This document discusses the UK government's introduction of a carbon price floor to address fluctuations in the EU Emissions Trading Scheme carbon price that have resulted in uncertainty for low-carbon investors. It outlines how the government will introduce a price floor through changes to the Climate Change Levy and fuel duties, starting at £16/tonne in the 2020 target of £30/tonne. It also provides background on the EU ETS and debate around introducing a carbon price floor.
This document discusses the UK government's introduction of a carbon price floor to address fluctuations in the EU Emissions Trading Scheme carbon price that have resulted in uncertainty for low-carbon investors. It outlines how the government will introduce a price floor through changes to the Climate Change Levy and fuel duties, starting at £16/tonne in the 2020 target of £30/tonne. It also provides background on the EU ETS and debate around introducing a carbon price floor.
This document discusses the UK government's introduction of a carbon price floor to address fluctuations in the EU Emissions Trading Scheme carbon price that have resulted in uncertainty for low-carbon investors. It outlines how the government will introduce a price floor through changes to the Climate Change Levy and fuel duties, starting at £16/tonne in the 2020 target of £30/tonne. It also provides background on the EU ETS and debate around introducing a carbon price floor.
Last updated: 7 November 2013 Author: Dr Elena Ares Section Science and Environment Section
Fluctuations in the price of carbon in the form of EU ETS allowances have resulted in uncertainty for investors in low carbon technologies. This has contributed to a lower level of investment in these technologies, below what is required to meet UK carbon reduction and renewable targets. To address this, the Coalition Government committed to introduce a floor price carbon and published a consultation on carbon price support in December 2010. Following this it announced in the March 2011 Budget that it would be introducing price support via the Climate Change Levy and fuel duty with a target price of 30 per tonne of carbon dioxide in 2020. The floor price will start at about 16 per tonne. At the time of the announcement the trading price was around 15 per tonne, but by J anuary 2013 it had fallen to under 4. The Government published its consultation in December 2010. This set out how the exemption from the Climate Change Levy for fossil fuels used to generate electricity would be removed. The Government proposed taxing fossil fuels at rates that took into account of their average carbon content. Detailed proposals for the carbon price floor were published by HMRC in December 2012 as part of the draft Finance Bill 2013. The rate for 2103 is equivalent to 4.94 per tonne of carbon dioxide. From 1 April 2014, the CPS rates of CCL and fuel duty will be equivalent to 9.55 per tonne. Indicative prices have been published up to 2017. Revenue raised will be retained by the treasury. Background on the Climate Change Levy is available in Library Standard Note SN/BT/235
This information is provided to Members of Parliament in support of their parliamentary duties and is not intended to address the specific circumstances of any particular individual. It should not be relied upon as being up to date; the law or policies may have changed since it was last updated; and it should not be relied upon as legal or professional advice or as a substitute for it. A suitably qualified professional should be consulted if specific advice or information is required. This information is provided subject to our general terms and conditions which are available online or may be provided on request in hard copy. Authors are available to discuss the content of this briefing with Members and their staff, but not with the general public. 2 Contents 1 Background 2 1.1 The EU ETS 2 1.2 Is the price of carbon too low? 2 2 A Floor Price for Carbon 3 3 Coalition Position 4 3.1 Consultation on carbon price support 5 4 Government Budget Announcement 6 4.1 Costs and Benefits 7 4.2 Reactions to the decision 7 5 Nuclear 7 6 Energy and Climate Change Select Committee Report 9 7 Proposals in Detail 9 8 Carbon Floor Price to 2017 10
1 Background 1.1 The EU ETS The EU Emissions Trading Scheme (EU ETS) is a mandatory cap-and-trade scheme for carbon dioxide, which is central to the EUs climate change target of reducing emissions by 20% by 2020. It sets a decreasing cap for emissions from energy intensive sectors, and allocates or auctions emissions allowances (EUAs) which can be traded on the open market. It is currently in Phase II, which imposes reductions of 6.8% compared to 2005 emissions. The details of Phase III of the EU ETS, which will run from 2013 to 2020, were approved by the EU Council in April 2009. Over half of allowances will be auctioned and there will be an overall reduction in emissions of 1.74% per year compared to Phase II levels. This will represent a 21% reduction by 2020 in emissions for all sectors covered compared to 2005 levels. Phase III will also include aviation for the first time. 1.2 Is the price of carbon too low? Over allocation of permits in Phase I led to the price falling to only a few cents. The consensus is that an allowance price of at least 30 a tonne is needed to drive investment. For Phase II the price reached 29 in 2008. However prices have fallen significantly since and at the end of J anuary 2013 were hovering around 4. 3
