UK Emissions Trading Scheme: proposed amendments: impact assessment - Section 1. What action is the Welsh Government considering and why?

The Welsh Government, along with the other members of the UK ETS Authority (UK Government, Scottish Government, and Northern Ireland Executive) are seeking to make amendments to the UK Emissions Trading Scheme (UK ETS). The UK ETS is a cap-and-trade scheme which works on a “polluter pays” principle and applies broadly to electricity generators, heavy industry, and the aviation industry (herein referred to as the “traded-sector”). 

The mechanics of the scheme are that a finite number of allowances are released to the market [1] – which when surrendered covers the polluting emissions of the industry operator [2] – and the demand for these allowances by market participants determines their price. This type of scheme is judged to be economically efficient as the price of allowances will encourage those who can afford to abate at costs below the prevailing allowance price will do so, therefore the cheapest available abatement solutions should be utilised first.  

This integrated impact assessment (IIA) has been produced as the UK ETS Authority (herein referred to as “the Authority”) is seeking to make changes to the scheme in line with net zero ambitions, which include:

• Amending the overall cap trajectory, which determines the number of allowances available to reach the market each year.
• Amending the industry cap, which determines the maximum share of the overall cap that can be provided to industry in the form of free allowances to mitigate carbon leakage.
• Determining how to utilise allowances that have not yet been allocated (referred to as “unallocated allowances”).
• Amending the level of free allowances made available to aviation operators under the scheme.
• A number of more technical changes to ensure the scheme continues to function effectively.

Other areas that are addressed in the government response to the Developing the UK ETS consultation, but which will be consulted on further before any changes are made, are not covered by this IIA.

  [1]Either through auctioning or being provided directly to participants.
  [2] One UK ETS allowances permits the participants to emit one tonne of Carbon Dioxide equivalent (CO2e).

Section 44(1) of the Climate Change Act 2008 gives the four UK governments the power to make regulations for trading schemes relating to greenhouse gas emissions (GHG). The Greenhouse Gas Emissions Trading Scheme Order 2020 established such a trading scheme (the UK ETS) and has been amended by further Orders largely of a technical nature. An Order will be required to amend the cap and the amount of it that should continue to be given freely to those at risk of carbon leakage, along with a series of smaller and more technical changes to continue the effective functioning of the scheme. This will be more substantive than previous amending Orders.

The UK ETS is a policy that is in keeping with the Welsh Government’s long-term objectives as set out within the Well-being of Future Generations (Wales) Act 2015. It contributes to the well-being goals for a resilient Wales, a healthier Wales, and a globally responsible Wales, by limiting the emissions associated with the traded-sector and helping to plot a course that will aid Wales in meeting its legislated target to reach net zero by 2050.  The policy proposals that will be carried forward, as set out within the Developing the UK ETS government response, enhance the scheme’s contribution to these well-being goals.

The UK ETS is one of the most credible levers available to government to reduce emissions in the traded sector. The incentive to reduce emissions is in mitigating impacts associated with human-induced climate change. The Intergovernmental Panel on Climate Change (IPCC) stated in 2022 that these impacts are already being felt and include “more frequent and intense extreme events… widespread adverse impacts and related losses and damages to nature and people, beyond natural climate variability”.  [3]

Reducing emissions through the scheme is also a desirable policy aim given the health-related impacts associated with carbon intensive activities. Emissions from industrial processes and energy generation are associated with the emissions of pollutants, such as fine particulate matter (PM2.5) and nitrous dioxide (NO2), which are believed to be harmful to human health. In 2020 Public Health Wales stated that reduced life-expectancy associated with exposure to air pollution in Wales is equivalent to 1,000 to 1,400 deaths each year. 

 [3] PCC, 2022: Summary for Policymakers [H.-O. Pörtner, D.C. Roberts, E.S. Poloczanska, K. Mintenbeck, M. Tignor, A. Alegría, M. Craig, S. Langsdorf, S. Löschke, V. Möller, A. Okem (eds.)]. In: Climate Change 2022: Impacts, Adaptation and Vulnerability. Contribution of Working Group II to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change [H.-O. Pörtner, D.C. Roberts, M. Tignor, E.S. Poloczanska, K. Mintenbeck, A. Alegría, M. Craig, S. Langsdorf, S. Löschke, V. Möller, A. Okem, B. Rama (eds.)]. Cambridge University Press, Cambridge, UK and New York, NY, USA, pp. 3–33, doi:10.1017/9781009325844.001

Changes to the UK ETS are aligned with multiple well-being objectives set out in the Welsh Government’s Programme for Government (2021 to 2026):

• Embedding our response to the climate and nature emergency in everything we do.
• Building a stronger, greener economy as we make maximum progress towards decarbonisation.
• Building an economy based on the principles of fair work, sustainability and the industries and services of the future.

