WHO ARE THE BIGGEST LOSERS FROM THE UK REFERENDUM?

To revert to the normal blog section click here.

The following has gone viral. I have been unable to trace and credit the original author.
Since posting events have moved rapidly. The truth in this comment has become increasingly apparent, with descent into farce across the political spectrum.

If Boris Johnson looked downbeat yesterday, that is because he realises that he has lost.

Perhaps many Brexiters do not realise it yet, but they have actually lost, and it is all down to one man: David Cameron.

With one fell swoop yesterday at 9:15 am, Cameron effectively annulled the referendum result, and simultaneously destroyed the political careers of Boris Johnson, Michael Gove and leading Brexiters who cost him so much anguish, not to mention his premiership.

How?

Throughout the campaign, Cameron had repeatedly said that a vote for leave would lead to triggering Article 50 straight away. Whether implicitly or explicitly, the image was clear: he would be giving that notice under Article 50 the morning after a vote to leave. Whether that was scaremongering or not is a bit moot now but, in the midst of the sentimental nautical references of his speech yesterday, he quietly abandoned that position and handed the responsibility over to his successor.

And as the day wore on, the enormity of that step started to sink in: the markets, Sterling, Scotland, the Irish border, the Gibraltar border, the frontier at Calais, the need to continue compliance with all EU regulations for a free market, re-issuing passports, Brits abroad, EU citizens in Britain, the mountain of legislation to be torn up and rewritten ... the list grew and grew.

The referendum result is not binding. It is advisory. Parliament is not bound to commit itself in that same direction.

The Conservative party election that Cameron triggered will now have one question looming over it: will you, if elected as party leader, trigger the notice under Article 50?

Who will want to have the responsibility of all those ramifications and consequences on his/her head and shoulders?

Boris Johnson knew this yesterday, when he emerged subdued from his home and was even more subdued at the press conference. He has been out-maneouvered and check-mated.

If he runs for leadership of the party, and then fails to follow through on triggering Article 50, then he is finished. If he does not run and effectively abandons the field, then he is finished. If he runs, wins and pulls the UK out of the EU, then it will all be over - Scotland will break away, there will be upheaval in Ireland, a recession ... broken trade agreements. Then he is also finished. Boris Johnson knows all of this. When he acts like the dumb blond it is just that: an act.

The Brexit leaders now have a result that they cannot use. For them, leadership of the Tory party has become a poison chalice.

When Boris Johnson said there was no need to trigger Article 50 straight away, what he really meant to say was "never". When Michael Gove went on and on about "informal negotiations" ... why? why not the formal ones straight away? ... he also meant not triggering the formal departure. They both know what a formal demarche would mean: an irreversible step that neither of them is prepared to take.

All that remains is for someone to have the guts to stand up and say that Brexit is unachievable in reality without an enormous amount of pain and destruction, that cannot be borne. And David Cameron has put the onus of making that statement on the heads of the people who led the Brexit campaign.

A real conspiracy theorist would go on to say that Juncker and Brussels are part of the plot. I'm not sure they or Cameron are smart enough to have thought of it that quickly. But they are certainly playing their part admirably.

A priority for the rest of us should be to question forensically the truth of the claims made by official Leave during the campaign, and the meaning and reality of the explicit and implicit promises made in relation to budgets and immigration; and then to disseminate these as widely as possible.

POST BREXIT WE CAN GET BACK TO SOME OF THE OTHER BIG CHALLENGES FOR THE ENERGY SECTOR

This comment is also published on the Oxford Martin School website.

The Energy Institute’s second Energy Barometer annual survey of energy sector professionals shows the two issues of most concern to this group as policy uncertainty, and also lack of investment. Chaotic post-Brexit uncertainties will accentuate the first problem and probably the second. However these are already important and difficult issues, with features that require exploration of the wider context of infrastructure investment. In the Oxford Martin School Programme on Integrating Renewable Energy, one of our early objectives has been to identify the areas of market challenge/ market failure in progressing to a low carbon economy. There are several potential market failures of concern to investors in energy infrastructure that are particularly acute in the context of seeking to decarbonise the power sector. They go a long way to explaining these two professional concerns for the sector as a whole. Solutions almost certainly demand a new system architecture.

