More than a Nudge: The Long Road to a Low Carbon Future
As world crude oil prices reached a two and a half year high in early March, causing financial pain for motorists and fuel users, Labour called for the government to abandon the increase in fuel duty planned for the forthcoming budget. Despite being touted as an environmental tax necessary to put us on the route towards a low-carbon future, an increase in fuel duty during a time of recession and high oil prices was never going to be politically popular.
In the budget announced on the 23rd March, the government not only cancelled the planned fuel duty increase, but actually reduced duty by 1p from its pre-budget level. A ‘fair fuel stabiliser’ was announced through which future oil price rises will be cushioned by a drop in duty paid for by a levy on North Sea oil and gas production. If oil prices should fall, duty will again rise and the oil and gas levy will fall in proportion.
Thus ran the latest chapter in the chequered history of a tax constantly on the verge of an identity crisis. Is it a regressive incursion into the budgets of those dependent on fuel for their livelihoods or a necessary pro-environmental tax designed to make us greener and more efficient?
Fuel duty is periodically justified as an environmental tax, designed to have the long term effect of shifting energy consumption away from fossil fuels towards lower carbon alternatives – indeed Ed Balls, now shadow chancellor, explicitly argued for the tax in this way while Labour were in government.
Chris Huhne, current Secretary of State for Energy and Climate Change, also recently encouraged us to take the long view, emphasising that higher fossil prices represent a golden opportunity for catalysing a low carbon transition. Drawing on work by government economists, Huhne argued that when oil prices exceed $100 a barrel UK, consumers would become overall winners as a result of having kicked the fossil fuel habit1.
However, in the short term when oil prices rise, politicians, whether in opposition or in government, struggle to uphold economic theory.
Kicking the Fossil Fuel Habit
With current prices of Brent Crude already nudging $120 a barrel, can we expect the low carbon transition to take off in the near future? If Huhne’s analysis is correct, do we even need taxes and other unpopular policies? Surely energy companies will simply deliver investment in low carbon technologies as a rational reaction to the inevitable upward march of fossil fuel prices.
Unfortunately it’s not quite so simple. Although oil prices have indeed been following an upward trend since the late 1990s, they remain volatile and unpredictable. Neither companies nor governments have been prompted to make sustained and significant investments in renewable technologies on the basis of certainty in the continuing rise in oil prices. Although the oil shocks of the 1970s did briefly stimulate a significant increase in investment in government research, development and demonstration (RD&D) spend on renewable energy technologies, this spending level declined through the 1980s and 90s and remained at less than 10% of total energy RD&D spend into the 2000s (see figure above); this was despite further notable oil price spikes in 1990 and 2000.
Can we expect
the low carbon
take off in the
In more recent years government spend on low carbon RD&D has increased modestly – most notably in 2009 due in large part to one-off stimulus spending following the financial crisis. However, the IEA still notes a funding gap of $40-90 billion between the current annual low-carbon RD&D spend and the level required to catalyse a major low carbon transition2.
Apart from government funding, much of this gap needs to be filled by private sector investment. However, major energy companies remain slow to invest heavily in non-fossil energy. BP, for example, which some years ago rebranded itself as ‘Beyond Petroleum’, estimates that it has spent $4 billion in low carbon technology development since 20053 – a small figure in comparison to the total $80 bn it has invested during the last five years, most notably in exploration for oil and gas from unconventional sources such as Canadian tar sands4.
For companies that are already in the oil business there is significant reluctance inhibiting the development of alternative technologies due to the fact that they have a natural preference for continuing to invest in areas where they have already amassed considerable technical expertise. Rather than encouraging such companies to make a major switch to developing renewable technologies, higher oil prices are far more likely to be seen as improving the business case for the exploration of more expensive and hitherto uneconomic, unconventional sources of oil, such as tar sands, oil shale, and sub-arctic sources. Many of these will be even more carbon intensive and environmentally damaging than conventional sources.
A comprehensive shift towards low carbon sources of energy requires the development and rollout of a diverse range of technologies. Such products have a time lag between investment and reward – they require extended periods of R&D and the establishment of new production facilities and supply chains before any serious return on the initial investment can be recouped. In order to justify such long-term investments, companies need to have some confidence in the likely existence of a future market for their products at the end of the process. A transition to a low carbon economy is unlikely to occur on the basis of a series of short term and inherently unpredictable oil price spikes and while the large energy players continue to demonstrate a huge reluctance to move away from traditional oil and its derivatives.
A Low Carbon Revolution in the UK?
With dwindling domestic oil and gas supplies and a declining conventional manufacturing base, the UK has much to gain from a low carbon transition. As well as having the potential to be at the forefront of offshore wind- and marine-generated power, UK based companies are among the world leaders in developing innovative low carbon transport technologies. Modec, for example, is a company that produces electric delivery vans for Tesco from its plant in Coventry. Smith Electric Vehicles, based in Tyneside, is the world’s largest manufacturer of electric vehicles.
Neither companies nor
governments have been
prompted to make sustained
and significant investments
in renewable technologies on
the basis of certainty in the
continuing rise in oil prices
However, at present these are small companies operating in restricted markets. The extent to which these trailblazers will step in to reinvigorate our declining industrial sectors, thus spurring a new low carbon industrial revolution, depends on confidence that there is a sustainable future market for low carbon products in the UK. The periodic panic which courses through the veins of the country in response to an oil price spike is no basis for such confidence.
A Role for Government?
