UK Emissions Trading Scheme: proposed amendments: impact assessment

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.

The UK ETS Authority carried out a 12-week public consultation from 25 March 2022 to 17 June 2022. The consultation was published in both English and Welsh 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 through existing stakeholder groups. Relevant NGO’s and wider stakeholders were notified through existing comms channels. All were offered the opportunity to meet Authority officials to discuss the proposals.

During the consultation process, a series of workshops were run on the various chapters of the consultation. These were open to everyone, and presentation materials were provided in both English and Welsh.  

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.

There are three significant impacts that have been identified in assessing the proposals, which relate to the effect they will have on human health, business costs, and energy bills for consumers. 

The scheme is judged to have a positive impact by incentivising the abatement of emissions from the traded sector that are believed to be harmful to human health, such as nitrogen dioxide (NO2) and fine particulate matter (PM2.5). There is evidence to suggest these pollutants could both cause and aggravate existing health conditions and have a differential impact across groups (such as on children, older adults, and disabled people).

The costs to business associated with the scheme relate to both the cost of purchasing allowances (at higher prices than if no action was taken) or the cost of abatement motivated by the carbon price. The economic impact assessment, conducted for the Authority on behalf of the Department for Net Zero and Energy Security, estimates that the cost to business from the preferred option will be £2.4bn. These costs will be contingent on the delivery of other aspects of public policy, such as by the deep decarbonisation that could be achieved from the deployment of CCUS and hydrogen, as well as wider electrification of existing processes. If less public policy is delivered than expected, the need for business to find alternative abatement solutions (that will be more costly) will increase.

Finally, the impact on consumers via increased energy bills is judged to be complicated by the time-horizon the policy is assessed over. While the Authority was not able to credibly estimate the impact of the policy on household bills, in the short term any policy that increases the marginal cost of producing electricity using fossil fuels (such as natural gas) is expected to be passed onto consumers. Within the recent energy context, this impact is expected to be minimal compared to other factors. Over the longer-term the impact on energy bills is dependent on developments across the wider energy market – for example, how the cost differential between different forms of generation evolves. As the proposals should accelerate the adoption of cleaner forms of electricity generation, should these technologies prove more cost effective over their lifetime, these savings could be passed onto consumers. 

• maximise contribution to our well-being objectives and the seven well-being goals;  and/or,
• avoid, reduce or mitigate any negative impacts?

By accelerating the pace of decarbonisation within the traded sector, compared to if these changes were not made, this IIA finds that the proposals support three of the Welsh Government’s well-being goals; namely it supports our goals to be a resilient Wales, a healthier Wales, and a globally responsible Wales. 

Welsh Government’s net zero ambitions and tackling fuel poverty are compatible objectives. Our long-term ambition is to improve the energy efficiency of Welsh homes, ensuring we use only the energy we need, to keep homes comfortably warm at an affordable cost. The new Warm Homes Programme will continue to act as the Welsh Government’s primary mechanism to tackle fuel poverty. It will also contribute towards achieving a net zero Wales by 2050 and directly enable a just transition - ensuring we leave no-one behind as we move to a cleaner, stronger, fairer Wales, through the twin objectives of tackling fuel poverty and the climate emergency. 

Welsh Government is very conscious of the impacts of the high energy costs on the most vulnerable households and individuals. This is an area that is evolving daily, and we are continuing to develop plans to mitigate the impacts. Welsh Government's Tackling Fuel Poverty 2021 to 2035 Plan sets out steps we are currently taking, and we will continue to develop this as the issues evolve.

In Wales we expect the development and scaling up of technological options for industrial decarbonisation, such as fuel switching and carbon capture utilisation and storage, to have a transformative impact on emissions from the end of the 2020s and through the 2030s. This transition will be supported by collaboration with industrial clusters, a decarbonised energy network with enhanced grid infrastructure and access to UK-wide funding to implement decarbonisation plans.

The Climate Change Committee has assessed that by 2050 around 60% of the changes needed in Wales to achieve a pathway to net zero are influenced by powers mostly reserved to Westminster. For the industry sector the majority of powers and resources that will support industry to transition to net zero processes to meet our climate targets, such as hydrogen and carbon capture are reserved to the UK Government. To ensure Wales benefits from the support available we will continue to press the UK Government to develop and deliver their policies to ensure that businesses in Wales can credibly meet the ambitions set out in these proposals (such as the UK ETS cap trajectory) and receive access to the necessary infrastructure, investment, and to enable business to manage the costs associated with the changes we are making to the UK ETS.

In addition we will work with UK Government to maximise opportunities arising for Welsh industry and business from UK level initiatives including the Industrial Energy Transformation Fund (IETF) which provides grant funding for feasibility and engineering studies to enable companies to examine energy efficiency and decarbonisation projects prior to making an investment decision, the deployment of mature energy efficiency technologies that reduce industrial energy consumption and the deployment of deep decarbonisation technologies that reduce carbon emissions from industrial processes.

The UK ETS Authority is committed to evaluating the effectiveness of the scheme in driving emission abatement, as well as understanding the impact it has on participants and the wider economy. 

