Brexit Deal Will Leave Carbon Market Question Wide Open

The Brexit trade deal still under negotiation between the U.K. and European Union will probably exclude any explicit agreement on carbon trading, leaving it to authorities in London to decide on how to price pollution starting Jan. 1.

British negotiators are poised to commit to building an emissions pricing system that’s at least as strong as the EU’s cap-and-trade program, according to two officials with knowledge of the matter. They are likely to stop short of giving any more clarity about the new arrangements, leaving industry and power market traders guessing about what will be in place in just five weeks.

“Industry desperately needs certainty on the U.K.’s post-Brexit carbon pricing regime,” said Adam Berman, EU policy director at the International Emissions Trading Association.

While a Brexit deal may come in the next few days, the government in London is still weighing options on how to price emissions. Chancellor of the Exchequer Rishi Sunak favors a carbon tax, while Alok Sharma’s business department prefers a domestic cap-and-trade program. Prime Minister Boris Johnson has until the end of this year to decide, and some officials expect him to do so in time for a Dec. 12 United Nations meeting on climate action that he is hosting.

Sunak didn’t offer any hints about his thinking Wednesday in a speech to parliament in London about his spending priorities. Instead a new infrastructure strategy only reaffirmed that after Brexit, energy intensive industries will continue to receive free emissions allocations in whatever replacement mechanism is decided upon. A spokesman for the U.K.’s business department said the government is still seeking a deal with the EU, but wouldn’t comment on ongoing negotiations.

Britain has been a part of the EU Emissions Trading System since that carbon market started in 2005. The system places thousands of utilities and industrial polluters under increasing pressure to cut back on greenhouse gas emissions. It’s one of the mechanisms that is persuading utilities to close power plants fired by coal in advance of the 2025 deadline the U.K. set to phase out the dirtiest fossil fuel.

The government has taken procedural steps to ensure it can create a U.K. ETS. On Nov. 11, it issued a Greenhouse Gas Emissions Trading Scheme order that could be implemented on the first day of 2021.

Businesses and energy traders have predominantly backed creating a U.K. cap-and-trade system with a link to the EU ETS, a move that would be most similar to the existing system. The advantages that they highlight include continuity with current policy and flexibility for businesses most exposed to the rising cost of pollution.

Companies are especially interested in flexibility and predictability after the coronavirus pandemic upended the global economic outlook and triggered the worst recession on record. Ministers are “mindful” of the impact of the carbon pricing on the heavy industry, Kemi Badenoch, exchequer secretary to Treasury, said last week.

The EU ETS imposes annually shrinking CO2 limits on about 12,000 facilities in the region. Those that pollute less can sell their unused permits. The system covers around 45% of Europe’s greenhouse gas discharges and is set to impose increasingly strict emission limits in the coming years as the region starts implementing its Green Deal.

Main climate provisions in a draft Brexit deal being negotiated by the EU and U.K.:
  • Both the U.K. and European Union aim to become climate-neutral by 2050
  • Neither will adopt measures that would lower ambitions for cutting emissions set at the end of the transition period, which expires in December
  • Each will be seeking to step up climate efforts in the future
  • The U.K. will adopt a carbon pricing-system with “at least the same scope and effectiveness” as the EU ETS
  • If the U.K. opts for a carbon market and seeks to link it with the EU ETS, Europe will be open as long as it doesn’t risk affecting the integrity of its own cap-and-trade program

Under the terms of the Withdrawal Agreement, U.K. companies remain subject to their 2020 EU emissions caps and must fulfill their obligations to surrender allowances by April 30, 2021. That compliance cycle offers some additional room for maneuver for policy makers to agree on a link between the EU and U.K. carbon markets that could still cover the first year after Brexit.

The alternative to a market is a tax that the U.K. Treasury would levy directly on each company’s greenhouse gas emissions. Should the U.K. opt for carbon trading, negotiators would have several months to reach a deal on conditions conditions to link the British system to the EU ETS. The deadline for companies to hand in allowances for 2021 emissions falls in April 2022.

“It is then for the U.K. to find out how to bridge the transition between where we are today and the U.K. leaving the EU, and how to link up at a future date and time, which should be, at the latest, at the beginning of 2022,” Jos Delbeke, EIB Climate Chair at the European University Institute told a hearing in the U.K. Parliament last month.

©2020 Bloomberg L.P.

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