House of Commons - Environment, Transport and Regional Affairs

Select Committee on Environment, Transport and Regional Affairs Fifth Report

UK CLIMATE CHANGE PROGRAMME

The Business Sector

58.We heard from a range of industrial and business witnesses during the course of our inquiry. The views offered on climate change and policies to reduce emissions were very diverse. Some groups (such as the Institute of Directors) offered little support for the climate change strategy whilst others (for example, Pilkington) saw opportunities ahead from an increased emphasis on improved energy-efficiency. We focus here on some of the specific measures which have been proposed or are under active consideration. One of the features of business groups' evidence was a lack of consensus about the most appropriate instruments to reduce emissions most effectively at lowest cost. Some favoured emissions trading alone, others tax or regulation and some argued that only negotiated agreements were needed.

SMALL AND MEDIUM-SIZED ENTERPRISES

59.There are strong similarities between domestic users and the three million small and medium sized enterprises with regard to energy-efficiency.[149] Both groups have a large energy-efficiency potential but, because energy spending forms a relatively small proportion of the outgoings of a household or a small business, this potential often remains untapped.[150] Also, many of these businesses are in the service sector and, like domestic users, much of their energy consumption is used for heating and lighting. As with domestic users, the most effective tools for this sub-sector are likely to be information, grants and building regulations. There is also a significant role for the financial institutions. The Association for the Conservation of Energy told us that:

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We recommend that the Government negotiate with the largest landlords of commercial property to improve the energy-efficiency of their properties. Negotiated agreements should be sought to reduce energy use by at least 25% by 2010.

THE INTEGRATED POLLUTION PREVENTION AND CONTROL DIRECTIVE

60.The Integrated Pollution Prevention and Control (IPPC) Directive will be implemented between now and 2007 and includes an energy-efficiency requirement. IPPC will cover most major energy users and around 40% of greenhouse emissions from the business sector. The Government have put forward a 'pessimistic' assumption that this will save a minimum of 0.5 MtC by 2010 with a maximum of 3 MtC.[152] Some witnesses suggested that IPPC could form the cornerstone of climate change policy in the business sector.[153] Certainly, the IPPC regime could be used to ensure that there is marked improvement in energy-efficiency in some industries. There is also a role for IPPC to be linked to other policies such as negotiated agreements, emissions trading schemes or systems of taxation.[154] However, it is important to recognise the limitations of IPPC. Lord Marshall wrote that:

155

Lord Marshall goes on to note that failure to meet IPPC requirements will be a prosecutable offence and, as such, requirements for energy-efficiency improvements will tend to be set at conservative levels. Further, the legislation is "existing process based" and this means that IPPC requirements will not necessarily spur changes to the manufacturing process or innovation. We also recognise the additional costs that IPPC brings to industry and particularly note the anxiety this is causing to the agriculture industry, especially the pig and poultry producers.[156]

61.We conclude that the Integrated Pollution Prevention and Control Directive will play a significant but partial role in reducing emissions from the business sector. We are not convinced that Government thinking is well advanced on the details of implementing IPPC to deliver energy-efficiency savings and urge it to ensure that the savings approach the 'maximum' suggested in the consultation of 3 MtC.

THE CLIMATE CHANGE LEVY

62.During the course of our inquiry, it was announced that the Climate Change Levy would be introduced in April 2001 on the business use of energy, broadly in line with the recommendations made by Lord Marshall. Following on from the initial announcement about the Levy in March 1999, the Government consulted on the details of the scheme and made significant modifications in the pre-Budget report in November 1999. The Committee took evidence after the initial proposals were published and then again in January 2000, after the changes made in the pre-Budget Report.

63.Although the Climate Change Levy is an instrument which will reduce emissions of greenhouse gases without a major impact upon the UK's competitiveness, it cannot be described as a good policy. As the BG Group noted, "This [the pre-Budget Report] in turn will considerably increase the scope of negotiated agreements and arbitrary tax levels/allowances - the antithesis of market-based economic instruments. In short a badly designed economic instrument is made worse."[157] In July 1997, the Government issued its 'Statement of Intent on Environmental Taxation' which laid out its plans for shifting taxation away from employment and onto pollution. Within this document, it is stated that "environmental taxation must meet the general tests of good taxation. It must be well designed, to meet objectives without undesirable sideeffects; it must keep deadweight compliance costs to a minimum; distributional impact must be acceptable; and care must be had to implications for international competitiveness."[158] We do not believe that the Climate Change Levy meets the tests of good taxation. The system of exemptions, negotiated agreements and reduced rates has produced an extremely complex and cumbersome market instrument which will result in a relatively modest emissions reduction.

64.The Energy Intensive Users Group told us that the original proposals for the levy would, if implemented without exemptions, hit their members' industries very hard[159] and we accept that an unmodified levy would indeed have been excessively harsh for this sector. However, the Government announced in the pre-Budget report that energy-intensive sectors would receive a rebate of 80% if they entered into negotiated agreements to improve their energy efficiency. Although the use of negotiated agreements raises a number of concerns (examined in a separate section below), witnesses mostly accepted that the 80% rebate would limit the impact upon their competitiveness.[160] We welcome the protection which the system of Climate Change Levy rebates and negotiated agreements will offer to energy-intensive industries.

