Sandbag briefing The UK Carbon Floor Price by benbenzhou

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									The UK Carbon Floor Price


  Introduction
  In the Autumn statement in 2011 the
  Government announced that it planned to                                                     About Sandbag
  introduce a ‘floor price’ for the carbon market
  beginning in April 2013.                                                       Sandbag is a UK based not-for-profit
                                                                             organisation campaigning for environmentally
                                                                             effective carbon markets and focusing on the
  This short briefing explains what a carbon floor
                                                                                     EU Emissions Trading System.
  price is and why the UK Government believes it
  is needed. It also highlights some concerns and                              Our campaigns are supported by in-house
  briefly explores alternative options.                                          research monitoring the environmental
                                                                                robustness of the caps, the distribution of
  The Government is seeking to create the right                                     allowances, and how key sectors,
  conditions to decarbonise the British economy,                               installations and companies in the scheme
  however, the challenge is to grow the
                                                                                             are affected by it.
  sustainable energy sector whilst being mindful of   For more information visit our website at
  the impact of policy interventions on energy          www.sandbag.org.uk or email us at
  prices and economic competitiveness. Whilst is                info@sandbag.org.uk
  very important that prices for carbon are
  increased from their current low level, the
  decision to introduce a carbon floor price in the UK carries considerable risk and it is
  questionable whether it will meet this challenge.

  What is the UK carbon floor price and why is it needed?
  Since 2005 Emissions of greenhouse gases have been subject to regulation under a market
  based mechanism known as the EU Emission Trading Scheme (ETS). This European wide policy
  regulates roughly half of all emissions in the EU. A finite number of allowances1 to emit are
  created and distributed. Participating installations must then surrender allowances to match their
  emissions produced. Those who can cheaply and easily reduce their emissions can sell spare
  allowances to those who find it harder or more expensive to do so. The balance of supply of and
  demand for allowances creates a traded price for carbon.

  At present, because there are too many allowances available in the market compared to the
  demand, prices are relatively low – currently around £6.502 per tonne of carbon dioxide
  equivalent. As the White Paper on Electricity Market Reform puts it “the carbon price resulting
  from this cap has not been stable, certain or high enough to encourage sufficient investment in
  low-carbon electricity generation in the UK”3. In this context ‘sufficient’ means compatible with
  Britain’s commitments under the Climate Change Act to achieve emissions reductions of 80% by
  2050 relative to 1990 levels.

  In order to provide the robust and reliable incentive that the ETS is so-far failing to deliver, the UK
  has decided to introduce a unilateral “carbon floor price”. This essentially consists of a “top-up
  fee” paid to Treasury, set in advance and announced in the annual Budget statement.


  1
    Allowance = European Unit Allowance (EUA).
  2
    Price taken from www.pointcarbon.com on the 19th March.
  3
    DECC, Planning our electric future: a White Paper for secure, affordable and low-carbon electricity, July 2011,
  http://www.decc.gov.uk/assets/decc/11/policy-legislation/emr/2176-emr-white-paper.pdf, [Accessed 12 March 2012].
Sandbag briefing                                                    The UK Carbon Floor Price

   How will it work?
   The UK’s coalition Government has stated that it wishes to introduce a Carbon Floor Price as
   part of a range of policies to drive investment into low carbon solutions. The stated aim of the
   policy is to ensure that the price paid for carbon by electricity producers in the UK is around
   £15.70/tonne CO2e in 2013 rising in a straight line to £30/tonne CO2e in 2020 and £70/tonne
   CO2e in 2030.4 The floor price introduces changes to the existing Climate Change Levy, which
   was a downstream tax on energy use rather than a direct upstream tax on greenhouse gas
   pollution.

   The additional sums required to meet the floor price are levied at the point of sale of fossil fuels5.
   This means they are paid by the suppliers of coal and gas sold into the electricity market. Oil
   suppliers did not pay the Climate Change Levy (CCL) since they were already taxed under fuel
   taxation policies. Because this charge was higher than the CCL they were able to claim a rebate
   to take the level of fuel tax down to the equivalent level of the CCL. Under the new system the
   rebate is reduced so less money may be claimed back keeping it in line with the new higher rates
   due under the carbon floor price policy.

   The floor price is set to start in April 2013 and is expected to continue indefinitely, although each
   annual Budget Statement and Finance Bill provides an opportunity for the Treasury to revise the
   policy.

