Major announcements on the UK CBAM and UK ETS – 2024 earmarked to be a transformative year

On 18 December 2023, the Government published a suite of new documents on the UK Carbon Border Adjustment Mechanism (UK CBAM), voluntary product standards and the development of the UK ETS. An early Christmas gift, so to speak, for those involved in decarbonisation and emissions trading.

Policy is developing rapidly in this area and there is a degree of overlap and integration between the various regimes. This aim of this article is to take stock of where we are, by providing an overview of the documents released before Christmas and the key policy decisions, and comment on what's ahead in 2024.

What was published on 18 December 2023?

The following documents were published:

A UK CBAM by 2027

In the consultation response on addressing carbon leakage (no.1), the Government announced that it will implement a UK CBAM "by 2027". The UK CBAM will apply an effective carbon price to imported goods in certain sectors, to ensure that they are subject to a comparable price incurred by UK-based producers.

In the same consultation response, the Government has also confirmed that it will:

• work with industry to establish voluntary product standards, to promote low-carbon products, and
• develop an embodied emissions reporting framework to provide reliable data on embodied emissions in products, which may inform future policy.

Government has, for now at least, confirmed that it will not proceed with mandatory product standards for embodied carbon emissions.

Further information on the consultation response and the proposed UK CBAM, including scheme design and potential commercial impacts, can be found here. Further consultation will occur on the design and delivery of the UK CBAM in 2024.

The long-term pathway for the UK Emissions Trading Scheme

The UK CBAM announcement has somewhat overshadowed a number of key announcements in the long-term UK ETS pathway policy paper (no.2).

The headline points from this policy paper are:

1. The UK ETS will be extended until "at least 2050" (current legislation provides for it to continue until the end of 2030).

2. The UK ETS Authority will consider extending the next phase of the UK ETS, starting in 2031, for longer than 10 years to align with the dates of the UK carbon budgets.

3. The UK ETS will continue to be developed. This includes:

a. aligning the UK ETS cap with the net zero trajectory from 2024;

b. expanding the UK ETS to new sectors including domestic maritime (see further our article on maritime emissions and international maritime emissions) and energy-from-waste (see further our article on EfW), and to cover engineered greenhouse gas removals (GGRs);

c. reviewing free allocation alongside the development of the UK CBAM.

4. The UK ETS Authority will consider expanding the UK ETS to other new sectors, including high emitting sectors. No specific sectors are mentioned for inclusion; however it is confirmed that agriculture will not be included (for now).

Free Allocation Review

The UK ETS Authority has launched a second-stage detailed consultation on the review of free allocation in the UK ETS. Free allocation is the practice of allocating allowances to emitters exposed to carbon leakage for free. Carbon leakage is the risk of emissions associated with production of carbon-intensive goods moving to jurisdictions with less stringent policies on emissions reduction. Free allocation therefore softens the impact of carbon pricing on UK ETS operators.

The consultation seeks views on proposed changes to the methodology for distributing free allowances. The overall aim is to ensure that free allowances are "better targeted" for the sectors most exposed to carbon leakage.

In summary, the consultation proposes various amendments to the component parts of the formula for calculating an emitter's free allocation. The consultation envisages changes to 'activity level changes', benchmarks, the carbon leakage list, the application of the carbon leakage exposure factor and the application of the cross sectoral correction factor. These are each terms of art and so the consultation is technical and complex. However, owing to the value of free allowances, UK ETS operators which receive a large number of free allowances should get to grips with the proposed changes to understand how they could impact their level of free allocation.

The review also considers a number of other technical changes, including how free allowances are allocated to operators upon the closure of an installation or sub-installation.

Overall, this is by no means a 'light read' however it may be of significant financial consequence to those operators receiving free allowances. The consultation closes on 11 March 2024.

UK Emissions Trading Scheme: Future Markets Policy

The future markets policy consultation is, following the call for evidence in the, Developing the UK ETS Consultation, the second stage of a two-stage approach to develop proposals on future UK ETS markets policy. The purpose of the consultation is to seek views on the most significant risks to effective market functioning and the suitability of different policy options to address those risks. Further, the consultation seeks views on the design of individual market stability policies.

The main purpose of the consultation is to ensure that the UK ETS continues to have the necessary economic safeguards to ensure a stable carbon market.

While the consultation is relevant to operators, particularly those with significant carbon emissions and that are exposed to the carbon price, the consultation is likely to interest those concerned with economic theory and the design of emissions trading scheme (as opposed to those focusing on day-to-day compliance).

The consultation sets out that:

1. The Authority is minded to retain the two existing market stability mechanisms in the UK ETS, namely:

a. The Auction Reserve Price (ARP), to guard against price decreases;

b. The Cost Containment Mechanism (CCM), to mitigate against the risk of price increases.

The Authority is consulting on the design of the ARP and the CCM to ensure that they provide appropriate risk mitigation. For example, the consultation asks for feedback on the level of the ARP (currently £22) and the trigger thresholds for when the CCM applies.

2. The Authority is considering additional mechanisms alongside the ARP to mitigate the risk of low auction prices. Policy options considered include an absolute price floor across both primary (auctions) and secondary markets, temporary price floors, an emission containment reserve and a reverse cost containment mechanism.

3. The Authority is minded to implement a 'Supply Adjustment Mechanism' or SAM. The SAM would be 'quantity triggered', meaning that if the total number of allowances in circulation in the UK ETS crosses an upper or lower threshold, adjustments are made to manage excessive or insufficient surplus of allowances.

The consultation closes on 11 March 2024.

Those with an interest in the design of the 'checks and balances' in the UK ETS to maintain a stable carbon market may wish to participate. In particular, operators with significant exposure to carbon prices may wish to comment on the CCM and SAM which would act to mitigate significant carbon price increases.

A look-ahead for 2024 – numerous consultations on the horizon

In addition to the two 18 December 2023 consultations on future markets policy and free allocation, we expect to see the following additional consultations in 2024, as government looks to develop policy in this area:

1. UK CBAM – further consultation on design and delivery

2. Voluntary product standards and embodied emissions reporting – technical consultation

3. UK ETS scope sectors – further consultations are expected on detailed aspects of the expansion of the UK ETS to cover the waste (EfW) and maritime sectors and on the inclusion of Greenhouse Gas Removals (GGRs)

4. UK ETS scope gases – consultation on the inclusion of methane and nitrous oxide emissions from the upstream oil and gas sector in the UK ETS and to review the definition of safety flaring

5. Non-pipeline transport for Carbon Capture Usage and Storage (CCUS) – consultation on the development of a regulatory framework for integrating non-pipeline transport for CCUS

6. Sustainability criteria for biomass – consultation on implementing UK ETS sustainability criteria for all types of biomass. The intention is to expand UK ETS sustainability criteria to cover solid and liquid biomass (in addition to the existing liquid biomass criteria).

If you have any questions on the issues raised in this update, please get in touch with one of your Ashurst contacts below.