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Cambridge Econometrics
Press Release

Embargoed until 00.01 Friday 16 September 2011

 

The decline in UK's carbon emissions is set to accelerate after 2020 as power generation, helped by a rising floor price of carbon on fossil fuel inputs, makes good progress towards de-carbonisation 

Our forecast explained

On our latest projections to 2025: 

• because of the increase in emissions in 2010, driven by increases in emissions from households, industry, and power generation, the previous government’s long-standing carbon reduction policy goal - a 20% reduction in CO2 emissions between 1990 and 2010 - has been decisively missed despite the sharp reduction in emissions in 2009 due to the recession. This salutary lesson on the policy difficulty of making a reality out of rhetoric should be heeded by the Coalition as it strives to be the ‘greenest government ever’
• the decline in the UK’s carbon emissions is expected to accelerate from around -½-1% pa over 2010-20 to around -1¼% pa thereafter to 2025 as power generation makes considerable progress towards de-carbonisation helped by the introduction of a rising floor price of carbon on fossil fuel inputs to power generation based on the policy announced in Budget 2011
  …but the government will need to put in place effective policies to achieve its renewable generation targets or to reduce energy demand if it is to make good progress towards meeting its longer-term goal of a low-carbon economy
• on existing policies, including those inherited, endorsed and shortly to be put into effect by the Coalition government, the UK is set to miss the carbon budget targets narrowly in the first two budget periods (2008-12 and 2013-17), but by a wider margin in the third (2018-22) and especially the fourth (2023-27)  

  

Because of a further increase in carbon emissions in 2010, the previous government’s long-standing domestic goal of a 20% reduction by 2010 has been decisively missed, despite the sharp reduction in emissions resulting from the recession in 2009. 

 

Carbon emissions, based on provisional official data on final energy use, rose by some 3¾% in 2010 as modest recovery in economic activity of around 1¼% was driven by stronger growth in manufacturing output which boosted energy use and emissions in industry. This boost was accompanied by strong growth in household energy demand due to increased consumption for heating resulting from markedly lower-than-average temperatures in the winter months and also by fuel switching to coal and gas for electricity generation and away from nuclear power because of supply disruptions at the UK’s ageing nuclear stations. This combination led to a marked pick up in emissions.

As a result the UK decisively missed the previous government’s long-standing domestic goal of a 20% reduction in carbon emissions by 2010 on 1990 levels despite the sharp reduction in emissions in 2009 resulting from the recession. The 2010 provisional official data indicate a 16½% reduction by 2010, and our forecast also suggests that the 20% threshold is, on current policies, not likely to be crossed until 2020. Without the financial crisis and the unanticipated impact of lower economic activity on energy use by final users and hence on emissions in 2009, this goal would have been missed by an even larger margin, as we had previously forecast. The Coalition government accepted in June 2011 legally binding, ambitious carbon budget targets up to 2027 and re-stated its intention to be ‘the greenest government ever’. However, the failure of its predecessor to achieve the 20% goal set soon after it came into power in 1997 illustrates the difficulty of setting long-term targets and implementing policies that ensure that they are met.

  

The decline in the UK’s carbon emissions is forecast to accelerate from around -½% pa over 2010-15 and -1% pa over 2015-20 to around -1¼% pa thereafter to 2025 as power generation makes considerable progress towards de-carbonisation.

 

Over 2010-15, carbon emissions, based on domestic abatement effort (and excluding net purchases of EU ETS allowances), are forecast to decline by around -½% pa, led by reductions in road transport (around -1¾% pa), power generation (-1% pa), and households (-¾% pa). However, emissions are expected to rise from air transport (4% pa), the energy-intensive industries (2¾% pa), other industry (1½% pa) and households (¾% pa), while they are expected to be broadly stable in commerce.

Over 2015-20, we expect total carbon emissions to decline by around -1% pa. Over this period, the steepest declines in emissions are expected in power generation (-2¾% pa), road transport (-¾% pa), and the energy-intensive industries (-½% pa). In contrast, emissions from air transport (3% pa) and commerce (½% pa) are expected to increase in both cases broadly in line with their growth in energy consumption, while emissions from households and other industry are broadly unchanged.