Historical Background

Until comparatively recently, ie around 1990, the almost universal form of organisation for the power sector in most developed economies (and indeed elsewhere) was vertically integrated monopoly. This meant either state ownership or a private sector with strict monopoly regulation. Economists explained this through two characteristics of the sector. First this was an industry that embodied complex control and coordination issues to a degree that made it unsuited to the unbundling of the different functions of generation, system operation, network management and supply. Second, infrastructure investors putting their money into long-lived immobile assets, without alternative uses or markets, and dependent on revenue streams over 30 years or more, tend to demand, as a pre-condition, protection against any risks to their revenue stream, but especially policy or regulatory risks outside their control. Historically this was achieved through a monopoly, public or private, typically regulated on a “cost of service” or “rate of return” basis.

The first characteristic was partly overcome in the 1990 UK unbundling and privatisation. A clever market device (pricing at system marginal cost) replicated the very effective use of the merit order principle by the old CEGB (in which generating stations are deployed in ascending order of cost against fluctuating consumer load). A bidding system produced a half-hourly price and replicated the old “central controlled” optimisation of efficiency.  Even so the system operator retained significant command and control functions through the various industry protocols.

The second characteristic is more deep-rooted. Transmission and distribution remain subject to traditional style regulation. There are issues but they can be managed within a regulated return framework. Generation and supply are more problematic. The big players in generation reacted quickly to competitive markets by vertically integrating into supply, but even this has been insufficient to support new investment without more certainty at the end of the revenue chain. The result is that the only new investment in the sector is supported directly by government – as with new nuclear, or indirectly through feed-in tariffs and the new capacity auctions. And of course government has been sucked back into all major strategic decisions.

 Analysis of the Challenges

There are misconceptions about appetite for risk in the private sector – in this instance infrastructure investors such as pension and sovereign wealth funds.  These funds have a lot of money, and look for a modest but safe return. They will, unsurprisingly, not tolerate the non-diversifiable risks[1] associated with investment in a sector where revenues are at the mercy of a regulatory or policy regime, ie the entire economic value of their asset can be expropriated by an opportunistic government or regulator for the benefit of voters.  New generation assets, including pipe networks for carbon capture, and investment in storage or load management systems, may require billions to be sunk in non-moveable assets which have no alternative use, are not mobile and have very limited access to alternative markets.

Policy uncertainty is a good if incomplete description of these risks, but the difficulties are further amplified and compounded by some new features. Our analysis has identified several factors that accentuate and amplify these familiar concerns. These arise from the major transformations of the power sector envisaged as essential to cope with the challenges posed by climate change. Five are particularly important.

1. The price of carbon fails to reward low carbon investment. The EU ETS does not do the job. It does not offer long term security. It was captured in its early stages by special interests demanding excessive quotas. Its mechanisms have been too inflexible to respond to recession or to the advent of additional non-market national and EU-wide policies which further undermine the carbon price. In consequence, even if all else were satisfactory, there is no near term prospect of a market, unaided, delivering low carbon investment. This is a major factor that has driven government interventions to date, but by no means the only factor. For the UK Brexit simply adds an additional uncertainty.

2. Energy only markets promote efficient operation of existing fossil plant, but were always insufficient to reward new capacity investment without some additional intervention. This weakness is increasingly amplified by the zero marginal cost effect induced by an increasing proportion of low carbon plant with sunk capital costs and near zero operating costs. Zero wholesale prices accentuate investor concerns over revenue streams.

3. The wholesale market looks broken in more fundamental respects. It is losing contact with its original function of replicating the merit order and promoting efficient operation. So its position as the lynchpin in the market structure of the generation sector is now questionable; and new problems in coordinating system operations may result in reversion to greater reliance on the system operator and less on wholesale markets.

4. Given the very different and complex features of new low carbon generation and other low carbon technologies, the importance of a balanced mix both for operational and reliability reasons may further undermine the notion of reliance solely on markets to produce the right balance of investments, not just in generation but in storage, demand side management and interconnection.

5. The fifth factor is a retail supply market that currently fails to provide price messages that incentivise demand side and decentralised responses. This market needs a very different competition architecture to stimulate the innovations in the supply function that will be essential to ensure consumers (and “prosumers”) are properly integrated into a low carbon economy.

Conclusions

De facto, much of strategic decision making and major investment across the power sector has moved from the market back to the public arena, with more central or local coordination. This reflects both fundamentals of infrastructure investment and the nature of low carbon systems. At the same time we need more competitive structures to produce innovative solutions in downstream retail supply. Search for an improved “system architecture” will be an increasingly urgent priority if we are to deal with policy uncertainty and lack of investment, and meet all these challenges.

