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This report forms part of the Energy Systems Catapult project ‘Rethinking Decarbonisation Incentives’ co-
funded by the Energy Technologies Institute.
Current Economic Signals for
Decarbonisation in the UK Rethinking Decarbonisation Incentives
William Blyth, Oxford Energy Associates
May 2018
Current Economic Signals for Decarbonisation in the UK
© 2018 Energy Systems Catapult
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Contents
1. Introduction .................................................................................................................................................... 3
Project Scope and Aims ................................................................................................................. 4
Current Economic Signals ............................................................................................................. 4
Implications for Policy – Why Do Variations in Carbon Price Matter? ......................... 5
2. Methodology ................................................................................................................................................. 8
Using Taxes and Subsidies to Calculate Incentives ............................................................. 8
Calculating Emissions Reductions from Low-Carbon Options ........................................ 9
Treatment of Other (Non-Carbon) Externalities ................................................................. 10
Defining a ‘Target Range’ ............................................................................................................ 10
3. Results ............................................................................................................................................................ 12
Price Signals by Sector ................................................................................................................. 12
Notes and Commentary ............................................................................................................... 14
4. Conclusions................................................................................................................................................... 19
Preliminary Conclusions ............................................................................................................... 19
Using the Results Priortise Policy Action ............................................................................... 19
Evidence Gaps and Areas for Further Work.......................................................................... 23
5. APPENDIX: Sectoral Analysis of Incentives ....................................................................................... 24
Upstream ........................................................................................................................................... 24
5.1.1. Electricity Generation .................................................................................................. 24
5.1.2. Other Upstream Energy: Oil, Gas & Solid Fuels ................................................ 31
Downstream ..................................................................................................................................... 35
5.2.1. Transport .......................................................................................................................... 35
5.2.2. Business and Industry ................................................................................................. 39
5.2.3. Residental ........................................................................................................................ 42
5.2.4. Public Buildings ............................................................................................................. 44
5.2.5. Agriculture, Forestry and Other Land-Use (AFOLU) ........................................ 45
5.2.6. Waste ................................................................................................................................. 49
6. References ..................................................................................................................................................... 51
Current Economic Signals for Decarbonisation in the UK
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Glossary of Terms
Downstream sectors These are end-use sectors where fuels and electricity are finally consumed
(e.g. transport, households, businesses etc.).
Dynamic efficiency The efficiency of resource allocation taking account of the dynamic nature
of economic conditions, particularly likely changes in the future, and
balancing outcomes for current and future generations.
Externality During a transaction between two parties, an externality is a cost or
benefit that is incurred by a third unrelated party (or parties).
First best First best policy solutions will lead to optimal outcomes if other prevailing
conditions are also optimal (e.g. perfect markets and rational consumer
behaviour). In practice, if conditions are not optimal, then first best
policies may not lead to the best available outcome.
Internalising
externalities
Ensuring all costs and benefits of all third parties are reflected in the costs
of transactions between two parties.
Price discovery When the costs of transactions between two parties are revealed through
publicly observable price signals. This has benefits to the market since
costs data is a public good.
Static efficiency The efficiency of resource allocation given prevailing economic conditions
at a given point in time.
Upstream sectors These are sectors such as oil, gas and electricity that produce or process
energy vectors, before passing them on to final consumers
Wealth transfer Money or other assets are reallocated between different parties or sectors
in the economy, creating winners and losers, without changing the overall
level of activity or size of the economy. Potential losers may seek to avoid
such losses, creating inefficiencies in the system.
Current Economic Signals for Decarbonisation in the UK
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1. Introduction
Project Scope and Aims
The “Rethinking Decarbonisation Incentives” project aims to develop and articulate a range
of policy options capable of improving the coherence of economic signals for
decarbonisation across the UK economy.
The project builds on the whole system analysis and perspective developed in recent years
by the Energy Technologies Institute (and now being carried forward by the Energy Systems
Catapult). The project will apply a whole system perspective, but within a policy context by
developing credible approaches to market and incentive design for emissions reduction
across the system.
In future stages of the project, policy options will be analysed in detail, taking account of the
range of policy objectives that exist in different sectors. This is intended to inform debate
about options to improve the feasibility and cost-effectiveness of meeting deep
decarbonisation targets, within a broader pragmatic context of industrial strategy, economic
competitiveness concerns and potentially competing policy objectives in different sectors.
This report provides a comparison of the current framework of economic signals for
decarbonisation in the UK. The aim is to explore and visualise the extent of variation in
decarbonisation incentives across different sectors, in order to provide a baseline from which
to assess in more detail the different sector drivers, and future options for policy reform.
Current Economic Signals
In an idealised policy environment, a single price signal across the whole economy would in
principle be the most efficient way to internalise the carbon externality, as long as it could be
combined with other instruments to address R&D market failures and other externalities
(Advani et al., 2013). In practice, ‘first-best’ policy options for other related externalities are
not practicable, and decarbonisation incentives become mixed with other policy objectives
such as raising revenue, supporting particular technologies, protecting industrial
competitiveness and addressing other externalities such as fuel poverty and other (related)
environmental impacts. Also, some sectors may be less responsive than others to carbon
pricing; for example, if there are relatively few affordable decarbonisation options, or where
carbon pricing is less salient to decision-making due to non-price barriers. These factors can
reduce the effectiveness of pure price signals and point to the need for other types of policy
intervention. Variations in economic signals have therefore often arisen for understandable
policy reasons.
However, not all sector variations exist for good policy reasons, and even when they do, they
will tend to lead to a reduction in the ability of the economy to adjust dynamically to
Current Economic Signals for Decarbonisation in the UK
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progressively tightening carbon targets in the most efficient way. Given the very deep levels
of decarbonisation required in coming decades, it is timely to reassess the status quo, and
explore the options for reforming policy/ies in a way that enables carbon goals to be
delivered as efficiently and pragmatically as possible in future decades.
Implications for Policy – Why Do Variations in Carbon
Price Matter?
In a ‘first-best’ policy world, an economy-wide carbon price would in principle be more
efficient than the current patchwork approach to reducing emissions (Helm, 2017). However,
in the real world, carbon pricing does not exist in a policy vacuum, and a first-best world is
not always achievable. The main arguments and counter-arguments for a single carbon price
are set out below.
Arguments for single carbon price Counter-arguments
Short-term: static efficiency and behavioural effects
A single price minimises overall economy-wide
abatement cost because emissions reductions
will be made wherever they are most cost-
effective. Policy-makers do not necessarily know
where the lowest-cost options are, and these
can be exposed through an economy-wide
price.
The static efficiency of climate policies depends
on the extent to which carbon prices are
matched to sectors’ abatement opportunities.
For sectors with high costs of abatement, raising
prices would add to their costs (and lead to
wealth transfer), but deliver little in the way of
short-term emissions reductions. If abatement
costs are known to policy-makers, then
matching prices to sectors’ ability to reduce
emissions can recreate the efficient market
response (at least in the short-term), with less
wealth transfer effects.
A single price avoids policy fragmentation, and
improves efficiency because it avoids firms and
regulators having to manage complex
sometimes overlapping regulations.
However, a first-best policy framework for
carbon also requires a first-best policy
framework for the other externalities and market
failures.
If first-best policies for other externalities and
market failures are unattainable (e.g. due to
political unpopularity, or because the UK is
required to follow international policy
formulations), then it is likely in practice that
special arrangements get made in particular
sectors, and multiple policy objectives again
become clustered together, reducing the
benefits of simplicity of a single carbon price.
At the level of individual projects, a single price
provides more streamlined incentives for project
developers leading to better design particularly
for projects that cut across current policy silos
In some sectors, carbon pricing is not the salient
driver that affects the choices and investments
of individuals and firms. Other types of policy,
such as product standards or mandates are
Current Economic Signals for Decarbonisation in the UK
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(e.g. projects incorporating renewable district
heating with CHP and building efficiency)
required to change behaviour and overcome
barriers.
Medium-term: technology development incentives
A single price mechanism helps price-discovery
which allows all market players to observe and
compete, allowing markets to deliver and
respond dynamically to technology ‘surprises’.
If the required technologies are known, then it
may be more efficient to set targeted incentives
for managing their development and
deployment because risks may be easier to
manage on a targeted basis compared to
economy-wide incentives. This approach is less
likely to lead to breakthroughs in unexpected
sectors / technologies.
Long-term: dynamic efficiency and structural effects
The economy will eventually reshape in
response to price signals, favouring sectors,
activities and behaviours with lower carbon
intensity. Achieving these benefits requires
economic flexibility to deal with the creation of
winners and losers, with some sectors increasing
and some sectors decreasing activity levels,
whilst being beneficial to the economy as a
whole.
Economic restructuring will have regional
growth and employment consequences that
may be difficult to tolerate politically and may
meet labour market constraints in terms of skills
and availability. Additional political pressure is
created by the fact that the rest of the world will
continue to operate with differentiated pricing,
creating competitive disadvantages in some
sectors for the UK. To the extent that political
reality may prevail, e.g. through exemptions and
special arrangements for ‘strategically important
sectors’, this will limit the extent to which a first-
best policy framework would in practice deliver
the expected dynamic efficiency gains.
As the next section shows, the UK currently experiences wide variations in carbon pricing
between sectors. It is beyond the scope of this report to estimate how much more efficient a
first-best policy world might be compared to the current policy arrangements. However, it
can be observed that both sides of the arguments and counter-arguments presented above
have considerable weight. This points to two preliminary conclusions about any possible
transition towards a more consistent set of carbon prices between sectors.
Firstly, such a transition will be disruptive. Some of this disruption will create new
technologies and value, but some of the disruption may be value-destroying, at least in the
short-term. Secondly, the biggest benefits of moving closer to a first-best policy world are
likely to emerge over medium to longer timescales, in response to new technology
development and structural adjustments. This suggests that moves to harmonise price
signals should evolve rather gradually. This report looks at mid-term price expectations (for
2030) as a guideline for the direction of travel of current policies.
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Finally, this report does not focus on specific policy design options, but it is worth
mentioning here some of the complexities involved in implementing a single carbon pricing
or incentive mechanism as these would likely impact on the effectiveness of such an
instrument in practice. The design of a carbon policy instrument requires careful
consideration of multiple, sometimes competing objectives.
In particular, there is a trade-off to be made between setting firm targets for carbon prices
vs. carbon emissions. A carbon tax provides certainty over the carbon price but does not
guarantee what the resulting emissions level will be, whereas a cap-and-trade scheme
controls emission quantities but loses control of the resulting price. If the purpose of climate
policy is to achieve a given level of emissions reduction by mid-century, then the latter policy
might be preferred, but investors may prefer a greater level of certainty over prices,
depending on the type of investment they are making. Hybrid policies, where quantity
targets are set in a cap-and-trade scheme, but with upper and/or lower bounds on prices
allow some of the benefits of both price and quantity mechanisms, but at the cost of greater
complexity. These will be important areas for policy-makers to consider when assessing
options for policy reform, which can draw on considerable body of previous literature.
