The UK's emissions trading scheme from 2021

Out-Law Guide | 08 Jun 2020 | 9:16 am | 5 min. read

The UK's Department for Business, Energy and Industrial Strategy (BEIS) has confirmed that a new UK emissions trading scheme (ETS) will run from the start of 2021 until 2030.

The confirmation, which follows a consultation on the future of UK carbon pricing once the EU ETS ceases to apply, is significant news for the over 1,000 UK participants in the EU ETS. These businesses will now need to put in place appropriate systems to achieve compliance with the UK ETS, including new trading arrangements and documentation.

We are awaiting confirmation from BEIS of a number of finer details of the scheme, not least of which are around the date for the first auction of allowances and suitable trading documentation.

The UK government wants to remain at the forefront of domestic and international action on climate change, and the introduction of the UK ETS is part of its drive to deliver clean energy and a net-zero carbon future.

What sectors will be covered by the UK ETS?

As with the current EU ETS, the UK ETS will apply to energy intensive industries, the power generation sector and aviation. It will cover activities involving combustion of fuels in installations with a total rated thermal input exceeding 20MW.

The main business sectors covered by the scheme will also follow the same pattern as the EU ETS and so will include refining, heavy industry and manufacturing.

What exemptions are available?

There will be a number of exemptions and exceptions to the scheme:

  • exceptions for the incineration of hazardous or municipal waste;
  • a small emitter and hospital opt-out for installations with emissions lower than 25,000 tonnes carbon dioxide equivalent (t CO2e) and a net-rated thermal capacity below 35MW; and
  • an ultra-small emitter exemption for installations with emissions lower than 2,500t carbon dioxide for trading.

How will trading work under the UK ETS?

BEIS has not confirmed whether the UK ETS will run as a scheme linked to the EU ETS or as a standalone scheme, and that question is left open in the consultation response.

Furthermore, there is no date provided on when the UK registry will be up and running, or when the first auction of allowances will take place.

BEIS has confirmed that international credits will not be permitted in the UK ETS at this time. However, this will be under review, as well as the use of offsets. Furthermore, 'banking' and borrowing of allowances will be allowed, as proposed in the consultation.

Power plant coal fired pollution

Power plant

The initial approach to allocation of free allowances will be similar to that under Phase IV of the EU ETS, in order to ensure a smooth transition for participants. There will also be a ring-fenced new entrant reserve (NER) of free allowances set aside for installations that become eligible for participation during the first phase of the scheme, as well as for existing installations that significantly adjust their activity levels.

There are as yet no details on the trading framework and documentation to be used for trading under the UK ETS, and we have submitted questions to the BEIS team on this point. Stating the obvious, participants will need to understand the framework and have documentation ready for trading from the start of 2021.

What is the cap on allowances?

BEIS has stated that the cap for allowances under the UK ETS will initially be set 5% below the UK's notional share of the EU ETS cap for Phase IV.

This will make targets for UK participants harder to meet than for their EU counterparts under the EU ETS.

How will auctioning work?

BEIS has confirmed that auctioning will be the primary means of introducing allowances into the UK ETS, and a proportion of allowances will be allocated for free.

We do not as yet have a date for the first auction under the UK ETS, or information on whether there will be any form of introductory or practice period for compliance under the new scheme. We suspect the scheme will just operate from day one with less enforcement for the first year as participants get to grips with the requirements.

What about free allowances?

Free allocation of allowances will be the main policy instrument through which carbon leakage risk and competitiveness impacts are addressed in the UK ETS.

The initial approach to allocation of free allowances will be similar to that under Phase IV of the EU ETS, in order to ensure a smooth transition for participants.

There will also be a ring-fenced new entrant reserve (NER) of free allowances set aside for installations that become eligible for participation during the first phase of the scheme, as well as for existing installations that significantly adjust their activity levels.

How will monitoring, reporting and verification work?

BEIS has confirmed that it will be mirroring the monitoring, reporting and verification (MRV) regime in the EU ETS, with five improvements as suggested in the consultation document:

  • the ability to aggregate multiple source streams adding up to 10t CO2e or less;
  • reduced frequency of site visits by verifiers for operators of offshore oil and gas installations;
  • updating the definition of 'significant changes' which warrant notification to the regulator to exclude a change in default calculation values;
  • reduced frequency of improvement reporting; and
  • simplification of monitoring plans.

How will the carbon price be controlled?

Responses to the carbon price consultation indicated the desire for price continuity and the need for the UK ETS to be able to react to high price spikes – particularly as the EU ETS has been very difficult to manoeuvre at times of very high or low carbon prices, given its regulatory structure.

To address this concern, BEIS has said that it will introduce:

  • a transitional auction reserve price (ARP) of £15 (nominal) on the UK ETS, to ensure a minimum level of ambition and price continuity; and
  • a cost containment mechanism (CCM) which will have lower price and time triggers, providing a mechanism by which the UK government can decide whether to intervene sooner should very high prices occur.

How will the scheme be enforced?

Proposals relating to penalties received mixed responses, with some disagreeing based on concerns that they were disproportionately high.

However, BEIS intends to implement its proposals on penalties, appeals and enforcement – including powers of entry – as set out in the consultation.

What about the proposed carbon tax?

Following the announcement in the 2020 Budget, BEIS has confirmed that the UK government will publish a consultation later this year on the design of a carbon emission tax as an alternative to a UK ETS.

There is no real explanation of why the carbon tax consultation is going ahead despite the announcement that the UK ETS is starting from 2021. BEIS has simply stated that "given inherent uncertainty, it is sensible to have a fall-back carbon pricing option" which "if needed, will ensure a carbon price remains in place in all scenarios".

When will the new scheme be reviewed?

The government will implement two of the three reviews proposed in the consultation document.

There will be an initial review of the UK ETS conducted from 2023 to assess whole system performance during the first half of the first phase of the scheme, which runs from 2021 – 2025. Any necessary changes will be implemented by 2026.

A full review will then take place from 2028 onwards to assess whole system performance across the entirety of Phase 1, with any updates to be implemented from 2031.