Since the UK’s exit from the European Union (EU) on 1st January 2021, the UK has been participating in its own ETS scheme after leaving the EU counterpart. The ETS plays a crucial role in helping the UK decarbonise, but the scheme is currently being adapted by the UK ETS Authority. LGE’s article sets out all you need to know about the scheme and any potential changes.
What is the UK ETS?
The UK ETS currently covers heavy industry, power and aviation sectors, which make up 25% of UK territorial emission output. The scheme therefore sets a cap on the amount of emissions allowed to be produced from these sectors and creates a ‘carbon price’ for emissions over the cap. The government has adopted this approach in the hope that it will incentivise businesses in these industries to decarbonise at speed. The scheme also aims to tip the balance between businesses who continue to emit and those who are using or investing in low carbon technology by creating a market for carbon allowances, allowing those who decarbonise to trade allowances with those who continue to emit.
‘Cap & Trade’ Approach
The ETS operates based off the principle of a ‘Cap & Trade’ approach, meaning that an overall cap on total emissions is set for participants and represents the total amount of greenhouse gases that can be emitted by the sectors covered. This cap is then divided into allowances which are the equivalent of 1 tonne of CO2 emissions. Businesses in the relevant sectors then must surrender ‘allowances’ to cover their emissions for the year. These ‘allowances’ are acquired through auctions and purchased from other participants in the scheme.
Some ‘allowances’ are allocated as ‘free allowances’ to mitigate for businesses in sectors who could be susceptible to carbon leakage. Businesses may also sell any extra ‘free allowances’ they have at the auctions, helping to cover the financial costs of the decarbonisation processes.
The cap will decrease over time to further incentivise decarbonisation and ensure that businesses are making long-term commitments.
Participants and Potential Expansion?
The UK ETS currently applies to the following three sectors:
- Energy Intensive Industries
- Power Generation
- Aviation
However, in 2023 a consultation set out a pathway for expanding participant sectors. Following on from the consultation, the feedback found that the scheme should be expanded to help support the UK’s decarbonisation process. The initial new sectors to be covered are:
- Waste incineration and energy from waste (from 2028, following a 2-year monitoring, reporting and verification period beginning on 1st January 2026)
- Maritime transport (from July 2026)
The scheme is also being tightened for existing participants, with the scope of emissions coverage also now set to include venting of CO2 in the upstream oil and gas sector and non-pipeline transport of CO2, when emissions move from an entity regulated by the ETS to a non-regulated entity.
As part of the government’s long-term pathway for decarbonisation, the ETS is expected to run until 2050, in line with net zero targets. The first phase of the scheme was expected to run until 2030, but the government is currently consulting on expanding this first phase.
Other Developments
Alongside expanding the coverage of the scheme, the government has also been assessing changes to the three core areas of ETS, the cap, free allocation and markets policy.
- The Cap- In July 2023 it was confirmed that decreases in the cap would be done so inline with the UK’s net zero progress to create a proportional approach that covered decarbonise at pace and scale. This was implemented from 2024.
- ‘Free Allowances’- Reviews of the ‘free allowances’ policy have been ongoing to ensure that it continues to incentivise emissions reduction and protect industries at risk of carbon leakage. Reviews have aimed to better target those sectors most at risk, make ‘free allowances’ tailored to a UK context and provide clarity on the future of ‘free allowances’. A December 2024 consultation confirmed that the start of the second ETS ‘free allowances’ period will be between 2026 & 2027. Consultations are ongoing around the options for ‘free allowances’ adjustments for sectors covered by the UK’s Carbon Border Adjustment Mechanism (CBAM) due for implementation in 2027.
- Markets Policy- When established the ETS had two key market stability mechanisms. These were an Auction Reserve Price which set a minimum bid price of £22 and Cost Containment Mechanism which allowed the ETS Authority to intervene if prices became too susceptible to increases. Ongoing consultations are assessing the most significant risks to effective market functioning, the suitability of different market policy options and minimising intervention and disruption in the market.
Linking the UK ETS to the EU ETS
Linking the ETS’ of different areas can help create larger markets and help increase competitiveness. In May 2025, the UK government announced that it had agreed with the European Union to link the UK & EU ETS, with a timetable for this currently being negotiated.
For more information on the ETS speak to your account manager today or contact us at info@lgegroup.com.