UK ETS – Will It Take Off For Aviation?

The UK ETS includes aviation emissions from UK domestic flights, flights between the UK and Gibraltar and flights from the UK to the EEA conducted by all aircraft operators participating, regardless of nationality. The scheme is not applicable to commercial aircraft operating less than 243 flights within a four-month period for three of those periods consecutively, or to flights producing less than 10,000 tonnes of annual carbon emissions. It does not apply to non-commercial operators producing less than 1000 tonnes of annual carbon emissions. 

The UK ETS is divided into phases, the first running between 2021-2025 and the second from 2026-2030.The initial cap for the UK ETS is set at approximately 156 million allowances for 2021, 5% lower than that of the EU ETS. This cap will be reduced annually by slightly over 4.2 million allowances. This cap is temporary and the government has committed to consult on the implementation of a net zero cap trajectory to 2050, but will give participants at least one year's notice of any changes. It plans to implement any changes by 2024 at the latest. 

Most UK tradeable allowances are auctioned; however a proportion are free in order to mitigate carbon leakage. Carbon leakage refers to a scenario where, for reasons of costs linked to climate policies, businesses may transfer production to other countries with more relaxed emissions constraints, which could ultimately lead to an increase in their total emissions. In relation to aviation, the risk is twofold: firstly, that flights from airports located close to a border could shift to airports outside the territory where the ETS applies, and secondly that flights using airports located within the territory covered by the ETS as a connecting hub could be re-routed. 

Aviation receives free allocation of allowances in the EU ETS and will continue to do so under the UK ETS. There is a free allocation application process for aircraft operators and allocations are awarded to reflect operators' historic activity on flights covered by the previous year's free allocation. The free allocation entitlement is set out in the Aviation Allocation Table published by the UK ETS Authority. Aircraft operators can then purchase allowances on top of what is allocated to them through a trader with a trading account in the UK ETS Registry, other participants or through an auction. Aviation operators must then surrender the amount of allowances equivalent to their aviation emissions in each scheme year to their regulator. This means that the lower an operator's emissions are, the fewer allowances they will need to buy.

The government has proposed in its Net Zero Strategy to adopt credits for direct air capture or GHG removal (GGR) into the UK ETS. Direct air capture uses chemical reactions to capture CO2 directly from the air. The carbon dioxide is then stored underground or reused. The government has said that atmospheric extraction technologies would be required at scale in order for the UK to meet 2050 net zero targets. This is particularly the case in sectors which are more difficult to decarbonise, such as aviation. It is hoped that linking direct air capture to the UK ETS would create a market for GGR. Although the government suggests that GGR credits could function within the ETS market by allowing polluting sectors to meet their obligations through the procurement of negative emissions, it has not yet set out how such inclusion would work in practice. The government plans to issue a call for evidence in the coming months on the role the UK ETS could have in creating a GGR market. 

The UK ETS provides for both an auction reserve price and cost containment mechanism to ensure the price stability of allowances. 

A transitional auction reserve price (ARP) has been set at £22, and is the minimum price for which allowances can be sold at auctions. This ARP will not change until the government consults on its intent to withdraw the ARP as part of the consultation to align the UK ETS cap with a net zero trajectory. 

The UK ETS also provides for a cost containment mechanism (CCM), allowing the UK ETS Authority to intervene if prices are elevated for a sustained period. Although the UK CCM mirrors the design of the EU equivalent, it has lower price and time triggers in the first two years to provide more flexibility in intervening whilst the UK ETS matures. In the third year of the scheme the CCM will revert back to mirror the EU design. 

During year one of the UK ETS, the CCM will be triggered if the average price of an allowance is more than an amount equal to two times the average price in the preceding two-year period for three consecutive months on secondary futures markets. During year two, it will be an amount equal to two and half times the average price. The next possible opportunity for the CCM to be triggered is December 2021, where the average carbon price in September, October and November will need to be above £52.88. 

