Global | Publication | July 2023
On 3 July 2023, the UK ETS Authority[1] (the Authority) published its response to the March 2022 consultation on reforming the UK ETS (the Consultation). The Consultation sought views on various proposals designed to meet the Authority’s commitment to implementing a net zero consistent cap for the UK ETS, reviewing the free allocation policy, and expanding the use of emissions trading across the economy. It is clear from the Authority’s response to the Consultation that stakeholder input has been considered and progressive structural changes are going to be introduced to the UK ETS.
The UK ETS was established in January 2021 (to replace the EU ETS after the end of the Brexit transition period). In March 2022, the Authority launched the Consultation, focusing on proposals to align the UK ETS’s cap with net zero and review the role of the free allocation policy as a carbon leakage mitigation tool (see summary in our previous article). It also considered proposals to expand the scope of the UK ETS in existing sectors (e.g. upstream oil and gas venting) and additional sectors (e.g. shipping, waste and energy-from waste).
Since the launch of the Consultation, there have been significant developments in UK climate policy which provide further context to the Authority’s response to the Consultation. In March 2023, the UK government published a detailed strategy for how it will enhance energy security, and as part of its ‘Green Day’ announcements, the UK government also confirmed an enhanced role for the UK ETS as a driver towards a decarbonised economy and mechanism to achieve net zero (see our previous article on the topic).
The Authority provided initial responses to the consultation in August 2022, setting out its position on a small number of proposals to be implemented by 2023. However, the Authority’s main response to the Consultation was published on 3 July 2023 and we discuss its key points and conclusions below.
A. UK ETS cap and free allocation
The Authority is resetting the cap for 2021-2030 at the top of the net zero consistent range, (i.e. 936 million allowances, a drop of 30% over the course of this phase)[2]. The net zero cap will be implemented for 2024 and, according to the Authority, will enable a smooth transition to ensure no sudden drop in allowance supply in 2023 and 2024.
Separately, the Authority will set aside 29.5 million allowances (equivalent to over 3% of the overall cap) for future market resilience and stability mechanisms.
In respect of free allowances, the industry cap, which sets the limit on the volume of free allowances, is to be set at 40% of the overall cap, a higher level than the current limit of 37%. This is regarded as necessary for sectors most at risk of carbon leakage and will enable flexibility for future decisions regarding the distribution of free allowances in the next phase of the free allocation review.
The Authority is also phasing out the free allocation of allowances for the aviation sector by 2026. Aircraft operators will receive their existing entitlement of free allowances for 2024 and 2025 so they can prepare for the phase-out. Allocations will then reduce at 2.2% in 2024 and 2025, with full auctioning taking place in 2026.
B. Expanding the scope
The scope of the UK ETS is to be expanded to include the following additional sectors:
The inclusion of these sectors is in line with commitments to bring high emitting sectors into the scope of the UK ETS and may provide incentives for companies to cut their emissions and invest in cleaner alternatives. With regards to waste, the UK ETS could help reduce emissions from waste by encouraging residual waste to be recovered in ways which lower carbon emissions and incentivising investments in cleaner technologies and carbon capture and storage (CCS).
The proposals are in line with the recent changes to the EU ETS as part of its Fit For 55 initiative, where emissions from maritime transport have been included within the scope of the EU ETS. The EU is also looking to expand the EU ETS to cover EfW by 2030.
C. Further proposals
The Authority intends to incorporate engineered greenhouse gas removal (GGR) technologies (e.g. direct air capture) into the UK ETS, subject to further consultation in 2023. The UK ETS may offer an appropriate long-term market for high quality nature-based GGRs, subject to issues of permanence, costs and wider land management impacts.
It also intends to carry out further work to establish how to bring non-pipeline modes of transportation (NPT) of CO2 (such as shipping, rail and road) into the scope of the UK ETS. By regulating NPT, UK ETS operators will be allowed to make carbon subtractions when CO2 has been permanently stored in a geological storage site. Notably, the Authority will also engage with industry to better understand what forms of carbon utilisation (i.e. CCU projects) may be appropriate for inclusion in the UK ETS.
The Authority will also look at how it can expand the UK ETS to include methane emissions from upstream oil and gas and other traded sectors, and will consult on introducing UK ETS biomass sustainability criteria for all biomass.
A further consultation will be published at the end of 2023 to develop and set out the details of the proposed expansion of the UK ETS. By the end of the year, the UK government aims to publish its vision for the long-term development of the UK ETS.
The Authority’s response to the Consultation introduces the prospect of major structural changes to support the ongoing transformation of energy systems and transition to a low carbon economy. The industry will need to carefully consider these changes and assess how they affect their existing and future operations.
We will continue to monitor and provide further updates on amendments to the UK and EU ETS. Our global climate change and sustainability practice has extensive experience advising clients across all key environmental and carbon markets.
Dani Bass (trainee) assisted in the preparation of this article
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