The UK has tied itself in knots over the carbon tax

The chancellor has frozen the UK carbon tax until 2020, but what should happen to it after that? Marion Huebener, Stephan Segieth and Samuel Ebohon run three scenarios through their paces.

Given the significant effects that increases in the cost of carbon price support have had on the electricity bills of businesses and households since its introduction in April 2013, it is not surprising that the chancellor decided to freeze it until March 2020. However, this has created uncertainty for those looking to make long-term investments in the electricity generation sector and has highlighted some flaws in the UK’s approach to carbon pricing.

To assess the impact and the implications of different possibilities for the carbon tax from April 2020, we have used our pan-European electricity market model to develop three scenarios. Scenario one sees the carbon tax scrapped, scenario two sees an extension of the current freeze from April 2020, and scenario three sees the carbon tax doubled from April 2020. These scenarios are compared with the baseline, which sees the carbon tax rise in line with its original trajectory from April 2020. The baseline is what will occur if the chancellor does not make further changes to the carbon tax.

A number of interesting implications can be drawn from this analysis. First, we see that no additional measures are required to see the end of unabated coal-fired generation in the UK by 2025 if at the very least the current freeze in the rate of the carbon tax is extended from April 2020. However, if it is scrapped, additional measures, such as those expected to be put forward by the government in a consultation this spring, are required to achieve the government’s goal of an end to unabated coal-fired generation by 2025. Unabated coal persisting out towards 2030 is the significant contributor in a major increase in carbon dioxide emissions (82 per cent in 2030) relative to the baseline.

What is also clear is that whatever the government does on carbon pricing, it will have an effect on the rest of Europe. When comparing the baseline, where the carbon tax rises in line with the original trajectory, to a no carbon tax case, there is significant additional CO2 abatement in GB (45 per cent in 2030). However, emissions in the rest of western Europe will increase (3 per cent in 2030) as the UK imports more electricity across interconnectors (20 per cent of demand by 2030) to replace its lower levels of domestic generation. This highlights one of the consequences of the government’s decision to go it alone on carbon pricing: the introduction of the GB carbon tax is leading to greater CO2 emissions in western Europe.              

The carbon tax also reduces the receipts from EU Emissions Trading System (ETS) auctioning, directly hitting the coffers of all member states.

Doubling the carbon tax does not appear to deliver enough additional benefits in terms or increased decarbonisation (10 per cent in 2030) to justify the increase in GB wholesale electricity prices (15 per cent in 2030).

We suggest three options for levelisation. The first two options aim to reintroduce equality of carbon pricing across the EU, while the third option seeks to eradicate the negative price impact of the carbon tax on the EU ETS.

The first option restores uniformity to carbon pricing across Europe through the introduction of a European-wide carbon price floor and carbon price support mechanism, supplementing the EU ETS. This would ensure abatement took place where it was most efficient or cost-effective and would avoid creating competitive disadvantages between member states. It allows electricity generators to compete on more even terms.

The second option is to replace the EU ETS with an EU-wide carbon tax. This would remove price uncertainty and prevent low carbon prices leading to the wrong investment decisions. However, this introduces uncertainty regarding the ability of EU to reach any decarbonisation target it sets.

The third and final option would be for the UK to cancel the EU ETS allowances equivalent to the volume of CO2 abated as a result of the GB carbon tax. This would remove the negative price impact caused by a go-it-alone strategy but would not address the competitive disadvantage of British businesses and electricity generators relative to those on the continent.

Carbon pricing has complex political and economic implications, and the issues could become even more complicated depending on the result of the EU referendum. However, it is clear that the current system is doing harm, although the government may argue that the end justifies the means. A better approach would be for the government to find a long-term solution that provides the right incentives to allow the UK to meet its low carbon goals while not competitively disadvantaging British businesses, not harming the decarbonisation attempts of the rest of the member states of the EU and providing a more level playing field for GB electricity generators to compete in an increasingly interconnected European energy landscape.

Marion Huebener, Stephan Segieth and Samuel w are energy experts from PA Consulting’s energy markets modelling and analytics team