Reforms and transformations are likely to include a technically competent body.to handle strategic decisions for the industry, redefinition of the consumer offering and of reliability standards and protections, and re-orientation of market competition to promote innovation in supply.

---

[1] Large funds cope with normal “market correlated” risks through diversification, but infrastructure investments tend to have very large and very project specific risks where the counterparty may have both opportunity and incentive to renege.

BREXIT. A CHANGE IN THE CLIMATE? FIRST REACTIONS.

Meanwhile the petition for a second referendum is gathering signatures at the rate of 1000 per minute. (8.40 am today). At this rate it seems likely to pass the 3 million mark before midday.

So what are the implications of the referendum vote for climate and energy policy issues? These are not at the forefront for the moment, and no doubt the Leave politicians, many of whom have disappeared from public view and seem to be largely maintaining radio silence at the moment, will have some difficult questions to answer that relate more closely to their campaign promises and claims. It’s perhaps worth rehearsing a few of these, with possible implications for the energy sector.

As earlier comments in this blog have suggested, EU membership has been at most a limited constraint on UK policy. We have criticised the weakness of the EU’s flagship policy, the emissions trading scheme, which has perhaps led to a greater reliance on individual national policies (across Europe), not necessarily consistent with each other or with European targets, than would have been ideal.

There are specific areas which may be profoundly affected.  The most obvious is British/ French collaboration on Hinckley Point nuclear station, which must now be facing almost insuperable political difficulties. The other area that could matter greatly to us is collaboration over interconnectors, where the EU was developing a very useful role.

The biggest issues however lie in the broader political arena, around support for climate policies in which the UK has been a leader. Most of the  leading figures in the campaign to leave the EU are climate policy sceptics, including former Tory chancellor, Lord Lawson, former environment secretary, Owen Paterson, Johnson, Gove, Redwood and many others.

Even though our politicians will be pre-occupied with fire-fighting, an early challenge in the new political landscape will arrive next week, when ministers are due to approve new greenhouse gas reduction targets under the UK’s Climate Change Act.  Advice from the Committee on Climate Change is that the UK should aim for a 57 per cent cut in emissions by the early 2030s but it is possible that the climate ideologues, emboldened by Thursday’s vote, will try to reject this.

However with millions of voters already feeling they have been the victims of a fraudulent campaign, and a petition for a second referendum already approaching 3 million signatures, my guess is that this will not be the time or the issue where the embattled Brexiters choose to stand against current policy.

Looking slightly further ahead, a critical question will be the UK’s commitment to the Paris agreement. As I have suggested before, this is an issue that will almost certainly become closely intertwined with trade, especially in relation to heavy industry.  In the steel industry context, I noted earlier that a Brexit would almost certainly entail significant devaluation of sterling, possibly to the short term benefit of that industry.  That has now happened with remarkable speed, although with Brexit I fear the prospects for steel and many other industries are looking much less attractive.

…………………………..

 Small questions at random for future Brexit ministers.

·         How is the £350 million a week Brexit dividend to be spent? How much of this can now be put to restoring the cancelled CCS funding is one question that might particularly interest those concerned with climate policy? We understand from the campaign that in general the commitments to environment spending will be maintained.

·         Does the Brexit bonus of cutting EU regulation extend to disavowing the Basel 3 recommendations? This is the implication of Leave campaign’s statements to the effect that this the second largest “cost” of red tape. Since these were essentially the reserve ratio requirements to limit post-crash activities of the banks, would this impact on UK credit standing, and on financing of energy projects?

BREXIT RAMBLINGS. A QUESTION.

Costs of Regulation and Solvency of Banks (Prudential Regulation)

I have been told that the Leave estimates of the "cost" to the UK of Brussels regulation include a figure put in for the extra capital requirements imposed on the banks post-crash. This will be an extremely large sum but, as with so much of the debate, all is not quite what it seems.

First the requirement stems not from the EU but is a requirement of  the Basel Committee on Banking Supervision, which aims to strengthen the regulation, supervision and risk management of the banking sector. Basel 3 proposals were formulated by a group of central bankers from ten countries including the UK, but not the EU as such, and endorsed by the G20 in 2010.  It has been implemented in Europe through adoption into the EU legal machinery but in all essential features is a global agreement between developed countries.

Second the inference of claiming this as a cost must be that Leave are saying that this capital requirement could be scrapped if the UK were to leave the EU. That seems unlikely. It would, one might assume, be the end of London as a financial centre and probably consign the UK to banana republic status.

