Greenhouse Gas Emissions Trading Scheme (Amendment) Order 2025

Lord Hunt of Kings Heath Excerpts

Monday 27th January 2025 Grand Committee

Moved by

[Lord Hunt of Kings Heath]

That the Grand Committee do consider the Greenhouse Gas Emissions Trading Scheme (Amendment) Order 2025.

[The Minister of State, Department for Energy Security and Net Zero (Lord Hunt of Kings Heath) (Lab)]

My Lords, this order was laid before Parliament on 3 December 2024. Noble Lords will know that the UK Emissions Trading Scheme, UK ETS, was established under the Climate Change Act 2008 by the Greenhouse Gas Emissions Trading Scheme Order 2020 as a UK-wide greenhouse gas emissions trading scheme, contributing to the UK’s emissions-reduction targets and net-zero goal. The scheme is run by the UK ETS authority, a joint body comprising the UK Government and the devolved Governments. Our aim is to be predictable and responsible guardians of the scheme and its markets.

Under the UK ETS, operators are required to monitor, report on and surrender allowances in respect of their greenhouse gas emissions. Most allowances are purchased at regularly held auctions. However, operators in certain sectors at risk of carbon leakage are given a number of allowances for free in order to manage both their exposure to the carbon price and the risk that businesses’ decarbonisation efforts could be undermined by higher-carbon imports.

Under the UK ETS, an operator is the person who has control over an installation. Installations are stationary units at which regulated activities take place. Sub-installations represent operations carried out at an installation in respect of which free allocation operators are required to report activity levels for the purposes of the ETS.

I now turn to what this statutory instrument does. We have brought forward this SI to enable important changes and improvements to the scheme to be made. Under previous UK ETS policy, where a sub-installation ceased operation, free allowances were no longer distributed in respect of that sub-installation in the year after the year in which the relevant sub-installation ceased operation.

However, the operator was entitled to retain the full amount of free allowances made available in respect of the sub-installation without recalculation to account for the permanent cessation of the sub-installation within the scheme year. Noble Lords will readily see that this had the potential to result in the overallocation of free allowances beyond the volume required for carbon leakage mitigation, as well as the distribution of free allowances that were no longer associated with an activity that resulted in emissions.

This instrument ensures that the volume of free allocation to which an operator is entitled in the final year in which operations are carried out at one or more sub-installations is calculated by reference to the level of activity at the relevant sub-installation in that year. To facilitate this change, this statutory instrument will require that operators prepare an activity level report in respect of the final year in which operations are carried out at a sub-installation. That report will be used to recalculate the volume of free allocation to which the operator is entitled in the final year in which operations are carried out at a sub-installation, and any overallocation will be recoverable in accordance with existing scheme rules.

This instrument includes an exception to the final-year rule in circumstances in which the permanent cessation of operations at a sub-installation is part of a series of changes that has resulted in a material reduction in the specified emissions per unit of production of those pre-cessation products that continue to be produced at the installation. This exception to the final-year rule will incentivise decarbonisation, as operators that can demonstrate that the relevant requirements are met will continue to be entitled to the free allocation calculated in accordance with existing UK ETS rules, which is calculated in advance on the basis of historic activity levels.

This instrument also amends the circumstances in which an installation or sub-installation has ceased operation for the purposes of the UK ETS legislation. The previous definition of the circumstances in which an installation or sub-installation had ceased operations was at the point in time when it became technically impossible to resume operation. This definition was difficult to apply consistently in practice. The updated definitions provide that an installation has ceased operation when all regulated activities, in the case of an installation, or the relevant operation, in the case of a sub-installation, have permanently ceased to be carried out at the installation. This amendment increases certainty for both the scheme regulators and operators.

This instrument also introduces a requirement for operators to notify the relevant scheme regulator of circumstances in which all regulated activities cease to be carried out at an installation by the end of the scheme year in which the cessation occurs or within one month of the date of cessation—whichever is later—and to confirm whether the operator intends for one or more regulated activities to resume at the installation. Operators are similarly required to provide details of a cessation of operations in respect of a sub-installation in annual activity level reports prepared in relation to the 2025 scheme year and thereafter. Requiring these reports will facilitate the application of the new final-year rule.

