Comment by Dr. Danial Sturge, Carbon Policy Practice Manager at Energy Systems Catapult. 

Kicking off the summer, the UK Government and devolved administrations published their long awaited response to last year’s ‘Developing the UK Emissions Trading Scheme (UK ETS)’ consultation. For those of us who spend a considerable amount of time thinking about carbon pricing and carbon markets, this much anticipated document not only lays out where the UK ETS is heading for the remainder of this decade, but what its role might be out to 2050.

The consultation, which was published over a year ago was more representative of a nesting doll of consultations and calls for evidence all wrapped up into one document; covering a wide range of areas including:

• Introducing a Net Zero consistent cap, which would effectively align the UK ETS with the Net Zero target and the Sixth Carbon Budget.
• A review on free allocation, the method by which the government currently addresses carbon leakage. A further consultation on future carbon leakage policy measures recently closed, which we also responded to.
• Market design, which in essence looks at how the ETS market deals with sudden supply and demand shocks and the resulting excessive price fluctuations.
• Amendments to aviation and expanding the market within already covered sectors (e.g., venting and flaring, and carbon capture and storage (CCS) transportation).
• Expanding to new sectors, including waste incineration and energy from waste, and domestic maritime.
• Long-term market options for greenhouse gas removals (GGRs), including a call for evidence on reducing emissions from agriculture and land use.

Our response covered many of these areas, but we also went beyond and made recommendations around heat and buildings and economy-wide enablers.

The government’s latest position

So, what did the government’s response consist of? The government, unsurprisingly, was clear that the decisions made balance the impacts that recent events (cost of energy and cost-of-living) posed to businesses. With that, the following decisions were made:

• The UK ETS cap will be made consistent with Net Zero, starting from 2024. It will result in a relative drop of 30% over the course of this phase, sitting at the top of the range set out in the earlier consultation – this effectively allows for greater flexibility in how businesses respond to the cap. The release of additional allowances from reserve pots (built up over previous years) between 2024-2027 will help smooth the transition.
• Phasing out of aviation free allocation between 2024-2026, due to the minimal risk of carbon leakage for the sector.
• Expanding the scope of the scheme to include domestic maritime by 2026, and energy from waste and waste incineration from 2028. Both are subject to further consultation on the details of implementation. In addition, the ETS will also be expanded within the already covered sectors, as listed.
• Engineered GGRs will be incorporated into the UK ETS in the long-term, subject to further consultation and a robust monitoring, reporting, and verification (MRV) regime being in place.

The decisions laid out in the government’s response are a welcome step forward, and with careful design, the scheme can continue to evolve to provide long-term market confidence. An outcome that will see investors more likely to support innovation in low/zero/negative carbon technologies, business models, and consumer propositions.

But as with all policy, the devil is in the detail. For example, we recommended that a separate GGR marketplace – for both nature-based and engineered GGRs – be set up and linked to the UK ETS, instead of direct integration into the carbon market. Our reasoning for this was to ensure that sectors that sit outside of the UK ETS (e.g., agriculture and international aviation) also have access to negative emissions. Government has yet to lay out a timeline on when GGRs will be integrated but will be consulting again later in 2023.

The long-term strategy for UK ETS

The interesting bit of the response for me was the discussion around a longer-term pathway for UK ETS development. In the run up to the original consultation, there were rumours floating in the media of extending the UK ETS to heating and transport fuels, much like the European Union is doing. Rather unsurprisingly given the cost-of-living crisis that was just beginning at the time, this did not make it into the published consultation.

Since then, we have had the Independent Review of Net Zero and government has accepted the review’s recommendation that it should develop a long-term pathway for the UK ETS, including:

• Setting out a vision on the future design and operation of the UK ETS and an intention to legislate to continue the scheme beyond 2030 until at least 2050.
• Exploring expanding the UK ETS to more sectors of the economy, including high emitting sectors.
• Developing options for inclusion of GGRs to incentives early investment in new technologies.
• Consider how the government will mitigate the risk of carbon leakage as a result of expanding the UK ETS.

Much of this work is already underway, and government has committed to publishing its long-term pathway for the UK ETS by the end of 2023.

In our consultation response last year, we proposed that the UK ETS should eventually be extended to include all material sources of emissions across the economy. The strategy for extending the scope of emissions trading will need to be adapted to reflect the unique challenges and opportunities of individual sectors and to facilitate innovation that helps these sectors decarbonise.

We at Energy Systems Catapult are working with the Grantham Research Institute at the London School of Economics to explore extending the UK ETS to heating and transport fuels, building on our work from last year. Separately, and highly relevant to ensuring robust MRV for GGRs, we have just kicked off a two-year project, as part of the Cross-Catapult Carbon Accounting programme, to develop options for operationalising a Carbon Regulator – providing regulatory oversight for carbon accounting and MRV.

If you are interested in working with us on either of these projects, please get in contact.