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The Budget freeze in Carbon Price Support

In the recent Budget, the Chancellor made the widely anticipated move to freeze the Carbon Price Support from 2016/17. Here we take a look at the implications for reducing emissions in the power sector – what it means for electricity bills, for low-carbon investment and for coal.

The Carbon Price Support tops up the carbon price from the EU Emissions Trading System to the published UK ‘floor price’ trajectory, which rises to £32 per tonne in 2020 and £75 in 2030. The trajectory remains, but the top-up has now been capped (at £18 per tonne) to 2020 – unless the ETS price rises significantly (it is currently around £4 per tonne), the target trajectory is unlikely to be met and UK carbon prices will be lower than previously assumed.

This should mean lower electricity prices, with the Treasury estimating that the average household will be around £15 per year better off by 2020 under the capped support. That seems about right from our calculations too.

Could it undermine investment in low-carbon generation, storing up costs and risks for the future? In reality, the direct impact is likely to be marginal.

  • It was always questionable how much investors could ‘bank’ the planned carbon price rise given there was no legal commitment to the trajectory and the support was only announced two years ahead.
  • Under the new Energy Act, low-carbon investors can access long-term contracts guaranteeing a fixed return that is not dependent on the carbon price.
  • And finally, there is sufficient funding in the Levy Control Framework (£7.6 billion) to absorb the impact of a lower carbon price (around £0.3 billion) for the Government’s central scenario for low-carbon deployment (which costs £7.0 billion), along with the existing headroom which allows an additional 20% should this be required.
  • We may end up with more coal being burnt in the UK in the short term, but this will not increase overall EU emissions given that these are capped in the EU ETS. By the 2020s, and provided that investment in low-carbon technologies proceeds, existing coal plant will either close or run at very low load factors to balance the system. There is no risk of new coal plants being built since the Government has introduced a moratorium on new coal without Carbon Capture and Storage.

However, introducing a policy and then fundamentally changing it a short time later is not conducive to providing the clear and consistent signals that investors require. This is in a context where the Government has already given mixed messages, and where there is a high degree of uncertainty about its commitment to support investment in low-carbon technologies coming on the system in the 2020s. Given this uncertainty, incentives for project development and supply chain investment are weak.

As we have previously recommended, the way to address this is through setting a power sector decarbonisation target for 2030, and to commit to funding this. This would put us on the economically sensible path to building a low-carbon economy. The debate about the decarbonisation target is likely to be lively going into the election, and early in the term of a new government, given the provision in the Energy Act to set a target in 2016.