Carbon Price Floor

Standard Note: SN/SC/5927

Last updated: 7 November 2013
Author: Dr Elena Ares
Section Science and Environment Section


Fluctuations in the price of carbon in the form of EU ETS allowances have resulted in
uncertainty for investors in low carbon technologies. This has contributed to a lower level of
investment in these technologies, below what is required to meet UK carbon reduction and
renewable targets.
To address this, the Coalition Government committed to introduce a floor price carbon and
published a consultation on carbon price support in December 2010. Following this it
announced in the March 2011 Budget that it would be introducing price support via the
Climate Change Levy and fuel duty with a target price of 30 per tonne of carbon dioxide in
2020. The floor price will start at about 16 per tonne. At the time of the announcement the
trading price was around 15 per tonne, but by J anuary 2013 it had fallen to under 4.
The Government published its consultation in December 2010. This set out how the
exemption from the Climate Change Levy for fossil fuels used to generate electricity would
be removed. The Government proposed taxing fossil fuels at rates that took into account of
their average carbon content.
Detailed proposals for the carbon price floor were published by HMRC in December 2012 as
part of the draft Finance Bill 2013. The rate for 2103 is equivalent to 4.94 per tonne of
carbon dioxide. From 1 April 2014, the CPS rates of CCL and fuel duty will be equivalent to
9.55 per tonne. Indicative prices have been published up to 2017. Revenue raised will be
retained by the treasury.
Background on the Climate Change Levy is available in Library Standard Note SN/BT/235

This information is provided to Members of Parliament in support of their parliamentary duties
and is not intended to address the specific circumstances of any particular individual. It should
not be relied upon as being up to date; the law or policies may have changed since it was last
updated; and it should not be relied upon as legal or professional advice or as a substitute for
it. A suitably qualified professional should be consulted if specific advice or information is
required.
This information is provided subject to our general terms and conditions which are available
online or may be provided on request in hard copy. Authors are available to discuss the
content of this briefing with Members and their staff, but not with the general public.
2
Contents
1 Background 2
1.1 The EU ETS 2
1.2 Is the price of carbon too low? 2
2 A Floor Price for Carbon 3
3 Coalition Position 4
3.1 Consultation on carbon price support 5
4 Government Budget Announcement 6
4.1 Costs and Benefits 7
4.2 Reactions to the decision 7
5 Nuclear 7
6 Energy and Climate Change Select Committee Report 9
7 Proposals in Detail 9
8 Carbon Floor Price to 2017 10

1 Background
1.1 The EU ETS
The EU Emissions Trading Scheme (EU ETS) is a mandatory cap-and-trade scheme for
carbon dioxide, which is central to the EUs climate change target of reducing emissions by
20% by 2020. It sets a decreasing cap for emissions from energy intensive sectors, and
allocates or auctions emissions allowances (EUAs) which can be traded on the open market.
It is currently in Phase II, which imposes reductions of 6.8% compared to 2005 emissions.
The details of Phase III of the EU ETS, which will run from 2013 to 2020, were approved by
the EU Council in April 2009. Over half of allowances will be auctioned and there will be an
overall reduction in emissions of 1.74% per year compared to Phase II levels. This will
represent a 21% reduction by 2020 in emissions for all sectors covered compared to 2005
levels. Phase III will also include aviation for the first time.
1.2 Is the price of carbon too low?
Over allocation of permits in Phase I led to the price falling to only a few cents. The
consensus is that an allowance price of at least 30 a tonne is needed to drive investment.
For Phase II the price reached 29 in 2008. However prices have fallen significantly since
and at the end of J anuary 2013 were hovering around 4.
3


The response from the Commission has been to consider raising the emissions reduction
target for 2020 from 20% to 30%. This has full support from the UK Government and most
Member States, although it has so far been strongly resisted by Poland. The EU Commission
has also proposed holding back future credits due for auction or backloading but there is
opposition to this from the EU Parliament.
2 A Floor Price for Carbon
Debate on the need to set a floor price for carbon increased significantly following the fall of
Phase II allowances in 2009 to half what would be necessary to drive the low investment.
The issue was raised in the Environmental Audit Committees report on Carbon Budgets
during which witnesses called for a floor price of carbon to incentivise investment in low
carbon technologies:
Several witnesses called for the creation of a floor price, below which the carbon price
would not be allowed to fall, to help to reduce the risks, and thus costs, of investing in
low carbon projects. Perhaps Professor Dieter Helm (chairman of the Academic Panel
of economists at the Department for Environment, Food and Rural Affairs) has put the
case most strongly:
[] it is hard to think why one would not have a floor: what could the downside risk
possibly be? For, if policy-makers genuinely thought that the carbon price might fall
below the floor, there would be a credibility question about the scheme as a whole.
Either the Commission believes that the EU ETS price will always be above the floor
(in which case, there is no problem putting a floor in place), or it believes that the price
could fall below (in which case, there is a good case for having a floor).
1



