From the 1st January 2019, in the absence of an agreed transition period, EU law requires that EUAs issued by the UK must be differentiated from EUAs issued by other member states. In practice EUAs issued by the UK in respect of:
- Free allocation
- Auctioned EUAs
- ‘Swapped’ EUAs, i.e. as a result of exchanging International Offsets (CERs)
will be marked in some way. It is expected that the marking will take the form of a “GB” pre-fix.
EUAs marked in this way cannot:
- Be used for compliance with 2018 emissions
- Be used by EU 27 companies for compliance with future emissions obligations
- Be used to offset a UK carbon tax in the case of a ‘hard’ Brexit
Consequently, unless the “GB” mark is removed from such EUAs or there is a change in EU legislation or UK installations are greenlighted to use UK EUAs for compliance during any Brexit transition period, UK EUAs issued after 31st December 2018 risk being worthless.
Consequence 1: no auctions or low clearing prices
Even if a transition period is agreed, the existing EU legislation will have to be revised before the “GB” marking can be removed from UK EUAs.
As a consequence of the marking legislation it is likely that the UK will refrain from auctioning EUAs, as it has previously suggested it will, for at least the first 3 months of next year or until the EU overturns or adjusts the marking legislation.
To the extent that the UK does hold EUA auctions they are likely attract less bidding interest. In the case of a transition period “GB” EUAs will likely be useable by UK installations for compliance with 2019 EU ETS obligations. Poorly subscribed auctions may well bestow some advantage to UK installations in the form of “GB” EUA prices being lower than regular EUA prices faced by EU competitors. In certain circumstances “GB” EUAs are a positive development.
Finally, buying “GB” EUAs cheaper than regular EUAs can be a trading opportunity if the “GB” marker is subsequently removed.
Consequence 2: invalid EUAs
If the UK does auction EUAs or allow issuance against surrendered CERs then marked EUAs will enter the EU ETS registry system.
Buyers across Europe must make sure that any contracts they have to buy EUAs (spot and especially forward contracts) specify that “GB” marked EUAs will not be delivered.
Consequence 3: lost International Offset (CER) exchange value
If UK installations exchange CERs for EUAs after 31st December 2018 then they will receive marked EUAs. It has also been mooted that the exchange of International Offsets will simply be blocked by the UK registry. In the event of a ‘hard’ Brexit then the value that can be unlocked by exchanging cheaper CERs for “GB” EUAs will be lost. In the event of a soft Brexit they are more likely to have value, in particular if the “GB” marking is removed at a later date.
Given the risk involved, the UK’s Environment Agency recommends that UK Operators and Aircraft Operators with remaining International Offset entitlement:
“may want to consider using up any remaining international credit exchange entitlement they may have to exchange international carbon credits for unmarked allowances before 1st January 2019. After this time any International Credit exchange transactions will result in the creation of marked allowances which cannot be used for surrender.”
In short, given that CERs trade at a substantial discount to EUAs, it would be prudent to buy CERs for any remaining international credit entitlement and swap these for EUAs before 1st January 2019.
A final consideration
Unmarked UK EUAs (i.e. those issued before 1st January 2019) can be sold in the EUA market at their full market value or can be used for compliance with the EU ETS (by EU / EEA member states) at any time both now and in the future. In the case of a hard Brexit, because access to the UK’s access to the Community Independent Transaction Log (CITL) will be blocked after 11pm on 29th March 2019, any unused unmarked EUAs should be held in a non-UK registry account to preserve their transferability / marketability.
If you have any further questions or concerns about marked EUAs, early exchange of International Offsets or storing unmarked EUAs in a non-UK registry account, please contact the Redshaw Advisors team on firstname.lastname@example.org or +44 20 3637 1055 for more information.