Explanatory note

The United Kingdom Emissions Trading Scheme (the “UK ETS”) was established by the Greenhouse Gas Emissions Trading Scheme Order 2020 (S.I. 2020/1265). The UK ETS runs for 10 “scheme years”, which is split into two “allocation periods” (the 2021-2025 allocation period and 2027-2030 allocation period) and one standalone scheme year (the 2026 scheme year). Operators of certain industrial installations are required to monitor, submit verified reports on, and surrender “allowances” equivalent to, their greenhouse gas emissions each scheme year. Allowances (which are tradable) are held in accounts in the UK ETS registry, and there is a cap on the number of allowances that may be created. Allowances are sold at auction, but some operators of installations receive an allocation of allowances free of charge (“free allocation”) for each scheme year.

This Order amends Commission Delegated Regulation (EU) 2019/331 (the “Free Allocation Regulation”) to make three main changes to the calculation of free allocation for the 2027-2030 allocation period. To implement these main changes across the UK ETS, amendments to the Greenhouse Gas Emissions Trading Scheme Order 2020 and Commission Implementing Regulation (EU) 2019/1842 (the “Activity Level Changes Regulation”) are also made.

The first main change arises as a result of the introduction of the United Kingdom Carbon Border Adjustment Mechanism (“UK CBAM”) from 2027. Industrial installations that operate in one of the five sectors covered by UK CBAM (cement, fertilisers, iron and steel, aluminium and hydrogen) will have their annual free allocation reduced by a set amount over the 2027-2030 allocation period (see articles 19(9) and 22(3) of this Order).

Operators of “incumbent” installations will specify during the second stage of their application for free allocation in the 2027-2030 period whether they operate in any of the five UK CBAM sectors (see article 14(2) of this Order) and some operators may be required to resubmit the data they submitted in their stage one application (see article 14(3) and (6) of this Order). The operators required to resubmit will also be required to modify their monitoring methodology plan and vary their permit (see articles 10 and 16 of this Order) - these operators will later have to resubmit in 2027 the “activity level report” they submitted in 2026 (see article 28(2) of this Order). If an incumbent installation operates in a UK CBAM sector, a UK CBAM reduction factor will be applied to the calculation of their free allocation in each of the 2027-2030 scheme years (see article 19(5) and (9) of this Order). The Secretary of State, the Scottish Ministers, the Welsh Ministers and the relevant Northern Ireland department (collectively referred to as the “UK ETS Authority”) may change the UK CBAM reduction factor that applies in a scheme year via secondary legislation using powers provided for in Part 3 of the Climate Change Act 2008 (c. 27) (see article 19(9) of this Order).

Similarly, “new entrants” are required to inform the regulator, when they apply for free allocation in the 2027-2030 allocation period, if they operate in any of the five UK CBAM sectors (see Article 5(4) and (5) of the Free Allocation Regulation) and if they do, a UK CBAM reduction factor will be applied to the calculation of their free allocation in each of the relevant 2027-2030 scheme years (see article 22(3) of this Order). As above, the UK ETS Authority may make changes to the UK CBAM reduction factor that applies in a scheme year via secondary legislation using powers provided for in Part 3 of the Climate Change Act 2008 (see article 22(4) of this Order).

The second main change is to enable operators of incumbent installations to have their 2020, or 2020 and 2021, scheme year data excluded from the calculation of their “historical activity levels” (the arithmetic mean of their activity levels in the 2019-2023 scheme years) upon which their free allocation entitlement is calculated. This is in recognition of the impact of COVID-19 on activity levels in the 2020, or 2020 and 2021, scheme year/s resulting in historical activity levels that do not represent an installation’s typical activity. Where an operator seeks to have this data excluded, they must inform the regulator during the second stage of their application for free allocation in the 2027-2030 allocation period (see article 14(3) of this Order). Where an operator informs the regulator of this, their historical activity levels are recalculated excluding this data and free allocation for the 2027-2030 allocation period is based on this recalculated historical activity level (see article 14(5) of this Order).

The third main change is to provide that existing “benchmarks” (which reflect an average emissions intensity per unit of product of the most efficient installations in each sector) in Annex 8 to the Free Allocation Regulation will be used to calculate free allocation in the 2027 scheme year (an installation’s historical activity level is multiplied by the relevant benchmark as part of the calculation), and that the UK ETS Authority will subsequently adopt updated benchmarks for the 2028, 2029 and 2030 scheme years via secondary legislation using powers provided for in Part 3 of the Climate Change Act 2008 (see articles 19(9) and 22(5) of this Order). Where the UK ETS Authority does not adopt updated benchmarks for the 2028, 2029 and 2030 scheme years by 30 September 2027, the existing Annex 8 benchmarks will apply (see article 13(3) of this Order).

This Order also makes an amendment to the Activity Level Changes Regulation to clarify that the reporting requirement in Article 3(1a) (which will come into force on 1st January 2026) applies in all circumstances in which Article 3za applies (recalculation of FA entitlements) even if the installation is not an “FA installation” at the end of the relevant scheme year (see article 28(3) of this Order).

An impact assessment is available from the Industrial Decarbonisation and Emissions Trading Directorate, Department for Energy Security and Net Zero, 3-8 Whitehall Place, London SW1A 2JP and is available alongside this Order on www.legislation.gov.uk.