The person in the street may not regard the 19th of May as a date of any real significance.
Students of history may be able to recount it was the date, in 1536, when Anne Boleyn met her untimely death, and perhaps slightly more obscurely the date that England became a republic in 1649! In 2021, it is a relatively significant date in the world of UK tax.
Albeit not one that students of history are likely to reflect on in decades to come, as it sees the first auction of allowances under the new UK Emissions Trading Scheme (UK ETS).
The UK ETS replaces the EU ETS that the UK has been part of since its inauguration in 2005. An ETS is simply a market-based approach to controlling, and by progressively cutting, the number of allowances in circulation thereby achieving an overall reduction in emissions.
The EU ETS has resulted in an underlying carbon price that has been relatively benign for many years. In the UK, the carbon price was underpinned by a carbon pricing support which, in conjunction with the EU ETS, produced a minimum carbon price floor. That was also augmented, in relation to power generation, by other imposts such as the climate change levy.
Carbon prices under the EU ETS have been rising gradually since 2018. There has been a step change in 2021 with a new high of over €53 per tonne being achieved on the 11th of May this year – more than double the price pre the COVID 19 pandemic. The surge in price is a clear indicator that the market anticipates much higher carbon pricing in the EU over the remainder of this decade as the bloc pursues its carbon reduction goals.
That dramatic rise in EU carbon prices has created significant speculation as to what price the UK ETS may achieve. The reserve price of £22 per tonne seems very low by comparison to the current EU pricing. On the 11th of May the Government issued its UK ETS Allocation table for 2021-2025. These are the allocations of free allowances to installations that fall within the UK ETS and are set at exactly the same levels as the installations would have received under Phase IV of the EU ETS. Thus, the stage is now set for the market price to be established on the 19th. Like the situation in the EU the price may be heavily influenced by the activity of traders who will wish to acquire allowances based on their perception of future market trends.
Regardless of the price achieved on the opening day, one thing is certain: carbon pricing is here to stay, and will play an increasing role in achieving national and international policy goals on emission reduction.
Across the globe carbon pricing schemes (ETS arrangements and carbon emission taxes) are being introduced and they are currently deployed in 46 national jurisdictions and 35 sub-national jurisdictions. It is estimated that the current total value of carbon pricing mechanisms is $359bn. With 187 countries ratifying the Paris Agreement that trend is set to continue, and the total value will increase.
The US has already revised its emission reduction target for 2030 to 50%-52%, up from the previous 26%-28% and we wait to see what policy will be developed in the US around carbon pricing in support of these increased ambitions. Canada, too, has reset its ambition with targeted reductions now being 40%-45% compared with the previously stated 30%. To support that higher target Canada has introduced a federal carbon pricing regime.
In the East, Japan has also revised its emission reduction target to 46%-50%; South Korea has introduced a temporary carbon pricing floor due to low pricing with its ETS; Indonesia is launching a pilot carbon market; and China looks poised to revise its new ETS having announced that it will strictly control the output form coal-fired power plants and phase them out completely by 2026.
In the meantime, the EU is not standing still.
In recognition of the higher carbon price under the EU ETS and how that could adversely impact competition with non-EU countries, the EU is pressing ahead with plans for a Carbon Border Adjustment Mechanism (CBAM) to be introduced in 2023. It is likely that the regime will initially cover imported steel, cement, chemicals and fertilisers, but will be expanded over time to cover all EU imports.
The UK would aspire to escape the application of the CBAM on exports to the EU but it could all become complicated when the UK exports finished goods containing materials imported from other countries that would have been subject to the CBAM had they been imported directly into the EU.