Newpapers today reported a calculation by Ofgem that credits distributed free to energy generators in the second round of the EU ETS will net them £9bn. The Association of Electricity Producer’s denial did not actually deny it. Ofgem apparently then proposed that the Treasury levy some sort of windfall tax and redistribute it to poor consumers who have been hit by rising energy prices (which are mainly driven by wholesale energy prices, not the EU ETS).
But why should free distribution of the credits yield a windfall? The free credits do have a market value, but the generators cannot sell them because they need them to cover their own emissions. There is a highly inefficient reason behind the windfall: consumers have to bribe generators not to shut down. Once generators have been given credits, one option is to shut down and sell them. Consumers must therefore pay the generators the price of the electricity plus the price of the credits to persuade them not to do so. The credits need not be sold. Ofgem estimates that 17 per cent of retail electricity prices and 13 per cent of retail gas prices is accounted for by this cost.
From 2012, more credits will be auctioned. That will not reduce retail energy prices, but it will put the price of credits in the government’s pocket rather than the generators’. In the meantime, stopgap legislation should be passed to allow the government to repossess credits or fine an EU ETS installation if it scales down or ceases trading. Competition should then push retail prices back down so that they do not include the market value of freely distributed credits.