But I would be grateful if anyone has any information that contradicts any aspect of the above.

Addendum. A commenter has advised that exactly this point has been covered by Jonathan Portes in an overall review of the supposed costs of EU regulation. Portes says this is the second highest item in the list.

BREXIT RAMBLINGS

"Responsible debate is paramount. I fear, however, that we won’t get it. What I do know is that Britain should be engaged and leading in Europe not disengaged and waving goodbye."

Jo Cox on her website at the start of the referendum campaign in February. Reuters.

……………………………………..

We are a very different country to what we used to be 6 months ago. “Know-nothingism” and conspiracy theory are now part of British public discourse and have been legitimated by leading politicians. Experts are corrupt, anyone who disagrees is lying or on the take, there are secret plans to let in foreign hordes, abolish the British army etc. Where conspiracy theories grow, extremists lurk.

FT reader, paraphrased, 16 June

……………………………………..

However if anyone feels they could do with more facts, then I can strongly recommend the dispassionate analysis provided by Tim Harford on Radio 4  facys and figures  on Saturday.  On the famous £ 350 mn he essentially covers the same ground as Andrew Tyrie’s Select Committee Report (I hope everyone has read paragraph 36). But there is a lot more including some surprising facts on the “sovereignty” issue.

There is a very good analysis of the campaign in Andrew Rawnsley’s Observer article.  

…………………………………

A few more snippets

The economy

……Vote Leave has said that £350m a week is “the core number”, and that it is using the number “again and again”. It is very unfortunate that they have chosen to place this figure at the heart of their campaign. This has been done in the face of overwhelming evidence, including that of the Chair of the UK Statistics Authority, demonstrating that it is misleading. Without qualification this is unavoidable.   Brexit will not result in a £350m per week fiscal windfall to the Exchequer as a consequence of ending the UK’s contributions to the EU budget. Despite having been presented with the evidence contradicting this claim, Vote Leave has subsequently placed the £350m figure on its campaign bus, and on much of its recent campaign literature. The public should discount this claim. Vote Leave’s persistence with it is deeply problematic. It sits very awkwardly with its promises to the Electoral Commission to work in a spirit that reflects its “very significant responsibility” and the “gravity of the choice facing the British people”.

Paragraph 36. Treasury Select Committee Report.

……………………………..

Immigration

Our findings indicate that, when considering the resident population in each year from 1995 to 2011, immigrants from the European Economic Area (EEA) have made a positive fiscal contribution, even during periods when the UK was running budget deficits, while Non-EEA immigrants, not dissimilar to natives, have made a negative contribution. For immigrants that arrived since 2000, contributions have been positive throughout, and particularly so for immigrants from EEA countries. Notable is the strong positive contribution made by immigrants from countries that joined the EU in 2004.

2014 Report on the Fiscal Impacts of Immigration. Dustmann and Frattini. Probably the most careful and comprehensive analysis of data on this issue to date.

One implication you might draw from this is that under any “points system” seeking to identify the most economically productive, European migrants will continue to generally out-compete non-European, and Brexit impact on the European content of immigration will therefore be small. Since non-EEA immigration, of whatever status, is prima facie unaffected by the Stay or Leave choice, political choices on immigration should be seen as largely irrelevant to the Brexit debate.

……………………

The Bank of England

The calibre of, and grasp of constitutional issues shown by, some of our MPs is revealed in the recent letter from the Governor of the Bank of England to Bernard Jenkin. 

………………….

A lot of parallels with the climate debates

So what has this got to do with climate policy? The main connection is the protagonists. Much of the same continuous low level misrepresentation, vilification of “experts”– in this case science and scientists, and a perversion of evidence and argument, with largely the same personnel. (See earlier blogs.)

GLOBAL TEMPERATURE IN MAY 2016. RECORD RUN CONTINUES

For the 13^th consecutive month, May 2016 was the warmest month on record for global temperature according to the NOAA.  Whether this was the 8^th (NASA) or the 13^th consecutive month (NOAA) depends on which data set you are looking, but none of the different observation sets indicate significantly different patterns or trends.

It is now expected that a moderating el Nino, which stirs up the earth’s heat energy content to put slightly more heat into the surface areas on which measurement is concentrated, will result in some slowing down. So it is possible that May will be the last “record month” for the time being. What is abundantly apparent from the data of the last two years, however, is that the underlying global temperature trend is continuing to move inexorably upward. Comparison with peak years coinciding with previous el Ninos (eg 1998) shows a clear and substantial increase The “pause”, if it ever existed, is well and truly buried.

