On Tuesday in the House of Commons, the Secretary of State for Energy and Climate Change, Chris Huhne, announced that the UK would adopt the recommendations of the Climate Change Committee and shift the economy towards ambitious 2030 carbon reductions. Specifically, Huhne announced a 4^th Carbon Budget of 1950 Mt CO2 for the period 2023-2027 which is aligned with an indicative 2030 target to reduce emissions by 60% relative to 1990 levels (46% relative to 2009 levels). The government did deviate from the recommendations in one important area in that it accepted the need to keep carbon trading options open – “to maintain maximum flexibility, and minimise costs in the medium-long term”.

But there is an important caveat to this ambition – namely the need to ensure alignment with the EU. While the UK may well be an island and even one with its own currency inside the EU, at least for carbon it is joined at the hip to the EU by the emissions trading system. A UK power generator and emitter handles exactly the same allowances as a continental EU one and sees, at least for now, exactly the same carbon price. If the UK happens to embark on its own reduction pathway independent of that prescribed by the EU then the result will be 100% carbon leakage into the EU via allowance trade. As such, the announcement by the Secretary of State included the following;

 Under the Climate Change Act, emissions reductions by the UK’s industrial and power sectors are determined by the UK’s share of the EU Emissions Trading System cap. This protects UK industrial and power sectors from exceeding EU requirements. However if the EU ETS cap is insufficiently ambitious, this could mean placing disproportionate strain on other sectors outside the EU ETS such as transport. 

 To overcome this and to provide clearer signals for businesses and investors, government will review progress towards the EU emissions goal in early 2014. If at that point our domestic commitments place us on a different emissions trajectory than the Emissions Trading System trajectory agreed by the EU, we will, as appropriate, revise up our budget to align it with the actual EU trajectory.

At least in terms of the power sector, the future differences appear stark. In recent months the EU has released its Low Carbon Roadmap for 2050 which sees an EU wide reduction of some 40% by 2030 compared to 1990. This equates to a reduction in the power sector of around 60% by 2030 (or 54% for the EU-26), in contrast to the proposal of the 4^th Carbon Budget which sees a nearly 90% reduction.

 

Although the time period is short, the UK and EU power sectors appear to have followed more aligned pathways since the start of the EU-ETS, as would be expected given the underlying trade in allowances. Between 2005 and 2008, both have been relatively flat.

A sustained, more aggressive pathway for the UK is not possible unless supplementary domestic policies are introduced to force the direction. As noted in previous postings, this will drive up the cost for UK consumers relative to the EU and potentially impact UK competitiveness. So the challenge now sits with the UK to force the issue in Europe, rather than focus on domestic energy policies to meet its goals. To date there has been an almost singular focus on the EU 2020 target (i.e. the 20% or 30% debate), but the reality is that 2020 emissions are now largely defined by major projects already in planning, car designs on the drawing boards and the current building codes. This means that the UK needs to get the EU to turn its attention to Phase IV of the EU-ETS and open up the discussion regarding its structure and ambition (i.e. the 2030 target).

The current EU legislation would see the post-2020 ETS continue to deliver reductions of 1.74% per annum (absolute percentage points, not percent relative to the previous year), which means about 35% between now and 2030. This is far short of the recommendations of the 4^th Carbon Budget proposal for the UK.

The UK government has quite a challenge ahead.

Photo by Salvatore Vuono.