1
EAC, Carbon Budgets, 5 J anuary 2010
0
5
10
15
20
25
30
J an 06 J an 07 J an 08 J an 09 J an 10 J an 11 J an 12 J an 13
EU ETS carbon prices
Forward month pri ce, per al l owance
Source: www.theice.com
4
However many businesses were against, arguing that it would create uncertainty unless
clear notice was given. Some argued that it was unnecessary:
RWE npower thought it would help investment in low-carbon technologies if investors
are confident that the Scheme will not be subject to further political interference, and
that the threat of further intervention in EU ETS, for example price floors and ceilings,
will only serve to undermine confidence in the scheme. The Carbon Markets and
Investors Association argued that concerns over whether a volatile ETS price leading
to lower investments than would otherwise be the case are unfounded; the long run
market signals within the EU ETS are sufficiently stable. Their conclusion was that
any market intervention should be used as a last resort, but that some potential
measures might be consideredincluding introducing a reserve price for auctioning
so long as they were signposted far in advance so as to give long-term certainty over
their effects on the carbon price. Barclays Capital, meanwhile, argued against any price
interventions on the basis that they can only be maintained by ignoring the
environmental goals defined by the cap, thereby introducing inefficiencies into the
market.
2

The previous Government, in its response to the report, made it clear that it did not support a
floor price. In its view the aims of the EU ETS would be achieved if emissions were kept
below the overall cap and that any adjustments should involve tightening the cap:

The Government considers that there are risks in intervening in the market to control
the carbon price. The best approach to give the strong long-term signal sought by
investors is through setting the right, long-term regulatory framework with a reducing
cap on emissions. Under the revised EU Emissions Trading System (EU ETS)
Directive, the EU ETS cap will fall by 1.74% (compared to phase II) each year after
2013.
Longer term, the most effective way of strengthening the carbon price is by limiting the
supply of allowances by tightening the cap. Our efforts are focussed on taking forward
the work agreed at Copenhagen to secure an ambitious legal treaty including an
increase in the EUs overall reduction target from 20% to 30%. This would trigger a
review of the ETS including tightening of the cap..
3

3 Coalition Position
The Coalition Agreement made the following commitments with regard to the EU ETS:
We will push for the EU to demonstrate leadership in tackling international climate
change, including by supporting an increase in the EU emission reduction target to
30% by 2020.
We will introduce a floor price for carbon, and make efforts to persuade the EU to
move towards full auctioning of ETS permits.
4

Further details on a floor price were provided in J uly 2010 in response to a written
parliamentary question:
The creation of a floor for the carbon price is an important commitment in the
Programme of Government. As announced in the Budget, the Government will publish
proposals in the autumn to reform the climate change levy in order to provide more


2
ibid
3
EAC, Carbon budgets: Government Response to the Committees Third Report, 16 March 2010
4
Cabinet Office. The Coalition: Our programme for Government, May 2010
5
certainty and support to the carbon price. Further detail will be published as part of the
consultation process.
5