One of the hopes, promoted inter alia by climate sceptics trying to play down climate impacts, was that we would see some amelioration of temperature rises with CO₂ concentration, due to an established physical phenomenon called the log linear effect, in which, if CO2 were the only factor involved (ie ignoring feedbacks) the warming impact eventually rises much more slowly than the rise in CO2 concentration.[1]  To illustrate, doubling from 560 ppm to 1120 ppm might theoretically only produce the same impact as doubling from 280 ppm (pre-industrial level) to 560 ppm. What now increasingly looks like a steady linear increase suggests that this factor is not yet having much effect.

---

[1] This issue is one of those discussed on the page SCIENCE VS SCEPTICISM

ENERGY POLICY, TRADE AND IMMIGRATION. CLIMATE RELATED ARGUMENTS FOR REMAINING IN THE EU.

In energy and climate policy, the UK has both led and benefited from membership of the EU.  Europe’s policies have had some defects, but continued membership provides the opportunity both to strengthen Europe’s backbone in dealing with climate questions and to exert more leverage internationally. Ultimately climate issues cannot be separated from other important features of the campaign, including trade and in the longer term migration.

This blog usually avoids the overtly political but the UK referendum carries so many implications for climate policy globally that it seems impossible and irresponsible to avoid entering the fray.  Much of the essential substance for energy policy, from a focused UK perspective, has been carefully analysed by Buchan and Keay of OIES[1].  It is clear that, in this field, the UK has been a leader in the EU, thereby increasing the effectiveness of its own policies, but it has not suffered any serious constraints in terms of its own freedom of manoeuvre.

Probably the most important inference to be drawn from their work is the importance of the international leverage that the UK can exert through EU membership. The UK is, with very broadly based support, heavily committed to strong action on emissions, exemplified in the 2008 Climate Act. Through the EU it can leverage its efforts in mitigating the worst outcomes on climate change.  This is very important both in maintaining the pressure on or support for potential backsliders in Europe, such as coal-dependent Poland and "Green" but poorly performing Germany, and in wider international negotiation.

Previous comments in this blog have focused on some of the manifest weaknesses of the EU as a whole, in relation to its flagship carbon trading schemes and an obsession with market fundamentalism (the latter at least in part a product of UK influences on policy). But these merely emphasise both the opportunity to achieve positive change and the cost of being outside the tent, particularly if the UK then finds itself bound by policies over which it has no say (ie a real loss of sovereignty).

On the two issues that have dominated the referendum campaign, there are some very strong connections to both climate policies and the impact of climate change.

Trade and Climate Policies.  

Brexit economists (notably Minford) have argued that the UK will gain from a purist free trade approach in which it opens its own borders to tariff-free imports, without any reciprocity on the part of others or any formal trade agreement.  As a theoretical free trade argument this is at least a tenable and ideologically pure position, although most trade economists will disagree with it and many regard it as politically absurd. But in any case it falls to the ground in a world in which externalities, like carbon emissions, are not properly priced.

Following the Paris agreement it will increasingly be impossible to sustain trading relationships without agreements that cover, inter alia, the treatment of the energy sector, whether through carbon taxes or emissions quotas and trading schemes. This will be to ensure a level playing field for manufacturing competitiveness and prevent one country free riding on the abatement policies of others. So if the UK is to participate in the global economy of traded goods, it will have no option but to sustain low carbon energy policies. Again it makes far more sense to participate in the rule making with our largest trading partners around what is still the world’s most sophisticated and developed trading scheme, and to improve that scheme, possibly extending it to embrace other countries moving towards low carbon policies, rather than to attempt to start from scratch. [China, incidentally, is piloting seven separate regional carbon trading schemes.]

Climate and Migration. 

Migration has become a very emotional subject into which it is difficult to inject rational analysis and fact. Economic considerations are not the only issue, but it is worth noting that one of the most comprehensive analyses available reached conclusions is not widely reported in the current debate. Dustmann and Frattini [2]found that looking at the fiscal impact of immigration on the UK economy, and with a focus on the period since 1995:

Our findings indicate that, when considering the resident population in each year from 1995 to 2011, immigrants from the European Economic Area (EEA) have made a positive fiscal contribution, even during periods when the UK was running budget deficits, while Non-EEA immigrants, not dissimilar to natives, have made a negative contribution. For immigrants that arrived since 2000, contributions have been positive throughout, and particularly so for immigrants from EEA countries. Notable is the strong positive contribution made by immigrants from countries that joined the EU in 2004.