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2. Methodology
Using Taxes and Subsidies to Calculate Incentives
The economic signals addressed in this report mainly comprise taxes or subsidies on fossil
fuel use or low-carbon alternatives. Specifically, positive carbon prices arise either from taxes
on emitting activities (such as fuel use in road transport), or from subsidies to low-carbon
alternatives (such as rail). Conversely, negative carbon prices arise either from subsidies for
emitting activities1, or taxes on low-carbon alternatives.
Some carbon-emitting sectors and technologies face direct taxes which are easily translated
into a positive carbon price based on the carbon intensity of the fuel. Examples include the
climate change levy, EU emissions trading scheme allowances, and the carbon price support
levied on producers of electricity. Subsidies to carbon-saving generation such as renewables
or nuclear also result in a positive carbon price signal.
Other end-use sectors receive a subsidy on energy use (e.g. reduced VAT on residential
energy use) which translate into a negative carbon price signal, again based on the carbon
intensity of the fuel.
The carbon intensity for direct combustion by end users is determined by the average
national values for each particular fuel concerned (natural gas and other fossil fuels). The
carbon intensity of electricity as far as end-users is concerned is taken to be the average for
the UK electricity system as a whole (this approach follows national emissions reporting
guidelines).
Some taxes and subsidies are explicitly applied with climate change policy goals in mind (e.g.
renewable energy subsidies in power generation), whereas in other cases they are in place
for historic reasons (e.g. reduced VAT rates on domestic electricity and gas consumption).
This report considers provision of a consistent approach across all sectors, by applying the
following principles:
As far as possible, all taxes and subsidies that affect the volume, the price or the carbon-
intensity of a particular sector activity or output should be included.
Incentives are evaluated at the point at which they influence behaviour and investment
decisions by different groups and sectors in the economy:
For upstream energy sectors (i.e. electricity generation and oil and gas
production), the analysis includes direct taxes, tax allowances, subsidies and other
direct pricing signals2.
1 Tax rates that are below general rates for the economy as a whole are also treated as subsidies and indicate a negative implicit carbon price. 2 For oil and gas, this includes allowances against the petroleum revenue tax for more difficult fields
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For downstream end-use sectors, the analysis includes both direct price signals
on downstream emissions, as well as indirect signals from the pass-through of
carbon prices associated with emissions from the upstream production of fuels
and electricity.
It is considered that sectors should in principle be self-sustaining financially, so therefore
tax receipts are calculated net of public expenditure in each sector. E.g. in road transport,
net public income is calculated as gross road tax receipts (mainly fuel duties + vehicle
excise duties), minus total public expenditure on road infrastructure. This net public
income is the quantity used to compare to the level of various externalities such as
congestion, carbon emissions and so on.
VAT at the standard rate (20%) is assumed to be neutral (neither tax nor subsidy) for
carbon. Reduced VAT rates (such as the 5% rate for household gas and electricity
consumption), are treated as a subsidy by OECD, but not by the UK government. Both
approaches are applied to show sensitivity to this assumption.
Prices are based on recent data, or where necessary adjusted for inflation to be
approximately consistent with 2016 or 2017 monetary values.
Electricity market prices are assumed to include feedthrough of the carbon costs of
fossil-based generators which includes both the carbon price support (CPS) at its current
frozen rate of £18/tCO2, plus the price of EU-ETS allowances (EUAs). In this analysis, EUAs
are valued based on average 2017 price of £5.10/tCO2. This total of £23.10/tCO2
represents a carbon price signal for end-users of electricity and producers of low-carbon
electricity, that is additional to the direct taxes and subsidies on those sectors.
Calculating Emissions Reductions from Low-Carbon
Options
Translating subsidies and taxes for low-carbon alternatives into an effective carbon price
requires an assumption about the amount of carbon that is reduced as a result of the low-
carbon activity. The following key assumptions are made:
For renewable and nuclear electricity generation, it is assumed that they are displacing
new CCGT plant which would otherwise be the long-run default plant3 that would be
built in the absence of a carbon price signal, giving an emissions intensity of 0.34
tCO2/MWh of electricity displaced4.
For end-users, energy price signals are assumed to lead to reductions in emissions by
incentivising the reduction of energy consumption through investment in greater energy
efficiency or switching to less energy intensive processes. The effective carbon price
3 This is a slightly conservative assumption. If the counter-factual was that coal plant would instead be built (in a world where there were was no carbon price signal), then a greater level of emissions reductions from these low-carbon sources would be achieved for the same subsidy, implying a lower effective price signal. 4 For data source, see page 5 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/599761/Background_documentation_for_guidance_on_valuation_of_energy_use_and_greenhouse_gas_emissions_2016.pdf
Current Economic Signals for Decarbonisation in the UK
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associated with a particular energy tax or subsidy is calculated using the carbon intensity
of each fuel. For electricity, it is assumed that current end-user reductions in
consumption will save the average current level of emissions per unit for the electricity
system, giving an emissions intensity of 0.352 tCO2/MWh5.
For rail transport, it is assumed that the displaced activity is the equivalent level of road
transport (either passenger-km or t-km for freight) at the relevant national average
carbon intensity. Further details are given in Appendix Section 3.
Treatment of Other (Non-Carbon) Externalities
In several cases, taxes or subsidies may address more than one externality. In the case of
transport, these other non-carbon externalities such as congestion have been quantified by
other studies (e.g. Johnson and Stoye, 2012). This allows a range of results to be presented
for the effective carbon price which depends on assumptions about the degree to which
these other externalities are priced into the particular tax or subsidy being considered.
In the case of renewables, subsidies could be considered to address climate externalities or
market failures relating to lack of investment in technology development (or a combination
of the two). In this case, it is not straightforward to assess the degree to which taxes or
subsidies should be attributed to each of the externalities involved, and the scale of R&D
externalities in the market is not readily quantified. In this case, the subsidy is attributed
entirely to carbon, but recognise that this will lead to an overestimate of the effective carbon
price that the subsidy represents.
Defining a ‘Target Range’
Whilst it is difficult to define exactly what the price of carbon should be, various estimates of
the social cost of carbon and other approaches to forecasting carbon prices have been
undertaken. These provide a useful benchmark for this analysis, helping to place discussions
of price harmonisation within a context of whether prices in different sectors are likely to
need to rise or fall over time.
IMF (2013) used a figure of $25/tCO2 for the present-day value of carbon, based on 2010
reports by the US Interagency Working Group (IWG) on Social Costs of Carbon. IWG
estimates for the 2020 value of carbon have since been revised upwards in 2016, with a 5%-
95%’ile range of $6-140/tCO2, average $42/tCO2 (approximately £30/tCO2) at 3% discount
rate6. Looking slightly further ahead, BEIS calculates a carbon price range of between
£40-119/tCO2 as being required by 2030 to be on track for mid-century decarbonisation
5 BEIS; UK Government GHG Conversion Factors for Company Reporting 2017 6 Estimates for the social cost of carbon are very sensitive to the discount rate because it is used to discount all future climate damages, and those that occur in the very long-term count for little at current value if high discount rates are used. The IWG uses three different discount rates, with 3% as the central case.
Current Economic Signals for Decarbonisation in the UK
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targets. This relatively wide range reflects uncertainty over the cost of abatement and the
global pathway to 2050.
This analysis takes this latter 2030 BEIS price range as a ‘target’ range. Although the
timeframe for this analysis is to look at current subsidies, a medium-term comparator for the
target range is used because in practice it would take some time to achieve convergence of
economic signals across different sectors and a mid-term target helps identify where
subsidies or taxes may need to be raised or lowered to achieve greater consistency across
sectors and activities.
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3. Results
Price Signals by Sector
Figure 1 shows the range of carbon price signals within each sector / technology category.
The legend is as follows.
Orange bars represent sectors / technologies which are receiving a subsidy as a result
of policy interventions;
Purple bars represent sectors / technologies which are subject to a tax.
The blue diamonds show the level of emissions from each sector (in M/tonnes CO2e
pa), to show the importance of the sector as a component of total emissions.
The green horizontal shaded band indicates the ‘target’ range of carbon prices based
on BEIS projections for 2030 of £40-119/tCO2.
There are a number of different reasons for the ranges in estimates reflected in the following
colour-coding for the price ranges:
Solid shading: the range of prices faced by different projects or different companies
within a particular sector / technology category;
Striped shading: tax or subsidy may or may not qualify as a carbon price signal (e.g.
reduced VAT rates on domestic electricity consumption, or lack of VAT on air travel)
depending on assumptions;
Graduated shading: tax or subsidy is attributed to climate externalities as opposed to
other externalities (e.g. congestion externalities in road transport) depending on
assumptions.
The range of values for each sector shown in Figure 1 is explained briefly in the table in
section 3.2, (with further details in the appendix).
Current Economic Signals for Decarbonisation in the UK
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Figure 1. Effective carbon prices and emissions by sector7. Source: author calculations, see Appendix for details.
7 Chart amended 18/07/2018: a) values corrected to 2016/2017 prices, b) low carbon power generation figures only include new or recently built plant, c) include feedthrough of CPS and EUA prices to electricity prices.
Current Economic Signals for Decarbonisation in the UK
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Notes and Commentary
Upstream
Sector
Category Methodological note (further details in
Appendix)
Commentary on results
Renewables Solar, wind,
biomass CHP,
advanced
conversion
technologies8
and other
energy from
waste.
Renewables subsidies are based on the
Round 1 and 2 CfD strike prices adjusted for
inflation, plus the feedthrough of CPS and
EUAs to final electricity price. Carbon savings
are based on displacing long-term marginal
system plant, CCGT.
The entire subsidy is attributed to carbon
externalities. No attempt is made to separate
out those components of the subsidy which
could be attributed to R&D or early-market
barrier externalities. Doing so would reduce
the resulting effective C-price.
The results for renewables technologies span quite a wide range
because costs are generally coming down quite significantly over
time, and the range represents the difference between different
rounds of the CfD auction (see Appendix Section 1 for further
details).
The upper end of the subsidies for renewables projects for Round 1
are mostly above the target range, except for solar PV which falls
roughly within the target range. The range is based on different
prices received at auction. The most recent CfD auction results for
advanced combustion, biomass CHP and offshore wind are roughly
within the target range of carbon prices.
Other
Electricity
Nuclear Nuclear subsidies are based on the CfD strike
price for Hinkley Point C adjusted for
inflation, plus the CPS and EUAs. Carbon
savings are based on displacing long-term
marginal system plant, CCGT.
Decommissionng costs are included in the
CfD price, but are uncertain. No allowance is
made here to adjust for possible future
The effective carbon price for Hinkley Point C is above the target
range. The range shown underestimates the cost uncertainties
associated with new nuclear, see Appendix for further discussion.
8 Advanced conversion technologies are gasification and pyrolysis technologies, for treatment of residual waste as an alternative to landfill or mass-burn incineration
Current Economic Signals for Decarbonisation in the UK
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Upstream
Sector
Category Methodological note (further details in
Appendix)
Commentary on results
public expenditure liabilities that might arise
if these costs are higher than budgeted.
FiTs Feed-in tariffs (FiTs) apply mainly to smaller
renewables projects which attract widely
varying subsidies according to project size.
These are the published FiT prices, rather
than the prices at which projects are actually
built.
