Analyzing The Effectiveness Of Cap And Trade And Carbon Tax Policy Tools In The UK In The Context Of Paris Climate Agreement

Cap and Trade policy

Climate change has become a very serious risk in the global environment system as well as on the economy. Various impacts of the climate change have been observed in the past decade, such as, increase in the global temperatures, widely known as global warming, massive melting of the snow and ice sheets near the Arctic and Antarctic circles, and rising sea level. These all have a severe implication that the climate is changing and something should be done to stop these climate change and global warming, so that the environment sustains and the damages could be repaired to some extent. United Nations Climate Change Conference in Mexico in 2010 recognized the need for cutting down the global GHG emissions to put a cap on the increase in global temperature by 2°C (OECD 2012) above the pre-industrial levels. It has been found that a rise in the temperature of over 2°C would likely shove the elements of the Earth’s environment system to cross the critical thresholds, known as the ‘tipping points’ (Bruckner et al. 2012).

Thus, the global policy of reducing the carbon emissions and controlling the temperature rise by 2°C is famously known as the Paris Climate Agreement. In December 2015, 195 countries signed the agreement to reduce greenhouse gas emissions and limiting the global warming below 2°C at the Paris climate conference (Frieler et al. 2013). All the governments agreed to take proper actions to limit the temperature rise as per the latest science and technology. For this to be effective, the G8 nations agreed to collectively reduce 80% of the carbon emissions by 2050 (European Commission 2012). Two such measures are the Cap and Trade, and the Carbon Tax. This report focuses on these two policies and how much effective these have been in UK.

Cap and trade policy is another name for emissions trading. It refers to the general term for the regulatory program of the government, which is designed to limit or put a cap on the aggregate level of the particular chemical by-products generating from the private industrial activities. The purpose of this policy is to build a market price for the pollutants or emissions, which were not existent previously and address the probable negative externalities. Its goal is to offset the damages to the environment caused by industrial activities and not represented in the cost of production (Pendleton et al. 2012).

Cap and trade is a powerful way to reduce the pollution. Caps help to limit the harmful emissions. The companies are restricted to emit a limited amount of the harmful greenhouse gases. This cap is expected to get stricter every year. Companies have to pay penalties if they cross the cap. Trade refers to the buying and selling of the permits of emission for a certain amount. This helps the companies to save money by reducing the emissions (Rogelj et al. 2013).

The government designs the cap on an industry or on the economy as a whole and also decides the cost of violations. The harmful greenhouse gases and carbon dioxide are the targets of the cap. The amount of this cap is divided into allowances, which permit the companies to emit a ton of gases. The cap is distributed by the government either through auction or for free. It declines over time and provides incentives to the companies to become more efficient. The companies, which reduce their emission faster, can sell the allowance to other companies creating more pollution. It gives flexibility to the companies to use this allowance as required. The companies adopt energy efficient technologies to combat the pollutant activities. For instance, this policy had been very much effective in controlling the acid rain in the USA. To control the acid rain, companies developed electric utilities, made more efficient pollution control equipment and figured out the ways of burning lower sulfur coal.

Cap and Trade in UK

There are some disadvantages of this cap and trade policy. It is difficult to create markets for something like carbon dioxide, which has no such intrinsic value. If the permits are given away for free, then it did not yield any effective result. Hence, putting a price on the permit is necessary. The offset permits, which are obtained from paying for the pollution reduction activities in the poor and developing countries, are allowed to be traded although these are not much effective (Seto, Güneralp and Hutyra 2012).

In the United Kingdom, there is a voluntary emission trading system, known as the UK Emissions Trading Scheme. It was the world’s first multi-industry carbon trading system. There were 34 industries and companies that participated in this scheme and applied the cap and trade policy to reduce pollution.

