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


Further Memorandum by BG plc (CC36A)

EXECUTIVE SUMMARY

  1.  The Government's proposed Climate Change Levy (CCL) is seeking to fulfil two policy objectives:

    —  as an economic instrument, to induce greater energy efficiency through the price mechanism, thereby reducing carbon dioxide emissions and helping to tackle the problem of climate change; and

    —  as a source of revenue for redistribution by the Government, to reduce the tax burden on employment and encourage the creation of more jobs, mainly in the manpower-intensive service sector.

  2.  Both these objectives are desirable but, in the form proposed, the Levy falls between two stools. With better design, the CCL could be much more effective in inducing energy efficiency—in directly creating new jobs in this regard—and in contributing to the achievement of the UK's emissions targets for greenhouse gases—both in the first phase and long term.

  3.  Advancing technology is creating many new opportunities for substantially greater energy efficiency throughout the UK economy. One of the prime benefits in this regard is the achievement of high levels of efficiency in progressively smaller applications. Thus, there is scope for highly energy-efficient Combined Heat and Power (CHP) units in many smaller scale applications. BG Technology has developed the prototype of a micro-CHP unit suitable for the individual household. At the same time, most opportunities for renewable sources of energy are small in scale.

  4.  While these advances of technology offer much promise, economic factors have been working in the opposite direction. Energy prices have generally fallen in real terms, and in the UK this has been strongly reinforced by the consumer benefits of market liberalisation for gas and electricity. For the most part, these economic factors have militated to discourage extensive new investment to realise the considerable potential for greater energy efficiency from advancing technology. The use of a levy as an economic instrument has considerable potential to reserve the price signals and encourage beneficial energy efficiency investment. But, even in its revised form the CCL will largely fail to realise this potential.

  5.  Energy use in the bulk of businesses is relatively modest in relation to total costs and the incentive to invest in greater energy efficiency is therefore muted. It is in these businesses—and the domestic sector—where the technological developments in small-scale energy efficiency have most to offer. The intensive energy users, who face the strongest energy price signals, are the constituency who are, in the main, already energy efficiency conscious.

  6.  Instead of addressing the flawed design of the original Climate Change Levy proposals the Treasury is now (Pre-budget Report) seeking to mitigate the damage to the international competitiveness, (and jobs) of Britain's intensive energy users by greatly extending the scope of negotiated agreements and the related rebates. This in turn will considerably increase the scope of administrative discretion and arbitrary tax levels/allowances—the antithesis of market-based economic instruments. In short a badly designed economic instrument is made worse.

  7.  Without altering the basic framework of the Government's CCL proposal, or necessarily further reducing the revenue target, these flaws could be overcome by making the following changes to the design of the Levy:

    —  the individual rates of the Levy for the different sources of primary energy would need to be "carbon tuned" to reflect the relative carbon content of the different fossil fuel sources; (There are no substantive reasons why this should be impracticable.)

    —  a carbon-tuned system could still retain a single Levy rate for electricity, based on the prevailing fuel mix; and

    —  tax credits—should be given for accredited investments which result in verifiable reductions in carbon emissions in designated fields such as CHP, renewable energy projects and energy poverty programmes. These credits should be obtainable throughout the economy, providing the basis for a traded market to intermediate between those wanting to reduce the impact of the Levy on their competitiveness, and those with the best opportunities for energy saving investments.

  8.  A form of CCL modelled on these lines would induce beneficial energy saving investment throughout the economy. The Levy would have a much greater impact in reducing carbon emissions, in thereby tackling the problem of climate change, and in meeting the UK's targets in this regard. It would establish good foundations both for the initial stage of the Kyoto targets, over the next decade, and thereafter. It would also further contribute to the development of emissions/environmental trading as a substantial activity, and capability, within the UK.

