On 14 June 2021, the Department for Business, Energy and Industrial Strategy (“BEIS”) opened a consultation (the “Consultation”) to review the existing UK schemes to compensate energy intensive industries for indirect emission costs in electricity prices.
Specifically, the Consultation seeks views and evidence on:
- the risk of carbon leakage due to the indirect emission cost from the UK Emissions Trading Scheme (“UK ETS”) and the Carbon Price Support (“CPS”);
- which sectors are most at risk; and
- the design of the potential scheme if there continues to be a rationale for compensation.
Where does this fit in the policy framework?
In March this year, BEIS published the Industrial Decarbonisation Strategy (see our commentary here), which emphasised the extensive, systematic change required across all sectors, including industry. According to BEIS modelling, in order to meet net zero, industrial emissions will need to fall by at least 90% by 2050 - which is equivalent to taking all the cars off the roads today. Furthermore, in order to decarbonise industry and meet carbon budgets under the Paris Agreement, emissions will need to fall by around two thirds by 2035.
The UK ETS was also launched earlier this year (see our commentary here), which intended to provide some continuity with how the EU Emissions Trading System (“EU ETS”) works in regulating the greenhouse gas emissions of the UK’s most energy intensive industries, whilst keeping the UK in check with its net zero ambitions. BEIS has announced that it will also be consulting on setting a net zero consistent cap trajectory later in 2021.
BEIS acknowledges that compensation schemes must also fit within the UK’s decarbonisation framework. In addition, compensation schemes can also contribute to the delivery of BEIS’ Build Back Better Plan (see our commentary here). As part of this, the Government is committed to minimising energy costs for businesses, to ensure a strong and competitive economy whilst recognising the need to manage the impact of climate change policies on industrial electricity prices. However, any such support (especially for the indirect emission cost due to the UK ETS and CPS) would need to fit within the scope of the new UK subsidy control regime, which the government consulted on earlier in the year (see our commentary here).
Carbon Leakage risks for the UK
Concerns about carbon leakage, or the displacement of the production activities and the associated greenhouse gas emissions to jurisdictions with less stringent decarbonisation policies are not new. The additional costs to the energy intensive industries have been recognised by governments around the world who are conscious of not displacing the emissions to a different jurisdiction. In the UK, these indirect emission costs result from the obligation on power stations to purchase ETS emission allowances and pay a tax on the carbon content of the fossil fuels used to generate electricity. This increases costs for power stations, which is reflected in the wholesale electricity market. This in turn leads to increased retail electricity prices for energy intensive industries.
What’s more, the Consultation acknowledges the risk streams on carbon leakage (as is illustrated in Figure 1) and how higher production costs put certain energy intensive industries at risk of a competitive disadvantage internationally, thereby creating a risk of carbon leakage. This is also contrary to the aims of the Industrial Decarbonisation Strategy which seeks to promote decarbonisation of key industrial sectors in the UK and create jobs to stimulate local economies.
Figure 1: Illustration of carbon leakage risk streams
Source: BEIS
The Consultation acknowledges that UK industrial electricity costs are higher compared to those of other countries. Since 2013 and 2014, BEIS has run the Energy Intensive Industries (“EII”) exemption scheme for the indirect emission costs due to the EU ETS and CPS for certain energy intensive industries. The aim of these schemes is to reduce the risk of carbon leakage by providing incentives for energy intensive industries to carry out low-emission production and investment activities in the UK. Through this Consultation, the Government seeks to review these programmes of support and to engage with a wide range of audiences including energy intensive industries, other electricity consumers, trade bodies, consumer associations, the devolved administrations and other interested parties. As such, this Consultation fits within the wider re-evaluation by the UK Government of its policies for the industrial sector.
Impact of the Cost Containment Mechanism under UK ETS
Separately from the Consultation, BEIS is conducting a review of the UK ETS scheme and the allocation of free allowances under this scheme, including to energy intensive industries[1]. The UK ETS, which replaced the UK’s participation in the EU ETS from 1 January 2021, aims to better incentivise greenhouse gas emissions reduction but also has mechanisms which are designed to counter periods of excessively high prices.
The first UK ETS auction which was held on 19 May 2021 cleared at £43.99 for UK allowances (“UKA”). Thereafter, on 10 June 2021, BEIS published further guidance on the UK ETS. This latest UK ETS guidance includes a description of a Cost Containment Mechanism (“CCM”) which anticipates the UK ETS Authority (the UK government and the devolved administrations) intervening in the UK ETS auctions to manage high price spikes[2].
In order for the CCM to be triggered in August 2021 (earliest possible point), the UKA prices will need to remain on average above £44.74 within each individual month through the monitoring period i.e. in May, June and July 2021. Given that the average UKA prices in May 2021 were £49.09, which is above the August trigger price of £44.74, if the prices remain on average above £44.74 in June 2021 and in July 2021, the CCM will be triggered in August 2021.
In such a case, the UK ETS Authority may take a number of actions, including:
- redistributing allowances between the current year’s auctions;
- bringing forward auctioned allowances from future years to the current year;
- drawing allowances from the market stability mechanism account; and
- auctioning up to 25% of the remaining allowances in the New Entrants Reserve.
Where it fails to do so, the final decision can be taken by HM Treasury.
Comment and next steps
As outlined above, BEIS is seeking a wide range of views on the risk of carbon leakage due to the indirect emission cost from the UK ETS and CPS mechanism as well as feedback on sector eligibility and scheme design. Although the Consultation notes that there is little quantitative evidence to suggest carbon leakage is currently taking place from the UK, the rise in carbon prices recently may mean that that information is out of date and the risk of carbon leakage is greater. What’s more given the ability of UK government to review scope of sector eligibility in light of the new UK based methodologies and subsidy controls, the list in Annex A of the Consultation may be of particular interest to those stakeholders who had not been eligible to participate in the schemes to date.
The Consultation closes on 9 August 2021 and responses can be sent via the online survey or by email.
The CCM trigger prices should be monitored (available here). The next update will be published on 12 July 2021.
[1] The UK ETS applies to energy intensive industries, the power generation sector, aviation, and covers activities involving combustion of fuels in installations with a total rated thermal input exceeding 20MW (except in installations for the incineration of hazardous or municipal waste).
[2] In summary, the unsold allowances from the first UK ETS auction which opened on 19 May 2021 are redistributed across the following four auctions up to 125% of those auctions’ original number of allowances. Over this limit, allowances transfer into the market stability mechanism account. The UK ETS has a transitional Auction Reserve Price (“ARP”) of £22, which establishes a minimum price at which allowances can be sold at auctions. The ARP value was set in the Auctioning Regulations published on 11 February 2021.
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