On 3 July 2023, the UK ETS Authority comprising the UK government and the devolved administrations (together, the “Authority”) published its response to a 2022 consultation on developing the UK Emissions Trading Scheme (“UK ETS”). The Authority have committed to reform of the ETS in line with the UK’s net zero legal requirements under the Climate Change Act. Scope will broaden to maritime, incineration and energy from waste and process emissions from carbon dioxide venting of upstream oil and gas alongside changes impacting all existing market participants with a commitment to further expansion of sectors covered.
The UK ETS, launched on 1 January 2021 following EU exit, seeks to reduce greenhouse gas (“GHG”) emissions and requires those operating in specified sectors (e.g. manufacturing, energy generation and aviation) to surrender emission allowances to reflect in scope carbon dioxide (“CO2”) and other emissions.
In March 2022, the UK Government published a consultation on proposals for significant reform to the UK ETS. A small number of these reforms were dealt with in an initial response to the consultation in August 2022, but the bulk of the reforms had not been addressed before the Authority’s July response.
Announced reforms and proposals for further review
The Authority has announced that it will make various changes to the UK ETS, including:
- Setting the UK ETS cap to be consistent with net zero and doing this at the top of the net zero consistent range
- A total emissions cap of 936 million allowances, a drop of 30% over the course of this phase.
- The cap will require further adjustment following the addition of new sectors to the UK ETS.
- Smooth the transition to the net zero cap for 2024 by releasing 53.5 million additional allowances from the reserve to the market between 2024 and 2027, so that there is no sudden drop in allowance supply between 2023 and 2024.
- Raise the industry cap (i.e. the quantity of allowances that are allocated for free) at 40% of the overall cap, from 37% so as to continue to provide free allowances to those sectors at most risk of carbon leakage
- Phase out free allocation for the aviation sector for the 2026 to 2030 allocation period. Aviation free allocation will reduce at 2.2% annually in 2024 and 2025, and there will be full auctioning in 2026.
- Expand the scope of the UK ETS to include:
- Domestic maritime transport for vessels of at least 5,000 gross tonnes from 2026.
- Waste incineration and energy from waste from 2028 (phase in monitoring and reporting period from 2026).
- Process emissions from CO2 venting from the upstream oil and gas sector from 2025.
- Set aside 29.5 million allowances (equivalent to over 3% of the overall cap) for future market management and long-term market resilience.
In addition, the Authority also committed to consider further reforms to the UK ETS. In particular, it will work to:
- Establish how to bring non-pipeline modes of CO2 transportation (e.g. shipping, rail or road) into the UK ETS’s scope.
- Expand the UK ETS to include methane emissions from upstream oil and gas sectors.
- Consult on introducing UK ETS biomass sustainability criteria for all biomass before the end of 2023.
- Consult on incorporating engineered GHG removal technologies (GGR) (e.g. direct air capture) in the UK ETS.
- Consider whether the UK ETS could provide an appropriate long-term market for high-quality nature based GHG removal technologies.
- Review technical changes to free allocation in order to update the methodology to better protect sectors most at risk of carbon leakage.
Next steps
Given some changes are expected from the 2024 scheme year, we expect secondary legislation to be laid before the end of 2023. At the end of 2023 the Authority will publish a consultation which will capture proposed but not yet agreed changes relating to expansion of the UK ETS, GGR technologies, market reforms, biomass sustainability criteria and the free allocation policy. By that date, it will also publish its vision for the long-term development of the UK ETS including its continuation until at least 2050 and its expansion into more high emitting sectors. Whilst agriculture is not presently considered a candidate for inclusion, the need for robust carbon audit tools as the first step is being pursued with a research project commissioned by Defra on ‘Harmonisation of Carbon Accounting Tools for Agriculture’.
Comment
Given legal GHG emission reduction requirements both in the EU and the UK, the scope of emissions covered in the ETS regime has been under review for some time. There has been major reform of the EU ETS which has recently expanded to maritime and to buildings and road transportation. Further development of the UK ETS was widely anticipated.
For the UK ETS, the changes will not only affect existing participants and those organisations operating in the maritime, waste incineration, energy from waste or the upstream oil and gas sector but all dealing with those sectors. The implications (together with other possible carbon related measures such as UK CBAM) should be assessed to inform investments, financial impacts and carbon leakage proposals. The time period for change is limited (in accordance with trajectories to net zero) and in addition to those imminently affected, those sectors next to be considered, should start planning now.
The UK Government accepted the Independent Review of Net Zero recommendation that it should work within the Authority to develop a long-term pathway for the UK ETS and the vision for development of the scheme is due by the end of this year. Subject to agreement within the Authority, the pathway will set out the intention to legislate to continue the ETS beyond 2030 until at least 2050 while remaining aligned to net zero, and to explore expanding the scheme to more sectors of the economy.
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