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The UK government has made it cheaper for industry to pollute in Britain compared with the EU by watering down reforms to the carbon market, in the latest sign that the Conservative party is backsliding on its climate agenda.

Whitehall recently quietly announced changes to the UK’s carbon trading scheme, including offering more allowances than expected to polluting industries. The move has pushed carbon prices to trade at a steep discount compared with those in Europe, sparking warnings from industry that it will undermine green investments and increase fossil fuel use.

“The changes to the carbon market have largely passed under the radar in the UK but will have the biggest impact of any policy on the UK’s emissions path,” said James Huckstepp, an analyst at BNP Paribas.

The UK Emissions Trading Scheme was launched in 2021 after Brexit. Like its equivalent in the EU, it puts a price on emitting a tonne of CO₂. Large industrial emitters and electricity generators receive allowances to cover some of their emissions.

Over time, the schemes reduce the allowances available under a so-called cap and trade system — giving an incentive to companies to cut emissions rather than pay to buy more. If they cut the amount they pollute they can buy fewer credits or sell any excess for profit.

This month the UK government surprised the industry by announcing that it would make more allowances available than anticipated as part of an overall reduction in the emissions cap. It also said it would give 53.5mn tonnes of extra allowances — about half a year’s worth of UK emissions covered by the scheme — to polluters between 2024 and 2027.

It excluded domestic shipping from the scheme until 2026, two years later than the EU. The UK also makes power generators pay an additional £18 a tonne “carbon price floor”, adding to their costs — but because of the substantial fall in the carbon price, their overall costs are still notably lower than in the European bloc.

Since the announcement, the UK ETS has fallen to trade at a near-40 per cent discount to its EU counterpart, at £47 a tonne compared with €88.50 (£75.86).

The two schemes previously traded near parity; a discount first emerged this spring as traders grew nervous over the UK government’s commitment to matching the climate ambitions of the EU. The gap has widened this month.

The change has damped UK electricity prices, driving power prices below those on the continent. This could boost investment and help cool inflation.

But the energy industry and analysts warned that the government risked derailing efforts to slash carbon emissions and expand renewable energy, at a time when Prime Minister Rishi Sunak has been criticised for not making climate change a priority.

“A robust carbon price is critical to attracting investment in clean energy that can bring down prices, reduce emissions, and bolster our energy security,” said Adam Berman, Energy UK deputy director of advocacy.

“Swapping lower prices in the long run for a short period of low prices today is the definition of a penny-wise, pound-foolish approach.”

The carbon market is the “cornerstone of the UK’s decarbonisation strategy”, he added.

Huckstepp said: “While there are short-term benefits to energy-intensive industries, the discount that has emerged versus the EU will make it much more challenging for the UK to meet its climate goals, from disincentivising wind farms to encouraging power generators to burn more gas.”

The Department of Energy and Climate Change said the government wanted to “ensure a smooth transition” giving “the market and participants time to adapt”. It added that the extra allowances were held over from previous years, so “the strength of overall ambition will not be affected”.

UK Steel said that carbon prices in the UK were still “historically high”, while Dave Dalton, chair of the Energy Intensive Users Group, said that though the drop was “welcome” it was down to “market dynamics” and might not last.

E3G, a climate consultancy, warned that the UK risked “making itself less attractive as a place for low-carbon industrial development”.

“It is not a recipe for economic success and will make us less competitive in the race to zero.”

Huckstepp said the impact on emissions could already be seen in the power market, with UK utilities starting to burn more gas to generate electricity, while cutting imports.

UK power imports generally come from low-emission sources such as Norwegian hydropower or French nuclear.

Meanwhile, ministers are set to announce on Monday the latest winners of state investment in carbon capture and storage projects, which the government hopes can help lower emissions. They are expected to approve the Acorn carbon capture project in Scotland, which has backing from companies including Storegga, Shell and Harbour Energy, according to people briefed on the plan.

Additional reporting by Jim Pickard, Sylvia Pfeifer and Lucy Fisher

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