Thereafter, over 2020-25, we expect carbon emissions to decline by around -1¼% pa, despite the forecast growth of around ½% pa in total final energy demand, and despite the growth in emissions from air transport (3½% pa) and commerce (1% pa). The increases in emissions from these sectors are broadly in line with their increase in energy demand. This decline in overall emissions occurs in our forecast because we expect emissions from power generation, which accounted for around a third of the total by source in 2010, to decline by around -4¾% pa over 2020-25, while the growth in electricity generation, at around ½% pa, is set to meet the expected growth in electricity demand from final users.

The main reasons for a significant reduction in the carbon intensity of electricity generation (see chart: Carbon Intensity of Power Generation) towards the end of the forecast period are:

• a substantial reduction in coal-fired capacity and generation after 2020 (when plants fitted with end-of-pipe filters are decommissioned as they have reached the end of their lives and generation is also sharply reduced as our assumption of a rising floor price of carbon on fossil fuel inputs, discussed in the Context of the forecast section below, makes coal even less competitive in relation to gas as a fuel input) 
• an increase in less-carbon-intensive CCGT generation that accounts for around 52% of the total by 2025, compared with around 40% in 2010
• a significant increase in the share of renewables in the electricity generation mix; rising, on a Renewables Obligation (RO) basis, from around 13% in 2020 to 17½% by 2025, compared with around 6% in 2010
• an increase in contribution to base-load generation from nuclear, based on our assumption, as discussed below, that two new nuclear power stations will be on line from 2020

The UK seems likely on current policies to just miss its carbon budget targets for the first two budget periods, 2008-12 and 2013-17. The target is set to be missed by a wider margin in the third period 2017-22 and especially in the fourth period 2023-27, as the carbon budget which became law in June 2011 tightens.

We forecast that, on existing policies and those inherited and endorsed by the Coalition government and due to be put in place shortly, the UK will narrowly fail to meet its carbon budgets in the first two periods 2008-12 and 2013-17. The target is set to be missed by a wider margin in the third period 2017-22 and especially in the fourth period 2023-27, because of the tighter carbon budget of 1950 MtCO2e, recommended by the CCC, accepted by the government and legally binding from June 2011 (see chart: UK Carbon Budgets and CE Forecast of Net GHG Emissions). In the traded sector, where the emissions will probably be set at the level of the UK share of the EU ETS cap over Phase 3 of the scheme, our forecast points to the UK purchasing EU ETS allowances (EUAs), particularly in Power Generation, as it will find it difficult to reduce traded emissions to the level of the EU ETS caps.

In the traded sector where the emissions will be set at the level of the UK share of the EU ETS cap over Phase 3 of the scheme, our forecast indicates that EUAs, on a net basis and equivalent to an annual average of around 19 MtCO2 and 13 MtCO2, will need to be purchased, respectively, over the second and third five-year budget periods. This result occurs in our forecast for two main reasons:

1. We predict a lower share of renewables, on a RO basis, in electricity generation, at around 13% by 2020, well below the official aspiration of a 30-35% share in total electricity supply in order to meet the EU Renewables Directive target of 15% of final energy demand set for the UK.
2. We assume that only two new nuclear power stations providing around 6½ GW of new capacity are constructed in the final part of the forecast period. This small number reflects the continuing uncertainty about the viability of a large-scale programme, given the commitment in the Coalition Agreement that new nuclear power plants could be built so long as there was no public subsidy; and also because, in our judgment, the policy environment is not yet firmly established in favour of new nuclear construction, although some progress has been made by the parliamentary approval in July 2011 of the government's National Policy Statements on energy. This new nuclear build has a relatively minor impact in reducing the need to buy permits towards the end of the third budget period.

