This article looks at the joint consultation of the UK, Scottish, Welsh and Northern Irish governments (the Government) on Developing the UK Emissions Trading Scheme (UK ETS) and its role in the reduction of greenhouse gas (GHG) emissions in the aviation sector. It follows our previous article on the UK ETS in aviation more generally. The Consultation, open until 17 June 2022, seeks views on its proposals for the UK ETS and calls for evidence on potential future opportunities.


The Consultation

Along with sustainable aviation fuels (SAFs) and GHG removals, the UK ETS plays a large part in the government's strategy for decarbonising aviation. The UK has set a target to achieve net zero by 2050 and aviation specific targets to become a world-leader in zero emission flight and to enable delivery of 10% of SAFs by 2030. The Scottish government has separately set an ambitious target of decarbonising scheduled flights within Scotland by 2040. The UK ETS plays a role in achieving these goals as its aim is to incentivise both reduction of carbon emissions and increased investment in low carbon technologies.

The Consultation seeks views on three main commitments relevant to aviation:

1. implementing a net zero consistent cap;

2. reviewing the free allocation policy;

3. identifying future scope for the UK ETS

Net Zero Consistent Cap

The UK ETS works on a cap and trade principle, meaning each sector in the scheme can only produce GHG emissions up to a cap. They have to buy allowances for any surplus emissions. These can be purchased at auctions or on the secondary market. Each year, aircraft operators covered by the scheme must surrender allowances to cover their reportable emissions. The cap is reduced over time, so that total emissions must fall. The Consultation sets out proposals to align the UK ETS cap with the above net zero targets.

The UK ETS original cap was set at 5% below that of the phase four of the EU ETS (2021-2030), equating to approximately 156 million allowances in 2021. This was set to reduce annually by 4.2 million allowances. The Climate Change Committee (CCC) recommended that the UK ETS cap be adjusted to align with the net zero trajectory in its letter of advice to the Government dated June 2021. The Government took this into consideration in the Consultation, but ultimately decided that the cap should be based on the UK Government's Net Zero Strategy published October 2021, reasoning that the Net Zero Strategy was published more recently than the CCC's letter of advice and includes stricter recommendations and would therefore allow for a stricter trajectory in the fall of emissions production. Accordingly, the Consultation proposes that the Net Zero Strategy provides the base for the cap trajectory from 2024.

What, then, is this trajectory proposed to look like? The Government has set a suggested range of values to reflect uncertainty in expected sectoral emissions reductions. This range is set between 887 million and 936 million allowances for the entire first phase (2021-2030), equating to a reduction of around 30-40% from the current cap for phase 1 (1365 million allowances). The Government is leaning towards setting the cap at the higher end of this range, in order to allow for uncertainty over exact emissions savings and the possibility that carbon reductions could exceed what is required for the fourth carbon budget. Stciking towards the lower end of the range would nonetheless ensure compliance with the Net Zero Strategy, carbon budgets and the UK's 2030 Nationally Determined Contributions (NDCs) under the Paris Agreement.

The Government has also decided to delay implementation of this net zero consistent cap from 2023 to 2024 to lengthen the period of notice to the market and enable the Emissions Trading Scheme Authority to consider responses to the Consultation in full.

Free Allocation Policy

Free allowances have been one of the most controversial elements of the EU ETS and now the UK ETS in determining its success in reducing aviation emissions. Free allowances are currently allocated to sectors at higher risk of carbon leakage, which include aviation. Carbon leakage is where carbon emissions are displaced to another country due to a lack of consistency in climate policies and their implementation. Those receiving free allowances allocated to mitigate carbon leakage will need to buy fewer allowances to cover their emissions, in turn reducing their carbon price.

The methodology for calculating free allowances differs for aviation. The UK ETS kept the EU ETS calculation methodology to maintain consistency in the transition between the two trading schemes. The methodology multiplies the aviation benchmark by the tonne-kilometre (TKM) data activity from 2010 and the reduction factor, which is set out in the UK ETS legislation (in line with EU ETS free allocation trajectory).

The Consultation addresses a number of issues which have been identified in response to the call for evidence on aviation free allocation policy. Firstly, it has been identified that the risk of carbon leakage with aviation is minimla and the Government is therefore consulting on options to speed up the phasing-out process of aviation's free allocations. There are currently three proposals for this aviation free allocation trajectory:

1. Early phase out with full auctioning applying from 2026

2. Intermediate phase out with full auctioning applying no later than 2028

3. Later phase out with full auctioning applying from 2031

Because of issues highlighted by aircraft operators, such as the impact of the Covid-19 pandemic as well as expected increases in operating costs, the Consultation also proposes a linear year-on-year reduction whereby, for example, smaller reductions are made immediately and are increased to larger reductions over time.

