UK govt sets limits for carbon market launch
No longer part of the European Union, the UK government set out May 5 the terms and conditions that will govern its own carbon emissions trading scheme (ETS) May 19. That is when it will auction off the first allowances for big polluters such as power generators, energy intensive industries and aviation.
The timing is unfortunate, as the new scheme is being launched in what have become very choppy waters: European Union (EU) Phase IV certificates traded lately as high as €50 ($60)/metric ton (mt), doubling in price in the past six months or so.
Before that they had been a very stable commodity but the higher the goals for CO2 reduction, the greater the scarcity of the certificates as the deadlines draw near. But also investors are seeing them as a safe bet since supply can only go down over time. This new class of buyers is reportedly driving the price up faster.
The higher the ETS price goes, the more economical decarbonisation schemes such as carbon capture and storage become, and the greater the incentive to switch from coal to gas in the power sector; and to adopt low carbon transport fuels such as biogas or LNG in the heavy goods sector.
That is hardly an option now in the UK as there is a very small percentage of coal-fired generation left in operation. But if the UK were to adopt something like a carbon border tax that dodges WTO restrictions, as the EU has been considering, then the cost of imported finished goods such as steel would rocket and become more competitive with locally produced goods.
Floors and ceilings
The government has put in place a series of mechanisms to stop the price from collapsing and also from going too high. On the way down, bidders will come up against an auction reserve price (ARP) of £22/metric ton (€25/mt). The existing carbon price support, £18/mt, will also contribute to the total UK carbon price and be paid for by relevant emitters.
On the way up, bidders could meet the Market Stability Mechanism and Cost Containment Mechanism (CCM) to reduce volatility in the market.
"Together, these provide some certainty to the market in setting a minimum overall price for total UK carbon at £40/mt, said consultancy Cornwall Insight May 6.
"The UK has initially set its emissions cap 5% lower than the previous cap it had under the EU ETS, which logically could push prices higher. However, the [independently run] Climate Change Committee (CCC) note that real emissions for 2021 are likely to be significantly lower than this cap which could help balance the price.
"A tighter, net-zero aligned emissions cap is therefore likely to increase the cost of carbon over time. This price increase could be balanced to some extent by the planned phase-out of the CPS. However, the recent Budget announcement on extending the CPS through to April 2023 gave little in the way of a longer-term transition plan. Without this plan, the tighter caps points towards price rises.
"The government is planning to use market tools for a good reason. These tools have shown a beneficial impact on prices within the EU ETS. However, likely, the UK ETS will naturally face higher levels of volatility in its early years as the system adjusts to a smaller and, therefore, potentially less stable market.
Cornwall concludes: "It is also clear that UK policy will play a major role in shaping this market as it becomes a key tool in meeting the net zero target."
But the government has also left open the door to rejoining the ETS – if the EU will accept this, or at least to linking the two – and major EU energy trader group EFET believes this would be best for liquidity and regulatory purposes.
The government told NGW in April: "We also recognise the important role that international co-operation on carbon pricing and carbon markets can play in cutting emissions in the most cost-effective way which is why the UK is open to linking the UK ETS internationally in principle and we are considering a range of collaborative options."