Abstract
This article explores whether a carbon price will effectively encourage the more efficient use of greenhouse gas intensive materials such as steel. The article identifies a range of distortions that arise when some of the restrictive assumptions of neoclassical economics are relaxed. Distortions occur due to the sequential nature of decision-making along supply chains, due to imperfect competition and due to government intervention to reduce the risk of carbon leakage. If upstream sectors do not pass on carbon costs, downstream sectors do not have the opportunity to react. Of the distortions identified, compensation mechanisms that reduce the risk of carbon leakage are likely to act as the greatest hinderance to appropriate incentives for the more efficient use of steel in the UK: as things currently stand, unless upstream companies are encouraged to make windfall profits, incentives downstream are weakened. The article concludes by exploring policy options to address the distortions identified, including efforts to reinstate the carbon price downstream and efforts to remove other distortive taxes.This article is part of the themed issue ‘Material demand reduction’.
Highlights
Greenhouse gas (GhG) emissions are a textbook example of an externality
Where At is the maximum permissible aid intensity, Ct is the assumed carbon emissions factor for UK electricity, Pt is the carbon price (either the European Emissions Trading Scheme (EUETS) price currently at approximately £5/tCO2 or the UK carbon floor price at £18/tCO2), E is a product-specific electricity consumption efficiency benchmark set by the European Commission (0.49 MWh/tsteel for electric arc furnaces (EAFs) steel) and O is the baseline output [22]
The UK Carbon Price Support (UK CPS), which was introduced to impose a credible carbon price given the weak performance of the EUETS, is compensated for in such a way that energy-intensive sectors would not be expected to pass on the full cost of the GhG emissions embodied in their production activity, weakening incentives downstream
Summary
Greenhouse gas (GhG) emissions are a textbook example of an externality. Activities undertaken by businesses, households and governments that emit GhG emissions impose a cost on society that, in the absence of government intervention, is not reflected in the costs faced by relevant decision-makers. A carbon price—levied either as a tax or via a cap-and-trade scheme—achieves these criteria by pricing GhG emissions at source, causing a chain of price changes along supply chains that reflect the social cost of GhG emissions embodied in intermediary, and subsequently final, goods These price changes should offer appropriate incentives for both upstream GhG abatement activity (such as the pursuit of renewable energy generation) and downstream GhG abatement activity (including the pursuit of greater energy efficiency in industry, the pursuit of greater efficiency in the use of embodied emissions-intensive materials, and the substitution of demand towards less emissions-intensive options), restoring ‘production efficiency’ and ‘product mix efficiency’ at the new set of prices. Subsequent sections (within §3) explore how distortions to downstream incentives arise when various neoclassical assumptions are relaxed
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