The Consultation also suggests mechanical changes to the aviation free allocation policy may be necessary, with responses to the call for evidence stating that taking the TKM data from 2010 is outdated and leads to a disproportionate spread of free allocations. In addition, some aircraft operators receive more allowances than their reported emissions, so avoiding paying any carbon price on their emissions. To avoid this scenario, the Consultation considers imposing a cap on the total amount of allowances aircraft operators are eligible to receive as a proportion to their reported emissions. Lastly, the current free allocation policy for aviation does not differentiate between the type of route. The Consultation suggests that this needs to be taken into account in any review to the free allocation policy in order to prevent lack of connectivity where routes become unprofitable.

Future Scope

The Consultation also discusses the potential of including SAFs and non CO2 emissions within the scope of the UK ETS and identifies future international cooperation opportunities with other trading schemes.

As SAFs are one of the main strategies for decarbonising aviation, it is necessary to consider how these will fit into the UK ETS. Currently, where a SAF meets the sistainability criteria set out in the Renweable Transport Fuel Obligation (RTFO) it is not subject to the obligations of the UK ETS. All SAFs are currently treated equally, although this may need to be reviewed as the use of SAFs may still lead to some GHG emissions by aircraft operators. The Government is currently reviewing how these emissions should be treated under the UK ETS. Additionally, the Government recently consulted on introducing a SAF blending mandate in the UK. The resulting proposal is a GHG reduction mandate, giving suppliers who have surpassed the mandate the ability to trade credits with those who have not supplied sufficient SAFs. The Consultation recognises the important role of aircraft operators as consumers of SAFs for the success of this SAF mandate, and seeks feedback on whether this should be taken into account in the UK ETS. In any case, the use of SAFs should only be counted once in meeting climate targets.

Aviation emissions do not solely consist of carbon dioxide, but also include nitrogen oxide (NOx) and contrails, which are the product of water vapour and soot emissions. Although these emissions currently have a net warming effect, their full impact is uncertain and there is the possibility for them in the future to have a net cooling effect. The Consultation is nonetheless interested in gathering evidence about the possible inclusion of NOx emissions in the UK ETS and welcomes information on the potential inclusion of contrails, although no long term changes would be made to the ETS policy before January 2024.

Lastly, we look at the Government's approach to international cooperation. The UK ETS currently has no linking arrangements. The Consultation proposes to mirror the exisiting arrangement set out in the Trade and Cooperation Agreement that would include UK-EEA flights and UK to Switzerland flights within the UK ETS. Flights from the UK to Switzerland account for around 2.7% of aviation emissions in the UK. The Government would then work with Switzerland to incorporate flights from Switzerland to the UK in the Swiss ETS.

Other than this proposal, the Consultation is relatively silent on international cooperation proposals, only mentioning the potential to expand the geographical scope of the UK ETS and seeking evidence on the potential benefit of international cooperation on UK ETS compliance. There is the opportunity to interact with the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) and cooperate with other carbon markets worldwide, particularly now that Article 6 of the Paris Agreement has been finalised after COP26. The Government states that it is open to potential linking arrangements.

Because aviation and its emissions are inherently international, cooperating with other emissions trading schemes worldwide is likely going to have a greater impact on reducing global aviation emissions. The UK ETS currently covers domestic flights, flights from the UK to the EEA and flights between the UK and Gibraltar, which together made up 44% of all commercial flights to and from UK airports in 2019. That still leaves over half of flights to and from the UK not covered by the UK ETS. Hopefully the responses to the Consultation will progress this matter, and there will be greater clarity on how CORSIA will unfold and be implemented in the UK as well as potential use of Article 6.

Conclusion

What new information is given from the Consultation? We get an overall view on what proposals and policy decisions the Government is inclined to make, as well as its preferences for the net zero cap and the free allocation review. We also learn more about the potential interaction of SAFs with the UK ETS, and how non-carbon emissions could be covered. Although no new decisions have been made on the international cooperation front, the Government remains open to linking the UK ETS with other schemes worldwide.

Now the UK Government has published the Net Zero Strategy, its climate targets and how they will be implemented are much clearer, which in turn gives clarity to the UK ETS and how it will fit into overall climate targets. Aviation is expected to become one of the UK's largest residual emitting sectors by 2050, along with shipping. It is one of the most challenging areas to decarbonise, and a range of measures will be required to achieve net zero in aviation. Hopefully, the UK ETS if aligned with the Net Zero Strategy and other measures such as SAF mandates and GHG removals will be a successful tool in reducing aviation emissions and achieveing overall climate policy goals.

To read our previous article from November 2021 on UK ETS - will it take off for aviation?' click here.

To read more about our take on the Net Zero Strategy, click here.

Key Contacts

Alexander Sarac

Alexander Sarac

Partner, Infrastructure Projects & Energy
UAE / Germany

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Inga Aryanova

Inga Aryanova

Managing Associate, Infrastructure Projects & Energy
London

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Michelle Headrige

Michelle Headrige

Partner, Environment & Sustainability; Construction & Engineering
Manchester, UK

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Carl Baker

Carl Baker

Legal Director, Finance
London

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