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Higher or lower? Transitioning to the UK ETS

Laura Woolsey Analyst

Carbon prices, especially the EU Emission Trading System (ETS), have experienced considerable volatility over the last year, influenced first by COVID-19, which saw prices crash, and more recently by expectations of increased EU climate ambitions, driving prices to record highs. In this Chart of the Week, we consider the potential scenarios for UK carbon prices as we transition to the new UK ETS, noting the role of market tools, policy, and recent pricing trends in determining these costs. The UK ETS came into force on 1 January 2020, marking the start of the UK’s transition to a separate carbon market following the Brexit Withdrawal Agreement. However, owing to the timings of the agreement the scheme itself is still in “set-up mode”, with the first auctions for UK allowances not commencing until 19 May. Uncertainty also persists over the carbon prices we are likely to see. To protect market prices from major disturbances and smooth the transition to the new system, UK carbon prices will be governed by a number of market tools. Most notably, an Auction Reserve Price (ARP) of £22/t will be introduced to minimise the risk of a significant fall in allowance prices in this transition, establishing a minimum price for which allowances can be sold at auctions. The Carbon Price Support (UK CPS), set at £18/t, will also continue to contribute to the total UK carbon price and be paid for by relevant emitters. Together, these provide some certainty to the market in ...

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