Prices span a wide range extending from well above to well below
the target range, although the lowest end of the range may be too
low to attract investment.
Coal, gas and
other fossil
The main tax for these technologies is the
CPS and EUAs.
Combination of CPS (£18/tCO2) plus EUAs at 2017 average values
(£5.10/tCO2) result in total effective price of £23.10/tCO2 is below
the target range for 2030. However, EUA prices have risen
significantly in the first half of 2018, which if continued, could start
to close the gap.
Other
Upstream
Oil and gas
E&P and
solid fuels
Upstream energy activities receive some
subsidies such as relief against the petroleum
revenue tax for some smaller oil fields.
The denominator is the emissions specifically
from upstream operations (rather than the
carbon content of the fuel produced).
Subsidies for emitting activities imply negative effective carbon
pricing.
Current Economic Signals for Decarbonisation in the UK
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Downstream
Sector
Category Methodological note (further details in
Appendix)
Commentary on results
Transport Road The main taxes are fuel duties and vehicle
excise. Subtracted from this income is the
level of public expenditure on road
maintenance to give a net public income. The
remaining tax income can be assigned to
externalities, of which congestion is the
largest but neither fuel duties or vehicle
excise are well targeted to address
congestion. Results therefore depend
strongly on assumptions about attribution of
taxes to congestion vs. climate externalities.
Road transport is a major emitter and may be either over-taxed or
under-taxed (relative to the target range) depending on how other
externalities (in particular congestion) are accounted for. Given the
importance of road transport, both in terms of its emissions levels,
and as a source of revenue from fuel and vehicle excise duties
(and the subsequent decline in revenues if there is a structural
shift to electric vehicles), this sector needs very careful
consideration.
Rail In terms of emissions reductions, the use of
rail is assumed in this report to replace road
transport. Carbon savings are based on the
average carbon intensity in the UK of
passenger and freight transport for each
mode. Subsidies for rail are based on total
public expenditure less total public income
from national statistics. As for road transport,
assumptions about congestion externalities
have a large impact on the results.
Rail transport is quite heavily subsidised in relation to its carbon
reduction impacts. The top end of the range assumes that public
subsidies are combined with foregone income from avoided road
journeys, and that no contribution is made to reducing road
congestion or any other social goals (e.g. regional development).
The lower end of the range excludes foregone tax revenue from
avoided road journeys and includes reduced congestion. A mid-
point estimate assuming both forgone tax revenue from car
journeys AND rail’s contribution to reducing congestion puts the
effective carbon price signal at £364/tCO2. This is based on annual
average congestion externality costs. Using peak congestion
calculations could give a very substantially lower figure.
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Downstream
Sector
Category Methodological note (further details in
Appendix)
Commentary on results
Air Air travel attracts a passenger duty, but does
not include VAT. The upper end of the range
assumes that passenger duty is taken on its
own to represent an energy / carbon tax. The
lower end of the range assumes that the lack
of VAT is effectively a subsidy on air travel.
The assumption about whether or not the lack of VAT constitutes
a subsidy has a very large effect on the calculation of effective
carbon price. The lower end of the range indicates considerable
negative carbon price, whilst the upper end of the range indicates
that passenger duties per unit of fuel are equivalent in carbon
terms to the lower end of the target carbon price range.
Business
energy use and
industrial
emissions
The range of energy taxes paid by business
on gas and electricity is taken from CCC
analysis on energy pricing. The differentiation
of taxes is mostly by size and type of
business, with lower taxes levied on large,
trade-exposed companies receiving
compensation for the costs of low-carbon
support schemes in the upstream sectors.
Prices on solid and other fuels is based on
climate change levy rates for those fuels, and
the upper limit also includes EU-ETS
allowance prices paid by eligible sectors.
In the business sector, electricity use is taxed quite strongly for
small businesses, and lightly for large businesses due to concerns
about international competition. For all business types, gas use
appears to be relatively under-taxed. Likewise, there are a number
of non-combustion GHG sources from refrigerants which appear
to be under-taxed. Industrial process emissions of greenhouse
gases are included in the EU-ETS and incur the cost of EUAs.
Residential
energy use
Energy and carbon taxes are taken from CCC
analysis on energy pricing.
The key variable in the residential sector is
the assumption about whether or not
reduced VAT rates for electricity and gas (5%
rather than 20%) constitute a subsidy.
In the residential sector, electricity use is either appropriately
taxed, or under-taxed depending on whether the reduction in VAT
rate is considered as an effective carbon subsidy.
Residential gas and other heating fuels appear to be under taxed,
especially if the reduced VAT rate is taken into account, and this
constitutes an important source of emissions (circa 12% of total).
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Downstream
Sector
Category Methodological note (further details in
Appendix)
Commentary on results
Public sector
energy use
Energy and carbon taxes are again taken
from CCC analysis on energy pricing.
The effective carbon price for electricity taxes are towards the
upper end of the target range, whilst for gas, it is below the target
range.
AFOLU Agriculture Two main types of subsidy are provided via
the EU common agricultural policy. The first
are single farm payments, which are not
linked to production, but based on farm size.
The second are rural development grants
which aim to incentivise environmental
improvements of agricultural land.
Agriculture is an important source of emissions (51mtCO2e direct,
plus 12mtCO2e from land-use change), but is excluded from the
EU-ETS and other pricing mechanisms, and therefore appears to
be significantly under-incentivised to reduce emissions at present.
Whilst agricultural subsidies are not directly tied to output (and
therefore arguably should not be treated as subsidising
emissions), they nevertheless help to maintain the financial
viability of farming activities, and therefore will tend to lead to an
increase in activity in the sector, which would effectively represent
a subsidy to emissions. The range of carbon prices shown in the
chart reflects simple metrics of sector subsidies and associated
emissions. The assumptions made in this initial analysis are set out
in the annex.
Waste disposal Landfill The main tax operating in this sector is tax on
land-fill gas (LFG), amounting to £987m 2015.
LFG emissions for this year were 12.1mtCO2,
giving an average tax rate of £81.5/tCO2.
The LFG tax is broadly within the target range.
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4. Conclusions
Preliminary Conclusions
The analysis in the previous section shows that the UK currently has quite wide variations in
carbon pricing, and suggests that the following sectors have prices that are in general below
the target range:
Agriculture
Coal and gas consumption in electricity generation
Some of the lowest-cost PV schemes
Natural gas consumption by all main end users (residential, business and public
sector)
Electricity consumption in residential sector and large businesses
Other sectors with relatively low prices which have smaller individual emissions, but which
are significant collectively include the upstream oil and gas sector, business and industrial
emissions from combustion of liquid and solid fuels and emissions of non-CO2 greenhouse
gases, and land-use change.
The analysis suggests that sectors which have prices above the target range in relation to
emissions reductions include:
Rail transport
Historical renewables projects9
Nuclear power
Possibly road transport (if congestion and other externalities are not valued
subtracted from the tax revenues received)
Sectors where current pricing is broadly aligned with expected target prices for 2030 include:
Solar PV and the most recent offshore wind bids of CfD auctions
Possibly road transport (if congestion and other externalities are valued and offset
against tax receipts)
Using the Results to Prioritise Policy Action
As noted in the introduction, carbon pricing has different impacts over different timescales.
Whilst in the long-run it would lead to dynamic efficiency improvements by encouraging
structural shifts to low-carbon activities, the short-term impacts will depend on the saliency
of pricing. Saliency is the extent to which decisions and behaviours that drive emissions in
each sector are sensitive to pricing. Saliency depends on the degree to which behaviours and
investments are sensitive to price signals in general, the degree to which a change in carbon
9 This conclusion assumes that the entire subsidy is attributed to carbon externalities rather than other externalities such as R&D externalities.
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price will materially affect these price signals, the availability and cost-effectiveness of low-
carbon alternatives, and the timescale over which such investments are made (e.g.
depending on the lifetime of equipment / infrastructure being invested / replaced).
According to analysis by Michael Grubb (Grubb, 2014), three different economic domains
apply to energy transition:
Short-term economic processes driven by behavioural economics which can drive
behaviour away from equilibrium expectations (e.g. due to barriers, herding and
other effects).
Medium- to long-term economic processes that tend towards equilibrium based on
prevailing price signals
Long-term processes that respond to evolving economic and institutional structures,
as well as the physical infrastructure and environmental conditions.
Pricing effects tend to be dominant in the second of these, and less relevant or salient in the
other two. These issues of saliency therefore need to be taken into account when
considering options for policy reform.
Detailed analysis of saliency is beyond the scope of this report, but this section offers a brief
overview of some of the key drivers in different sectors to assess where action on pricing is
likely to have more effect, combining this with the results of Section 3 in order to help steer
further work on prioritising policy action. Based on the analysis of carbon prices and other
policy drivers set out in section 5.3, comparisons are drawn between sectors regarding the
level and salience of effective carbon-price incentives to investment and operational
behaviour affecting emissions in each sector. To aid comparison across sectors, Table 1 uses
the following colour coding:
Carbon pricing:
Below target range
Within target range
Above target range
Potential
Salience:
High salience
Moderate salience
Low salience
Partial or diagonal shading indicates the range of variation in the sector.
Blue or red shading in the C-price column indicates that policy action may be justified to
introduce or adjust the level of effective carbon prices in those sectors. The shading in the
salience column indicates how effective such policy action might be in directly influencing
emissions-related behaviour or decisions. Sectors with high potential C-price salience will
tend to see relatively strong carbon emissions impacts from a change in effective price.
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Red shading in the salience column indicates that action might be expected to have
relatively strong effects, with less impacts for sectors shaded yellow or green.
Table 1. Summary conclusions and comparisons between sectors
Sector 2015
Emissions
mtCO2/yr
Sub-sector /
technology
C-price
relative
to target
range
Salience of carbon pricing (initial
assessment relative to other drivers)
Power
sector
105 Fossil fuels Investment and operational decisions highly
sensitive to fuel and carbon prices
Mature low-C Mature renewables starting to compete on
price, so future investments are sensitive to
feedthrough of c-price to wholesale elec.
price.
Emerging low-C Carbon pricing is relevant to the long-term
viability, but emerging technologies likely to
require other policy support, so other drivers
may be more important in the short-run
Other (UK-
based)
upstream
energy
34 Oil, gas & solid
fuels
Emissions levels from upstream UK energy
sectors relatively low compared to
downstream, so sector driven more by end-
use prices. Nevertheless, subsidies do affect
production decisions.
Transport 170 Road & rail
Higher fuel prices drive more efficient
transport choices, so C-prices are salient, but
transport externalities dominated by
congestion which are poorly targeted by
current policies.
Air Evidence on the impact of c-pricing on
demand for air travel is mixed. Air travel is
currently under-taxed, since tickets do not
attract VAT, though this is partly
compensated by passenger duty.
Business &
industry
157 Large energy
intensive
industries
Large energy intensive industries are
sensitive to energy and c-pricing. Process
emissions are often hard to mitigate. Key
driver in the sector is international
competition and pricing, making the sector
politically sensitive.
