The UK Emissions Trading Scheme (UK ETS) has been running since May 2021, but this year will see some significant changes. The Hub team get a lot of queries about the scheme, so we created this FAQ to answer the most common questions. If your question isn’t answered here, get in touch and we’ll do our best to help.

What is the UK Emissions Trading Scheme?

The UK ETS is a system of carbon reduction and trading for UK businesses in energy-intensive sectors, run by the governments of the United Kingdom.

What is the point of the UK ETS?

In 2019 the UK made a legally binding pledge to reduce its greenhouse gas emissions to net zero by 2050. By imposing a cost on carbon emissions, the UK ETS is intended to create a financial incentive for industries to decarbonise. The UK government believes that it will make a “significant contribution” to our carbon reduction commitments.

How does the UK ETS work?

It follows the “cap and trade” approach. A maximum level, or cap, is set on total emissions and in theory every unit of emissions up to this maximum is part of a system of tradeable allowances. But in practice there is some wiggle room; the “free allocation” which allows you to emit a limited amount that isn’t included.

In place as of 2024 is a rule that industries in the UK ETS will have to cut emissions at a rate compatible with net zero.

What is the point of free allocations?

The designers of the UK ETS system wanted to guard against the risk that carbon-intensive businesses would respond to increased carbon costs by transferring operations to countries with fewer regulations and lower costs. (This counterproductive phenomenon is known as “carbon leakage” and the design of the EU ETS also takes it into account.)

There are also a number of free allowances set aside for new operators (or existing operators who have significantly increased their capacity). This is known as the New Entrants Reserve (NER). The logic behind this is that the government doesn’t want to discourage businesses from starting up or investing in new capacity.

But there is a concern that being too generous with these allowances could undermine the success of the UK ETS in reducing emissions. The UK government is currently re-evaluating its methodology for calculating free allocations and there is a consultation open until March 2024.

Why does the UK have a trading scheme and not just a cap on emissions?

Cap and trade systems like the UK ETS are considered compatible with a free market economy because they do not seek to control how and where emissions are created. By allocating a financial value to each unit of emissions, it leaves that up to the market. Crucially, every year the overall cap is lowered, which means the cost of emissions allowances goes up and the financial case for decarbonisation gets stronger.

Why does the UK have its own emissions trading scheme?

The UK used to be part of the European Union’s emissions trading system, the EU ETS, but we left it when we left the EU at the end of 2020. The UK ETS is what we created to replace it.

When did the UK ETS start?

It came into force on 1 January 2021, but UK operators were still bound to comply with the EU ETS until the end of the scheme year in April 2021. So the carbon market didn’t actually open for trading until May 2021.

Who does the UK ETS apply to?

At the time of writing (early 2024), the UK ETS applies to three specific sectors:

  • Energy-intensive industries (such as steelmaking or glassmaking)
  • Power generation
  • Aviation

But the scheme is set to expand to include more high-emitting sectors.

From 2026: the UK ETS will include domestic maritime transport (vessels of 5000 gross tonnage and above).

From 2028: it will include waste incineration and waste from the energy sector.

Between 2026 and 2028 there will be a period where emissions from waste industries will be monitored but not traded, in preparation for this sector becoming part of the UK ETS.

How do you trade carbon on the UK ETS?

Trading under the UK’s Emissions Trading Scheme is done through auctions of carbon allowances. The ICE Futures Exchange has been appointed by the government to host these auctions and receives a small fee from successful bidders. There is guidance on how to participate.

The first allowance auction took place on 19 May 2021 and since then they have taken place every other Wednesday between noon and 2pm UK time. ICE publishes the auction calendars every year.

How is the UK ETS different from the EU ETS?

The UK Emissions Trading Scheme works in a very similar way to the EU scheme, except that while the EU ETS applies to all countries in the European Economic Area, the UK ETS only applies to the UK.

Perhaps the biggest difference is in the approach to reducing emissions over time. The UK ETS started out in 2021 with a cap that was 5% lower than it would have been under the EU ETS. Now, as of 2024, it has a cap that is consistent with net zero. The EU’s approach is slightly different: it plans a Linear Reduction Factor (LRF) of 2.2% a year until the current phase ends in 2030.

How does the UK ETS apply to aviation?

The UK ETS covers UK domestic flights, flights from the UK to countries within the European Economic Area and flights between the UK and Gibraltar.

The aviation sector is currently eligible for free allocation but the government will be phasing this out from 2026. To receive a free allocation, an aircraft operator has to meet certain requirements and be approved by the UK ETS authority.

The Aviation Allocation Table gives each operator’s free allowance for 2024 and 2025, but these numbers should be treated as indicative because the free allocation system is currently under review.

What units does the UK ETS trade in?

One allowance under the UK ETS is called a UK allowance, or UKA. This gives your organisation permission to emit one tonne of carbon dioxide equivalent, or CO2e. The UK government publishes spreadsheets allowing you to convert emissions-intensive activities into CO2e. (These often aren’t published until May or June, so the 2023 figures are the most recent ones at the time of writing in January 2024.)

What paperwork do you need?