Of course this analysis represents only a snapshot of just one of the economic questions related to migration, and there are plenty of qualifications to the analysis. Nevertheless it does seem surprising that immigration concerns, in the referendum debate, should have become quite so focused on EU immigration, when the economic questions around non-EU immigration are prima facie much more significant.  Looking ahead to a much bigger picture, one of the consequences of significant climate change will be a very large increase in migration across the globe, as particular populations, mainly non-EU, fail to adapt. It has been claimed that some of the increases in global migration already taking place are at least in part due to climate factors (one being persistent drought in the Middle East[3]) as well as associated conflicts.

Europe as a whole has some important ethical and practical choices to make in how it responds to this future - of a world on the move - and has so far failed to grapple with them adequately, but they are not choices that the UK, or any other country, will be able to escape.

And the future for climate policy?

Energy and climate policy has so far featured little, if at all, in the referendum debate. But what was in theory supposed to be a choice on a fundamental constitutional issue has quickly metamorphosed into a choice between staying with an imperfect status quo and a rather incoherent manifesto, which effectively pledges more spending on the NHS, continued farming subsidies and various loosely specified plans for new trade deals and to control immigration. In this context, Andrea Leadsom, a prominent figure in the Leave campaign, told the Commons in March that the UK would enshrine a net zero emissions target into legislation, in line with the global pact in Paris.

Whether this squares with views of the climate sceptics, who make up the bulk of the political wing of the Leave campaign[4], is another question.

---

[1] The UK in the EU – Stay or Leave? OIES. Oxford Institute for Energy Studies. 2016

[2] The Fiscal Effects of Immigration to the UK. Published in The Economic Journal, 2014

[3] NASA study. “Worst drought for 900 years.”

[4] Where Brexit and climate-change scepticism converge. The Economist. 22 March 2016

FLAWS IN EU CLIMATE POLICY BUT NO ENVIRONMENTAL CASE FOR A BREXIT.

The general case for carbon pricing as a major policy instrument in combatting climate change is very clear. So it is unsurprising that it should be the flagship policy in the EU’s efforts to assert a leadership role on climate issues. Unfortunately the policy has not to date lived up to its expectations, and the reasons behind its inadequacies mirror some of the more fundamental problems in the operation of the European Union itself. But does that mean concern to have effective climate policies should lead the UK, or other member states, to leave the EU? The answer is emphatically not.  We consider the balance of arguments.

The range of energy policy issues that will be affected by any UK decision to stay in or leave the EU have been explored in some depth in an impressive summary by David Buchan and Malcolm Keay, in  “The UK in the EU. Stay or Leave” published by the Oxford institute for Energy Studies.

The significance of the EU in carbon emissions.

Emission statistics show that the USA and China are the G2 of climate policy. Without their participation in a global agreement to limit emissions, any attempts elsewhere to limit CO₂ and greenhouse gas emissions (GHG) will have at best an extremely limited impact on climate outcomes. Fortunately both countries are starting to take climate policy very seriously indeed.

Moreover the ambition of the Paris agreement is for outcomes that essentially require “net zero” policies for CO₂. This implies very high levels of commitment that draw in virtually every country of any significance. But the EU as a block is still the third largest source of global CO₂ emissions. In consequence it remains hugely important in global terms, and together with the G2 accounts for well over half of emissions.

Source:chart prepared by the Union of Concerned Scientists

So if the UK wants to exert a maximum of influence in international climate negotiations, continuing to do that through the EU seems like an obvious choice. Buchan and Keay emphasise these points.  “The UK has prided itself in being, along with France and Scandinavian members of the EU, instrumental in sustaining the ambition of EU climate goals. With Brexit, this influence inside the EU would disappear, and probably outside the EU too. The global scope of the United Nations climate negotiations is such that only the big players or big blocs count, not a medium-sized European state by itself.” To put this argument in perspective from our statistics, the UK accounts for 1 to 2 percent of global emissions, while the EU accounts for about 10 times as much.

Problems in EU policy making.

