Momentum is building behind a plan to link the carbon markets of the European Union and the United Kingdom. What's the reasoning driving this idea forward?
When the UK voted to leave the EU, part of the divorce settlement included leaving the bloc’s emissions trading system, the ETS.
The ETS sets a price per tonne of carbon emitted, which big industrial installations, power generators and intra-EU flights must pay. It is designed to incentivise these companies to invest in greener forms of manufacturing, generation and travel.
After Brexit, these two markets have operated next door to one another, with no overlap. The EU ETS has gone from strength to strength, setting a stable price and driving impressive decarbonisation numbers across all the sectors it covers.
However, the ETS picture on the other side of the Channel is not so rosy.
The UK’s market is a fraction of the size of the EU’s, so there are fewer carbon permits in circulation. This lack of liquidity has prevented a stable carbon price from developing since the market was launched. Haphazard government policy made before the Labour Party took power also destabilised the market.
A weak price means the incentive to decarbonisation doesn’t really exist and revenues are low. Lower revenues means less money to pump into decarbonisation initiatives, so a virtuous green circle has not yet developed.
So for the UK, carbon market linkage would make a lot of sense, as it would massively increase the number of permits. But what’s in it for the EU?
There is a risk that the UK’s weaker ETS could actually drag the EU’s market’s price down, which is the last thing Brussels wants just as the ETS is starting to do its job properly.
However, what is true for the UK is also true for the EU: a larger market means more liquidity, a better price signal and more potential for decarbonisation. The UK is a leader in the green sector so linkage could be a boon for both sides.
There’s also the matter of carbon border taxation. Both the EU and UK are deploying or planning to deploy a so-called CBAM, which will put a charge on imports that are produced using dirty energy.
That price will be determined by the carbon market, so if the two ETSs were linked, imports and exports across the Channel would be exempt from CBAM charges. Businesses on both sides have lauded the benefits of doing this and warned against allowing the CBAMs to cannibalise each other.
Momentum is indeed building.
The EU-UK cooperation agreement makes specific mention of linking the markets if it is in both sides’ best interests and the government has been advised by a special committee to give it serious consideration.
Relations between Brussels and London appear to have improved greatly since Labour Party leader Keir Starmer was elected prime minister, so the chances of the EU taking a punt on the UK and pressing on with the idea are improved as well.
Most people in the energy industry are of the opinion that this is a no-brainer and that it is only politics standing in the way.
If that obstacle can be overcome, then the EU and UK could be in a position to announce the linkage at the COP30 climate summit in November and champion it as a good example of international cooperation on climate action.
It would take at least a year to carry out the linkage, if not longer, as carbon markets are difficult beasts. But the EU has done it before: Switzerland’s ETS is linked to the EU’s and no problems have been reported since it launched in 2020.
An EU-UK summit in mid-May could well be the landing zone for an ETS deal.
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