UK Emissions Trading Scheme: Island Communities Impact Assessment (ICIA)

2. Step one - Develop a clear understanding of the objectives

2.1 Policy objectives and possible impact on island communities

The UK ETS was established on 1 January 2021 by the UK ETS Authority (the “Authority”) –formed by the Scottish, UK and Welsh Governments and the Department of Agriculture, Environment and Rural Affairs for Northern Ireland.

The UK ETS aims to incentivise cost-effective decarbonisation across energy-intensive industries, the non-renewable power sector, and aviation^[4] to support ambitious climate targets across the UK. When establishing the UK ETS, the Authority committed to increasing the climate ambition of the scheme and therefore published the “Developing the UK ETS” consultation with proposals to further develop and strengthen the UK ETS, including through better alignment with net-zero targets. ^[5] The Authority has published two Government Responses and associated impact assessments setting out its policy intentions in response to that consultation.^[6]

This ICIA covers policy changes included in the final Government Response, published in July 2023, which may have an effect on island communities or impact these differently compared to other communities.

The changes to the UK ETS that have the potential to impact island communities differently are:

• The phasing out of aviation free allocation (AFA) of allowances by 2026: Companies in the scope of the UK ETS are required to purchase an allowance for each unit of emissions they produce. The Authority auctions most of these allowances every scheme year, but some are given for free to industries at risk of carbon leakage.^[7] Aircraft operators are among the participants that receive a percentage of the allowances for free. Under current UK ETS legislation, free allocations can only be used for mitigating carbon leakage.^[8] However, independent research commissioned by the UK Government showed that for aviation there is a limited risk of carbon leakage under the current scope of the UK ETS.^[9] Therefore, after thorough consideration, the Authority considered it disproportionate to maintain free allocations for the aviation sector. Ensuring free allocations are used where most needed for mitigating carbon leakage is essential as we are reducing the number of free allowances in line with the new net zero cap trajectory. This decision means that aircraft operators will have to start buying all their UK ETS allowances instead of receiving a percentage for free, which has the potential to impact operators’ costs, including those operators providing some services to island communities (some operators and island services are not currently in the scope of the UK ETS, as shown later in this document).
• The inclusion of domestic maritime in the UK ETS from 2026 for vessels over 5000GT: The UK ETS represents one part of a wider policy mix necessary to address barriers to maritime decarbonisation. The UK ETS could incentivise the adoption of low-carbon fuels, support the deployment of fuel-efficient technologies and introduce more efficient operating practices. Therefore, the Authority is including the maritime sector in the UK ETS from 2026, with the intention for this to apply to vessels over 5000GT. That threshold will capture some of the lifeline ferry services to island communities, meaning that they, along with other maritime operators under the UK ETS, will need to either reduce their emissions or purchase allowances to cover their vessels’ emissions, which could impact their operating costs. The Authority will be consulting further on the implementation of the UK ETS for domestic maritime, to finalise remaining policy details.

These UK ETS changes have the potential to impact operators providing services to island and mainland communities. Given the absence of road and rail transport options to most of the island communities, air and maritime routes play a more important role in ensuring their connectivity and viability. That means these UK ETS changes may impact some island communities differently, compared to other communities across the UK (including other island communities).

Though neither of the changes noted above will directly impact island communities, they are likely to impact operators who serve those communities. That may influence those operators’ commercial decisions, which could, in turn, impact Scottish island communities. Cabinet Secretary for Transport, Net Zero and Just Transition, Màiri McAllan, wrote to her counterpart Ministers across the UK to secure commitment that the Authority would work together to mitigate any negative outcomes to island communities due to UK ETS policy changes. All nations replied, acknowledged this risk, and agreed for the Authority to identify and address any negative impacts on these communities. The Scottish Government will therefore work with the rest of the Authority and the Department for Transport on this risk and share possible mitigations in due course.

The Scottish Government does not believe any other changes to the UK ETS would have a different effect on island communities. Therefore, this ICIA does not cover any other decisions in the Government Response. For maritime, this ICIA focuses only on the potential impact on lifeline ferry services to island communities. We have not identified any areas where the inclusion of the wider maritime sector (above 5000GT) could impact island communities differently to other communities.

Please refer to the UK ETS Business and Regulatory Impact Assessment (BRIA) for an analysis of the impact on businesses of the changes to the UK ETS outlined in the Government Response. ^[10]