The Helm Cost of Energy Review: the invisible hand versus the activist state

October 29, 2017

Professor Dieter Helm’s independent Cost of Energy Review, commissioned by the Government and released last week, sparked much debate online. Weighing in at an impressive 242 pages, it certainly gave the energy policy community something to chew on. Reactions ranged from glowing praise for its technology neutral, free market approach.

To consternation at his recommendation to abolish the Contacts for Difference auction scheme that is claimed have been responsible for halving offshore wind costs in a matter of years.

The UK does at least have a broad political consensus across all major parties that climate change is happening and that greenhouse gas emissions need to be reduced. The debate is about how we reduce emissions, not if we should. The dividing line is now between a technology neutral, pro-market approach versus an activist state that subsidises anything low carbon. The central plank of Professor Helm’s review is the implementation of an economy-wide carbon tax coupled with technology neutral auctions to incentivise new investments. His critics maintain that such an approach would not have led to the dramatic cost reductions achieved in certain renewable sectors, like offshore wind. Is this a valid criticism?

The reduction in the cost of offshore wind, if real and sustainable, is something to celebrate. The UK is a windy country with long coastlines. If we were going to bet on a low carbon, renewable source of electricity – to ‘pick a winner’ – this was always the horse to bet on, but this does not excuse the inefficiency of a massive state-subsidized roll-out of anything and everything renewable. Similar to wind, the cost of solar panels has plummeted worldwide in recent years. Again, something to be celebrated, but this would have happened internationally without our wasteful and expensive feed-in tariff policy. The UK is one of the least suitable places in the world to deploy solar power, partly because of our lack of sun, but also because our peak electricity demand is in winter (I’m sure you can spot the problem there). Labour Government Ministers were told by Civil Service advisers that subsidising the roll-out of immature, expensive solar power in the UK was a wasteful use of money in the drive to reduce carbon emissions, but it was an easy sell to the public so it went ahead.

The greatest success of energy policy in the UK has been the almost complete phasing out of coal power and this was largely, though not entirely, due to the UK’s Carbon Price Support policy. It tipped the economics in favour of natural gas, whilst the Emissions Performance Standard effectively banned new power plants fuelled by coal unless they were equipped with carbon capture and storage. Coal power, one of the biggest obstacles to overcome in the fight against climate change, has met its demise in the UK through a combination of good regulation and a modest carbon price, not through a state-subsidized renewable revolution. This is why economists like a carbon tax: it is efficient. The other benefit of an economy wide carbon tax is that it covers all forms of energy use. In energy policy, the focus is far too often placed on electric power production, meaning we miss less costly gains in emissions reduction elsewhere and unnecessarily raise the cost of decarbonisation that is eventually paid for by consumers and taxpayers.

The most valid criticisms of a carbon tax as a means to reduce emissions are twofold. Firstly, investors will not commit to risky capital intensive projects without some degree of certainty, but Professor Helm does not advocate the complete removal of guaranteed prices for low carbon generation, only to attempt to level the playing field between different technologies through use of Equivalent Firm Power auctions. If properly implemented (a big if), this would allow auctions to be truly technology neutral and reduce costs to consumers. The technologies that are trapped between the research and commercialisation phases could still be given innovation funding for demonstration at scale, like the (cancelled) CCS commercialisation competition.

The second major criticism is that a unilateral carbon tax simply offshores emissions to countries without such a tax. The way to mitigate this ‘carbon leakage’ is through the use of a border carbon adjustment (BCA). Using this measure carbon emissions are taxed at source, meaning that if China wants to sell steel in the UK it must pay the same environmental taxes that a UK producer would. This idea has been around a long time and Professor Helm even wrote a paper on it for Policy Exchange in 2010 (Greener, Cheaper: the Case for a Carbon Tax).

A true border carbon adjustment has not been adopted anywhere in the world, but the idea is gaining traction. California legislators recognised the problem and have just enacted the Buy Clean California Act, which has similarities to a BCA, but contains within it whiffs of nationalism and protectionism. Some complain that BCAs are too complicated to implement. Indeed, applying a BCA on every single product entering the country would be near impossible, but as a first step applying it to the electricity that comes through interconnectors and to energy intensive goods like steel would be quite straightforward.

The UK’s exit from the EU means the possibility of also leaving the EU Emissions Trading Scheme. If the Government are to maintain their aim to be outside the jurisdiction of the European Court of Justice, it may require it. This opens up the potential for British innovation in the field of carbon pricing. As mentioned in our previous blog, a reaction to the Clean Growth Plan, the energy and economics teams at Policy Exchange are currently looking into how a carbon tax with a border carbon adjustment could be implemented in the context of the UK. We will publish our findings in the coming months.

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