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Sector 2015
Emissions
mtCO2/yr
Sub-sector /
technology
C-price
relative
to target
range
Salience of carbon pricing (initial
assessment relative to other drivers)
General elec use
Electricity and gas use is usually not a
significant proportion of overall business
costs, but companies are sensitive to energy
and carbon prices, and higher prices
incentivise efficiency & behavioural change.
General gas use
Residential 112 Electricity
Higher energy & carbon prices help
incentivise efficiency and behavioural change
& development of alternative technologies,
but many other barriers exist particularly in
tenant-landlord situations. Energy prices
politically sensitive.
Gas
Public 15 Electricity Electricity and gas use is usually not a
significant proportion of overall costs, but
higher prices incentivise efficiency &
behavioural change.
Gas
AFOLU 63 Agriculture Emissions uncertainties are high, but a new
reporting regime is being implemented
which could provide basis for future C-
pricing regime. Sector has various abatement
options available including potential land-
use choices with different emissions levels.
+7
-26
Other Land-use change has high levels of
uncertainty over emissions levels, making c-
pricing difficult.
Waste 18 Landfill Landfill tax driven by several externalities,
and waste management decisions driven by
multiple objectives on recycling policies &
targets etc. Uncertainties in emissions may
make carbon pricing impracticable.
Other Emissions relatively complex to measure and
uncertainties are high, making c-pricing
difficult.
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Evidence Gaps and Areas for Further Work
This report provides an initial evaluation across the economy of effective carbon prices,
policy drivers and the salience of carbon pricing. The report identifies a number of areas
where more work is required, either because the results are very sensitive to a few key
assumptions, or because there appear to be evidence gaps. The most significant of these
areas include:
Road transport. Assumptions about the treatment of congestion externalities is a strong
swing item. Further work is required to assess the degree to which better targeted road-
use or congestion charging and charges for other externalities such as air quality, could
lead to a reduction in fuel duties, and the extent to which changes in how motoring is
paid for could affect carbon emissions. Longer-term sector transition scenarios away
from liquid fossil fuels also need to be investigated to explore further the relationship
between revenue raising and carbon pricing in the sector.
Rail transport. Congestion externalities are also a large swing item in calculating the
effective carbon price in the rail sector, as well as assumptions about what emissions are
avoided. A more detailed assessment is required of the true extent of rail’s contribution
to reducing congestion externalities in order to refine these assumptions.
Air transport. The treatment of VAT for air transport is the assumption with the biggest
impact on c-price estimates. Further work is required to achieve more accurate
accounting for the link between emissions, fuel use and passenger ticket values.
Agriculture. Further work is required to assess the extent to which farm subsidies act in
practice as a production subsidy, despite being formally de-linked from production
levels. In addition, the salience of carbon pricing in the agriculture sector needs further
assessment, to judge the extent to which increased carbon prices or other economic
instruments could help incentivise lower emissions, or whether other policies would be
more effective.
Relative cost of emissions reductions in all sectors. The short-term impact of carbon
price changes in a given sector will depend at least to some extent on the abatement
costs in that sector, and it would be useful to assess relative costs in different sectors to
see where the short-term gains / response may be strongest. A starting point for such
analysis would draw on work such as that undertaken by the Committee on Climate
Change (2015) in their sectoral analysis for the 5th carbon budget, which could be
extended through additional modelling work.
Long-term structural adjustments. In the long-run, the economy would adjust to a
harmonised carbon price through longer term technical and structural change, including
by changing output levels from different sectors. Further work on the likely impacts of
such adjustments would help inform the policy analysis, particularly helping to identify
where sectors are most exposed to international variations in the stringency of carbon
policies.
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5. APPENDIX: Sectoral Analysis of Incentives
This section provides a brief summary of the decarbonisation incentives and other salient
economic drivers for each of the main sectors identified in Figure 1.
Upstream
5.1.1. Electricity Generation
Historically, there has been a relatively complex set of subsidies and decarbonisation price
signals in the electricity sector. However, for current projects, these now boil down to four
main policy instruments, carbon price support (CPS), EU emissions trading scheme
allowances (EUAs), contracts for difference (CfDs), and feed-in tariffs (FiTs), described below.
The CPS is a tax paid for combustion of fossil fuels in the electricity generation sector (Hirst,
2017), frozen in the 2014 and 2016 budgets at a rate of £18/tCO2. In addition, fossil fuel
generators have to purchase EUAs to cover their associated emissions. In the analysis
presented in Figure 1, this is included at average prices for 2017 (£5.10/tCO2), giving a total
tax rate of CPS + EUAs of £23.10/tCO2. In practice, this figure goes up or down according to
the EUA price, which has been rising in the early part of 2018. Both CPS and EUA prices are
assumed to feed through directly to the market price of electricity, since fossil fuels-fired
generation tends to be the price-setting marginal plant on the system.
Low-carbon generation sources receive an additional subsidy through CfDs which guarantee
a fixed payment per unit of electricity (the ‘strike price’) generated for large-scale generation
from low-carbon energy sources such as renewables and nuclear power. The subsidy
element of CfDs is a top-up over and above the market price for electricity. For the purposes
of these calculations, the current market price has been taken as £41/MWh, as used in the
CfD strike price methodology (BEIS, 2016a). Since the market price also includes the CPS and
EUA prices, renewables and nuclear see an effective carbon price signal equivalent to the
top-up level (strike price minus the market price), plus the CPS and EUA price. As noted
above, in order to convert the top level price expressed in £/MWh to carbon equivalent, low-
carbon sources are assumed (in the long-run) to displace new CCGT from the system. A
figure of 0.34 tCO2e is taken as the carbon saving for each MWh produced10. Table 2 shows
how the CfDs strike prices achieved in recent round 1 and 2 auctions have been converted to
a carbon price equivalent. The steps in the table are as follows:
A. Contracts for difference strike price
10 See page 5 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/599761/Background_documentation_for_guidance_on_valuation_of_energy_use_and_greenhouse_gas_emissions_2016.pdf
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B. Subsidy element is the strike price (A) less the wholesale market price (assumed to be
£41/MWh in the strike price methodology)
C. Inflate by 8% to convert from 2012 to 2016 equivalent prices
D. Convert to a carbon price equivalent by dividing the electricity price subsidy by the
assumed carbon intensity of displaced CCGT generation at 0.34 tCO2/MWh, then
adding on the combined CPS and EUA price at £23.10/tCO2 which is built into the
market price and therefore also received by low carbon generators.
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Table 2. Effective carbon price arising from contracts for difference11
Round 1 Round 2
2015/
16
2016/
17
2017/
18
2018
/19
2020/
21
2021/
22
2022/
23
A. CfD Strike
price £/MWh
(2012 prices)
ACT 120 114 75 40
EfW with CHP
80
Biomass CHP
75
Onshore Wind
79 80 83
Solar PV 50 79
Offshore Wind 120 114 75 58
B. Subsidy
element of CfD
£/MWh
(2012 prices)
B = A - 41
ACT 79 73 34 -1
EfW with CHP
39
Biomass CHP
34
Onshore Wind 38 39 42
Solar PV 9 38
Offshore Wind 79 73 34 17
D. Effective
C-price £/tCO2
incl CPS +EUA
D=B/(0.34)*
108%+23.10
(2016/17
prices)
ACT CfD
269 252
126
EfW CfD
142
Biomass CHP
CfD
126
Onshore Wind
CfD
140 142 150
Solar PV CfD 47 140
Offshore Wind
CfD
269 252
126
11 2015-2018 figures from Round 1 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/407465/Breakdown_information_on_CFD_auctions.pdf 2019-2021 figures from Round 2 auctions https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/643560/CFD_allocation_round_2_outcome_FINAL.pdf
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Figure 2. Effective carbon pricing in CfD Rounds 1 and 2
For nuclear power, the same methodology was used as for large-scale renewables, taking the
CfD strike price range for Hinkley Point C as the reference point. This ranges from £89.5-
92.5/MWh depending on whether a follow-on plant is agreed at Sizewell C. This gives an
effective carbon price for Hinkley in the range £188-197/tCO2e when adjusted to 2016 prices
and the CPS and EUAs are included. This relatively narrow range significantly underestimates
the true uncertainty associated with new nuclear costs. For example, the CfD price includes
provision for decommissioning costs, so that the entire lifecycle costs of the plant are
intended to be included within this single subsidy figure. In practice however, estimating the
future costs of decommissioning is difficult given uncertainty over the final disposal options.
In recognition of this, the Government will eventually receive funds from the company to
take title to and liability for the operator’s spent fuel under the terms of the Waste Transfer
Contract12, and this payment is subject to a cap (set at £1,159,250/t uranium in 2012 prices).
This cap is necessary because uncapped future liabilities would be commercially impossible
to manage, and therefore in effect represents an additional subsidy.
On the other hand, if the build costs and/or profitability of Hinkley Point C turn out to be
better than was assumed when calculating the CfD strike price, there is a mechanism to
return funds to the public purse though various gain share mechanisms13. The cost of future
12 Waste Transfer Agreement relating to the transfer of spent fuel arising from Hinkley Point C https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/556776/6_-_Waste_Transfer_Contract_-_Spent_Fuel.pdf 13 See Fig 15 NAO report https://www.nao.org.uk/wp-content/uploads/2017/06/Hinkley-Point-C.pdf
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plant are also expected to be lower than for Hinkley C if similar plant can be replicated. In
reality therefore, the true range of uncertainty in effective carbon prices for new nuclear are
wider than shown in Figure 1.
The third main policy instrument relates to FiTs, which are applied to projects below 5MW,
with a range of implied carbon price signals according to project size categories, as outlined
in the Table 3.
Table 3. Effective carbon price arising from feed-in tariffs14,15
Technology Size category
kW
Tariff p/kWh £/tCO2
Standard Solar photovoltaic
receiving the higher rate (see
footnote on different rates for PV)
0-10 4 118
10-50 4.22 124
50-250 1.89 56
Standard solar photovoltaic
receiving the middle rate
0-10 3.6 106
10-50 3.8 112
50-250 1.7 50
Standard solar photovoltaic
receiving the lower rate
0-10 0.38 11
10-50 0.38 11
50-250 0.38 11
Standard large solar photovoltaic 250-1000 1.54 45
1000-5000 0.38 11
Stand-alone solar photovoltaic 0-5000 0.23 7
Anaerobic digestion 0-250 4.99 147
250-500 4.72 139
500-5000 1.76 52
Combined Heat and Power 0-2 13.95
Hydro 0-100 7.78 229
100-500 6.24 184
500-2000 6.24 184
2000-5000 4.54 134
Wind 0-50 8.26 243
50-100 4.88 144
100-1500 2.58 76
1500-5000 0.8 24
14 Rates to 31st December 2017 https://www.ofgem.gov.uk/environmental-programmes/fit/fit-tariff-rates 15 Solar rates are in three bands. Higher rates apply to buildings that meet EPC energy efficiency standards of level D or above, and where owners do not have more than 25 installations. Middle rates apply to owners that have more than 25 installations, and lower rate applies to buildings not meeting the EPC level D standard.
