Why counting the cost of carbon is anything but straightforward

Do you know the price of a pint of milk? It’s the classic question to catch out politicians – challenging how in touch they are with the lives of ordinary voters.

I have some sympathy with the hapless interviewee as the issue is not that simple. The answer depends in part on where you buy the milk – corner shop or supermarket for example. However, politicians clearly do need to have a feel for the markets that they are influencing – whether it is food, housing or decarbonisation.

I make this point because, up until recently, I thought that I knew what the cost of carbon was – about £80 per tonne. It turns out that I was as flummoxed as your average politician.

But £45/tonne? £95/tonne? Even £880/tonne? How is a business meant to plan when the cost varies by 10 times? What is going on with carbon, and what are the implications for construction, manufacturing and development?

Perhaps I should start with a carbon pricing 101. The UK has had a carbon cap and trade scheme since 2005. If an organisation emits more carbon than allowed by their cap, they have to buy credits on an open market.

Early schemes were badly implemented and, until 2017, the carbon price was less than £5/tonne. Recent reforms cut the number of credits and made them much more valuable, and the price of carbon in the EU system has risen to fluctuate between €80 and €100/tonne.

At this price manufacturers and other carbon emitters have both the confidence and financial incentive to invest heavily in carbon reduction technologies.

So why does the price vary so much in the UK? The answer is a combination of policy and politics – so often a threat to consistent long-term planning and investment. Policy because public bodies are waking up to the need to incentivise and fund decarbonisation, and politics as crisis after crisis hits the government of the day.

The falling cost of carbon credits combined with the impact of higher interest rates on their long-term value means the value of the incentive has fallen by 75% in the past 18 months

If we take the UK’s emissions trading scheme (UKETS) for example, more credits were added to the system to reduce inflation pressures in spring 2023. The intervention worked and the cost of carbon fell to £45/tonne, reducing manufacturers’ costs.

However, the long-term negative impact to the UK net zero agenda could be very severe indeed. The falling cost of carbon credits combined with the impact of higher interest rates on their long-term value means that the value of the incentive has fallen by 75% in the past 18 months. Carbon reduction projects could be cancelled because of this, which is hardly a good look.

But the UKETS is only one of a plethora of mechanisms affecting UK development and construction that involve pricing carbon. Carbon offset funds, for example, are being introduced in London and other cities to raise funds for decarbonisation projects.

They work by applying a charge on operational carbon emissions that exceed a certain threshold. Again, they act as an incentive to invest in low-emissions plant and equipment and also provide funds to support local investment in emissions reduction projects.

The London Borough of Islington has run such a scheme since 2012, and the Greater London Authority (GLA) has been promoting their wider adoption since 2022. The price for carbon recommended by the GLA is £95/tonne, which is where my second price for carbon comes from.

The idea is that the charge is predictable, enabling developers to either target investment to reduce emissions or alternatively to factor in offset costs where the savings cannot be made.

But the £95/tonne offset rate is not set in stone, and recently Westminster council opened a consultation on a potential increase of the rate to £880/tonne. Viewed from the carbon reduction perspective, such a high offset rate is a huge incentive to improve operational efficiency. Furthermore, the increase in offset revenue that such a rate might generate would go a long way to funding public sector decarbonisation works in the borough.

I’m a fan of carbon taxes. But to work, the price of carbon, like Goldilocks’s porridge, needs to be just right.

Viewed by a client, however, it is a massive local tax on new investment. The risk is that, by setting such a high offset rate, not only might development in Westminster stop or be pushed into neighbouring boroughs, but schemes that do proceed might also over-invest in carbon reduction – representing a misallocation of resources that could be better utilised to cut more carbon more cheaply elsewhere.

Don’t get me wrong, I’m a fan of carbon taxes. But to work, the price of carbon, like Goldilocks’s porridge, needs to be just right.

The price then has to be applied consistently so that markets become investable and so owners can see value in investing to reduce emissions from assets and processes. Recent evidence suggests that, just as the UK had got to a sensible place on carbon pricing, we are throwing the cards up in the air again.

>> See also: The battle SMEs face in reducing their emissions - and proving it

>> See also: Innovations to tackle construction’s carbon problem

Ultimately, the price of carbon will not be set by a trading scheme or by a London borough. It will be set by the cost of carbon capture, use and storage (CCUS), another policy initiative that received a big boost this year. 

Subsidies will be needed to create demand so the government will have a role in setting the price. But ultimately a new carbon price will be established based on actual cost.

Long-term investment in carbon emissions reduction should be focused on what the cost of CCUS could be, not the latest wheeze from either the Treasury or a local authority. We need to fix the carbon price problem and that might require the fixing of the carbon price too.

Simon Rawlinson is a partner at Arcadis