Select Committee on Environment, Transport and Regional Affairs Appendices to the Minutes of Evidence


Further Memorandum by Friends of the Earth (CCO7A)

THE CLIMATE CHANGE LEVY

INTRODUCTION

  1.  The Climate Change Levy will make a significant contribution to securing the Government's ambitious manifesto commitment of a 20 per cent cut in UK carbon dioxide (CO2) emissions by 2010. We are concerned, however, that under the current design proposals for the Levy the Government will struggle to achieve the projected savings of 2 million tonnes of carbon per year by 2010. If the Levy rates for fossil fuels reflected their carbon content and the framework for negotiated agreements with more energy intensive firms was tightened we believe that at least this level of carbon savings would be achieved.

  2.  Crucially, the Levy will also install an economic incentive for the commercial and industrial sector to reduce CO2 emissions beyond 2010. Responding to this incentive for increasing energy productivity through innovation, investment and better management will allow firms to cut their costs as well as their CO2 emissions. It is vital that the negotiated agreements also include such an incentive to ensure these firms do not lock into business as usual options for improvement.

  3.  Friends of the Earth has for several years argued for an industrial energy tax and welcomed the Climate Change Levy announcement at Budget 99 [1]. Since then we have put forward strong arguments for improvements in the design of the Levy and the recycling of the revenues back to business [2]. Several of those improvements were announced in the Pre-Budget Report. Further improvements in the design of the Levy can and should be made before it is introduced at Budget 2000 in order to improve its environmental effectiveness.

IMPROVEMENTS ANNOUNCED AT THE PRE-BUDGET REPORT

Exemption for renewable energy

  4.  As the reduction of carbon dioxide emissions is the primary purpose of the levy, it was essential for the credibility of the instrument that renewable energy was exempted as far as practically possible. The announcement that the Government intends to exempt electricity generated from renewable sources of energy (other than large scale hydro plant) from the levy is therefore very welcome. We have commented on the legal and practical considerations mentioned in the Pre-Budget Report as potential barriers to this improvement in design in our response to the consultation on the Levy conducted by HM Customs and Excise (a copy of the relevant paragraphs from this response are enclosed).

Exemption for combined heat and power

  5.  The exemption of electricity generated by "good quality" combined heat and power (CHP) plant is also welcome. Investment in CHP will be a cost-effective and readily available option for many firms in response to the levy's incentive to increase energy efficiency. This exemption will tip the balance for a large number of schemes and boost the market for a technology that is central to achieving Britain's obligations under the Kyoto Protocol.

Exemption for rail-freight traction electricity

  6.  Rail-freight has an important role to play in developing an integrated and sustainable transport system in the UK. We therefore welcome the exemption of traction electricity used by rail-freight locomotives from the Levy.

Greater assistance and incentives for firms to invest in energy efficiency

  7.  Since the Levy was announced we have argued that a greater proportion of the revenues should be reinvested in schemes to help firms invest in energy efficiency and renewable energy. We recommended that the amount reinvested through direct support for energy efficiency was increased from £50 million to £100 million and that a further £100 million was invested in targeted capital allowances [2]. We therefore welcome the increase in direct support for energy efficiency and the introduction of a capital allowance scheme. The proportion of revenues reinvested in this way is likely to need to be increased further following an appraisal of the demand for such support in the first year the levy is in operation.

FURTHER IMPROVEMENTS IN THE DESIGN OF THE CLIMATE CHANGE LEVY FOR BUDGET 2000

Carbon-tune the Levy

  8.  The rates of the Levy need to better reflect the carbon content of fossil fuels. The existing framework of differing rates for primary fuels, a single rate for electricity, need not be altered to achieve this. Two reforms are required. First, industrial oil must be brought within the Levy to avoid creating a perverse growth in demand for oil. Second, the rates of primary fuels need to be based upon carbon content of the fuels and not energy content as currently proposed.

