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Published

9 January 2024

By

Tim Atkinson, Lili Strege

UK ETS Consultation

UK Government Announces a series of consultations to reform the UK ETS and introduce an Import carbon pricing mechanism.

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On 18th December the UK Government published a number of consultations on further reform of the UK Emissions Trading Scheme (UK ETS) and Introduction of an "Import carbon pricing mechanism" from 2027. This follows on from the main response on "Developing the UK ETS" published on 3 July 2023.  The consultations close on 11 March 2024 and included:

1. Long term pathway

In response to the January 2023 "Independent Review of Net Zero" which highlighted the importance of giving businesses long-term policy certainty to enable decarbonisation investment, the UK ETS Authority has announced the following:

  • It intends "to legislate to continue the UK ETS beyond 2030 until at least 2050".
  • Considering extending the next phase of the UK ETS, starting in 2031, for longer than ten years to align it with the dates of UK carbon budgets.
  • Committed to aligning the ETS cap with an appropriate net zero trajectory.
  • Exploring expansion of the scheme to more sectors of the economy.

CFP Comment - This commitment reinforces the UK ETS as the main tool to decarbonise carbon emission across existing sectors (power generation, industry, manufacturing and aviation) and the paper gives weight to inclusion of new sectors in the future (subject to five key tests).

2. Future Markets Policy

In its annual review of the operation of the UK ETS, the authority notes that the scheme "is mostly operating well" (an opinion CFP would share) but recognises the importance to "maintain stable and effective market conditions that will continue to incentivise decarbonisation in the traded sector."

The Authority has recognised that there are several factors that can have adverse effects on market functioning. In the long term, the degree of surplus in the market (excessive or insufficient) will set the overall trend for prices but short-term market conditions might also have a more sudden and dramatic impact.

Following an assessment, the Authority is minded on refining existing mechanisms as well as introducing new ones.

  • Retaining of the Auction Reserve Price (ARP)

    After considering alternatives or even removing the ARP, the Authority intends to retain the current approach but will explore options to alter its design such as a higher trigger level (currently £22) and altering the way unsold allowances are treated

  • The Cost Containment Mechanism (CCM)

    The Authority is minded to keep the CCM in place, but look at ways to make it more reactive to "the risk of a sudden, significant, and sustained price increase". This could be reflected in changes to the trigger price calculation and amended length of the reference period

  • Introduction of a Supply Adjustment Mechanism (SAM)

    A SAM would function as a quantity triggered mechanism (similar to the EU MSR) to buffer excessive allowance surplus or shortfall by absorbing or releasing allowances into auctions, triggered by an upper or lower threshold of the total allowances in circulation (TNAC). Very little detail is provided, and the consultation is asking for responses on design and timing of a SAM

CFP Comment – the UK ETS carbon market has faced challenges in terms of liquidity and efficiency since it started in May 2021. However, with an in depth understanding of how the market functions and the impact of auctions, CFP can help clients manage allowance purchases effectively. It also appears slightly incongruous that the July reforms added 53.5m "additional allowances" from 2024-2027 and there is now talk of a supply adjustment mechanism to remove this!

3. Free Allocation Review

The consultation explores stricter distribution of free allocations (FA) from 2026 that will be "better targeted for sectors most at risk of carbon leakage" and take into account the new net zero consistent industry cap.

The government is also considering bringing forward a phase-out of all free allocation to sectors not included on the carbon leakage list from 2030 to 2026. Further, now that UK Government has committed to introduce a CBAM (see below) this phase out could be applied to ALL sectors.

  • Methodology: As an alternative to the current distribution, a dynamic approach is being considered to allow provisional issuance of FA based on data of a specified 2-year rolling period.
  • Benchmarking: The intention is to update benchmarks for the next allocation period based on UK installation data only and use of a combined calculation based on reference data of the top performing installations (based on 2016/2017 and 2022/2023) and an updated Annual Reduction Rate (ARR).
  • Activity Level Changes (ALC): Either retain the existing 15% threshold, reduce or remove it if a dynamic allocation approach is adopted.
  • Carbon Leakage List (CLL): The current list is based on EU ETS Phase IV data and the Authority is minded to use recent UK data from an independent source.­­­
  • Cross-Sectoral Correction Factor (CSCF): Rather than a reduction across all sectors, reductions could be better targeted to high or low risk of carbon leakage in sectors.
  • Additional Factors: FA could become dependent on additional factors that could be introduced into the calculation for free allocation entitlement, including availability of decarbonisation technology and conditionality.
  • Permanent and temporary cessations of facilities: to adjust for actual activity, FA to installations in the final year of operation could see retrospective reductions and allowances received in excess would have to be returned. If activities are merely paused, evidence of intent to re-start regulated activities would be required.

CFP Comment - The final outcomes of the free allocation consultation will clearly be subject to much debate – especially the Phase out of free allocations entirely - but it is clear that industry faces a future where they either have to decarbonise or take steps to manage rising UK ETS compliance costs.

4. Import carbon pricing mechanism

The UK Government (HM Treasury) also announced on Monday (19 Dec 2023) that goods imported into the UK from countries subject to a lower or no carbon price will have to pay a carbon levy by 2027. The new rules aim to tackle ‘carbon leakage’, reducing the risk of production and associated emissions being displaced to other countries because they have a lower or no carbon price.

The sectoral coverage is slightly different to the EU’s CBAM and will target imports of iron, steel, aluminium, ceramics and cement from overseas. The design and delivery of the CBAM will be subject to further consultation in 2024, including the precise list of products in scope.

CFP Comment – whilst we need to see more details of how the mechanism will work, the introduction of a CBAM would give UK business some protection against cheaper more carbon intensive imports but does give Government the ability to push ahead with the removal of free allocation to all UK ETS sectors.

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