The EU Emissions Trading System - Energy and Climate Change Contents


4 UK unilateralism

125.  If the policies that we are advocating at the EU level are to be effective, it is important to signal the continued support of, and confidence in, the ETS policy as the main vehicle to reach the EU's international commitments on climate change. This means that individual Member States should not adopt policies that undermine the effectiveness of the EU ETS.[175]

126.  Whereas EU leadership internationally is necessary to stimulate further action, unilateral action by individual Member States is less likely to be beneficial and risks undermining the EU ETS. If Member States break ranks within the EU, it could unbalance competitive positions within the EU and weaken the EU's negotiating position. The potential for individual Member States to allow access for different kinds of offsets is just one example of a unilateral action that could damage the coherence of the scheme. In this Chapter, we look at the possible effects of the UK's unilateral action to support the carbon price and how it could damage both UK competitiveness and the efficiency of EU ETS.

The Carbon Price Floor

127.  On 23 March 2011 the Chancellor announced a Carbon Price Floor of £16 per tonne of carbon dioxide in 2013, rising to £30 by 2020 in 2009 prices. The Carbon Price Floor sets out a minimum price of carbon that would apply only in the UK. It works by charging a "top up" tax on emitters if the price of EU Allowances falls below the pre-determined price floor. The starting price would be equivalent to £19.16 in estimated 2013-14 prices. The aim of the Carbon Price Floor is to provide a stronger, more certain carbon price for investors in the face of the weakness and volatility of prices in the EU ETS.[176]

CHANGING PRICES

128.  HMRC estimates that the levels the Government has set for 2013 would be equivalent to £4.94 per tonne of carbon dioxide "extra" tax, on top of the forecast price of carbon established by the EU Emissions Trading System in 2013-14. Indicative rates for 2014-15 and 2015-16 will be equivalent to £7.28/tCO2 and £9.86/tCO2 respectively.[177] However, these estimates were made before the price of EU Allowances fell to just €7. The analyst Point Carbon has revised its estimates of Phase III EU ETS prices to suggest a price of about €8.[178]

129.  The lower the price of EUAs, the more "top up" tax UK emitters will have to pay in comparison with EU emitters. The price of EU Allowances is the lowest it has been for years. At present prices, we calculate that the power sector and industry in the UK would be subject to an exorbitant top-up tax of around £10 per tonne in 2013. By 2030, emitters could be facing a top-up tax of £25 per tonne. This could have a devastating effect on UK industry. The Government should immediately update and publish its assessment of the range of possible top up rates that will be necessary under the Carbon Price Floor in the light of current carbon prices and forecasts for Phase III.

THE RATIONALE FOR THE CARBON PRICE FLOOR

130.  As we noted in the previous chapter, the EU ETS provides a broad encouragement for emissions reductions, but other policies may be necessary to overcome other market failures. For example taxation, subsidies and regulation may be required to support the research, development and deployment of new technologies or behavioural barriers to energy efficiency. Witnesses argued that individual states should use the policy tools that were most appropriate for their own specific circumstances, as noted in Mark Lazarowicz MP's report into the EU ETS.[179]

131.  The UK is in a particularly difficult position because of its extremely challenging investment needs and renewable energy targets. Under the EU Renewable Energy Directive 2009 the UK must generate 15% of energy from renewables by 2020.29 In order to meet this target, approximately 30% of electricity generation would need to come from renewable sources by 2020, up from 6.6% in 2009.30 According to DECC, this target is equivalent to a seven-fold increase in UK renewable energy consumption from 2008 levels: the biggest requirement of any EU Member State and a reflection of the UK's disappointingly slow progress in developing renewable energy sources. In order to create a low-carbon electricity system and to ensure security of supply, the UK is likely to need £200bn of investment in the energy sector by 2020, which is equivalent to half of the capital investment requirements needed in the EU over the period.[180] Faced with the scale of the challenge, the UK must develop additional incentives for investment in the sector over and above the signals provided at the EU level.

132.  The Government has engaged in domestic action in the traded sector because it believed that the EU would continue to lower its cap on emissions and that a high carbon economy will become extremely expensive.[181] In this context, some witnesses argued that the Government was right to provide further climate change policies, including ones that complement the EU carbon price, to ensure a UK specific investment signal.[182] Furthermore, unilateral action in the UK could spur the Commission to work on tightening the EU ETS to ensure that it generated stronger signals.[183]

INTRA-EU LEAKAGE

133.  We recognise that incentives are needed to increase the amount of renewable generation available in the UK. However, the majority of our witnesses believed that the introduction of a unilateral carbon price floor was an extremely risky strategy that will increase the problem of leakage from the UK. By applying a minimum price of carbon in just one country, the UK is exposing UK businesses to higher prices than the rest of the EU.

