Report warns scrapping UK ETS could cost businesses £10bn

UK carbon pricing faces critical juncture as export tax risks emerge

British businesses exporting to the European Union could face up to £10 billion in additional taxes over the next decade if the UK abandons its carbon pricing system. This warning comes as the UK Emissions Trading Scheme reaches a critical decision point, with manufacturers caught between domestic carbon costs and the EU’s new border tax regime.

The stakes are high for energy-intensive industries. From 2026, the EU’s Carbon Border Adjustment Mechanism will charge import duties on goods from countries without equivalent carbon pricing. For UK exporters of steel, cement, aluminium and other carbon-intensive products, scrapping the UK ETS would trigger these charges at EU carbon prices.

This creates an uncomfortable choice. Keep the UK’s independent carbon market and accept its costs, or scrap it and pay the EU instead. Neither option is simple, and both carry significant implications for UK manufacturing competitiveness.

How the UK carbon market diverged from Europe

The UK Emissions Trading Scheme launched on 1 January 2021, replacing British participation in the EU system after Brexit. It covers roughly 30% of UK greenhouse gas emissions from power generation, industry and domestic aviation. Plans are in place to extend coverage to upstream oil and gas, domestic maritime, energy-from-waste and waste incineration sectors.

Unlike the EU scheme, the UK system operates independently. Consequently, prices have diverged between the two markets. The UK also maintains a Carbon Price Support tax of £18 per tonne of CO₂ on fossil fuel power generation in Great Britain, adding to the total carbon cost faced by generators.

To protect competitiveness, the scheme includes free allocations for energy-intensive industries. Price stability mechanisms include an Auction Reserve Price, currently £22 per tonne of CO₂ equivalent and rising to £28 in 2026, plus a Cost Containment Mechanism that can release additional permits when prices surge.

Meanwhile, the EU’s Carbon Border Adjustment Mechanism became fully operational in 2026. This targets carbon-intensive imports, aiming to prevent businesses relocating to countries with weaker climate policies. Without a UK carbon price, British exports to the EU would face CBAM duties equivalent to EU carbon prices.

Recent carbon price movements reveal market pressures

UK carbon prices peaked at approximately £100 per tonne in early 2023. By 16 January 2025, the price had fallen to £32.57 per tonne, down 11% year-on-year. For civil penalties in the 2025 scheme year beginning 1 January, the UK government set the price at £41.84 per tonne.

Third quarter 2025 data showed UK prices running roughly £18 per tonne below EU levels. This gap matches the Carbon Price Support rate, suggesting the additional UK tax on power generation creates a combined cost that exceeds EU carbon prices for electricity generators.

However, earlier in 2025, UK businesses faced a different challenge. UK firms paid over £75 per tonne compared with the EU’s approximately €85 per tonne, creating a premium of around 10% for UK businesses. This gap has narrowed, but persists because the two markets remain unlinked.

The 2026 emissions cap stands at 77.4 million tonnes of CO₂ equivalent. The first phase runs until 2030, with Phase II starting 1 January 2031. As free permit allocations phase out, analysts project UK carbon prices could reach £60 to £140 per tonne by 2030.

Government decision deadlines add urgency. The UK ETS Authority must announce its Cost Containment Mechanism decision by 18 January 2026. Ministers have stated no current plans to link with the EU ETS, though the option remains under consideration.

What removing carbon pricing would mean for exports

The £10 billion figure represents potential CBAM charges on UK exports if domestic carbon pricing disappears. This estimate covers the next decade and reflects the difference between having a recognized carbon price and facing EU border taxes.

For manufacturers of steel, cement, aluminium and similar products, the calculation is straightforward. Currently, UK carbon pricing gives exporters a CBAM exemption because the UK has an equivalent system. Remove that system, and EU importers must pay carbon duties on British goods at EU carbon price levels.

This matters because EU carbon prices have generally traded higher than UK prices in recent months. Even with UK prices rising toward £60 to £140 per tonne by 2030, CBAM exposure would shift the cost burden from UK businesses to their customers or profit margins.

The UK government’s 2024 Carbon Market Report acknowledged this risk. Officials noted that linking with the EU ETS could facilitate cheaper decarbonization through a larger, more liquid carbon market. However, linking would also mean accepting EU price levels and regulatory alignment.

Green Alliance warned that scrapping the scheme would create a multi-billion pound hole in government finances. Some of that lost revenue would instead flow to the EU through CBAM charges. This represents not just a cost to business, but a fiscal transfer to Brussels.

For energy-intensive industries, the choice involves balancing domestic compliance costs against export competitiveness. Free allocations currently cushion the impact, but these are scheduled to decline. Compensation schemes can prevent production displacement, though research from the LSE Grantham Institute notes they create perverse incentives that may increase overall emissions.

Price volatility creates planning challenges for industry

Recent price movements illustrate the challenge facing businesses. A 10% premium over EU prices in late 2025 shifted to an £18 per tonne discount by the third quarter, then rebounded. This volatility makes long-term investment decisions difficult.

Power generators face particular complexity. The £18 per tonne Carbon Price Support sits on top of ETS costs, meaning total carbon costs for fossil fuel generation in Great Britain exceed those for equivalent EU facilities. Some plant closures have been attributed to these combined costs.

The government’s Cost Containment Mechanism offers one response. By releasing additional permits when prices spike, authorities can moderate volatility. However, the mechanism must balance price stability against maintaining sufficient incentive for decarbonization.