The government of UK agreed to follow 2008 Climate Change Act to reduce the GHG gas emissions by minimum of 80% by 2050. UK planned to meet this target by moving towards a more energy efficient and low-carbon economy (CCC 2016). This had another aspect of making UK less dependent on the imported fossil fuels and less prone to higher prices for energy in the near future. The country had taken some actions to achieve this goal, such as, setting up a national strategy and policy, reducing the energy demand and making the businesses more energy efficient, increasing the investments in the low-carbon technologies, public reporting of the carbon emissions by the private sector. All these are done by establishing the necessary bills and legislation. UK also tries to reduce GHG emissions from the agricultural sector. It has funded more than £200 million to innovate the low carbon technologies. There are more than 1000 participants in the European Union Emission Trading System (EU ETS), who pledged to reduce 50% of the emission reduction target with the use of cap and trade policy between 2013 and 2020. UK has also been a major part in the Paris Climate Agreement (Vaughan 2016).

UK divided the carbon budget into five phases as shown in the below table. The first phase was achieved successfully and currently the second phase is going on.

Carbon budget (Years)	Limit for emissions (MtCO2e)	Equivalent reduction compared to 1990
1. 2008-2012	3,018	26%
2. 2013-2017	2,782	32%
3. 2018-2022	2,544	38%
4. 2023-2027	1,950	52%
5. 2028-2032	1,725	57%

Table 1: UK carbon budgets (Current legislation)

(Source: CCC 2016)

The government announced in a press release in 2014 to bring major reform for improving the cap and trade system to achieve the goals of reducing carbon emissions. The UK market currently has more than 2 billion cap and trade allowances, given by the EU ETS, which indicates that these are not helpful in stimulating the low-carbon investment required for meeting the 2050 goal. Several factors, like the global economic slump and inadequate ambitions for 2020 led to less than expected demand for the allowances and thus, resulted in weak price for such investment. The reform actions would focus on increasing the investments in the cost effective low carbon technologies. The actions include cancellation of surplus allowances to restore balances between demand and supply before 2020, revising the free allowance provisions, and removing of redundant red tape to balance between cost efficiency, simplicity and fairness, such as, reduction of compliance and administrative costs. The emissions of UK have reduced by 24% relative to the 1990 levels. UK needs to reduce the emissions by 20-24 billion tonnes, that is, around 50% of the target, to be consistent with their target for 2050 to keep the temperature controlled below 2°C (gov.uk 2017).

Carbon tax

Carbon tax is an alternative to the cap and trade policy, with the same purpose. This tax is imposed on the carbon content of the energy fuels. It is one form of the carbon pricing. In all types of energy sources, carbon is present, and yields massive amount of CO_2, causing global warming. The combustion of fossil fuel produces greenhouse gases and releases CO_2, which plays a major role in raising the global temperature, and thus, the emission of this carbon element are taxed. It is levied on the businesses that produce excessive CO₂ through their activities. The tax thereby raises the price for such activities and forces the businesses to cut down in the activities to save their money (Kesieme et al. 2013). This tax aims to reduce the negative externalities created by the carbon emissions. Hence, it creates social and economic benefits. To achieve the goals to reduce the global temperature by 2°C, it is necessary to reduce the GHG emissions, which also include CO₂. This can be done with effective carbon taxation along with cap and trade policy.

The government of UK first kind of environmental tax on the petroleum products in 1993, named Fuel Duty Escalator. It was meant to reduce the carbon emissions in the transport sector. After a lot of criticism, it was withdrawn in 1999. According to Komanoff (2017), UK has successfully reduced the carbon emissions to the lowest since 1894. In 2016, the CO₂ emissions by UK have dropped by 5.8% due to a record fall of 52% in the usage of coal (Evans 2017). The top-up carbon tax was introduced by the UK government in 2013 to encourage low carbon power generation (Gosden 2016). The power generators pay the carbon tax on the top of the price under the EU ETS, which forces the businesses and industries to submit one permit for carbon for every tonne of CO₂ emission.