The statutory instrument introduces a new power for regulators to issue a notice to an operator which determines that an installation or sub-installation has ceased operation for the purposes of UK ETS legislation. The new power is available in circumstances where the regulator is not satisfied that the operator intends regulated activities to resume at the installation or intends for regulated operations to resume at the sub-installation level. The change will increase certainty for operators and facilitate equivalent treatment for all installations undergoing a cessation.

The changes follow comprehensive engagement and consultation with stakeholders. Between 18 December 2023 and 11 March 2024, the UK and devolved Governments ran a consultation, seeking views on proposals to alter the free-allocation methodology for the UK ETS statutory sectors to better target those most at risk of carbon leakage and ensure that free allocations are fairly distributed. The UK Emissions Trading Scheme: Free Allocation Review covered the provisions included in this statutory instrument on permanent cessations. The responses to this consultation were in broad support of the proposed technical changes to the treatment of permanent cessations. The authority response to this consultation will be delivered in two parts; an early response to proposals on permanent cessations was published last November.

In conclusion, I have spoken at considerable length on what seems to me a perfectly sensible order that builds on the work of the last Government. It seems to me absolutely sensible and proportionate. I beg to move.

[Lord Teverson (LD)]

I do not think I have ever known something so simple be made to sound so complicated, if I am honest. Basically, this will stop people having a free ride after they have closed down a particular part of their business; I think that describes it. Therefore, it makes sense and is right to do.

Perhaps I may come back to a slightly broader canvas, because this is a really important area for the UK ETS. Free allocations come primarily from grandfather rights and work through. I presume that all free permits will cease as the UK introduces the carbon border adjustment mechanism, which I think is coming in 2027, as planned by the previous Government. Free allocations are all about carbon leakage and, when we have a carbon border mechanism, clearly, carbon leakage is solved by that instrument rather than by free issue. So will they be phased out in that time?

The Minister will also be aware that, under the trade and co-operation agreement negotiated by the previous Government, there was a strong inference that the UK ETS and the EU ETS should recombine in a single scheme. In fact, one of the issues at the moment is that the UK ETS carbon price is significantly less than the European one. This is due to what I would probably see as an overallocation of free permits.

So my question is: are this Government still considering bringing those two schemes together? This is particularly important at present because, in one year’s time, the EU will introduce its carbon border adjustment mechanism for heavy industry, but, in particular, energy exports will be taken into account by the first phase. If we do not have an equivalent scheme or are not part of a joint scheme, effectively we will be subject to tariffs in terms of those effective carbon charges.

A particular problem with the carbon border adjustment mechanism is the GB-Northern Ireland issue, because there will effectively be a tariff for carbon costs and energy between Great Britain and Northern Ireland. I visited Energy UK one or two weeks ago, and it was particularly concerned about these aspects of the UK ETS into the near future and when the EU moves forward with its well-planned carbon border adjustment mechanism. It is really important to make decisions here and get on with them, because there will be very difficult issues if we do not resolve this over the next 12 months.

[Lord Offord of Garvel (Con)]

My Lords, this statutory instrument proposes amendments to the UK emissions trading scheme, including expanding its scope to cover CO2 venting for upstream oil and gas operations, lowering the emissions cap and introducing new penalties alongside a flexible reserve mechanism. It is crucial that industries and communities affected by these changes receive the necessary support during the transition period.

The amendments introduced by this order significantly expand the UK ETS. Notably, it will now cover CO2 venting from upstream oil and gas operations, requiring companies in this sector to purchase allowances for their emissions. The adjustment of the emissions cap ensures that the allowances for companies to buy in 2025 will be reduced by 12.4%. By 2027, the number of allowances will fall by 45%, ultimately reaching a 70% reduction by 2030.

I draw noble Lords’ attention to the introduction of new penalties and a deficit notice in this instrument—fines for non-compliance linked to the carbon price, obviously designed to incentivise businesses to meet their obligations. How will these penalties be enforced in practice and are they really proportionate, particularly for industries already facing complex and burdensome regulatory frameworks? Additionally, the establishment of a flexible reserve to buffer against market volatility can be seen as a step towards ensuring stability in the carbon market, but can the Minister explain what assurances the Government can give that this mechanism will not inadvertently lead to market manipulation or instability, rather than solving it?

