Key Takeaways:
The EU Emissions Trading Scheme has been trading almost 50% higher than the UK equivalent in the last two fiscal years.
Lost revenues due to low Emissions Trading Scheme pricing limit the UK government’s ability to fund climate change mitigation.
Free UK Emissions Trading Scheme allowances reduce polluters’ incentive to decarbonise.
The UK government has an opportunity to decrease the number of free allowances as the risk of carbon leakage is eliminated from 2027.
6 March 2025 (IEEFA) | The UK government would have received an additional £2.9 billion in revenues from its Emissions Trading Scheme (ETS) over fiscal years 2024-25 and 2025-26 had it pegged prices to the EU equivalent.
New research from the Institute for Energy Economics and Financial Analysis (IEEFA) finds that the EU ETS has been trading 50% higher than the UK scheme in the last two fiscal years, with significant impacts on UK tax receipts.
Lower UK ETS prices are in part because the government lowered the emissions cap in 2023. To compensate, more ETS allowances have been released into the market. This contributed to reduced UK carbon prices in 2023 and created a sustained discount to the EU ETS in 2024.
“Lost revenues due to low ETS pricing limit the government’s ability to pay for global warming mitigation and to support the energy transition to a greener economy,” said Andrew Reid, an IEEFA energy finance analyst and author of the research. “Changes must be considered for carbon pricing to more effectively support the country’s net-zero ambitions.”
The study points to EU reform in 2018 and 2019 that allowed its ETS prices to be regulated by increasing or decreasing permits. This helped to significantly raise EU ETS prices.
The UK ETS issues free allowances to emitters to prevent “carbon leakage”, whereby polluters move their operations to countries with lax climate policies.
As of 2027, this protection will no longer be needed as the UK’s Carbon Border Adjustment Mechanism is introduced, applying the country’s ETS price to imports covered by the scheme. This coincides with a second free ETS allocation period planned for 2027-2030.
“The UK government now has a golden opportunity to vastly reduce the number of free ETS allocations as the risk of carbon leakage is eliminated,” said Reid.
The research also finds that free allowances shield certain heavy polluters from ETS payments. In 2023, the cement and lime sectors received 99% of their ETS obligations for free, while the refining and airlines sectors had 65% and 59% of their ETS obligations waived, respectively.
More than one-third (38%) of emissions captured under the UK ETS were allocated for free in 2023. The value of these free emissions, based on the average UK 2022 ETS price, was £2.8 billion.
“The UK’s approach to free allowances constrains ETS pricing, which protects polluters from paying for the costs of climate change and reduces their incentive to decarbonise,” said Reid.
Notes to editors
- The UK ETS applies to energy-intensive industries, power and aviation. Under the scheme, emitters must obtain and surrender a permit for each unit of their greenhouse gas emissions. Those without enough permits must either curb their emissions or buy the required amount from another company or at auction. Permit prices increase when there is high demand and fall if demand reduces. The rationale is that polluting firms are given a financial incentive to cut their emissions while raising funds and making the “polluter pay” for the consequences of global warming.
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About IEEFA
The Institute for Energy Economics and Financial Analysis (IEEFA) examines issues related to energy markets, trends and policies. The Institute’s mission is to accelerate the transition to a diverse, sustainable and profitable energy economy. www.ieefa.org
