Frontier Economics report on decarbonisation incentives published by ESC

Frontier Economics was  commissioned by Energy System Catapult (ESC) to consider the potential design, implementation and impact of a tradeable carbon intensity standard. This report has now been published  as part of ESC’s Rethinking Decarbonisation Incentives project. 

A carbon intensity standard would set an obligation on consumers, producers or suppliers in the energy sector to meet minimum standards for the carbon content of energy that they respectively consume, produce, or sell. Obligated parties that could overachieve the standard would earn tradeable credits that could be purchased by others whose consumption, production or sales do not meet the standard.

Our assessment and modelling found that a tradeable carbon intensity standard may have some practical benefits. In particular, the impact on energy prices may be lower as the cost of purchasing credits incurred by suppliers of a high carbon fuel is offset by the revenue gained by suppliers of the low carbon fuel.

However an intensity standard will generally be less economically efficient than a carbon tax or tradeable permit system. While the standard acts as an implicit tax on fuels with an intensity above the standard, it also acts as an implicit subsidy for any fuel with a carbon intensity below the standard. This means that the effective price per tonne of carbon for different abatement options will differ, and the carbon intensity standard will not deliver abatement at least cost across the economy.  To minimise the distortions associated with this type of policy, careful design would be crucial.

Frontier has also considered the links between productivity and climate change policy for ESC’s Rethinking Decarbonisation project.