  9.  Widespread energy saving investment would itself create many new jobs, both skilled and semi-skilled. For example, Transco (BG) has developed a blueprint for an "Affordable Warmth" programme to eradicate energy poverty. This would entail the provision and installation of efficient gas-fired central heating and cooking facilities; the fitting of home insulation and draught-proofing to modern energy efficiency standards; and the provision of finance through leasing arrangements. There are multiple benefits. The fuel savings from the greater energy efficiency justify the capital outlay, and offer savings to the householders. The environment will benefit from the substantially improved energy efficiency. The basic health standards of those affected by energy poverty are improved. There is also a substantial incremental employment dimension.

  10.  Adjustment of the CCL to incorporate carbon tuned rates and tradable tax credits is most likely to put the UK and its business sector in a position of leadership rather than competitive disadvantage.

INTRODUCTION

  11.  This submission is made by BG plc, one of the two successor companies of British Gas plc following its demerger in February 1997. BG comprises two main businesses:

    —  Transco, the developer and operator of the substantial majority of Britain's gas transportation network which is regulated as a monopoly service provider to gas shippers; and

    —  BG International, which comprises oil and gas exploration and production in UK offshore waters and overseas and a downstream gas business which is engaged in the development and supply of gas markets in Northern Ireland and overseas.

  12.  On a smaller scale, BG Storage provides gas storage services to participants in Britain's gas industry. In addition, BG Technology underpins the Group's leading international capability in gas-related technology. BG Property is engaged in an extensive programme of clean-up and re-sale into beneficial use for BG's substantial inheritance of old gasworks sites.

THE GOVERNMENT'S CLIMATE CHANGE PROGRAMME

  13.  BG supports the UK's Kyoto target of 12.5 per cent reduction of greenhouse gas emissions—and beyond this, the manifesto commitment of a 20 per cent reduction of carbon dioxide emissions by 2010. The public policy challenge is not simply to meet those targets, but to do so efficiently—with the minimum costs and maximum benefits to the UK economy—and to set in place a framework for the longer term, that can deliver reductions beyond the first Kyoto commitment period.

  14.  BG supports the prime policy tools that the Government is using in order to meet its targets. In particular:

    —  we agree that the contribution of Combined Heat and Power (CHP) to electricity generation must be increased;

    —  we welcome the Government's target that renewables should account for 10 per cent of electricity generation by the year 2010, compared to around 2 per cent now;

    —  we endorse the Government's proposals designed to ensure that economic regulation promotes its environmental objectives; and

    —  we endorse the Government's drive to promote energy efficiency.

ECONOMIC INSTRUMENTS

  15.  BG agrees, in principle, with the Government's intention to use economic instruments to achieve its emissions targets. Using economic instruments to provide the market with appropriate signals is preferable to prescriptive regulation. Adjusting cost structures works with the grain of the market, whereas prescriptive regulation tends to cut across it, and often has perverse effects.

  16.  BG submits that emissions trading built around the principle of "cap and trade" should be the principal economic instrument for achieving reductions in carbon emissions. Emissions trading allows companies that produce excess emissions to purchase emission permits from companies that achieve low emission levels, generating an economic benefit for good environmental performance. Unlike an energy tax, it offers certainty of the reduction that will be achieved, as the overall volume of emissions is fixed. An emissions trading system would encourage supply-side initiatives such as investment in CHP, renewable energy technology and energy efficiency schemes. The current plan to allow energy efficiency per unit of output targets in the negotiated agreements—while promoting energy efficiency—does not guarantee carbon reductions.

  17.  The greater scope for relatively "painless" reductions in energy use is in the domestic sector and the bulk of the business sector whose energy use is not intensive. Therefore, there is a role for an energy tax, provided that it is part of a wider policy framework and is designed to complement other environment and energy policy instruments. Our concerns that current proposals do not establish such a policy framework are set out in further detail below.

THE ROLE OF GAS

  18.  The gas sector will continue to play a crucial role both in achieving the UK's climate change targets and in meeting its energy demands.

  19.  Between 1990 and 1997, fuel switching to gas resulted in the UK's carbon emissions falling by more than 13 million tonnes of carbon, with the principal reasons being the switch from coal to gas in the generation of electricity. Despite its increased market penetration n the electricity generation sector, gas is a long way from being a dominant source of fuel in the UK. Indeed, there is certainly further scope for significant carbon savings through switching to gas in other sectors.