The response from the Commission has been to consider raising the emissions reduction target for 2020 from 20% to 30%. This has full support from the UK Government and most Member States, although it has so far been strongly resisted by Poland. The EU Commission has also proposed holding back future credits due for auction or backloading but there is opposition to this from the EU Parliament. 2 A Floor Price for Carbon Debate on the need to set a floor price for carbon increased significantly following the fall of Phase II allowances in 2009 to half what would be necessary to drive the low investment. The issue was raised in the Environmental Audit Committees report on Carbon Budgets during which witnesses called for a floor price of carbon to incentivise investment in low carbon technologies: Several witnesses called for the creation of a floor price, below which the carbon price would not be allowed to fall, to help to reduce the risks, and thus costs, of investing in low carbon projects. Perhaps Professor Dieter Helm (chairman of the Academic Panel of economists at the Department for Environment, Food and Rural Affairs) has put the case most strongly: [] it is hard to think why one would not have a floor: what could the downside risk possibly be? For, if policy-makers genuinely thought that the carbon price might fall below the floor, there would be a credibility question about the scheme as a whole. Either the Commission believes that the EU ETS price will always be above the floor (in which case, there is no problem putting a floor in place), or it believes that the price could fall below (in which case, there is a good case for having a floor). 1
1 EAC, Carbon Budgets, 5 J anuary 2010 0 5 10 15 20 25 30 J an 06 J an 07 J an 08 J an 09 J an 10 J an 11 J an 12 J an 13 EU ETS carbon prices Forward month pri ce, per al l owance Source: www.theice.com 4 However many businesses were against, arguing that it would create uncertainty unless clear notice was given. Some argued that it was unnecessary: RWE npower thought it would help investment in low-carbon technologies if investors are confident that the Scheme will not be subject to further political interference, and that the threat of further intervention in EU ETS, for example price floors and ceilings, will only serve to undermine confidence in the scheme. The Carbon Markets and Investors Association argued that concerns over whether a volatile ETS price leading to lower investments than would otherwise be the case are unfounded; the long run market signals within the EU ETS are sufficiently stable. Their conclusion was that any market intervention should be used as a last resort, but that some potential measures might be consideredincluding introducing a reserve price for auctioning so long as they were signposted far in advance so as to give long-term certainty over their effects on the carbon price. Barclays Capital, meanwhile, argued against any price interventions on the basis that they can only be maintained by ignoring the environmental goals defined by the cap, thereby introducing inefficiencies into the market. 2
The previous Government, in its response to the report, made it clear that it did not support a floor price. In its view the aims of the EU ETS would be achieved if emissions were kept below the overall cap and that any adjustments should involve tightening the cap:
The Government considers that there are risks in intervening in the market to control the carbon price. The best approach to give the strong long-term signal sought by investors is through setting the right, long-term regulatory framework with a reducing cap on emissions. Under the revised EU Emissions Trading System (EU ETS) Directive, the EU ETS cap will fall by 1.74% (compared to phase II) each year after 2013. Longer term, the most effective way of strengthening the carbon price is by limiting the supply of allowances by tightening the cap. Our efforts are focussed on taking forward the work agreed at Copenhagen to secure an ambitious legal treaty including an increase in the EUs overall reduction target from 20% to 30%. This would trigger a review of the ETS including tightening of the cap.. 3
3 Coalition Position The Coalition Agreement made the following commitments with regard to the EU ETS: We will push for the EU to demonstrate leadership in tackling international climate change, including by supporting an increase in the EU emission reduction target to 30% by 2020. We will introduce a floor price for carbon, and make efforts to persuade the EU to move towards full auctioning of ETS permits. 4
Further details on a floor price were provided in J uly 2010 in response to a written parliamentary question: The creation of a floor for the carbon price is an important commitment in the Programme of Government. As announced in the Budget, the Government will publish proposals in the autumn to reform the climate change levy in order to provide more
2 ibid 3 EAC, Carbon budgets: Government Response to the Committees Third Report, 16 March 2010 4 Cabinet Office. The Coalition: Our programme for Government, May 2010 5 certainty and support to the carbon price. Further detail will be published as part of the consultation process. 5