65.However, the Government is currently offering negotiated agreements and rebates only to those industries which are covered by the Integrated Pollution Prevention and Control (IPPC) legislation. In general, IPPC applies to those industries with the greatest potential to pollute and tends to focus upon larger sites. The Government argues that it is using IPPC as the criterion because the legislation requires firms to operate in an energy-efficient manner and also offers legal certainty in defining those firms which are eligible to enter into a negotiated agreement and receive rebates from the levy.[161] Clearly, legal certainty is important but much of the evidence we heard in January of this year argued that IPPC was a very poor proxy for energy-intensity and that using IPPC was "arbitrary and artificial", "illogical" and "inequitable."[162] Perhaps the best example of the anomalies provided to us was by Water UK: the water industry is the third most energy-intensive industry but is not covered by IPPC legislation. Other witnesses provided examples of specific energy-intensive processes which were not covered by IPPC and many suggested that there were a number of simple alternative criteria which could be used to define energy-intensive industries.[163] We concur with the Trade and Industry Select Committee that the use of Integrated Pollution Prevention and Control to define which industries are eligible to enter into negotiated agreements and receive rebates from the Climate Change Levy is "likely to create anomalies and inequities which will serve only to discredit the levy."[164] We urge the Government to adopt a simple, rigorous and equitable approach to define energy-intensive industries eligible for agreements and rebates.

66. A recurring point made about the levy was that it impacted unfairly on manufacturing industry, particularly smaller firms.[165] Although the levy will be revenue neutral across all of industry, it was suggested to us that it resulted in money being transferred from manufacturing industry and passed to the service industry sector through the reduction in National Insurance employer contributions. This is essentially because the manufacturing sector tends to employ fewer people than service sector firms. However, the Financial Secretary to the Treasury, Stephen Timms, told us that:

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although he went on to acknowledge that this assertion involved "making some rather broad brush assumptions."[167] Although we recognise that the system of negotiated agreements and levy rebates may indeed mean that the overall impact upon the manufacturing sector as a whole is 'broadly neutral', it does seem likely that larger manufacturing firms will do rather better out of the levy than smaller manufacturing firms. In general, small firms will be unable to enter into negotiated agreements, will receive no rebate of the levy and still have numerous barriers to increasing their energy-efficiency. We are concerned that the Climate Change Levy will have a negative impact upon small and medium-sized businesses and urge the Government to pursue schemes which alleviate this problem by targeting information and resources at these businesses.

67.We heard from some witnesses that the effectiveness of the levy would be less because it was essentially a downstream energy tax, rather than an upstream carbon tax.[168] One of the principal reasons for the Government opting for a downstream tax was the need to protect domestic electricity users from the levy.[169] This is practically much easier to achieve by imposing the levy at the point of use (where the 'business' user can be identified) rather than point of generation, where the final user is usually unknown. However, by introducing an energy levy there is no incentive to encourage electricity generators to switch to less carbon-intensive fuels. The exemptions for renewable sources and Combined Heat and Power (announced in the Pre-Budget Report) will help to address this situation. Nevertheless, witnesses suggested that the levy in its existing format could still be 'carbon tuned' with the levy rates adjusted to reflect the carbon content of different fuels.[170] Given that the primary purpose of the levy is to reduce emissions of carbon dioxide, this would seem to be a sensible approach. We believe an upstream carbon tax would have been simpler than the proposed Climate Change Levy but we are concerned about the implications this would have for fuel poverty. We also believe that there remains an opportunity for the rates of the levy to better reflect the different carbon content of fuels and urge the Government to bring forward proposals to do this.

68.Given that the original structure of the proposed levy offered no advantage to low-carbon means of generation, it was widely argued that exemptions should be granted for renewables. This argument was accepted by the Government and exemptions for renewable sources were announced in the Pre-Budget Report. We welcome the Government's decision to exempt renewable sources from the Climate Change Levy. Similarly, the Combined Heat and Power Association argued that combined heat and power should also be made exempt from the levy.[171] Although the case is a much less clear-cut one than for renewables (since the emissions advantages of combined heat and power over conventional sources of generation are much smaller), we welcome the Government's decision to exempt 'good quality' combined heat and power from the Climate Change Levy. However, it is worth reiterating that an upstream carbon tax would be simpler to implement since there would be much less need for the various exemptions and cases for special treatment that we have discussed above.

69.Although the levy will not be introduced until April 2001, we note the comments of Lord Marshall on future rates of the tax: "a clear signal should be given of the long-term direction of policy, with changes in the rate of tax made in a gradual and predictable way."[172] Some witnesses suggested that various policies, including the climate change levy, be "ratcheted up"[173] and that the proposed level of levy was too small to have much impact.[174] In the same way that the fuel duty escalator gave a clear signal to car users about their behaviour, progressive increases in energy taxation would give a plain message to industry about its need to reduce energy use. With such a policy, firms can invest in energy-efficiency measures with confidence.

