Bullish carbon puts UK Treasury on alert

Author: Henry Evans


LONDON (ICIS)--UK Treasury sources have said they are ‘considering the implications’ of this year’s surge in the EU ETS price, which has gone beyond previous government forecasts underpinned by its carbon price floor target.

The ICE December ’18 EUA – the benchmark for European carbon futures – has tripled in value since the start of 2018 and climbed to a new ten-year high of €25.00/tCO2e on Monday morning.

As a result, the cost of carbon for UK fossil-fuelled generators has climbed above the Treasury’s carbon price floor trajectory, which was set in the 2011 budget.

Combined with the carbon price support (CPS), which is frozen at £18.00/tCO2, the ETS benchmark climbed above the price floor – accounting for inflation – in mid-July for the first time since the policy was implemented in 2013 (see graph).

The Conservative-Liberal Democrat coalition government announced a target carbon price – also termed a carbon price floor – in the 2011 budget.

Implemented in April 2013, the floor started at £16.00/tCO2 and was set to rise in annual £2.00 increments to a price of £30.00/tCO2 in 2020 (in 2009 prices). The trajectory was set even steeper for the 2020s as the government targeted a price of £70.00/tCO2 by 2030.

The intention was to provide industry with a long-term incentive to invest in low-carbon generation, compensating for the depressed ETS price.

At the time, the government also introduced the CPS, its mechanism for ensuring the UK’s cost of carbon could be adjusted according to forecast ETS prices and the overall price floor trajectory.

The government froze the CPS at £18.00/tCO2 from April 2016, concerned that an ETS price languishing below €10.00/tCO2e for a number of years was making energy-intensive businesses in the UK uncompetitive with the rest of the continent.

News that the Treasury is getting twitchy about the current premium in European carbon prices could signal yet further consideration of the CPS, which is priced into forward wholesale electricity contracts.

Previous changes to the future CPS rate, as made in the 2014 budget, have prompted a revaluation of products on the forward curve.

However, adjusting future rates would have repercussions for the Treasury’s coffers, which accrued £1bn from CPS proceeds in 2017.

According to current policy, the rate of £18.00/tCO2 is frozen until 2020 before rising with inflation out to April 2021. The Treasury said in last November’s budget that it would target a total carbon price until the phase-out of coal fired generation, expected by 2025 at the latest.

The Treasury said it would target a similar carbon price to the combined CPS and ETS at last November’s levels before this year’s surge in ETS prices.

However, Centre for Policy Studies research fellow Tony Lodge, an expert in UK energy policy, believes the concept of the carbon price floor is dead.

“You could strongly argue that the carbon price floor no longer applies,” he said. “The price floor was the creation of the Conservative-Lib Dem coalition and as with so much policy of that period, it has been discarded by the current Tory government.”