3.1 Consultation on carbon price support The Government published its consultation in December 2010. This explained how the exemption from the Climate Change Levy for fossil fuels used to generate electricity would be removed. The Government proposed taxing fossil fuels at rates that took into account of their average carbon content. These rates would be known as the CCL carbon price support rates: The Government proposes to introduce a carbon price support mechanism to support investment in low-carbon generation. The Government has decided that this is best achieved by the climate change levy (CCL) and fuel duty being levied on all fossil fuels used in the UK to generate electricity. In most cases, fossil fuels currently used to generate electricity are exempt from CCL. The Government proposes to remove these exemptions and to tax these commodities at rates that take account of the commodities average carbon content. These rates will be known as the CCL carbon price support rates, and will be different from the main CCL rates levied on consumers use of gas, coal, LPG and electricity, which will be retained. This does not propose any changes to existing energy supplies paid through CCL. Oils are not subject to CCL but fuel duty is payable at the point oils leave the refinery. Currently, the duty can be reclaimed in full by the electricity generator but, as part of the carbon price support mechanism, the Government proposes to reduce the amount of fuel duty that can be reclaimed, in effect creating oils carbon price support rates. Other more detailed features of the Governments proposal include: electricity used to generate further electricity will remain exempt from CCL; the CCL liability of electricity supplied to the final consumer arising from generation using fossil fuels will be unchanged, as will the treatment of imported electricity; fossil fuels used to generate electricity in the UK that is subsequently exported will be liable to the relevant carbon price support rates; all fossil fuels burnt in CHP stations will be subject to CCL or fuel duty (at the relevant carbon price support rates) regardless of their rating through the CHP Quality Assurance (CHPQA) programme; and supplies of fossil fuels to auto-generators will continue to be liable to CCL and fuel duty but at the relevant carbon price support rate. Auto-generators will no longer be able to reclaim CCL or fuel duty charged on the fossil fuel they use to produce electricity, which is subsequently supplied to the electricity transmission and distribution networks. The level of the CCL will be set, depending on the EU ETS price, to achieve a predetermined overall target price trajectory. An illustration is set out in the consultation document:
5 HC Deb 24 J un 2010 c343W 6
The aim of this is to address carbon price uncertainty which according to the consultation document is predominantly driven by wider regulatory uncertainties and the Government might therefore be better placed to manage some carbon price risk. 6
Background on the Climate Change Levy is available in Library Standard Note SN/BT/235 A regulatory impact assessment was published along with the consultation documents. This considered three scenarios. All set a target price for a tonne of carbon dioxide in 2030 of 70. They differed in the target price for 2020 which was set at 20, 30 or 40. The projection for 2020 under the current EU target of 20% emissions reduction is a price of 16.3 per tonne of carbon dioxide. 7
The Committee on Climate Change published its Fourth Carbon Budget report in December 2010. This set out the Committees views on what price would be required by 2020: Carbon price underpin. Given carbon price volatility and the current low carbon price, a carbon price underpin would complement electricity market reforms. It could also strengthen incentives for investment in low-carbon technologies in other sectors, subject to competitiveness and affordability concerns being addressed. A carbon price underpin which reached at least 27/tCO2 (i.e. 30 euros per tonne) in 2020 and rising through the 2020s would provide appropriate signals. 4 Government Budget Announcement The Government announced its decision in the March 2011 Budget: Carbon price floor The Government announces a floor price for carbon in the power sector from 1 April 2013 to target a price for carbon of 30 per tonne of carbon dioxide in 2020. The floor will start at around 16 per tonne of carbon dioxide and the carbon price support rates for 2013-14 will be equivalent to 4.94 per tonne. The Government intends to introduce relief for carbon capture and storage and combined heat and power (CHP), and remove an existing exemption in the climate change levy for electricity CHP plants supply indirectly to an energy consumer. Anti-avoidance