134.   The threat of leakage within the EU is particularly problematic for the electricity sector, which is otherwise unaffected by leakage from outside the EU. As we showed in our Report on A European Supergrid, levels of interconnection capacity already amount to 3.5 GW and are expected to reach 16 GW by 2030 and 35 GW 2050.[184] Electricity is readily transportable and can be traded between the UK and mainland Europe on an instantaneous basis based on spot market prices. This makes electricity generation more susceptible to carbon leakage than other sectors, such as goods manufacture, which may be restricted by difficulties associated with relocation of production.[185]

135.  The Carbon Price Floor will artificially raise the price of electricity in the UK by increasing the price of emissions more than in other countries. Over time, a significant difference between electricity prices in the UK and electricity prices on the continent would create an incentive for increased imports of electricity. The policy therefore risks the economic future of the UK's conventional generation, potentially harming both the UK's economic future and security of supply. It may lead to higher carbon emitting flexible generation plant in the UK closing earlier, whilst similar generation plant in neighbouring Member States enjoys a longer operating life.[186]

136.  Flexible generation plant (which is almost all fossil-fuelled) will be important for security of supply in the short-term, until lower carbon emitting generation investment replaces it. National Grid argued that whilst it was desirable for investors to have the certainty which the carbon price support mechanism would provide, it should not be set substantially above the EU ETS price level in order to avoid "exporting" carbon emissions.

137.  Of equal concern is the potential flight of new industrial capital to other EU countries or to countries outside the EU.[187] We heard that the Carbon Price Floor has the potential to damage the competitiveness of UK industry at a time when energy intensive sectors have an important role to play in promoting economic recovery. As we pointed out in our Report on Electricity Market Reform, the early introduction of a high Carbon Price Floor is likely to have a negligible impact on the deployment of renewables.[188] Given the high level and early date for introduction, this has all the hallmarks of a revenue raising mechanism for Treasury rather than a scheme intended to stimulate low carbon investment in the electricity sector. [189]

ENVIRONMENTAL EFFECTIVENESS

138.  The incentive created by the Carbon Price Floor means that the UK is likely to achieve greater emissions reductions, but those reductions will "leak" to other Member States. In other words, because the amount of emissions allowed in the EU ETS is capped at a European level, reducing emissions in any particular Member State will not reduce overall emissions—emitters in other countries would simply have more EU Allowances available and would not need to reduce their own emissions as much.

139.  If the variance between the Carbon Price Floor and the ETS price becomes large, the impact will be a redistribution of CO2 emissions across the EU and an increase in the overall cost of CO2 abatement. Effectively, the UK would subsidise higher fossil fuel emissions elsewhere in Europe. Interventions targeted at the same emission sources covered by the EU ETS would simply re-distribute carbon emissions, undermining confidence in the market mechanism and increasing the societal costs of emission abatement.[190]

EFFECT ON THE EU ETS

140.  By pursuing increased emissions reductions at the Member State level, there is also a risk that the UK could reduce the overall economic and environmental effectiveness of the EU ETS. Paying extra for emissions reductions in the UK could reduce the overall price of EU Allowances and signal a lack of faith in the importance of EU ETS as the main policy for emissions reduction in the EU.

141.  Legally, individual Member States remain free to create the policy frameworks which enable their domestic industries to maximise competitive advantage within the EU ETS.[191] However, several witnesses warned that domestic policies should be consistent and compatible with the EU ETS and should aim not to undermine the price signals it gives.[192] Regional acceleration of carbon reductions lowers the overall demand for allowances, thereby reducing the EU-wide carbon price (while increasing local costs) and slowing the pace of abatement elsewhere.[193] The UK Carbon Floor Price could make the EUA price fall by reducing demand for allowances. In doing so, it could allow higher emissions elsewhere, reduce the price signal for long-term investment and exacerbate the problem of carbon leakage from the UK to the rest of the EU.[194]

142.  Reports by Credit Suisse and the Institute of Public Policy Research pointed out that the effect of the UK Carbon Floor Price was likely to be a rise in consumer energy prices and an increase in fuel poverty. It would also generate windfall profits for existing energy generators of around £1 billion per year—notably for nuclear power stations which would benefit from increased electricity prices, with no need for EU Allowances—while doing nothing to reduce emissions.[195]

143.  We can see two potential reasons for introducing a Carbon Price Floor: (1) raising revenue; and (2) helping to achieve a low-carbon generation more quickly in the UK than in the rest of the EU by creating certainty for investors. However, we are concerned that the mechanism would not reduce emissions overall, because reductions made in the UK would be soaked up in the rest of the EU.

