Low carbon price threatens investment

Copenhagen turned out to be a damp squib – derided by the Prime Minister as "at best flawed, at worst chaotic". But the failure to reach a global deal also left UK electricity generators calling for the government to guarantee the carbon price, or face missing its ambitious green targets.

Few dispute that the key to cutting Britain's emissions by 34 per cent by 2020, and 80 per cent by 2050, is to clean up electricity generation. But the economics are tricky at best. And with little substance from Copenhagen, generators are warning the government must intervene soon or the nuclear power and carbon capture and storage (CCS) technology the UK needs will not get built.

The problem is the carbon price. Off-shore wind farms are part-subsidized by the Renewables Obligation mechanism, which raises money from within the market to help offset the massive upfront costs. Plans for four trial CCS plants are to be paid for by a levy of two per cent on customers' bills. But nuclear and widespread use of CCS, retrofitted to coal-fired plants, will rely on the income from carbon permits sold through the European Union Emission Trading Scheme (the EU ETS).

New nuclear facilities are eye-wateringly expensive – as much as five times the cost of gas plants and taking twice as long to build. CCS is so new and untried that there are not even any easy comparisons. In both cases, the business case is difficult to make and the commercially sensible decision is to throw up gas plants instead.

Carbon trading was supposed to be the answer. As the EU ETS progresses, setting electricity producers ever-lower carbon emissions caps, the cost gap between clean and dirty generation should be narrowed. But Copenhagen has floored hopes of a global market that would push up the price, passing the buck back to the UK government. Paul Golby, the chief executive of E.ON UK, said: "We cannot simply leave things as they are. We need changes to the market that mean it makes sense to build and operate lower carbon forms of generation."

There are two problems. One is the actual price. Carbon has proved surprisingly buoyant this year, holding up at a decent €14 per tonne. But electricity producers say the figure must be nearer €50 to make the economics of nuclear energy stack up. The International Energy Agency says it must be €33 in 2020 and €73 by 2030 to make low-carbon technologies economic.

The other problem is uncertainty. The price does not need to be high now, but investors need the assurance that it will be. Instead, the signs are tending the other way. In the aftermath of Copenhagen, carbon dropped to a six-month low. And the implications for the UK are even worse.

While Britain races for 34 per cent reductions by 2020, Europe's target is only 20 per cent – leaving the price-setting EU ETS out of synch with what UK generators need. Europe had pledged to raise the bar to 30 per cent in the event of a global agreement at Copenhagen – thus narrowing the gap – but that promise is now void. A Centrica spokesman said: "The EU ETS should remain central, but in the shorter term it may be necessary to underpin carbon prices in this country until EU prices catch up with our objectives."

There are plenty of levers the government can pull to put a floor under the carbon price. Alternatives listed by the independent Committee on Climate Change include setting an auction reserve price, or using either a carbon tax or contracts for difference to set a minimum price. A favourite with some generators is a low-carbon obligation similar to that in the renewables sector. Such a scheme would act as an incentive for both nuclear and CCS investment by requiring electricity providers to supply a certain percentage of energy from low-carbon sources, or buy a permit from clean generators.

In the post-Copenhagen confusion, the government is reticent – acknowledging the need for a credible carbon price, but with no detail about how it might be achieved. There is little time. For EDF to turn on its first new nuclear plant in 2017 as planned, the investment decision must be made in 2011. And discussions with industry will need to address such thorny questions as what constitutes a reasonable return.

Either way, doing nothing is no longer an option.

"The government does not really have a choice, it is just which level they decide to pull," Alistair Scrimgeour, a partner at Deloitte, said.