6 HM Treasury, Carbon Price Support Consultation, 16 J anuary 2010 7 HM Treasury, Carbon Price Support Regulatory Impact Assessment, 16 J anuary 2010 7 provisions will be introduced to prevent forestalling with effect from 23 March 2011. (Finance Bill 2011) The then Energy and Climate Change Secretary, Chris Huhne, welcomed the decision, together with the commitment in the Budget to a Green Investment Bank: Theres a clear, long term signal to energy investors in todays Budget. A Green Investment Bank with substantially more capital and borrowing capacity and a stronger, more stable carbon price put investment in green energy technologies at the heart of the coalitions strategy for sustainable, balanced economic growth. 4.1 Costs and Benefits The costs and benefits for a target price of 30 for 2020 were set out in the regulatory impact assessment. This concluded that the resource cost investment in new technology would be around 6.1bn for 2013-2030. Over the same period there would be a carbon saving of 7.2bn and savings due to improvement in air quality of 0.9bn. This results in a total benefit in net present value of 1.9bn. 4.2 Reactions to the decision The CBI welcomed the introduction of carbon price support but warned it needed to be co- ordinated with other measures: With a third of our existing power generation capacity retiring by 2020, CBI has been calling for reforms to the electricity market since 2009. This carbon floor price is one part of a broader package of measures, which all need to fit together. To mitigate the concerns of businesses' about this new energy tax, Government will need to take action to support the UK's industrial competitiveness by the time it takes effect. 8
The Renewables Energy Association also welcomed the announcement, but would like the commitment to go beyond 2020 to provide greater certainty to investors: While supporting the carbon-floor price, which will make low carbon electricity more competitive with electricity from coal and gas, the industry called for a longer term indication of post 2020 levels. RenewableUK also called for a commitment to reinvest proceeds (projected at over 3 billion in 2013-2016) in low carbon transition programmes and green energy R&D. Todays details on the carbon floor price and the GIB should be the first steps towards a long term solution on funding for a host of technologies such as the next generation of offshore wind farms and wave and tidal devices. We would encourage more clarity and further action following todays budget, as the measures so far look promising, concluded Edge. 9
5 Nuclear There have been criticisms since the announcement that a carbon floor price would result in higher energy prices and therefore provide a windfall for existing nuclear generators and a hidden subsidy for any new generation. Experts were divided on the effectiveness of the new floor price. Many warn it will not be high enough to drive significant increases in low-carbon investment, while others
8 CBI, The Budget and the Low Carbon Economy, 24 March 2011 9 REA Press Release, Budget to re-energise funding and planning for renewables, 23 March 2011 8 predict it will deliver a major windfall in excess of 1bn a year to existing nuclear power plants. Matthew Spencer, director of green business think tank the Green Alliance, predicted the floor price would prove far too low to drive increases in investment. "The Treasury has been tying itself in knots trying to keep the floor price to avoid giving a big windfall to nuclear operators," he said. "But that could have been tackled through a windfall tax. There are also no measures to protect people in fuel poverty from the resulting impact on energy prices, so there is a risk this will just be seen as a stealth tax." 10
However nuclear generators welcomed the proposals as a way of providing investment in future generation. EDF Energy welcomed the move: The Carbon Price Floor is important for all low carbon technologies as it restores the carbon price to what was originally intended. It will support the economics of renewables and carbon capture and storage and can reduce the need for specific measures to support those technologies. For nuclear, helping to restore the carbon price to what was originally intended is important to encourage investment in existing plants and in new build. We welcome the Chancellors confirmation the floor price will be introduced in 2013 at 16 per tonne and reach 30 per tonne in 2020 as we believe this trajectory strikes the right balance, meeting the needs of policy makers, consumers and investors. 11
More recently, the Lib Dem voted at their conference in favour of a windfall tax for existing generators to claw back some of the increased revenue a floor price of carbon would mean: Pressure is mounting on the government to include a windfall tax on nuclear operators as part of its electricity market reforms, after the Liberal Democrat conference voted in favour of a new levy on existing nuclear power plants. Under the government's planned electricity market reforms, the Treasury will impose a 'carbon floor price' to ensure that fossil fuel-based power generators pay a minimum amount per tonne of carbon they release. The move is intended to drive investment in low carbon alternatives such as renewable energy and nuclear power, but critics have warned that, while the measure should stimulate low carbon investment, the resulting increase in energy prices will also deliver a multi-billion pound windfall to existing nuclear and renewable energy plants that will not have to pay the new carbon levy. Green groups have called for a windfall tax to generate revenue for the Treasury from the additional profits that will result, and the Lib Dems yesterday added their voice to such calls, voting in favour of a motion calling for a windfall tax at their annual conference. 12