   The amount of top up to be paid is calculated two years in advance by comparing the future
   traded price of carbon for the tax year concerned. The top up rate for 2013-14, announced in
   2011, is: £4.94/tCO2e6.

   In the 2012 Budget the top up rate to be paid in 2014-15 will be announced. Over the last twelve
   months, because of the substantial over-supply of allowances the price of carbon in Europe has
   fallen sharply. The UK’s target carbon floor price of £17/tonne in 2014 is over double the future
   traded price for that period (at around £8/tonne). This poses an interesting dilemma for Treasury
   since the top up rate will have to rise substantially if the floor is to be met – this will result in more
   revenue than anticipated but impose a greater cost on British industry compared to our European
   competitors.

   The Government proposes to introduce compensatory policies for certain sectors that it
   considers will be competitively disadvantaged by the higher electricity costs created by the policy.
   This would require some form of rebate/subsidy being made available and Government is
   currently consulting on the precise form of policy support. A support package worth £250m has
   been pledged over the current spending review period (next 2-3 years) to protect energy
   intensive industries. These policies will be subject to EU state aid clearance.

   Evaluating the Government’s policy
   The key question is whether the extra cost the carbon floor price places on industry and
   consumers is justified in terms of stimulating investment in UK energy infrastructure and as an
   effective means of reducing emissions. Starting as it does in 2013, before any significant

   4
     HM Treasury, Carbon price floor consultation: the Government response, March 2011, http://www.hm-
   treasury.gov.uk/d/carbon_price_floor_consultation_govt_response.pdf, [Accessed 12 March 2012].
   5
     HM Revenue & Customs, Carbon Floor Price, March 2011, http://www.hmrc.gov.uk/budget2011/tiin6111.pdf, [Accessed 12 March
   2012].
   6
     DECC, Planning our electric future: a White Paper for secure, affordable and low-carbon electricity, July 2011,
   http://www.decc.gov.uk/assets/decc/11/policy-legislation/emr/2176-emr-white-paper.pdf, [Accessed 12 March 2012].
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Sandbag briefing                                       The UK Carbon Floor Price

   volumes of new low carbon capacity can be installed, the carbon floor price creates a windfalls
   for previous investors in existing low carbon capacity, such as nuclear, whose decision were
   already justified by the market conditions under which they originally invested. Some lobby
   groups have argued that for this reason the floor price policy is illegal under EU State Aid Rules.

   Will it secure investment?
   The main problem with the floor price is that it is set each year in the Finance Bill therefore there
   is no long-term certainty of what the top-up levy will be. The more the UK price deviates from the
   prices paid in the rest of Europe the more criticism the policy is likely to attract and it will be
   perceived as subject to a high degree of political risk.

   The carbon floor price is also a relatively imprecise tool in terms of securing investment
   compared to other policy options that have either been implemented or proposed. The
   Renewables Obligation, for example, provides a strong incentive to invest in new renewable
   capacity with financial feedback mechanisms that reward those who build new capacity to meet
   their obligations at the expense of those companies who do not. The proposed auctioning of fixed
   price contracts (contracts for difference or ‘CfDs’) for new low carbon power capacity included in
   the Governments Electricity Market Reform package are also targeted at securing new
   investment in projects. Under these contracts the future price of wholesale electricity is
   underwritten by Government but monies are only received once new capacity is up and running.
   In contrast the Carbon Floor Price is paid by everyone irrespective of whether new capacity is
   built or not – it is therefore the owners of existing low carbon capacity that stand to benefit the
   most. It seems highly likely that the Carbon Floor Price is primarily a means for the Treasury to
   limit its exposure under the proposed contracts for difference. This is because a low carbon price
   feeds into the wholesale price of electricity making it more likely that the overall wholesale price
   will be lower than the agreed price in the contract, meaning that the Government will have to pay
   out.

   Will it have an environmental impact?
   The UK’s floor price will hopefully reduce the carbon intensity of the UK’s energy system,
   however, it will not reduce the overall amount of CO2 being emitted. The overall number of
   carbon allowances allocated across Europe via the emissions trading scheme (ETS) determines
   the level of pollution that will occur over time. Simply changing the price at a national level does
   nothing to alter this. While national prices rises should encourage more abatement to take place
   within the UK, this simply increase the share of carbon allowances available to the rest of
   Europe. It is incredibly important therefore that a floor price does not become a substitute for
   ensuring that there is enough demand for emissions reductions in the emissions trading scheme.

