UK to phase out coal by 2021 with current carbon tax

The UK is on track to phase out coal from its power system by 2021, but the carbon-intensive fuel could make a comeback in 2020-25 if the government lowers its carbon tax — something it could do as soon as next week when it publishes its budget on 29 October.

New research published today by Aurora Energy sheds light on the implications of one of the biggest decisions for the power sector next week — whether or not Chancellor of the Exchequer Philip Hammond will choose to lower the UK's carbon tax — now set at £18/t CO2 equivalent (CO2e).

"There's actually quite a lot of uncertainty around the future of carbon pricing," Aurora's director of research, Richard Howard, said. "Which is why with the budget coming up we thought we'd do an analysis to see the impact."

In four different scenarios, Aurora models how various carbon support price (CSP) levels would dictate how long it takes for the UK's remaining 10GW in coal-fired capacity to be phased out as coal becomes less and less competitive with gas-fired generation.

In a scenario where the carbon tax is left at £18/t CO2e, coal plants are phased out of the grid by 2021, well in advance of the official 2025 target. I In a scenario where the UK lowers the tax to £7/t CO2e, coal units stay on the system until 2025. Wholesale electricity prices are slightly lower in this case, reducing power system costs by £700mn/yr, enough to save households on average £9/yr in 2021-40. But the extra coal-fired generation also creates an additional 29mn t of carbon emissions during the fourth phase (2023-27) of the EU emissions trading system (ETS), 20pc higher than in the first scenario.

"The government faces a difficult decision in the upcoming budget," Howard said. "If the carbon price was cut, then households would save around £9 per year. But this risks a surge of coal power in the early 2020s, making it extremely difficult to meet our climate goals."

A third scenario looks at what might happen if the government hiked the carbon tax to £70/t CO2e by 2030, in line with the original trajectory stated in 2011. Compared with the scenario where the CSP is kept at £18/t CO2e, this would result in an extra 10GW of renewable capacity coming on line by 2040, mainly in the form of onshore wind and solar photovoltaics (PV).

A fourth scenario imagines a constant CSP, but with gradually rising ETS allowance (EUA) prices. The first two scenarios assume a constant EUA price of £17/t CO2e.

Until this year, there was little reason to believe the government would lower the carbon tax. EUA prices were still relatively low, ending last year at around €8/t CO2e. When first adopted by the UK in 2013, the CSP was intended as a stand-in for the ETS — widely perceived to have failed because of oversupply and prices near zero — and it was seen as doing its job.

But in recent months, EUA prices have soared to as high as €25/t CO2e, sending total carbon costs for UK emitters at one point in early September to €45.74/t CO2e. That undermined the logic that a strong CSP was needed to do the work that the ETS could not.

More recently, of course, EUA prices have crashed back below €20/t CO2e, touching as low as €18.50/t CO2e several times this week. But those losses could turn out to be a mirage. The recent crash was largely because of market speculation that the UK will fail to agree a deal with the EU before its scheduled departure from the bloc on 29 March 2019 — an outcome that would result in it quitting the ETS, the government said last week, opening the way for a flood of allowances held by UK emitters to make their way back into the market. Were a deal agreed, that vision would fade and the EUAs could recover the ground recently lost.

Even coal-fired operators back a "strong" CSP.

There is little appetite in the power industry for a cut. Amid uncertainty about whether the carbon tax will be lowered or not, industry participants have made their voices heard. Utilities SSE, Drax, and Orsted sent a letter yesterday to Hammond, urging the government to maintain a "strong and stable" CSP to help maintain industry confidence after Brexit and facilitate the Clean Growth strategy.

Drax and SSE each own coal-fired generation in the UK, but both have staked a future for themselves in renewables. SSE owns the Fiddler's Ferry coal-fired plant near Liverpool, but it has also invested heavily in onshore and offshore wind. Last year, it urged the government to adopt a strong carbon price floor post-2020.

Meanwhile, as the owner of most of the UK's remaining coal-fired plants, Drax's call for a robust carbon tax is perhaps more surprising. But Drax has also converted several of its older units to biomass and plans to switch at least a couple of its remaining coal-fired plants — Drax 5 and 6 — into combined-cycle gas turbines (CCGTs).

The Aurora study, Carbon Pricing Options to Deliver Clean Growth, was commissioned by Drax. But Howard said the company had no influence over its findings.

With a lower carbon support price, coal generation revives TWh