A rise in fossil fuel subsidies or an effective carbon pricing scheme — which direction for the UK’s Covid 19 recovery.
There is much talk from the Chancellor about the opportunities of a “green recovery” from the inevitable recession lying ahead for the UK economy as a result of Covid 19. There is clear evidence from the 2008 financial crisis that the countries that invested heavily in sustainable infrastructure and based their economic recovery strategy around sustainable goals, targets and metrics, recovered the fastest economically, and which economic performance continued to outperform those countries that looked to more traditional fossil fuel industries to restart their economy.
Government research, and research from the private sector, has shown a promising recovery path for the UK economy with a plan centred around investing in decarbonising the economy via green infrastructure investments, effective GHG emission taxation, investment in low carbon innovation and investments centred around the wider sustainable development goals. Benefits of such an investment strategy are both environmental and economic and would likely generate “blue collar” long term job creation in the regions worst hit by the economic hardships of Covid 19. Such regions are also those that have suffered most from the past years of austerity and borne most of the negative job and income distribution outcomes from globalisation. Finally, investment in green innovation has the ability to make the UK internationally productive and competitive for years to come, and hub for future green investment and job, as the City of London is today with respect to finance.
However, so far, we’ve not seen much evidence of such a strategy in practice and, instead, we’ve seen worrying amounts of investment instead in propping up the fossil fuel and other carbon intensive sectors, even more so (as things stand) than the investment that when into such post financial crisis in 2008. What’s more concerning is that the vast majority of this investment has been provided — predominately through corporate bond buying — with no conditions attached in respect of meeting GHG emission reduction targets in the future operations of the businesses this funding has been provided to.
If we wanted to distil these competing economic interests into two policy initiatives, this is best done by comparing the government’s present and future approach to fossil fuel subsidies vs its approach to an effective carbon pricing and taxing regime.
Fossil Fuel Subsidies
There are a number of different definitions being used for a “fossil fuel subsidy” (leading to many countries under-reporting the value of their subsidies in the space) but generally it can be defined as “any government action that lowers the cost of fossil fuel energy production, raises the price received by energy producers, or lowers the price paid by energy consumers”. Essentially, it’s anything that rigs the game in favour of fossil fuels compared to other energy sources.
The UK government subsidises fossil fuels by roughly £10.5bn a year, more than any other EU country, according to a recent report from the European commission. A significant part of the UK subsidies takes the form of a “consumption subsidy” via a 5% rate of VAT on domestic gas and electricity, which is 15% less than the standard 20% VAT rate applied in the UK. The UK also provides “production subsidies” via tax breaks to oil and gas companies in the North Sea. The justification for such subsidies is that they provide a policy mechanism for the government to keep the cost of energy down for the consumer and businesses, thereby boosting spending in other areas of the economy. There is no doubt that in the past, access to such cheap energy has lifted people out of poverty and catalysed economic growth, wealth creation and healthier living environments. However, such a policy needs to be now be considered in light of the impact it has today, where cheap and sustainable alternatives exist.
The justification for such a policy in places such as the US, where subsidies more take the form of massive investment and tax breaks for fossil fuel production companies, is different from the UK, and is that these US companies need to be subsidised to ensure they are competitive with state owned oil and gas companies in the middle east, upon which the US does not want to become reliant, and become “a hostage” (in their minds) to foreign states to power its economy.
Since the Kyoto Protocol in 1997, governments across the OECD have made large commitments to reducing or even outright removing all consumption and production fossil fuel subsidies, recognising that whilst they may be a politically helpful tool, particularly in western countries driven more by their consumption, such subsidies are directly adverse to achieving the goals set under the Paris Agreement, create a “carbon lock-in” through continuing the dependence on fossil fuels (thereby increasing the risk of stranded assets making their way onto government balance sheets in the future), and massively distort competitiveness and investment return for fossil fuel businesses compared to the renewable energy sector — meaning that yet more private investment goes into fossil fuels in pursuit of those returns where such investment is desperately needed for renewables.
Added to this, it is highly unlikely that cheap energy will be the cornerstone to economic growth as it has been past times, where the most advanced economies of the world (responsible for the majority of GDP) either are, or are moving towards, being service based economies (which are far less energy intensive) and increases in energy innovation and efficiency means we need less energy now to produce the same level of GDP increase.
However, despite all the pledges, we have not seen any serious policy changes among the governments of the world’s largest fossil fuel providers and consumers to move away from subsidies in favour of supporting renewable energy.
The primary reason for this “all talk and no action” approach is twofold: (a) the reliance upon revenue from the export of oil and gas for economies build on fossil fuel production, such as Saudi Arabia and Russia; and (b) in respect on the “consumer countries” such as the UK and US, the major lobbying influence from the oil and gas industry on policy makers responsible for phasing out such subsides.
Therefore, where the business case for continued subsidization of this sector no longer stacks up in the context of fuelling an economic recovery, what are we left with? Seemingly only vested interests perpetuating a false claim for their own interest at the expense of the environment and, ultimately, people’s future livelihoods. It is supremely ironic that governments think that we can generate a recovery from a recession brought about (albeit indirectly) by our blatant disrespect for nature and biodiversity, by greater investment into actions which further promote and undertake such environmentally damaging behaviour. It does not take a genius to predict where we are going to end up again with such an approach.
