It’s time for a UK carbon tax

With just over thirty days until the end of the Brexit transition period, a link between the EU carbon market and the UK after Brexit is now impossible. A UK-only Emissions Trading System would be risky and highly complex, so the best case scenario for the climate is for the UK to implement a carbon tax on January 1st.

The UK government’s consultation on a Carbon Emissions Tax closed two months ago, and we’re now awaiting a response. In it, they outlined their intention to begin next year with a UK-only carbon market, or a carbon tax. It’s long past time for the government to make a decision, and allow businesses and investors to begin to plan for the new carbon pricing system.

A UK-only Emissions Trading System risks low carbon prices – and dysfunctional climate policy

We’ve outlined previously why we think a UK-only carbon market is so difficult to design – and will struggle to give the modest and gradually rising carbon price that helps drive decarbonisation. UK electricity in 2020 so far has been just 1.7% coal, and the 2024 final coal phase-out date is fast approaching, but a mistake on carbon pricing now would see a rebound for coal generation as the UK hosts COP26. We’re worried that the UK is set to repeat the same mistakes as the EU Emissions Trading System (EU ETS), which we’ve been tracking (as Sandbag) since 2008. Namely, the UK is planning to set the cap far above real emissions, creating a large surplus in allowances, and risking leading to low carbon prices, as with the first decade of climate policy failure in the EU ETS.

We can’t risk repeating low or volatile carbon prices in the UK now. The EU ETS price is currently ~€28/t (£25/t), whilst the UK ETS price floor is just €17/t (£15/t), which would be an international embarrassment for the UK’s commitment to climate action.

A UK Carbon Tax is the least worst option

Alternatively, the Carbon Emissions Tax proposal is relatively simple, and effectively links the UK carbon price to its much larger brother, the EU ETS price – without trying to achieve the same goal via an untested (and therefore risky) UK stand-alone trading system. In this way, UK power stations will not be paying a lesser carbon price than those on the mainland, and UK factories will be protected from the carbon price and international competition to the same extent as European manufacturers. We’ve explored in more detail how the CET can be improved in our September HMRC/HMT consultation response.

The carbon tax can help provide carbon pricing stability as the UK goes through the Brexit process. We would suggest, however, that the government continue to explore formally linking to the EU ETS, with a future UK ETS system – and restore the benefits of being part of a much larger carbon market.

How should the UK improve its carbon pricing plans?

Set up an independent panel to recommend the necessary carbon price rate, and the sectors it should apply to. This would give businesses greater confidence in the cost of carbon over the longer term, and help drive greater zero carbon investments, with lower risk. This could be hosted within the Climate Change Committee, or an external set of experts. This is especially necessary if the government moves away from the indicative link between the UK CET and the EU ETS price.

Explore using auction or tax revenues to pay ‘carbon dividends’ to citizens. Such payments could improve public support for carbon pricing, and help mitigate the regressive effects of increased electricity prices.

Remove the carbon price exemption for biomass. There is now scientific consensus that biomass should not be assumed to be carbon neutral by default – the true emissions from biomass burning are dependent on the type of feedstock, the counterfactual, the time horizon considered, and the supply-chain emissions. The UK’s new system for pricing carbon after Brexit provides a golden opportunity to correct a mistake in EU carbon pricing – making sure the growing number of wood-burning power stations pay for their net carbon emissions. This would not only be great for the climate, and the UK’s green leadership – it could bring in billions of pounds to the Treasury. Read more about our proposals for a carbon price on biomass.

Introduce a carbon border adjustment. This could eventually allow for greater industrial exposure to the carbon price signal, and so faster zero-carbon investment. We’ve previously suggested that a carbon border adjustment may be simplest to implement first on electricity.

Firm up the proposal to tie carbon pricing to the net zero target, and the interim Carbon Budgets. If the UK is not on track to meet the five-yearly Carbon Budgets under the Climate Change Act, as it is not for the 4th and 5th Budgets, the price can be increased to accelerate the transition in those sectors.

The government should investigate extending the sectors covered by carbon pricing, including fugitive methane emissions released during the production and transport of fossil fuels (coal and gas).