The introduction of the EU carbon border adjustment mechanism late this year could see the UK subject to extra costs – a good reason, say proponents, for the UK ETS to link with that of the EU.
Creating any system that runs across jurisdictions is always likely to face hurdles. However, some experts believe that the benefits of linking the separate schemes to drive down emissions in the UK and the EU would outweigh the challenges, by improving carbon price discovery, eliminating bureaucracy and resolving post-Brexit trade tensions.
Emissions trading schemes, which are designed to encourage decarbonisation, enable companies that cut their emissions to sell their unused allowance to other businesses. In order to reduce the risk of “carbon leakage” – whereby businesses move their production to countries with laxer emissions controls – companies covered by the scheme are usually given a set allocation of free allowances.
This year, both the UK and the EU have announced major reforms to their schemes.
The UK’s Emissions Trading Scheme Authority – comprising the UK government, the Scottish and Welsh governments and the Department of Agriculture, Environment and Rural Affairs in Northern Ireland – began consulting on reforms to the ETS in March 2022.
The authority published its response to the consultation on July 3, and announced plans for more stringent emissions limits for key sectors, including aviation. It also set out its intention to reform the cap on the number of allowances permitted under the scheme, pledging to reduce these from 2021’s 156mn allowances to around 50mn in 2030.
The EU, meanwhile, increased its “overall ambition” to reduce emissions by 2030 in the sectors covered by its ETS to a cut of 62 per cent on 2005 levels.
It also confirmed plans to phase out the free allocation of allowances for certain sectors, along with the launch in May of its carbon border adjustment mechanism, which will work in tandem with the EU ETS to bring down emissions.
“There has been debate over the possibility of the UK ETS linking with the EU ETS or on an international platform,” Lucy Bruce Jones, counsel at law firm Norton Rose Fulbright, tells Sustainable Views.
“The UK government has indicated that in principle it remains open to linking with the UK ETS. However, there are concerns about how a globalised system can be established, as it would mean embedding a completely new system in multiple jurisdictions with various different stakeholders trying to reach agreement,” she adds.
The legislation that underpins the UK’s ETS does allow for it to be linked to the EU’s scheme, should an agreement be reached between the UK and the EU.
Linkage opportunities
The EU ETS was the world’s first international emissions trading scheme when it launched in 2005. The UK’s ETS took effect in 2021, following its departure from the European Union and the EU scheme (there had been calls for the two schemes to be linked before the UK formally left the EU that year).
Under the EU ETS, the average price for an allowance has risen from €30 in December 2020 to €90 since August 2022. The average price for UK ETS allowances is higher, and has also risen from £47 in May 2021 to £78 since August 2022.
Scotland has consistently favoured a closer relationship between the UK ETS and its European equivalent. In a Scottish government consultation on aviation conducted in October 2021, the government said it “strongly supports the formal linking of the UK ETS with the EU ETS, in order that companies participating in the two schemes face equivalent carbon pricing regimes”.
A Scottish government spokesperson tells Sustainable Views: “We believe the UK ETS should be linked with other carbon pricing markets, including the EU ETS. We continue to urge the UK government to progress with negotiations for linking with the EU ETS and to remain open to the possibility of linking with other jurisdictions.”
And Julia Michalak, EU policy director at the International Emissions Trading Association, says it would be “natural” for the two systems to link, adding that linkage would allow participants to benefit from “more liquidity, better carbon price discovery and more efficient management of carbon risks”.
Extra compliance
The EU CBAM, which begins operating in October, will ensure the price paid for carbon emissions generated in the production of specified goods entering the EU is equivalent to the carbon price of EU-produced goods.
The CBAM’s authority will be ramped up, with free carbon allowances for sectors it covers – such as electric energy production and hydrogen – set to be phased out between 2026 and 2034.
It is also likely to impose additional costs on UK companies. While UK MPs say this could be averted by linking the two ETS, the UK is also consulting on developing its own CBAM.
“While the UK may be exempted from paying the CBAM fee, unless it is linked with the EU ETS, the UK exporters will have to comply with [measurement, reporting and verification] obligations at the very least, adding to their costs,” says Michalak at the IETA.
The EU and UK MRV rules impose emissions reporting requirements on ships of at least 5,000 gross tonnage. According to maritime industry consultancy DNV, the two regimes are “analogous” with some differences, including variations in areas such as scope of travel.
Post-Brexit tensions
In June, UK MPs acknowledged that the EU CBAM could create a “bureaucratic hurdle” for UK companies.
The UK parliament’s European Scrutiny Committee reviewed a report on the UK’s Windsor Framework, a post-Brexit agreement aimed at resolving relations between the EU, Northern Ireland and the rest of the UK.
The committee said: “If the EU ETS price is higher than the UK, it is unclear whether carbon-emitting UK businesses, having already paid a carbon price in the UK, will have to pay the difference when exporting products to the EU.
“The committee notes that electricity traded between Northern Ireland and the Republic of Ireland will likely be exempt from the EU CBAM, meaning that the CBAM levy would almost certainly be applied to electricity traded between Great Britain and Northern Ireland.”
It warned that the EU CBAM could be applied to all goods travelling from Great Britain to Northern Ireland, and suggested: “The issues raised could be resolved by linking the UK ETS to the EU ETS.” However, it cautioned: “Any such policy development would require thorough analysis.”