What role should government play in creating a sustained demand for low carbon technologies? This very question is being grappled with at the moment as the government considers how to reform the electricity markets. Since privatisation in 1987, the UK electricity market structure has encouraged the construction of flexible, low capital cost gas powered plants, but has provided insufficient incentive for the construction of high capital low carbon generation plants such as renewables and nuclear. A clearer signal of the future price available for low carbon electricity would greatly encourage low carbon investment.
Amongst measures proposed by the UK’s Department for Energy and Climate Change (DECC) to improve this market structure is a low carbon ‘feed in tariff’ based on a ‘contract for difference’. The government will ‘top up’ the market price received by low carbon generators to an agreed tariff level, thus creating greater long-term certainty around the revenue stream available for low carbon projects.
In its consultation document on the electricity market reform, the government is trying to balance on the one hand its acknowledgement of the need to intervene in markets which are clearly not delivering important public goods, with on the other hand a deeply ingrained trepidation that intervening too deeply in such markets stifles innovation by private actors.
Can we expect the low carbon transition to take off in the near future?
However, increased government intervention is not necessarily synonymous with an inefficient and unwieldy delivery of services in comparison to what is achievable by an untrammelled private sector.
A transition to a low carbon
economy is unlikely to occur on the
basis of a series of short term and
inherently unpredictable oil price
spikes and while the large energy
players continue to demonstrate a
huge reluctance to move away from
traditional oil and its derivatives
The early years of the electricity supply industry in the UK were characterised by huge numbers of private firms competing to provide specific loads with dedicated power stations via their own distribution systems. The result was a system that was incredibly inefficient due to the fact that power stations and distribution networks were operated with extremely low load factors. The situation changed in 1926 when the government established a Central Electricity Board (CEB) to bring greater coordination to the industry. The CEB began work on a new 132kV interconnected system – the forerunner to the National Grid – and presented a clear signal to the industry: if they built a large scale plant of high enough efficiency, it would be connected to this new network.
This signal of a clear future demand overcame the major stumbling block for companies considering investing in larger, more efficient plants – that due to the number of other small competing companies building small power stations very quickly, there could never be sufficient confidence in future demand to justify a large power station5. The actions of the CEB had the effect of creating a new market – a future demand that generators could be certain of – and as a result investment and innovation was stimulated.
It is clear that, while it is often the case that private sector competition is a factor that contributes to innovation, there are also situations where the combined effect of the motivations of the various private sector actors results in a lack of innovation due to an aversion to risk. In such situations government action to coordinate the development of secure future demand for certain kinds of products can be the stimulus that an industry needs in order to take off.
A similar principle is at work in the pharmaceutical industry in the form of ‘advance market commitments’ (AMCs), which could significantly accelerate the development, by private sector companies, of critical vaccines for developing countries6. Indeed, a pioneering AMC for a pneumococcal vaccine is already proving successful as the newly developed vaccine will be rolled out in Kenya at the same time as in developed countries – an impressive contrast to the 15-20 year delay which typically precedes roll-out in the developing world7.
Importantly, none of these cases involves ‘picking winners’ – the government itself attempting to decide which particular type of technology fits the bill. The government simply expresses the demand for a kind of service – be it a more efficient power plant, a low carbon power plant, or a new vaccine – and leaves it to the private sector to provide the innovation. The key thing is that private actors are able to justify RD&D investment because they know that if they produce a product that meets the specifications, they are guaranteed a market.
An unwillingness to
create long term certainty
for potential low carbon
investors via measures
such as fuel duty risks
missing out on an
opportunity to stimulate
a low carbon transition
A Secure Price for Carbon
And what about fuel duty, the tax embroiled in a perennial identity crisis? Repeated government decisions to slash it as a short-term response to oil price spikes and wider economic conditions inevitably undermine any government rhetoric about the need for long-term price signals and the macro-economic benefits of making a low carbon transition. An unwillingness to create long term certainty for potential low carbon investors via measures such as fuel duty risks missing out on an opportunity to stimulate a low carbon transition, as a result of which we would all be much better off as oil prices continue on their erratic, but inexorably upward progress. However, the government’s ’fair fuel stabiliser’ could be used as a mechanism not only to insulate UK consumers from the vicissitudes of the global oil price, but also to create greater long-term certainty for potential investors in low carbon technologies in the UK.
The level of duty could be managed
to ensure that the price of fuel at
the pump retains a steady, upward,
but crucially predictable trajectory
Essentially, if duty can be reduced at times of high oil price, it can also be raised if the oil price falls. The level of duty could be managed to ensure that the price of fuel at the pump retains a steady, upward, but crucially predictable trajectory. Like the feed in tariff proposed in the electricity markets, this mechanism could provide investors with that much needed clear signal about the future viability of a certain technology – except instead of guaranteeing a revenue stream for the low carbon option, it would guarantee the fuel cost of the high carbon option. If this trajectory were set out clearly several years in advance it would enable, for example, developers of low carbon transport technology such as electric vehicles to calculate the year in which their products would be cost competitive with vehicles running on fossil fuels. On a broader scale, this would create the kind of certainty required to enable small, innovative, and currently niche, companies to significantly scale up operations thus helping us to reduce our dependency on oil and creating jobs in the process.
Nick Hughes is a PhD student at the Centre for Environmental Policy at Imperial College London, where he is studying the evolution of low carbon electricity networks in the UK.
 IEA (2010). Global Gaps in Clean Energy RD&D.
 BP (2011). Sustainable Energy – Sustainable Business.
 BP (2011). The Energy Mix.
 Hannah, L. (1979). Electricity Before Nationalisation. Palgrave Macmillan.
 Barder et al. (2005). Making Markets for Vaccines. Center for Global Development.
 Nature (2011). Pneumococcal vaccine rolls out in developing world.