In the wake of Brexit, 2021 marked the UK’s departure from the EU Emissions Trading System (EU ETS) and the establishment of its own UK Emissions Trading Scheme (UK ETS). While the UK ETS retains some foundational elements of its EU predecessor, the two operate as distinct carbon markets with notable differences. Now, recent discussions hint at the potential for these schemes to be reconnected. This article delves into the structure of both systems, drawing on expert industry insights to explore whether UK operators face disadvantages compared to their EU counterparts, and evaluates the potential benefits of re-linking the two trading systems.
EU Emissions Trading System
Set up in 2005, the EU ETS was the world’s first international emissions trading system. Today it covers over 10,000 installations across the EU, which roughly equates to 40% of total EU greenhouse gas emissions. In terms of emissions, over one billion tCO2e were reported in the EU ETS by stationary installations in the 2023 reporting year (European Union, 2024).
With the EU ETS operating in all EU countries, as well as Iceland, Liechtenstein and Norway, the EU claims the system has helped bring down emissions from European power generation and industry plants by 47% compared to 2005 levels. It is also worth noting the scheme is ever growing and was expanded to Switzerland in January 2020 and now also includes electricity generators operating in Northern Ireland (European Union, 2019).
UK Emissions Trading Scheme
Since its inception in 2021, the UK Emissions Trading Scheme (UK ETS) now covers around 1,000 installations across England, Scotland, Wales and Northern Ireland (excluding electricity generators in Northern Ireland). The UK ETS is estimated to be around 10% of the size of the EU ETS. In the 2023 reporting year almost 90 million tCO2e were reported by full participant stationary installations covering 25% of total UK domestic emissions (based on 2022 figures) (DESNZ, 2023).
How do the two schemes differ?
Both schemes operate under similar regulations, however there are notable differences between the schemes, which have been summarised below:
| Differences | UK ETS | EU ETS |
| Number of installations | >1 000 | >10 000 |
| End of Free Allocation (FA) | · 2026: Aviation
· The UK ETS Authority is committed to maintain current levels of FA until 2026 for all other industries. A baselining exercise is currently being undertaken that will determine how FA is distributed from 2027 – 2030. |
· 2026: Aviation · Due to the implementation of CBAM, FA shall be slowly phased out from 2026 to 2034. |
| Average allowance price (Nov. 2023 – Nov. 2024) | ~£40.18 | ~€68.19 |
| Total Emissions Cap | · Began with a cap set at 5% lower than the cap set for EU ETS. The UK has since amended this to ensure the cap is consistent with the UK’s Net Zero targets.
· 2024: 92.1 million UKAs · 2030: 24 million UKAs |
· The EU is similar in that its cap is aligned with its climate target. The reduction factor has been increased to 4.3% from 2024 – 2027 and 4.4% from 2028 onwards.
· 2024: ~ 1.3 billion EUAs |
| Extensions (including monitoring periods) | · 2024: CO2 Venting
· 2026: Maritime Transport · 2026 / 2028 (TBC): Energy from Waste and Waste Incineration · TBC: GGR Removals |
· ETS2 (some sectors covered include buildings and road transport)
· 2024: Maritime Transport · 2024: Municipal Waste Incineration |
Are UK Operators disadvantaged in comparison to their EU counterparts?
Since late 2022, participants in the UK ETS carbon market have benefited from lower carbon prices relative to the EU ETS market. However, the planned implementation of the EU Carbon Border Adjustment Mechanism (CBAM) in 2026 could significantly impact UK industries. The EU CBAM will introduce a carbon price on emissions-intensive goods like electricity, aluminium, cement, fertiliser, hydrogen, and iron and steel imported into the EU. While the UK plans to implement its own CBAM in 2027, it will exclude electricity, which may affect its competitiveness.
Lower carbon prices in the UK may initially advantage exports, but the EU CBAM could negate this benefit, with projected costs to UK industries ranging from £0.2 billion to £0.8 billion between 2026 and 2030 (Frontier Economics, 2024). Furthermore, the EU CBAM could hinder the growth of renewable energy investments in the UK due to uncertain effects on curtailment, making such ventures riskier for investors. UK electricity generators may encounter challenges in exporting to the EU because of heightened emission calculations under the EU CBAM. This situation could benefit EU electricity generators, as domestic power production would need to increase to meet demand, though EU consumers might face higher energy costs as a result.
How likely is it that the EU ETS and UK ETS shall link?
Despite the significant efforts to separate the UK from the EU ETS after Brexit, the UK Government now believes that linking the two systems is crucial for aligning and achieving shared climate goals. The imminent introduction of CBAM by both the UK and EU, aimed at addressing carbon leakage, may offer an opportunity to facilitate such a link.
The similarity between the UK and EU ETS makes linking technically feasible, and the EU-UK Trade and Cooperation Agreementprovides a framework for cooperation, stating that both parties should ‘seriously consider linking their carbon pricing systems to enhance effectiveness while preserving system integrity’.
Historical precedent exists with the Swiss ETS successfully linking to the EU ETS in 2020, illustrating that such arrangements are achievable. Nonetheless, integrating the two schemes would not be a straightforward merger and would require careful coordination to address complexities and ensure mutual benefits.
What benefits would we see if the schemes linked?
Connecting the UK ETS with the EU ETS would remove the need for carbon borders between UK and EU markets, while aligning decarbonisation strategies to identify the most cost-effective emissions reductions across the market. This linkage could stabilise the carbon market, mitigate price shocks, and enhance market liquidity, offering participants better opportunities for hedging against price volatility. By minimising transactional costs in smaller markets and providing a more stable framework, the link would attract investment in low-carbon solutions. Furthermore, the link would facilitate efficient trade, support the cost-effective achievement of climate goals, and exempt UK businesses from the complex reporting obligations and financial burdens imposed by the EU Carbon Border Adjustment Mechanism (CBAM). Overall, such collaboration would reflect shared international leadership in tackling climate change.
Navigating the evolving landscape of UK and EU ETS reporting requirements can be challenging, but staying informed is crucial for compliance and future planning. If you have any questions about current obligations or upcoming changes, Swan Energy can help. Visit their website.
