Energy Buzz: UK ETS Evolution | Preparing for a Post-2030 Carbon Market

On 12 February 2025, the UK ETS Authority launched a consultation on proposals for extending the UK ETS beyond the end of Phase I - 31 December 2030. 

Background 

The UK ETS is a cap-and-trade scheme designed to reduce greenhouse gas emissions by setting a cap on the total amount of emissions allowed from specific sectors. The scheme covers energy-intensive industries, power generation and aviation operating within the UK. 

Consultation 

The scheme operates in phases, with Phase I running from 2021 to 2030. The Authority now seeks input on a number of proposals, including: 

1. Extending the UK ETS into a second phase (Phase II) from 1 January 2031 onward. 
2. The length of Phase II. 

Whether to allow banking of emissions allowances between Phase I and Phase II. 

Extending the UK ETS beyond 2030 

In line with a previously announced intention for the long-term pathway for UK ETS, the Authority is proposing to continue the operation of the scheme from 1 January 2030. The extension aims to ensure continued emissions reductions across covered sectors by maintaining market stability and predictability for businesses planning low-carbon investments. Furthermore, the Authority will be able to expand the scope of the scheme to enable deeper decarbonisation. The detailed cap profile for Phase II will be subject of a future consultation. 

Proposed duration of Phase II 

In deciding what length would be appropriate for the duration of Phase II, the Authority seeks to strike a balance between: 

1. giving the participants clarity of their compliance obligations to facilitate long-term abatement planning and a greater range of decarbonization investments; and 
2. the uncertainty of emerging technologies, economic conditions or changes in international policy, alongside associated costs.

The consultation document proposes 3 possible options for the length of Phase II: 

1. 2031 – 2037: aligning with the end of the UK Carbon Budget 6 and bringing UK ETS into cycle with the 5-year UK-wide carbon budget cycle. Although a shorter second phase would give businesses less opportunity for forward planning than the 10-year first phase, this duration is considered optimal to enable accurate modelling of emissions trajectories for the covered sectors. This is the Authority’s preferred option. 
2. 2031 – 2040: continuing with 10-year phases would provide greater certainty for stakeholders than a 7-year phase and would align with the Phase I approach. On the other hand, predicting emissions pathway in the final years of a 10-year phase would be more difficult.
3. 2031 – 2042: aligning with the end of the UK Carbon Budget 7, this would provide the greatest certainty to stakeholders, but the emissions pathway modelling would be less accurate.  

Inter-phase Banking and Emissions Trading 

The consultation proposes allowing allowances from Phase I to be used for compliance in the extended Phase II, to ensure that participants retain the value of any surplus allowances and can strategically manage their obligations by taking advantage of abatement options over the long term. 

Inter-phase banking is seen as a way to prevent market distortions and price volatility while maintaining incentives for emissions reductions. Without banking, businesses may rush to use up allowances before the end of the current phase, potentially leading to an increase in emissions and significant price falls. 

However, the consultation also raises concerns about the potential for excessive accumulation of Phase I allowances which could incentivize increased emissions in the early years of Phase II undermining the scheme’s environmental effectiveness. To address this, the UK ETS Authority will be exploring mechanisms to account for inter-phase banking when the Phase II cap is set and designing the cap trajectory accordingly. This will be developed in a second-stage consultation. 

Conclusion 

Stakeholders are invited to provide feedback on these proposals by 9 April 2025, to shape the future design and operation of the UK ETS. 

If you have any questions, please do not hesitate to get in touch with any of the key contacts listed, your usual Hogan Lovells contact, or click here to get in touch with a member of the Hogan Lovells energy team. 

Authored by Ese Imafidon.