3.1 Consultation on carbon price support
The Government published its consultation in December 2010. This explained how the
exemption from the Climate Change Levy for fossil fuels used to generate electricity would
be removed. The Government proposed taxing fossil fuels at rates that took into account of
their average carbon content. These rates would be known as the CCL carbon price support
rates:
The Government proposes to introduce a carbon price support mechanism to support
investment in low-carbon generation. The Government has decided that this is best
achieved by the climate change levy (CCL) and fuel duty being levied on all fossil fuels
used in the UK to generate electricity.
In most cases, fossil fuels currently used to generate electricity are exempt from CCL.
The Government proposes to remove these exemptions and to tax these commodities
at rates that take account of the commodities average carbon content. These rates will
be known as the CCL carbon price support rates, and will be different from the main
CCL rates levied on consumers use of gas, coal, LPG and electricity, which will be
retained. This does not propose any changes to existing energy supplies paid through
CCL.
Oils are not subject to CCL but fuel duty is payable at the point oils leave the refinery.
Currently, the duty can be reclaimed in full by the electricity generator but, as part of
the carbon price support mechanism, the Government proposes to reduce the amount
of fuel duty that can be reclaimed, in effect creating oils carbon price support rates.
Other more detailed features of the Governments proposal include:
electricity used to generate further electricity will remain exempt from CCL;
the CCL liability of electricity supplied to the final consumer arising from generation
using fossil fuels will be unchanged, as will the treatment of imported electricity;
fossil fuels used to generate electricity in the UK that is subsequently exported will
be liable to the relevant carbon price support rates;
all fossil fuels burnt in CHP stations will be subject to CCL or fuel duty (at the
relevant carbon price support rates) regardless of their rating through the CHP
Quality Assurance (CHPQA) programme; and
supplies of fossil fuels to auto-generators will continue to be liable to CCL and fuel
duty but at the relevant carbon price support rate. Auto-generators will no longer
be able to reclaim CCL or fuel duty charged on the fossil fuel they use to produce
electricity, which is subsequently supplied to the electricity transmission and
distribution networks.
The level of the CCL will be set, depending on the EU ETS price, to achieve a predetermined
overall target price trajectory. An illustration is set out in the consultation document:


5
HC Deb 24 J un 2010 c343W
6

The aim of this is to address carbon price uncertainty which according to the consultation
document is predominantly driven by wider regulatory uncertainties and the Government
might therefore be better placed to manage some carbon price risk.
6

Background on the Climate Change Levy is available in Library Standard Note SN/BT/235
A regulatory impact assessment was published along with the consultation documents. This
considered three scenarios. All set a target price for a tonne of carbon dioxide in 2030 of
70. They differed in the target price for 2020 which was set at 20, 30 or 40. The
projection for 2020 under the current EU target of 20% emissions reduction is a price of
16.3 per tonne of carbon dioxide.
7

The Committee on Climate Change published its Fourth Carbon Budget report in December
2010. This set out the Committees views on what price would be required by 2020:
Carbon price underpin. Given carbon price volatility and the current low carbon price,
a carbon price underpin would complement electricity market reforms. It could also
strengthen incentives for investment in low-carbon technologies in other sectors,
subject to competitiveness and affordability concerns being addressed. A carbon price
underpin which reached at least 27/tCO2 (i.e. 30 euros per tonne) in 2020 and rising
through the 2020s would provide appropriate signals.
4 Government Budget Announcement
The Government announced its decision in the March 2011 Budget:
Carbon price floor The Government announces a floor price for carbon in the power
sector from 1 April 2013 to target a price for carbon of 30 per tonne of carbon dioxide
in 2020. The floor will start at around 16 per tonne of carbon dioxide and the carbon
price support rates for 2013-14 will be equivalent to 4.94 per tonne. The Government
intends to introduce relief for carbon capture and storage and combined heat and
power (CHP), and remove an existing exemption in the climate change levy for
electricity CHP plants supply indirectly to an energy consumer. Anti-avoidance


6
HM Treasury, Carbon Price Support Consultation, 16 J anuary 2010
7
HM Treasury, Carbon Price Support Regulatory Impact Assessment, 16 J anuary 2010
7
provisions will be introduced to prevent forestalling with effect from 23 March 2011.
(Finance Bill 2011)
The then Energy and Climate Change Secretary, Chris Huhne, welcomed the decision,
together with the commitment in the Budget to a Green Investment Bank:
Theres a clear, long term signal to energy investors in todays Budget. A Green
Investment Bank with substantially more capital and borrowing capacity and a
stronger, more stable carbon price put investment in green energy technologies at the
heart of the coalitions strategy for sustainable, balanced economic growth.
4.1 Costs and Benefits
The costs and benefits for a target price of 30 for 2020 were set out in the regulatory impact
assessment. This concluded that the resource cost investment in new technology would
be around 6.1bn for 2013-2030. Over the same period there would be a carbon saving of
7.2bn and savings due to improvement in air quality of 0.9bn. This results in a total benefit
in net present value of 1.9bn.
4.2 Reactions to the decision
The CBI welcomed the introduction of carbon price support but warned it needed to be co-
ordinated with other measures:
With a third of our existing power generation capacity retiring by 2020, CBI has been
calling for reforms to the electricity market since 2009. This carbon floor price is one
part of a broader package of measures, which all need to fit together. To mitigate the
concerns of businesses' about this new energy tax, Government will need to take
action to support the UK's industrial competitiveness by the time it takes effect.
8