The problems with the EU emissions trading scheme (the EU ETS) are well known. They began when a number of major large users succeeded in negotiating excessively large allowances in the early stages of the scheme. Problems were accentuated by the advent of recession in 2008 and failure to adjust targets downwards.  Finally the carbon price, which is implicitly one measure of the success of the scheme, was further undermined by a plethora of additional EU-wide and national policies. This is essentially the equivalent of assuming that the market will solve all the problems, while simultaneously putting in place a string of interventionist measures, on energy efficiency and promotion of renewables, which distort what a market might otherwise have achieved. The reality, as is argued elsewhere, is that successful policy relies on a combination of instruments that can work together.

One simple explanation of the perceived failure of the EU ETS is that it represented an elementary but unfortunate confusion of means and objectives, and that this was compounded by the unwieldy nature of the EU’s decision making procedures. Most of the early proponents of a European emissions trading scheme assumed that it would provide a realistic carbon price that would provide the incentive necessary to encourage the infrastructure and other investments that would transform the energy economies of Europe away from high fossil fuel dependence to one of a number of plausible low carbon alternatives. When this failed to happen, for the reasons given above, the response was to increase the level of intervention.

In fact the EU ETS can, in a technical sense, be viewed as a success. (Undemanding) emissions targets were met, and the scheme operated smoothly.  But the real objective had never been to meet an arbitrary short term target, but a bigger implicit and unstated objective of supporting wholesale transformation of the energy sector. Had the EU adopted a carbon tax, instead of tradeable quotas, or had it had sufficiently flexible mechanisms to adjust the quotas as a response to events (including the recession), the scheme might now be viewed as a success. But a carbon tax had been ruled out as politically unpalatable, and the cumbersome process of reaching agreement between 27 countries over quantity adjustments to the trading scheme, a flexible response to changing circumstances was all but impossible.

There are other problematic elements in EU policy. Earlier comments have drawn attention to actual or potential conflicts between climate objectives and competition rules, but in practice adverse or constraining influences on the UK’s approach to climate policy have been limited. Buchan and Keay state that: “… in practice, the UK has followed an energy policy of its own choosing and has had considerable influence on the development of EU policy.  It also benefits from the opening of EU markets, and the collective approaches to decarbonisation and energy security.”

Equally we should recognise some of the general successes of the EU in environmental regulation and the likelihood that it will necessarily play a vital role in enabling the changes necessary to decarbonise road transport and in measures for the transformation of the motor industry. And the interconnection measures that are increasingly seen as essential to the future of the power sector will also require cooperation on operating and other protocols, if they are to be done in an efficient and effective manner.

Consequences of Brexit for UK climate policies

The biggest damage to UK climate policies from a Brexit would undoubtedly be the loss of influence both in Europe, where the UK has been a prime mover in identifying climate risks and pressing for stronger policies, and globally. In a world where energy and climate challenges are increasingly important, these challenges will be correspondingly important in trade agreements, as no country will want to see its own industry out-competed by states that do not follow the same rules (eg on taxing or pricing of carbon). Membership of the EU gives us a better chance of being able to influence those rules, and for scientists and environmentalists to push for effective global policies.

THE IMPORTANCE OF CARBON PRICING

It is an occasional fallacy that we can have a successful market-based policy for our energy needs and for tackling climate problems and that this can always be easily reconciled with continuous downward trends in energy prices.  Markets and prices are essential components of an effective energy policy, especially one designed to attack the large hidden costs of environmental damage and climate consequences. However the essence of markets is that they allow costs and prices to go up as well as down. Reflecting environmental costs in energy markets helps in stimulating low carbon investment, in promoting low carbon operation of the capital stock, and in encouraging lower and less wasteful consumption. But that will on occasions mean that prices rise as part of the natural process, market or otherwise, by which societies adjust to resource limitations and other constraints.

The Case for Carbon Pricing

A general and common sense principle of economics is that if commodities are produced and sold at a price below the cost of producing them, then this is a prime indication that something is wrong. Fortunately market economies do not usually allow this to happen.  Planned economies in which prices are set without reference to cost are a different matter. That is why so much of the former Soviet economies was characterised by waste, inefficiencies and shortages.

But market economies are also in trouble when the largest costs are not carried directly by either producers or consumers, but are imposed on the world at large. This prevents an efficient allocation of resources and will reduce human welfare. That is what is happening with fossil fuels and CO₂ emissions. It is an annoying and inconvenient truth that: “if damaging externalities are not internalised in prices, there is no basis to assume that free markets and free trade will improve human welfare”.[1] In other words market economies that fail to deal with environmental costs will also suffer the historically documented weaknesses of the Soviet system, with excessive and wasteful use of energy produced in an environmentally destructive way, inefficient choice between technologies, and ultimately a shortage of the common good that we call environment.  

