How could the UK ETS work for industry and help UK competitiveness?
Comment by Dr. Danial Sturge
Carbon Policy Practice Manager - Markets, Policy and Regulation
Net Zero now means that UK industrial emitters have the same imperative to decarbonise as everyone else. To date, much of the reduction in UK industrial emissions has been driven by broader international trends (i.e. the relocation of many emitting industries, and their emissions, outside of the UK), as well as the effect of a mix of policies impacting abatement.
If UK industry is to lead the green industrial revolution, Government will not only have to incentivise deep decarbonisation of industry, but also ensure that UK industrial competitiveness is not unduly impacted. That’s to say, while low carbon markets are nascent, and the costs for low carbon production are higher than their fossil-fuelled counterparts, UK industry should not be penalised for taking the necessary steps to combat climate change.
There have rumblings of a Carbon Border Adjustment (CBA) or Carbon Border Adjustment Mechanism (CBAM) for many years now. But recent pushes forward by the EU Commission (and potentially President Biden’s Government) have brought the idea of applying a carbon price (or equivalent) at the border on imported goods to the forefront of global carbon policy.
The potential impact for industry is significant, as is the way the UK Emissions Trading System (UK ETS) develops in the near-term to account for it. Currently, free allowances are allocated to energy-intensive, trade-exposed industrial emitters to mitigate the potential competitive disadvantage compared to their international peers not covered by an equivalent carbon price. However, allocating free allowances as an approach does tend to dampen incentives to reduce emissions, and arguably could inhibit necessary step changes in technologies or processes required for Net Zero. Free allowances do not, however, remove the incentive entirely as industry can still gain rewards if they are able to trade surplus allowances.
What is the UK ETS?
The UK Emissions Trading System (UK ETS) came into operation on 1 January 2021 following the UK’s departure from the European Union’s ETS – covering electricity generation, heavy industry, and domestic flights. Under the ‘cap and trade’ principle, an upper limit of emissions is set – the cap – for all participating installations. Allowances for emissions within the system are auctioned off or allocated for free. Trading of allowances between installations can occur if an installation exceeds or outperforms its limit. In this way, installations are able to achieve emissions reduction in the most cost-effective way that meets their business needs. Government have said the emissions cap will soon be aligned with the UK’s 2050 Net Zero commitment.
In our recent work for the Climate Change Committee, we assessed the carbon policies that can promote deep decarbonisation of industry, while also mitigating potential competitiveness impacts. We found that there is no one-size fits all approach and there may be advantages in an approach based on tailored policy packages for each key industrial sector. The broad brush policy pathway, however, is likely to be applicable across all key emitting industries (see figure below). This includes:
Continuing to provide direct funding in the near-term and improving the methodology by which the allocation of free allowances is determined (in order to reduce incentive dampening effects).
Alongside these, design and implement additional support measures such as low carbon public procurement practices.
Explore the role of a CBAM, which could be integrated with the UK ETS, but potentially, more importantly, form the basis for wider coverage of standards on producers later down the line.
Over time, implement longer-term policies, including standards on carbon on both purchasers and producers, with border standards eventually used for the latter.
Many of these decisions are likely to have significant political and potentially diplomatic dimensions over the short- to medium-term. Regardless of how this is negotiated during the years ahead, it will be to improve the robustness of MRV (monitoring, reporting, and verification) processes and accounting for emissions that originate from outside the UK. Getting a robust and reliable fix on these so-called ‘embodied emissions’ or ‘consumption-based emissions’ will be vital in enabling the UK to develop a well-targeted and effective policy mix to decarbonise its own industries, whilst remaining competitive on a global playing field. As well as addressing carbon leakage risks and promoting positive change in global supply chains.
We’ve begun to explore this in our recently published report in which we make the case for a ‘Carbon MRV and Accounting Regulator’, the role of which and how it relates to the UK ETS will be discussed in more detail in a future blog.
For now, the UK ETS has an important role for industrial decarbonisation. Not only does it provide a major component of the incentive to abate for industry, but its future development will also largely dictate the next steps in how the UK competes in what will remain a carbon-intensive global economy for a few years yet to come. The UK should adopt a pragmatic and cautious approach to the design of any CBAM, carefully considering its interaction with the UK ETS (in particular, the allocation of free allowances) as well as the EU’s and other international trading partners’ plans for any CBAM design.
What is required for the UK ETS to link to the EU ETS – which remains the world’s largest carbon market and has seen the price of allowances soar in recent months?
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