The UK Emissions Trading Scheme - what’s new?

On 10 March 2021, the Department for Business, Energy and Industrial Strategy (“BEIS”) published updated guidance on participating in the UK Emissions Trading Scheme (“UK ETS”) which launched on 1 January 2021. While the UK ETS closely follows the EU Emissions Trading Scheme (“EU ETS”), for now at least, it is a standalone scheme, established by the Greenhouse Gas Emissions Trading Scheme Order 2020 (“TSO”). It is intended to provide some continuity with how the EU ETS works in regulating the greenhouse gas (“GHG”) emissions of the UK’s most energy intensive industries, whilst keeping the UK in check with its net zero ambitions. On 4 March 2021, BEIS also published updated compliance guidance for aircraft operators subject to the UK ETS to follow up previous guidance from December 2020. We consider below the main features of the UK ETS, its divergence from the EU scheme and the potential implications of the new standalone scheme for UK industry.

An overview of the UK ETS

As set out in the UK Energy White Paper (which was published on 14 December 2020) the UK ETS forms a key part of achieving the UK’s net zero targets ambitions. According to BEIS it intended to provide industry with "the certainty they need to invest in low-carbon technologies". The UK ETS retains the EU’s ‘cap and trade’ market-based approach to incentivise the reduction of emissions from industrial activity. It continues to apply to energy intensive industries, the power generation sector and aviation but the UK Energy White Paper states that the government is “committed to exploring expanding the UK ETS to the two thirds of uncovered emissions”.

However there is intended to be some important changes. Key features of note include:

1. A lower cap

The UK’s emissions cap has initially been set at 5% below the cap which was notionally set for Phase IV (2021-30) of the EU ETS. This is a temporary cap and is to be updated within 8 months of the Committee on Climate Change publishing its advice on the sixth carbon budget. With fewer allowances available, having a lower cap may make it harder for UK participants to be as competitive as their EU counterparts, or drive up the price of carbon.

In an update to the previously announced position for the UK ETS mechanism, the auction reserve price (ARP), which is one of the two price components in the scheme has been updated for the transitional period to £22 per tonne of carbon dioxide equivalent. The ARP sets a minimum price at which allowances can be sold at auction. This aims to secure price continuity and minimise the risk of any significant fall in carbon pricing. The BEIS guidance notes that this APR is likely to be withdrawn as the UK ETS matures.

1. A new registry and enforcement system

With the new scheme the TSO also sets up a new registry, the UK Emissions Trading Scheme Registry. This is particularly relevant for new entrants to the market, who will need to ensure they have the correct operator or aircraft operator holding accounts with the UK ETS Registry, and permits (or for aviation, an emissions monitoring plan) from the appropriate UK regulator. Looking forward, the UK Government intends to develop a new system to replace the current permit system (Emissions Trading System Workflow Automation Program/ETSWAP) in 2021/2022.

The TSO also sets up an enforcement system to be carried out by the relevant environmental regulators, who can issue enforcement notices or civil penalties for breach of the TSO.

1. Simplification for small emitters

The TSO provides simplified compliance provisions for hospitals or small emitters (emitting less than 25,000 tonnes of carbon dioxide each year, and having a thermal input of less than 35MW, where applicable). These installations are subject to emissions targets rather than trading allowances. Ultra-small emitters, emitting less than 2,500 tonnes per year are exempt from the trading scheme. BEIS has indicated that further information for such installations will be provided in due course.

1. Free allocation

The UK ETS will continue to issue free allowances to qualifying operators, both existing and new, to account for carbon leakage. Initial benchmarks used to calculate free allocation are to be the same as those determined for Phase IV of the EU ETS.

• Aircraft operators who wish to apply for free allocation, which will be based on their historical aviation activity, must do so by 31 March 2021.
• For stationary operators, a number of allowances will be made available in a new entrants reserve.
• This will also be available for existing operators who increase their activity.
• Stationary operators will be required to submit verified activity level reports by 30 June in 2021, and by 31 March each year after that.
• By the end of June this year, the UK ETS authority must compile and publish an allocation table, showing the proportion of allowances for each applicable entity.