When an activity is damaging to society, one option is to prohibit or limit it; we try to do this with dangerous drugs, excessive speed on our roads or various forms of water pollution, usually through regulation but occasionally through a price mechanism. Arguably, “health” taxes on tobacco or sugar also fall in this category. We are beginning to understand, collectively and globally, the scale of our problem with burning fossil fuels and emitting CO₂. Immediate cessation may be an impossibility, but limiting harmful CO₂ emissions through a price or tax penalty is widely seen as necessary and desirable.

The costs of not pricing carbon

A market-based approach that fails to incorporate adequate carbon pricing is unable to deliver low carbon investment or even to ensure the most carbon-efficient operation of an existing stock of plant.  In other words additional policy instruments become a necessity. This impacts on all the main economic features of the sector – incentives for investment, true costs against which the operation of existing plant can take place, and retail prices that encourage economic use of resources (allocative efficiency).

The largest adverse consequence of failure to internalise costs may be the effect on low carbon investment incentives, such as the failures to incentivise the carbon capture investments widely recognised as key, at least with known technologies, to decarbonisation of the power sector at a reasonable cost.  But it can also lead to perverse operational choices between fuels, an obvious recent anomaly (in Northern Europe) being the closure of highly efficient gas power stations, while coal stations continue to operate baseload due to cheap coal. To a significant degree this can be blamed on deficiencies in the EU ETS have given rise to very low carbon prices. In climate terms this is an expensive anomaly, even though the immediate financial implications for the utilities were relatively trivial.

Recent UK experience is an illustration of the scale of the issue at the operational level. Between 2009 and 2012 the substitution of coal for gas, induced by changes in gas/coal price relativities, increased UK coal consumption by about 15 million tonnes. This increased annual CO2 emissions by around 20 million tonnes, to which past Treasury guidelines [2] might have attached a notional “social cost of carbon” value of around £ 1.2 billion. Actual fuel savings to generators are likely to have been at most 10% of this amount.  In other words this single failure to price carbon will, on the basis of UK Treasury guidelines, have generated a real but hidden long term net “social cost” of up to £ 1 billion per annum over that period.

Conditions for a successful policies towards carbon pricing

In some senses carbon pricing is a transitional issue. Since the direction of travel is to a near zero carbon economy, the regulation and organisation of the sector in the very long term will not depend on carbon markets or taxes. Energy prices can then reflect only the cost of supply from zero carbon sources. But this is a very long term perspective. In the short and medium term, even comparatively modest levels of carbon prices can assist attainment of cumulative emission objectives in the timescales with which we are concerned, even if they remain insufficient to incentivise investment.[3]  An important role for carbon prices is to counteract the “rebound effect”, when higher energy efficiency induces (through lower costs to the consumer) additional use. This is particularly important for the heat sector, where energy efficiency programmes are a major instrument of policy.

If the cost of CO₂ emissions is at least partly internalised, explicitly through a tax or cap and trade regime, or implicitly in policy, then consistency matters. Inconsistent or incomplete coverage will lead to “leakage” between sectors or geographies, with perverse effects that can drive up total emissions and damage the competitiveness of more carbon-efficient producers.  Inter alia that implies a strong argument for regional carbon markets such as the EU ETS. The ETS has had many deficiencies which deserve a separate comment, and needs a serious overhaul, but the principle of a wider international market is an important one and should be retained.

It also implies that the coverage of the policies needs to be as wide as possible in sector terms, so that it covers all fuels giving rise to carbon emissions, in all parts of the economy, and not just particular sectors. Without this condition there is again a risk of distortions. 

An example of such a potential distortion was the “twin track” approach implicit in UK Treasury guidelines, in which carbon prices differed as between “traded” sectors governed by the EU ETS, and “non-traded”, governed by an assumed “social cost of carbon”.

Finally, as in shown in a fuller discussion of the power sector, it is quite clear that carbon prices alone are unlikely to be a sufficient measure to achieve the low carbon infrastructure investments that are a necessary part of meeting emissions and climate related targets.

---

[1] This expression of the idea is acknowledged to Michael Grubb, speaking at a BIEE Climate Policy Seminar.

[2] Valuation of energy use and greenhouse gas emissions for appraisal and evaluation.  October 2011.  DECC and HM Treasury.

[3] €15/ tonne may be sufficient to induce early gas for coal substitution in existing plant, for example.