UK and EU ETS after 2021? Markets should be price-linked, EFET says

From 2021 onwards, the UK emissions trading system should be as closely price-linked as possible to the European EU ETS. This will support trading liquidity and reduce electricity generators’ hedging costs, EFET says (the European Federation of Energy Traders).

The UK has not yet made a final decision on the principles on which its emissions market will be based from the beginning of 2021. Three options are currently under consideration: a standalone emissions trading system, an emissions trading system price-linked to the EU ETS, or a carbon tax.

One of the largest organisations bringing together energy traders has also contributed its view to the decision-making process. It has come out in favour of a system that is price-linked to the EU ETS.

If the UK were to opt for a standalone emissions trading system that was not linked to the EU ETS, the result would be low trading liquidity. The price at which emission allowances were traded on the market might then not fully and accurately reflect the actual cost of emissions reductions and could be more volatile. This could ultimately lead to higher energy prices, as traders’ costs of hedging against the risk of unpredictably high or, conversely, low prices would rise.

EFET also sees an impact on hedging costs in the case of a switch solely to a carbon tax. The cost of hedging trading risk would increase because the carbon tax would be set annually, complicating price forecasts over multi-year periods. At the same time, it would be subject to regulatory oversight and possible adjustments.

A further advantage of price-linking the two emissions markets is that it reduces the risk of so-called carbon leakage, meaning the relocation of industry and investment to other parts of the world in pursuit of lower emissions costs.

EFET recommends an “ex ante” price linkage, namely linking to average EUA forward prices, without any further increase or adjustment to that price. Thanks to this link, emissions costs would be easily predictable for electricity generators in particular, meaning they would not have to incur high costs to hedge against potential fluctuations in the price of emitting emissions.