The UK Emissions Trading Scheme (UK ETS) started trading in May 2021, replacing the UK’s participation in the EU ETS.

It was designed to be ambitious from the outset – reducing the cap by 5% compared to the UK’s notional share of the EU ETS cap. Now the UK and devolved governments are set to go further with developments that will bring the scheme in line with the UK net zero target.

A consultation which explored a range of changes to the UK ETS closed in June 2022. We’ve outlined some of the key proposals below.

Setting a cap consistent with net zero

When the UK ETS was launched, the cap was set at 5% below the UK’s expected notional share of the EU ETS cap. This equated to around 156 million allowances in 2021 and was set to reduce annually by 4.2 million allowances.

The government has committed to setting the cap in line with a pathway to net zero emissions in 2050, and it wants to make these changes no later than January 2024.

The range of values for the total cap is being considered, between 887 million allowances and 936 million allowances in the first phase (2021-2030). Compared to the current legislated cap for the whole phase, 1365 million allowances, this would equate to a reduction of between around 30-35% over the course of the phase. This would require a step change in the level of the cap in 2024, with the cap becoming tighter over the phase and an annual cap of around 50 million allowances in 2030.

The implementation of the net zero consistent cap in 2024 will require a significant drop in allowances reaching the market in 2024 compared to previous years. So, the consultation considers bringing a portion of 2021-2023 unallocated allowances and/or flexible share to auction to smooth the transition to the net zero consistent cap.

Changes to Free Allocation policy

The industry cap sets an upper bound on free allocations that can be issued each scheme year. Under current scheme rules the industry cap is set at the UK’s notional share of the EU ETS industry cap for Phase IV of the EU ETS. This equated to around 58 million allowances in 2021 and will reduce annually by around 1.6 million allowances. The industry cap is currently legislated for as fixed numbers and will not automatically change with a revision to the overall cap.

The government proposes resetting the industry cap to make up a percentage of the overall cap rather than being set as fixed numbers, as in current legislation.

There are also plans to review the current methodology for distributing free allowances and will explore ways to better target free allocations for those most at risk of carbon leakage and ensure they are fairly distributed. The UK-ETS Authority will consult on these proposals in 2023.

Expanding the scheme to other sectors

The UK ETS currently applies to energy intensive industries, the power generation sector and aviation. Now that the scheme has been established, the UK-ETS Authority wants to bring more of the economy, and more of our carbon emissions, within the UK ETS.

It is therefore exploring options for expanding the UK ETS to domestic maritime, waste incineration and energy from waste. In 2019, domestic shipping activity was responsible for around 6.0 MtCO2e, representing around 5% of UK domestic transport greenhouse gas emissions. Domestic shipping was responsible for more emissions than the UK rail and bus network combined.

In their recently published progress report, the CCC stressed that Government needs to “address with urgency the rising emissions from, and use of, Energy from Waste”. The UK ETS may help raise the efficiency of conventional EfW plants by incentivising more plants to supply heat (i.e. heat offtake), or by potentially encouraging residual waste to be recovered in a way which lowers overall carbon emissions, such as chemical recycling.

We will see more changes to the UK ETS in the future, including the potential incorporation of greenhouse gas removal into the scheme, and a review of the scheme’s approach to aviation emissions, including how to incentivise Sustainable Aviation Fuels.

You can read more in the UK ETS Authority’s recent consultation. Or, for advice on the UK-ETS and how it affects your business, get in touch.