  9.  This design improvement would bring greater cuts in CO2 emissions, allow firms to reduce their tax bill by switching to lower carbon content fuels and make the Levy compatible with future trading schemes that will be based upon carbon.

Target the discounts on the rate of levy more tightly upon genuinely energy-intensive installations

  10.  It is proposed that an 80 per cent discount from the levy rates will be available to those energy sectors which enter into legally-binding agreements to implement all energy saving measures that are cost effective for companies themselves. We are extremely concerned that this element of the climate change levy, which has not been open to public consultation, will make deals that overall are too generous, are difficult to enforce and crucially will include no incentive for innovation or continuous improvement.

  11.  Ensuring the environmental and fiscal efficiency of the levy demands that any reduced rates of the levy granted via the agreements approach should be very tightly targeted at truly energy intensive processes. The Government has chosen to use the EU's Integrated Pollution Prevention and Control (IPPC) Directive as the basis for determining eligibility for special consideration largely because it offers the necessary legal certainty.

  12.  There is, however, a wide range of energy intensity amongst the thousands of installations that will be covered by IPPC. To grant an 80 per cent discount to all is inefficient both from an environmental and fiscal viewpoint. In manufacturing industry energy on average makes up only 1.6 per cent of total production costs compared to average business expenditure on energy of 1 per cent of costs. Intensive energy users within manufacturing, for whom energy represents more than 10 per cent of costs, account for just 2.2 per cent of manufacturing businesses.

  13.  Modelling work conducted for Friends of the Earth of an industrial energy tax indicates that some sectors with installations that come under IPPC, such as pharmaceuticals and general manufacturing are already likely to be net gainers from the levy/NICs package. Moreover, these less energy-intensive installations stand to benefit from the new options announced in the Pre-Budget Report of switching electricity supply to renewable energy sources and investing in combined heat and power. The Digest of UK Energy Statistics identified many of the less energy intensive sectors currently negotiating agreements with the Government as having the greatest opportunity to make cost-effective savings by investing in combined heat and power [3].

  14.  The Government does not have to abandon the legal certainty of using IPPC as the initial criteria for eligibility for a negotiated discount. The Pollution Prevention and Control Act 1999 includes enabling powers to force companies to disclose detailed information regarding their energy consumption. These powers exist because of amendments tabled by the Government. Ensuring that the discounts on the rates of the climate change levy are targeted at those installations which require it would be a proper use of such powers.

Sign negotiated agreements with the individual firms

  15.  We believe it is essential that agreements are signed by the individual firms concerned. This would provide a clear and strong incentive for firms to comply with the agreement and would allow the Government to move quickly to reinstall the full rate of the levy where a firm fails to meet the conditions of the agreement. The option of signing an agreement with the relevant trade associations would weaken the incentive for individual firms to comply and so make enforcement highly problematic. Under this system if the sector target was not met and several free rider companies were identified the only line of enforcement open to the Government would be to pull the plug on the deal with the trade association. This enforcement process is therefore likely to become a game of chicken with the Government having to judge how bad the situation needs to get before it dares act. This type of agreement would also disadvantage progressive firms in comparison to free-riders. The more heterogeneous the sector is the more serious this problem is likely to be.

  16.  In order to ensure that firms are complying and are seen to be complying, the agreements should require that each company pays for an independent site-by-site audit of its annual emissions that is submitted to the Government. Each company should also be required to fund an independent energy audit of its processes and premises to establish opportunities for energy saving and the uptake of renewable energy sources. A progress report on exploiting these opportunities should be required each year and a new audit conducted every three years.

Ensure agreements are dynamic and not static

  17.  It is vital that the agreement signed provides a dynamic incentive for the firms involved and is not locked into investing in existing technologies with short payback times alone. One of the key attributes of an economic instrument like the Climate Change Levy is that it does provide an ongoing dynamic incentive for firms to reduce emissions that stimulates innovation. It would be ludicrous if the agreements made with these sectors who are the most energy-hungry failed to do this also. We are concerned that the current negotiations are locked into business as usual options rather than providing an incentive to innovate, go beyond compliance and change the pattern of investment.

