The Polluter Doesn’t Pay: credits in UK carbon compliance market 45% cheaper than EU ETS!

New report from The Institute for Energy Economics and Financial Analysis (IEEFA) suggests lost revenues due to low ETS pricing affecting ability of the UK government to transition to lower GHG economy.

The UK Emissions Trading Scheme: Leaking Value-Source ieefa.org

A new report released by The Institute for Energy Economics and Financial Analysis (“IEEFA”) suggests that UK ETS is trading at prices that are too low, and that they don’t represent the real costs to society of the emissions produced since the management and issuance of free allowances creates distortion that shields major polluters from carbon pricing. This in turn reduces the cost, and thus the incentive, for polluters to reduce their operational emissions.

The lost revenues due to low ETS pricing limit the ability of the UK government, and taxpayers, to pay for mitigation of global warming and to support the energy transition to a lower GHG economy. As it stands, the polluter doesn’t pay, said the report.

After the UK compliance carbon market (UK ETS) was introduced in 2021, the value per tonne traded at a slight premium to the EU ETS due to perceived risks in the initial period of operation. During the fiscal years (FY) 2021–22 and 2022–23, UK ETS values were 3% and 7% higher, respectively. However, during the following two years there has been a much larger disconnect, with the EU ETS trading at a 51% premium in FY2023–24 and a 45% premium during FY2024–25 to date.

The stark difference in pricing is in part due to UK government intervention during the summer of 2023 when it tightened the emissions cap to 931 MtCO2e between 2021 and 2030. To reduce the financial burden of the cap reduction, 53 million unallocated allowances were designed to be released into the market between 2024 and 2027, and the level of free allocation of allowances available to industry increased from 37% to 40%. These measures contributed to the collapse of UK carbon prices during 2023 and created a sustained discount to the EU ETS throughout 2024.

The value of free allowances distributed in 2023, based on the average UK ETS price during 2022, was £2.8 billion.

Sectors such as steel, cement and lime production received 41% of the 2023 free allocation; refining, airlines and fuel combustion, which included operations from offshore oil and gas installations, received about half.

The 20 largest beneficiaries of free allowances, included specific industrial sites and airlines, accounted for 63% of all allowances issued during 2023.

Certain sectors are heavily shielded from payments. The cement and lime sectors received 99% of their ETS obligations for free, while the steel sector’s ETS costs were waived for 92% of its 9 MtCO2e 2023 emissions over two sites.

Other highly polluting sectors were also being protected, including refining and airlines, which had 65% and 59% of their ETS obligations waived, respectively.

The UK government plans to extend the first free allocation period from 2021 to 2025 by a year to 2026. The second free allocation period would run from 2027–2030. This is to allow for the second period to coincide with the introduction of a UK Carbon Border Adjustment Mechanism (CBAM), which applies the UK ETS price to imports that are covered by the UK scheme. The IEEFA study suggests that an opportunity exists for the UK government to vastly reduce the number of free allocations for 2027–2030 as the risk of carbon leakage, a core justification for creating free allowances, is eliminated.