Drax power plant

First auctions of the UK's Emissions Trading Scheme graze Cost Containment Mechanism

Written by Alex Luta

Last week the first auctions of the UK’s Emissions Trading Scheme cleared at £43.99/tCO2e.  In line with expectations, it was roughly 3% above the EUA spot market of the day (€ 49.55/tCO2e), which had fallen as owners of British installations swapped EUAs for UKAs.

While most commentators believe that UKAs will continue to track EUAs in price, there is uncertainty over how the Cost Containment Mechanism (CCM), a British design innovation, may influence prices going forward. The CCM sets a threshold for the UKA price which, if persistently exceeded, may trigger interventions to bring prices down, such as bringing forward future auctions or releasing reserve allowances. The first auction cleared barely below the May CCM threshold (£44.74/tCO2e), and recent shifts in spot and forward contracts suggest that it may not be long before the CCM is triggered.

This is because the CCM formula relies on historical carbon prices applicable in Britain.  Importantly, the formula ignores the months when the UK had no such price in place, such as between the date of Brexit and last week’s auctions, during which EUAs rose by around 50%.  Our expected June CCM threshold is around £45.02/tCO2e.  At €52.22/tCO2e, this is below recent bullish EUA spot prices.

Naturally, the UK ETS is in its infancy, and prices may drift amid supply-side uncertainty.  However, it is interesting that British authorities have reserved several possible price containment contingencies while, independently, EUAs continue to explore higher ranges.

The coming years will be interesting for both ETSs. Design and relative prices will be key considerations in discussions about future linkages.  Get in touch with AFRY to stay abreast with forthcoming developments.

Get in touch with our experts

Gareth Davies

Director, AFRY Management Consulting

Alex Luta

Consultant, AFRY Management Consulting

Bradley Steel

Senior Consultant, AFRY Management Consulting

Mostyn Brown

Senior Consultant, AFRY Management Consulting