Research and analysis

Traded carbon values used for modelling purposes, 2023

Published 30 November 2023

Background

The Department for Energy Security and Net Zero’s (DESNZ) traded carbon values for modelling purposes are used to estimate the financial cost of purchasing allowances under the United Kingdom Emissions Trading Scheme (UK ETS) under 4 different scenarios. The UK ETS Authority governs the UK ETS – the work herein has no connection to the UK ETS Authority or any of the work or decisions of that Authority. Values quoted in this paper correspond to the period up to 2050. They should not be considered as forecasts of prices of UK ETS allowances, rather independent scenario-based projections and the actual price of allowances may fall outside of the range included in this publication.

Scenarios

The projections are all based on assumptions and the range of emissions planned to reach net zero in 2050. There is a range, rather than one series, as the pathway will be affected by elements such as GDP growth and fossil fuel prices which are impacted by issues outside of government control (for example world energy prices).

The central trajectory is based on Net Zero Strategy projected emissions and assumes a level of decarbonisation achieved through other policies to achieve net zero in 2050.

The high trajectory reflects the state of the world where fossil fuel prices are relatively lower, which make fossil fuels more competitive in comparisons with renewables, whilst the economic growth is also high. This results in higher emissions relative to the central scenario, and thus higher carbon values are needed to incentivise more abatement to meet the cap.

The low trajectory reflects the state of the word where fossil fuel prices are relatively higher, which make fossil fuels less competitive in comparisons with renewables, whilst the economic growth is also low. This results in lower emissions relative to the central scenario, and thus lower carbon values are needed to incentivise more abatement to meet the cap.

The market trajectory assumes that in the first few years, whilst market is still new, there are some unobservable market factors that affect the carbon value (transaction costs, liquidity, market inertia etc). It assumes the effects of these will dissipate over four years, the extent of foresight in the models, returning to the underlying fundamentals reflected above.

Methodology

The Department for Energy Security and Net Zero uses a fundamentals-based approach to estimate UK traded carbon values. Its Carbon Market Model (CMM) finds the equilibrium between demand for and supply of abatement over a chosen period. The CMM utilises information about future abatement costs, emissions and caps to derive carbon values. ^{[footnote 1]}

The 2023 traded carbon values are based on methodology using two data sets:

• Business As Usual (BAU) emissions projections and corresponding Marginal Abatement Cost Curves (MACCs). These have been commissioned from consultants Enerdata and produced by them using their POLES model, a top-down global sectoral model of the world energy system ^{[footnote 2]}. These BAU emissions projections and MACCs use the Department’s fossil fuel price assumptions and underlying economic growth projections.
• market prices of UKA futures contracts. This includes data on daily settlement prices of UKA futures contracts with maturities up to 2023 traded on the Intercontinental Exchange (ICE) for the first six months of 2023. Observed market prices are the best source of information when projecting the price of traded carbon. However, the forward market provided prices for liquid contracts only for end-year, so these data are used for the start of the trajectory only

Overview of assumptions

The current scope of UK ETS is assumed up to 2050. This modelling assumption is based on the current legislated policy and should not prejudge future developments in UK ETS scope expansion.

After 2030, the UK ETS cap will follow the net zero strategy emissions pathway for the traded sector.

Foresight is set as four years (Until 2047, from which it reduced one year each year to one year in 2050), this is the timeframe in which participants assess the degree of scarcity in the market and, consequently, their future abatement and carbon trading strategies.

The cost of carry is set at 3.25%, this is the rate in the model at which firms discount future investments in abatement and is sometimes called the discount rate.

Hedging is assumed to be 1.35 times the annual allowances needed in the power sector.

The model adjusts to keep a minimum price of the Auction Reserve Price (ARP) at £22, however the ARP was not triggered in any scenarios under the specified assumptions.

2023 modelling carbon values

The following estimates for UK traded carbon values have been used in the latest update to the department’s Energy and Emissions projections ^{[footnote 3]} and will be used in other models across government. These values are annual and actual prices will vary within the year. These values will be revised periodically. The 2023 updated values are shown in Table 1 and Figure 1.

Table 1: Traded carbon values for modelling purposes, £/tCO2e (real 2023)

Year	Market Carbon Values	Low Sensitivity - High Fossil Fuel Prices and Low Economic Growth	Net Zero Strategy Aligned	High Sensitivity – Low Fossil Fuel Prices and High Economic Growth
	(2023 GBP)	(2023 GBP)	(2023 GBP)	(2023 GBP)
2023	70	51	59	64
2024	72	63	76	84
2025	79	71	88	100
2026	91	77	98	114
2027	97	73	97	116
2028	98	69	98	124
2029	89	58	89	118
2030	87	56	87	118
2031	94	60	94	128
2032	101	67	101	131
2033	108	70	108	136
2034	111	72	111	139
2035	121	80	121	149
2036	128	85	128	156
2037	135	94	135	162
2038	145	104	145	170
2039	145	106	145	171
2040	142	103	142	169
2041	139	100	139	166
2042	135	97	135	165
2043	133	95	133	162
2044	133	94	133	164
2045	134	94	134	165
2046	133	93	133	167
2047	133	92	133	166
2048	135	93	135	168
2049	134	93	134	169
2050	138	95	138	172

Figure 1: Traded carbon values for modelling purposes, £/tCO2e (real 2023)

Caveats and limitations

Please note these values are based on a specific set of assumptions with respect to the policy mix, cost of fuels, level of emissions etc. Consequently, these values should not be considered as ‘forecasts’ of future prices and the Department for Energy Security and Net Zero accepts no responsibility for any outcomes arising from the use of these figures.

Prices rise and fall inevitably in a traded market, with participants able to choose how and when to approach buying allowances in time for annual compliance. There is no targeting of specific prices – but there are market stability mechanisms to manage short-term extremes (including an Auction Reserve Price of £22). 

The four modelled trajectories reflect ‘what if’ scenarios based on specific sets of assumptions that are chosen to produce a plausible and meaningful range for sensitivity analysis. As such, they are not meant to depict a likely outcome. Instead, these values represent our best understanding of fundamentals-based value of carbon allowances in UK ETS.

All trajectories assume that net zero strategy is met through other policies and ETS carbon values correspond to the cost of abatement at the margin to meet UK ETS 2023 NZ cap. Should these assumptions not hold (NZ strategy is not delivered or partially delivered through other policies), carbon values can go outside of the projected sensitivity range.

Fundamentals-based trajectories are also subject to numerous modelling assumptions in the CMM (including perfect foresight and discount rate) and in the POLES model (including cost of abatement technologies, deployment rates etc.) that attempt to simulate market participants’ behaviour in future states of the world and as a result are subject to considerable uncertainty.

1. Further information about the methodology in the report and peer reviews published previously. ↩

2. Further information on the POLES model ↩

3. Energy and emissions projections ↩