  18.  The Government can improve the agreements approach in this regard by setting ambitious emission reduction targets related to international benchmarks for what is economically and technically possible. The Netherlands has adopted such an approach in the recent Energy Efficiency Benchmarking agreement which requires processes to be benchmarked against similar processes around the world in terms of energy efficiency with the requirement that firms achieve a top 5 rating within a certain period of time. The aim should be to move these firms toward making more far-reaching energy efficiency investments with a payback of 8 to 10 years rather than just those with a 2 to 4 year payback which companies are putting in place already as part of the normal business cycle.

Minimise trading provisions within negotiated agreements

  19.  The Government has already announced that it wants to allow some form of trading within the agreements. This could create significant barriers to the development of wider emissions trading schemes. There is a consensus that once the practical difficulties surrounding trading systems are addressed properly such systems will play an important role in reducing CO2 emissions. The Government needs to ensure that the design and extent of any trading provisions included in the agreements do not create barriers to establishing such trading systems. There are three particular problems.

  20.  First, all agreements are likely to be based upon improving energy efficiency per unit output. Emissions trading schemes will rely upon an overall ceiling or cap for emissions, regardless of output. The trading scheme within the agreement would be "cap-less" and as such directly incompatible with any domestic emission trading scheme and lacking credibility on the international stage. We understand that the Government intends to offer firms the chance to convert from energy efficiency based agreements to carbon-based agreements to allow firms within the agreements to trade with firms in trading systems outside the agreements. The effectiveness of such a system will depend on both the targets set and the details of the conversion process.

  21.  Second, the negotiated agreements are being agreed on the basis of what is cost-effective for firms in that sector alone. They are likely to vary in how accurately they reflect this given the process of negotiation involved and the problems of the Government having to rely upon the firms themselves for full and accurate information in order to set the target. Emission trading systems operate on the basis that trading occurs between sectors according to a common metric. There is a concern that if the trading market within agreements is more attractive to the firms involved they will not engage in wider emissions trading systems when they are established.

  22.  Third, emissions trading systems have to be transparent to operate properly. The negotiated agreements have not been transparent to date.

Relevant paragraphs on renewable sources of energy from Friends of the Earth's response to the HM Customs and Excise consultation on the Climate Change Levy.

  23.  The Energy Saving Trust is currently working on a scheme which will verify "renewables only" electricity contracts, called Future Energy. Once this system is up and running, which should be well before April 2001, there is no technical reason why energy sold through these contracts could not be exempted from the levy. The European Commission has a strong policy in favour of encouraging renewable electricity. There is a good case to argue that imported non-renewable electricity should not be given the same rate of tax in the UK as this would actively discourage the uptake of renewable energy. Renewable sources are already recognised as meriting different treatment in the Electricity Directive. However, assuming perfect transfer of policy objectives between European institutions does carry some risk so another approach may be worth considering.

  24.  The levy will be paid by electricity suppliers, who also pay the fossil fuel levy (FFL). Renewable energy is currently exempt from the FFL. The body which administrates the FFL, the Non-Fossil Purchasing Agency, has sufficient information on the content of electricity supplied which comes from renewable sources for Customs and Excise to offer a quarterly rebate of the CCL reflecting the amount of renewable electricity used in that period. In this way, no special rate is required but all renewables are effectively exempted from the levy. It would also create an incentive for all electricity supply companies to increase their uptake of renewables.

  References

  [1]  Friends of the Earth, 1999. Britain's First Green Budget. London, FOE.

  [2]  Friends of the Earth, 1999. More Carrots—Fewer Sticks: Reinvesting Britain's Green Tax Revenues. London, FOE.

  [3]  DTI, 1998. Digest of UK Energy Statistics 1998. London, The Stationery Office.

18 November 1999


 
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