(see edit at end of blog)
So it’s official – the UK will launch its own emissions trading system in 2021. Of course, it won’t actually begin on January 1, as the Department for Business, Energy and Industrial Strategy – the regulator – has yet to work out what the free allocations should be, how many UK Allowances (are we OK with UKA as an abbreviation?) will be auctioned, etc etc.
But we know a few things:
1. Auctions will have a floor price of £15/tonne (€16.63 at today’s rate).
2. ICE Futures will be doing the auctioning.
3. ICE will launch spot and futures contracts, as well as the auctions, some time in the second quarter.
4. The UK ETS will cover energy-intensive industries, the power generation sector and aviation, pretty much the same as the EU ETS, with a threshold of 20MW thermal input.
There’s a wealth of additional information on the BEIS website, but we’ll need to wait for things like the allocation plan and auction schedule before we start getting excited.
The overall cap is, for the moment, a bit of an unknown quantity. According to the legislation, the cap starts off at 155m tonnes in 2021, and shrinks to 117.5m tonnes in 2030.
I’ve posted this chart on Twitter already, which shows the UK’s verified emissions under the EU ETS in 2019, compared with the annual caps for the UK ETS as laid down in “The Greenhouse Gas Emissions Trading Scheme Order 2020”, published on the government’s legislative website.
It suggests that, on the surface at least, the UK ETS could have a surplus of at least 37 million tonnes in the first year. In fact, the cap doesn’t even get close to what UK emissions were in 2019 until 2030.
Some people have even suggested the cap will be revised before the UK ETS gets underway. But for the moment let’s assume it won’t be. There will no doubt be allowances held back for new entrants, and possibly also for a cost containment reserve and other contingencies, but it still feels like supply will exceed demand.
But we should be generous, and patient. Some of us still remember Carbon Expo 2006, during which DG Clima accidentally released early the 2005 verified emissions data. The scrum at the Kleinwort stand to get a glimpse of the data was something to behold, and the price action was, well, dramatic.
(Incidentally, does anyone else remember a certain eastern EU member state's Phase 1 allocation plan, in which every single installation's proposed allocation ended in ",000"?)
So as I said, we shouldn't be too harsh on the UK... yet. Once we see the first set of verified emissions data, that's a different story.
More broadly speaking, all the information that the UK government has released to date suggests the UK ETS will operate very similarly to the EU market. Just as an example, the section on monitoring, reporting and verification in the ETS legislation is prefaced with the following:
“Commission Implementing Regulation (EU) 2018/2066 of 19 December 2018 on the
monitoring and reporting of greenhouse gas emissions pursuant to Directive 2003/87/EC
of the European Parliament and of the Council has effect for the purpose of the UK ETS.”
If it ain’t broke, why fix it? CTRL-C, CTRL-V.
There are quite a few important details missing from the legislation, such as whether there will indeed be a supply adjustment mechanism (the MSR to you and me) and a cost containment reserve, as was suggested in the consultation, how the auction floor price may change over time, what will happen in the event an auction is not successful, and so on. These are not insignificant details, as the EU ETS experience has shown.
So what might trading be like?
I would hazard a guess that how this market trades will depend very much on who wants to trade it. And we probably won't know the real character of the market until well into 2021, once the allocation and auctions have had a chance to "bed in".
Obviously, I’m not expecting this to be another Swiss ETS, but with an ETS whose cap is 10% the size of the EU ETS, you wouldn’t expect to see the same kind of liquidity, and perhaps not the same volatility either.
While people have rightly praised the UK for the important role it played in establishing the EU ETS, and the central role London has played ever since, there is no getting away from the fact that this is going to be a relatively small market. To put the UK ETS cap into perspective:
EU ETS - 1.57b tonnes/year in 2021
South Korea - c. 600m tonnes/year in 2020
California - 334m tonnes/year in 2020 (economy-wide)
UK - 155m tonnes/year in 2021
RGGI - 68m tonnes/year in 2021 (utility-only)
Quebec - c. 52m tonnes/year in 2020
Nova Scotia - 12.7m tonnes/year in 2020
Will the financial sector get involved? A floor price isn’t a great signal to send to those who enjoyed riding EUAs all the way from €7 to €25 back in 2017-18. We might be in for a more Californian experience, where the auctions and the futures market have both clung pretty closely to the oh-so-predictable floor price.
Source: ARB
A lot could depend on how generous BEIS is going to be in its free UKA allocation to industrials. If industry is short from the start, that would help the market build up at least some sort of transparent price discovery.
Another thing to bear in mind is that utilities will be needing to hedge forward power sales with this new carbon allowance, since EUAs won’t be eligible. So there could be a repetition of what we saw in the EU ETS back in the run-up to Phase 3, when open interest in futures contracts ballooned as power generators built up their forward carbon portfolios.
This in turn could scare off some compliance-focused industrials, who’d probably be happier with a more rustic market where they can pick up spare EUAs as and when they feel like it. They might eschew the futures market in favour of getting their bank, or power supplier, to do the work.
Frankly, it’s too early to have a strong idea of what the UK ETS will look and act like. But for those of us who are going to inhabit this new world, we might need to get used to a little less leg-room.
EDIT: The chart of UK 2019 emissions versus the future cap does not include aviation emissions, which totalled just over 11 million tonnes in 2019. That would make the market oversupplied by around 25 million tonnes in 2021, rather than the 37 million as stated.
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