Brexit and the EU ETS

We know Brexit means Brexit. However, one of the many things not yet clear is what it means for the carbon price and the UK’s participation in the EU emission trading system (EU ETS).

With the government just weeks away from triggering Article 50, Utility Week has been told there are no obvious answers to the conundrum.

Broadly speaking there are three options for the UK.

First off, it could remain a full-member of the scheme, carrying on as if nothing has changed.

Alternatively, it could choose a half-way house; creating its own emissions trading scheme and then linking it into the EU scheme.

Lastly, it could separate itself entirely from the mechanism; perhaps by introducing a straight up carbon tax.

Managing director of environmental think tank Sandbag, Rachel Solomon-Williams says staying in would be the “easy” option. “Administratively we wouldn’t have to change anything; we wouldn’t have to set up a new mechanism; the industry understands it.”

As the UK has been “one of the most ambitious voices” on tackling emissions, “staying at the table” would help to keep up pressure on cutting emissions.

On the other hand, she wonders whether continued participation would be politically acceptable. “If the ambition is that the UK is going it alone industrially, being in an EU trading mechanism doesn’t seem completely consistent with that.” Staying part of the EU ETS would mean being subject to rulings by the European Court of Justice, something which prime minister Theresa May has indicated is a no go.

“Any option in which we remain in the EU ETS but lose our vote on how it is designed, would be completely unpalatable to anybody,” Solomon-Williams adds.

“As with so many issues related to Brexit, the UK’s influence over the rest of the EU 27 would be relatively marginal.”

She also questions whether it’s really worth staying in given the chronic oversupply which has plagued the mechanism ever since the financial crisis, and has left the European carbon price in the single digits.

Just last week member states voted in favour of proposals which would help to mop up this surplus and boost the carbon price, but Sandbag’s view is that it will make “no difference at all”: “If the UK government wants to stay in the EU ETS they would need to be fundamental reform for that to be worth doing.”

So what about the linked trading scheme? This would enable allowances issued under one system to be meet the regulatory obligations under another.

“There’s a number of ways in which linking can it happen”, explains Martin Nesbit, senior fellow and head of the climate and environmental governance programme at the Institute for European Environmental Policy. “It can either happen unilaterally – so the UK could decide that allowances from the EU ETS could be used to meet domestic UK obligations but without securing the right for UK issued allowances to be used in the EU – or you could have a fully linked system where the allowances are traded both ways.”

Nesbit says this should in theory allow the UK to retain involvement in the EU ETS whilst offering some flexibility to decision makers. In practice, however, this flexibility “wouldn’t be very attractive to exercise”.

If, for example, ministers wanted to make faster progress on climate change and set more demanding caps “the price impact of that would be immediately diluted by the EU ETS”.

Nesbit, says it also unlikely the EU would allow the UK to do the reverse – increasing the caps to slow progress. “As with so many issues related to Brexit, the UK’s influence over the rest of the EU 27 would be relatively marginal.”

The final option would be creating a mechanism which is completely independent from the EU ETS. This could mean creating a domestic cap and trade scheme without linking to the European mechanism, although a straight carbon tax seems the more likely option.

A carbon tax would offer independence from the EU and would allow ministers to give long-term certainty over the carbon price, if they so wished. Williams says going it alone could be attractive bearing in mind the failure of the EU ETS to provide a sufficient carbon price to drive investment decisions.

It was this issue which drove the government to place levies on fossil fuels ensuring that UK emitters paid a minimum price – the carbon price floor – and later introduce a cap on the top-up payments when they became too big. In terms of its practical implications, introducing a carbon tax wouldn’t all that different to what the UK has already.

The downside would be relinquishing any influence beyond persuasion over the European carbon price and emissions.

Both Williams and Nesbit says there is no clear right answer for the UK. “It depends a lot on what the UK’s vision is for decarbonisation,” says Nesbit.

Given the way things are going, he believes the UK will eventually end up leaving the EU ETS. “Although both sides might want continued UK participation in the EU ETS, I find it difficult to see how you get a deal on that in place in time, de-linked from the rest of the Article 50 fiasco.”

Whatever path the UK follows; a difficult path lays ahead.