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Role of Carbon Pricing
Carbon reduction is a strong policy driver in the electricity generation sector. Low-carbon
policy has two interrelated goals:
1. Directly reduce emissions by incentivising investment in lower-carbon generation
2. Develop and/or reduce the cost of new low-carbon technologies
Carbon pricing primarily addresses the first policy goal. The UK government, and the UK
electricity generation sector itself was a strong proponent of carbon trading, and was
instrumental in the development of the EU-ETS. A carbon price floor was introduced,
originally intended to be a risk-reduction measure, designed to protect low carbon
investments from down-side carbon price risk. The rate was originally set at £9/tCO2, but was
set to rise rapidly on a pre-set trajectory. The original consultation document envisaged the
price floor rising to £30/tCO2 in 2020 and £70/tCO2 in 2030. The floor was to be guaranteed
by levying a new tax, the carbon price support (CPS), which would top-up the EUA price
when necessary to meet the floor price. However, in practice when carbon prices in the EU-
ETS collapsed after 201016, a decision was made in 2014 and 2016 budgets to freeze the CPS
at a level of £18/tCO2 in order to avoid creating an ever-larger gap in the price paid in the
UK relative to the rest of Europe17. The combination of CPS + EUAs at 2017 values is
£23.1/tCO2, below the BEIS forward view of £40-119/tCO2 by 2030, suggesting that fossil
fuels use for power generation in the UK is currently under-taxed, though EUA prices appear
to be rising in early 2018, which if continued could start to close the gap.
The experience with carbon pricing so far in the sector is that whilst the detailed design of
policy can be complex, and is not free of political risk (since EU-ETS caps and price floor
levels are essentially political decisions), the prices themselves feed transparently through to
electricity prices, and therefore provide a direct financial reward to low-carbon sources18. This
mechanism is generally well-understood in the sector, and is factored into routine
operational and investment decisions.
Regarding the second policy goal, the UK has introduced dedicated policies to stimulate
development of renewables, over-and-above direct carbon pricing. Most economists agree
that left to themselves, markets may underdeliver on research and development of new
technologies, which may justify additional policy interventions to support infant industries.
Though opinions differ on the extent to which UK renewable energy policies to date have
been cost-effective (Helm, 2017), the costs of renewable energy have come down
16 The price collapse was partly due to the financial crisis and subsequent reductions in economic activity and emissions, compounded by the impact of renewable energy being subsidised by other means 17 Since the CPF feeds through to wholesale electricity prices, and is not paid elsewhere in the EU, the CPF is politically exposed to problems of competitiveness for UK industrial users. 18 This is, however, judged to be insufficient on its own to drive investment in low carbon generation – hence the need for CfD mechanisms
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substantially in recent years. For solar power, this is largely a result of international cost
reductions as well as the development of UK supply chains. For off-shore wind power,
economies of scale and improvements through learning-by-doing in the UK market itself
have also played an important role in cost reduction. Nuclear power has always required
strong policy support from the state, not only because of the need for technological
development, but also because of its large scale, heavy regulatory requirements regarding
safety and long-term waste disposal, and strategic links to nuclear weapons.
Although low-carbon policies often aim to address two or more different externalities with a
single policy instrument, all of the low-carbon policy costs are allocated to the carbon
externality. This means that the estimates made in this report could arguably overestimate
the effective carbon price because they allocate the entire policy cost to carbon, rather than
allocating the policy cost between the two externalities (carbon and R&D market failures).
This is mainly for reasons of transparency, (since there is no simple way to allocate costs
between the externalities). Recent CfD auctions indicate that some renewable technologies
(notably off-shore wind) are starting to become mature technologies in their own right, and
so the allocation of the policy cost to carbon reductions is reasonable in such cases, but for
newer technologies, it should be borne in mind that a significant part of the policy cost
would ideally be allocated to R&D market failure externalities.
Given that low-carbon technologies are at different stages of development, and given the
assumption that policy costs are all allocated to the carbon externality, it is therefore not
surprising that there is quite a wide range of effective prices calculated for different low-
carbon options.
In principle, it would be cleaner to have an economy-wide carbon price signal in the sector
to incentivise low-carbon investment, and then address research and development
externalities via different economy-wide policy instruments (e.g. patent protection and/or
public funding of some R&D activities). However, to the extent that supporting learning-by-
doing will tend to also result in emissions reductions or a reduction in the cost of lowering
emissions, there is no simple way to cleanly separate the two policy outcomes, meaning that
low-carbon-specific technology support programmes/interventions will always tend to
interact with carbon pricing mechanisms.
In practice, because of these multiple policy objectives, some pricing differentiation through
policy may still make sense in the power generation sector as new technologies are
supported through their development pathway, buying down their costs. However, to the
extent that several important low-carbon technologies are getting close to being cost-
competitive at target levels of carbon pricing, there is now a strong case that carbon pricing
could take a more central role in the policy structure.
A final point to bear in mind when interpreting the results in Figure 1 is that the carbon price
calculations for renewables and nuclear are sensitive to the assumed wholesale market price
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of electricity, because the subsidy is taken as the difference between the CfD strike price and
wholesale electricity prices. The assumed market price value is taken as £41/MWh, based on
the government’s strike price methodology (see p12 BEIS, 2016a). However, this value is
arguably artificially suppressed by the effects of low-marginal-cost plant starting to
dominate the dispatch curve, combined with the effects of capacity markets providing a
portion of the income to thermal plant. A market price of £41/MWh is unlikely on its own to
stimulate investment in fossil-fired power generation, a fact recognised when the
government initiated capacity auctions as a way to ensure the maintenance of sufficient
supply margins. A fairer comparison of the subsidies for low-carbon generation might be to
compare their strike prices with the economic cost of new CCGT plant, the long-run default
plant which are assumed to be displaced, an assumption supported by the success of CCGT
plant in the capacity auctions (OFGEM, 2017). Figures from BEIS suggest that levelized cost of
electricity from CCGT, including carbon pricing, should be closer to £66/MWh (BEIS, 2016b).
If wholesale were up at this level, the implied subsidy to low-carbon alternatives would be
£25/tCO2 lower than indicated in Figure 1, though in reality, energy markets would unlikely
reach this level because some of the income to new CCGT plant will come from the new
capacity markets rather than the wholesale electricity markets.
5.1.2. Other Upstream Energy: Oil, Gas & Solid Fuels
The UK has progressively reduced subsidies to fossil fuels over the past 30 years in line with
EU and OECD guidelines. There are no end-user price controls, with all prices being set by
the market. The following analysis is based on OECD calculations of energy subsidies for its
member countries (OECD, 2013).
Producer Support
The main type of producer subsidy remaining in the UK is in the oil and gas sector and
relates to tax allowances to partially offset the petroleum revenue tax (PRT). The PRT is the
main tax levied at 50% of gross profits on oil and gas production in the UK. All oil and gas
producing countries levy some kind of tax or royalties on production which is how they gain
value from the resources being extracted. There is no common international standard for the
rate of such taxes and levies, the level is set by each country. The standard PRT therefore
defines the ‘normal’ baseline tax rate for oil production in the UK.
Various allowances which partially offset the PRT are available to companies which act as
subsidies. These include a new-field allowance that was introduced in 2009 for small,
ultrahigh-pressure and high-temperature oil fields, and ultra-heavy oil fields. Such subsidies
for high-cost fields are not uncommon (Global Subsidies Initiative, 2010). This allowance was
subsequently extended by the government to cover remote deep-water gas fields (March
2010), very deep fields with sizeable reserves (March 2012), and certain large shallow-water
gas fields (July 2012). Other measures to support certain types of production include
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Promote licences, which allow small and start-up companies to obtain a production license
first and secure the necessary operating capacity and financial resources later through
reduced rent for the first two years. These PRT allowances added up to £159m in 2011 for oil,
and £121m for gas (Environmental Audit Committee, 2013). These translate into effective
emissions subsidies as shown in Table 4.
Table 4. Effective carbon price subsidies for fuel production. Source: Environmental Audit Committee,
(2013)
2011 Subsidy Emissions
from UK
production
Effective C-price
£m mtCO2 £/tCO2
Oil subsidies 159 13 -12.2
Gas subsidies 121 5 -22.7
Solid fuels 4 15 -0.3
The OECD considers that in the context of the UK tax system design, the ability of oil and gas
companies to write off exploration and production expenditures immediately does not
constitute a subsidy.
Producer support for coal-mining sector has been removed since 2006, with only inherited
liabilities relating to previous public ownership estimated by the OECD at a level of £4m in
2011. This includes management of abandoned mines and treatment of mine-water
discharges.
Looking ahead, shale gas is a potentially important new area of energy resource
development in the UK. HM Treasury is currently consulting with industry on a fair tax regime
for this new development (DECC 2012). The definition of a ‘fair’ tax in this context will have
to take into account whether special tax treatment is required for the sector given its
different pattern of capital investment and other differences compared to conventional oil
and gas fields. Given the normative nature of subsidies in the energy sector, a decision on
whether or not any special treatment given to shale gas vis-à-vis conventional sources would
have to take into account similar considerations. In the US which has the greatest experience
of shale gas development, emerging subsidy issues include the adequacy of bonds used by
oil and gas producing states to assure funding for reclamation of drilling sites, cover
regulatory costs and offset public infrastructure costs. Road damage from use of heavy
trucks on secondary roads, and payments for clean-up of fracking water are also emerging as
costs which will need to be accounted for.
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Consumer Support
By far the largest subsidy for fossil fuels in the UK relates to the lower VAT rate of 5% for
domestic energy supplies (compared to 20% for the economy as a whole). Since VAT is a
general economy-wide tax, any reduction from the general national rate is considered by the
OECD to be a subsidy. Domestic energy supplies have always been taxed at a lower rate in
the UK, since being raised from zero to 5% in 1994, but this practice is unusual, as most
countries tax energy at the prevailing rate of VAT. In 2011, this tax was worth £81m for coal,
£380m for oil and £3,510m for gas. The reduced VAT-rate subsidy is considered further in
Appendix Section 5 on residential emissions.
Other than VAT, there are very few measures that support energy consumption in the United
Kingdom. Schemes such as winter fuel payments for the elderly or cold-weather payments
do not depend on the price of fuels and are provided in-cash to eligible households. Most of
the remaining measures target consumption technologies such as low-carbon vehicles and
hydrogen refuelling equipment rather than energy use per se, and are therefore not included
further in the analysis.
Discounts to the climate change levy CCL (an end-user energy tax) are offered for eligible
energy intensive users in return for committing to a climate change agreement to reduce
energy consumption, and are considered in Appendix Section 4 on Industrial emissions.
Missing Data
The OECD study points to a number of areas where data was not available to calculate
subsidy levels for fossil fuels19. These include:
Ring-Fence
Expenditure
Supplement
The Ring-Fence Expenditure Supplement (RFES) was introduced in
January 2006 to replace the former Exploration Expenditure Supplement
(EES). In its current version, it provides oil and natural-gas companies
with a yearly 10% increase in the value of unclaimed deductions for
expenses related to exploration and appraisal for a period of up to six
years.
Field Allowance This new allowance was first introduced in 2009 and later extended to
encourage the development of small or technically-challenging fields.
