Since global agreement of the Kyoto Protocol in 1997, Governments around the world have introduced ‘Cap and Trade’ emissions trading schemes as a key policy tool to reduce a country’s carbon emissions. A cap-and-trade system, sets a limit on the total emissions allowed within the scheme and then allows participants to buy and sell allowances as required through a carbon market.
The EU Emissions Trading Scheme (EU ETS)
The EU ETS is the largest international carbon trading scheme, covering more than 11,000 power stations and manufacturing plants. Since its inception in 2005, the EU ETS has seen many policy changes but now more than ever binds European industry to tougher emissions targets over the next decade at a time of record EU Allowance (EUA) prices – see price chart below.
Phase 3 (2013-2020) saw several new measures introduced to improve the scheme, such as auctions, a reduction in free allocations and the Market Stability Reserve (MSR) in 2019, which significantly reduced the EU Allowance surplus created by the financial crisis during Phase 2 (2008-2012).
Phase 4 (2021-2030) will see a further reduction in the EU ETS cap, continued functioning of the MSR mechanism, more auctioning, tighter benchmarks and a reduction in free allocations to many industry sectors. These reforms combined with increased ambition under the EU 2030 Green Deal proposals (expected to set a new 55% cut in GHG emissions vs 1990 levels) are expected to tighten EU ETS targets over the next 10 years as the EU moves towards a net-zero future.
The EU Carbon Market
The EU carbon market is split into the benchmark ‘wholesale market’, dominated by exchanges and forward trades of EU Allowances (EUAs) involving Energy, Large Industrial, Financial and Commodity Trading companies, and the compliance market where operators enter the market periodically to trade specific EU ETS compliance needs.
The EUA wholesale market functions as a well developed commodity market but remains volatile and susceptible to sharp price swings. EUA prices have continued to rise over the last year to reach record highs in early 2021, supported by market participants who feel the proposed increase in EU ETS targets for Phase 4 will drive carbon prices higher.
As such it is increasingly important for EU ETS operators to keep up do date with the market and develop an appropriate compliance strategy to manage costs.
Please see below for more details on how CF Partners services can help.
The UK Emissions Trading Scheme (UK ETS)
On 14th Dec 2020, as part of its Energy White Paper announcement, the UK Government confirmed the launch of a UK Emission Trading Scheme (UK ETS) from 1 Jan 2021. The statutory rules for a UK ETS have been put in place (The Greenhouse Gas Emissions Trading Scheme Order 2020) and the auctions and related carbon market commenced on 19th May 2021.
The UK initially set targets at 5% above the EU ETS Phase 4 goal but committed to take into account advice from the Committee on Climate Change (following the Sixth Carbon Budget), so we expect to see targets tightened and free allocations reduced in the future.
UK operators will have to manage a significant reduction in free allocations under the UK ETS, at a time of rising carbon prices and concerns about liquidity in the UK Carbon market (see below). With over a decade of experience in carbon markets, CF Partners can help UK operators keep up to date with the market and develop a strategy to manage and reduce compliance costs.
We outline the key features of the scheme below but please do get in touch if you would like more information.
UK ETS Key Features
- Establishes a new UK ETS with Phase I running from 2021-2030.
- Broadly follows the current EU ETS rules and will begin as a standalone system.
- Applies to energy intensive industries, power generation and aviation.
- Auctioning will continue to be the primary means of allocation but a proportion of allowances are allocated to industry for free.
- UK Allowance (UKA) auctions started on 19th May 2021 and run every 2 weeks.
- There will be a transitional Auction Reserve Price (ARP) of £22 / tCO2e.
- Free allocations to industry were issued on 26th May 2021, totalling 39m UKAs for 2021.
- New UK ETS Registry operational for Trading and Operator Holding Accounts.
- Small Emitter and Hospital Opt-Out and ultra-small Emitter Exemption.
- Operators can’t use EU Allowances (EUAs) for UK ETS compliance but many UK Utilities hold EUAs as a “proxy” hedge whilst UKA market liquidity develops.
- Cost Containment Mechanism (CCM) which allows the UK ETS Authority to intervene [potentially add more UKA supply] if prices are elevated for a sustained 3 month period.
The UK Allowance (UKA) Carbon Market
The early UK Carbon market has been characterised by a lack of liquidity but this is improving as more UK Allowance volume comes into the market via auctions and to some extent free allocations.
UKA prices continue to track EUA prices and ,to date, there has been a premium for UKA prices over EUAs but this is reducing.
CF Partners has developed a number of trading solutions and to help clients access both the secondary market and the increased liquidity around the auction timetable.
There has been no official update about a link with the EU ETS but the post Brexit trade deal states the UK and EU “…shall give serious consideration to linking their respective carbon pricing systems in a way that preserves the integrity of these systems and provides for the possibility to increase their effectiveness.”
Please contact us for more information.
CF Partners’ award winning carbon trading and risk management team can help you understand the market and manage your ETS compliance objectives. We provide regular market updates to keep you up to date with policy and carbon prices and can help you develop an appropriate trading strategy to meet the requirements of your organisation.
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CF Partners provides clients with access to the full suite of carbon and compliance products, including:
- EU Allowances (EUAs)
- Aviation sector EU Allowances (EUAAs)
- Certified Emission Reductions (CERs) for exchange
We trade vanilla products, including Spot, Futures, Forwards within an EU and global client base. We also offer options and structured solutions to larger more sophisticated clients looking to purchase below market price, access elevated returns on existing assets, and seek value from varied solutions.
Please Contact us to find out more.
Our social responsibility
CF Partners is strongly committed to continuously reducing its carbon footprint and taking responsibility for its impact on the environment by partnering with, supporting and advising for-profit and non-profit organisations.
Actions taken include:
- Ensuring all power and gas supplied by Brook Green and So Energy is 100% green.
- Our CDM Portfolio: We have invested in 34 renewable energy projects.
- Membership of the Institutional Investors Group on Climate Change; a forum for collaboration on climate change for European investors.
- Bikin Tiger Project: CF Partners has contributed to the conservation of the Amur Tiger through participation in the Bikin Tiger Project by advising and investing in a unique WWF and German Ministry of Environment carbon credit project to save half a million hectares of virgin forest in Russia
CF Partners provides clients with access to a range of commodities, covering the physical and financial supply of natural gas, power, emissions, crude oil, refined products, biodiesel petrochemicals markets, agriculture and green certificates.