Emitters in energy-intensive industries or power generation will need to apply to the UK ETS regulator for a greenhouse gas emissions permit. To trade in allowances, they must have an Operator Holding Account (OHA) with the UK ETS registry.

Aircraft operators will need to apply for an emissions monitoring plan. To trade, they must have an Aircraft Operator Holding Account (AOHA).

Opening an OHA or AOHA with the UK ETS registry involves “the same level of scrutiny as when opening a bank account” and the process can take up to two months.

How do you apply for a UK ETS permit?

You apply online using the Manage your UK Emissions Trading Scheme reporting service. (This replaces the older ETSWAP system.)

Can my organisation opt out of the UK ETS?

You can opt out if your organisation is classed as a small emitter or a hospital/service provider for hospitals. If either of these is the case, you will need a “hospital or small emitter” (HSE) permit.

Energy suppliers can get a HSE permit if at least 85% of the heat produced by your installation is supplied to hospitals.

Organisations qualify as “small emitters” if they:

  • emit less than 25,000 tonnes of carbon dioxide equivalent (CO2eq) each scheme year in the relevant period
  • have a total rated thermal input of less than 35 megawatts (MW) in the relevant period (if applicable)

Organisations do not automatically qualify for exemption, even if they meet the criteria. You will need to check eligibility carefully and then submit your application for exemption within a specific window of time. Applications for exemption in the period 2021 to 2025 are now closed and applications for the next period open on 1 April 2024. Read the full guidance for hospitals and small emitters here.

Aircraft operators never qualify as small emitters, but certain flights are exempt from ETS obligations, such as military and search & rescue flights. The full list of excluded flights is in Schedule 1 of the relevant legislation.

Has the UK government set a minimum or maximum price for ETS permits?

The government has put two mechanisms in place to guard against extreme highs and lows in pricing:

  • the Auction Reserve Price, or ARP;
  • the Cost Containment Mechanism, or CCM.

The ARP sets a minimum price for a UK allowance. Bids below this price will not be accepted. At the time of writing (January 2024) it is set at £22. The government previously signalled an intention to withdraw the ARP as the market matures, but in a December 2023 consultation document the UK ETS authority said it was “minded to retain an ARP as an effective policy mechanism to mitigate the risk of sudden, significant and sustained price decreases”.

The CCM doesn’t set a maximum price, but it allows the UK ETS authority to intervene if prices are too high for a sustained period. The authority uses a reference period of the previous two years as a basis for what “normal” looks like. Then it looks at the futures contracts being offered for UK allowances. If the futures contracts start hitting three times the average price of a UK allowance in the reference period, this is a sign that prices might be getting too high. If this happens for three consecutive months, the CCM is triggered.

If the CCM is triggered, the UK ETS authority will take steps to bring prices down. This might mean increasing the number of permits on the market by bringing forward some of next year’s allowance, or releasing some of the permits earmarked for the New Entrants’ Reserve. It has plenty of leeway about how to act, but if there is no agreement within the UK ETS authority then the Treasury will take over making the decision.

What is the price of a UK ETS permit at the moment?

The website of the ICE Exchange, where UK ETS trading takes place, has a list of all the UK emissions auctions that have taken place since trading opened in May 2021. This includes the price of a UK allowance at each auction.

How many permits are there?

The carbon allowance auction calendar for 2024 shows that there are 2,759,000 tradeable permits for every fortnight up to the end of October. From 30 October 2024 the number of permits available each fortnight drops to 2,758,500, giving an annual total of just over 66 million.

The 2024 trading volume represents a 12.4% reduction in the number of carbon allowances available for purchase compared to last year. It is part of a strategy to impose stricter emissions limits and bring the UK ETS in line with the country’s net zero goals.

The total will keep reducing in the coming years, dropping to 44 million by 2027 and 24 million by 2030.

Who runs the UK ETS?

It is run by the UK ETS Authority, which has four constituent members:

  • The UK Government
  • The Scottish Government
  • The Welsh Government
  • The Department of Agriculture, Environment and Rural Affairs for Northern Ireland.

How will the UK ETS change in the future?

As we have already explained, the plan is to reduce the number of permits available and also reduce free allocations, so the overall quantity of permitted emissions will reduce for sectors in the scheme. This is highly likely to increase the cost per permit.

The ongoing consultation gives some clues as to what other changes the government is considering, including the possible implementation of a Supply Adjustment Mechanism (SAM) to keep the market stable.

It is also worth noting that the EU-UK Trade and Cooperation Agreement, signed in 2020, specifically mentions cooperation on carbon pricing. It says:

“The Parties shall cooperate on carbon pricing. They shall give serious consideration to linking their respective carbon pricing systems in a way that preserves the integrity of these systems and provides for the possibility to increase their effectiveness.”

In November 2023, questions were asked in Parliament about the divergence of the EU and UK systems and whether this would cause problems for UK exporters in the near future. To avoid such problems, it may be that the UK ETS evolves to align more closely with the EU system or even link up with it. At present this is speculation, but the Energy Advice Hub will bring you news of any changes as they happen.

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