The UK Emissions Trading Scheme (ETS) has been running since 1 January 2021, when it replaced the UK’s participation in the EU’s version (in place since 2005). At its core, the ETS is a “cap-and-trade” system that puts a price on greenhouse gas emissions.

Here’s how it works:

• There’s a cap on the total emissions allowed from certain sectors.
• Businesses get allowances within that cap.
• If a business emits more than its allowance, it has to buy extra permits at the market price.
• If it emits less, it can sell its spare permits to others.

The cap is gradually reduced over time, so overall emissions fall.

Right now, the UK ETS covers energy-intensive industries, power generation, and aviation. But in 2024, the government asked for feedback on whether it should also cover emissions from shipping and waste.

Those proposals are now starting to take shape and on 21 July 2025, the UK government released its responses to three big consultations on the UK ETS, which took place in 2024. These covered:

• Expanding the scheme to cover the maritime sector
• Expanding the scheme to cover the waste sector
• Bringing greenhouse gas removals (GGRs) into the scheme

Businesses, environmental groups, and members of the public have all shared their views on the government’s proposals. The newly published responses set out how the government plans to move forward, making clear which ideas it will take on board and what actions it intends to pursue. In short, they represent the official government line on the future direction of the UK ETS.

In this short video, Gravis CEO Phil Kent goes back to basics, explaining how carbon credits work, before looking at where the ETS currently stands and talking about the consultation responses in more detail.

A full transcript is below.

Within the UK Emissions Trading System, which is a cap and trade model, carbon credits are issued by the government. They're tradable certificates. They exist electronically, so they exist within bank accounts or registries, effectively, where each certificate entitles the holder to emit one tonne of carbon dioxide or carbon dioxide equivalent. So what you have is, issued every year in line with the cap the government has set, a series of, effectively, permits to emit, and those permits can be accessed at a price.

Industries that are part of the scheme then have to source those credits in line with what they forecast to emit. If the aggregate emissions across all industries exceed the cap, then there's competition for those credits, which generates a price signal to the market. Ultimately, the decision then for those industries, is it cheaper to not emit, is it cheaper to debate, or is it cheaper to source the credits in the market?

So effectively, what carbon credits do is they put a price on emissions, and that price is determined by the government and set in the volume. I guess your alternative is a carbon tax, where what the government are doing is setting the price, and that price will mean the market sets the volume.

So there's two approaches. There's a tax - we see that in some places, and indeed in some applications within in the UK, whereas the cap and floor model sets the volume, and then the market will determine the price.

What we're seeing the government consult on recently is the extent to which carbon credits generated outside of what they issue as part of that cap-and-trade model, can be imported within the scheme and used as substitute credits. So in the case of high quality carbon removals - and what we mean by carbon removals is effectively a technology that's taking carbon dioxide out of the atmosphere and storing it, so this could be forestry type projects, avoiding deforestation or afforestation, or more industrial type mechanisms, so direct carbon capture with storage underground.

What the government have consulted on, and have come out recently saying they're in favour of, is the ability to generate those carbon credits from those types of projects and import in those carbon credits and being able to trade them as part of the system. What we think that does is put a price on carbon from other technologies that are not currently captured by the scheme, which provides a clear investment signal to those other technologies that we think is really important.

We would like to see it go further. We think there's a lot of capacity for emissions mitigation as part of the existing projects that are reaching the end of their life over the next 5 to 10 years, particularly in fuel biomass - so waste wood to energy or anaerobic digestion-type projects - where the projects are more operationally geared. They have a higher operating cost base compared with, say, solar or wind, and therefore, absent a subsidy, it's not clear how they cover their operating cost base and can continue to operate. Yet, the actual physical kit on the ground can likely operate for 10 to 20 years longer than the original subsidy period. So there's almost fully depreciated plant there that has the ability to continue its life, continue to generate emission reductions relative to a counter factual. In the case of waste wood, that would be that waste would go into landfill and decompose it to produce methane, now, which is a significantly more damaging greenhouse gas than carbon dioxide. So what we would like see is the government widen the scope of what they're looking for in terms of how they use the UK Emissions Trading Scheme to generate a price signal to include other technologies.

So for example, if our waste wood biomass projects could receive the benefit of a carbon credit in respect of future emissions mitigations that are truly additional beyond the current subsidy period that could be traded as part of the EU or the UK scheme, that would give a clear price signal for us investing in the maintenance of that plant to continue its life beyond the current end of the subsidy period. And we think the capacity of those assets to continue to generate is certainly there.

So it's really positive that the government are looking to leverage the UK scheme to support other technologies. We'd like to see them go further and we look forward to engaging with government more on that basis.

Important Information

This article and video have been prepared by Gravis Capital Management Ltd (“Gravis”) and are for information purposes only. They are not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. Any recipients outside the UK should inform themselves of and observe any applicable legal or regulatory requirements in their jurisdiction and are treated as having represented that they are able to receive this article or video without contravention of any law or regulation in the jurisdiction in which they reside or conduct business.

This article and video should not be considered as a recommendation, invitation or inducement that any investor should subscribe for, dispose of or purchase any such securities or enter into any other transaction in a fund affiliated with Gravis. 

No undertaking, representation, warranty or other assurance, express or implied, is made or given by or on behalf of the Investment Manager or any of their respective directors, officers, partners, employees, agents or advisers or any other person as to the accuracy or completeness of the information or opinions contained in this article or video and no responsibility or liability is accepted by any of them for any such information or opinions or for any errors, omissions, misstatements, negligence or otherwise. In addition, the Investment Manager does not undertake any obligation to update or to correct any inaccuracies which may become apparent. The information in this article is subject to updating, completion, revision, further verification and amendment without notice.

Past performance is no guarantee of future performance.

Gravis Capital Management Ltd is authorised and regulated by the Financial Conduct Authority; registered in England and Wales No: 10471852 and its principal place of business is 24 Savile Row, London W1S 2ES.