The Renewables Energy Association also welcomed the announcement, but would like the
commitment to go beyond 2020 to provide greater certainty to investors:
While supporting the carbon-floor price, which will make low carbon electricity more
competitive with electricity from coal and gas, the industry called for a longer term
indication of post 2020 levels. RenewableUK also called for a commitment to reinvest
proceeds (projected at over 3 billion in 2013-2016) in low carbon transition
programmes and green energy R&D.
Todays details on the carbon floor price and the GIB should be the first steps towards
a long term solution on funding for a host of technologies such as the next generation
of offshore wind farms and wave and tidal devices. We would encourage more clarity
and further action following todays budget, as the measures so far look promising,
concluded Edge.
9

5 Nuclear
There have been criticisms since the announcement that a carbon floor price would result in
higher energy prices and therefore provide a windfall for existing nuclear generators and a
hidden subsidy for any new generation.
Experts were divided on the effectiveness of the new floor price. Many warn it will not
be high enough to drive significant increases in low-carbon investment, while others


8
CBI, The Budget and the Low Carbon Economy, 24 March 2011
9
REA Press Release, Budget to re-energise funding and planning for renewables, 23 March 2011
8
predict it will deliver a major windfall in excess of 1bn a year to existing nuclear power
plants.
Matthew Spencer, director of green business think tank the Green Alliance, predicted
the floor price would prove far too low to drive increases in investment.
"The Treasury has been tying itself in knots trying to keep the floor price to avoid giving
a big windfall to nuclear operators," he said. "But that could have been tackled through
a windfall tax. There are also no measures to protect people in fuel poverty from the
resulting impact on energy prices, so there is a risk this will just be seen as a stealth
tax."
10

However nuclear generators welcomed the proposals as a way of providing investment in
future generation. EDF Energy welcomed the move:
The Carbon Price Floor is important for all low carbon technologies as it restores the
carbon price to what was originally intended. It will support the economics of
renewables and carbon capture and storage and can reduce the need for specific
measures to support those technologies.
For nuclear, helping to restore the carbon price to what was originally intended is
important to encourage investment in existing plants and in new build.
We welcome the Chancellors confirmation the floor price will be introduced in 2013 at
16 per tonne and reach 30 per tonne in 2020 as we believe this trajectory strikes the
right balance, meeting the needs of policy makers, consumers and investors.
11

More recently, the Lib Dem voted at their conference in favour of a windfall tax for existing
generators to claw back some of the increased revenue a floor price of carbon would mean:
Pressure is mounting on the government to include a windfall tax on nuclear operators
as part of its electricity market reforms, after the Liberal Democrat conference voted in
favour of a new levy on existing nuclear power plants.
Under the government's planned electricity market reforms, the Treasury will impose a
'carbon floor price' to ensure that fossil fuel-based power generators pay a minimum
amount per tonne of carbon they release.
The move is intended to drive investment in low carbon alternatives such as renewable
energy and nuclear power, but critics have warned that, while the measure should
stimulate low carbon investment, the resulting increase in energy prices will also
deliver a multi-billion pound windfall to existing nuclear and renewable energy plants
that will not have to pay the new carbon levy.
Green groups have called for a windfall tax to generate revenue for the Treasury from
the additional profits that will result, and the Lib Dems yesterday added their voice to
such calls, voting in favour of a motion calling for a windfall tax at their annual
conference.
12