A Department for Business, Energy and Industrial Strategy spokesperson confirmed in late 2025 that the UK ETS Authority was considering appropriate action under the cost containment mechanism. The announcement came with a commitment to decide by 18 January 2026 to provide market certainty.

This deadline matters because businesses need visibility to plan. Investment in low-carbon technology depends on expectations about future carbon prices. Too much volatility undermines confidence, while too little price signal reduces the incentive to invest.

Essential facts about UK carbon pricing and CBAM exposure

• UK carbon prices fell from £100 per tonne in early 2023 to £32.57 per tonne by January 2025, with civil penalty rates set at £41.84 per tonne for the 2025 scheme year.
• British exporters could face £10 billion in EU Carbon Border Adjustment Mechanism charges over the next decade if the UK removes its carbon pricing system.
• The UK Emissions Trading Scheme covers approximately 30% of national greenhouse gas emissions, with the 2026 cap set at 77.4 million tonnes of CO₂ equivalent.
• UK carbon prices currently run roughly £18 per tonne below EU levels, matching the Carbon Price Support rate applied to power generation in Great Britain.
• Analysts expect UK carbon prices to reach £60 to £140 per tonne by 2030 as free permit allocations phase out under current policy.
• The UK ETS Authority must announce its Cost Containment Mechanism decision by 18 January 2026, determining whether to release additional permits to moderate prices.
• Linking the UK and EU carbon markets remains under consideration but would require accepting EU price levels and regulatory alignment.

Weighing domestic carbon costs against EU border taxes

The fundamental question is whether UK businesses benefit more from an independent carbon market or from avoiding one altogether. Each path involves trade-offs between cost, compliance burden and strategic control.

Keeping the UK ETS preserves domestic policy independence. The UK can set its own cap trajectory, free allocation rules and price stability mechanisms. This flexibility allows calibration to British industrial needs and economic conditions. Furthermore, maintaining a recognized carbon price protects exporters from CBAM charges.

However, independence comes with costs. Market liquidity remains lower than in the larger EU system, potentially increasing price volatility. The Carbon Price Support adds an extra layer for power generators, creating higher combined carbon costs than EU competitors face. Some manufacturers argue this undermines competitiveness.

Scrapping the scheme would remove direct carbon costs for covered installations. Businesses would no longer need to purchase allowances or navigate compliance requirements. This could reduce operating costs and administrative burden, particularly for smaller operators.

Yet this approach triggers CBAM exposure. British exporters would face EU border taxes calculated at EU carbon prices, likely higher than current UK levels. The £10 billion estimate suggests this could exceed the cost of maintaining domestic carbon pricing. Additionally, removing the price signal would complicate efforts to meet net zero targets.

Linking with the EU system offers a middle path. Businesses would gain access to deeper market liquidity, potentially reducing price volatility. CBAM concerns would disappear, as the linked system would count as equivalent carbon pricing. The 2024 UK Carbon Market Report noted this could provide a cheaper route to net zero.

Nevertheless, linking means accepting EU carbon prices and regulations. UK prices would likely rise by roughly 25% based on recent price gaps, according to analysis from Electric Insights. Regulatory autonomy would diminish, with Brussels effectively setting British carbon policy.

For SMEs in affected sectors, the practical impact depends on export exposure and emissions intensity. Manufacturers selling primarily to the EU face the starkest CBAM risk. Those serving domestic markets or non-EU exports would see less direct impact, though supply chain effects could still ripple through.

Supporting businesses through carbon pricing uncertainty

Understanding your exposure to carbon pricing changes requires looking at both direct obligations and supply chain effects. Covered installations must manage allowance requirements, but even businesses outside the scheme face indirect impacts through energy costs and customer requirements.

For manufacturers exporting to the EU, CBAM compliance will require carbon accounting regardless of UK ETS status. Getting ahead of these requirements makes sense even before final policy decisions. ESG compliance support can help establish the reporting systems needed for either outcome.

Energy-intensive businesses should model scenarios for different carbon price trajectories. If UK prices rise toward £60 to £140 per tonne by 2030, capital investment in efficiency pays back faster. Conversely, if linking with the EU pushes prices up by 25% sooner, different project economics may apply.

Supply chain considerations matter too. Many public sector tenders now require carbon reporting and reduction plans through PPN 06/21. Even if direct ETS obligations disappear, procurement requirements persist. Our net zero program for carbon reporting compliance helps businesses meet these evolving standards.

The January 2026 Cost Containment Mechanism decision will provide a near-term indicator of government thinking. A decision to release additional permits would signal concern about price impacts on competitiveness. Declining to do so would suggest confidence that current prices support decarbonization without excessive burden.

Looking further ahead, the Phase II design from 2031 onwards remains under development. Businesses should engage with consultations on scheme design, particularly regarding free allocation rules and sector coverage. These decisions will shape competitive impacts for the next decade.

Where to find authoritative carbon pricing information

The UK government’s guidance on participating in the UK ETS provides official information on compliance requirements, auction schedules and regulatory updates. This remains the primary source for scheme rules and deadlines.

For carbon price data and market analysis, ICE Futures Europe publishes daily UK carbon allowance prices and trading volumes. This helps track price movements and understand market dynamics.

The 2024 UK Carbon Market Report sets out government thinking on scheme development, including potential EU linkage and market linking principles. It offers insight into policy direction beyond immediate decisions.

Details on the EU’s Carbon Border Adjustment Mechanism can be found through the European Commission’s CBAM guidance. This explains how the system works and which goods face border carbon charges.

For sector-specific impacts and competitiveness analysis, the Green Alliance research on UK carbon pricing provides independent assessment of policy options and their economic effects on British industry.