UK government puts forward EU ETS contingency planning for no deal scenario

This analysis has originally been published  for ICIS EU carbon subscribers on 15 Oct 2018 at 12:12 CET. 

The UK has brought forward a series of technical notes on various topics regarding the implications of Brexit. On Friday (12 October), the UK government published a technical notice on on climate-related topics in case of a “no deal” scenario. The note is of technical nature and does not have legal character.

Main Points

• The UK’s Climate Change Act is domestic legislation and will be unaffected by exiting the EU – consequently, the UK is further committed to reach their domestic CO2 reduction targets
• The UK will remain a party to international climate change agreements and its commitment to them will be unaffected by EU exit

EU ETS

• In a no-deal scenario UK installations will drop out of the system and no flights landing or departing in the UK will be covered anymore by the EU ETS
• In such scenario, UK installations would consequently cease to have compliance obligations (as of 2019 emissions) within the EU ETS framework and UK operators would very likely lose access to the EU registry
• The EU Commission already prepared for a no deal scenario in February 2018 by implementing a safeguard mechanism that marks and restricts the use of allowances issued by the UK
  • As a consequence, for the compliance year 2018, the UK adopted domestic legislation by advancing the compliance deadline to 15 March 2019, hence ensuring compliance before the Brexit deadline on 29 March
  • This lifted the marking and restriction of use for UK’s 2018 allocation
  • But the marking and restriction of use will kick in again as of 1 January 2019, unless the UK commits to a continued participation of its installations within the EU ETS
  • The technical note clarified that any allowances that may be distributed by the UK for 2019 cannot be used by UK operators to meet their 2018 compliance obligations
• Regarding UK operator’s access to the registry system, the technical note recommends to open a second account in another EU member state and to transfer their EUAs to these accounts in order to maintain access even in case of a no deal scenario
• Airline operators currently administered by the UK with flights within the European Economic Area will have to move to other EU member states for EU ETS administration
• Meanwhile the UK government intends to maintain MRV obligations in place to ensure consistent data collection which will also result in verified emission reports

CERs

• With a no deal scenario, accounts in the UK Kyoto Protocol National Registry, which is located within the consolidated European system, might not be accessible anymore
• The UK plans to publish additional advice later this year to holders of CERs
• Also for this scenario, the UK government recommends to open an additional account in another member state to ensure registry access

Carbon Pricing

• With its autumn 2017 budget the UK government announced that the Total Carbon Price was set at the right level
• At the moment the Carbon Price Support (CPS) which is paid by UK power sector emitters on top of the EUA price is capped since April 2016 at £18.00/t until 2019-20 with a planned inflation uprating in 2020-21
• The fact that the government is willing to keep the total UK carbon price on current levels implies that some mechanism needs to “replace” the EU ETS cost component should the UK leave the ETS
• The technical note states that in a ‘no deal’ scenario, the UK government will initially meet its existing carbon pricing commitments via the tax system, taking effect in 2019 with a carbon price applying across the UK, including Northern Ireland
• The forthcoming 2018 budget will provide more detail on how to set-up such carbon pricing system in view of updating the 2018-19 finance bill

Analysis

What’s next?

• The technical note says that a no deal scenario remains unlikely, even though the EU and UK did not find common grounds over the weekend and decided to halt negotiations until the EU summit on Wednesday
• Meanwhile, recent statements by government officials point towards ongoing discussions within the UK government on the best way forward with Treasury seemingly in favour of a CO2 tax while the UK Energy Department (BEIS) appears keen to retain an ETS option if no better alternative is found

Key market risks in a “no-deal” scenario

• More details can be found in our Analyst Update from 21 September 2018
• Unwinding of utility hedges: roughly 85m tonnes carbon locked in for 2019/20 power generation; 70% from companies with installations outside of the UK; potential to use the hedged EUAs for non-UK installations as locked in at cheaper CO2 prices; we estimate the volume at risk to come back to the market at 25-30m EUAs
• Industrial banking: main holdings by company owning non-UK installations; we estimate the volume at risk to come back to the market at 30m EUAs
• Volume could come quickly back as soon as “no-deal” scenario materialises; at least for power sector volumes; some smaller industrials might need more time to take trading decisions
• In addition, market sentiment across equity and commodity markets is likely to send an additional cold bearish shiver through the market in the short term

Marcus Ferdinand is Head of European Carbon & Power Analytics at ICIS. He can be reached at Marcus.Ferdinand@icis.com

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