Jane Burston explores the impact a carbon floor price may have

One of the fundamental aims of the EU emissions trading scheme (EU ETS) is to set a price on carbon, and in doing so incentivise investments in low carbon technology.

Since second quarter in 2009, the price has been hovering around €13-€15 per tonne. This is well below the €50 per tonne that the Committee on Climate Change, the body charged to advise the UK government on climate matters, believes is required to stimulate adequate levels of investment in clean energy and energy efficiency.

But the UK’s new coalition government believes it has the answer: to establish a “floor” price for permits within the scheme.

So far the UK government has been quiet on how exactly this mechanism will work. What it has indicated is that it will bring forward the relevant legislation in the 2011 finance bill, and initial details are expected soon.

The rest of Europe looks unlikely to follow suit, meaning that the UK is limited in its options for implementing a floor price.

Minimum price

The most likely approach is that the UK government will set a minimum price for auctioning off permits to polluters. Currently a maximum of 10% of UK permits are distributed in this way but this is set to increase to 60% during phase III of the EU ETS.

The idea is that, if the price of permits on the open market dips below this minimum level, UK industry will have to pay the higher price. This price certainty will support the business case for low carbon solutions and drive clean investment for the long term.

With UK industry already claiming to be at risk from competition outside the EU, the coalition is treading a difficult path in determining which sectors will be exposed to potentially higher prices. Initially, only the energy sector is likely to be affected, primarily because at present this is the only sector required to buy all of its permits from the government.

Even if this remains the case, other sectors will still be exposed to the subsequent risk of higher energy costs, as generators raise their prices to cover the higher costs of carbon. Lobbyists claim that knock on effects could then hit the competitiveness of other industrial sectors.

But business association the Confederation of British Industry remains positive. Matthew Farrow, head of energy, transport and planning at the CBI says: “If we are going to deliver the low-carbon economy the UK and the world needs then we must ensure there are incentives for the market.” He argues that a carbon floor price is one option that should be considered alongside other ideas such as “capacity payments, low-carbon obligations and a tighter future emissions cap”.

Fewer questions remain about the timing of the intervention. Charles Hendry, minster of state at the UK Department of Energy and Climate Change, has indicated that the floor price may not kick in until 2018. The intention of this is to provide sufficient price predictability to lower the cost of capital for new nuclear power generation, which is not going to come online before this date.

A tighter cap

A simpler alternative to the floor price would be to tighten the cap in the EU ETS. This would not only increase the price, but would also bring down emissions – something a UK floor price is not set to do.

As Per Klevnas, senior consultant at economic consultancy NERA points out: “A floor price in the UK unfortunately would not affect total EU or global emissions levels. The level of emissions in Europe is set by the cap in the emissions trading scheme. A UK floor price does not change this cap, and any reductions in UK emissions therefore would be offset by increases in other parts of the EU.”

The UK government is pushing for the European commission to tighten the cap – and aim for a 30% reduction in emissions from a 1990 baseline by 2020, rather than the 20% cut that the EU is currently working towards.

But with Italy, Poland and other eastern European countries currently blocking the move, the floor price is one way for the UK to take matters into its own hands.

Jane Burston is co-founder of Carbon Retirement, a company which buys “permits to pollute” directly from the European emissions trading scheme and then permanently removes them from the scheme. www.carbonretirement.com

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