Emissions from the non-traded sector are defined as those emanating from those UK sectors not included in the EU ETS ie households, transport, the majority of the commercial and public sectors, land-use change and non-CO2 GHGs. In our forecast, we expect that the UK will come close to, but not quite meet, its EU target of a 16% GHG emissions reduction by 2020 compared with the level in 2005. However our forecasts also indicate that non-traded emissions will fall short of the implied target in the first two periods, 2008-12 and 2013-17, but will miss the target by a wider margin over the third budget period 2018-22. The shortfall in the first period comes about because the recovery in economic activity in 2010 and colder-than-average winter weather increases energy use, particularly from households, and hence emissions over the short term. But over the longer term, the policies we have either modelled or taken into account in the forecast are not enough to bring emissions within the target budget.
However, the role of renewable energy in heat supplied and transport will be critical in determining whether or not the official carbon budget targets are met, as there is now a firm policy commitment, albeit subject to confirmation by the Coalition government, but as yet no firm policies in place (ie after 2015 in the case of transport); and in the case of heat and the Renewable Heat Incentive, there is insufficient evidence to estimate a likely impact.
If the Coalition government puts in place effective policies, as signalled by the draft Carbon Plan, published in March 2011 (and due to be updated in October 2011), that promote the increased use of renewable energy in transport and heat supply, then it seems quite likely that non-traded sector emissions would move more in line with the carbon budget target in the third 2018-22 period and perhaps also, although this may be more challenging, in the fourth 2023-27 period.

The government accepted in May 2011 the Climate Change Committee’s advice on the fourth carbon budget, 2023-27; but the trends identified in our forecast highlight the extent of policy effort that will be necessary to meet the tighter target. 
 
In the fourth budget period, 2023-27, the trends identified in our forecast over the third 2018-22 budget period become more pronounced and highlight the sheer scale of policy effort that will be required to meet the fourth carbon budget set at 1950 MtCO2e. These trends include:

• an increasing reliance on net purchases of EUAs to meet the traded sector target (recommended by the CCC but not yet adopted by the government) as purely domestic effort proves inadequate
• a widening gap between our forecast and the implied target for non-traded emissions as the budget constraint tightens 

Policies whose delivery will be critical in achieving the third and fourth budget targets include:

• the effectiveness of long-term contracts for low-carbon generation through a 'contract for difference' Feed-in-Tariff to replace the RO announced in the July 2011 Electricity Market Reform White Paper
• the Green Deal and Energy Company Obligation, included in the Energy Bill 2011 currently going through Parliament, to increase the energy efifciency of buildings
• a strategy to promote microgeneration building on the action plan published in June 2011
• the success of the Renewable Heat Incentive (the details of which were confirmed by DECC in March 2011 after consultation and took account of the October 2010 Spending Review)
• the extension of the Renewable Transport Fuel Obligation (RTFO) above the 5% level after 2015 and the implementation of the more stringent EU vehicle fuel-efficiency targets beyond 2015, as currently proposed

Consequently, any improvement in the UK's performance, particularly in the third and fourth periods, seems likely to depend on the success of the Coalition government's policies on renewable energy and energy efficiency in the non-traded sectors

 

Professor Paul Ekins of the UCL Energy Institute at University College London, who is Senior Consultant to Cambridge Econometrics and co-editor of its report UK Energy and the Environment, comments on our forecasts and singles out their most important messages:

'The missing by a large margin of the previous government’s CO2 reduction target in 2010, despite a nearly 10% unforeseen fall in emissions in 2009 which should have brought the target within reach, shows the policy challenge of carbon emission reduction. The unmistakable lesson from the effect of emissions reduction policies over 1997-2010 is that policies tend to have a lower impact than forecast, and therefore their strength needs to be increased if targets are to be achieved. This was a message that emerged clearly from Cambridge Econometrics’ modelling of the policies over these years, and we repeatedly warned that implemented policies were not sufficient to achieve the emissions reductions sought.

'The Coalition government has put in place a number of new policies, most of which are not yet sufficiently firm or clear to be included in the modelling reported here. So, on the face of it, there is still a good prospect that, with these policies, the gap between these forecasts and the now legally binding targets will be closed. But the time taken for new policies to be worked up, consulted on and implemented is long, and few new policies will be able to be put in place and be effective even for the third budget period (2018-22), if it becomes clear that emissions are not being reduced as hoped. The Coalition government must therefore be ready to bring forward further policies, especially in the non-EU ETS heating and transport sectors, at the first sign of lower falls in emissions than expected. This response will be needed if the achievement of the still large further required reductions for the fourth carbon budget are to be proof against the kind of policy optimism that has so far been evident in this area.'

