UK outlines possible design of standalone ETS post-Brexit

On 1 June 2020, the UK government confirmed that it intends to establish its own domestic carbon market from 2021 but remains open to linking a standalone UK ETS with the EU ETS.

The proposal to establish a UK system comes after the UK Government and Devolved Administrations consulted on the future of carbon pricing in the UK after the EU exit, first outlining four options in 2019 with a preference for a national ETS linked to the EU ETS.

The UK Government and Devolved Administrations’ response published on 1 June 2020 advances the preferred option and outlines major design elements of the UK ETS. These design elements mirror many aspects of the EU ETS but also contain notable differences. The response states that the country retains the option of a Carbon Emission Tax as a fallback option to ensure that emissions are covered by a carbon price in all contingencies and announces a separate consultation on this tax later in the year.

Phase I of the UK ETS would run from 2021, following the end of the EU ETS Phase III, to 2030. Like the EU ETS, the UK ETS would cover energy-intensive industries, power generators, and domestic and intra-European flights. Aviation routes would include UK domestic flights, those between the UK and Gibraltar, flights from the UK to European Economic Area countries, and flights from the UK to Switzerland pending a separate agreement.

The UK ETS cap would initially be set 5% below the UK’s notional share of the EU ETS cap for Phase IV of the EU ETS (156 million allowances) and decline at a higher and rising linear reduction factor than the EU ETS (2.69% in 2022 compared to 2.2% in the EU-ETS). Later this year, the UK’s Committee on Climate Change (CCC) will recommend a cost-effective pathway to net-zero as part of their advice on the country’s Sixth Carbon Budget. Upon receiving the CCC recommendation the government will consult separately on the appropriate trajectory for the UK ETS cap. The UK government aims to align the cap with a net-zero trajectory by 2023 if possible, and no later than January 2024.

As in the EU ETS, allowances will be distributed primarily through auctions. A proportion of allowances, however, would be allocated for free to safeguard competitiveness and reduce the risk of carbon leakage. Some free allocation will also be available for new entrants and operators that increase their activity through a New Entrants Reserve. The initial UK ETS free allocation approach would be similar to Phase IV of the EU ETS to ensure a smooth transition in 2021, but the government will begin a review for possible future changes in the coming months.  

If the UK ETS starts as a standalone system, it would also introduce a novel design feature in the form of a transitional Auction Reserve Price (ARP) of £15 (nominal). The ARP is meant to ensure a minimum level of ambition and price continuity during the initial years of UK ETS and would be reviewed alongside a subsequent consultation on the system cap.

To address concerns around the reactiveness of the UK ETS in managing price spikes, in years one and two the UK ETS would feature a cost containment mechanism (CCM) to enable the UK government to manage potential high prices (similar to EU ETS Article 29a). In year three, or sooner if a linking agreement is concluded, the mechanism would revert to EU ETS CCM. The UK government will consult separately on designing a supply adjustment mechanism (SAM), similar to the EU ETS Market Stability Reserve, in a standalone UK ETS if required.

In terms of flexibility, banking and borrowing provisions in a standalone UK ETS would mirror those of the EU ETS. However, participants would not be permitted to use any banked EU allowances for UK compliance obligations. International offsets would not be permitted at the outset of the UK ETS, though the government has indicated an openness to considering how best to implement programs such as CORSIA alongside a UK ETS.

The UK Government and Devolved Administrations’ response to the public consultation is not yet a legislative proposal, and the measures outlined still need to be put into law.