Carbon pricing has always been a thorny political issue, but as Ministers weigh how to drive the next phase of the net zero transition some experts believe it has a critical role to play

It all started with such ambition. The UK had left the European Union, and with it, had also opted to see sever its ties with the world’s largest carbon market, the EU Emissions Trading Scheme (ETS). As with so many other areas, the government wanted to strike out alone, eager to decisively end Brussels’ jurisdiction and prove its sovereign ‘Global Britain’ credentials.

The government’s original argument – and it seemed a fair one – was that, armed with its recently legally adopted net zero target, it could establish a domestic UK ETS that would prove even more ambitious in its scope and effective in its execution than that of its former partners in the EU.

So, after years of post-Brexit wrangling, the UK’s ETS sparked into life in May 2021. The UK’s initial cap on emissions is around five per cent lower than its previous share within the EU’s system, and carbon prices immediately competed with those in the EU’s, rising above £50 a tonne. As with the EU’s, the UK’s cap and trade scheme covers large power plants, heavy industry, and domestic air travel, amounting to roughly 1,000 intensive energy users and 140 aircraft operators. And, like the EU – which quickly followed the UK in adopting its own net zero goal – the UK government said its vision was to align the cap and trade scheme with its overarching 2050 emissions goal.

To that end, the government signalled that it was exploring the potential of expanding carbon pricing right across the economy to the additional two-thirds of emissions not currently covered by the ETS. It even hinted that it might in future be open to linking the UK’s market with that of the EU’s so as to further boost liquidity, ease concerns over business competitiveness, and help ensure decarbonisation is achieved at the lowest possible cost. As such a consultation setting out its proposals for building a net-zero aligned ETS in the UK was slated for the autumn, which would have allowed it to be released ahead of the COP26 Summit and in conjunction with the government’s long-awaited Net Zero Strategy.

And then… nothing.

As with so much of the government’s green policy agenda, the crucial consultation now appears to be caught up in wrangling between various factions in government over how to manage the tension between the UK’s long term emissions goals and the short term costs associated with decarbonisation. In June, media reports indicated the government was looking to expand the ETS to include road transport and heating, but if reports this week in The Telegraph are to be believed, these plans now look to have been ditched. As ever, fears abound in government that expanding carbon pricing in certain areas could risk a public backlash by heaping further costs onto consumers. The latest rumours suggest the consultation over the future of the ETS has now been delayed until spring 2022.

When contacted by BusinessGreen, the Department for Business, Energy and Industrial Strategy (BEIS) insisted it has not yet taken any decisions on the future design of the ETS, and it offered no date for the release of the consultation – although it is expected that decisions will be taken next year.

“The UK Emissions Trading Scheme enables businesses to plan ahead and invest in new technology so they can decarbonise at the least cost,” BEIS said in a statement. “No decisions have been taken on the expansion of the scheme.”

Of course, putting a price on emissions from cars and home heating does inevitably come with significant political risk, as it would likely drive up costs for consumers. The proposals were bound to antagonise those within government who already harbour strong misgivings over the ‘costs’ associated with building a net zero economy. Moreover, since the ETS was launched in May, the government has offered further policy measures designed to decarbonise road transport and heating by ramping up investment in new technologies through its Transport Decarbonisation Plan and Heat and Buildings Strategy. It is easy to see how some Ministers are now thought to be arguing that extending the reach of the ETS would be both politically risky and not strictly necessary.

As such, Hannah Dillon, head of the Zero Carbon campaign – which has been calling on the government to put a “meaningful” price on carbon – says she was disappointed but not altogether surprised that Ministers might now be looking to scale back plans that would have placed a carbon price on vehicles and heating.

“When the ETS was launched it was very much presented as though it was going to be net zero-aligned, and the starting point was to cap the volume of credits on the UK market at five per cent lower than our nominal share in the EU, so that was a definitely a positive start,” she tells BusinessGreen. “I think the disappointment is partly that expansion plans have been delayed, and partly that we are learning only after COP26 that these plans are potentially being scaled back.”

