Energy UK has called for a UK/EU emission trading system link to stop the “detrimental effect” the EU’s looming carbon tax will have on the nation’s renewable sector.
In a report released this week (30 October), Energy UK warned that “weak and volatile” carbon prices within the UK’s Emissions Trading Scheme (ETS) would have a “detrimental” effect on clean energy investment, especially if planned EU carbon tax legislations move forward.
An overall cap on emissions and auctioning allowances (which grant permission to pollute), the ETS was a key policy in enabling the UK to decarbonise almost 50% of its greenhouse gas (GHG) emissions since 1990. The report pointed out that this success was due to the scheme’s structure which sees the cap shrink and fewer allowances auctioned annually.
Implemented by the UK in 2002, the ETS pilot became the basis for the EU’s own ETS, in which the UK participated for 15 years before it left the EU.
In short, as the carbon market tightens, ETS prices increase and emissions decrease; however, the UK’s ETS prices have been decreasing, which will cause UK low carbon power to be penalised under new EU carbon tax legislations.
Concerning a “weak and volatile” carbon price
Although a success in the past, the trade association expressed concern that the UK ETS price had become “weak and volatile”, crashing to historic lows in recent months.
Figure 1: UK ETS prices
This trend, the report warned, was having a “detrimental” effect on low carbon investment from a scheme aimed to enable companies to decarbonise and incentivise investment in the UK’s renewable sector.
According to Energy UK, the ETS auctions raised £1 billion less between April and the beginning of October this year, than they would have done, had prices remained at 2022/2023 levels.
This, paired with growing competition from international markets, such as the US’ Inflation Reduction Act (IRA), a decrease of over 7GW in awarded contracts between the Contract for Difference Auction Rounds 4 and 5, as well as supply chain costs increasing by 40%, is sending worrying investment signals, continued the report.
The impending EU carbon tax
The EU is currently in discussion over introducing a Carbon Border Adjustment Mechanism (CBAM), which would be implemented in January 2024.
This will impose an EU border tax on imported goods that have paid a lower price than the EU ETS, which means that UK companies will have to pay the difference between their own ETS prices and the EU’s.
According to Energy UK’s report, the UK and EU’s ETS price disparities endure, over £500 million per year could be paid by the UK in EU carbon taxes.
Figure 2: Potential CBAM costs on UK exports to the EU by sector
The CBAM will cover imports of electricity from countries outside the EU, including the UK. To determine how carbon-intensive a country’s electricity is, the EU has adopted a benchmarking approach, this approach will see CBAM tax UK exports based on the average carbon intensity of the UK’s grid.
As 40% of the UK’s electricity comes from fossil fuels, all electricity exported to the EU will have to pay a 40% carbon tax.
This penalises electricity even if it is produced by 100% renewable sources, such as wind or solar.
The proposed solution
To avoid the billions of pounds that will likely need to be paid by British businesses due to the EU’s CBAM, Energy UK has urged for the UK and EU’s ETS’ to be linked. This would lead to a carbon price convergence between the two jurisdictions and exempt the UK from the EU’s CBAM – much like Switzerland already does.
Whilst the government has promised to give “serious consideration” to linking the two ETS’, Energy UK has urged fast action, to avoid looming issues, as CBAM’s implementation date looms ever nearer.
“The UK has led the way internationally on pricing polluting carbon emissions. Carbon pricing has played a critical role in the decarbonisation of the UK and has driven investment in clean energy and low carbon technologies. But a falling and volatile domestic carbon price threatens to deter clean investment at the very moment we need it most and could end up costing British companies billions of pounds simply for trading with their largest export market,” said Adam Berman, Energy UK’s deputy director.
“Linking our carbon pricing regime with the EU’s would exempt UK companies from these costs and remove the problems caused by the disparity between the two schemes. It would also stabilise and strengthen our carbon price, sending a powerful signal to bring forward investments in homegrown clean energy that can cut bills, reduce emissions, and bolster our energy security.
“We strongly believe that both sides would benefit from linkage, so we urge the Government and the EU to get round the table before UK companies start paying the price.”