Developing the UK Emissions Trading Scheme

Net Zero Carbon Policy is an Energy Systems Catapult thought leadership project, focusing on how the UK can develop an innovation-friendly, economy-wide incentive and policy framework for Net Zero. We are building on the insights from our Rethinking Decarbonisation Incentives project, to develop credible policy options for an efficient and socially beneficial transition.

In this report we respond to the key questions in the Government’s Developing the UK Emissions Trading Scheme (ETS) consultation, as well as highlighting opportunities for future sector expansion of the UK ETS not covered by the consultation.

What is the UK ETS?

The 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. The Government has said the emissions cap will soon be aligned with the UK's 2050 Net Zero commitment.

The UK ETS already forms an essential piece of UK carbon policy. As the scheme continues to evolve, it has the potential to provide the backbone of an enduring and economy-wide policy framework for Net Zero.

The Government’s consultation provides the first opportunity since the UK ETS’s inception at the start of 2021 to align it with carbon budgets and broader climate targets. While the proposals for transitioning to a Net Zero-consistent cap can ensure that the ETS will form the backbone of UK carbon policy, it also presents an opportunity to better account for the traded sectors and expand the market to the currently uncovered sectors.

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.

The Catapult believes 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.

These considerations lie behind the Catapult’s advocacy of a sector led approach to designing Net Zero carbon policies, where pragmatic policy approaches framed around the targeted sectoral decarbonisation outcomes are used to drive emissions reductions. Where appropriate sectoral policies can be designed to allow for the use of tradeable instruments (or carbon credits) for compliance. In the medium and long term, sectoral policy mechanisms can be progressively linked to create a wider system of emissions trading markets and mechanisms that covers the major emitting sectors.

The following are our recommendations for the future development of the UK ETS.

Recommendations for policymakers

1) Economy-Wide: Provide clarity around the intended role of the UK ETS for enabling decarbonisation in each sector, accounting for sectoral strategies.

2) Economy-Wide: Ensure that the design of all sectoral carbon policies, standards, or decarbonisation outcome obligations includes the potential for future linkages between sectors via trading of carbon credits, including with the UK ETS.

3) Industry: Develop an enduring set of incentives for deep industrial decarbonisation with appropriate mechanisms to mitigate competitiveness impacts, centred on the UK ETS.

4) Industry: Explore the use of standards on both producers and purchasers as part of the long-term policy framework to enable industrial decarbonisation. Standards on purchasers could be initiated through a low carbon public procurement programme providing initial demand for low carbon products, before expanding to cover other sectors.

5) Industry: In the long-term, to ensure that the implementation of standards is aligned with Net Zero levels of ambition while mitigating competitiveness impact, impose standards on producers at the border on imported goods.

6) Carbon Capture and Storage: Move to recognise non-pipeline transport of carbon dioxide in the UK ETS.

7) Biomass: For effective competition, imports and indigenous biomass should adhere to the same set of standards, accounting, and MRV

8) Electricity: Use the Review of Electricity Market Arrangements process to explore the potential to apply a clean electricity standard and to link or align the standard explicitly to the UK ETS cap for electricity emissions.

9) Energy from Waste: Move to include energy from waste in the UK ETS, while incentivising better waste management techniques to avoid unintended consequences such as sending more waste to landfill.

10) Greenhouse Gas Removals: Take initial steps to develop a separate Greenhouse Gas Removals (GGR) marketplace. The linking of the UK ETS and the GGR marketplace could be one of the first linkages established between Net Zero aligned sectoral carbon policies.

11) Economy-Wide: Establish a Carbon MRV (Monitoring, Reporting, and Verification) and Accounting Regulator, responsible for robust empirical and scientific methods for measuring or accurately estimating emissions, and ensuring emissions reduction actually occurs in line with Carbon Budgets and the Paris Agreement.

12) Heat and Buildings: Move to extend the UK ETS to include all emissions associated with buildings, for example, by developing a building carbon performance standard combined with the option of using tradeable carbon credits to support achieving compliance.

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Developing the UK Emissions Trading Scheme (ETS)

Net Zero Carbon Policy

Net Zero Carbon Policy is an Energy Systems Catapult thought leadership project, focusing on how the UK can develop an innovation-friendly, economy-wide framework for Net Zero.

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