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The Competitiveness Impact of a UK Carbon Price: What Do the Data Say?

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The Competitiveness Impact of a UK Carbon Price: What Do the Data Say? View metadata, citation and similar papers at core.ac.uk brought to you by CORE provided by LSE Research Online The competitiveness impact of a UK carbon price: what do the data say? David Grover, Ganga Shreedhar and Dimitri Zenghelis Policy paper January 2016 ESRC Centre for Climate Change Economics and Policy Grantham Research Institute on Climate Change and the Environment The Centre for Climate Change Economics and Policy (CCCEP) was established in 2008 to advance public and private action on climate change through rigorous, innovative research. The Centre is hosted jointly by the University of Leeds and the London School of Economics and Political Science. It is funded by the UK Economic and Social Research Council. More information about the ESRC Centre for Climate Change Economics and Policy can be found at: http://www.cccep.ac.uk The Grantham Research Institute on Climate Change and the Environment was established in 2008 at the London School of Economics and Political Science. The Institute brings together international expertise on economics, as well as finance, geography, the environment, international development and political economy to establish a world-leading centre for policy-relevant research, teaching and training in climate change and the environment. It is funded by the Grantham Foundation for the Protection of the Environment, which also funds the Grantham Institute for Climate Change at Imperial College London. More information about the Grantham Research Institute can be found at: http://www.lse.ac.uk/grantham/ This policy paper is intended to inform decision-makers in the public, private and third sectors. It has been reviewed by at least two internal referees before publication. The views expressed in this paper represent those of the author(s) and do not necessarily represent those of the host institutions or funders. Table of contents 1. Introduction ...................................................................................................................... 6 2. Distribution of costs and implications for cost competitiveness ................................ 10 2.1. Which industries rely most heavily on fossil fuels? .................................................. 11 2.2. The impact of a hypothetical carbon price ................................................................ 17 2.3. Input-Output methodology ........................................................................................ 18 2.4. Input-Output findings ................................................................................................ 20 2.5. Carbon price impact in the context of long-run oil price changes ............................. 24 3. Carbon mitigation policies and industrial location ..................................................... 26 4. Comparison to study using 2003 data .......................................................................... 30 5. Imported emissions ........................................................................................................ 31 6. Key findings and policy recommendations .................................................................. 32 7. References ....................................................................................................................... 35 Appendix A: Minor explanations for differences between 2011 and 2003 estimates ....... 40 Appendix B: Derivation of carbon price multiplier ............................................................ 41 Appendix C: Key statistics for all UK industries, ranked by carbon intensity ................ 42 Appendix D: Example of Input-Output data structure and content ................................. 48 Figures and tables Figure 1: Share of primary energy inputs by industry (per cent) ............................................. 13 Figure 2: Share of primary and secondary energy inputs by industry (per cent) ..................... 14 Figure 3: Product price increase due to carbon price, by industry (per cent) .......................... 20 Figure 4: Carbon price and oil price change impact on whole economy costs ...................... 26 Figure 5: Industry trade openness versus carbon price-induced cost increase ......................... 28 Table 1: Fuel price increase due to carbon price (2011) .......................................................... 19 Table 2: Impact of carbon price shock on overall production costs and consumer prices ....... 20 Table 3: Carbon price impact, expressed as equivalent oil price increase* ............................. 25 Table 4: Estimated carbon price impact: 2003 versus 2011 ..................................................... 30 Table 5: Industries’ intermediate consumption, 2011 (the ‘Combined Use’ or input-output matrix) ...................................................................................................................................... 49 3 Executive summary It is often argued that if the United Kingdom (UK) cuts its greenhouse gas emissions faster than its main trading partners then the competitiveness of UK industry will suffer as a result of high energy input costs. For this reason, firms will relocate to countries where climate change policies are less stringent. Many studies have estimated the impact of the costs of climate policies on particular sectors. However, less is known about the extent to which these sectors pass on policy costs through their value chain and, ultimately, to consumers. This analysis uses the Input-Output tables from the UK National Accounts for 2011 to simulate the full multiplied impact of a uniform £20 per tonne carbon price on fuels and production costs across all 106 industries that comprise the UK economy, as well as whole economy production costs and final consumer prices. The carbon price is imposed on top of any carbon cost that was already present in 2011. Full cost pass-through is assumed along the value chain. A £20 per tonne carbon price is a similar rate to that applied to electricity generators by the UK carbon price floor (currently frozen at £18 per tonne). The results of this study therefore provide an indication of the potential impact of extending the carbon price floor across all fuels. It shows that 94 industries would see their input costs increase by less than one per cent of gross output. Four industries would see their costs increase by more than five per cent. They account for close to five per cent of GDP and are thus a substantial part of UK output. However, most of that output is non-tradable (e.g. electricity and gas) and therefore not subject to international competition. Only a small number of industries, accounting for around two per cent of GDP, are likely to face production cost increases of more than two per cent, which put them under pressure of competition from abroad. These include refineries, coal, iron, metals, some chemicals and cement. However, carbon policies will provide incentives to increase energy efficiency and resource productivity which could afford UK producers a competitive advantage in the long term, in a world where fossil fuel prices could rise and carbon reduction policies are likely to become more widespread and ambitious. The impact on final UK consumer prices, assuming full cost pass-through, is estimated at 0.9 per cent. The results of this study are not affected by the price of fossil fuels in the base year In an Input-Output analysis, increasing the carbon price will have a linear impact on consumer prices. Therefore, if a far more ambitious carbon price of £73 per tonne - consistent with the DECC shadow carbon price in 2030 - were to be applied today, the cost impact would rise proportionately, rendering more industries vulnerable to competitive pressure and relocation. Electricity costs would rise by 43 per cent and tradable sectors such as steel and cement would, all else equal, see costs rise by 13 per cent and 9 per cent of gross output respectively. A rise of this order could potentially eliminate profit margins and whole- economy prices would rise by approximately 3 per cent. Such effects would likely have a significant impact on the location decisions of tradable carbon-intensive sectors and on UK productivity. Moreover, this analysis does not include emissions from non-heat related processes which vary from firm to firm and are very difficult to assess at the level of 4 aggregation used here. Though relatively unimportant at the whole economy level, some vulnerable sectors may face additional carbon costs as a result of such emissions. Nevertheless, the cost estimates presented here constitute upper bounds. Firstly, the revenues raised from carbon taxes or emissions permit auctions are not in fact lost to the economy and can be recycled back into affected sectors, or into reducing distortionary taxes elsewhere in the economy. They reflect one side of a transfer rather than an underlying resource cost (as would be the case if the cost of extracting fossil fuels rose). Moreover, these estimates are static and do not allow for any behavioural change in terms of input switching, consumption switching or technological and process innovation. In the real world, industries and consumers would undertake such actions to limit costs; indeed that would be the objective of the carbon pricing policy. The higher and more certain the carbon price, the more likely these substitution opportunities are to reduce costs to exposed sectors as they implement efficiency measures, but also the more likely to lead to the relocation of
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