Cap, trade, and windfall tax: could UK carbon cost strategy jump the Atlantic?

Carbon used to be pretty cheap under the European Emission Trading Scheme (ETS). This was because of tacit if not overt collusion between power generating companies, their home governments, and the European Commission (EC). The latter body sets national carbon caps, and either approves or rejects countries’ estimates of national emissions over a specified period (see article). The ETS was supposed to make it expensive to operate coal-fired power generating stations according to today’s practices. Power plants are the main industrial installations covered in the ETS.

I have suggested that, in the early days of a cap and trade scheme, easy permit prices might not be entirely a bad thing. A cap-and-trade system is more politically acceptable than an outright tax on emissions (see article), precisely because it gives emitters and their home governments the kind of wiggle room that was possible under the early ETS.

But let’s not overlook that the ultimate point of cap-and-trade is to put a cost on emissions, and thereby to compel emitting companies to reduce emissions. Companies and governments can wiggle for a while, but when people notice no emission reductions there will be pressure to either tighten the rules or introduce other measures that achieve reductions.

The pressure will become intense if it turns out that some major emitters are able to prosper under the emission trading rules without reducing emissions.

This is what has happened in the case of Drax, the UK’s biggest coal-based generating company. The early days of the ETS saw carbon permit prices so low that even with the cost of emissions tacked onto its roughly 25 billion kWh annual production Drax was able to underbid its gas-based competitors in the power markets to such an extent that it earned major profits. This price differential, called the “dark green spread”—the price of power minus the prices of coal and carbon—exists because of the stubbornly persistent difference between coal and gas prices, and because carbon permits have been cheap.

The UK government threatens to address this problem by introducing a windfall tax, to make companies like Drax pay a meaningful price for their emissions. So far this has remained only a threat. It seems the tougher ETS rules, in combination with higher coal prices, may have helped to narrow the Dark Green Spread: Drax’s profit fell by 45 percent in the first half of 2008.

(Interestingly, Drax last year mulled a merger with British Energy, the UK nuclear power company.)

Will the UK government continue to rely on its EU partners to hold the line on their home industries’ emissions to keep permit costs high?

Closer to home, how will the state governments involved in the Regional Greenhouse Gas Initiative (RGGI) respond to low carbon permit costs when RGGI kicks into gear following its inaugural permit auction this September? The American Coalition for Clean Coal Electricity (ACCCE) has publicly questioned the legality of RGGI. This indicates ACCCE members—which include railroads, power generating firms, and coal producers—believe RGGI’s auction will put immediate and meaningful costs on Northeast coal-based generators.

If coal-based generators in the deregulated markets whose territory is covered under RGGI find a way to make the Dark Green Spread work for them, will there be calls for a windfall tax in those states?

3 comments for “Cap, trade, and windfall tax: could UK carbon cost strategy jump the Atlantic?

  1. August 24, 2008 at 02:27

    We will see little change in how the money flows in the energy industry until someone introduces open technology reactors – machines so simple they can be built by anyone, and cheap enough to be built and given away for free. Same problem with electric cars. To break out of the status quo grip we need a really different approach. Linux proved that it can be done – you can build your own technology and you dont have to wait for rich people to give you permission either. This can be stated more harshly in that the public will get what it deserves. If people are willing to dig in and do the work themselves, then change will happen. Otherwise, we get lots of complaining and not much else.

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