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Lessons from the Budget: The Carbon Floor Price

The Coal Switching Price (CSP) and Carbon Price Floor (CPF)

In George Osborne’s latest budget last week a key feature was his action on UK competitiveness by addressing the much-debated issue of the carbon floor price.

In an attempt to stem one of the component drivers of the ever rising cost of electricity, Osborne announced a capping of the carbon price floor at £18.00 from 2016-17 to 2019-20 in order to “limit any competitive disadvantage British companies face in the global race”.

This move is forecast to save UK business up to £4bn by 2018-19, collectively, not individually sadly. For residential customers the saving is a more relatable £15.

But the impact of a change in the Carbon Floor Price goes beyond customer bills. It also impacts the economics of the energy market in general. A change in the Carbon Floor Price trajectory also affects the Coal Switching Price, which in turn will have varying impacts on the profitability of electricity generators depending on their generation fuel mix.

The level of the Coal Switching Price is affected by a number of different factors including the price of coal itself, the cost of transportation, system balancing costs and the carbon price.

Indeed Osborne’s move on the Carbon Floor Price reduces the cost of electricity generation from coal and therefore in turn impacts the Coal Switching Price.

Despite this generation businesses, like SSE, expect to see a coal to gas switch starting by Summer 2015.

So why is this if the underpin of the Coal price has been removed, or rather reduced, bringing down the cost of coal?

SSE say this is because taking a coal station operating at its lowest level of efficiency (35%) and comparing it to a gas station operating at its highest level of efficiency (53%) and vice versa at 39% and 47% respectively this creates a channel within which the upper and lower floors of the commodities can be mapped.

This mapping underlines that ranking on efficiency the least efficient coal station will be replaced by the most efficient CCGTs first. The extent to which this ‘switch’ will spread up the scale of coal stations will depend on how deep the gas price drops into the Coal Switching Price channel.

As the potential viability of shale gas improves, and gas becomes a potentially abundant source once more, having a negative impact on price, the carbon floor price move by Osborne could materially change the fuel mix in the UK, this time maybe for good, and the 2nd largest contributor of electricity generation, coal, could fall further behind 2012/13 levels of 29.2% to gas’ 40.7%.

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