10
Business Green, Budget 2011: Experts divided over carbon floor price impact, 23 March 2011
11
EDF Energy, Carbon Price Floor will encourage investment in nuclear, renewables and carbon capture and
storage, 23 March 2011
12
BusinessGreen, Lib Dems vote in favour of nuclear windfall tax, 21 September 2011.
9
6 Energy and Climate Change Select Committee Report
The Energy and Climate Change Select Committee published a report on 26 J anuary 2012
on the EU Emissions Trading System in which it was highly critical of the proposals for a floor
price for carbon:
Tim Yeo MP, Chairman of the Committee, said:
"The Chancellor was right to say we wont save the planet by putting the UK out of
business. Ironically, however, it is the Treasurys decision to set a Carbon Price Floor
that could result in industry and electricity production relocating to other EU countries.
Unless the price of carbon is increased at an EU-wide level, taking action on our own
will have no overall effect on emissions other than to out-source them. A revenue
raising exercise disguised as a green policy wont help anybody the price of carbon
has to be increased at an EU level to kick start investment in clean-energy."
Energy generators and heavy industry could be subject to an 'exorbitant' top-up tax of
up to 25 per tonne of CO2 under current plans, because the price of carbon in the
rest of the EU is so low. Electricity prices will increase as the price floor keeps the cost
of carbon higher than in other countries, effectively subsidising other Member States at
the expense of the UK consumer. This will cut emissions in the UK, but may not reduce
them overall as electricity production and industries may simply relocate to other
Member States resulting in "carbon leakage".
The threat of leakage within the EU is particularly acute for the electricity sector.
Electricity is readily transportable between the UK and mainland Europe and can be
traded instantaneously on spot market prices. DECC expects there to be as much as
10 GW of interconnection with other countries by 2020, some 10% of installed
capacity. This makes electricity generation more susceptible to leakage than other
sectors, such as goods manufacture, which may be restricted by the difficulties of
relocating production.
13

7 Proposals in Detail
The Government published its proposals in detail in December 2011.These were
summarised as follows in the overview of the draft Finance Bill 2013:
Finance Bill 2013 will include the final primary provisions needed to deliver the carbon
price support (CPS) rates of climate change levy (CCL) from 1 April 2013, which form
part of the Governments carbon price floor announced at Budget 2011. This will
include the CPS rates of CCL for 2015-16 (which will be confirmed at Budget 2013).
14

The rationale behind the legislation, which is to increase investment in low carbon power
generation, was set out as follows in the draft:
In order to encourage new and additional investment in low-carbon power generation,
the Government announced at Budget 2011 that, following consultation, it would
introduce a carbon price floor from 1 April 2013, which it would achieve by amending
CCL legislation (and fuel duty legislation for oils used in electricity generation since oils
are not subject to CCL). Supplies of coal, gas and LPG used in most forms of
electricity generation would become liable to newly created CPS rates of CCL, which
would be different from the main CCL rates levied on consumers use of these
commodities (and of other solid fuels and electricity). The amount of fuel duty
reclaimable on oil used in electricity generation would be adjusted to establish new


13
ECCC, Go-it-alone UK Carbon Price Floor could harm industry and consumers, 26 J anuary 2012
14
HMRC, Overview of Legislation in Draft, 11 December 2012
10
CPS rates of fuel duty. The changes needed to fuel duty are all set out in separate
secondary legislation [...].
15

The HMRC produced a 5 page brief setting out the proposals which contains further detail.
16

8 Carbon Floor Price to 2017
The Treasury announced in the 2012 Budget the rates for the carbon floor price up to 2015
and indicative prices up to 2017
CPS rates for 2013-14 and 2014-15
The CPS rates from 1 April 2013-14 were announced at Budget 2011, with the CPS
rates of CCL legislated for in Finance Act 2011. The rates will be equivalent to 4.94
per tonne of carbon dioxide (tCO
2
). From 1 April 2014, the CPS rates of CCL and fuel
duty will be equivalent to 9.55 per tCO
2
.
Indicative CPS rates for 2015-16 and 2016-17
Indicative CPS rates for 2015-16 and 2016-17 will be equivalent to 12.06 per tCO
2

and 14.86 per tCO
2
respectively.
Full details, including table setting out what this would translate to as part of the CCL can be
found in the HMRC publication Carbon Price Floor: Further Legislative Provisions and Future
Rates . The total cost to business will be the rate of the floor price plus the EU ETS credit
price. This is currently around 4 rather than the 11 originally estimated by the Treasury
when setting the carbon floor price. Therefore the original overall price to energy producers
was intended to be around 16, but is actually around 9.The Floor Price is set two years in
advance and as a result lags what the EU ETS price is doing, which changes in real time.
This is the reason why the indicative prices for 2105-17 are higher, as they take into account
the current low EU ETS credit price. Revenue from the Carbon Floor Price to 2018 was
estimated by the Treasury as follows:



15
HMRC, Finance Bill Consultation Draft, 11 December 2012
16
HMRC website, Carbon Price Floor, [on 8

February 2013]
Estimated income from the Carbon Price Floor
million cash
2013-14 2014-15 2015-16 2016-17 2017-18
975 1,420 2,025 2,075 2,200
Source: Budget 2013, HM Treasury