Carbon pricing is often regarded as the Holy Grail of climate policy. But according to Richard Cowart, Principal at the Regulatory Assistance Project (RAP), carbon prices cannot be a stand-alone solution. They have limited reach and – especially in electricity — can be expensive for consumers. Nor are high carbon floor prices a magical solution: they don’t reduce the surplus of allowances and may not even reduce emissions. According to Cowart, policymakers should deploy other instruments in the low-carbon toolbox, especially recycling carbon revenues to advance end-use energy efficiency.
“If your only tool is a hammer, every problem looks like a nail,” goes the saying. In the context of climate policy, the leading hammer is carbon pricing. To many economists and carbon market enthusiasts, putting a price on carbon is by far the preferred tool to drive down carbon pollution. So, whenever carbon prices fail to reduce emissions fast enough, those advocates simply conclude that the price isn’t high enough. The real message should be that price alone isn’t enough.
In response to the persistent problem of low carbon prices within the European emissions trading system (ETS), we now hear calls for high carbon floor prices—which would require covered emitters to pay, usually to national treasuries, the difference between the current ETS price and a higher set floor price. In 2013, the U.K. created a national carbon price floor with the aim of raising carbon prices to 70 pounds per tonne by 2030. Due to public concern over its high cost and modest benefits, the carbon price floor is now frozen at 18 pounds/tonne.
In today’s “single-price” power markets, when carbon prices drive up the cost of coal-fired power plants, they also drive up the market price of gas, nuclear, and even some renewable power plants
Despite the U.K.’s experience, in March 2018 officials in the Netherlands announced plans to impose a minimum carbon price rising to 43 euros/tonne by 2030, almost triple the current allowance price. French President Emmanuel Macron recently stated that France would push for a minimum carbon price regionally; discussions are underway in Germany as well.
Carbon prices can be an important tool, and creating a predictable carbon price corridor in Europe would be a useful ETS reform. But higher carbon prices by themselves are both too expensive and too limited in what they can deliver. We will not achieve our Paris objectives if we continue to overlook and underfund the other useful tools in the low-carbon toolbox. The policy mix should be guided not by a goal of high carbon prices, but by the principle of carbon efficiency: How much does a given policy cost the public per tonne of carbon actually reduced?
Carbon prices can be important—but their contribution will be much greater if we pay close attention to how the resulting carbon revenues are spent.
There are three main reasons a clean energy investment strategy must be part of any proposal to establish a carbon tax or a minimum floor price.
Power markets magnify the consumer cost of carbon prices
Most carbon price proposals focus on the sectors the EU ETS covers. Within that scheme, the largest sector subject to a floor price would be electric generation. Unfortunately, due to the way wholesale power markets are designed, when carbon prices are added to generators’ costs, electricity consumers end up paying far more than the market price of carbon for each tonne of carbon the new policy actually reduces.
Here’s why:
- In today’s “single-price” power markets, when carbon prices drive up the cost of coal-fired power plants, they also drive up the market price of gas, nuclear, and even some renewable power plants—resulting in a price increase for most power consumed.
- Meanwhile, even though coal and gas power are made more expensive, this doesn’t necessarily lead to large changes in total hours during which those fossil power plants will run over the course of a week, a month, or a year—so total emissions don’t change much.
- Therefore, because market clearing prices go up across the board, but there are relatively small changes in system operations and fossil emissions, end-use consumers can pay dearly in electricity costs for each tonne of reduction achieved across a power system.
This problem has been studied repeatedly but is still rarely discussed. In a study for the European Commission in 2008, the Energy Research Centre of the Netherlands (ECN) found that a carbon price of 20 euros would, on average across 20 EU power markets, end up costing power consumers 248 euros per tonne actually reduced.
Investing carbon revenues in well-run efficiency programs can save seven to nine times more carbon for a given price rise than just hammering consumers to use less through higher energy price
In a later study for RAP, using the same models, ECN and Cambridge Econometrics found that if carbon prices were to reach 80 euros, the cost to consumers for every tonne reduced in power markets would be 478 euros. This is not a uniquely European problem. Similar results have been modelled for power markets in the United States.
Energy efficiency is the low-cost carbon “scrubber”
If the purpose of a carbon price is to actually reduce emissions, and it’s not just a tax-raising scheme in disguise, designers should look for the lowest-cost way to rapidly reduce emissions, using both carbon prices and carbon revenues as tools.
Across Europe there are many low-cost energy efficiency options where well-run programs can cut energy bills for families and businesses while reducing emissions. Carbon revenues are an ideal source of funding for these efficiency programs.