Context of the forecast

Cambridge Econometrics today publishes the latest edition of UK Energy and the Environment, providing for the second time, forecasts up to 2025 of energy demand in physical units and CO2 and SO2 emissions consistent with our latest economic and industrial forecasts presented in UK Economy and Sectors, June 2011. The projections for CO2 are expressed in MtCO2 and greenhouse gases (GHGs) in MtC02e, in line with international reporting practice.
All forecasts are the outcome of data analysis by Cambridge Econometrics using the Multisectoral Dynamic Model of the UK economy (MDM-E3) developed by Cambridge Econometrics and the Cambridge Growth Project. The energy and environment forecasts are based on the results of the energy and environmental sub-models within MDM-E3. The cut-off date for the data and information used in the model run for this forecast was 31 May 2011 and therefore does not take into account the possible impacts of the deepening euro-zone debt crisis, the US government debt problems that have emerged during the summer and the outcome of the conflict in Libya.

We only model 'firm' policies, that is, those that will definitely come into force and on which there is sufficient detail to base the modelling. The Coalition government has made a number of announcements and introduced parliamentary bills in 2011 that flesh out the details of its energy policy. These include:

• the Green Deal: a pay-as-you save scheme, introduced as part of the Energy Bill that is expected to become law later in 2011 and become operational towards the end of 2012
• the replacement of the Carbon Emissions Reduction Target after 2012 by a new obligation on energy companies (this too is in the Energy Bill)
• the Climate Change Levy: to be extended, as announced in Budget 2011, as a carbon tax on the fuel inputs to power generation so as to give 'a floor price of carbon' for electricity production with effect from 2013, rising in real terms from £16/tCO2 to £30/tCO2 in 2020
• the July 2011 Electricity Market Reform White Paper: to be followed by further legislation to implement its findings including: (1) long-term contracts for low-carbon generation through a 'contract for difference' Feed-in-Tariff to replace the RO in due course; (2) a capacity mechanism: to encourage the construction of reserve plants or demand reduction measures to ensure sufficient capacity is available to meet peak electricity demand as the amount of intermittent and inflexible low carbon generation increases; and (3) an Emissions Performance Standard: set at 450g CO2/ kWh to limit the amount of carbon that coal-fired power stations will be permitted to emit
• a consultation on a new strategy for microgeneration of renewable heat and electricity (and in June 2011 it announced the results of a fast-track consultation which confirmed the earlier decision made in March to reduce the tariffs to large solar farms from August 2011 ahead of a comprehensive review of the Feed-in-Tariff in its first year of operation, 2010/11 that is due to be completed by the end of 2011)
• details of the Renewable Heat Incentive scheme announced in March 2011 (with parliamentary approval expected later in 2011), aimed at providing long-term financial support to renewable heat installations to encourage the take-up of renewable heat, initially by the big heat users in the commercial, business and industrial sectors, and then by households

However, only in very few cases has the government published sufficient information to allow us to model and estimate the impact of those policies. Therefore, most of the policies included in the forecast remain those inherited from the previous Labour government. 

In July 2009, the previous government published the 'UK Low Carbon Transition Plan' (LCTP) and the ‘Renewable Energy Strategy’ (RES), and these continue to underpin the current strategy for meeting the emissions targets to 2020. The LCTP consolidated the government's numerous existing and forthcoming policies on emissions reduction into a single strategy, and also proposed strengthening some of those policies. The other main purpose of the LCTP is to share out the overall emissions targets between six key sectors: power & heavy industry will contribute 54% to the 2018-22 carbon budgets; transport will contribute 19%; homes & communities will contribute 13%; workplaces & jobs will contribute 9%; and farming, land & waste will contribute 4%. Responsibility for meeting these targets will be shared among the relevant government departments.

Our current projection takes into account:

