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Carbon price floor

The European Union should adopt a minimum price on carbon dioxide from electricity generation to boost low-carbon investment, says a new paper from the Energy Policy Research Group at the University of Cambridge.

Industry in dramatic red sunset light. Chimneys and cooling tower of a coal fired power station.

The European Union should introduce a minimum price on carbon dioxide from electricity generation to accelerate low-carbon investment and the switch from coal-fired generation to cleaner gas, says a new paper from the Energy Policy Research Group (EPRG) at Cambridge Judge Business School.

Such a minimum price could be introduced within the EU’s existing Emissions Trading Scheme (EU ETS), effectively “topping up” the EU ETS price, says the paper. Currently, carbon prices in the EU lie well below levels needed to deliver on ambitious climate targets.

“An EU carbon price floor for the power sector would constitute a significant improvement to the EU ETS,” the paper concludes. “This would reaffirm the EU’s position as a climate leader and contribute to achieving its ambitious decarbonisation targets.”

Given the political difficulty of quickly implementing such an EU-wide carbon price floor, the paper says that individual EU countries might as an interim step wish to introduce a national carbon price floor, as Great Britain has already done and the Netherlands is planning. This can help address the future of coal – avoiding “lock in” to an unsustainable technology. The British price floor has had a dramatic impact, with the share of coal-fired generation dropping from 41 per cent in 2013 to less than eight per cent in 2017.

The EPRG is housed at Cambridge Judge Business School. Authors of the new paper – entitled “When is a carbon price floor desirable?” – are David Newbery, Emeritus Professor of Economics at the University of Cambridge and Director of the EPRG; Dr David Reiner, University Senior Lecturer in Technology Policy at Cambridge Judge and Assistant Director of the EPRG; and Robert Ritz, Senior Research Associate at Cambridge Judge and Assistant Director of the EPRG.

The paper points out that despite several positive developments – such as the 2015 Paris Climate Agreement and the EU’s ambitious Energy Roadmap 2050 to reduce carbon emissions – the EU’s main climate policy instrument, the EU ETS, has failed to deliver the carbon price needed to incentivise the low-carbon transition.

While the European Commission’s internal analysis shows that a “target-consistent” carbon price of €32-63 per ton of carbon dioxide emissions would be required by 2030, the actual carbon price during 2017 was only €6 per ton of carbon dioxide emissions. And despite a recent rise in the ETS price, current policy stymies investment by failing to give low-carbon investors any bankable guarantee on an adequate future carbon price.

The paper recommends that the carbon price floor should “top up” the EU ETS price to a level of €25 to €30 per ton of carbon dioxide for the power sector, rising at three per cent to five per cent annually above the rate of inflation until at least 2030. This would encourage a shift from coal to gas in electricity generation, achieve quick emissions reductions, and help reassure investors in low-carbon technologies.

A minimum price on carbon dioxide from electricity generation sidesteps potential concerns about international competitiveness because electricity, unlike cement or steel, is not traded internationally beyond European borders.

The paper says that a new Market Stability Reserve (MSR) in the EU ETS, which begins operations in January 2019, will enhance the value of a carbon price floor.

Until now, the EU ETS has been subject to a “waterbed effect”: if one country (or one sector) alone reduced its emissions, these would resurface elsewhere within the system – given the fixed overall EU-wide emissions cap. From 2023 onwards, the MSR will cancel surplus carbon allowances, which in the medium term should ensure that most unilateral emissions reductions translate into overall emissions reduction. The MSR will thus enable policies like a carbon price floor to achieve a global climate benefit.

The EPRG paper also discusses how over the last five years jurisdictions around the world – including California and the Regional Greenhouse Gas Initiative in the US – have already demonstrated how a price floor can be a practical design element for carbon trading while retaining the appeal of a market-based abatement mechanism.