UK May Change Law to End Free Carbon Allowances Loophole

The British government is considering introducing legislation to close a loophole in its Emissions Trading System, which has resulted in the UK handing out free carbon allowances to the operators of offline installations who have then reaped windfalls by selling the pollution permits for cash.

The move follows in the wake of a series of reports by OPIS over the last year, which have shown that the UK and several EU governments have handed free carbon allowances worth more than $400 million to offline plants operated by some of the world’s largest steel, oil, fertilizer and chemicals companies.

The loophole might even have had the unintended consequence of encouraging operators to shut down plants.

In effect, the loophole has resulted in the operators of offline plants being handed pollution coupons, but rather than polluting and handing back those coupons to governments, operators have sold them on for cash.

In the words of the Wall Street Journal’s Ed Ballard, who wrote in October about OPIS’s investigation: “In Europe, big polluters are getting paid for doing nothing…These [free] permits are supposed to be used to prevent companies with few options for reducing emissions from being saddled with crippling costs.”

In some cases, the loophole might even have had the unintended consequence of encouraging operators to shut down plants in the UK and EU, rather than do the hard yards of investing to decarbonize their installations.

For example, an installation operator, knowing that it will receive free allowances worth, say, $50 million, at the start of a calendar year, might be tempted to shut down its European plant, emit a tiny amount of carbon, sell on its surplus free allowances and use the proceeds to provide severance pay to workers and dismantle the site.

A consultation document released in December 2023 by the UK government’s Department for Energy Security and Net Zero on revising the allocation of free allowances to installations conceded that “current rules relating to permanent cessations can… lead to some operators receiving more free allowances in the final year of activity than they require.” The government said that it was “minded to amending the permanent cessation definition either through legislation or alternative routes, such as the publication of guidance.”

How the Loophole Enabled Some to Take Advantage of the System

Most polluters subject to the cap-and-trade EU and UK emissions trading systems must buy EU and UK emissions allowances through auctions or via open markets on the ICE exchange, with one such pollution permit allowing a company to emit one metric ton of carbon into the atmosphere.

Often installations identified by OPIS were not operational at any point during a calendar year but their operators were still handed free allowances that were used to cover the costs of emissions at other plants or were sold on to other emitters for cash.

But operators in several hard-to-decarbonize sectors such as oil refining, steel and chemicals receive allowances for free every year from domestic governments. If those operators cut their emissions, they are able to sell surplus free allowances to other emitters, thereby profiting from decarbonizing their assets. The free allowance systems are designed to prevent operators in these sectors from being undercut by imports from countries where there are no levies on emitting carbon.

However, dozens of UK and EU installations have continued to receive free allowances from governments, despite ceasing their operations and emitting tiny amounts of carbon in a calendar year. Often installations identified by OPIS were not operational at any point during a calendar year but their operators were still handed free allowances that were used to cover the costs of emissions at other plants or were sold on to other emitters for cash.

For example, US fertilizer company CF Industries stopped operations at its Ince ammonia plant in northwest England in September 2021 and the facility was never operational thereafter, while an attempt to sell the facility to a U.K.-based consortium was unsuccessful. At the start of 2022, the company’s UK subsidiary was nonetheless handed 488,602 free UKAs worth approximately £38.68 million ($48.1 million), using average carbon prices for the year.

CF Fertilizers UK Limited Ince Facility Key Data

(Verified emissions data from European Commission and UK government; emission and permit numbers refer to metric tons.)

Looking Ahead to 2024

Under the British government’s proposed changes, an installation operator such as CF Fertilizers UK would have its free allowances retrospectively reassessed. Rather than receiving 488,602 free allowances, the installation would have received 6,754 allowances, reflecting its actual emissions in its last year of operating.

Lawmaker Alex Cunningham, a Member of Parliament in the UK representing the Stockton North constituency, which includes installations that received free allowances despite ceasing operations, cautioned that the current rules remain in place.

“It is outrageous that industrial sites that have shut down production, with a loss of jobs as a result, continue to benefit to the tune of tens of millions [of pounds] from loopholes in the UK Emissions Trading Scheme (ETS), so I’m pleased … that the government have listened and are proposing to put a stop to this practice,” said Cunningham, one of two MPs who tabled questions in Parliament on the subject.

“This is a consultation process, however, and we will see the final recommendations sometime next year. I hope this exercise leads to a real reform of the UK ETS and puts a stop to this shameful profiteering on the back of lost livelihoods,” the Labour MP told OPIS in December.

Loophole in Related EU Emissions Trading System

The UK maintained the same installation cessation rules that it inherited from the EU Emissions Trading System, to which the country belonged until 2021 when the country began operating its own cap-and-trade system. Indeed, most examples identified by OPIS of installation operators benefiting from the loophole took place in the EU, not the UK.

Operators of offline Italian cement plants benefited from the loophole on more occasions over 2013-2020 than installation operators in any other sector across Europe, while the Polish government handed EUAs worth €83 million ($93 million) over 2020 and 2021 to a Krakow-based steel plant and blast furnace operated by ArcelorMittal that was offline after November 2019. Like other companies receiving free EUAs for offline installations, the world’s second-largest steel producer said that it complied with the rules.

The EU already looks set to change its own installation cessation rules. The European Commission’s Expert Group on Climate Change Policy met in June 2023 and discussed a proposal to cap an installation’s designated free allocations starting the day after it is shut down.

Although OPIS has previously reported that more than $400 million of permits have been allocated to the operators of offline plants, the true figure is far higher. In early 2024, OPIS will publish the results of further research regarding other plants, which will show that in the early years of the EU ETS, several governments handed valuable free pollution permits to the operators of offline installations for as long as five years after the plants had stopped operating.

–Reporting by Anthony Lane, alane@opisnet.com and Humberto J. Rocha, hrocha@opisnet.com; Data Investigating by Maryam Naqvi, mnaqvi@opisnet.com; Editing by Michael Kelly, mkelly@opisnet.com

Tags: Carbon