• the firmly announced policies (as opposed to the aspirations) in the July 2009 UK Low Carbon Transition Plan, the 2007 Energy White Paper, and other existing government programmes, including the Renewables Obligation on electricity suppliers and the Renewable Transport Fuel Obligation
• a review of the policies in the Coalition government’s Programme for Government, but these were generally too uncertain or undeveloped to be incorporated into the forecast (see below)
• the March 2011 Budget measures, including an increase in the Climate Change Levy discount from 65% to 80% for electricity, and the resulting fall in the CCL for electricity; the change in the fuel duty rate for petrol and diesel to reflect the 1p/litre cut
• the third phase of the EU ETS covering the period 2013-20: the emissions cap for industry within the system is assumed to decline by 1.74% each year and to be 21% below the 2005 level in 2020 (the caps are expected to be published officially by the European Commission later in 2011); and the inclusion of aviation in the EU ETS from 2012
• the fourth carbon budget target of 1950 MtCO2e that became law in June 2011 and the CCC’s recommended target of 690 MtCO2 for traded sector emissions over 2023-27, although the latter has not yet been accepted by the government
• an assumption that following the Budget 2011 announcement, the floor price of carbon on fossil fuel inputs to electricity production will increase, in nominal terms, from £22/tCO2 in 2014, to £42/tCO2 in 2020 and £77/tCO2 in 2025 (equivalent, based on our assumptions for inflation and the €/£ exchange rate to €47/tCO2 in 2020 and €87/tCO2 in 2025)
• an assumption that two new nuclear power stations, each with a capacity of around 3.34 GW, will be built by EDF at Hinckley C and Sizewell C and will come into operation between 2018 and 2025, and that only one existing station, Sizewell-B, will remain open by the end of the forecast period

However, we have not taken into account the following policy proposals because they have not as yet been followed by concrete measures or been specified in sufficient detail to allow us to estimate their impact:

• the Renewable Heat Incentive
• the Green Deal
• other policy proposals of the Coalition government, including a ‘fair fuel stabiliser’ and ‘contract-for difference’ feed-in tariffs for low-carbon electricity generation

The Carbon Emissions Reduction Target is also not fully modelled, but to some extent its impact is reflected in the parameter estimates. The CRC Energy Efficiency Scheme, a mandatory emissions allowance scheme, cannot yet be modelled as there is still insufficient information on its coverage. The existing Feed-in Tariff is not taken into account, because our forecast does not cover microgeneration of electricity.

An average EU ETS allowance price of around €16/tCO2 is expected in 2011, as the impact of the recession in reducing demand for emissions allowances in 2009 is only partially reversed. An increase in nominal terms to €23/tCO2 is assumed by the end of Phase 2 in 2012 as the economy recovers; a rise of around 2% pa to €28, on the same basis has been assumed in the period thereafter to 2020. After 2020 a 4% pa increase has been assumed, implying an allowance price of €34/tCO2, also in nominal terms, by 2025.

Notes for Editors

Cambridge Econometrics is an independent private limited company and is owned by a charity, the Cambridge Trust for the Promotion of New Thinking in Economics. It has been providing detailed economic and industrial forecasts since 1978. Our company also provides detailed regional and energy forecasts for the UK, and regional forecasts for the European Union. We provide the most detailed long-term economic and industrial forecasts available for the UK. The projections are produced using the 'Cambridge model', known as the Multisectoral Dynamic Model of the UK economy (MDM), which was originally developed in the University of Cambridge’s Department of Applied Economics. This large computerised system has approximately 5,000 endogenous variables and nearly 16,000 behavioural parameters and other coefficients. The model is continually revised and improved to take account of new data and advances in economic theory and econometric techniques.

In the energy-environment aspects of MDM-E3, demand is modelled for eleven fuel types by twenty-five fuel users (to allow more detailed E3 analysis), and a capacity-based sub-model of the electricity supply industry is included. Energy demand for sectors other than power generation is determined econometrically, and is consistent with the macroeconomic and industrial forecasts released on 17 June 2011.

All historical energy data are consistent with the 2010 Digest of UK Energy Statistics and environmental data with the UK's National Atmospheric Emissions Inventory maintained by AEA Energy and Environment.

The cut-off date for the information used in the model run for this forecast was 31 May 2011. Our system of quality management for economic modelling has been approved as complying with the international standard ISO 9001:2000.

UK Energy and the Environment is published twice a year. The forecast and analysis are available on our Knowledge Base website (www.camecon.com) to companies and Government departments by subscription to our Energy-Environment-Economy Service, which combines energy and environment forecasts with detailed projections for the whole UK economy.

For further information please contact:

Philip Summerton 

Manager UK and Energy Modelling
Cambridge Econometrics
Covent Garden
Cambridge CB1 2HT, United Kingdom

Tel (01223) 533100
Fax (01223) 533101
Email ps@camecon.com