The UK Emissions Trading Scheme carbon price has been volatile. After trading at elevated levels in the early 2020s, the allowance price fell sharply through 2023 and has moved considerably since. For organisations using carbon pricing as part of their decarbonisation business case — in energy audits, transition plans or ESOS action plans — this volatility has real consequences. Here is what you need to understand.
How the UK ETS works and why it matters for decarbonisation decisions
The UK ETS puts a price on carbon emissions from large industrial installations, power generation and aviation. The cap on total emissions falls over time, which — in theory — drives the allowance price upward as scarcity increases.
For organisations that are not directly covered participants in the scheme, the UK ETS carbon price still matters because it flows through into the financial case for decarbonisation. When we build a 15-year NPV appraisal for a boiler replacement, heat pump installation or building fabric upgrade, we include a carbon cost saving line — the tonnes of CO₂e avoided, multiplied by a projected future carbon price. The higher and more stable that price, the stronger the financial case for investment today.
The volatility problem
Using a single carbon price assumption in a long-run financial model introduces meaningful uncertainty. A project that looks attractive at £40/tCO₂e may look marginal at £20/tCO₂e, and compelling at £70/tCO₂e.
The standard approach we use — and recommend — is to run a sensitivity analysis. The base case uses the central UK ETS price projection aligned to HMT Green Book guidance. We then show the same NPV at a low and high scenario, allowing decision-makers to understand how sensitive the investment case is to carbon price assumptions. For most energy efficiency measures with paybacks of under eight years on energy cost savings alone, the carbon price sensitivity is secondary. For longer-payback technologies — deep retrofit, hydrogen-ready heat networks — the carbon price assumption becomes more important.
What the UK ETS reform pipeline means
The UK Government has been consulting on UK ETS reform, including the potential expansion of the scheme to additional sectors and the trajectory for the overall cap. Expanding the scheme to cover commercial buildings — a possibility that has been discussed — would directly affect landlords and companies with large property footprints, by creating a direct compliance cost for carbon emissions from heating and power.
We are not at that point yet. But the direction of travel in UK climate policy is clear: the cost of carbon is structurally expected to rise over the medium term, even if the short-term price is volatile. Organisations that build decarbonisation plans on the assumption that carbon will always be cheap are taking a policy risk that investors and lenders are starting to price.
Practical implications for your energy and decarbonisation programme
Three things follow from this for organisations currently planning investment decisions:
First, do not let short-term UK ETS price weakness undermine the long-run business case for decarbonisation. The financial case for energy efficiency investment is driven primarily by energy tariff savings — gas and electricity — not carbon price. Carbon pricing adds value to the case; it should not be the foundation of it.
Second, use sensitivity analysis. If a technology or measure is only financially viable at high carbon prices, that is important information. It means the investment case relies on a policy assumption, not a market certainty, and the board should understand that.
Third, if your organisation is a large energy user — ESOS-qualifying or larger — the directional risk from UK ETS expansion is worth including in your TCFD transition risk assessment, even if you are not currently a covered installation. The policy trajectory is material to long-run energy cost projections.
The bottom line
Carbon price volatility is not a reason to defer decarbonisation investment. It is a reason to build the business case correctly — on energy cost savings first, with carbon savings as a supplementary benefit — and to stress-test the financials across a range of carbon price scenarios. Organisations that do this now will have more defensible investment plans and more resilient balance sheets as UK climate policy tightens.
If you are building or reviewing a decarbonisation business case and want to make sure the carbon price assumptions are handled correctly, speak to our team about our decarbonisation pathway service.