UK Needs Heat and Transport Emissions Pricing
The government is under legal pressure to tighten its climate policies, and pricing the fossil fuels used to heat homes and power cars could be part of the answer.
At a time when the UK government faces legal pressure to ramp up its climate policies, a new report has found that the UK could cut its carbon emissions by as much as 26% by pricing those generated by heating and road transport fuels.
Conducted by the London School of Economics and Political Science’s (LSE) Grantham Research Institute on Climate Change, the research found that extending the UK’s Emissions Trading Scheme (ETS) to heating and transport fuels could produce a “double dividend” by cutting emissions and expanding the economy by as much as 0.3% through the redistribution of the revenue raised to households and businesses.
The report followed a High Court ruling last week, which found that the UK government’s existing climate action plans were unlawful as they failed to demonstrate how they would meet legally binding targets under the Climate Change Act. The ruling underscored that courts take the legislated climate targets and obligations seriously, meaning the government must find new ways to reduce emissions beyond the power sector.
The heat and transport sectors present an obvious opportunity. Both are major contributors to global warming, accounting for 18% and 23% respectively of the UK’s total greenhouse gas emissions, the report found. But so far, the government has not put a price on emissions from these sectors in the way it has for industrial and power sector emissions.
Extending the ETS to heat and transport would help push households to lower carbon alternatives to gas boilers such as heat pumps, while addressing tax breaks that make gas artificially cheaper than electricity, according to the LSE report. It would also increase take-up of electric vehicles and use of public transport.
With a carbon price on heat and transport fuels starting at £0 per tonne and rising to £80 by 2040, UK emissions across the economy could fall by an extra 26% by that date, the report said. If the price reached £40, emissions would fall by 16%, which would help the government meet the legally binding goal of net zero emissions by 2050.
“Our modelling shows that extending the UK ETS to transport and heating will lower greenhouse gas emissions and boost the economy,” Josh Burke, report co-author and Senior Policy Fellow at the Grantham Research Institute, said. “But any changes to the ETS must include steps to redistribute the proceeds to lower income households who would be hit by the expansion. Failure to do so could undermine public and political support for extending carbon pricing.”
UK falls behind Europe
Although the UK has historically been a leader on climate policy and played a key role in developing Europe’s ETS, introduced in 2005, it has been lagging behind the EU since Brexit.
While the UK introduced its own ETS in 2021, closely modelled on the European one, it did not mirror the EU’s subsequent decision to extend the scheme to buildings and transport. Europe’s introduction of a Carbon Border Adjustment Mechanism (CBAM), implemented by governments to account for the carbon cost of producing imported goods, has added further pressure on the UK to stay apace.
In December 2023, the UK government announced it would introduce a CBAM, with plans to consult on the framework this year.
Still, climate has fallen down the list of priorities under incumbent Conservative Prime Minister Rishi Sunak, who has wound back key climate policies – including timelines for bans on the sale of petrol cars and gas boilers.
The opposition Labour party has also pared back its climate ambitions, dropping a pledge to spend £28 billion a year on green projects if it formed a government.
So far, neither party has given an indication of whether it would extend the ETS in line with EU requirements, but last week’s High Court ruling likely ramps up the pressure to tackle carbon emissions more seriously for whoever takes over Downing Street.
Start with gas
If the UK government was to expand the ETS, the most efficient place to start would be with gas used to heat buildings and cook with, the report said. Just over 83% of buildings in the UK are currently heated in this manner, while only 7.5% use electricity.
But gas has been given an unfair advantage over electricity, according to the report. While the latter is subject to both carbon pricing under the ETS and a 20% value-added tax (VAT), the former is not covered by a carbon price and is only subject to a 5% VAT.
The mismatch means there is an effective carbon price of £305 per tonne of CO2 on electricity, and £0 per tonne on gas, according to the report.
“Basically, this is making the cleaner thing [electricity] comparatively more expensive than the dirtier fuel,” Burke told ESG Investor.
The report proposed applying the ETS to gas retailers, and using the proceeds to create a special fund to provide financial aid to lower income households – a model currently followed under the EU’s plan. “Redistributing that money would have a net positive impact on gross domestic product,” Burke said.
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