If the CCM is triggered, the UK ETS Authority will consider a suitable intervention. If no such decision is made, HM Treasury can implement a number of measures, such as redistributing allowances between the current year's auctions, bringing forward auctioned allowances from future years to the current year, drawing allowances from the market stability mechanism account or auctioning up to 25% of the remaining allowances in the New Entrants Reserve. 

This discretion to intervene is provided to prevent spikes in carbon prices. Although higher prices will further incentivise emissions reduction, the UK wants to ensure a smooth transition from the EU ETS and therefore ensure the UK ETS carbon price is cost competitive. If the price of allowances is too high, it may affect profitability of a UK aviation business, even driving companies out of business in an extreme scenario. Volatile prices also create uncertainty for businesses and put off investors.

In the government's May 2019 consultation there was a proposal to introduce a supply adjustment mechanism widely based on the EU ETS market stability reserve. This would change the number of allowances to be auctioned in certain years if predefined volume surplus triggers were activated. This mechanism cannot be introduced until the first year of the scheme finishes, as data on UK ETS allowances would be required for implementation. 

Aviation operators are issued an emissions monitoring plan from the Environment Agency detailing how to monitor and report aviation emissions in line with requirements. Once this is received, an Aircraft Operator Holding Account will be set up in the UK ETS Registry. The UK ETS Registry is essentially a bank for allowances, and records free allowance allocations, annual verified aviation emissions, allowance transfers and allowance surrenders. The Environment Agency is currently the Registry administrator for the whole of the UK.

Aircraft operators must prepare an annual emissions report. This report includes the appointment of an independent verifier, who will assess monitoring methods, information, data and calculations as well as procedures undertaken. In case of breach of any requirements, such as failure to comply with monitoring and reporting requirements and failure to obtain a permit or an emissions monitoring plan, the UK ETS Registry administrator can issue enforcement notices. If then an enforcement notice is not complied with, the relevant national ETS regulator can impose a civil penalty in respect of the breach. 

The UK ETS Authority has an oversight and monitoring role and comprises the Secretary of State, Scottish Ministers, Welsh Ministers and the relevant Northern Ireland department. Its role is one of reviewing and reporting on the UK ETS before the end of 2023 and 2028, publishing carbon prices, issuing allowances in accordance with the cap, creating and overseeing central accounts to ensure free allocation, as well as delivering auctioning and market stability policies.  

Participating aircraft operators in the UK ETS have the possibility of using one of the five fuel use monitoring methodologies approved for use under CORSIA. [1] CORSIA, another market-based mechanism, is the Carbon Offsetting Regime for International Aviation, which is an international scheme for offsetting aviation emissions developed through International Civil Aviation Organisation (ICAO). Although participation is voluntary from 2021-2026, this scheme will become mandatory for nearly all countries from 2027 onwards. The UK is participating from the beginning of the pilot phase which began this year, and it therefore makes sense to align UK ETS monitoring, reporting and verification obligations with CORSIA's in order to simplify compliance for aviation operators.

The government undertook a consultation on the detailed proposals for the implementation of CORSIA offsetting in the UK, published in April 2021. In relation to this consultation, the Climate Change Committee advised that three of the six options for CORSIA implementation proposed by the government were inappropriate. The Committee states that any interaction between the UK ETS and CORSIA should ensure that CORSIA credits do not qualify to offset emissions from flights covered by the UK ETS unless they can satisfy strict eligibility criteria set out by the Committee. Although the UK ETS and CORSIA's monitoring, reporting and verification requirements are set to be aligned, the government has not yet decided which policy option for implementation of CORSIA it will choose, and it is still unclear as to how the UK ETS and CORSIA will exactly intertwine. Any such alignment by the government should be mindful that CORSIA has significantly lower carbon prices, and exempting overlapping routes from the UK ETS because they are covered by CORSIA would mean airlines paying a substantially lower price for their emissions, and less than other sectors included in the UK ETS. 

[1] The Air Navigation (Carbon Offsetting and Reduction Scheme for International Aviation) Order 2021