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How do you start pricing carbon into infrastructure decisions?
The Treasury’s Green Book provides an established system for the assessment of projects to incorporate such carbon pricing.
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Pricing carbon into the UK’s infrastructure decisions

As the UK pursues its goal of net zero carbon emissions by 2050, is it time the government reviewed the approach to carbon pricing set out in the Treasury’s Green Book? Craig Lucas explores the issues.

With the UK committed to reducing its net emissions to zero by 2050, it’s clear that all major infrastructure decisions the government makes over the next three decades must be viewed through a climate change lens. Recent legal challenges to major projects such as the expansion of Heathrow Airport have only reinforced the importance of this. In the world of net zero, no new infrastructure ought to be given the green light unless it is shown to have a strategic case that is compatible with our environmental commitments. It’s also vital that the method used for the economic appraisal of investment options should include an explicit and robust price signal that reflects the lifetime emissions arising from the proposed investment.

The Treasury’s Green Book, and the BEIS guidance that supplements it, provides an established system for the assessment of projects to incorporate such carbon pricing. Yet this relies on the EU’s Emissions Trading System (ETS) as its pricing reference. As the UK’s exit from the EU is completed, it will be possible to maintain this system by creating a UK version of the ETS. But would this provide a strong enough signal and the transparency that decision-makers need – or could we take the opportunity to do better?

The ETS-based approach has several key weaknesses when considering the ‘whole economy’ nature of the net-zero challenge. Its carbon price is calculated through the trading of emissions allowances allocated to major polluters such as power stations; between them these major polluters only account for less than half of overall emissions, with key sectors such as agriculture being omitted.

Moreover, since investment appraisal is concerned with whole-life emissions, in practice it is reliant not on the current carbon price but on forecasts of future ETS carbon prices made by BEIS. These forecasts operate using three scenarios – following a high, medium or low trend line – and over the long time horizon involved in decisions about infrastructure, calculations reflect this uncertainty by generating a wide range of values. It is not yet clear how moving to a UK-specific ETS will impact on this process, but the current reserve price is well below the ranges of ‘shadow’ carbon prices being increasingly adopted by international institutions and private sector investors.

Whatever approach is adopted, it needs to consistently drive the right behaviour by decision-makers, and be clear enough to eliminate the kind of ambiguities or multiple interpretations that can result in legal challenges.

The best way of doing this would be to have a single carbon price that follows an understandable, predictable path between now and 2050. But the question then becomes, how can this single price path be arrived at?

The fundamental difficulty with attempting to place a ‘correct’ value on carbon emissions is the enormous amount of information this would require on climatic conditions and their effects, much of which is lacking or speculative. But the settled UK policy of achieving net-zero by 2050 suggests a way out of the difficulty. From the point of view of net-zero, the appropriate price path for carbon is the one that will achieve net-zero by 2050 if applied consistently across government policy. The government should consider setting a single price path which, if imposed on policy makers across the public sector through the Green Book system, is the one they believe will induce the mix of investments and regulations that will lead to net zero. Monitoring progress towards net zero could then provide an automatic stabiliser: higher prices if progress is too slow, lower prices (or possibly bringing forward the 2050 date) if progress is rapid.

Whatever the precise mechanism used, infrastructure decision-makers will need to ensure that strategic business cases better consider the holistic fit of a project or investment to the net-zero target. They will also need to take account of the physical effects of climate change, and ensure that associated risk is given due weight. For example, it would be irrational to build zero carbon infrastructure in an area of flood risk without appropriate investment in resilience. In some locations it would be irrational to build at all. A quality-adjusted weighting approach, similar to that used for health and safety risks, may be one way of pricing-in these concerns.

Private sector views on carbon pricing are developing too: institutional investors are increasingly looking at how the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) can be implemented, and are considering measures such as setting a shadow carbon price in their decision-making. The Carbon Pricing Corridors Initiative, for example, gives ranges for energy intensive sectors rising well above the current ETS price over the next 15 years. It is critical that HM Treasury continues to take account of the methodologies used by private investors and that approaches are aligned wherever possible.

Whatever the results of another look at Green Book appraisal tools, it remains true that ‘what gets measured, tends to get done.’ The UK cannot achieve the net zero transition without setting metrics consistent with this ambition.

Craig Lucas

Director for energy transformation, Mott MacDonald

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