In the latest developments, BEIS launched a call for evidence on 17 March 2021, seeking evidence on how free allocations can better incentivise emissions reduction and protect industry from the risk of carbon leakage. In particular BEIS is seeking inputs on the advantages and disadvantages of the current approach to free allocation and potential solutions for distributing free allocations more fairly or better targeted. The call for evidence closes on 23 April 2021 following which BEIS intends to consult on its proposals later in 2021.

1. Auctions and timings

Under the UK ETS, each scheme year is to run from 1 January to 31 December, with the first phase in place from 2021-25, and the second running from 2026-2030. Draft regulations governing the UK ETS auctioning system were published in February 2021, and an auction calendar for 2021 has now been published by Intercontinental Exchange (ICE) Futures, confirming fortnightly auction dates from 19 May as well as the volume of allowances available at each auction. Minor revisions to the calendar may be expected once the volumes for free allocation are finalised in June 2021.

Updated compliance guidance for aviation

On 4 March 2021, BEIS published updated compliance guidance for aircraft operators subject to the UK ETS to follow up previous guidance from December 2020. The aviation scope under the UK ETS is to cover domestic flights, flights between the UK and Gibraltar and flights from the UK to the EEA. Relevant changes for aviation highlighted by this guidance include:

1. the process for getting an Emissions Monitoring Plan (“EMP”). If currently regulated by the UK for the EU ETS, an operator’s regulator remains the same and it will issue a UK ETS EMP on substantially the same terms as the EU ETS. Otherwise, aircraft operators must contact the appropriate regulator (depending on their place of registration or establishment) and apply for an EMP within 6 weeks of becoming an aircraft operator. Once issued, the next step is for an aircraft operator holding account (“AOHA”) in the UK ETS Registry to be opened. The guidance highlights that this can take up to 2 months;
2. the option to use any of the five fuel use monitoring methods approved for use in the CORSIA (compared with two under the EU scheme), allowing aircraft operators to use the same methods for both schemes. The government has recently closed its consultation on the implementation of CORSIA in the UK, which invited initial views on its alignment with the UK ETS. A second consultation is expected this year on the detailed policy design of any interaction between the two schemes;
3. the requirement to use a UK Accreditation Service accredited verifier (as listed in ETSWAP) for verifying annual emissions reports; and
4. the ability to undertake simplified reporting instead of appointing an independent verifier if (i) emitting less than 25,000 tonnes of carbon dioxide per year from full scope flights (i.e. flights in and out of the UK, Gibraltar or an EEA state) and/or (ii) emitting less than 3,000 tonnes of carbon dioxide per year from aviation activities.

Comment

Whilst the UK ETS commits to a similar approach to the EU ETS, which most operators will be familiar with, the changes made may give rise to challenges for both new and transitioning participants. In particular:

• It is not clear if, and how, the UK ETS may link with the EU ETS, particularly where the UK differs in climate policies and commitments. Under the EU-UK Trade and Co-operation Agreement, co-operation on carbon pricing is required, and serious consideration is to be given to link up the two schemes. On a similar note, if the UK is to have a tighter cap, an ARP and generally more ambitious climate change targets, UK industry may lose competitiveness being a smaller and less diversified market. We are yet to see whether the UK government will expand the scope of the scheme to additional sectors, as mentioned in its June 2020 consultation response on the future of UK carbon pricing. If it does, this will cause further divergence and perhaps more complications with EU linkage.
• With only first drafts of the auctioning regulations being published in February 2021, it is questionable if the pace of implementation of the regulations is fast enough for participants to fully comprehend and prepare for the changes to be made. While an auction calendar has now been published for this year, offering some clarity on imminent dates and allowance volumes, various other aspects of the UK scheme are either subject to approval, temporary or further guidance implementing legislation before it can be certain how the scheme is to operate in the long term. With only one month to go until EU ETS allowances are to be surrendered, little time remains for industry to properly prepare and understand the full scope of changes to be made at an already uncertain time.