The UK ETS is an important lever that will contribute to us meeting our climate objectives as set out in Net Zero Wales Carbon Budget 2 (2021-25).  Reducing emissions from the traded sector will also assist our aim of improving air quality to mitigate negative outcomes on human health, biodiversity, the natural environment, and the economy, as set out in our Clean Air Plan for Wales. 

The UK ETS Authority carried out a 12-week public consultation from 25 March 2022 to 17 June 2022. The consultation was published on the UK Government’s website (gov.uk), with a link published on the Welsh Government’s website (gov.wales). Existing participants of the scheme were notified of the consultation via email and offered the opportunity to meet Authority officials to discuss the proposals. Existing stakeholder groups were also used to highlight the consultation with wider stakeholders that would have an interest in the proposals. In recognition that the consultation included proposals on expanding the scope of the scheme to new sectors, existing stakeholder groups on these sectors were contacted to inform them of the scheme and the consultation proposals, and again offered the opportunity to meet with Authority officials. 

During the consultation process, a series of workshops were run on the various chapters of the consultation, with both existing stakeholders and new sector stakeholders. These workshops began with informative sessions to ensure stakeholders fully understood the proposals and provide a space to raise initial views and questions. These were then followed by further workshops on the specific proposals to enable stakeholders to feed into the development of the various policies and how they should be delivered. Engagement activities such as individual meetings and attending existing stakeholder group meetings were continued after the consultation closed to ensure that all stakeholders views were considered as the policies were being developed.

The key policy intent of changes to the UK ETS is in incentivising cost-effective decarbonisation within the traded sector, assisting Authority members in meeting their climate ambitions, and enabling the transition to a net zero economy – all with the goal of limiting the impacts of human induced climate change and improving air quality. Decarbonising these sectors will secure these important industries and provide long-term economic benefit for Wales and the UK as a whole and, in doing so, support a transition in our workforce making it fit for a global net zero economy. However, we are aware that doing so needs to be balanced by an awareness of pressures on competitiveness the traded sector is exposed to and the reliance (particularly for industry) on certain enabling technologies being delivered by public policy. A failure to take account of these factors could lead to carbon leakage, whereby economic activity is driven outside of the UK to areas with less stringent (or with a total absence of) carbon pricing regimes, reducing economic welfare within the UK while conceivably increasing global emissions at the same time.

The Authority’s main assessment of the economic impacts of the suggested proposals is contained within the impact assessment (IA) prepared by the UK Government’s Department for Energy Security and Net Zero, which utilises cap composition modelling and a Carbon Pricing Model framework to estimate the carbon values and abatement costs associated with the policy changes being proposed.  That assessment suggests that the changes to the UK ETS contained within the government response should work as intended in reducing emissions within the traded sector than would otherwise be the case.

The changes proposed in the Developing the UK ETS consultation primarily relate to making amendments to the current scheme that should not incur additional administration costs for business or government.

An appraisal of the headline UK ETS cap proposals provided by the Department for Energy Security and Net Zero shows that all cap options (including the preferred option) represent high value for money for the UK as a whole. The preferred option has a central net present value (NPV) of £10.1bn and a benefit-cost ratio (BCR) of 7.1 under the high policy baseline, which assumes a high level of government funded decarbonisation alongside the UK ETS. Under the low policy scenario, where there is a lower level of decarbonisation driven by other government policy, the NPV is expected to be higher (as more decarbonisation will be attributable to the UK ETS) but the BCR will be lower (as higher carbon prices will cause the cost of decarbonisation driven by the scheme to be higher). Despite this analysis being done for the UK, the policy is still expected to represent value for money at a regional level, as the mechanics of the scheme are the same regardless of place. The expected annual cost to business because of changes made to the cap, its composition, and the release of unallocated allowances is expected to be approx. £2.4bn for the UK as a whole, primarily derived by deploying carbon abatement technologies. Should less government policy be delivered, it is expected that business costs would climb primarily driven by the increased costs of abatement.