UK urged to avoid solo emissions trading system post-EU

The UK should introduce a carbon tax to replace its membership of the EU emissions trading system (ETS), UK think-tank Policy Exchange has said, while the alternative option of a UK ETS should only be considered if it can be linked to other systems, and should not be introduced before 2024.

The UK will drop out of the EU ETS at the end of the Brexit transition period on 31 December. London has indicated that its preference is to set up a domestic ETS that would then link back to the EU system.

But the lack of progress in Brexit negotiations makes it unlikely that a link will be established in time for 1 January 2021 implementation — in which case a standalone UK ETS is the government's preferred alternative, with a carbon tax being considered as a back-up option if no ETS is in place by the start of next year.

But Policy Exchange has called for the UK to reject a standalone ETS, citing its vulnerability to volatility owing to the limited size of the market.

Instead, it urged the government to "commit to a long-term, rising carbon emissions tax as its preferred post-Brexit carbon pricing regime", as part of recommendations it published this week on the future of UK-EU energy co-operation.

The tax should cover the same sectors as the EU ETS and be set in line with current EU ETS prices, the think-tank said. And the existing carbon price support (CPS) tax imposed on the UK power sector should be removed from 2024, to ensure that carbon prices are aligned across all sectors.

This differs slightly from the think-tank's previous calls , in 2018, for the UK to expand the CPS itself to cover all sectors of the economy as an alternative to EU ETS membership.

If the government does pursue a UK ETS, it should not be introduced before 2024, and a carbon tax should be put in place for the intervening period, Policy Exchange said. This would allow for a link to be established with the EU ETS, while a more developed picture of global carbon pricing policies by this stage would increase the potential for establishing links to other systems, such as those in Switzerland, California and Quebec.

And a UK ETS should include a floor or reserve price to avoid the risk of low carbon allowance prices, Policy Exchange said. Although the government's plans for a UK ETS include a £15/t (€16.50/t) auction reserve price, under current proposals this would only apply in the case of a standalone system.

Carbon border adjustment The think-tank also called in its recommendations for the UK government to co-operate with the EU on the bloc's plans to introduce a carbon border adjustment mechanism.

The European Commission last month launched a consultation on the mechanism, which would be applied to certain sectors deemed at risk of carbon leakage — whereby firms relocate to other jurisdictions to avoid carbon costs.

Such a mechanism between the UK and the EU would protect heavy industry in both jurisdictions from any potential negative impacts of differing carbon pricing systems, Policy Exchange said, as adjustments could be made to UK or EU producers depending on the carbon price in either region.

But the think-tank acknowledged that the introduction of such a mechanism in the UK could have an impact on the country's efforts to negotiate trade deals with other states, particularly in the context of Brexit, and emphasised the importance of ensuring that any such system is compatible with World Trade Organisation rules.

By Victoria Hatherick

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