The UK Emissions Trading Scheme has been running since May 2021 and is set to expand into more sectors from next year. 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?
The point of all emissions trading schemes is to reduce overall emissions by imposing a cost on them and therefore creating a financial incentive to decarbonise. The UK government has a legally binding target of reaching net zero emissions by 2050 and believes that the UK ETS will make a “significant contribution” towards achieving this target.
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). 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 point of the UK ETS, which is to reduce overall emissions. So the UK government has been consulting on ways to improve its methodology for calculating free allocations. A consultation closed in March 2024 and at the time of writing in June 2024 we await the outcome.
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 (June 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. The UK ETS Authority is currently consulting on the details of how to expand the scheme to the waste sector. This consultation closes on 18 July 2024.
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. Since then they have taken place every other Wednesday between noon and 2pm UK time. ICE publishes the auction calendars every year. The 2024 calendar is here.
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.
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, an ultra-small emitter or a hospital/service provider for hospitals. If any of these definitions apply, you will need either a “hospital or small emitter” (HSE) permit or an “ultra-small emitter” (USE) permit.
Organisations qualify as “small emitters” if they:
- emit less than 25,000 tonnes of carbon dioxide equivalent (CO2e) 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)
Installations qualify as “ultra-small emitters” if they:
- emitted 2,500 tonnes of CO2e or less in scheme years 2021, 2022 and 2023;
- were carrying out an activity in scope of the UK ETS on or before 1 January 2021.
Exemption from the UK ETS is not automatic. If your organisation meets the criteria, you still need to submit an application for exemption. Applications for exemption in the period 2026 to 2030 are open until 30 June 2024. You should check your eligibility carefully and submit evidence to support it.
Energy suppliers can get a HSE permit if at least 85% of the heat produced by your installation is supplied to hospitals.
Read the full guidance for hospitals and small emitters here. Guidance for ultra-small emitters is 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 (June 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. Then the UK ETS Authority might intervene to increase the number of permits on the market and bring prices down. It might do this by bringing forward some of next year’s allowance, or releasing some of the permits earmarked for new entrants to the scheme. 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 nearly 69 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 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, but at present this is speculation.
There are currently two separate consultations open on different aspects of the UK ETS: how to expand it to the waste sector and how to include greenhouse gas removals (GGRs) as tradeable commodities on the market.
This FAQ section is updated regularly and the Energy Advice Hub will report on any significant changes as they happen.