For Dillon, while putting a price on carbon emitted by cars and heating is fraught with complication, simply deferring the consultation is delaying the inevitable, and underscores the government’s persistent failure to be more honest with the public about the potential costs that may lie ahead for activities that emit carbon. After all, by thinking more strategically about phasing in some of these measures, such as by ensuring households have access to funding that enables them to cut emissions ahead of carbon costs coming in, the risk of a public backlash could be minimised, she suggests.

“I completely understand that this is politically difficult and we need to be careful not to just lump costs onto households – that’s the whole premise of our campaign,” she explains. “But to just dilute the consultation for fear of political backlash is particularly disappointing… I think the broader frustration about all of this is that it just signals a lack of willingness to engage with the more thorny elements of net zero.”

Without – and even with – carbon pricing, far more ambitious policy measures, regulations, and incentives are needed to drive business and public behaviour change in support of the next phase of the net zero transition, but Dillon does not see the government grasping the nettle here either.

“We absolutely need to talk more about the benefits of net zero, and make sure they are realised by society,” she explains. “We can’t just keep shying away from the fact this is going to be difficult and the public are going to have to play a role. So whether this is the right policy or not, the longer this is avoided, the more complicated it’s going to be when the public are asked to do something.”

So, if cars and heating at present look unlikely for inclusion in carbon pricing, where next for the ETS? The Telegraph reported yesterday that the government is still looking at expanding the ETS, and that energy-from-waste plants, shipping, and potentially even agriculture could soon face a price on carbon.

Waste to energy would seem to be the least controversial sector to target, given the industry operates power plants that do emit CO2 – just like many facilities already covered by the ETS – and growing numbers of operators are now starting to look at carbon capture and storage systems in order to align their operations with a net zero future. Pulling these facilities into the UK ETS would arguably further strengthen the investment case for bolting CCS technologies onto waste-to-energy plants.

Shipping would present a bigger logistical and political challenge, with the International Maritime Organisation (IMO) and many within the industry having long lobbied against the emergence of a patchwork of different domestic decarbonisation and carbon pricing schemes for operators who span the globe. But there is a clear precedent here in the inclusion of aviation in both the UK and EU ETS, which demonstrates that operators who cross international borders can be successfully pulled into regional carbon markets. If the shipping industry wants to counter the introduction of new carbon charges, the IMO would likely need to come up with a far more robust plan of its own for delivering net zero emission shipping worldwide by mid-century – something it is very much still struggling to manage.

But of the three sectors under consideration for inclusion in the UK ETS, perhaps the government’s biggest challenge would be in designing a cap and trade system that works for domestic agriculture. According to the Telegraph some Ministers are already wary that new carbon levies for farmers could be characterised as a ‘meat tax’, and the sector is also highly exposed to international trade, which could further complicate efforts to price carbon from farming. Moreover, before the sector could ever be folded into the ETS, far stronger measurement systems would be needed for agricultural emissions – something the government is reportedly now exploring.

But Stuart Roberts, deputy president of the National Farmers Union (NFU), indicated the trade body would nevertheless be open to farmers’ future inclusion in a carbon pricing scheme, as farmers “are well placed to deliver greenhouse gas removals through on-farm sequestration and engineered carbon storage”.

“Coupled with ongoing actions to reduce emissions from food production, there is a real possibility that agriculture could benefit from the ETS in the future and actively play a part in helping other sectors decarbonise,” he said. “However, we cannot underestimate the significant challenges of measuring agricultural emissions and attributing and monitoring a financial trading framework for carbon stored or carbon emissions avoided. And a robust carbon price will be crucial if farm businesses are to incorporate this into their plans. While it’s unlikely agriculture will be directly impacted for some years yet, we need to use this time to consider the risk of carbon leakage, assess any impact on food security, incentivise decarbonisation, and prepare so that agriculture is in a position to benefit from this scheme and maximise our contribution to national net zero targets.”

