UK-EU ETS linkage trade turns sour

Prime Minister Starmer pledges never to re-join the EU

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Estimated reading time ~ 8 mins

Optimism that a Labour government would quickly seek a link between the UK and EU carbon markets has evaporated based on recent moves in the UK carbon price.

To recap, the UKA percentage discount to the EUA price narrowed from 52% in September 2023 to as little as 14% in mid-June. The prospect of a closer working relationship between the UK and the EU, coupled with the Labour Party’s nod to more ambitious climate policies, helped drive a convergence between the two markets in the runup to the UK general election.

The UKA price had found support at the €40 per tonne level during the first 4-5 months of the year. But beginning in mid-May, the UKA price surged by 40% over the following four-weeks, hitting a high of close to €60 per tonne. EUA prices meanwhile were broadly rangebound during the same period.

However, a notable change in market sentiment has occurred. The spread has begun to widen again, ballooning to as high as 30% in recent weeks. Far from embracing a no holds barred closer relationship with the EU, the new UK Government has maintained a ‘closer, but not too close’ narrative that seems to have spooked those who have bet on a rapid linkage between the two markets.

At a campaign rally a couple weeks before the general election, Sir Keir Starmer made it clear that the UK would not re-join the bloc, either in the short or long term, “We are not re-joining the EU, we are not re-joining the single market or the customs union.”

Asked again days before the election if there would be any circumstances where the UK would re-join the single market or the customs union within his lifetime, 61 year-old Starmer replied: “No, I don’t think that that is going to happen. I’ve been really clear about not re-joining the EU, the single market, or the customs union, or returning to freedom of movement.”

The first opportunity that Prime Minister Starmer can even begin discussing a linkage between the UK and EU ETS is May 2026. It’s then that the pre-agreed review of the Trade and Co-operation Agreement (TCA) will automatically start. Article 776 of the TCA states: ‘The Parties shall jointly review the implementation of this Agreement and supplementing agreements and any matters related thereto five years after the entry into force of this Agreement and every five years thereafter.’

Importantly, the TCA does leave open the possibility of linking, but without adding much in the way of detail. Article 392 (6) of the TCA states that, ‘The Parties shall cooperate on carbon pricing. They shall give serious consideration to linking their respective carbon pricing systems in a way that preserves the integrity of these systems and provides for the possibility to increase their effectiveness.’

Linkage is important to the UK

The act of linking your carbon market to a larger, more established market can be thought of as a country pegging its currency to the US dollar or a basket of currencies. One reason governments pursue this strategy is to reduce currency volatility with their main trading partners and to establish monetary policy credibility. The same principles apply when carbon markets decide to link-up (see Pegger thy neighbour: Why smaller carbon markets link up with larger cap-and-trade schemes).