," energy minister Kwasi Kwarteng said.

Industry association Energy UK today welcomed the government's proposals. "We strongly support the government establishing a UK ETS linked to the EU ETS and back its efforts to agree this approach with the EU," interim chief executive of Energy UK Audrey Gallacher said.

"This is the best long-term carbon pricing mechanism to continue driving decarbonisation at the lowest cost to consumers, which will allow us to benefit from the liquidity of the world's largest carbon market and help us meet our net-zero target by 2050."

But the group called for more details on the government's potential plans for a carbon tax.

"We urgently need clarity from the treasury of the level of the carbon emissions tax (CET) or at least the methodology in July. This will ensure that power operators have full visibility of the total carbon price, whether via a standalone UK ETS or CET fallback, in January 2021," Gallacher said.

By Victoria Hatherick