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The world has lost faith in the UK’s green ambitions. For evidence, look no further than the country’s carbon price. It has collapsed to £36 per tonne, less than half the level in the EU.
Forget prime minister Rishi Sunak’s target tinkering for EVs and heat pumps. This is a more serious risk to UK decarbonisation.
The credibility gap may not be immediately obvious to onlookers. The carbon market is often talked about in terms of short-term supply and demand dynamics. These are currently bearish for CO₂ prices.
Sectors covered by the UK carbon trading system are expected to emit about 100mn tonnes of carbon dioxide this year, according to consultancy ICIS. That is some 10mn tonnes less than last year. Low power demand is taking a chunk of fossil fuel generation offline. Meanwhile, the supply of credit will be 118mn tonnes, meaning lots going spare.
The situation should persist into 2024. Emissions are expected to decline further. Yet the government in July announced it would be making additional carbon credits available. That is a recipe for continuing oversupply.
Attributing the decline in carbon prices only to purely technical factors misses an important point. Investors can buy an allowance today and surrender it any time. And — if they believed the government’s midterm targets — that would be a worthwhile thing for them to do.
The UK still targets a carbon budget of roughly 50mn tonnes by 2030 — about half the level of emissions today. Achieving that would require expensive industrial abatement, for instance switching fuel for steel production. The carbon price would need to rise to £97 per tonne to incentivise businesses to do that, according to Aurora Energy. On that assumption, an entry point of £36 today would yield a juicy internal rate of return above 15 per cent.
The obvious implication of current prices is that the market no longer believes the UK will stick to midterm objectives. That is worrying. Low carbon prices harm the UK economy in the long run. True, industry and power companies might save £3bn a year if prices remained constant, but that would be money forfeit by government.
Meanwhile, higher carbon prices are required to incentivise fuel switching. Phasing out coal in power generation is mandated by policy. But other sectors of the economy will need prompting. Official vacillation benefits no one.