• New report draws on expert input from the heat and buildings, greenhouse gas removal (GGR) and road transport sectors to make recommendations for extending UK ETS.
• Carbon markets and pricing should be at the core of a net zero compatible policy framework, but the question of ‘when’ carbon pricing should be extended is critical.
• “Polluter pays” principle must be managed sensitively in heat and buildings to avoid adverse impact on low-income households already facing cost of living crisis.

A new report from Energy Systems Catapult and the Grantham Research Institute on Climate Change and the Environment has found that while the UK Emissions Trading Scheme (ETS) could provide the backbone of an enduring economy-wide framework for reaching net zero, expanding it too early to sectors not yet covered risks undermining the scheme.

The report – The future of UK carbon policy: how could the UK ETS evolve to help achieve net zero? – draws on views from three expert roundtables examining the implications should the UK ETS be expanded to include three further sectors beyond those already covered by the scheme.

According to the report, for these sectors – heat and buildings, greenhouse gas removal (GGR) and road transport – government should focus on delivering a complementary set of policy packages, building on existing sector strategies to introduce tailored carbon markets which could later be linked together.

More progressive introduction of carefully-designed carbon markets to new sectors would help avoid price uncertainty and volatility – which could inhibit investment and innovation – ensure a fairer system for all, and set a pathway to a future economy-wide UK ETS.

After leaving the European Union’s ETS, the UK ETS was introduced in 2021 as the country’s mechanism for capping and reducing the carbon emissions from power generation, industry and aviation.

The report identifies near-term challenges in expanding the scheme to each of the three additional sectors, notable barriers being the already complex policy landscape in road transport; lack of economically viable low carbon alternatives in heat and buildings; and the relative immaturity of GGR technologies.

Summary of recommendations from the report (see report for full recommendations and insight):

• If the UK government were to eventually expand the UK ETS to heat and buildings, it must be developed as part of a wider package of complementary policies that address specific challenges, including fuel poverty and distributional impacts.
• The UK ETS requires wider system architecture changes to be able to incorporate GGR techniques: for example, expanding sectoral coverage to include sectors where achieving net zero is likely to require GGR (due to difficulty of reducing emissions) or setting the cap to net negative.
• Including road transport within the UK ETS offers an opportunity for policymakers to enact broader fiscal reform of transport taxes, most notably fuel duty (supported by policies that encourage a move away from private internal combustion engine vehicles).
• Introducing well designed sector-specific markets, with eventual linking to the UK ETS, could be a pathway to an economy-wide UK ETS in the future. Therefore, policy capacity in the near term should focus on delivering a complementary set of policy packages for the three sectors considered, building on existing sectoral strategies.

The report notes that introducing a carbon price on energy fuels (the “polluter pays” approach) without implementing compensatory policies would hit low-income households particularly hard, since they’re less able to change consumption behaviour – or invest in low carbon alternatives – in response to higher prices.

To ensure fairness and support the improvement of low carbon consumer propositions such as a market for heat pumps, the report recommends the UK ETS compliance requirement in the heat and buildings sector could be the responsibility of energy suppliers.

Dr Danial Sturge, carbon policy practice manager at Energy Systems Catapult, said:

“An economy-wide UK ETS that forms the backbone of a net zero policy framework is achievable if government focuses on developing sectoral carbon policies rather than a one-size-fits-all approach.

“While extending the UK ETS will remain challenging in the near term, by creating sectoral policies and new carbon markets designed to link together gradually can avoid price volatility, and yield a way that is fair and protects low-income households.”

Josh Burke, senior policy fellow at the Grantham Research Institute on Climate Change and the Environment, said:

“The extension of carbon pricing to sectors not previously covered by the UK ETS would significantly expand the application of the polluter pays principle.

“However, the policy must be underpinned by equity and fairness as without compensatory policies, expansion may risk entrenching inequality given that energy costs constitute a higher share of expenditure for lower-income households. This could be achieved through the creation of a ringfenced fund with the carbon pricing revenues used to reduce the impact of higher energy and fuel costs.”

Last month the government set out proposals for changes to align the UK ETS cap and trajectory with the country’s net zero target, and called for early views on the incorporation of GGR into the scheme. It also set out proposals to expand the scheme to the domestic maritime sector, and opened a consultation seeking views on including waste incineration and energy from waste.

A recent report from the Environmental Audit Committee (EAC) concluded that a UK carbon border adjustment mechanism (CBAM) – which would impose a levy on imports of carbon-intensive goods – could help the country meet its net zero targets.