70.The Government is committed to making the levy revenue-neutral by recycling all the revenues back to businesses and currently proposes that out of a total revenue of £1 billion, £850 million is put to reducing employer's National Insurance Contributions with £150 million put towards a fund for energy-efficiency measures. Although this £150 million is up from £50 million in the original proposal, many witnesses still argued that there was an opportunity being missed by not recycling a much larger proportion of the revenues towards energy-efficiency measures. Lord Marshall discussed the need for levy revenues to be used to fund greater efforts to help small and medium-sized enterprises.[175] The need to find funding for energy-efficiency initiatives is a pressing one, particularly for small and medium-sized businesses and should not be passed over in favour of reducing employment taxation. We welcome the Government's plans to put £150 million from the total Climate Change Levy revenue towards energy-efficiency measures. However, we recommend that this amount be increased substantially in future years, with a sizeable fraction put towards helping small and medium-sized businesses overcome the various barriers to improving their efficiency.

CLIMATE CHANGE LEVY: NEGOTIATED AGREEMENTS

71.Negotiated agreements between industries and Government are an important part of the Climate Change Levy system. For those industries eligible, a negotiated agreement to improve energy-efficiency results in an 80% rebate of the levy. Much of the evidence we took in January of this year focused on the details of these negotiated agreements. Heads of Agreement were due to be reached with the original ten sectors by 20 December 1999 and another thirty-one were due to be completed by the end of February 2000. However, there appears to be little detail in the agreements signed in December 1999 which contained only 'indicative targets' and will need to be finalised. Indeed, the timescale allotted for reaching agreements caused some concern to the Chemical Industries Association:

"Frankly, we do not think it is realistic because DETR are lacking in resources. The people we are working with are working day and night and they are showing real signs of strain ... That is dealing just with us and really the initial wave of ten associations. Each deal is quite complex, there are a lot of issues to be resolved."[

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Other witnesses expressed various concerns about the use of negotiated agreements, including the ambition of the agreements signed, the methods of enforcement and the penalties for not reaching the agreements. There are questions about how an agreement can be shared out, or ultimately enforced, by trade associations to their individual firms and how it can be ensured that a given company cannot 'free ride' on the actions of the others. While all of these concerns are important, we believe that there is one issue which, if tackled, would help resolve these worries: Friends of the Earth noted that the agreements were not open to public consultation.[177] The Confederation of British Industry expressed some support for agreements to be in the public domain once they were agreed and this will, effectively, be the case. However, if draft agreements, their conditions and penalties were opened up to public scrutiny, representations could be made by environmental groups and other interested parties about all the issues noted above before the agreement was finalised. We are concerned that the negotiated agreements are not open to public scrutiny and recommend that the details of draft negotiated agreements between Government and energy-intensive industries be made publicly available.

EMISSIONS TRADING

72.Some witnesses were particularly keen on the potential of emissions trading as a cost-effective method of reducing emissions.[178] BP Amoco told us of the success of their own internal trading scheme and their belief that a UK scheme should be set up as soon as possible.[179] Indeed, Lord Marshall's report concluded that trading could be an effective tool to reduce emissions and the consultation document talks of introducing such a scheme. However, there was division amongst other industrial witnesses as to the merits or otherwise of a trading scheme,[180] even amongst those from the same industry.[181] We believe that a domestic trading scheme should be pursued and set up as soon as is practicable and support the work of the CBI/ACBE Emissions Trading Group in developing such a scheme. The details of the scheme will inevitably be very complex and there are also problems with the interaction between any emissions trading scheme and the Climate Change Levy which need to be resolved. An early start to a national trading scheme would undoubtedly benefit the UK once the international scheme starts in 2008. Although we support the early introduction of emissions trading in the UK, we do believe that caps should be placed on the contribution that trading, and the other 'flexible mechanisms' under the Kyoto Protocol can make to meeting a nation's emissions targets. Only in this way can it be ensured that the flexible mechanisms are largely 'supplemental' to domestic policies, as the Protocol requires. We believe that any scheme of emissions trading should be designed so as not to provide an opportunity for those trading in emissions credits to make excessive profits. The primary purpose of emissions trading must be to reduce emissions.

149 Q113 Back

150 Q175 Back

151 Q312 Back

152 Consultation Paper, paragraph 101 Back

153 Ev p99; Q234 Back

154 Q474 Back

155 Economic Instruments and the Business Use of Energy, paragraph 33, a Report by Lord Marshall, November 1998 Back

156 Q1251 Back

157 CC36A Back

158 HM Treasury, "Environmental Taxation - Statement of Intent", 2 July 1997 Back

159 Q456 Back

160 CC25A, paragraph 2, CC69, paragraph 2.3 Back