The CO₂ emissions from the fossil fuels in the country totaled to 381 million metric tonnes in 2016, which is 6% less than the level in 2015 and 36% less than the 1990 levels (Evans 2017).

Change in the CO2 emissions in UK since 1990
Total CO2	MtCO2	Change since 1990
2010	495.8	-16.4%
2011	452.6	-23.7%
2012	472.1	-20.4%
2013	463.3	-21.8%
2014	422.0	-28.8%
2015	404.7	-31.7%
2016	381.1	-35.7%

Table 2: Change in carbon emission in UK since 1990

(Source: Evans 2017)

The most important factor in this case is the top-up carbon tax, which the government made double in 2015 to £18 per ton of the carbon dioxide. In 2014, this price cap was meant to valid till 2020, which was extended to 2021 in 2016 (gov.uk 2017). This tax mainly targets the usage of coal due to higher carbon content than in gas and oil. In 2016, the massive decline in the CO₂ emission was offset partially by the augmented emissions from gas by 12.5% and oil by 1.6% (Clark 2016). The carbon price is determined by the EU ETS through the permits auctioning system and the tax is levied on that price.

According to Carbon Brief, if the carbon tax is removed, then the generation of coal would be doubled and emission would increase by 21%, which is quite high. On the other hand, if the tax is doubled, then the coal generation would reduce by 47% and CO₂ emission would reduce by another 10% (Twidale and Hobson 2016).

On the other hand, due to a higher carbon tax, the experts predict that UK might have to import energy from countries with lower carbon tax, rather than producing enough to meet its own demand. UK has planned to shut down all the coal fired power plants by the end of 2025, unless the plants implement low carbon power generation technologies to reduce carbon emission. Thus, it is expected that, the necessity for carbon tax would be lower after 2025, as it is not used for low-carbon investment (Fell et al. 2012). However, carbon tax needs to be phased out, else the old coal plants might shut down by 2020 rather than by 2025. Importing energy from dirtier plants in Europe would push up the energy prices further in the country. The government has frozen the tax at 2015-16 level until April 2021. The major power generators of UK, such as EDF energy, SSE, support this tax by the government, as it is used to provide incentives for investment in low carbon technologies, such as renewable energy sources and biomass. They also support this because the tax makes the prices of electricity go up and their revenue is increased (He, Wang and Wang 2012).

Although the industrial and the household sectors are against the tax as it makes the electricity prices of UK uncompetitive. They suggest that the carbon tax should be phased out by the mid 2020s to cut down the household and industrial electricity bills by 7% (Du et al. 2013). The presence of the carbon tax also indicates that, the European coal power plants have a significant cost advantage over the power generators of Britain due to lower carbon price. Thus, removing the tax could shift the generation of power from Europe to UK. The overall emissions in Europe would also be reduced if the new and efficient power plants in UK can replace the older coal power generation in UK and Europe. It helps to achieve the bigger goal of contributing in the global temperature (Goulder and Schein 2013).

The Spring Budget 2017 indicates that, the UK government would keep the carbon pricing, which helps in the reduction in the carbon emission. It would help to move towards the target of reducing carbon and other GHG emissions by 80% from the 1990 levels and keep the temperature increase below 2°C by 2050.

Conclusion

There have been many agreements among the powerful nations of the world regarding the climate change. It is one of the biggest concerns of the world currently. As the population is increasing and economies are growing, the demand for energy is growing too. Along with this, the energy generation is increasing and this has led to massive increase in the greenhouse gases. It has resulted in the increase in the global temperatures, which possess threats for the future. The environmental scientists have suggested that the temperature increase of the earth should be kept below 2°C to protect the earth. For that, the CO2 emissions should be reduced by all the countries. The Kyoto Protocol, 2008 Climate Change Act, Paris Climate Agreement are various agreements and legislations that have been effective to combat the climate change. The report has discussed the effectiveness and comparison of cap and trade and carbon tax in the context of UK. Both the policies have worked effectively and reduced the co2 emissions by the country.

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