The UK should change the way it accounts for emissions under its legally binding carbon budgets, whether or not it remains part of the EUETS.
An apparently technical question about the UK’s accounting for its carbon budgets raises broader questions about alignment of targets and policy instruments.
The UK’s carbon budgets are legally binding obligations under the Climate Change Act (2008) to limit total emissions from the UK. Checking whether emissions are within the budget ought to be simple. Measure the UK’s emissions to see if they are at or under budget. If not there’s a problem.
But it does not work that way. For sectors not covered by the EUETS actual emissions are indeed used. However for those sectors covered by the EUETS – power generation and large industry – emissions are deemed always to be equal to the UK’s allocation under the EUETS (which is made up of both auctioned allowances allocated free of charge), whatever emissions are in reality. Actual emissions from the covered sectors could be much higher and carbon budgets would still be met
While this may sound bizarre, there was a logic to it when the rules were established. If UK emissions from the traded sector are above the UK’s allocation UK emitters need to buy in EUAs. If the scheme were short of allowances, as was expected when present accounting rules were set, the additional EUAs bought by UK emitters to cover emissions above the UK’s allocation would lead to reduced supply of EUAs for others. There would in consequently be reduced emissions elsewhere matching the increased emissions in the UK. The approach was therefore to some extent a reliable measure of net emissions. It also aligned with the EUETS having clear National Allocation Plans (NAPs) for EUAs for each Member State, something that no longer exists.
Now this type of accounting no longer makes sense. With a large surplus of allowances in the EUETS, if the covered sectors in the UK emit more than their budget they will simply buy surplus allowances. These allowances would otherwise almost all eventually be placed in the Market Stability Reserve (MSR). Under current proposals (and indeed most likely eventualities), these EUAs would eventually be cancelled. Additional emissions in the UK are therefore not balanced by reductions elsewhere – they simply result in buying surplus EUAs which would never be used. This type of situation is sometimes called “buying hot air”.
To avoid this occurring in future, accounting for carbon budgets needs to change to actual emissions. This will necessarily happen anyway if the UK leaves the EU ETS. UK allocations under the EUETS will no longer exist. Accounting cannot be based on a non-existent allocation.
But even if the UK stays part of the EU ETS the basis of accounting should change to prevent the UK is meeting its carbon budgets by simply buying in surplus EUAs.
The possibility of buying in surplus to cover UK emissions appears quite real. UK emissions were above allocation until quite recently. This was not too serious a problem then, because carbon budgets were being met fairly comfortably anyway. However the situation may recur under the 2020s and early 2030s under fourth and fifth carbon budgets, which will be much more challenging to meet. Total UK emissions could be allowed to rise above those carbon budgets simply as a result of an accounting treatment.
When a target applies to a jurisdiction that does not wholly align with the policy instrument there will always be a need to consider circumstances in assessing whether targets are being met. The UK should not be able to meet its carbon budgets simply due to an accounting convention. Current rules were put in place before the current oversupply under the EUETS arose. It is no longer fit for purpose. It should be changed to accounting based on actual emissions whether or not the UK is part of the EUETS.
Adam Whitmore -20th June 2017
 This consists of auctioning plus free allowances plus UK allocation under the NER. In Phase 4 it would also include any allocation from the Innovation Fund. Future volumes placed in the MSR and thus excluded from auctioning would also be deducted from the total. If the UK were to leave the EU ETS and backloaded UK allowances currently destined for the MSR were to return to the market this would have a significant effect on measured performance against carbon budgets under current accounting.
 Whether this led to total actual emissions being above carbon budgets would depend on the performance of the non-traded sector.