Before 2012, qualifying fields had to be small in size, feature ultra-high
pressure or temperature, possess ultra-heavy oil reserves, or be remote
deep-water gas fields. In 2012, it was then announced that new field
allowances would also be extended to very deep fields with sizeable
reserves, and large shallow-water gas fields. This extension is expected to
generate revenue losses of about GBP 20 million per year (HM Treasury,
19 The quantification of energy subsidies is the subject of ongoing research by a range of organisations including the OECD, World Bank, IMF and NGOs such as the Global Subsidies Initiative
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2012). The field allowance provides companies with a partial exemption
from the Supplementary Charge. Relief is calculated at the level of the
field but is provided at the company-level. Unclaimed allowances can be
carried forward.
Mineral
Extraction
Allowance
The Mineral Extraction Allowance (MEA) was introduced in 1986 to
provide mining companies (including coal, oil, and natural-gas
producers) with faster rates of depreciation for qualifying capitalised
expenditures. The latter include the acquisition of mineral rights or
deposits and expenditures connected to access to the reserves.
Prescribed rates vary with the type of expenditure to which the provision
applies. Analysis of this provision is, however, complicated by the
interaction of the MEA with the general tax regime that applies to oil and
gas extraction. These caveats do not apply to coal though. Although this
provision applies to the mining sector as a whole, data from the OECD’s
STAN database indicate that mining of fossil fuels accounts for nearly
90% of total gross output for the mining and quarrying sector (as
defined in the standard ISIC Rev.3 sector classification).
Abandonment
Costs
This provision allows capital expenditures connected to the
abandonment of fields and mines to be deducted in full in the year in
which they are incurred. Deductions are coupled with a carry-back
provision which makes it possible for companies to use losses arising
from decommissioning costs against profits earned in earlier years. This
may therefore result in tax refunds. Although this provision applies to the
mining sector as a whole, data from the OECD’s STAN database indicate
that mining of fossil fuels accounts for nearly 90% of total gross output
for the mining and quarrying sector.
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Downstream
5.2.1. Transport
Data from Department of Transport (2016) shows the breakdown of transport activity by
mode, which can be combined with information from national accounts showing tax rates
and from national emissions inventories to identify effective carbon prices for different
modes of transport. This section outlines how these calculations have been carried out.
Activity data is summarised in Figure 3. It should be noted that air transport in these charts
only includes domestic (intra-UK) flights.
Figure 3. Activity levels and emission by transport mode in the UK (2014 data)
Road Transport
The road transport sector is an important source of public revenue, including fuel duty of
£27.6bn and vehicle excise duty of £5.5bn together amounting to a combined tax revenue of
£33.1bn, comprising 5% of total UK tax revenue in 2017 (Institute for Fiscal Studies, 2016).
However, this revenue needs to be offset by direct public costs, including expenditure on
road building and maintenance, which in 2017 amounted to £9.5bn covering both central
and local authority spending (HM Treasury, 2017), so that net revenues (less expenditure)
from transport amounted to £23.5 bn. Total emissions from road transport (including
passenger and freight) amounted to 124 mtCO2, or 25% of the UK total in 2017.
If all of the net public revenues from road transport are assigned to carbon externalities, then
the effective carbon price would be 23,500 / 124 = £190/tCO2. This is included in the analysis
as an upper bound effective carbon price for road transport. This upper bound figure implies
that road transport is over-taxed relative to the expected carbon price range.
However, one complication is how to account for other externalities. A recent economic
survey of transport sector externalities (Johnson and Stoye, 2012) suggested that total non-
greenhouse gas emissions externalities amounted to around £20bn per year in the UK,
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mostly attributed to congestion externalities. If these externalities are netted off, then
amount of public revenue attributed to climate externalities drops to £3.5bn, implying an
effective carbon price of 3,500/124 = £29/tCO2. This is included as the lower bound of the
effective carbon price for the transport sector. This lower figure implies that road transport is
under-taxed relative to the expected carbon price range.
Clearly, assumptions about congestion externalities are a swing item that dominate the
results. Whilst the principle is clear that public revenue from a sector should at least cover
public expenditure plus externalities, the case of congestion externalities is complicated by
the fact that transport fuel duties were never intended to address congestion, and are in fact
poorly designed to do so. Road charging and congestion charging schemes would be much
more appropriately targeted, but have been routinely seen to be unpopular with drivers,
even if they are substituted for fuel duties.
Another issue facing the design of road transport taxation is the risk of steeply declining
public revenues if and when road vehicles shift towards battery-powered or other low carbon
alternatives to fossil fuels (e.g. hydrogen). This suggests that in the medium to longer term,
there is the potential to significantly transfer the taxation burden from the fuel consumption
to road usage rates, potentially including a time-of-use or other congestion-related
component. These charges should in principle be set at a rate that is adequate to cover
public road spending, plus congestion externalities. The remaining road fuel tax rates could
significantly drop from their current level to help make these new taxes affordable, and still
adequately cover climate externalities, which would like fall in the medium-long term as a
result of fuel switching.
Rail Transport
Rail transport is less carbon intensive than road transport, so each km of passenger
transport, or t-km of freight transport will save some carbon emissions. Unfortunately,
emissions from rail transport are not broken down by freight and passenger transport.
However, rail transport is close to 10% of total UK transport activity levels across both
passenger and freight, but only accounts for 3% of total transport carbon emissions.
Therefore, the carbon savings in both freight and passenger transport are approximated by
assuming that emissions levels per unit of activity are approximately 3/10th of the level of
their road transport alternatives.
Average road transport emissions levels based on the activity levels and emissions identified
in Figure 3 are 0.118 tCO2/’000 passenger-km for passenger transport, and
0.275 tCO2/’000 t-km for freight. The assumed emissions levels for rail is 0.036 tCO2/’000
passenger-km, leading to total emissions savings of 6.35 mtCO2 for passenger transport, and
0.084 tCO2/’000 t-km, leading to emissions savings 3.44 tCO2 for freight. This leads to total
emissions saving from rail transport of 9.8 mtCO2.
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Rail sector income and expenditure is summarised in Figure 4. Government subsidies are
£3.7bn per year, which divided by the annual carbon saving amounts to around £380/tCO2.
However, rail travel contributes significantly to reducing road transport congestion. If the
78 bn passenger-km currently travelled by rail were to be transferred to cars instead, car
usage would increase by around 12%. This implies that the contribution of rail to reducing
total congestion costs in the UK is around 12% x £20bn = £2.3bn per year. Netting this off
the public subsidy implies that the effective carbon price is (3,700-2,300)/9.8 = £140/tCO2.
This is taken as the lower bound of the carbon price in the analysis, though it is possible that
the contribution of rail to reducing congestion externalities has been underestimated since
the true value would depend on the relative proportions of rail and car journeys undertaken
at peak congestion times and locations.
Figure 4. GB Rail Industry: income, expenditure and government funding 2015-16. Source: (Office of Rail
and Road, 2017)
The upper bound of carbon pricing signals for rail transport considers the incentive that
applies to some passengers if they face a decision on modal shift between car and rail
transport. These passengers effectively see a double incentive, firstly through the direct rail
subsidies, and secondly from avoided payment of road fuel duty. The upper bound case
arises for passenger journeys undertaken during non-peak hours when there is no
contribution to reduced congestion externalities of shifting transport mode, and including
the foregone fuel tax revenues associated with the offset car journey. The lower bound case
arises when congestion is fully costed, and foregone tax revenues from offset car journeys
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are not included. In this case, rail’s share of total journeys (approximately 10% of all
passenger and freight activity) is assumed to offset around the same share (~10%) of total
annual congestion costs.
A mid-point estimate for the rail sector is to assume that the foregone fuel duty tax revenues
from offset car journeys are included as part of the price signal for rail, but that the benefit of
reduced congestion costs are also factored in. This gives the following result:
A = public expenditure on rail = £3.7bn
B = forgone income from avoided road journeys = £2.2bn
C = contribution of rail to reduced congestion externalities = £2.3bn
E = emissions savings from switching from road to rail = 9.8 mtCO2
Effective carbon price signal = (A+B-C) / E
= £ 364/tCO2
Air Transport
Revenue from air transport arises mainly from air passenger duty which amounted to £3.2bn
in 2016/17 (Institute for Fiscal Studies, 2016). However, neither tickets nor aviation fuel for
international flights attract VAT. Obstacles to raising such taxes in aviation are discussed by
Seely (2012).
The upper bound estimate of the effective carbon price takes account of foregone VAT just
on the aviation fuel itself. Consumption of fuel for air travel from the UK amounts to
12.6 billion tonnes oil equivalent20, worth £6bn21 which implies foregone VAT income of
£1.2bn, reducing the effective public revenue to 3.2-1.2 = £2.0bn. The majority of air miles is
from international journeys, for which total emissions amount to around 41mtCO2 based on
government statistics22. This suggests that the effective carbon price arising from air
passenger duty is 2,000/41 = £49/tCO2.
In addition, air travel emissions are included in the EU-ETS, which adds £6/tCO2 at current
prices, raising the overall effective carbon price to £55/tCO2 putting it within the expected
range for 2030.
If the foregone VAT from the full price of passenger tickets is included in the analysis, this
results in the air transport sector shifting from a net source of revenue to a net source of
subsidy. UK passenger expenditure on flights totalled £44bn in 201623. Since international
20 Digest of UK Energy Statistics 21 Using global average aviation fuel price of $641 per metric tonne, data for December 2017 from http://www.iata.org/publications/economics/fuel-monitor/Pages/index.aspx 22 UK Department of Transport Statistics https://www.gov.uk/government/statistical-data-sets/env04-total-greenhouse-gas-emissions-from-transport 23 https://www.ons.gov.uk/peoplepopulationandcommunity/leisureandtourism/articles/traveltrends/2016
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flights are zero-rated, this amounts to foregone VAT income of £8.7bn, reducing tax revenue
from the sector from £3.2bn to -£5.5bn. Accounting for the EU-ETS allowance price, this
suggests that the effective carbon price for air transport is -5,500/41 + 6 = -£130/tCO2.
However, this overstates the carbon price effect because it is associated with undercharging
on the overall ticket price, not just the fuel element.
This analysis is subject to a number of important caveats. In particular, there is no agreed
international method for allocation of aviation emissions between countries, and there is not
a simple way to align the statistics for fuel consumed for international transport (which
covers both domestic and international transfer passengers) with the value of passenger
tickets. This is reflected in the differences in expenditure estimates from different sources.
Whilst the Department for Transport emissions data and DUKES energy consumption figures
both tally, implying consumption of around 13 mtonnes of aviation fuel worth £6bn, figures
on passenger ticket purchases £44bn would suggest a higher level of fuel consumption,
since fuel typically accounts for between 30-50% of airline costs. These estimates should
therefore be regarded as broad-brush figures, and further work on these is recommended.
Analysis carried out by the International Air Transport Association (IATA, 2008) suggests that
the demand for air travel is relatively sensitive to prices, with supra-national price elasticities
of -0.5 to -0.9 for intra-European, trans-Atlantic and Europe – Asia travel. This suggests that
carbon pricing could be effective in reducing overall emissions. On the other hand, when the
passenger transport duty was introduced, it was intended to be purely as a revenue raising
tax, and it was not expected to suppress demand significantly (House of Commons Library,
2012). Overall, the salience of carbon pricing may be assumed to be relevant, but not a very
strong driver of activity in the sector.
