UK energy market faces ‘instability’ over carbon trading delay

The UK’s leading power companies have warned that the energy market faced “instability” unless the government provides urgent clarity on Britain’s post-Brexit carbon trading scheme.

The scheme, which came into force at the end of the Brexit transition period on January 1 to replace its EU counterpart, is designed to reduce greenhouse gas emissions by setting a cap on the levels heavy polluters can produce and forcing them to buy carbon credits to cover their annual output.

But the government is still in talks with industry about key aspects of the scheme, which has not yet started trading. This has left UK power producers selling power without knowing the cost of the associated emissions.

Typically, power producers sell electricity up to two years in advance, and before Brexit UK companies priced forward contracts linked to the cost of the EU scheme.

The sector is still waiting for the government to set the date of the first auction beyond plans to hold the process at some point during the second quarter.

Companies are also waiting on the volumes of carbon credits the UK government plans to sell during the first auction and a decision on whether the scheme will be linked to the EU programme, the world’s largest, which would establish pricing.

“I’m worried about the complete lack of a carbon price in the UK,” said Emma Pinchbeck, the head of Energy UK, an industry association whose members include SSE, RWE, Drax and EDF Energy.

“We have been very lucky not to see instability as it is, but I wonder how long that will keep going,” said Pinchbeck, adding that there was a risk that the volatility gets passed on to consumers in higher prices.

Many UK power producers have already purchased EU credit in the expectation the schemes will be linked. “Our carbon price is unknown and the market is operating on the assumption that we are going to link with the EU,” she added.

But Brussels said formal talks with the UK on a link with the EU scheme had not yet begun. “For the moment we cannot say when negotiations will start,” the European Commission said in a statement. It added the Brexit deal envisaged that the two sides would give “serious consideration” to linking the respective systems.

But the government’s recent energy white paper has raised concerns in the industry that may not happen. The policy document stated the UK was open to international linkages in general, without naming the EU specifically.

Power producer Drax said a link between the UK and EU trading schemes “should start as soon as possible,” as it would provide greater liquidity.

The lack of trading of carbon credits has caused pent up demand and Louis Redshaw of Redshaw Advisors, a London-based carbon consultancy, said the delay risked a “massive” price spike.

The UK government has set a price floor of £22 per tonne but this is still far below the current price of an EU allowance, which recently surged to a record high of more than €40 per tonne.

“There will be more buyers than sellers on the first auction,” said Redshaw. The situation is “a car crash in slow motion,” he warned. “Brexit is difficult enough for UK industry, why is the government insisting on this own goal when it comes to the cost of carbon?”

Power producer SSE recently said it would likely have to suspend forward hedging of its thermal power generation in the UK, until the new scheme was up and running.

Although companies have until April 2022 to submit their carbon allowances for this year, generators typically hedge their contracts one or two years in advance.

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Iwan Hughes, head of policy at VPI Generation, said the huge uncertainty made it difficult for power companies to know whether or not to operate their power plants. 

“Without a UK carbon market, neither industry nor gas power generators know their marginal cost to operate,” he said. He warned that since leaving the EU scheme at the start of the year, every time a power plant generated electricity it was “increasing its unknown liability in carbon”.

In a statement, the government said the new UK trading scheme was “a crucial step towards achieving the UK’s target for eliminating our contribution to climate change by 2050”, adding that it was “more ambitious” than the EU scheme. It said it would “soon consult” on how the scheme would “align with our world-leading net zero target”.

Additional reporting by David Sheppard