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The UK’s green ambitions have fallen out of favor. An example of this is the country’s carbon price which has dropped to £36 per tonne, less than 50% of the EU level.
Prime Minister Rishi Sunak’s focus on EVs and heat pumps pales in comparison to this significant obstacle to UK decarbonization.
Although not immediately apparent, there is a credibility gap. The carbon market is often discussed in terms of short-term supply and demand dynamics which are currently unfavorable for CO₂ prices.
Consultancy ICIS predicts that sectors covered by the UK carbon trading system will emit approximately 100mn tonnes of carbon dioxide this year, 10mn tonnes less than last year. Low power demand has reduced fossil fuel generation, while the supply of credit will be 118mn tonnes, resulting in an oversupply.
This oversupply is expected to continue into 2024, with further emissions decline. However, the government announced in July that additional carbon credits would be made available, perpetuating the oversupply problem.
Attributing the decline in carbon prices solely to technical factors overlooks a crucial point. Investors can purchase an allowance today and surrender it anytime, assuming they have confidence in the government’s midterm targets.
The UK aims to achieve a carbon budget of approximately 50mn tonnes by 2030, half of today’s emissions. This requires costly industrial abatement measures, such as switching fuel for steel production. According to Aurora Energy, the carbon price would need to rise to £97 per tonne to incentivize businesses to make these changes, offering a juicy internal rate of return above 15% at today’s entry point of £36.
The obvious implication of current prices is that the market doubts the UK’s commitment to midterm objectives, which is a concerning development. Low carbon prices have long-term negative effects on the UK economy. While industry and power companies may save £3bn annually if prices remain constant, the government loses out on that revenue.
Furthermore, higher carbon prices are necessary to encourage fuel switching. Although phasing out coal in power generation is mandated by policy, other sectors of the economy require motivation. Official indecision benefits no one.
The Lex team is interested in hearing more from readers. Please tell us what you think of the UK carbon price in the comments section below.
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