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The UK is leaving Europe’s carbon market as prices hit record highs

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  • Michael J. Coren
By Michael J. Coren

Climate and emerging industries editor

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In a messy divorce from Europe, the United Kingdom is taking its emissions with it.

The UK has been participating in the continent’s emission trading system, the EU-ETS, since 2005, but left as part of Brexit last December. This week, the country released a final report under the system, and it’s leaving on a high note. The UK reported a drop of 15% in emissions over the previous year, according to Refinitiv Carbon, a subsidiary of the London Stock Exchange.

That’s on trend. Over the past decade, the UK has managed to slice its emissions by about one-third—a milestone last seen in the 1880s—while growing its economy. And after years of low prices and stagnant trading, carbon prices across Europe are now reaching record heights: €40 ($47) per metric ton. Policymakers in Brussels say they’re committed to maintaining a meaningful price on carbon in the future to drive more emission reductions.

The UK starts a carbon market

The EU-ETS allows major emitters to buy and sell emission permits, effectively setting a price on carbon for major industries. The multinational marketplace can claim some success: It helped the bloc curb its total emissions by 3.8% (1 billion tons of CO2) between 2008 and 2016, according to a 2020 study in the Proceedings of the National Academy of Sciences.

And for now, the UK has nothing concrete to replace it. The country announced the creation of a “UK-ETS,” primarily for its 1,000 domestic power plants and the aviation sector, but auctions don’t start until May. UK policymakers have left open the possibility of rejoining the EU-ETS, similar to its arrangement with Switzerland, but nothing is on the books.

“Everyone is quite pleased, given all the difficulties around Brexit, the UK will stay with emission trading,” says Jill Duggan, executive director of the Environmental Defense Fund in Europe. It leaves “the door wide open” for the UK to rejoin the system in the future. The country must cut its emissions at least 68% by 2030, and reach net-zero by mid-century, based on the 2015 Paris Agreement. Duggan says achieving those goals will be “more complex and expensive” without the EU-ETS.

That’s because when it comes to carbon markets, the bigger the better. And the EU-ETS is the world’s biggest: Of the 10 billion tons of carbon permits traded worldwide last year, 80% were on the EU-ETS. A large, well-designed carbon market, economists argue, optimally reduces the cost of cutting emissions by allowing every major player in the market to either abate emissions, or pay others to do it more cheaply. Over time, this theoretically surfaces options for reducing emissions that are cheaper and more palatable than, say, taxes.

Emissions trading is better with friends

The UK, once representing about 11% of total emissions in the EU market, is now on its own. Fewer emitters mean less emissions, less liquidity, and potentially higher prices for comparable volumes of emission reductions. That will ratchet up pressure on politicians to over-allocate permits and keep carbon prices low, deterring investment in emission reductions.

That critique is already being raised about the UK-ETS system. Last December,  UK prime minister Boris Johnson said the new scheme would be “more ambitious than the EU system it replaces,” but initial estimates suggest the UK-ETS is set to over-allocate at least 37 million surplus metric tons in its first year, with an initial price floor of $30 (£22) per metric ton. That could depress carbon prices well below the EU’s through 2030.

It’s still too early to say if the UK’s carbon market can match the ambition of the EU, but the answer will have global ramifications. More than 80 countries have mentioned carbon markets as a tool they may use to meet their commitments under the Paris Agreement, most notably China, which is rolling out a national cap-and-trade system. “The empirical evidence to justify this global diffusion is mixed at best,” warned the PNAS study. If regulation is strong, “carbon markets can work even when prices are low….But absent such political will, low prices will do little to decarbonize regulated economies.”

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