What is the UK ETS, and how does it work? In this video explainer, Neil guides you through an introduction to the UK carbon market.

The UK ETS

Before Brexit, the UK was part of the EU’s ‘emissions trading scheme’, or ETS. In the lead-up to leaving the EU, the UK government began consultation on whether to continue using a similar system, a UK ETS, or to impose a ‘carbon emissions tax’. Ultimately, it decided to go with the former. On 1 January 2021, the UK ETS was launched.

How the ETS works

An ETS is a system in which ‘allowances’ to emit greenhouse gases are auctioned off by the government. These allowances can then be traded on a secondary market. This is sometimes referred to as a ‘cap-and-trade’ system.

The government sets a cap on the amount of specified greenhouse gases that those covered by the scheme may emit annually. This amount is split up into allowances (one allowance is equivalent to 1 tonne of greenhouse gas emissions). These allowances are then auctioned off to businesses, or awarded for free in some cases.

These free allowances tend to be given to companies that face fierce international competition from businesses in countries that do not levy an equivalent price. As such, companies like Tata Steel and British Steel were awarded millions of free allowances for 2021.

At the end of the year, a given business must surrender the requisite allowances to cover its emissions over that period. Any leftover allowances can then be carried over into the next year, or traded on a secondary market.

Potential issues

There are some potential issues with the ETS system. The free allowances defeat the object of having carbon prices at all, as these emissions escape pricing completely.

On top of this, only around 30-40% of emissions generated in the UK come from businesses that participate in the scheme. This is due to the selection of industries that are covered - or not covered - by the scheme. For example, those in agriculture, among others, do not need to obtain allowances for their emissions.

Some argue that a more comprehensive, catch-all carbon tax would provide a bigger incentive for businesses and consumers to adopt greener alternatives to fossil fuels.

It is clear that the ETS goes some way to disincentivising and reducing UK carbon emissions. That said, the government may need to adopt a sturdier, more ambitious system if it is serious about achieving its net zero targets.

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