In the 2011 Budget, the Chancellor announced the implementation of a minimum carbon price or "carbon price floor" for electricity generation companies, making the UK the first country in the world to adopt such measures. The government will implement the carbon price floor in order to provide certainty for low-carbon investment which includes, somewhat controversially, nuclear power. Ofgem has declared that UK energy plant and infrastructure needs up to £200 billion of investment by 2020 to secure a low-carbon energy future but the generation industry is divided over the carbon price plans.

From 1 April 2013, the proposed carbon price floor will take the form of a tax on carbon dioxide emissions. This will be an additional tax payable by electricity generators which use fossil fuels. Currently such generators are exempt from the climate change levy (CCL) but the proposals will amend the CCL to remove this exemption. The government proposes to tax fossil fuels at rates which take account of their average carbon content and these rates will be known as the "CCL carbon price support rates".

The polluter pays

The Government's proposal is based on the "polluter pays principle" under which a generator's liability will be directly linked to the carbon content of each type of fossil fuel and the emissions produced (each fuel has a known "emissions factor"). The carbon support mechanism rates will start at £16/tonne CO2 in 2013 and increase in a straight line to £30/tonne CO2 in 2020. Put simply, by increasing the cost of emitting carbon dioxide it is expected to alter the investment and generation behaviour of the industry. For example, the carbon support mechanism will likely have a heavy impact on coal-fired power generators and may well accelerate the roll out of CCS technology.

The consumer pays

However, questions have been raised over the accuracy of the polluter pays principle under the carbon price floor. Research carried out on behalf of HM Treasury by Redpoint Energy estimates that wholesale electricity prices may be around £5-£6/MWh or 10% higher by 2020. On the one hand these higher prices will benefit renewables and nuclear generators while older fossil fuel plants will have to pass on their higher costs of electricity generation to consumers.

It is not just the generators who will feel the effect of the carbon price floor and the Confederation of British Industries (CBI) has criticised the Government for failing to protect the UK's energy intensive heavy industries. The carbon price support imposes extra costs on companies engaged in the steel, chemical, cement and aluminium industries which already need to comply with emissions limits under the EU Emissions Trading Scheme (ETS). The CBI argues that such companies will have their competitiveness undermined as their costs will rise more than those of their European or global competitors. As a result, there is increased risk of not only "carbon leakage" (the movement of carbon intensive industry to jurisdictions of lower cost or regulation) but also losing jobs and economic activity to other Member States in the EU or further afield.

The EU steps in?

The creation of the price floor allows for the UK to maintain its position as a leader on taking action on climate change. The previous government pushed for higher emission reductions across the EU with a proposed increase from 20% to 30% below 1990 levels. Agreement had not been forthcoming and the current Government has unilaterally proposed the price floor as a further emissions reduction measure. However, all this may be about to change. The Environment Committee of the European Parliament (comprising some 60 MEPs) voted on 24 May to urge European leaders to put in place legally binding emissions cuts of 30% by the end of the year. European leaders will meet to discuss the proposals before the full EU Parliament will vote on them on 23 June.

Whilst there are those in business who are upset by the prospect of higher energy bills and the threat of a loss of competitiveness, should the EU agree to a 30% reduction it is expected to create significant upward pressure on the price of carbon allowances. With increased demand for carbon allowances and higher prices for carbon across the EU, the UK price floor might never be used in anger (if the market price is higher than the target). Given that many analysts expect the EU to exceed the so-called 20/20/20 targets, the potential of an increase in emissions reductions to 30% is real. Only time will tell whether the 30% target is introduced but if it is, it will lessen the burden on UK business and to some extent at least it will level the playing field across the EU.