That is of course and overly reductive analysis of events and the role of fossil fuels in our future economies. They no doubt have a continued role to play but surely not front and centre of the UK’s Covid 19 recovery plan. We must think of Covid 19 as wiping the slate clean of what is politically achievable for our future. Nobody thought that western democracies would accept or abide by such a draconian imposition on their civil liberties as being forced to “lock-down” in manner they were, and I think we have tested people’s resilience to fast exponential change and the results have been more favourable then we expected. We should therefore ride this wave of change to bring about sweeping changes in our economic policy which starts with a rapid phase out of fossil fuel subsidies.
A wide-ranging analysis of what other policy changes are required to compliment such a phase out is beyond the scope of this short blogpost, but from an energy perspective this must involve massive infrastructure investment and subsidisation of the green energy.
Carbon Pricing
One area of policy focus which we can give some thought to here and which should feature with prominence in any UK recovery package is the issue of carbon pricing and carbon taxation. This issue is closely related to the issue of fossil fuel subsidies as by governments keeping the “carbon price” (meaning the cost paid by a company per tonne of “CO2 equivalent” emitted into the atmosphere) artificially low, this is just another form of fossil fuel subsidy, and perhaps the most radical one in need of reform with the fossil fuel industry being largest emitters of GHGs.
Climate change is considered a market failure by economists, because it imposes huge costs and risks on future generations who will suffer the consequences of climate change, without these costs and risks being reflected in current market prices. To overcome this market failure, they argue, we need to ‘internalise’ the costs of future environmental damage by putting a price on the thing that causes it — namely greenhouse gas emissions. We therefore need an effective “carbon price” which takes into account the damage being done by emissions today and the cost to future generations in having to mitigate against this damage in the years to come. It is widely considered that the current carbon pricing regime in the UK (indeed globally) does not correct this market failure.
The UK’s current carbon pricing regime (in relation to major producers of GHG emissions) consists, broadly, of the EU cap and trade system called the European Trading System (“ETS”) and then the Carbon Floor Price/Carbon Price Support (“CPS”).
The ETS is a cap and trade scheme that seeks to reduce GHG emissions by requiring operators of installations in certain EU energy-intensive sectors (including manufacturing facilities, oil refineries and power stations) to surrender an equal number of emission allowances (allowances) as the total emissions of carbon dioxide (and some other GHGs) from the installation for that year. The UK will formally exit the ETS upon expiry of the Brexit transition period and negotiations are slow with respect the UK’s access to the ETS through the national trading scheme being proposed, because the EU fear the UK’s involvement in the ETS post Brexit may undermine the ETS without the UK signing up to level playing field obligations across all environmental regulations.
The CPS, on the other hand, is effectively a top up price on carbon production paid by UK carbon emitters. The CPS (introduced through the Coalition government’s Electricity Market Reform scheme) requires carbon generators to pay a minimum carbon price, based on the Carbon Floor Price, which is levied on businesses through the Climate Change Levy (“CCL”). It was introduced to prop up the price of carbon in UK, given that the price on the free market via ETS was consistently trading too low to bring about the intended economic incentives to reduce GHG emissions from facilities. The CPS was introduced in 2013 at a rate of £16 per tonne of carbon dioxide-equivalent and was set to increase to £30 by 2020. However, the government since decided to cap the CPS at £18.08 till 2021, widely considered to be far too low to have any effect on the large-scale emitters.
The CPS price freeze and the low trading price of allowances within the ETS has meant that in the UK the carbon price has remained lower than expected and is inconsistent with meeting the Paris Agreement and the UK’s own targets. A study by the Word Bank in 2009 estimated that the carbon price needs to be between $40–80 per tonne of carbon dioxide (tCO2) by 2020 and US$50– 100/tCO2 by 2030, if the UK/world is going to meet the Paris Agreement targets.
Wide ranging reforms have been proposed for the UK energy sector in the report by Dieter Helm CBE entitled “Cost of Energy Review”. In respect carbon pricing and taxation, Mr Helm proposed replacing the UK’s current fragmented system with a universal carbon tax across the most polluting sectors. This has proved politically challenging and, so far, his recommendations are no nearer to implementation.
A strong and fixed carbon price, coupled with other sector specific regulatory changes, is needed to act as a deterrent against the reliance on fossil fuels and future fossil fuel lock-in. It will also assist the government when introducing sector specific recovery packages, such as in the aviation sector, where a strong carbon price can be linked to emission reduction targets upon which the continued bailout packages should be made conditional.
Finally, a high carbon price could raise billions in tax revenue which will be so desperately needed to help balance the books following the huge borrowing undertaken as a result of spending. This is a helpful alternative to simply raising personal and corporation taxes — moving the tax burden from the people to the polluters. Any new source of tax revenue will be particularly helpful given it will be politically challenging for the current government (who campaigned on an anti-austerity platform) to bring in any austerity policies to reduce public debt.
In summary, we are at a crossroads, where the extreme reaction Covid 19 has actually presented an environment where wholesale, drastic changes can be made with far less political and economic backlash and negative repercussions. The slate has been wiped clean and we now need to seize this opportunity with both hands. Fossil fuel subsidies should be reviewed at the production and consumer levels and a plan should be implemented for them to be phased out in a staged manner, and the government should look at how those subsidies can be redirected to renewable energy sectors. At the same time the UK’s carbon pricing regime needs reform, resulting in a price that reflects the future damage and mitigation costs of further emissions and an application of that price across the production and consumer landscape in an effective manner which can deter business and consumer reliance upon GHG intensive sectors and at the same time place the tax burden on those whole fail to alter their practices.
