UK ETS: What Businesses Need to Know

What is the UK Emissions Trading Scheme?

The UK Emissions Trading Scheme, a cap and trade system, puts a price on carbon emissions from large industrial emitters and aviation operators. It replaced UK participation in the EU Emissions Trading System following Brexit and began operating on 1 January 2021. Most small and medium sized businesses are not directly covered by the scheme, though they may feel its effects through higher energy prices.

How the cap and trade system works

The UK ETS sets an overall cap on the total amount of greenhouse gases that can be emitted by sectors covered by the scheme. This cap reduces over time, pushing down total emissions. Businesses within scope must hold enough carbon allowances to cover their annual emissions, with each allowance permitting one tonne of carbon dioxide equivalent.

Allowances enter the market through two main routes:

• Free allocation, where eligible participants receive a portion of allowances at no cost based on benchmarks for their sector
• Auctions, where participants bid for allowances sold by the UK ETS Authority

Participants can also trade allowances with each other on the secondary market. At the end of each compliance year, operators must surrender enough allowances to cover their verified emissions. Those who emit less than expected can sell surplus allowances or bank them for future years. Those who exceed their allocation must purchase additional allowances or face penalties.

The UK ETS Authority is a joint body made up of the Department for Energy Security and Net Zero, the Scottish Government, the Welsh Government and the Department of Agriculture, Environment and Rural Affairs in Northern Ireland. This authority oversees the scheme. Day to day administration falls to the Environment Agency in England, with equivalent regulators in the devolved nations handling participants in their jurisdictions.

Which businesses are in scope

The UK ETS currently covers three main categories of emitters:

• Stationary installations with a total rated thermal input exceeding 20 megawatts, including power stations, oil refineries, steel works, cement plants and large manufacturing facilities
• Aircraft operators flying within the UK or between the UK and certain other countries
• From 2026, maritime transport will be phased into the scheme, covering emissions from large ships

The government has also consulted on bringing waste incineration and energy from waste plants into the scheme. This remains under consideration and any inclusion would likely involve a phased approach.

Smaller installations may apply for hospital or small emitter status, which can mean simplified reporting requirements or exclusion from the trading element, depending on their emissions levels. These operators typically still face carbon pricing through alternative mechanisms.

In practice, the scheme directly affects around 1,000 participants across the UK. The vast majority of businesses, including most SMEs, are not required to participate directly.

How carbon costs reach SMEs

Even though most smaller businesses are not direct participants in the UK ETS, they can still feel the effects through what is sometimes called cost pass through.

Energy generators must hold allowances for the carbon they emit when producing electricity. These costs typically get reflected in wholesale electricity prices, which in turn feed through to the rates businesses pay. Gas intensive industries may also pass carbon costs on to their customers.

This means a small manufacturer or retailer may see higher electricity bills partly as a result of UK ETS carbon pricing, even though they have no direct compliance obligations themselves. The exact amount passed through is difficult to isolate from other factors affecting energy prices, but it forms part of the broader cost of decarbonising the energy system.

Businesses concerned about energy costs can contact Ofgem for information about wholesale price trends or speak to their energy supplier about how contracts are structured.

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The UK Carbon Border Adjustment Mechanism

The government has announced plans to introduce a UK Carbon Border Adjustment Mechanism from 2027. This would apply a carbon price to imports of certain goods from countries without equivalent carbon pricing, helping to prevent carbon leakage where production shifts overseas to avoid UK carbon costs.

The proposed mechanism would initially cover sectors including iron and steel, aluminium, cement, fertilisers, hydrogen and ceramics. Importers would need to report the embedded carbon in relevant goods and pay a charge reflecting the difference between any carbon price already paid abroad and the UK ETS price.

Details remain subject to consultation and may change before implementation. Businesses importing goods in affected sectors should monitor developments through DESNZ announcements and begin considering how they might need to adjust their supply chains or reporting processes.

Policy in this area is evolving rapidly. The information here reflects the position at the time of writing, but businesses should check GOV.UK for the latest official guidance from the UK ETS Authority.

Frequently asked questions

Does my small business need to register for the UK ETS?

In most cases, no. The scheme only directly covers large installations with rated thermal input above 20 megawatts and certain aviation operators. Typical SMEs fall well below these thresholds.

Why have my electricity bills gone up if I am not in the scheme?

Power generators pass UK ETS costs through to wholesale electricity prices. This means businesses of all sizes may see some carbon pricing reflected in their energy bills, even without direct participation in the scheme.

Where can I find official guidance on the UK ETS?

The UK ETS Authority publishes guidance on GOV.UK covering registration, monitoring, reporting and allowance surrender. The Environment Agency handles day to day administration in England, with equivalent bodies in Scotland, Wales and Northern Ireland.

Will the UK ETS expand to cover more sectors?

Maritime transport is due to be included from 2026, and the government has consulted on including waste incineration. Further expansions may follow as policy develops, so affected sectors should monitor government consultations.