Linking the EU and UK emissions trading schemes can support efficient trade and the cost-effective achievement of climate goals, and could avoid foregone revenue to the UK government of up to £8bn from 2025 to 2030.

In our report for Centrica, Drax, Equinor, National Grid, SSE and Uniper, we explore the case for linking UK and EU carbon markets. Effective and credible carbon pricing is widely considered as a key part of the policy toolkit for reducing greenhouse gas (GHG) emissions. The EU Emissions Trading System (ETS) was set up in 2005 and is the world’s largest carbon market by value. Following the UK’s withdrawal from the EU, the UK has operated its own separate ETS.

The UK and EU ETS are “cap-and-trade” systems: participating installations are legally required to acquire and surrender at the end of each year tradeable allowances (or permits) equivalent to their total GHG emissions in the relevant year. Total emissions from the sectors covered (industry, power generation and aviation) are “capped” in the sense that the total volume of allowances allocated in any one year is fixed (with a share being auctioned by public authorities, who receive the corresponding revenues, and the remainder allocated for free).

Participants are free to trade allowances between themselves. By putting a price on GHG emissions, schemes such as the EU and UK ETS ensure efficiency: those participants that can reduce GHG emissions at least cost will be incentivised to do so, selling allowances to other participants for whom abatement is more costly. 

Linking could allow EU ETS allowances (EUAs) to be used for compliance in the UK ETS, and vice versa. 

We find that linking can support efficient UK-EU trade and reduce the costs to both the UK and EU of meeting decarbonisation goals. A linked market would support efficient financial risk management for UK and EU participants, supporting industrial competitiveness, by creating a combined carbon market with even more depth than either market standing alone. In addition to these benefits, as part of a broader EU-UK reset, linking the schemes could be a powerful way for the UK and EU to signal intent on global climate leadership. 

We also modelled the implications for UK Government revenues from auctioned UK ETS allowances if there was a sustained carbon price differential in the absence of ETS linking. Since Spring 2023, the UK ETS allowance price has been below that of the EU ETS, reaching a peak discount of £31/tCO2 over September 2023 (over June 2024 the UK ETS discount averaged £13/tCO2). If such ETS price differentials between the EU and the UK were to persist over 2025-30, this could lead to cumulative forgone UK Government revenue of £3.5bn to £8bn. In addition, with the introduction of the EU Carbon Border Adjustment Mechanism (CBAM) in 2026 where imports into the EU have to pay a top up to the EU ETS price, a persistent UK ETS discount relative to the EU ETS could lead to UK exporters to the EU paying up to £800m into the EU budget by 2030.

Click here to read our full report Linking UK and EU Carbon Markets.