UK companies use EU ETS to hedge carbon amid post-Brexit uncertainty

British companies were some of the biggest buyers of EU ETS permits, but now face an uncertain carbon price [LINDSEY PARNABY / EPA]

Some British companies are still buying permits from the EU carbon market as uncertainty over Britain’s planned domestic carbon market means they can’t yet use it to protect themselves against future price rises.

When utilities sell power – often years in advance – they also buy emissions trading system (ETS) permits to hedge the carbon price exposure of that future power generation.

British emitters were among the biggest buyers of permits in the EU ETS before Britain left the system at the end of 2020 and launched a domestic equivalent.

The government has said auctions of UK carbon permits will start no later than the second quarter of 2021. But for now, there are no British permits available.

“For all those installations that were previously covered by the EU scheme, what are they subject to now at this moment in time?” said Mark Lewis, chief sustainability strategist at BNP Paribas.

Redshaw Advisors and ClearBlue Markets, companies that assist emitters with carbon market compliance, said they have British clients buying EU carbon allowances (EUAs) to hedge their future carbon price exposure.

UK-based firms can still buy EU permits and have until end April 2021 to comply with the EU ETS for 2020. But after Britain severed ties with the single market at the end of last year, it no longer has to comply with the EU scheme from 2021 onwards.

“The only hedge available is an EUA at present. It’s not a perfect hedge. But it’s a better hedge than no hedge,” said Tom Lord, head of trading at Redshaw Advisors.

The EU and Britain have agreed to consider linking their carbon markets – a move that would eventually allow British companies to use EU permits to comply with the UK ETS.

The UK ETS – once it is properly up and running – will be very similar to its EU predecessor, covering the same industries and with only a slightly higher fine for exceeding the emissions limit, reflecting a more ambitious emissions reduction target for 2030.

But the longer it takes to link the two markets, the harder it will be to do it as they may diverge from each other.

It is still unclear whether they will even choose to link the systems.

“The UK is open to linking the UK ETS internationally in principle and we are considering a range of options, but no decision on our preferred linking partners has yet been made,” says the government’s Energy White Paper, published in December 2020.

A spokeswoman for power company RWE declined to comment on its hedging strategy, but called for the British government “to re-establish the link to the EU ETS as a matter of urgency”.

Without the link, permit prices in the UK ETS could rise quickly once trading begins, analysts said.

Energy Aspects analyst Trevor Sikorski said until several UK ETS auctions have taken place, there will be high demand and little supply of UK permits.

“We see prices initially as a premium to EUAs, unless a link [with the EU ETS] for the first year gets announced quickly,” he said.

Industrial sectors where emissions will be covered by the UK ETS said they were concerned about potential carbon price rises.

“Unfortunately, steel companies will not be able to hedge against higher future prices in the UK ETS presently,” said Frank Aaskov, energy and climate change policy manager at industry group, Steel UK.

The exact price of a UK ETS permit won’t be known until trading starts. EU carbon prices rose almost 30% last year and most analysts expect further increases.

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