Utility Week

10 | 19TH - 25TH JULY 2019 | UTILITY WEEK Utility of the Future: climate change Towards net zero carbon Utility of the Future Climate change D ecarbonising the world's energy sup- ply is likely to be cheaper (eventually) than the alternative, but that doesn't make it cheap. The 2006 Stern Review sug- gested a cost equivalent to 1 per cent of GDP forever; chancellor Philip Hammond has recently (and controversially) suggested a cost of £1 trillion for the UK. So who should foot the cost? Logically, there are three groups that could end up paying. First, individual energy consumers who want to heat their homes, power their appliances and fuel their vehi- cles. Second, businesses that buy energy in order to produce goods and services for sale, and public sector organisations. Third, tax- payers (who could also be divided into indi- viduals and corporate bodies). Decades of work by economists have given us some principles for how to pay for the government, or other projects inspired by the government. First, market prices should be as close to the true marginal cost of pro- duction as possible. The price of fossil fuels should include a carbon tax that reflects the cost of the damage done by climate change. However, estimating the value of this dam- age is difficult. Different assumptions give different val- ues (the previous US administration had numbers between £15 and £153/tonne of CO2 for 2020), and only time will tell whether any of these numbers are even roughly correct. We do know, however, that a carbon price of zero is precisely wrong, and the UK govern- ment now works backwards from its com- mitments to reduce emissions, estimating the carbon price that would spur the invest- ments needed to meet those commitments (£14/tonne in 2020 but £81/tonne in its cen- tral case for 2030). Carbon tax good The good thing about adding a carbon tax to the price of fossil fuels is that it should auto- matically be added to the prices of the goods and services being produced with those fuels, and in proportion to the amounts used. This is most obvious in the case of electricity – the price in the wholesale market closely matches the cost of fuel, as long as the cost of carbon is included. The chart right, "British fuel and electric- ity prices", shows this relationship, and also that the rising cost of carbon in Great Britain has now made gas cheaper for generators than coal. Crowding out the dirtier produc- tion processes is exactly the point of a carbon tax, which also gives consumers a reason to buy fewer carbon-intensive products. Carbon tax bad The bad thing about adding a carbon tax to the price of fossil fuels is that it makes the goods produced with those fuels more expensive, and less competitive against countries without a carbon tax. Replacing relatively clean production in the UK with imports produced while emit- ting more carbon dioxide would be counter- productive. International trade law allows the UK to rebate value added tax payments when products are exported, and to charge a similar tax on imports; this ensures that our exporters are not disadvantaged if VAT goes up. The equivalent would be a border carbon tax adjustment. Exporters would receive rebates equal to the estimated carbon tax they had paid, and importers would be taxed on the difference between the tax in the UK and the tax they paid (if any) at home. It would be almost impossible to calculate these numbers pre- cisely, but the broad-brush techniques for attributing the share of any input in the cost of a given output are well known. With a high enough carbon tax, some lower-carbon products and processes will be competitive without further support, but this may not be enough for the deep decarbonisa- tion we will need. In particular, transforming our infrastructure may need strategic invest- ment in new technologies that will initially be expensive until the benefits of learning- by-doing kick in, and the early investors may not be able to capture those benefits. Such investments deserve public support, which has to be paid for. This is the justification for the significant sums paid to renewable generators in recent decades, an investment that has now paid off in much cheaper solar panels and wind turbines. Common sense might dictate that the cost of these and other investments (think of the Who should pay for the energy transition? Economist Richard Green assesses the options for sharing out the costs of decarbonisation fairly.

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