Guides & Advice

Understanding the UK’s new emissions trading scheme

Published: 2nd July 2021
Area: Corporate & Commercial

At the end of the Brexit transition period, the UK exited the EU’s emissions trading scheme (EU ETS). Given the importance of such a scheme for combatting climate change, the UK has designed and implemented its own scheme (UK ETS), on the recommendation of the Climate Change Committee.

The recently published Energy White Paper stated that the UK ETS would have a significant role to play in ensuring that the 2050 net zero target is achieved, but this is just one tool available to help meet this challenging target, and it cannot work in isolation.

The EU’s emissions trading scheme

The EU ETS was established in 2005 and uses a ‘cap and trade’ approach. Emissions limits are placed on certain industries within each member state to lower overall emissions. There have been various phases of the EU ETS, with new sectors being added over time; it now covers:

  • Electricity generation and heavy industry
  • Steel production and oil refinement
  • Air travel

The cap and trade system forces those industries covered by the scheme to reduce emissions overall below current levels, with progressively lower caps introduced over time.

Initially, companies purchase emissions permits (and in some cases receive some free allowances) to cover the emissions they produce. The number of permits available is not enough to cover current activities, forcing a reduction. To lower the overall cost of reducing emissions, parties able to reduce emissions at lower cost are encouraged to do so in order to sell excess allowances to others.

Developing the UK emissions trading scheme

As the UK was instrumental in developing the EU ETS, it is perhaps unsurprising that the UK ETS has been modelled on the EU scheme. Mirroring the scope of the EU ETS, the UK’s model covers energy-intensive industries, fossil-fuelled power stations and the aviation sector.

One important difference with the UK ETS is that it has opted for a cap that is five per cent lower than that of the EU ETS, and future changes in the cap will be linked to the UK’s carbon budgets.

Claiming allowances

To purchase allowances to cover their emissions, operators of static facilities and aircraft operators will need to open accounts in the new UK emissions registry. Using a platform launched by ICE Futures Europe, these can be purchased either in an auction of new allowances issued by the government or in a secondary market.

Industries, where there is a risk of carbon ‘leakage’ through off-shoring production, will be entitled to claim some free allowances.

Creating liquidity in the marketplace

To guard against the risk of instability in a relatively small market, the UK ETS features both an auction reserve price and a cost containment mechanism. There is also the potential to introduce a supply adjustment mechanism in the future if needed.

Concerns have been expressed that insufficient liquidity in the secondary market could lead to higher prices for allowances, potentially making the UK industry less competitive internationally. Although this is yet to be tackled, one way to do so could be to link with other schemes internationally.

Could the UK ETS get us to net zero?

Although the new UK ETS should prove to be an important tool in lowering emissions, it will need to be part of a range of policy initiatives across the different sectors of the economy.

In order to achieve the 2050 net zero target, work also needs to be done in the domestic heating and road transport sectors, which, together, account for a large proportion of UK carbon emissions. The UK ETS is not currently planned to cover these (and this may not be possible in any event), so other measures will be needed to work alongside the new scheme.

Contact us

For further information please contact Mark Bartholomew in our dedicated energy team.

We recently hosted this year's AEEC Spring Conference, where energy experts from across Europe joined our own specialists to discuss some of the legal, policy and technological issues driving the responses to net zero, both here in the UK and the EU.

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