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Budget 2014: short-term gains for business, bad news for the environment

The big energy policy headline in the budget was well trailed. As expected, the level of the UK’s carbon tax on electricity generation will be frozen from 2016/17 until the end of this decade. Conceived…

The UK’s coal revival is set to continue. Gareth Watson, CC BY-NC-SA

The big energy policy headline in the budget was well trailed. As expected, the level of the UK’s carbon tax on electricity generation will be frozen from 2016/17 until the end of this decade. Conceived in response to lobbying by energy intensive industries and Labour’s price freeze policy, this change is part of a package that the government claims will save energy consumers up to £7bn.

The tax, known as the Carbon Price Floor, was implemented to compensate for the persistently low price of carbon in the European emissions trading scheme. Rather than increasing as planned, it will be capped at £18 per tonne of CO2. This will cost the government £1.8bn in lost revenue between 2016/17 and 2018/19.

Because this measure will make electricity cheaper than it would have been, electricity demand is expect to increase by 3-4%. Emissions may also rise too as a result. The compensation package for energy intensive industries that are liable to pay this tax will be extended to the end of the decade, and additional compensation will be available for these industries to offset the costs of renewable energy support policies.

Economics over environment

This freeze is unwelcome. It weakens the basic incentive for power generators to switch away from the use of carbon intensive fuels (particularly coal) towards lower carbon options such as gas, renewables and nuclear power. The only exception is a new exemption for electricity from efficient combined heat and power plants.

Coal-fired electricity has experienced a revival in the last couple of years at the expense of gas due to low coal prices. This has led to an increase in power sector carbon emissions after many years of decline. From a climate change perspective, it is very important that policies counteract this economic advantage to reduce the risk that coal generation will be locked in for longer than necessary.

But it is also important to remember that the Carbon Price Floor received mixed reactions when it was introduced. Many investors were sceptical, and foresaw the political risks associated with a measure that could be adjusted by the chancellor each year. They seem to have been vindicated. Its usefulness as a signal for new investment in low carbon technologies was already questionable – and now it is significantly weaker.

Keeping emissions reductions on track

To ensure emissions reductions remain on track, other measures may be necessary. The long term contracts for new sources of low carbon generation introduced by the Energy Act 2013 will be even more important. The budget does include positive statements about the government’s commitment to renewable energy through these contracts.

In addition to this, further details of the “capacity mechanism” were published on budget day. This is a complex mechanism designed to support new flexible generation to help balance supply and demand for electricity. The duration of capacity mechanism contracts for new gas-fired plants has been increased to 15 years.

This may help to improve confidence among investors who have put plans on hold because of poor economics. But the mechanism can also support existing coal plants, some of which could be awarded three-year contracts to pay for refurbishment. This adds to concerns that coal generation (and wider power sector emissions) will not be reduced quickly enough.

The demand side of energy policy was notable by its absence from the budget. A more comprehensive response to high energy bills would have included a greater emphasis on energy efficiency. This is especially the case for households and smaller companies that have limited resources to invest. While the government has an ambitious energy efficiency strategy that aims to avoid the need for 22 power stations by 2020, progress has been mixed.

The Secretary of State for energy Ed Davey MP recently admitted that the uptake of the flagship Green Deal policy had been “disappointing”. Some of the £1.8bn the government will forego as a result of the Carbon Price Floor freeze could have been used to strengthen energy efficiency programmes.

While the pressure to relieve the impact of high energy prices is understandable, this budget increased the risks that the UK’s carbon targets will not be met. It also missed an opportunity to improve energy efficiency, and to insulate energy consumers against high prices in future.