The UK Emissions Trading Scheme (UK ETS): where are we at?

Introduction

The UK Government recently published a significant package of announcements, including plans to improve energy security, green the financial system and ensure a robust net zero strategy (on a day now referred to as Green Day).  

Green Day included the publication of the Government’s new Net Zero Growth Plan following the High Court’s finding that the original strategy failed to meet the Government’s obligations to cut emissions, alongside a suite of decarbonisation measures across different sectors. Therefore, it is an opportune time to review what is happening in relation to the UK ETS, a scheme intended to assist in facilitating the achievement of net zero in the UK. 

This article also provides a brief comparison on the recently announced EU ETS reforms. 

Recap of the UK ETS

The UK ETS came into effect on 1 January 2021, replacing the EU ETS after Brexit. The UK ETS requires operators of installations in a number of energy-intensive sectors, such as manufacturing facilities, power stations and aviation, to surrender CO2 emission allowances equivalent to the total emissions of CO2 from the installations within a given year. 

The UK ETS works as a cap-and-trade system setting a cap on the total level of permitted greenhouse gas emissions, while also creating a carbon market of emission allowances for any unused allowances, which can be bought or sold (see our previous articles on the topic here and here).

Proposals for changes to the UK ETS

In March 2022, the UK ETS Authority launched a call for evidence exploring the role of the UK ETS as a potential long-term market for greenhouse gas removals (GGRs). As summarised in our previous article, the consultation included proposals to align the scheme’s cap with the net zero target and review the role of the free allocation policy as a carbon leakage mitigation tool. The consultation also looked at proposals to expand the scope of the UK ETS in existing sectors (e.g. upstream oil and gas venting) as well as additional sectors (e.g. shipping, waste, and energy-from waste). 

The UK ETS Authority provided initial responses to the consultation in August 2022, covering proposals to be implemented by 2023 (e.g. the inclusion in the UK ETS of flights departing the UK and arriving in Switzerland and operational amendments in relation to permitting, monitoring, reporting and verification). The response for the remaining proposals, including aligning the UK ETS cap with net zero, is expected later this year. 

Green Day: what was announced in relation to UK ETS and what to look out for?

The Independent Review of Net Zero published on Green Day sets out an enhanced role for the UK ETS as a foundation for a decarbonised economy. The Government accepts that a long-term pathway for the UK ETS is required and it proposes to work within the UK ETS Authority to do so this year. This pathway may include:

• Continuing the UK ETS beyond 2030 until at least 2050 to remain aligned with the net zero target.
• Exploring the expansion of the scheme to more sectors of the economy, including high emitting sectors. A response to the consultation on the expansion of the UK ETS’s scope to cover energy from waste/waste incineration and domestic maritime emissions is expected shortly. 
• Considering options for integrating GGRs in the UK ETS.
• Exploring the potential role of emissions trading in decarbonising heat.
• Developing a harmonised approach for measuring carbon emissions from farms (though the Government does not currently propose expanding the UK ETS to agriculture).

The Government has also launched a consultation on potential policy measures to address future carbon leakage risk, including a UK Carbon Border Adjustment Mechanism (UK CBAM), which could be deployed from the mid-2020s onwards. 

Additionally, the announcements on Green Day emphasised the importance of carbon capture, utilisation and storage (CCUS). In light of this, the interaction between the UK ETS and CCUS is likely to become an increasingly relevant topic.  

EU ETS update

As part of the ‘Fit for 55 in 2030 package’, the European Parliament and Council have recently adopted the long-awaited reform of the EU ETS, which includes the following key changes:

• Increased ambition to cut GHG emissions in ETS sectors by 62% by 2030;
• Phasing out of free allowances to companies from 2026 until 2034;
• Creation of a separate new ETS II for fuel for road transport and buildings to put a price on emissions from these sectors by 2027;
• Inclusion of GHG emissions in the ETS from the maritime sector; and
• Revision of the ETS for aviation, including the phasing out of free allocations by 2026 and the promotion of the use of sustainable aviation fuels. 

The EU has also adopted rules for a new EU CBAM which will be phased in from 2026 until 2034. A Social Climate Fund will also be established to combat energy and mobility poverty and to ensure that the climate transition will be fair and socially inclusive. 

Conclusion

Although we await a full Government response to the UK ETS consultation, on Green Day the UK Government confirmed an enhanced role for the UK ETS as a driver towards a decarbonised economy and as mechanism to achieve net zero. The announcements have confirmed that the Government is committed to ensuring that carbon leakage risks are mitigated at all stages of the UK’s net zero transition. On the other hand, the EU has positioned itself ahead as it is proceeding with a major reform of the EU ETS including expanding this to cover specific sectors. 

The Norton Rose Fulbright Environment team have been at the forefront of the development and implementation of carbon markets for almost 20 years. 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