The Authority has commissioned a two-phase evaluation study.  The first phase, which is due to be completed in 2024, will focus on the process of establishing the scheme and what the outcomes have been in its initial years. This phase will seek to understand whether the transition from the EU ETS to the UK ETS has been smooth for participants while delivering a functioning carbon market.

The second phase of the evaluation is due to be carried out between 2025-2026 and will be focussed on the impacts of the scheme within its first four years, such as understanding the effect the scheme has had on the emissions intensity of participant processes or in being attributable to carbon leakage. This phase will not just focus on what impacts have been felt because of the scheme but also how these impacts have been delivered, as well as wider spill over effects.

This phase of the UK ETS is planned to finish in 2030 but the scheme will be expected to continue past this point. Therefore, no concluding evaluations have been committed to at this time.

The objectives of the policies contained within the Developing the UK Emissions Trading Scheme government response are designed to improve the effectiveness of the scheme in driving emissions abatement within the traded sector. These policies are designed to aid a sufficient pace of abatement needed to meet the climate obligations of all four governments of the UK ETS Authority and ensure the UK plays its part in mitigating the worst impacts of human-induced climate change, which are likely to be felt most acutely by future generations.

The UK ETS is an industrial policy aimed at driving abatement associated with process emissions within the traded sector and as such, outside of the consultation process itself, engagement on developing the scheme has primarily been conducted with participants within the scheme and stakeholders with an interest and expertise in climate and industrial policy. 

In attempting to understand the effects of the scheme on children this CRIA has sought to gather evidence which relates to a primary negative externality associated with industrial emissions to air, notably the impact on health and the differential impact this has on children and young people.

The principal right that the proposals to develop the UK ETS are likely to affect is a child’s right to health and health services, as set out in Article 24 of the UN Convention on the Rights of the Child (UNCRC). These proposals should enhance these rights for children by driving emissions abatement and thereby reducing the volume of airborne pollutants that are released by the traded sector.

Academic evidence suggests that airborne pollutants are increasingly being identified as a preventable risk factor for a range of negative health outcomes for children and young people[1]. This includes air pollution being linked to increased incidence of asthma, reduced lung function and exacerbation of respiratory diseases. The World Health Organisation lists several reasons why children are more at risk of air pollution than adults, which are: 

1. [Children’s] lungs are still developing, and air pollution can interfere with this biological process.
2. Their bodies are less able to metabolize, detoxify, and excrete the toxicants contained in air pollution.
3. Their brains are still developing, and neurotoxic compounds in air pollution can affect children’s cognitive development.
4. They inhale more air per unit of bodyweight than adults.
5. They are more active and therefore breathe in more air pollution.
6. Babies born to women who were exposed to air pollution during their pregnancy are more likely to be premature and low birthweight. 

The UK ETS ensures that there is a legislated cap on greenhouse gas (GHG) emissions that can be emitted over the course of the scheme and the proposals contained within the Developing the UK ETS government response, amongst other changes, seek to tighten the current legislated cap. The UK Government estimates that the preferred policy options could reduce cumulative emissions to 2030, from the traded sector, by approximately 12.0 to 38.7MtCO2e. While it has not been possible analytically to attribute this reduction across UK nations, it is reasonable to expect that tightening the cap will lead to emissions being lower across all nations and regions than would otherwise be the case. Many of the GHGs have common sources with other local air pollutants, that cause health issues, particularly in children as listed above.  Therefore the proposals would bring about an overall health benefit to children. 

Apart from the direct impacts mentioned above, the overall benefits brought about by mitigating climate change will ensure a healthy natural environment that will bring health benefits to children and young people. The proposals, therefore, are in line with the thinking behind the Well Being of Future Generations Act and support our goal for A Healthier Wales which aims for a society “in which people’s physical and mental well-being is maximised and in which choices and behaviours that benefit future health are understood”. 

Evidence from the ONS suggests that families with at least one dependent child within them are more likely to experience some form of financial vulnerability. The same survey also found that 57% of parents living with their children were finding it difficult to pay their energy bills compared to 42% of adults who either have no children or do not live with them. Therefore, the possible impacts on household energy bills identified in the IIA will need to continue to be monitored in this context [2], to ensure the scheme is not having a negative long-term impact on children from low-income households. As the IIA sets out, it has not been possible to quantify these impacts, however they are expected to be minimal relative to other factors that have contributed to increased energy bills in recent months.

[1] Brumberg, H et al. (2021) Ambient Air Pollution: Health Hazards to Children. Pediatrics June 2021; 147

[2]   Those impacts being that short-term electricity prices may be higher because of the proposals but that longer term prices could be reduced.

The UK ETS is a specific tool within the wider climate change policy area. Ministerial advice therefore focused on the mechanisms of the scheme while reflecting the options in view of the wider benefits of climate change such as the health impacts of air pollution, which have been imparted as part of policy advice at various points by relevant climate change policy officials. The Minister has considered and approved the proposed policy changes.

The UK ETS Authority has committed to a two-phase study that will evaluate the process outcomes and impacts of the UK ETS in the first four years (2021-2024) of phase I of the UK ETS scheme. As well as the economic impacts of the scheme, this evaluation will help to inform our understanding as to how effectively the scheme is driving emission abatement in the traded sector, with the associated benefits identified in this CRIA it would bring.