Long and variable lags
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Understanding the relationship between the price of carbon and investment in decarbonisation is important for anyone with a stake in climate policy: from policymakers keen to understand what level the carbon price needs to be, to obligated emitters and the companies developing low-carbon technologies, and of course, anyone wanting to take a long-term punt on the carbon price.
As I’ve discussed previously, I believe that a strong carbon price is a signal that investors, businesspeople, and citizens trust their government’s commitment to combat climate change. In the same way that trust in individual currencies supports investment, innovation and trade, trust in the carbon market helps to bring about the capital, skills and long-term planning that is required to help meet long-term climate targets. A weak carbon price delivers the opposite signal.
A recent report by the UK’s National Audit Office (NAO), an independent public-spending watchdog, casts doubt on whether there is sufficient evidence to support this theory, and openly questions whether the UK carbon market is really delivering on its promise to curb emissions, more than four years after it launched in early 2021.
The NAO conclude that while emissions for those sectors covered by the UK emissions trading scheme dropped by 11 Mt CO2 during the first few years of the scheme, it is “difficult to conclude whether this reduction can be attributed” to the UK carbon market, and furthermore, that incentives for future decarbonisation by the more than 1,000 organisations covered by the UK ETS are uncertain.1
Two key factors need special attention according to the watchdog: the low UK carbon price relative to the cost of decarbonisation measures in the traded sectors (e.g. steel, petrochemicals, etc.) as well as compared to the EU ETS, and uncertainty around the availability and take-up of low-carbon technologies (e.g., carbon capture and storage, and sustainable aviation fuel) given that it could take several years before they start having a significant impact on emissions (see Britain's green credibility gap: UK carbon price slumps to record low, 50% below the EU).