8 june 2016

Leading by example? Impacts of a domestic French carbon price floor

June 8, 2016 by Haege Fjellheim, Yan Qin and Emil Dimantchev, Energy Post, June 8, 2016

If enacted, France’s plan for a domestic carbon price floor will lower CO2 emissions and increase power prices in France, but it will only have a marginal impact on total EU CO2 emissions and European carbon prices, write Hæge Fjellheim, Yan Qin and Emil Dimantchev, senior analysts at Thomson Reuters. They surmise that for the French government the plan is a way to lead by example. It will also bring in extra government revenues and improve the position of national utility company EDF.

Last month EU climate policy took a turn for the unexpected. On May 17, France’s environment and energy minister Ségolène Royal announced her intention to implement a domestic carbon price floor for the French power sector. The legislation would be put forward this summer, voted on by the Parliament in the autumn and start in January next year. The initiative came only two months after France proposed that the EU enact a union-wide carbon price floor as part of its Emissions Trading System (EU ETS) and six months after it presided over the landmark Paris Agreement in December.

While the details of the measure are yet to be revealed, it seems to be modelled after the “top-up” carbon tax in the UK. It would ensure that French power producers pay a minimum carbon price of €30/tCO2 by charging a tax on fossil fuels used for power generation. The new policy would tax fuels at a level such that it makes up the difference between the price floor and the carbon price generated by the EU ETS.

France’s action stands out compared to other carbon pricing efforts. The new levy will compete neck and neck with the UK’s for the title of the highest carbon price to ever be imposed on power producers in the world. But how much of an impact will it have on emissions? And, perhaps more importantly, how will it influence EU climate and energy policy?

French coal-based generators get burned

The French power system is dominated by nuclear power generation. In 2015, fossil fuel based generation from coal, oil and gas contributed a mere 1.6, 0.5, and 4 percent respectively of total power production, while nuclear supplied 76 percent and various renewables provided 18 percent.

The main impact of the new carbon price floor on the power sector will be to drive coal out of the generation mix, according to our dispatch model of the European electricity sector. The levy will eliminate coal from the power mix by 2019 by increasing its short run marginal costs to uncompetitive levels. Meanwhile, output from nuclear and gas plants will probably remain broadly unchanged.

All in all, we project that by 2020 fossil fuel based generation will supply 4.6 percent of power production. At this point, France would still be far from accomplishing its goal of transitioning from a nuclear-based power sector to one with a significant share of renewables. Its 2030 goal for 40 percent of renewable generation would probably require further action. So would the goal to cap nuclear capacity at 63.2 GW, which in essence means that no new plants can be built without old ones being taken off the grid.

The French power price will rise as a result of the price floor. Gas-power stations will produce the marginal power on the market, because France’s nuclear cap and slow growth in renewables means that these sources will fall short of meeting power demand. Thus, the domestic carbon price floor will lead to a direct increase in the yearly average power prices of around €3/MWh. This is around 8 percent increase from 2015 average price level of €38.5/MWh.

As the French power price rises, France will export less electricity. It is currently a net-exporter of power, to the order of 62 TWh in 2015, by sending electricity mainly to Spain, Italy and the UK and receiving some from Germany.

CO2 emissions nudged lower while carbon market unharmed

French CO2 emissions will decrease as coal generation goes extinct from the French power mix. Our model estimates that domestic emissions will fall by 6 million tCO2 per year, reducing French power sector emissions by a quarter.

But while French emissions decline, overall EU emissions will be less affected for two reasons. First, the rise in the French power price could lead to higher coal burn in Germany, which would probably partially offset the emission reduction in France. Second, lower emissions in France will decrease the overall need for CO2 allowances under the EU ETS, thus theoretically reducing the EU-wide carbon price and allowing emissions to rise elsewhere.

However, with regard to the latter, an emissions drop of 6 Mt will amount to only a third of one percent of emissions covered under the EU ETS. Thus, the impact on demand for CO2 allowances will be miniscule. Our carbon price model estimates that the annual EU-wide price may drop by 10 cents. If this impacts emissions, it will be by the tiniest amount, a small proportion of the 6 Mt domestic reductions in France.

This will be the case as long as the EU carbon market is oversupplied with CO2 allowances. But once the companies run out of their current permit surpluses, which may happen in the 2030s, the emissions reduced in France will be inevitably compensated. Therefore, the effect of France’s price floor will be lower emissions in the near to medium term and an unchanged cumulative amount of emissions in the long term.
Setting an example for EU and global climate policy

France’s new policy initiative has to be seen in the context of the ongoing debate over the EU’s carbon price. In February, Paris suggested to reform the EU ETS by introducing a price corridor – a combination of a price floor and a price ceiling.

The proposal is for a price corridor to be implemented through the daily auctions of CO2 allowances. Since more than half of all CO2 allowances are auctioned, member states could influence the price of CO2 by reducing or increasing the amount of auctioning depending on the price. For example, if an auction cleared below the price floor, no allowances would be sold, but rather stored for later. France introduced the idea as part of the current political process to determine the carbon market rules for the period 2021-2030.

The rationale behind this proposal is to ensure the EU ETS is a significant instrument of EU climate policy. A price floor would enable low carbon investments by giving financiers a minimum price guarantee. That would make a great difference compared to the current uncertainty surrounding the future carbon price. By driving emission reductions, an EU ETS with a price floor would help ambitious member states such as France, Germany, and the UK meet their domestic climate targets. This would discourage them from implementing unilateral climate policies that are currently leading to a fragmentation of EU policy and to the continuous weakening and sidelining of the EU ETS as a climate policy instrument.

The most important impact of the French carbon price floor plan may not be on short-term emissions, but on EU and global climate policy discourse

So far, no member state has spoken out in favour of the proposal. So France has gone ahead and announced its own domestic price floor in the form of a “top-up” carbon tax as we described. Is this paradoxical? In theory – yes. National policies lowering emissions in the power or industry sector and leading to lower demand for EUAs contributes to lower carbon prices. In practice – no. Since France has a low-carbon power system, a domestic carbon price floor in France would have no noticeable impact on EU ETS-wide emissions and therefore it will not undermine the carbon market.

For France, implementing a domestic carbon price floor is a way of leading by example. By walking the walk, it hopes that other climate progressive member states will follow suit. While these have so far shown little appetite for price floors – be it domestic or EU-wide – many of them seem to sympathise with the underlying concerns behind the French initiatives. Low and volatile carbon prices have led to a debate in the EU on how to reform the ETS. The French initiatives will inevitably raise the profile of this debate in EU Council discussions on climate and energy policies in general, and on the reform of the ETS directive in particular. Thus, the most important impact of the French carbon price floor plan may not be on short-term emissions, but on EU and global climate policy discourse.

All in all, the plan is a Kinder Egg of benefits for France – emission reductions, higher government revenues, and, not unimportant for the French government, an improved profitability of the largely state-owned EDF, the owner of France’s nuclear power plants. All of this without significantly affecting EUA price levels. The only loser will be the small fossil fuel generating industry in France. By implementing a domestic price floor, the French government would showcase that it is doing its share at home, while it advocates for carbon price corridors at the EU and global levels.

Editor’s Note

Hæge Fjellheim (@HaegeFjellheim), Yan Qin (@YanQinyq) and Emil Dimantchev (@EDimantchev) are senior analysts at Thomson Reuters, previously known as Point Carbon. See Emil Dimantchev’s author archive here.

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