In this guest post, Chimdi Obienu, research consultant at climate consultancy EcoAct, shares his thoughts on the current state of the EU and UK Emission Trading Schemes, and what businesses should be doing moving forward.
A true flagship of the European decarbonisation agenda, the EU Emissions Trading System (EU ETS) has been in operation for almost two decades and is the world’s largest carbon market. Lauded for its ambition, but also no stranger to criticism, the EU ETS has played a key role in forging the path and serving as a model for other carbon markets across the globe.
When it was inside the bloc, the UK played an important part in driving the scheme forward, including advocating for the inclusion of the aviation sector in the system. Since leaving the EU, the UK has established its own carbon trading system, the UK Emissions Trading Scheme (UK ETS).
Having seen the EU ETS from the inside and now working on the outside, the UK is in a unique position to learn from the successes and failures of the market and apply these to itself. Essentially, peeking at the EU’s homework, taking what works and tweaking what doesn’t. This should, in theory, empower UK legislators to follow in the footsteps of the EU ETS, providing an efficient system that facilitates deep decarbonisation while allowing regulated firms to remain internationally competitive.
The state of play
The emission reduction target of the EU ETS has been raised from 46% to 62% by 2030 compared to 2005 levels, and will soon cover emissions from the maritime sector. In addition, a Carbon Border Adjustment Mechanism (CBAM) – to price emissions from imported goods – will be phased in. With these revolutionary changes afoot, now would be a good time for the UK to pay particularly close attention.
This summer, the UK ETS Authority has signalled that the UK intends to retain a degree of alignment with the EU ETS. The Authority has lowered the UK-ETS emissions cap, announced the extension of the scheme to domestic maritime (by 2026) and waste (by 2028), and pledged to refine the way in which allowances are distributed.
However, despite the coming updates, UK ETS allowance prices have plummeted in 2023, and now sit far below the peak levels seen in 2022. The Authority chose the least ambitious cap floated in its consultation on ETS reforms, and the market response suggests that this will not restrict the supply of allowances enough to raise prices any time soon. Consequently, in terms of both the environmental ambition and potential impact of its ETS, the UK has now fallen comfortably behind the EU.
While some energy-intensive industries may consider this a financial gain, a low carbon price will make it much more challenging for British businesses to meet their climate goals, by failing to provide the same incentives seen on the continent. To preserve effective routes to deep decarbonisation in the UK, the crashing price of carbon must be addressed, or other pathways, such as the progressive innovation funding packages seen in the United States, must be pursued.
Is the EU ETS driving change?
The effectiveness of a carbon market can be judged against any number of metrics, but perhaps the first question to ask is whether it is actually promoting decarbonisation. From our research as part of the 2023 State of the EU ETS report, we found that the scheme has played a key role in reducing emissions within the power sector over the past ten years. For many, this won’t be surprising, as power generators have faced most of the costs of the EU ETS so far.
Other sectors, such as manufacturing, are more exposed to the challenges of international, competitive markets. Protections – in the form of free emissions allowances – have been put in place to ensure EU businesses are not priced out of international markets due to carbon costs faced at home. Over the years, many firms have grown used to receiving allowances for free, which has blunted, if not eliminated, the incentive to decarbonise.
As a result, the EU has decided to phase out free allowances for industrial installations by 2034 and instead use the phasing in of CBAM to ensure a level playing field for EU industry in international markets. This change is expected to have a major financial impact on businesses covered by the EU ETS. At a carbon price of €120/tCO2e in 2030, the cost of compliance for the manufacturing sector could amount to €8.5 billion in 2030, four times higher than in 2022. CBAM will be a valuable tool for EU manufacturers to remain internationally competitive even while facing a strong financial incentive to decarbonise.
From the UK’s perspective, the introduction of its own CBAM is a next logical step, and consultations to this end have been recently announced. This is where the country’s unique position can really benefit the UK ETS. As the EU begins the initial administrative phase of CBAM, UK policymakers can observe the process: How is it received? What are the costs? Are companies able to meet their reporting obligations? Are suppliers calculating their embedded emissions using the correct methodologies? What is the role of industry associations in the decision-making process? These learnings can feed into ensuring the UK CBAM is built from a position of knowledge.
What does it all mean?
As always, the landscape is complicated. According to our research, the cost impact of the EU ETS reforms on businesses up to 2030 can be minimal – if the bloc’s stringent emissions reduction target is met. Therefore, deep investments in industrial decarbonisation are needed as soon as possible. Alternatively, if emissions continue along their current trajectory, they could exceed the legislated cap within a few years and leave the EU short of its targets.
Done correctly, the phasing out of free allowances will allow CBAM and a more ambitious scheme to become part of a virtuous cycle – limiting the economic and social impacts of enhanced climate ambition while driving greater decarbonisation. The increased revenues can fund the scaling up low-carbon technologies, and should also be used to soften any impacts on vulnerable households and businesses negatively affected by higher carbon prices.
The UK has set a tighter carbon cap, but the success of the ETS must be enabled by other complementary policies, such as those enabling decarbonisation in hard-to-abate sectors. Investing compliance revenues effectively can provide funding for much-needed initiatives at home and abroad, including the provision of finance to support the greening of industry in low-and middle-income countries, which play a key role in the supply chains of British firms. For example, in the UK textile sector, 60% of the raw materials used are imported from developing countries.
What should businesses be doing?
To survive in a world of increasingly strict carbon regulations, companies must prioritise direct decarbonisation while looking closely at their Scope 3 emissions, or risk being left behind by competitors with cleaner supply chains and a sharper focus on sustainability.
Due to the aforementioned ETS alterations, carbon costs will soon start to bite, making it more important than ever to work with low-carbon suppliers and prioritise sustainable procurement strategies. The time to act is now, and those who can set clear transition plans and rapidly decarbonise their operations will enjoy a crucial competitive advantage in the short, medium and long terms.
Chimdi Obienu joined EcoAct in 2022 and brings over 5 years’ of experience in climate change research and consultancy. In his current role, he leads the delivery of both quantitative and qualitative analysis for clients across various sectors, with a specific focus on assessing financial risks associated with regulatory and voluntary carbon markets.
Prior to joining EcoAct, Chimdi served as a Research Analyst at the global research and consulting firm Washington CORE. During his time there, he supported both public and private sectors on diverse projects, spanning policy, business and technology.
Chimdi graduated from the University of Chicago with a B.A. in Public Policy Studies and Environmental & Urban Studies and holds an MS in Energy Policy from the University of Sussex, where he was awarded as the Best Student within the Science Policy Research Unit.
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