10 Business Green, Budget 2011: Experts divided over carbon floor price impact, 23 March 2011 11 EDF Energy, Carbon Price Floor will encourage investment in nuclear, renewables and carbon capture and storage, 23 March 2011 12 BusinessGreen, Lib Dems vote in favour of nuclear windfall tax, 21 September 2011. 9 6 Energy and Climate Change Select Committee Report The Energy and Climate Change Select Committee published a report on 26 J anuary 2012 on the EU Emissions Trading System in which it was highly critical of the proposals for a floor price for carbon: Tim Yeo MP, Chairman of the Committee, said: "The Chancellor was right to say we wont save the planet by putting the UK out of business. Ironically, however, it is the Treasurys decision to set a Carbon Price Floor that could result in industry and electricity production relocating to other EU countries. Unless the price of carbon is increased at an EU-wide level, taking action on our own will have no overall effect on emissions other than to out-source them. A revenue raising exercise disguised as a green policy wont help anybody the price of carbon has to be increased at an EU level to kick start investment in clean-energy." Energy generators and heavy industry could be subject to an 'exorbitant' top-up tax of up to 25 per tonne of CO2 under current plans, because the price of carbon in the rest of the EU is so low. Electricity prices will increase as the price floor keeps the cost of carbon higher than in other countries, effectively subsidising other Member States at the expense of the UK consumer. This will cut emissions in the UK, but may not reduce them overall as electricity production and industries may simply relocate to other Member States resulting in "carbon leakage". The threat of leakage within the EU is particularly acute for the electricity sector. Electricity is readily transportable between the UK and mainland Europe and can be traded instantaneously on spot market prices. DECC expects there to be as much as 10 GW of interconnection with other countries by 2020, some 10% of installed capacity. This makes electricity generation more susceptible to leakage than other sectors, such as goods manufacture, which may be restricted by the difficulties of relocating production. 13
7 Proposals in Detail The Government published its proposals in detail in December 2011.These were summarised as follows in the overview of the draft Finance Bill 2013: Finance Bill 2013 will include the final primary provisions needed to deliver the carbon price support (CPS) rates of climate change levy (CCL) from 1 April 2013, which form part of the Governments carbon price floor announced at Budget 2011. This will include the CPS rates of CCL for 2015-16 (which will be confirmed at Budget 2013). 14
The rationale behind the legislation, which is to increase investment in low carbon power generation, was set out as follows in the draft: In order to encourage new and additional investment in low-carbon power generation, the Government announced at Budget 2011 that, following consultation, it would introduce a carbon price floor from 1 April 2013, which it would achieve by amending CCL legislation (and fuel duty legislation for oils used in electricity generation since oils are not subject to CCL). Supplies of coal, gas and LPG used in most forms of electricity generation would become liable to newly created CPS rates of CCL, which would be different from the main CCL rates levied on consumers use of these commodities (and of other solid fuels and electricity). The amount of fuel duty reclaimable on oil used in electricity generation would be adjusted to establish new
13 ECCC, Go-it-alone UK Carbon Price Floor could harm industry and consumers, 26 J anuary 2012 14 HMRC, Overview of Legislation in Draft, 11 December 2012 10 CPS rates of fuel duty. The changes needed to fuel duty are all set out in separate secondary legislation [...]. 15
The HMRC produced a 5 page brief setting out the proposals which contains further detail. 16
8 Carbon Floor Price to 2017 The Treasury announced in the 2012 Budget the rates for the carbon floor price up to 2015 and indicative prices up to 2017 CPS rates for 2013-14 and 2014-15 The CPS rates from 1 April 2013-14 were announced at Budget 2011, with the CPS rates of CCL legislated for in Finance Act 2011. The rates will be equivalent to 4.94 per tonne of carbon dioxide (tCO 2 ). From 1 April 2014, the CPS rates of CCL and fuel duty will be equivalent to 9.55 per tCO 2 . Indicative CPS rates for 2015-16 and 2016-17 Indicative CPS rates for 2015-16 and 2016-17 will be equivalent to 12.06 per tCO 2
and 14.86 per tCO 2 respectively. Full details, including table setting out what this would translate to as part of the CCL can be found in the HMRC publication Carbon Price Floor: Further Legislative Provisions and Future Rates . The total cost to business will be the rate of the floor price plus the EU ETS credit price. This is currently around 4 rather than the 11 originally estimated by the Treasury when setting the carbon floor price. Therefore the original overall price to energy producers was intended to be around 16, but is actually around 9.The Floor Price is set two years in advance and as a result lags what the EU ETS price is doing, which changes in real time. This is the reason why the indicative prices for 2105-17 are higher, as they take into account the current low EU ETS credit price. Revenue from the Carbon Floor Price to 2018 was estimated by the Treasury as follows:
15 HMRC, Finance Bill Consultation Draft, 11 December 2012 16 HMRC website, Carbon Price Floor, [on 8
February 2013] Estimated income from the Carbon Price Floor million cash 2013-14 2014-15 2015-16 2016-17 2017-18 975 1,420 2,025 2,075 2,200 Source: Budget 2013, HM Treasury