The UK government is under pressure to abandon its carbon tax now that the European parliament's rejection of the European Commission's allowance back-loading proposal has sent the EU's emissions trading system (ETS) prices tumbling, electricity industry insiders have warned.
"People are now digesting what the rejection of the back-loading means for the carbon floor price and the disparity between the power prices the UK will be paying compared [with those paid in mainland Europe]," a UK power trader said.
"The UK's electricity will be priced-out of Europe, and I don't think that can be justified by the government."
Had the back-loading proposal passed, 900m EU allowances would have been temporarily removed from phase III (2013-2020) of the ETS and loaded back in towards the end of the phase.
Instead, the proposal's 16 April rejection sent the carbon market into turmoil. The December 2013 Benchmark contract hit an intra-day low of €2.63/tCO2e that day, dragging EU power markets down with it.
ETS prices are set to remain low for some time. Some industry sources have argued that the UK levy will price British electricity out of the European power markets, severely hampering cross-border trade. Many have said they believe that the UK will become increasingly exposed and become isolated from other European markets (see EDEM 6 March 2013).
The UK's carbon floor price, which is paid on top of the cost of EU allowances, is now £4.94/tCO2e (€5.80/tCO2e), having been introduced on 1 April. But it is set to rise significantly in the next few years.
The UK carbon support price is set two years in advance, so the price British carbon emitters pay can diverge widely from prices in the volatile carbon market. The 2014-2015 rate revealed in the government's 2012 budget was £9.55/tCO2e, or €11.22/tCO2e, almost four times the potential rate for power producers on mainland Europe. The UK rate will then be almost doubled for 2015-2016, to £18.08/tCO2e.
"The outcome of the ETS vote means there is a higher risk of ditching of the CO2 tax, although the earliest [the British government] would be able to ditch is April 2016," independent utilities analyst Lakis Athanasiou said. "It will be very interesting to see what they say at the next budget."
Meanwhile, the carbon floor price has been deemed ineffective as a way of achieving its aim, which is to reduce the amount of carbon emitted by the UK. A lack of confidence in its longevity is also knocking the confidence of low-carbon investors.
"The carbon tax is not effective in reducing emissions," Peter Emery, executive production director at Drax, told ICIS. "Instead, it is a windfall of profits for existing nuclear generators. Banks do not view the carbon tax [as] credible. That makes it difficult to raise finance for low-carbon generation."
A UK Treasury spokeswoman told ICIS it does not plan to abandon the tax. "The carbon floor price itself won't change as a result of the vote one of the principle points about the carbon price floor is that it is designed to provide certainty to the industry," she said.
"It's worth noting, though, that British businesses will benefit from the fall in the ETS price just like their European counterparts."
Some argue that it might be tricky to convince the government to relinquish the tax.
"The problem is that this is an extremely lucrative way for the government to raise money, although [the vote against back-loading] will increase pressure on the government to clearly state its intentions for the carbon floor price," Emery said.
Questions have also been raised about the government's intentions for the funds raised via the tax.
Alan Whitehead, a member of the House of Commons select committee for energy and climate change, said: "It is a mechanism for providing revenues for the government and there is no obligation for the government to re-invest the funds raised into green technology. This is free money for [UK chancellor of the exchequer] George Osborne." Katie McQue