   This can only be effectively and efficiently achieved by tightening the EU caps on emissions, or
   through an instrument that will recalibrate the ETS. If other large countries were to follow suit and
   introduce floor prices to meet their national climate goals, it could have an overall negative
   impact across Europe. Consistently over-paying for emissions reductions locally would increase
   the number of spare allowances in circulation, depressing the market price even further and
   reducing incentives across the whole of Europe. It would also lead to the fragmentation of climate
   policy where the aim to date has been to achieve greater harmonisation.

   What effects will the carbon floor price have on Industry and consumers?
   The carbon floor price will set the UK apart from other EU Member States. Industries that have
   high energy bills will see their operating costs increased compared to their European neighbours.
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Sandbag briefing                                                     The UK Carbon Floor Price


   Consumer bills will also increase. The carbon floor price is likely to increase bills in 2014/15 by
   around £2 billion. This is far higher than the previously published estimate by the Treasury (of
   around £1 billion). Given competition for industrial customers it is likely that more of the cost
   burden will be borne by households.

   Where will the money go?
   It seems likely that the revenues from the Carbon Floor Price will be used to underwrite the long
   term fixed price contracts introduced under the Electricity Market Reform package. Part of the
   revenue will also be used to compensate energy intensive industries for the impact of increased
   power bills.

   Given the political vulnerability of policies which significantly raise consumer prices it would be
   sensible to also use revenues to compensate consumers otherwise the success of the policy
   may be jeopardised. Social welfare and consumer groups are likely to demand that the most
   vulnerable in society are compensated for the higher energy bills they will face as a result of the
   floor price policy.

   The floor price is not the only option
   The UK’s carbon floor price is a direct intervention to increase the price paid to pollute to shore
   up investment decisions in the UK. Another way to support prices and provide stronger
   investment incentives would be to adjust the balance of supply and demand in the market for
   allowances, for example, issuing fewer allowances so that there is more scarcity in the market.
   This would be best achieved at an EU level where discussions are currently underway to do just
   that7, however, this may take some time and is not guaranteed to happen.

   As the second biggest player in the EU carbon market the UK could also withhold allowances
   unilaterally from the auctions of allowances that they control (or in co-ordination with Germany,
   the biggest participant). This would reduce the supply and boost the unit price with the potential
   for no net loss of income if the price rises sufficiently to compensate for the reduction in number
   of allowances available to be sold.

   Another option would be to set a reserve price for allowances scheduled to be released into the
   market by auction. Determining that allowances can only be sold at a price at or above a preset
   minimum would restrain the supply of allowances until the traded value reached the minimum
   reserve price in the auction. All of these unilateral actions, however, involve the UK risking a
   potential loss of income while all other EU countries benefit from the increased prices without
   themselves having to take any risk.

   An alternative approach to seeking the investment in low carbon capacity in the UK would be to
   adjust the existing ‘Renewables Obligation’ mechanism to include bands for new nuclear and
   carbon capture and storage, in effect creating a ‘Low Carbon Obligation’ which was calibrated to
   deliver a steady reduction in the carbon intensity of our electricity supply. This policy would put all
   low carbon options on a more level playing field and, like the Contract for Difference, only pay a
   subsidy as and when the new capacity started to operate. This would avoid the windfalls inherent



   7
     In May the Commission issues a communiqué where as part of a package of policies to take EU emissions to 30% below 1990
   levels by 2020 it proposed taking 1.4bn allowances out of the market to tighten caps.
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Sandbag briefing                                         The UK Carbon Floor Price

   in the Carbon Floor Price policy, which are currently paid by the consumer with no guarantee of
   any new capacity being delivered.

   Conclusion
   There is a very real need to increase the cost of carbon in Europe. To avoid competitiveness
   distortions and the fracturing of the EU policy this is best achieved through action at the EU level.
   The Carbon Floor Price is a flawed policy in that it provides excessive windfalls to existing
   operators but neither guarantees new investment in capacity nor secures additional
   environmental benefit. Continued unilateral intervention in the UK and sustained low carbon
   prices in Europe will amplify the competitive distortions it introduces. It can best be described as
   a financial hedge for the Treasury in light of the proposals contained in the Electricity Market
   Reform package.

   It seems likely that these features will make it politically vulnerable and that the rate at which it is
   set in the Budget each year will become a political issue. The only way therefore to make the
   policy sustainable is to ensure the price of carbon rises across the EU. The Government must
   work to secure the withdrawal of the necessary quantity of allowances at an EU level, or through
   partnering with other progressive high-emitting Member States, withdrawing allowances
   bilaterally.




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