5.2.2. Business and Industry
The carbon pricing regime for business is relatively complex because a number of different
policies are applied, with different rates and exemptions for different types and sizes of
business meant to manage conflicts between the need to incentivise emissions reductions
whilst managing international competitiveness concerns.
This analysis follows the work of the Committee on Climate Change (2017) which estimates
the combined effect of the different policies on different types of business. The CCC estimate
that average electricity prices for the commercial sector and manufacturing sector were 11
p/kWh and 7.7 p/kWh respectively in 2016, comprising the following elements:
Wholesale, supplier and network costs. Wholesale costs for both commercial and
manufacturing consumers are lower than for households. Larger business consumers of
electricity may be able to negotiate lower prices through direct contracts with suppliers.
Network costs may also be lower, by connecting directly to the transmission network and
avoiding distribution costs. Businesses will also be cheaper to supply where their demand
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includes more off-peak energy, and is more flexible. CCC estimate wholesale and
network costs were on average 7.7 p/kWh for the commercial sector and 5.3 p/kWh for
manufacturing in 2016, though this varies considerably depending on the quantity of
electricity consumed by the firm.
Carbon price. CCC estimate that the carbon price support mechanism and the
purchasing of EU ETS allowances by businesses cost around 0.8 p/kWh in 2016. However,
electricity-intensive firms in sectors deemed by government to be “most at risk” of
carbon leakage received compensation up to 80% of this cost (Box 2.1).
Support for low-carbon investment. Policies to support roll-out of low-carbon
generation increased the electricity price faced by businesses by 1.5 p/kWh, except for
certain electricity-intensive firms that receive compensation for some of this cost.
o Renewables Obligation (RO), micro-generation Feed-in Tariffs (FiTs) and Contracts
for Difference (CfDs) contributed 1.8 p/kWh. Electricity-intensive firms in sectors
deemed “most at risk” of carbon leakage received compensation of up to 85% of
these costs.
o ‒ Additional network costs from increased renewables deployment contributed
0.2 p/kWh, while CCC estimates suggest the merit order effect reduced wholesale
energy costs by around 0.6 p/kWh.
Climate Change levy (CCL). A tax on energy consumption which applies to all non-
residential consumers, the CCL was 0.6 p/kWh in 2016, although the majority of
manufacturing sectors have a Climate Change Agreement (CCA) and therefore receive a
90% discount from the levy, and metallurgical/mineralogical processes are exempt from
CCL (around 15% of electricity consumption).
CRC Energy Efficiency scheme. A mandatory carbon emissions reporting and pricing
scheme for non-residential organisations that consume over 6 GWh of electricity
annually and are not already covered by a CCA, the EU ETS or are
metallurgical/mineralogical processes. Participants must purchase and surrender
allowances for their emissions. CCC have estimated that the cost of the allowances for
electricity were 0.7 p/kWh in 2016.
To reflect the diversity of electricity costs and low-carbon policy impacts for businesses, the
CCC focus on five illustrative types of electricity consumption to show a range of prices.
Inevitably these do not cover all possibilities and the variety and complexity of businesses
may mean that different parts of operations are affected by different policies. However, they
give a reasonable picture of the most important differences.
Table 5 shows the CCC figures expressed in terms of an energy taxation in pence per kWh of
power consumed, and then converting these into an equivalent carbon price making
assumptions about the carbon intensity of the power based on methodology described in
Section 2.2.
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Table 5. Effective Carbon Prices for different business types Source: Energy prices and policy costs from
CCC 2017 Tables 2.2 and 2.3. Final column, author’s calculation.
Business type Total
energy
price
(p/kWh)
of which,
low-carbon
policy cost
(p/kWh)
Effective
Carbon
price
£/tCO2
Ele
ctr
icit
y
Small commercial 12 2.9 82
Medium commercial 10.7 3.6 102
Large manufacturing 7.8 2.4 68
Large manufacturing (low-carbon support
compensation)
6.4 0.9 26
Extra-large manufacturing (low-carbon support &
carbon price compensation)
3.7 0.3 9
Gas
Small commercial 2.6 0.2 10.9
Medium commercial 2.6 0.5 27.1
Large manufacturing (ETS) 1.6 0.2 10.9
Large (metal/mineral) manufacturing (ETS) 1.5 0.1 5.4
In addition to these rates for gas and electricity, which are the primary source of emissions
from the sector, other sources of emissions include the following:
Combustion of liquid and solid fuels in the business sector accounted for emissions
of 34mtCO2 in 2015, of which 12mtCO2 is from the irons and steel industry. These
fuels attract tax from the Climate Change Levy. Taking the 2019 rate (which will
increase slightly to account for scraping of the CRC scheme by then), the CCL is levied
at a rate of £0.02653/kg of fuel, equivalent to a carbon price of approximately
£9/tCO2 when multiplied by the carbon intensity of the fuel. For larger industrial
users, including the iron & steel sector, this rate is discounted to around £2/tCO2 in
return for companies entering into a Climate Change Agreement.
Most of these large industrial users will also be subject to the EU-ETS. Currently,
allowances are priced at around £11/tCO2. This is in addition to the reduced CCL rate
for the fuels.
Industrial process (i.e. non-combustion) emissions of CO2 and other greenhouse
gases amounts to 13 mtCO2, plus an additional 13 mtCO2e from refrigerant gases.
These sources do not attract any taxes or subsidies.
In general, policy costs associated with electricity consumption in the business and industrial
sectors are adequately taxed, but emissions from fossil fuel combustion, refrigeration and
industrial processes to be under-incentivised. This is partly due to competitiveness drivers in
the sector which act as a political constraint on raising carbon prices. Some authors propose
border tax adjustment as a way to overcome these constraints (Helm, 2017; Mehling et al.,
2017).
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5.2.3. Residential
The residential sector accounts for emissions of 112mtCO2 per year, 22% of UK total. Energy
consumption in the residential sector totalled 42 mtoe in 2016, 28% of UK final energy
consumption. The largest share 27 mtoe was from natural gas, and 9 mtoe from electricity
(DUKES, 2017). The majority of the energy is used for space heating, water heating and
cooking. The contribution of electrical appliances to bills is higher than the share of energy
consumption because of the higher unit cost of electricity, reflecting the efficient nature of
electricity end-use.
Figure 5. Breakdown of UK household energy consumption and bills by usage. Source: (Committee on
Climate Change, 2017)
Carbon prices in the residential sector arise mainly through the contribution of carbon policy
costs to energy prices, which are extensively covered by the CCC report on energy bills and
prices (Committee on Climate Change, 2017). The incentive is assumed in this work to be
mainly a price signal to switch fuel, reduce consumption, or increase efficiency.
The contribution of climate policies to residential energy prices is shown in Figure 6.
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Figure 6. Contribution of climate policies to residential prices, electricity (top) and gas (below). Source:
(Committee on Climate Change, 2017)
In addition to these climate policies, included here is the subsidy represented by the
reduction in VAT rates for residential consumers of electricity and gas, and the effective
carbon price for other domestic fuels (i.e. oil products and solid fuels). These totals are
shown in Table 6, which indicate that for electricity, the carbon policy costs for electricity are
largely offset by the VAT subsidy, resulting a low effective carbon price of just £8/tCO2, whilst
for gas the result is an overall subsidy (i.e. negative carbon price) of -£33/tCO2 and other
heating fuels a subsidy of -£19/tCO2. This is significant, since decarbonisation of heat is
recognised as a difficult technical challenge, and the presence of a major price distortion in
this sector is already impacting the incentive to develop alternatives.
Electricity
Gas
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Table 6. Calculation of effective carbon price for residential sector energy. Steps and assumptions shown
in black. Resulting carbon prices shown in red. Source: own calculations except where stated
Calculation steps and assumptions Units 2016 Source
Electricity
price
components
Total unit cost of electricity p/kWh 15.4 CCC
Climate policy costs p/kWh 2.6 CCC
Carbon intensity of purchased electricity kgCO2e/kWh 0.352 BEIS
Direct climate policy costs - electricity £/tCO2 74
Foregone VAT receipts on electricity p/kWh 2.31
VAT carbon subsidy - electricity £/tCO2 -66
Total carbon price - electricity £/tCO2 8
Gas price
components
Total unit cost of gas p/kWh 4.58 CCC
Climate policy costs p/kWh 0.08 CCC
Carbon intensity of gas
kgCO2e/kW
h 0.184
BEIS
Direct climate policy costs - gas £/tCO2 4
Foregone VAT receipts on gas p/kWh 0.69
VAT carbon subsidy - gas £/tCO2 -37
Total carbon price - gas £/tCO2 -33
Other
heating fuels
Value of energy traded £m 2005 DUKES
Energy value GJ 2.19E+08 DUKES
Calorific value GJ/t 45.3 DUKES
Weight kt 4,841
Carbon emissions per t kgCO2 / t oil 3190 DUKES
Total CO2 mtCO2 15.44
Foregone VAT receipts on heating oil £m 301
Total carbon price - other £/tCO2 -19
5.2.4. Public Buildings
Total energy consumption by the public administration sector amounts to 5,800 ktoe, or 4%
of UK total final energy consumption, whilst the sector is responsible for a slightly smaller
share (3%) of total UK emissions of greenhouse gases. Energy is predominantly used in
schools, hospitals, universities, offices and other buildings, as illustrated in Figure 7.
Public buildings such as schools and hospitals pay a commercial rate for electricity and gas
which includes the same carbon price support mechanisms as described in Appendix Section
4. for industry and business energy users. These include the pass-through to electricity prices
of the cost of low-carbon electricity support mechanisms (CfDs, FiTs, Carbon Price Floor etc.),
the Climate Change Levy, and for larger organisations, also the CRC energy efficiency
scheme. The upper bound is therefore taken from the CCC estimates of the carbon policy
component of energy bills (Committee on Climate Change, 2017). These replicate the values
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shown in Table 5 for the medium commercial category, giving an effective carbon price of
£102/tCO2 for electricity and £27/tCO2 for gas.
The CRC Energy Efficiency scheme only applies to larger organisations, so that publicly-
funded schools for example have been removed from the scheme, which reduces the
effective carbon price for smaller public organisations. However, the CRC is to be phased out,
and replaced with an increased rate for the Climate Change Levy in 2019, which will close
some of the gap. The lower bound estimate therefore adjusts the CCC figures by removing
the CRC component, and substituting the higher CCL figure for 2019. This results in an
effective carbon price of £90/tCO2 for electricity and £18/tCO2 for gas.
Figure 7. Breakdown of energy use in the public sector. Source: (BEIS, 2017)
5.2.5. Agriculture, Forestry and Other Land-Use (AFOLU)
AFOLU sectors include important greenhouse gas emissions sources amounting to
72 mtCO2e/yr, as well as sinks of amounting to -28 mtCO2e/yr in 2015. Sector drivers are
discussed in some more detail in the subsections below. There is considered to be significant
potential to reduce emissions from these sectors, with up to 12% savings at zero or negative
cost, and up to 17% savings at a cost of below £34/tCO2 (Moran et al., 2009). Since all these
sectors face either a low or negative effective carbon price, they could be an important
source of additional effort under a more coherent decarbonisation policy scenario.