Requiring oil and gas companies to purchase allowances for CO2 venting could significantly increase their operational costs, placing UK producers at a disadvantage compared to international competitors in regions without similar emissions trading schemes. This could lead to carbon leakage. The Government must address how they plan to mitigate such risks.

Another concern is the regulatory burden. The introduction of additional regulations and financial costs tied to purchasing allowances may create a substantial compliance burden, particularly for smaller operators. It is essential that the Government provide clear guidance and support to ensure that businesses can adapt without undue strain.

On investment and mitigation technologies, while the scheme encourages decarbonisation, can the Minister outline how it plans to incentivise and facilitate the scale-up of carbon capture, utilisation and storage technologies? All these are said to be necessary to keep to the Government’s timetable. Further clarity is needed.

Market price volatility presents an additional challenge. Fluctuating carbon prices expose companies to financial uncertainty. While the flexible reserves aim to stabilise the market, further clarity is needed on how effective this mechanism will be in managing price volatility and ensuring long-term stability.

The introduction of penalties and enforcement provisions raises important questions about fairness and proportionality. Will penalties be applied equally to all operators, or will they be adjusted based on companies’ size or ability to comply? Can the Minister clarify how this will be structured?

It is essential that the Government spell out how they intend to carry through this order without unintended negative consequences for the industry.

[Lord Hunt of Kings Heath (Lab)]

My Lords, I am grateful to the noble Lords who spoke in this short debate. I will first respond to the noble Lord, Lord Teverson, on international co-operation on carbon pricing. I certainly accept that, as we transition to net zero, it is important that we work across international borders to drive climate ambition. Under the terms of the trade and co-operation agreement, the UK Government and the EU agreed to consider linking our respective carbon pricing schemes and to co-operate on carbon pricing. The noble Lord will know that we are working to reset our relationship with the EU and strengthen ties and improve trade and investment relationships with it, including promoting climate, energy and economic security, while recognising that there will be no return to the single market or customs union.

The Prime Minister visited Brussels on 12 December 2024, and the joint statement with President von der Leyen illustrated that the UK and the EU would take forward this agenda of strengthening co-operation at pace over the coming months. As set out in the TCA, carbon pricing remains an area where we will continue to co-operate, and it is right that we will continue to develop the UK ETS to support our climate goals and support sectors in the transition to net zero.

The carbon price within the EU emissions trading scheme is determined by the market, and it is designed this way because competitive markets are likely to deliver the most efficient transition to net zero across the economy. This will give emitters the flexibility as to how they abate their emissions, thereby allowing businesses to cut carbon where it is cheaper for them to do so.

I assure the noble Lord, Lord Offord, that, as I said earlier, we are here simply building on the work of his Government in just making a sensible adjustment to make sure that there is no free ride in removing the excess allocation of free allocations, as the noble Lord, Lord Teverson, suggested. When the production has been ended as part of a decarbonisation programme, allowing them those free allocations recognises that. We do not think that these rules will lead to disproportionate regulation or that there will be potential manipulation of the market.

On oil and gas, I will write to the noble Lord with further details on his specific question.

[Lord Teverson (LD)]

I am afraid I do have to come back to the Minister. Is it the Government’s intention to integrate, if they can, the two emissions trading systems? Is that a government goal or not? Also, do the Government still intend to do what the previous Government suggested—to introduce a carbon border mechanism for the UK at the beginning of 2027? This is pretty fundamental stuff that industry and the whole economy need to understand. If the Government do neither of those, how will they solve the problem of the EU carbon border mechanism from the beginning of next year?

--- Later in debate ---

[Lord Hunt of Kings Heath (Lab)]

My Lords, I am not sure that I can respond any further than I have already. Clearly, we are now working with the EU on some of those issues, and clearly we accept the point that we need the systems to work effectively together to deal with wastage. But I am afraid that I cannot give the noble Lord any more certainty than that.

Motion agreed.