What Is the UK Emissions Trading Scheme (UK ETS)?

The UK Emissions Trading Scheme Puts a Price on Carbon for the UK’s Largest Emitters. Its Price Is Embedded in Your Energy Bills Whether You’re in the Scheme or Not.

The UK Emissions Trading Scheme — UK ETS — is the UK government’s primary policy mechanism for reducing greenhouse gas emissions from energy-intensive industries and the power sector. It works by setting a cap on the total amount of greenhouse gases that covered installations can emit, and requiring operators to hold sufficient allowances to cover their actual emissions. Operators who emit less than their allocation can sell surplus allowances; those who exceed their allocation must buy additional ones.

For most UK SMEs, the UK ETS does not directly apply — it covers large industrial installations, power generators, and aviation, not typical commercial or retail businesses. But the UK ETS affects your energy bill regardless of whether you are a direct participant, because the cost of carbon allowances flows through the electricity and, to a lesser extent, gas prices you pay.

How the UK ETS Came Into Existence

The UK participated in the EU Emissions Trading System (EU ETS) from its launch in 2005 until the end of the Brexit transition period on 31 December 2020. From 1 January 2021, the UK launched its own separate scheme — the UK ETS — to replace EU ETS participation for UK installations.

The UK ETS covers broadly the same sectors as the EU ETS: energy-intensive industries (steel, cement, aluminium, glass, chemicals, paper), electricity generators above a defined capacity threshold, and aviation for flights within the UK and to the EEA. These sectors collectively account for a significant proportion of UK greenhouse gas emissions.

How the UK ETS Works

The cap: The UK government sets an overall cap on the total tonnes of CO₂-equivalent emissions that covered installations can emit in a given year. This cap declines annually, creating increasing scarcity of allowances over time and driving the long-term carbon price signal that incentivises emissions reduction.

Allowances: UK Emissions Trading Allowances (UKAs) represent the right to emit one tonne of CO₂ equivalent. They are issued through free allocation to some covered installations (based on benchmarks for efficient production) and through government auctions. Covered operators must surrender one UKA for every tonne they emit.

The carbon price: UKAs are traded on the ICE exchange, and their market price represents the cost of emitting one tonne of CO₂ equivalent under the scheme. The UKA price has varied significantly since the scheme launched: from around £40–50/tonne in 2021 to over £90/tonne in 2022 during the energy crisis, and back to £30–50/tonne range in subsequent years.

Compliance: Each year, covered operators must surrender sufficient UKAs to cover their verified annual emissions. Failure to surrender sufficient allowances results in a penalty (currently £100 per missing tonne, plus the obligation to surrender the allowances in the following year).

How the UK ETS Affects Your Energy Bill

Electricity generators are covered by the UK ETS. When a gas-fired power station generates electricity, it emits CO₂. The operator must hold UKAs to cover those emissions. The cost of UKAs is a direct operating cost of the power station, and like all operating costs, it is reflected in the price at which the generator sells its output into the wholesale electricity market.

As the carbon price rises, the marginal cost of gas-fired generation rises proportionally, which flows through to higher wholesale electricity prices. At a carbon price of £50/tonne and a typical gas power station emitting approximately 0.4 tonnes of CO₂ per MWh of electricity generated, the carbon cost embedded in each MWh of gas-fired electricity is approximately £20 — or 2p/kWh.

This means that even businesses with no direct connection to industrial emissions — a retail unit, an office, a restaurant — are paying for the UK ETS carbon price through their electricity bills. The carbon cost is embedded in wholesale electricity prices and appears in your unit rate whether or not it is separately identified.

UK ETS vs EU ETS: The Divergence and Its CBAM Implication

Since launching separately in 2021, the UK ETS and EU ETS prices have diverged. The EU ETS has generally traded at a premium to the UK ETS — by 2023–24, the differential was typically €20–40 per tonne (approximately £17–34). This price gap has direct implications for UK manufacturers exporting to the EU under the Carbon Border Adjustment Mechanism (CBAM).

Under CBAM, EU importers of goods produced in carbon-intensive sectors must pay for the carbon cost that would have been paid under the EU ETS if the goods had been produced in the EU. If a UK manufacturer’s production was subject to the UK ETS at £35/tonne while the EU ETS price was €70/tonne, the EU importer must pay for the price differential in CBAM certificates.

The UK government has indicated a desire to align the UK and EU ETS prices over time — potentially through market linkage — but this has not yet been achieved. In the interim, UK manufacturers in CBAM-covered sectors (steel, aluminium, cement, fertilisers, hydrogen, electricity) carry a structural competitive disadvantage relative to EU-based competitors whose production faces only the EU ETS cost with no CBAM differential.

The Future UK ETS Carbon Price

The UK ETS cap is set to decline progressively toward 2050, creating increasing scarcity of allowances and a structural upward pressure on the carbon price over time. Government policy documents and independent analysis suggest the UK ETS carbon price is likely to rise from current levels over the medium term as the cap tightens — with estimates of £100–150/tonne by the early 2030s in various modelling scenarios.

Higher carbon prices increase the cost of gas-fired electricity generation proportionally, adding to the structural upward pressure on electricity prices from other sources. Businesses planning long-term energy strategy — particularly those evaluating renewable energy investments, heat pump transitions, or CHP installations — should factor an increasing carbon price trajectory into their financial models.

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