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The impact of carbon pricing on the UK

North Sea windfall tax
Derek Leith, global oil and gas tax lead at EY

Earlier this month saw the EU Emissions Trading Scheme (EU ETS) daily carbon price hit €40.  The EU ETS has been in place since 2005 and covers power and heat generation; energy-intensive industry sectors (including oil refineries, steel works and production of iron, cement, etc); and commercial aviation. For many years the carbon price traded below €10 but since 2018 the price had increased more than three-fold.

The EU ETS operates in all EU countries plus Iceland, Liechtenstein and Norway.  Following Brexit, the UK is no longer a participant country and it may be tempting to think the carbon price in Europe is no longer relevant.  That would be a mistake.

On 1 January 2021 the UK ETS came into force.  It follows many of the design features of the EU scheme and applies to energy intensive industries, the power generation sector, and aviation.  As the scheme is new there has been no auction process for allowances yet; the government is targeting no later than 30 June 2021 for the first such auction.

It’s noteworthy that the auction reserve price had been set at £15 but was revised to £22 in Auctioning Regulations published on 11 February: perhaps to reflect the escalating EU price.  Many commentators expect the first auction to record prices higher than the current EU ETS carbon price, but the scheme does provide for government intervention in the first two years if there are ‘extended price spikes’.  However, it is rational that the UK carbon price may edge ahead of the EU price simply because the UK has more aggressive emission reduction targets.

What will the impact be of €40+ carbon price in the UK? In the short term it is likely to be a marginal impact on the profits of affected companies.  The more material impact is that a price above €40 signifies that carbon prices are finally going to be used as a more significant means to bring about behavioural change – and the direction of travel for that carbon price will be upwards until such change is achieved.

The UK oil and gas industry has read the script and already committed to a timeframe for an absolute reduction of GHG emissions of 50% by 2030 (against a 2018 baseline) and a pathway to net zero by 2050.  To achieve these targets requires the electrification of some of the larger offshore installations and the adoption of new technologies such as carbon capture and storage.

An increasing carbon price will be a stick to beat the industry with. But the government needs to be careful it doesn’t prematurely extinguish the UK offshore oil industry, creating an increased reliance on imported oil. That would be merely displacing the emissions problem to another country with no net benefit, whilst at the same time weakening the UK’s security of supply.

The Climate Change Committee’s Sixth Carbon Budget recognises that the path to net zero for the UK requires 15-20 billion barrels of oil equivalent, which broadly equates to the remaining recoverable reserves in the UKCS.  As renewable energy is increasingly embraced, it is vital for the UK to source as much of its remaining fossil fuel needs from the UKCS.  That means the best strategy is to support the UK offshore sector to decarbonise.

This will ensure the UK retains security of supply, exploits its own hydrocarbon base rather that of another country (and preventing carbon leakage), and secures the longevity of the UK oil and gas supply chain.  That supply chain can then innovate, supplement its skill base, and fully embrace the opportunities that green energy provides.  That could enable the UK to play an important part in the development of energy transition technologies and export that expertise internationally.

For Aberdeen and the North East, the economy could evolve from a centre of excellence for oil and gas to a centre of excellence for energy by harnessing the existing skilled workforce, and the entrepreneurship, innovation and drive that has characterised the region for many decades.

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