Adam Berman, European policy director at the International Emissions Trading Association (IETA) in Brussels, says he does not expect agriculture to be included in the UK ETS any time soon, or at least “in the short to medium term”. Such a system would prove both highly complex for smallholder farmers and landowners, and as politically sensitive as the apparently rejected plans to extend carbon pricing for cars and heating, he tells BusinessGreen.

“I would be surprised from a regulatory perspective if that sector was included in the UK ETS, but you can see solutions in the future in which agriculture is treated slightly differently,” he explains. “You might come up with some sort of trade mechanism in which agriculture can act as a carbon sink. That could then form part of the UK’s broader net zero journey, with some sort of traded agricultural credit from farm owners or land owners ensuring their land is sequestering carbon through different ways. But I think the UK is right at the beginning of thinking about how those greenhouse gas removal systems could work.”

The UK is not alone in debating the future of its carbon pricing regime. The EU is also aiming to expand its ETS to cover more parts of the economy, and has begun exploring how to price carbon on road transport and buildings. To that end, it has proposed creating a separate ETS for these two sectors, but this has similarly stoked fears of a public backlash, not least from France which is particularly keen to avoid any repeat of the ‘gilets jaunes’ protests in 2018 that stemmed from anger over a hike in fuel taxes. A final decision on expanding the EU’s ETS is also, therefore, a long way off yet.

Berman agrees with Dillon that, both in the UK and the EU, there is still a broad unwillingness to wrestle with the more challenging aspects of decarbonisation that inevitably require a deeper role for the public. “At some point, consumers will have to feel this tangibly, and there’s a lot of political nervousness on both sides of the Channel about how to do that,” he says. “We’re not yet at the point either in the EU or the UK where the proposal yet exists to adequately reimburse those vulnerable households, and to ensure that we don’t get pushback from civil society when these more tangible effects at the consumer level are felt.”

Even so, with severity of the climate crisis only escalating and the chances of keeping the 1.5C targeted warming threshold alive hanging by a thread, deep decarbonisation is urgently needed in the current decade, and public clamour for action is growing. And while carbon pricing certainly offers no silver bullet for reaching net zero – with strong policy, regulation and investment still needed across the economy to deliver net zero – market-based measures on paper offer an attractive way for governments to incentivise decarbonisation without having to do as much of the heavy lifting, while also generating revenues that can be redistributed to businesses and households to help them decarbonise and manage the costs that come with new carbon levies. There is a growing library of academic literature exploring how carbon pricing or taxation regimes can be introduced in a way that is revenue neutral and actually benefits poorer households. Moreover, the growing push for carbon border taxes in the EU and beyond looks set to accelerate the drive for carbon pricing around the world.

For businesses, too, cap and trade systems tend to set a clear trajectory for decarbonisation many years ahead, which provides certainty for investing in green technologies and processes – certainly more so than flat taxes that can chop and change from year to year. Somewhat ironically, Ministers and officials in Westminster and Brussels appear to be pushing back against proposals to expand carbon pricing regimes at the precise point when the original carbon market – the EU ETS – finally appears to be working as intended, with record high carbon prices helping to drive investment in clean infrastructure.

“It’s complicated, unfortunately, if you end up with just a regulatory approach [to decarbonisation],” argues Berman. “So, I think ultimately, these market based mechanisms will be very popular… In the medium term, I have hopes that these mechanisms will probably become more widespread across the UK economy, as they will in the EU.”

Whether either the EU or UK ETS does eventually encompass the vast majority of the economy remains to be seen. But until a meaningful price is put on pollution, marshalling the economy towards decarbonisation will remains a huge struggle, Dillon warns. “I just don’t see how we’re going to facilitate the transition to net zero without pricing in externalities into the costs of goods and services,” she says. “Because how else are you doing to encourage different methods of production, but also purchasing too?”

Whatever the eventual shape of both the UK’s and the EU’s emissions trading schemes, the debate surrounding carbon pricing is clearly central to the growing, broader discussion around net zero, and how to balance the upfront costs of the transition and account for the costs of pollution. That discussion, it seems, has barely begun.

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