The Committee considered the impacts of the recession and credit crunch both on progress made towards meeting carbon budgets and the cost of tackling climate change.
This new analysis took into account HM Treasury predictions of GDP being around 6% lower in 2020 than what we assumed in our analysis for our December 2008 report. 

The impacts of the recession were considered in relation to: 

• The cost of meeting carbon budgets
• Emissions in the non-traded sector
• The carbon price and investments in the traded sector
• The opportunities and challenges for meeting carbon budgets

Whilst the recession presents both opportunities and challenges to meeting carbon budgets, the level of ambition underpinning carbon budgets should not be reduced as a result of the recession.

Impact of the recession on emissions in the non-traded sector

The non-traded sector includes direct emissions from buildings (i.e. non-electricity) including residential and most of the commercial sector, and transport. It also includes non-energy intensive industry not included within the EU Emissions Trading Scheme (EU ETS).

Emissions in the non-traded sector are dependent on economic growth as well as energy prices and other  drivers (such as population). The Committee used the DECC Energy Model and the Cambridge Econometrics model (MDM-E3) to explore the impact on emissions in the event of recession, as well as taking into account updated assumptions about other drivers (for example, outlook for fuel prices and policy impacts).

The analysis showed that emissions will fall as a result of the recession, although there is uncertainty around the magnitude of impact. For example, in the Cambridge model, cumulative emissions over the first budget period fell by around 75 MtCO₂ compared to the previous projection (adjusting for policy impacts);  whereas in the DECC model the overall impact is just a 20 MtCO₂ reduction.

Both models highlight the risk that it may be possible to meet the first budget purely due to lower economic growth; at the expense of not implementing necessary measures required to put the UK on track in the longer-term.

This demonstrates the fact that we must focus on more than just emissions reductions per se as a measure of UK progress against carbon budgets. We also need to maintain our  ambitious implementation of measures. Recognising that this may lead to more emissions reductions than we envisaged in our December 2008 report, the UK should aim to outperform the first budget (by up to 75 MtCO₂) and this outperformance should not be banked for future periods.

The recession has reduced emissions as a result of the decline in economic activity, which could give a false impression of rapid progress being made. As a result of this analysis, the Committee recommends that Government focuses effort on implementing policies that will lead to significant emissions cuts in the long-term. In doing this, the aim should be to outperform the first carbon budget and not to bank this outperformance through to the second budget period.

The carbon price and investments in the traded sector

The traded sector covers power generators and those energy intensive firms included in the EU Emissions Trading Scheme (EU ETS).  The EU ETS is the EU’s carbon trading system. It  works by capping the carbon emissions of energy-intensive firms, who can then reduce emissions and sell allowances, or emit beyond their cap and purchase allowances in the market.  The carbon price within the system will be set by the marginal (or most expensive) actions EU ETS participants are required to undertake to meet the cap.

The carbon price to 2020 is likely to be significantly lower than we previously projected. Output in energy intensive sectors has fallen as a result of the recession and is expected to remain lower than previously projected.  This means less abatement will be required to meet the EU ETS cap, and the resulting carbon price will be lower. In December 2008 we projected a 2020 carbon price of €56 tCO₂ in 2008.   Our current analysis suggests that it may only reach €22 tCO₂ by 2020. Most market commentators see a  price in the range of  €20-40 in 2020.

A lower carbon price will have consequences for investments in low–carbon generation. While a lower carbon price means it will be cheaper to meet the EU ETS cap in the period to 2020, it will also reduce incentives for investment in low-carbon technologies. Given that we rely on the carbon price as one of the main levers for delivery of low-carbon investment in long-lived assets in the energy intensive sectors, and given the long life of assets in these sectors,  a low carbon price to 2020 may mean that the economy becomes locked into carbon intensive assets which would make emissions reductions beyond 2020 more expensive and difficult.

As a result of this analysis, the Committee is not confident that the EU ETS will deliver the required low-carbon investments for decarbonisation of energy intensive sectors through the 2020s. A range of measures including tightening the EU ETS cap and a UK carbon price underpin should be seriously considered to strengthen incentives for low-carbon investments in the energy intensive sectors.

The recession has resulted in a significantly reduced carbon price. This is problematic as a strong price is required to encourage investment in low-carbon technologies. The Government should seriously consider options for strengthening the price of carbon.