UK confirms launch of ETS from January 2021

On 14 December 2020, the UK government confirmed that it will launch its own ETS starting 1 January 2021. The launch date of the UK ETS coincides with the end of the Brexit transition period, after which the UK will no longer be covered by the EU ETS.
 

To ensure continuity for covered entities, the UK ETS will adopt several features of the EU ETS at least in the initial years of its operation. However, there are also notable differences. The UK ETS has a more stringent cap trajectory than the UK’s notional share of the EU ETS cap during Phase 4. It also features differences in its approach to market stability, including an auction reserve price. The new system will not be linked with the EU ETS at the launch date, but the government notes its openness to linking with a range of international partners.   

The key design features of the upcoming UK ETS were outlined in the government’s response to consultation on the future of UK carbon pricing, which was released along with an impact assessment in July 2021. Draft legislation for the UK ETS had also been introduced in November 2020, but until the recent announcement it had not yet been confirmed whether the UK would opt for emissions trading or a carbon tax following the end of its participation in the EU ETS.

The UK ETS will cover the power sector, energy-intensive industry, and aviation within the UK and EEA states. There will be an exemption for hospitals and small emitters with emissions lower than 25,000 tCO₂e per year and a thermal capacity lower than 35 MW. This approach is similar to the UK’s opt-out scheme in Phase 3 of the EU ETS. For stationary installations emitting less than 2,500 tCO₂e per year there will be an ultra-small emitter exemption. Electricity generators in Northern Ireland will still fall under the EU ETS, as they are part of the Isle of Ireland’s Single Electricity Market.

The UK ETS cap for 2021 is set at 155.7 MtCO₂e, which is 5% below the UK’s notional share of the EU ETS cap and will decline by 4.2 Mt annually (2.7% initially). This exceeds the EU’s current Phase 4 linear reduction factor of 2.2% per year. Both the UK and the EU are yet to adjust the cap trajectories for their respective systems considering their recently increased mitigation ambition.

A significant, although yet to be specified, share of allowances in the UK ETS will be auctioned. Benchmark-based free allocation using a similar method as the EU ETS will be in place to address risks of carbon leakage. The use of international credits for compliance is not permitted. 

The UK ETS will contain a cost containment mechanism and a new entrants’ reserve which mirror the EU ETS from the outset, as well as a supply adjustment mechanism (SAM) in due course. The UK government will launch a consultation on the design of the SAM soon. In the interim period, the UK ETS will have a transitional auction reserve price (ARP) of £15 (USD 20) to ensure price continuity and a minimum level of ambition. The ARP will be kept under review and discontinued if a link between UK and EU ETS is established.

The system’s first phase will run until 2030, with planned reviews in 2023 and 2028. The government has stated that it is open in principle to the possibility of linking the UK ETS internationally and that it is considering a range of options. However, it has made no decision on preferred linking partners yet.

While the UK will leave the EU ETS, entities in the UK will still have compliance obligations for Phase 3 (2013-2020), for which the deadline to surrender allowances is in April 2021. Following the departure of the UK from the EU ETS, the EU will adjust the EU ETS cap and the amount of allowances which will be placed in the Market Stability Reserve from 1 September 2020 to 31 August 2021.