OPINION: Clever Climate Contracts Already Levelled the Energy Playing Field and They Could Help Ease Brexit (2)

–The U.K. could store EU emissions for 18 years, handy when Europe’s seeking net zero by 2050

By Mathew Carr

Dec. 11-13, 2020 — LONDON: Contracts for difference, measures being considered in climate policy circles to help decarbonize industry, have already pulled offshore-wind-energy investment forward in Britain.

They could now help to level the “state-aid” playing field after Brexit in sectors other than energy, as well as speed global decarbonization.

“The U.K. is already using CfD contracts in the space of renewable energy and has the expertise to extend them to other technologies,” according to report published by Vivid Economics and the University College London last week to inform the U.K.’s Climate Change Committee on the country’s mid-2030s emissions budget – which is about 80% less than 1990 levels.

The EU and Germany are also considering using them.

The market-based incentives can be linked to electricity prices and/or carbon market prices and can demonstrate to the world key net-zero-emissions pathways, Vivid/UCL said (see below for an explainer how they work).

“The U.K. could further accelerate the introduction of industrial clusters, carbon capture and storage, and hydrogen infrastructure. U.K. has a distinct advantage in CCS potential compared to other countries due to the high availability of usable CO2 storage sites for CCS infrastructure (70 billion tons of CO2, equivalent to the EU’s combined storage capacity) as well as having existing oil and gas expertise.”

That means it’s in the EU and U.K.’s interest to cooperate. Seventy billion tons would cover current EU emissions for about 18 years — handy when you’re seeking net zero within three decades.

It also makes sense for both sides of the Brexit divide to aggressively create a hydrogen industry, initially from natural gas (with CCS – blue hydrogen), but also from renewables (green hydrogen via electrolysis), because that market will end up being huge given the Paris emission limits. The carbon CfDs can help create that industry now, helping replace fossil fuels in cement and steel for instance.

“With more than 60% of modelled hydrogen use outside the leadership regions by 2050, the U.K. has clear opportunities in developing early domestic markets for hydrogen, as in the offshore-wind case,” Vivid/UCL wrote.

Michael Grubb, Professor of Energy and Climate Change at UCL, recently flagged the potential for EU-U.K. energy cooperation.

“The UK, as historically the most free-market of all the member states, should agree that state subsidies to declining industries should not undermine markets – which need not imply the full panoply of State Aid provisions, as is obvious from the wide range of existing trade agreements.

However, principles will not be enough, for either side. Some concrete deals are needed to show it is possible, to build on, and to preserve momentum and trust in an evolving relationship.

The EU has consistently refused to countenance a sector-by-sector approach, pointing to the sheer complexity of the Swiss model, and seeks a package. Yet a set of clear principles, with an agreed agenda of sectoral implementation following a successful lead, could offer the only feasible compromise.

One sector stands out as an obvious candidate for a prompt deal because it combines clear mutual interests with higher political and legal principles and institutions to which both sides adhere. There are reasons why the basics of an energy sector deal are already in place.“

See this: https://ucleuropeblog.com/2020/09/10/why-a-deal-on-energy-could-break-the-brexit-logjam/

CCS and hydrogen could provide such a “concrete deal.”

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HOW THEY WORK: The CfD already worked well in the U.K. power sector, encouraging offshore wind. Renewable generators located there that met eligibility requirements applied for and won a CfD by submitting a ‘sealed bid’. There can be a range of different renewable technologies competing directly against each other for a contract.

Successful developers of renewable projects entered into a private law contract with the Low Carbon Contracts Company (LCCC), a government-owned company (see link below). Developers are to be paid a flat (indexed) rate for the electricity they produce over a 15-year period, cutting their financial risks in the power market.

That rate is the difference between the ‘strike price’ (a price for electricity reflecting the cost of investing in a particular low carbon technology) and the ‘reference price’ (a measure of the average market price for electricity in the British market).

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The CfD system could in theory be attached to the steel and cement industries, but it becomes complicated with long supply chains and where the outcome isn’t completely green (which would be a case for blue or green hydrogen, or CCS), said Trevor Sikorski, carbon and natural gas analyst at Energy Aspects in London.

Because there’s one carbon price (at least for a couple more weeks), it could make sense to use that liquid market rather than power contracts.

There’s a lot of policy work going on right now to decide how to best structure the deals.

The clever thing about the CfDs is that they protect taxpayers as well as industry. If carbon prices end up higher than the strike, the holder of the contract will need to return the extra value to the government.

This prevents the companies from making too much profit from the climate measure, which is what happened back in 2006 when the EU handed out free EU carbon allowances to industry and utilities. This means dirty companies can be punished and clean ones rewarded … but the rewards need not be so high as to become a detriment to the taxpayer.

Super-normal profits also occurred in the United Nations carbon markets about a decade ago, which caused those markets to be criticised by environmental groups. Some of the credits were created for less than 1 euro a ton and sold for 15 euros a ton shortly afterward.

So, lawmakers can learn the lessons of the past when setting new climate policies in a bid to win more public buy in for the transition, which now needs to happen much faster.

The U.K. is likely to link its carbon prices to the EU market, whatever the outcome of post-Brexit trade talks, according to sources close to industry and finance.

Because anyone could compete for a clean-tech subsidy in Britain, the playing field would be level – something the EU’s Brexit negotiators are concerned about. They don’t want Britain creating national champions unfairly, nor attracting too big a share of available clean-tech capital.

Use of specialist green banks and development banks in the CfD auction process could also tip the system in favor of emerging countries, where modernization investment is sorely needed. That could be a political plus for climate justice.

The U.K. Climate Change Committee is recommending the British government consider using the (carbon) contracts for difference measure more widely to bring through the new clean investments, where investors won’t need to worry so much about immediate competition from fossil fuels.

Done well, this could become a more global climate measure that works for the world across industry, especially in areas with carbon prices.

So there are benefits beyond Brexit. As it seeks a green recovery from the pandemic and the greening of its financial sector, the U.K. could introduce innovation and commercialisation funds, according to the Vivid/UCL report. The EU could too.

Through its presidencies of both the Group of Seven (G7) and the United Nations Climate Change Conference (COP 26) in 2021, the U.K. “could play a prominent role in forming alliances together with other key players (e.g. the EU or China) and encouraging others to commit to green recovery measures,” the authors wrote. “Through international organisations, the U.K. could push for green conditions to be attached to any finance packages to developing countries.”

Finance can also favor countries phasing out coal, oil or even natural gas, which could drive demand for CCS and hydrogen.

There’s a lot for the U.K. and the EU to collaborate on, or lose out on.