144.  We believe that the Carbon Floor Price is one example of a policy that puts the robustness of the EU ETS at risk and impacts on UK competitiveness without real environmental benefit. In October, Rt Hon George Osborne MP said that "we are not going to save the planet by putting our country out of business. We're going to cut out carbon emissions no slower but also no faster than our fellow countries in Europe". Ironically, though, it is the Chancellor's Carbon Price Floor policy that is causing the UK to go faster than the rest of Europe in the one area where that will serve no useful purpose. By artificially supplementing the cost of EU Allowances in the UK, no extra emissions reductions will be achieved because the traded sectors are capped at the EU level.

145.  In our oral evidence session on DECC's Departmental Annual Report and Accounts, the Secretary of State attempted to explain the Chancellor's words by telling us that:

I quite understood in the context of a conference speech the difficulties of pointing out the fact that our tradable sector is meant to move in line with the rest of Europe, and that is actually built into the carbon budgets and is effectively automatic. It is an automatic feature of what we are committed to, that the tradable sector will move [at the same pace as the rest of Europe].[196]

If, as the Secretary of State suggested, the Chancellor was arguing that the UK should go no faster than the rest of Europe in the sectors covered by the EU ETS in particular, then we find the policy of the Carbon Floor Price even more perverse: the Carbon Price Floor pushes the UK ahead of the rest of the EU in the one area where increased emissions reductions will have no overall environmental benefit.

146.  The Carbon Price Floor is unlikely to convince other Member States to adopt a minimum price of carbon. Unilateral action by Member States in sectors covered by the EU Emissions Trading System will cause intra-EU carbon leakage. It is unlikely to reduce emissions in the EU. However, it will increase relative costs in the UK and reduce the overall efficiency of EU ETS. We agree that the shift to a low-carbon economy is vitally important, but we believe that targeted support for low-carbon technologies through feed-in tariffs would be a more effective way of achieving it.

147.  We are concerned that this Treasury policy is indicative of an emerging trend. The Treasury has recently intervened several times in policies to promote low-carbon development, with the result that political risk, investment risk and the cost of capital are increased. These risks are particularly acute in this instance. We do not believe that the levels of the Carbon Price Floor will be sustainable as the difference between the UK tax and the price of EU Allowances widens and this kind of uncertainty can deter large investors.

148.  The Treasury's North Sea tax grab in last year's Budget and its intervention on solar Feed-in Tariffs both damaged fragile investor confidence at a time when unprecedented amounts of low-carbon investment are needed. The Carbon Price Floor is in effect a tax on UK business with little environmental justification. We wonder whether it will prove to be a third example of a policy for which DECC is responsible being destabilised by Treasury intervention.


175   Ev w5 [Vattenfall]; Ev w41 [SSE]; Ev w68 [RWE UK]; Ev w70 [EDF Energy]; Ev 70 [IETA]; Ev w35 [E.ON] Back

176   HM Treasury and HM Revenue & Customs, Carbon price floor: support and certainty for low-carbon investment, December 2010 Back

177   HMRC, Carbon Price Support, Tax information and impact note, 23 March 2011 Back

178   "Thomson Reuters Point Carbon slashes carbon price prediction for phase 3", Point Carbon, 5 December 2011 Back

179   Ev w41 [SSE] Back

180   Energy and Climate Change Committee, Electricity Market Reform, Fourth Report of session 2010-12, HC 742,
16 May 2011 
Back

181   Ev w100 [ScottishPower] Back

182   Ev w24 [Centrica] Back

183   Ev w24 [Centrica] Back

184   Energy and Climate Change Committee, Seventh Report of Session 2010-12, A European Supergrid, HC 1040, published 11 September 2011 Back

185   Ev w33 [National Grid] Back

186   Ev w33 [National Grid] Back

187   Ev w104 [Emissions Trading Group] Back

188   Energy and Climate Change Committee, Electricity Market Reform, Fourth Report of session 2010-12, HC 742,
16 May 2011 
Back

189   Ev w1 [Prospect], 10 Back

190   Ev 70 [IETA]; Ev w59 [Pricewaterhouse Coopers]; Ev w68 [RWE UK]; Ev 83 [Carbon Markets and Investors Association]; Ev w89 [INEOS ClorVinyl]; Ev w92 [Carbon Capture and Storage Association]; Ev w100 [ScottishPower] Back

191   Ev w11 [City of London Corporation] Back

192   Ev w70 [EDF Energy]; Ev w35 [E.ON] Back

193   Ev 70 [IETA] Back

194   Ev 52 [Barclay's Capital]; Ev 70 [IETA]; Ev w99 [Chemical Industries Association]; Ev 89 [ScottishPower]; Ev w3 [Eurelectric]; Ev w5 [Vattenfall]; Ev w49 [Shell]; Ev w61 [Drax Power]; Ev w41 [SSE] Back

195   Ev w54 [Friends of the Earth]; Ev w1 [Prospect] Back

196   HC 1623-i, Q 2 Back


 
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© Parliamentary copyright 2012
Prepared 26 January 2012