Our latest Graphic of the month comes from our recent Decarbonisation of Heat paper written by Mark Howard and Johnny Gowdy.
This month’s graphic highlights the domestic fuel price distortion created by current environmental levies and highlights the opportunity to reconfigure these into a new domestic carbon levy.
A significant element of your household energy bill goes to meet the environmental and social obligation levies[1]. However, in our current system, the levy makes up around 20% of the average domestic electricity bill, but only 1.6 %[2] of the average domestic gas bill. Given that, on average, grid electricity now results in a similar carbon impact to gas for every kWh consumed[3], this creates a significant price distortion that is dissuading consumers from switching to lower carbon electricity for heating and cooking, or to adopting energy efficiency measures.
Our recent Decarbonisation of Heat paper recommended that these environmental levies and the domestic RHI (worth £3.8 bn per year) should be reconfigured into a new domestic carbon levy. This redistribution would remove the fuel price distortion that favours fossil fuels and give a much stronger price signal in favour of low carbon solutions and energy efficiency.
Many economists and policy makers now agree that the use of carbon pricing will be an important policy lever alongside regulations and other support mechanisms for low carbon technologies. This point was also highlighted in the new Chancellor’s March 2020 budget announcement during which he noted that “Electricity is now a cleaner energy than gas – but our Climate Change Levy, paid by companies, taxes electricity at a higher rate. So as another step towards equalising the rates and encouraging energy efficiency, from April 2022 I’m freezing the levy on electricity and raising it on gas.”[4]
The Chancellor’s policy change only focuses on a small part of the overall environmental levy and offers a freeze not a redesign. A broader domestic carbon levy proposed by Regen, even if revenue neutral, could see a £36 per tonne cost of CO2e applied across all fuels which would decrease electricity unit costs by approximately 14%, and increase gas unit costs by 16% per kWh, based on current prices and existing levies.
The impact for the “average” energy consumer would be negligible, but there would be a very positive incentive to reduce household carbon emissions through efficiency measures and the adoption of low carbon technologies. Those using electricity for heating, who are twice as likely to be in fuel poverty, would see an energy bill decrease, while those using higher levels of fossil fuels would see a bill increase.
Clearly for some, this would have distributional impacts which could tip people who are trapped in poor quality housing, and reliant on fossil fuels, into fuel poverty. This impact could be mitigated through banding or weighting for those in fuel poverty, and by other positive measures such as removing the VAT on low carbon heating solutions. More radically, the revenue raised by a domestic carbon levy ought to be used to tackle one of the root causes of fuel poverty – poor quality housing and low thermal insulation in the UK housing stock.
The adoption of a domestic carbon levy is one of a number of recommendations made in our latest Decade to Make a Difference: Decarbonisation of Heat paper.
[1] E.g. ROCs, FIT, ECO, UK capacity market. https://www.ofgem.gov.uk/publications-and-updates/energy-companies-consolidated-segmental-statements-css
[2] https://www.ofgem.gov.uk/consumers/household-gas-and-electricity-guide/understand-your-gas-and-electricity-bills
[3] https://www.gov.uk/government/collections/government-conversion-factors-for-company-reporting
[4] https://www.gov.uk/government/speeches/budget-speech-2020