Plans for carbon pricing post Brexit: a linked emissions trading system?

Posted in Energy Transport

On 2 May 2019 the UK Government, the Scottish Government, the Welsh Government and the Department of Agriculture, Environment and Rural Affairs in Northern Ireland (the Government) issued a joint consultation on the future of UK carbon pricing (the Consultation).

A linked UK – EU ETS

The Government’s preferred option is the establishment of a UK emissions trading system (ETS) linked to the EU ETS. This is similar to what is being implemented to link the Swiss ETS and the EU ETS and will require a linking agreement between the UK and the EU.

The advantage of a linked ETS is that it creates a larger market with potential to be more liquid and stable than separate emissions trading systems, helping reduce emissions at a lower cost.

In order to have a system to which the EU ETS could link, it will be necessary to develop a UK ETS in the first instance. To ensure compatibility with the EU ETS, the design of the UK system will mirror that of the EU ETS – it will cover the same sectors and greenhouse gases, adopt the EU approach of combining auctioning with free allocation of allowances, include mechanisms for safeguarding market stability and offer exemptions, aligned with the EU ETS.

Since a UK scheme would be part of a wider EU-linked carbon market, the cap on the level of available emission allowances will need to be negotiated with the EU and will reflect ambition across both systems and the overall integrity of the linked system.

An example of successful ETS linking is the California–Quebec joint carbon market which has been operating since 2014. Their experience has shown that for a link to be successful, it is important that the systems are relatively comparable, so that the market does not become unbalanced. Considering that the UK and the EU would start from a position of complete compliance, linking a UK system with the EU ETS should be straightforward, given sufficient political will.

A standalone UK ETS

A standalone UK ETS could function independently, including ahead of securing a linking agreement with the EU.

The approach to designing a standalone UK ETS has been to mirror the approach to designing a linked system, although some of its aspects will differ, reflecting the differences in size and dynamics of a standalone market.

For example, under a standalone UK ETS, the cap on emissions will need to take account of a smaller carbon market and is likely to be tighter than the UK’s notional share of the EU ETS Phase IV cap, to ensure continuing demand for allowances and incentives for participants to cut emissions. On the other hand, a tighter cap will result in higher carbon prices and higher costs to UK participants, impacting on their competitiveness.

In setting the cap for a standalone UK ETS, the Government will honour the commitment in the Clean Growth Strategy that the UK’s future approach to carbon pricing will be at least as ambitious as the existing system and will provide a smooth transition for the relevant sectors.  

The rate by which the allowances are reduced over time (the trajectory) could be steeper under a standalone system to facilitate the availability of more allowances in the first year(s) of the phase and fewer in later years, thus easing the effects of a tighter cap.

To facilitate a smooth transition, the Government is proposing to initially limit the areas of deviation from the EU ETS to those where the benefits to business of changes outweigh those of alignment, but keeping the UK ETS rules under review.

Aviation in the UK ETS

Aviation will be part of both a linked and a standalone UK ETS, including domestic UK flights, flights from the UK to the EEA and flights from the UK to Switzerland, with the aviation component of the cap calculated so that it is at least as ambitious as the UK’s proportional share of the EU ETS cap. However, unlike the EU ETS, for a standalone UK ETS a single cap that includes both stationary and aircraft operators is proposed, with all allowances in the scheme being interchangeable between participating sectors. In Phase III of the EU ETS there are separate caps for stationary and aviation operations, with the aviation sector being able to use allowances from the stationary sector, but not vice versa.

To take account of aircraft operators’ obligations under the UN International Civil Aviation Organisation’s global offsetting scheme, CORSIA, it is proposed that the operators should not pay twice for the same tonne of CO2 and that the aviation part of Phase I of the UK ETS be split into two sub-phases: 2021-2023 and 2024-2030, to accommodate any amendments for CORSIA.

In addition, the Government is considering postponing the first UK ETS annual compliance deadline for aircraft operators by at least one year and allowing aircraft operators to use CORSIA offset units to meet all or part of their UK ETS obligations.

A UK ETS will be kept under review, with a possibility to expand the system in the future to additional industry sectors and/or greenhouse gases. An initial review is proposed in 2023.

Other options

The Government’s proposals are building on the Political Declaration which envisaged cooperation on carbon pricing by linking a United Kingdom national greenhouse gas emissions trading system with the EU ETS.

If a linking agreement with the EU cannot be secured, other carbon pricing options being considered are a tax on carbon and participating in Phase IV of the EU ETS which will run from 2021-2030.

A carbon emissions tax (CET) was proposed in the Autumn 2018 Budget, and will be introduced through the Finance Act 2019. The tax would apply to all stationary installations currently participating in the EU ETS at a rate of £16 for each tonne of CO2 emitted over and above an installation’s emissions allowances allocated to that installation under the EU ETS.

The CET could form the initial basis of a tax alternative to the EU ETS. However, if a tax were pursued as a long-term carbon price policy, the UK Government would consult on options. Development of any carbon tax would be a reserved matter for the UK Government.

The CET was designed to work in a similar way to the EU ETS, but a long-term alternative tax would likely to be changed in order to provide an incentive for installations to reduce emissions below their emissions threshold and to ensure that businesses would have sufficient certainty on the future level of the rate.

The Consultation also includes proposed Phase IV implementation features, since while the UK is still a member of the EU or within the Implementation Period, the UK is obliged to transpose the Phase IV revisions to the EU ETS Directive into the UK law before 9 October 2019.

The Consultation is available from here. The closing date for responses is 12 July 2019.

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