Changes to Carbon Pricing across the UK and Europe

Carbon Pricing Changes across the UK and Europe: Exploring Market Divergence and Regulatory Mechanisms

Carbon pricing has emerged as an effective tax tool for mitigating the impacts of climate change, incentivising businesses for reducing greenhouse gas emissions. The UK and Europe have both implemented mechanisms to price carbon, each operating with its distinct features. However, there have been several economic drivers which have led to a divergence in prices within these two markets.

In this blog, we’ll be guiding you through the current carbon pricing in the UK and Europe, highlighting the differences between the two markets and the regulatory mechanisms used to control emissions allowances.

Understanding Carbon Pricing:

So, what is carbon pricing exactly? Carbon pricing encourages polluters to carefully consider the financial costs of the carbon emissions they produce, leading to an overall smaller amount of global greenhouse gas emissions. This system assigns a price to carbon emissions, incentivising businesses to reduce their carbon footprint to avoid or decrease costs. Carbon pricing includes two types: carbon taxes and cap-and-trade systems.

Carbon Pricing in the UK: The Carbon Price Support (CPS) and UK ETS:

In the UK, carbon pricing began with the introduction of the Carbon Price Support (CPS) mechanism in 2013, which supplemented the European Union Emissions Trading System (EU ETS). The CPS introduced a minimum price, known as the carbon price floor, for carbon emissions from electricity generation, ensuring a consistent market signal for low-carbon investment. Currently, the carbon price floor is set at £18 per tonne of carbon.

However, after Brexit, the UK introduced its own Emissions Trading System (UK ETS), replacing its participation in the EU ETS. The UK ETS sets a cap on the total amount of greenhouse gases that covered sectors can emit. Businesses receive or buy emissions allowances, which they can trade as needed, but they must surrender enough allowances each year to cover all their emissions. Again, this is then promoting a reduction in overall greenhouse gas output.

Carbon Pricing in Europe: The EU ETS:

In Europe, carbon pricing is executed through the EU Emissions Trading System (EU ETS), which is the world’s first and largest international emissions trading system. It operates in 31 countries, including 27 EU countries, as well as Iceland, Liechtenstein, and Norway, covering approximately 45% of the EU’s greenhouse gas emissions. Similar to the UK ETS, the EU ETS imposes a cap on emissions, and businesses can buy, sell, or trade emission allowances keeping them safely in their permitted limits!

Diverging Prices: EU and UK:

The impacts of Brexit meant that carbon prices between the UK and EU carbon markets we’re separated, which had previously operated in harmony. The UK’s ambitious climate targets and tighter cap on allowances resulted in higher prices initially in the UK ETS compared to the EU ETS. However, during 2023, weak power demand due to declining manufacturing numbers led to a large reduction in demand for UK electricity. Additionally, the fall of power prices in Europe led to higher nuclear imports from France over the interconnector, further reducing prices.

As a result, there is now a significant difference in price, with the UK ETS sitting at around £60 (EUR 70) per tonne and the EU ETS at around EUR 95 per tonne. The delta is now around the level of the UK carbon price support tax, which at £18/Tonne previously led UK power to be priced at a premium to European power. The decline of the UK carbon price could potentially result in a switch in interconnector flows should the divergence persist.

Regulation of Allowances:

Both the UK and EU systems tightly regulate the number of allowances. Caps are set to decrease over time, gradually reducing the total volume of emissions. Government auctions release allowances into the market regularly, providing businesses with the opportunity to purchase the needed emissions allowances. In the UK ETS, a cost containment mechanism has been introduced to manage price spikes by releasing additional allowances if prices exceed a certain threshold. Similarly, the EU ETS has a Market Stability Reserve that adjusts the supply of allowances to maintain price stability.

Conclusion:

Carbon pricing plays a crucial role in reducing greenhouse gas emissions. Understanding the differences between the carbon pricing systems in the UK and Europe is essential, given the ongoing divergence in prices. By exploring the market dynamics and regulatory mechanisms of carbon pricing, businesses and policymakers can adapt and respond effectively to the changing landscape, making significant contributions to a more sustainable future.

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