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Emissions levels from these sectors are much less certain than for energy-related emissions
sources. According to National Physical Laboratory (2017), agriculture, land use and waste
contribute the largest sources of uncertainty to the UK inventory:
Agriculture accounts for only 9% of the total CO2 equivalent emissions, but
contributes to 36% of uncertainty in the total inventory emissions. Uncertainties
around the emission factors and activity data are high.
Land use change contributes 8% of the total emissions but is responsible for 32% of
the total uncertainty in the UK inventory. In this case emission factors are the main
sources of uncertainties.
The waste sector constitutes 3% of the total CO2 equivalent emissions yet contributes
18% to the total uncertainty. Emission factors are the main issues for the sector
uncertainties with activity data also playing a role.
This uncertainty makes it much more difficult to price carbon directly, because the amount of
tax to be paid would also be uncertain. However, according to a recent Parliamentary
question24 a revised agricultural greenhouse gas (GHG) emissions inventory model is due to
be completed this year and implemented as part of the 2016 National Atmospheric
Emissions Inventory. Data from the 2016 inventory is due for submission and publication in
2018. Details of the methodology and assumptions within the revised agricultural GHG
emissions model will be published in 2018 as part of the annual UK National Inventory
Report. It is expected that this revised methodology will bring much improved data and
accuracy to GHG measurements in the agriculture sector. Further work is required to assess
whether this could form the basis on which some form of carbon pricing incentive could
operate.
Agriculture
National emissions inventories are separated out into direct emissions from agricultural
production, with emissions associated with agricultural change of use being allocated under
the land-use change and forestry section.
This analysis groups together the direct agricultural emissions and the change of land use for
agricultural activities, in order to better align total sectoral emissions with the level of
subsidies allocated to the sector.
On this basis, total emissions in the agriculture sector comprise direct emissions of
51.1 mtCO2, and associated emissions from land-use and land-use changes of 12.2 mtCO2,
totalling 63.3 mtCO2.
Agricultural subsidies under the EU Common Agricultural Policy are complex, but the way
these have been implemented in the UK essentially boil down to two strands of subsidy:
24 http://www.parliament.uk/business/publications/written-questions-answers-statements/written-question/Commons/2017-04-18/71084
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1. ‘Pillar 1’ payments, or single-farm subsidies. These are direct payments to farms
which are not connected to production levels, but are associated with the size of
individual farms.
2. ‘Pillar 2’ payments which are to support rural development and environmental
improvements
The total level of these payments is shown in Table 7
Table 7. UK agricultural subsidies covering the 7 year period 2014-2020. Source: (House of Commons
Library, 2014)
Pillar 1 Pillar 2
England €m 16,421 1,520
Northern Ireland €m 2,299 227
Scotland €m 4,096 478
Wales €m 2,245 355
TOTAL €m 25,061 2,580
Pillar 2 payments are intended to enhance environmental quality and rural development of
agricultural land, so it is assumed here that this is effectively carbon neutral, neither
incentivising or disincentivising emissions.
Pillar 1 payments are also in theory unlinked to production, so arguably, they could also be
treated as carbon neutral in the sense that they do not directly incentivise production. The
lower-bound case therefore treats the agriculture sector as un-subsidised with respect to
carbon emissions, leading to a zero lower bound for the effective price of carbon.
In practice however, Pillar 1 payments (totalling approximately £2,900 per year) help to
support farming in the UK by keeping farm incomes at sufficient levels to maintain
operations, although much of their impact may be capitalised in agricultural land prices. It is
likely therefore that agricultural activity levels are higher than they would otherwise be. The
upper bound case assumes the entire Pillar 1 payments act as a production subsidy. This
gives an effective carbon subsidy (negative price) of -2900 / 63.3 = -£45/tCO2.
It should be noted that this upper bound is an overestimate. The truth lies somewhere
between these two bounds, and further work is required to assess the degree to which farm
subsidies really act as a direct production subsidy.
Forestry and other land-use change
Forestry and other types of land use such as maintenance of grasslands are a fairly significant
sink of emissions in the UK, and amount in total to removals of 26 mtCO2 per year. The
detailed breakdown by sources is shown in Table 8.
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Table 8. Emissions from forestry and other land-use change 2015. Source: UK National Statistics25
Source Emissions
mtCO2
Forest land Forest land remaining forest land -16.5
Biomass burning 0.0
Land converted to forest land 0.6
Direct N2O emission from N fertilisation of forest land 0.0
Drainage of organic soils 0.1
Direct N2O emissions from N mineralization/immobilisation 0.2
Grassland Biomass burning 0.3
Grassland remaining grassland -4.9
Land converted to grassland -4.6
Drainage and rewetting and other management of organic and
mineral soils
0.2
Direct N2O emissions from N mineralization/immobilisation 0.0
Wetlands Wetlands remaining wetland 0.3
Non-CO2 emissions from drainage of soils and wetlands 0.0
Land converted to wetland 0.0
Land converted to flooded land 0.0
Other
(LULUCF)
Harvested wood -1.9
Land converted to other land 0.0
Indirect N2O emissions 0.3
According to public sector accounts, the forestry sector received public income of £111m in
2016/17. It is not clear the extent to which, if at all, these public payments are related to
incentivising the sink function of forests, but if it is assumed that they directly act as a carbon
reduction incentive, then the effective carbon price for the forestry sector is -111/15.7 =
£4.2/tCO2. This is taken as the upper limit of carbon prices, on the basis that the payments
fully incentivise carbon emission reductions. The lower bound is taken as zero on the basis
that the public payments may not create incentives one way or the other on emissions levels.
In either case, the carbon price is low, and significantly below the expected range for 2030
suggesting the sector is under-incentivised.
Other subsidies (e.g. for grasslands etc.) are not listed in national accounts, suggesting that
any subsidies to the sector are small. The range calculated for the forestry sector is therefore
taken as indicative of the wider land-use change sector.
25 https://www.gov.uk/government/collections/final-uk-greenhouse-gas-emissions-national-statistics
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5.2.6. Waste
Table 9. Emissions from waste management sector 2015. Source: UK National Statistics26
Sector Emissions mtCO2
Landfill 12.1
Waste-water handling 4.1
Waste Incineration 0.3
Composting 1.1
Anaerobic digestion 0.1
Mechanical biological treatment 0.5
TOTAL 18.2
Emissions from the waste sector are shown in
Table 9, though as noted in the previous section, uncertainties in emissions from waste are
high; the waste sector constitutes 3% of the total CO2 equivalent emissions yet contributes
18% to the total uncertainty (National Physical Laboratory, 2017). The biggest emissions arise
from landfill, which paid a total landfill tax bill of £987m in 2015. If this tax is assumed to act
as an incentive to avoid using landfill, and thereby reduces emission rates accordingly, then
the effective carbon tax rate facing landfill is 987/12.1 = £81.5/tCO2. This is taken as the point
estimate for the waste sector, suggesting it is in an appropriate range relative to expected
prices in 2030.
However, in practice, carbon emissions from waste management are complex. Firstly, waste
management is not a simple two-option process which compares an emitting option (e.g.
landfill) with a non-emitting option. Rather, there is a hierarchy of different waste
management options including recycling, energy recovery which respond in different ways to
price signals, and a single price for landfill cannot optimise for the whole hierarchy (DEFRA,
2011). Even within a single option such as landfill, determining the carbon price is complex
since the carbon content of landfill materials is dropping over time as other waste
management techniques are introduced (DEFRA, 2011), which also changes the economics of
landfill gas to power. Taking account of the lower carbon content of more recent landfilled
waste would tend to increase the effective carbon price using this methodology. On the
other hand, the landfill tax addresses other externalities than just carbon emissions (notably
constraints on the availability of suitable sites), so offsetting the tax income against these
other externalities would tend to decrease the effective carbon price. Some of the key issues
to address are set out in Box 1.
26 https://www.gov.uk/government/collections/final-uk-greenhouse-gas-emissions-national-statistics
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Box 1. Excerpt from DEFRA ‘Economics of Waste and Waste Policy’ June 2011
Landfill tax cannot reflect the differences in environmental performance between all levels of the waste
hierarchy above landfill.
Firstly, for the treatment and disposal of waste:
-On the whole, those treatment options which reduce embedded emissions by reducing energy
associated with extraction, primary production etc., such as re-use and recycling, do not have
their full external benefits reflected in the price of disposal.
-The emissions from waste combustion of non-biogenic material (via any technology including
mass-burn incineration) are also not comprehensively reflected in the price of disposal. Unless
the installation in question is in the ETS (municipal solid waste incinerators are excluded) a
negative externality persists – such installations are creating GHG emissions without paying the
relevant price.
-Subject to proving its environmental performance, MBT-landfill does not have its environmental
benefits reflected in the price of disposal.
To supplement the landfill tax, the Waste Review has introduced measures to encourage recycling, such
as better accessibility to recycling for businesses and consumers, agreeing responsibility deals with
business sectors, and introducing new packaging targets. This is in addition to other non-market
instruments, such as the revised Waste Framework Directive requirement on separate collection. While
such measures help internalise market failures and barriers, they have some limitations; for example, in
incentivising/determining the optimal level of activity
As well as ensuring that the relevant instruments are in place to reflect the impact of treatment options,
it is also necessary to address barriers to efficient response. For example, the lack of direct pricing of
household waste collections – households pay for their waste collections indirectly though council tax
and general taxation, rather than paying directly for the amount and type of waste produced - means
that other instruments such as information policies may take more prominence, although they are
unlikely to achieve efficient outcomes. Funding announced in the Waste Review for trial reward-and-
recognition schemes is a step in the right direction and will help develop the evidence base on the effects
of pricing mechanisms on household waste.
Second, even if all the externalities of waste treatment options were covered by policy, there would still
be a need for additional intervention to ensure efficient production and consumption decisions, and the
optimal level of waste arisings (in the absence of these intervention, waste arisings will be inefficiently
high). This is an important policy area because the additional greenhouse gas benefits from waste
prevention are significant. In addition to the environmental benefits, there are financial savings for
businesses, consumers and government from waste prevention - through reduced material use and
reduced collection, treatment and disposal costs.
Information was not readily available from national accounts regarding public subsidies for
waste water, which is the second-most important source of emissions in the sector,
accounting for 4.1 mtCO2. This work assumes that costs are fully recovered from waste water
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service users so the sector does not receive substantial subsidies, resulting in a zero value for
the effective carbon price incentive.
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6. References
Advani, A. et al. (2013) Energy use policies and carbon pricing in the UK.
BEIS (2016a) ‘Contracts for Difference : An explanation of the methodology used to set CFD
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BEIS (2016b) Electricity Generation Costs.
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Committee on Climate Change (2015) Sectoral scenarios for the Fifth Carbon Budget Technical
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Institute for Fiscal Studies (2016) A survey of the UK tax system.
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