The EU ETS and Brexit

14th September 2016


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  • Mitigation ,
  • Carbon Trading ,
  • Business & Industry ,
  • Energy

Author

Rhianne Menzies

The timing of leaving the EU could have complex ramifications.

The UK’s legislative history, including that in relation to its energy and climate change policy, has been intertwined with that of the EU for the past 44 years. A significant proportion of UK environmental policy is shaped at EU level. However, the outcome of the Brexit referendum will have no immediate impact on UK compliance entities or non-compliance entities that are active in the EU Emissions Trading System (EU ETS). Even when Article 50 notice is served, there is no immediate legal effect on the current laws, or current rights or obligations of UK businesses.

One option for the UK, after an exit from the EU, is to re-establish its own UK ETS and link it with the EU ETS.

The foundations for doing this exist in the Climate Change Act 2008, which requires the government to set a series of carbon budgets to enable at least an 80% reduction in greenhouse gases by 2050 compared to 1990 levels.

The EU ETS is currently in the middle of its third phase, expiring on 31 December 2020. Therefore, 1 January 2021 would be a natural break point. This date also coincides with the end of the second commitment period under the Kyoto Protocol and the targeted start date for obligations under the Paris Agreement.

However, given the mountain of other Brexit issues the government has to negotiate, there can be no confidence that this convenient timing will be achieved.

As such, it is possible either that the UK leaves the EU ETS prior to the end of phase 3 or that it is part of the EU ETS even after the start of phase four.

Any mid-phase change has the potential to be chaotic. Complexities arising from a mid-phase change include:

  • The ability for UK compliance entities within the EU ETS to manage deadlines;
  • The certainty of quantities for allocation of allowances;
  • Undertaking UK EU allowance (EUA) auctions and the effect on the number of UK EUAs that were due to revert back into the system at the end of backloading (except for the impact of the market stability reserve (MSR));
  • The January 2019 implementation date of the MSR and its impact on the level of EUAs in the system;
  • Strategies for banking EUAs into the next EU ETS phase;
  • The UK’s position in using the Union Registry, which guarantees accurate accounting for all allowances issued under the EU emissions trading system (EU ETS).

One of the principal purposes of the EU ETS is to provide a future price signal for carbon. The UK’s 780 installations accounted for 10.5% of the EU ETS’ total verified emissions (1.6 billion tonnes) in 2015. Arguably, that price signal will now reflect the above uncertainties, increasing the downward pressure on EUA prices.

What might the UK’s relationship with the EU ETS look like after the exit date?

Although it is possible that the UK may not seek to maintain a link to the EU ETS, some form of future linkage seems more likely at the present time.

However, there are many different ways in which the UK may link the EU ETS, including but not limited to those commonly described as the ‘Norway Model’, the ‘Swiss Model’ and the ‘FTA Model’.

The Norway model assumes the UK would join the European Economic Area (EEA) and the European Free Trade Association (EFTA), thereby giving it access to the single market and subjecting it to EU standards and regulations. Under this situation, the UK would participate in the EU ETS in much the same way Norway, Iceland and Liechtenstein currently do. By becoming an EEA and EFTA member, the UK could participate in the EU ETS with the least amount of disruption provided that the timing of its exit from the EU, its membership of the EEA and EFTA and the establishment of its relationship with the EU after its exit, were all to coincide.

The Swiss model involves the UK joining EFTA and negotiating bilateral agreements governing UK access on a sector-by-sector basis. The UK could negotiate a bilateral agreement linking a UK ETS to the EU ETS, in the same manner that the Swiss have agreed to link their emissions trading scheme to the EU ETS.

The FTA model assumes the UK would sign a free trade agreement with the EU which could include in its terms arrangements concerning the EU ETS.

In all but the Norway model, it is likely that the UK would first need to establish its own UK ETS, which could operate very similarly to the current EU ETS, making linkage that much easier.

Impact on the EU ETS phase four negotiations

The negotiations in relation to the next phase of the EU ETS are already under way. Legally, until its exit date UK representatives in the EU Parliament and the Council of Ministers can be involved in those negotiations. However, this may not be politically practicable. The UK has already given up its rotation of the EU presidency in the middle of 2017.

Given that the UK may need to follow a policy of selective disengagement, it is difficult to see the political feasibility of the UK having a persuasive voice in the phase four negotiations from now on.

Beyond the ETS

One of the first post-Brexit casualties in the UK was the abolishment of the Department of Energy and Climate Change (DECC) and the transfer of climate change responsibilities to the Department of Business, Energy and Industrial Strategy (BEIS). Although some commentators fear that this may reflect a downgrade of the government’s focus on climate change, in fact, it is probably too early to tell whether this is merely a name change rather than a change of emphasis. The activities of the BEIS in the early days of the new government will give a first indication of their priorities.

In terms of the UK’s international climate change priorities, where parties have not already done so, the Paris Agreement obliges parties to the UNFCCC to submit their nationally determined contributions (NDCs) by November 2016. The UK did not submit its own intended NDC in the run up to Paris as its submission was included within that made by the EU on behalf of its member states. Since the UK is not likely to be part of the EU at the time of the start of the commitment period under Paris Agreement, like EEA countries the UK may now need to submit its own NDC.

The EU and the 15 member states that were parties to the Kyoto Protocol (KP) when it was signed in 1997 jointly elected to meet their obligations under the first commitment period of the KP and therefore signed a burden-sharing agreement which redistributed emissions limits for each of those member states. Similar commitments were jointly made between all of the EU members (and Iceland) when the second commitment to the KP was agreed. If the UK exits the EU ETS prior to the end of the second phase on 31 December 2020, the UK may have to meet its obligations under the second phase separately from the EU and the EU may need to revise the burden-sharing arrangements accordingly.


Peter Zamen and Nicholas Rock are partners at Reed Smith.

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