In recent years, worries about runaway climate change forced by rising levels of carbon dioxide in the atmosphere have led many authorities to set ambitious targets in terms of reductions in future carbon dioxide emissions. The EU’s main instrument for implementing its climate policy is its Emissions Trading Scheme (ETS). The ETS provides an incentive to reduce carbon emissions and, for new entrants to the market, the carbon price is a direct tax on all emissions.

One of the difficulties of the scheme is that, in an economic downturn, there is likely to be a general excess of carbon allowances resulting in a fall in the ‘carbon price’. In February 2009, for example, carbon allowances fell to a little over €10 (US $13[10]) per tonne (of CO2) compared to €30 ($40) six months previously. In consequence the UK Government has recently proposed12 a carbon price ‘floor’ as part of its strategy for secure, affordable and low-carbon electricity. This is to be applied in the UK at a rate of £16 ($25) per tonne in 2013, rising to £30 ($46) in 2020 and £70 ($108) in 2030. As we shall see, one effect of this is to make nuclear power and renewables more competitive by driving up the costs of their CO2-emitting competitors.

PCGE assumes a carbon price of $30 per tonne of CO2. This looks reasonable when compared with an overall average price of around €20 ($27) in the three year period ending November 2008. When considering the next two to seven decades, however, it seems more likely to be an underestimate for Europe although possibly not for other countries. For the base calculation, therefore, we assume a carbon price of $50 per tonne of CO2 (Table 5.2) but will also consider a carbon price of zero.

The CO2 emission figures given for gas in Table 5.2 reflect only the carbon dioxide coming from the burning of gas. They do not include so-called fugitive greenhouse gas emissions that arise during gas production. These include direct leakages of gas to the atmosphere from boreholes and flaring of unwanted gas. From data presented in WEO 2011,1 3 it is estimated that, if they were to be included under the ETS rules, they would increase equivalent CO2 emissions above those shown in Table 5.2 by around 18%. For unconventional gas, fugitive emissions are likely to be higher still because fracking (fracturing of underground sediments by hydraulic pressurisation), which is used to release gas from low permeability deposits, requires as many as ten times more boreholes than conventional extraction. If this were covered by the carbon trading rules it would make a significant difference to the carbon price and must, therefore, be considered a potential risk.