The EU Emissions Trading Scheme

The EU Emissions Trading Scheme (EU ETS) is the main European Union policy tool to combat climate change and aims to reduce industrial greenhouse gas emissions cost-effectively. It remains the largest international scheme for trading emission allowances, covering more than 11,000 power stations and manufacturing plants in the 27 EU member states as well as Croatia, Iceland, Liechtenstein and Norway. From the start of 2012, aircraft flights within and between most of these countries are also covered. In total, around 45% of total EU emissions are covered by the EU ETS.

As a cap-and-trade system, the EU ETS sets an emissions cap or limit on the total emissions allowed by all EU ETS operators. The scheme then allows participants in the EU ETS to buy and sell allowances as required through an open carbon market with prices driven by demand and supply. In addition, EU Aviation allowances (EUAAs) have been created to be used for compliance by airline operators.

The EU ETS legislation also allows participants to use credits from the Kyoto Protocol's Clean Development Mechanism (CDM) towards fulfilling part of their EU ETS compliance up to a limit set by the EC. The use of international credits can significantly reduce the cost of compliance for operators ​- see Carbon Trading for more details.

The EU Emissions Trading Scheme has seen its fair share of challenges since its start in 2005. The recession fundamentally changed the demand-supply balance in Phase 2 and we have seen the European Commission take steps to rectify this in Phase 3, initially through the “back-loading” proposal and then with the Market Stability Reserve (MSR) which started in 2019. 

The current proposals for Phase 4 (2021-2030) see a further reduction in the EU ETS cap, plans for more auctioning, tighter benchmarks and fewer industry sectors receiving 100% free allocations.

All these changes will result in a greater impact of the EU ETS on operators both in terms of tougher targets and the likelihood of rising carbon prices. As such it is important for to keep up to date with policy developments and carbon market activity.

On 14th Dec 2020, the UK Government confirmed it would be establishing a UK Emission Trading Scheme (UK ETS) from 1 Jan 2021. UK operators will have to manage a significant reduction in free allocations under the UK ETS, at a time of rising carbon prices.

• Establishes a new UK ETS with Phase I running from 2021-2030.
• Will start as a standalone system initially
• Broadly follows the current EU ETS rules
• Applies to energy intensive industries, power generation and aviation
• The total cap will initially be set 5% below the UK’s notional share of the cap for EU ETS Phase IV (156m tCO2e in 2021)
• Auctioning will continue to be the primary means of allocation but a proportion of allowances will be allocated to industry for free
• UK Allowance auctions and free allocations not expected until Q2 2021
• There will be a transitional Auction Reserve Price (ARP) of £22 / tCO2e
• Activity level reporting required annually with allocation adjustments according to a 15% threshold
• New UK Registry being developed and tested – due to be operational by April 2021
• Small Emitter and Hospital Opt-Out and ultra-small Emitter Exemption.
• Operators can’t use EU Allowances (EUAs) for UK ETS compliance
• Carbon offsets not permitted “at this time” but could be considered in the future.