The UK’s Chancellor of the Exchequer, George Osbourne, led the announcement of the Comprehensive Spending Review last week, introducing what’s expected to be one of the most challenging economic periods in the history of the UK. Whilst spending cuts were inevitable from any Government, Ed Milliband, Leader of the Opposition, claims that the Coalition’s Government’s ‘slash and burn’ approach will hit those on the lowest incomes hardest, and risk the prospect of a double-dip recession in the UK.

With significant cuts announced across the board, the prospects for proactively transitioning towards a low carbon economy seem lost in the ashes, along with the Coalition’s claims to be the “greenest Government ever”. The Department for Environment, Food and Rural Affairs was the hardest hit Government department, an will be expected to reduce resource spending by 29% (including funding for biodiversity protection and climate change adaptation) and capital spending by 34%. Rises in public transport fees are also expected, but the Department of Transport has deferred these until next year. On the other hand, the Department for International Development (DfID) will see a 50% increase by 2015, making the UK the first major nation to spend 0.7% of GDP on international aid, as recommended by the UN – a controversial move in light of the major cuts in jobs and services across the UK.

The Department of Energy & Climate Change (DECC) suffered a number of changes, including:

1. Most controversial, was the Government’s U-turn on the Carbon Reduction Commitment energy efficiency scheme (CRC). The CRC requires small and medium emitters to buy permits to cover their energy emissions, with proceeds handed back to those who cut the most carbon, and penalising those who cut the least. However, the Comprehensive Spending Review shocked participants by announcing that all revenue raised from the emissions trading scheme (£1bn/year), which began earlier this year, will be used to support the public finances, instead of being recycled back to participants.

Steve Radley, director of policy at manufacturer’s group EEF, said: “If the private sector is going to play a greater role in increasing investment and growth it needs clarity. By changing the rules six months after the game has started and landing business with an unsignalled £1bn tax rise, the government has sent an unwelcome signal.”

Business and investment communities have been rallying Government for clarity on carbon policy, and this last minute ‘change of the rules’ is not expected to instill any confidence in the UK renewables market. Many participants also felt that the Government’s decision has punished the preparedness of hundreds of participants, which had already signed up to a number of initiatives, including the Carbon Trust Standard certification and others. Whilst the reputational advantages of performing well in the CRC are still expected to incentivise emissions reduction, the decoupling of the financial gain from recycled revenues has completely altered the investment equation. The pay back period and economics of existing investments will no-doubt be delayed, or even eliminated.

Climate Minister Greg Barker, said the decision had not been taken lightly, but was as a result of the “catastrophic” deficit inherited from the Labour government.

The Government now expects to raise around £3.5B (US$5.5B) over the next four fiscal years from the scheme in a move that means the CRC will effectively act as a carbon tax mechanism. Participants must reevaluate their financial budgets, to collectively raise to £1m each year to meet the Treasury’s estimation of £1bn/year (an implied price of £15/tonne of carbon).

Whilst these changes will simplify the incredibly complex scheme, designed to cut carbon, it has left participants, including the NHS and other businesses facing additional budget cuts, reeling with the potential implications. Whilst it is good news for the environment, it calls into question the equity of taxing small to medium GHG emitters, as the largest emitters, such as power stations, evade their carbon costs through the weak carbon price signals set by the EU ETS. The cap in the EU ETS remains ineffectually low as a result of the recession, and participants frequently make large windfall profits from the sell their share of surplus emissions allowances on the carbon market, over-allocated to them by the European Commission. Furthermore, weak political commitment for emissions reduction in the EU ensures that the carbon price remains low.

2. Osbourne announced a meagre £1bn for the proposed Green Investment Bank, which is expected to offer funding for investment in low carbon projects and industry development. Ongoing debate suggest that the bank will need a minimum of between £2-6bn to yield the investment power appropriate for the development of new energy infrastructure, to support the achievement of the UK’s CO2 targets.

Chris Huhne, Climate Secretary, has suggested that further funds may come in the form of the potential sale of the Government’s one-third stake in Urenco, the company, which makes enriched uranium for nuclear power. The previous Government’s attempt to sell its stake in Urenco as blocked by shareholders, raising questions over how long fundraising from the sale of assets could potentially take.

The final design of the ‘bank is still unclear, and there is much speculation about whether it will be a ‘real’ bank – independent and able to raise bonds etc – or simply a Government funding pot.

3. The Government’s commitment to the programme for the commercialisation of Carbon Capture & Storage has been reduced from the construction of four demonstration plants, to just a single one. However, the announcements confirmed that there is “up to” £1bn of public funds on the table for the first. DECC will have a challenge on its hands in restoring confidence as uncertainty around the policy environment and economics of the CCS projects has led to the withdrawal of all but one of the companies bidding for the Government funds, with E.ON pulling out last week.

Building and running four till 2015 would have cost about £10bn but the government still has the power – voted in with cross-party agreement – to charge a levy on consumer power bills to pay for the CCS demonstration. Watch this space.

4. DECC’s central budget is cut by 20%, though capital expenditure will increase by 28% by 2014-15 – most likely on nuclear decommissioning, carbon capture and storage and the renewable heat incentive for green home heating.

The state of the deficit has delivered a huge blow to the economics of the UK’s ambitions to transition to a low carbon economy. The introduction of a ‘carbon tax’ in the guise of the CRC, will mark a challenging time for the economy, as they struggle to internalise the carbon costs of their operations. The fact that revenues raised will not even feed into the Green Investment Bank signifies a significant lost opportunity, threatening risks to the economic sustainability of the UK economy.

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