The influential think tank has urged the government provide clarity on the future of the mechanism in the chancellor’s autumn budget statement next week.
Although the CPS has “largely failed” to meet its original objective of supporting investment in low carbon-generation, the report argued, it has been “instrumental” in prompting a switch from coal-fired to gas-fired generation. The mechanism helped to push coal’s share of generation to a nadir of just 3 per cent in the three months to the end of September – less than the share of solar.
Policy Exchange recommended that the CPS be retained until the early 2020s to continue to support the government’s plan to phase out all unabated coal generation by 2025. However, it said once the phase out is complete, the CPS should be gradually removed by the mid-2020s to bring carbon prices in Great Britain in line with those in Europe.
The CPS was introduced in April 2013 as a top-up to the EU Emissions Trading System (ETS) to ensure generators in Great Britain paid a minimum price for carbon emissions, called the Carbon Price Floor. The CPS takes the form of a levy on the fossil fuels used for generation.
Analysis by consultancy firm Arup indicated that removing the CPS in the 2020s would reduce wholesale electricity prices by around £4/MWh between the 2019 and 2030. This would save consumers around £12.5 billion over the period through lower energy bills, although the treasury would lose out on tax receipts from the CPS of £700 million. It would also reduce revenues to existing low-carbon generators, making them less profitable.
Another effect would be to shift generation from Europe to Great Britain as domestic generators would become more competitive with their continental peers. The UK currently imports large volumes of power from Europe via interconnectors in part because of the CPS. Modelling by Arup suggests imports would total 24TWh in 2030 if it was phased out, compared to 50TWh if it remained in place. This would lead to additional investment in the UK energy sector, create extra jobs and boost economic growth.
The modelling also indicates the removal of the CPS would result in an overall reduction in carbon dioxide emissions across Europe of 3.3 million tonnes per year by 2030. They would rise by 8.7 million tonnes in the UK, but fall by 11.9 million tonnes across the rest of the continent.
“This may seem counterintuitive,” the report remarked, “but is caused by new highly-efficient gas power stations in Britain displacing older gas and coal power stations in the rest of Europe.
“This is desirable from the perspective of reducing total greenhouse gas emissions, but perversely may be undesirable from the perspective of UK carbon budgets, which only consider UK territorial emissions. This raises questions about the logic of the carbon accounting framework which underpins carbon budgets.”
Manufacturers organisation EEF, the Energy Intensive Users Group and the think tank the Centre for Policy Studies have all called for the CPS to be scrapped on the basis that it puts UK industry at a disadvantage. Policy Exchange said, whilst this would result in savings for consumers, “it would significantly undermine investor confidence as well as the credibility of the government’s decarbonisation plans” if done immediately.
Those who have argued against abandoning the measure include Drax, SSE, campaign group Sandbag and researchers at University College London. Cornwall Insights has said getting rid of the scheme would shake up the energy market and lead to one last hurrah for coal, whilst Aurora Energy Research has echoed the conclusions of Policy Exchange, arguing that the CPS will become “irrelevant” after 2025.
Regardless of which path the government chooses to take, Policy Exchange urged ministers to provide more clarity on the direction in which the mechanism is heading. Citing discussions at a recent roundtable, it said: “The original carbon price trajectory was not seen as believable or ‘bankable’ by investors, and in fact it lasted just 12 months before the government changed course.”
It continued: “The future direction of carbon prices is just one of a number of uncertainties hanging over the forthcoming capacity market auction… As it stands, potential bidders do not have visibility of carbon prices beyond March 2021, making it very difficult for them to make an informed bid into the capacity market auction.”