The UK Emissions Trading Scheme: Leaking value
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Key Findings
The UK Emissions Trading Scheme is trading at prices that are too low and don’t represent the real costs to society of the emissions produced.
The management and issuance of free allowances shield major polluters from carbon pricing, reducing their incentive to address operational emissions.
Lost revenues due to low Emissions Trading Scheme pricing limit the UK government’s ability to fund climate change mitigation and support efforts to decarbonise the economy.
An opportunity exists for the UK government to vastly reduce the number of free allocations from 2027-2030.
Carbon pricing and the UK Emissions Trading Scheme
Carbon pricing attempts to capture the external cost of greenhouse gas emissions (GHG) ultimately paid for by the public or other stakeholders because of global warming. External costs include those related to damaged crops, property, economic productivity and health from heatwaves, droughts, rising sea levels and air quality.
Governments use two primary mechanisms to price carbon and apply this to polluting entities within their jurisdictions, namely carbon taxes and emissions trading schemes (ETS). The UK operates an ETS, which is a cap-and-trade scheme whereupon the host government sets a cap on the maximum amount of emissions and creates permits or allowances for each unit of emissions allowed under the cap. The cap reduces over time to align with the country’s emissions reduction and ultimately net-zero goals through to 2050.
Under the scheme, emitters must obtain and surrender a permit for each unit of their GHG gas emissions. To do this, emitters must monitor their relevant activities and apply ETS conversion factors to calculate their annual emissions in tonnes of carbon dioxide equivalent. Those that don’t have enough permits must either cut back on their emissions or buy the required amount from another company, or at auction. The price of these permits will increase when there is high demand and lower if demand reduces. The rationale is that polluting firms are given a financial incentive to reduce their emissions in line with the cap while raising funds and making the “polluter pay” for the consequences of global warming. It also aims to support vulnerable businesses and households with the costs of the energy transition.