One RAP study, which analyses years of energy efficiency expenditures in the U.K., reveals that investing carbon revenues in well-run efficiency programs can save seven to nine times more carbon for a given price rise than just hammering consumers to use less through higher energy prices.
Carbon revenues are just as important as carbon prices
European policymaking is stuck in a vicious cycle in climate debates, in which ETS advocates lament the oversupply of allowances, while consumer advocates and some national governments object to tighter carbon caps because they fear they will be too costly.
Any carbon price or tax regime should focus on the principle of carbon efficiency
Carbon floor prices by themselves will not solve these problems: They don’t reduce the surplus and may not even reduce emissions, while they increase costs to consumers. What we need instead is to link carbon prices and carbon revenues to create a ”virtuous circle“ that can sustain the political will to achieve economywide decarbonisation.
What’s the answer?
First, ask the right question. Any carbon price or tax regime should focus on the principle of carbon efficiency, which critically asks, “How much will this action cost the public per tonne of carbon actually reduced?” If we are to sustain the long-term political support needed to meet the Paris goals, carbon schemes need to deliver large-scale savings efficiently and affordably.
Fortunately, the key partner to the carbon pricing hammer is already in the toolbox: carbon revenue recycling. The final cost of carbon reductions will be much lower if we recycle carbon revenues back into the economy strategically, especially in low-cost energy efficiency measures that lower bills for families and businesses.
We do know how to do this
Many Member States already dedicate significant carbon revenues, or their equivalents, to clean energy initiatives, as promised in the ETS. Leading examples include Germany’s Energy and Climate Fund and the Czech Republic’s Green Savings Program. In the U.S., the leading example is the Regional Greenhouse Gas Initiative, where nine states have invested more than 60 percent of their carbon revenues in energy efficiency programs, lowering emissions and saving money.
To those seeking to speed the pace of carbon reductions, here is a simple message: It’s time to look deeper into the low-carbon toolbox and pick up more than just the carbon pricing hammer.
Editor’s Note
Richard Cowart is a Principal for global energy experts, Regulatory Assistance Project (RAP). He has wide experience on state and national energy and environmental issues in the U.S., across the EU, in China, and several other nations, with a particular focus on European energy and climate policy for the past decade. He serves on RAP’s Board of Directors, sits on the Executive Committee of the International Energy Agency’s demand-side management program, and served three terms as chair of the Electricity Advisory Committee of the United States Department of Energy..
This article was first published on the blog of RAP and is republished here with permission.
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Bas Gresnigt says
Yes, energy efficiency programs are the cheapest method to reduce emissions. It’s not relevant whether carbon tax money (as the author proposes) or other money is used for those programs.
The idea that “when carbon prices drive up the cost of coal-fired power plants, they also drive up the market price of gas, nuclear, and even some renewable power” is valid for the short term only.
With higher market prices more low emissions alternatives become viable and will be installed. That higher installed low emission capacity will bring power prices down again. And high emissions plants will stop for the simple reason they no longer can compete because of the high carbon emissions costs they have to pay.
Annemie Vermeylen says
A fair price for carbon reflecting the real cost of carbon pollution and impact to the society on a global scale is a necessary tool to reduce the carbon footprint in the generation of power, the manufacturing and transport of goods, the mobility of people.. energy efficiency is necesary but not sufficient. Energy efficiency needs the (threat of the) carbon price hammer to become mainstream practice and thus to generate carbon reduction results. The best awareness campaign is the wallet. Today a flight from Brussels to Barcelona is cheaper than going by train or car. The absence of carbon pricing pushes the consumer towards choices that are bad for climate .
Mike Parr says
One point not discussed is how renewables, energy efficiency and fossil systems are financed: answer mostly by “markets” and in most cases financing costs are similar, in the range 4 to 7%. Why not offer renewables and energy efficiency projects low cost rates (0.5%) via central banks. Most RES and EE projects are low risk & 0.5% in this context seems reasonable.
Given that the ECB bought Euro160 billion of bonds from private companies in the recent Quantitative Easing programme (albeit at market rates) – the precedent (central banks can buy private assets) has been set.
In such a set-up, RES and EE would increasingly out perform fossil systems on a cost/performance basis and the need for a carbon price |(at least with respect to electrical power production) would fade. It could still be used for other industries (steel & cement) coupled to low cost funding to reduce emissions – with the funding circularity mentioned by the author applied to projects aimed at these (& other) sectors.
Bas Gresnigt says
Your proposal would result in different carbon costs per sector, while the climate effects of carbon are not different…
Why complicate present ETS even more?