  20.  BG recognises that in the long term there is a growing need to reduce the UK's dependence on diminishing reserves of fossil fuels by developing and utilising renewable sources of energy. However, the development of sufficient renewable resources on a stable, secure and commercial basis will take decades to achieve. Fossil fuels should, therefore, be used as a bridge to long term reliance on sustainable energy resources. During this transition period, the UK will necessarily be dependent on a balanced mix of fossil fuels to provide secure supplies of energy. BG's concern is that the burden of the Climate Change Levy, which falls disproportionately heavily on the gas sector, will make this transition harder to manage—to the detriment of the environment.

PROBLEMS WITH THE PROPOSED CLIMATE CHANGE LEVY

  21.  BG submits that the proposed Climate Change Levy is not the most efficient and effective means of achieving the Government's climate change targets. The revised Levy proposals as detailed in the Pre-Budget Report still retains the fundamental design flaws.

Because of its blunt nature, although the Levy will hit business hard, it will contribute little to achieving the Government's climate change targets.

  22.  According to current forecasts, reductions of 29 million tonnes of carbon beyond current policies are needed in order to meet the Government's target of a 20 per cent cut in CO2 by 2010. Although the Climate Change Levy would make a contribution, at around 2.0 million tonnes, it makes little difference to the overall picture. Yet this saving is at a high cost. By improving the design of the tax, the Government could see larger carbon savings for less cost to business—a double dividend.

The Climate Change Levy does not provide a framework for least-cost compliance with the emissions targets, thereby having a detrimental effect on the UK economy.

  23.  Early analysis indicates that the Levy will produce significant wholesale price rises for industrial energy, with increases in excess of 13 per cent for gas, and around 8 per cent for electricity. Energy intensive companies will be hit especially hard, because of the importance of energy in their cost base and the fact they are likely to have already taken most of the economic energy efficiency measures that would have been available to them. This is the case even when 80 per cent reductions as a result of negotiated agreements are taken into account.

  24.  By contrast, for companies where energy represents only a small proportion of costs the incentive to use energy efficiently will be blunted by those companies' concentration on investment directly bearing on their primary trading activities—yet these are often the companies where the easiest efficiency gains are most readily available;

The proposed method of recycling revenues under the Climate Change Levy may not maximise the potential for job creation.

  25.  The revenues from the Levy (expected to be £1 billion in 2001/02) are to be recycled in full to businesses primarily through a 0.3 per cent cut in the main rate of employer National Insurance Contributions (NICs).

  26.  We understand that the Chancellor's rationale for recyclying the Levy via NICs was to reduce the cost of employment in order to create more jobs. However, here too the efficacy of the Levy is open to question. Because the ceiling on employers' NICs has been removed, the benefit of NICs reductions will go to companies with a highly-paid skilled and professional employees just as much as to companies with considerable scope to create the sort of jobs which would alleviate unemployment on a significant scale. A well-designed system that encouraged appropriate energy-saving investments could itself create many jobs in a new "energy-efficiency" sector, a sector that once initially nurtured within the UK could soon be exporting its services. The current CCL is a missed opportunity to develop this sector.

The design of the climate levy does not assist the UK's chances of developing a leading international capability in emissions trading.

  27.  Given the number of large international companies based here, the UK is especially well placed to take a leading role in any international emissions trading regime. The establishment of such a regime requires the various economic instruments deployed by the Government to work together coherently and consistently. That, in turn, demands that instruments are established on a "common currency" ie on a carbon-reflective basis. By choosing at the outset an energy tax unrelated to the carbon content of fuels as the principal economic instrument in the climate change programme, the Government impedes the development of an emissions trading regime and with it extra income and employment such activity could generate.

The climate Change Levy discourages switching to the least carbon intensive fuels.

  28.  The Levy taxes fuels at a uniform rate, per unit of energy rather than per unit of carbon dioxide emitted. As the wholesale price of gas is low in relation to other fuels, a unit rate of tax represents a larger percentage of the wholesale price of gas than it does for other fuels. This creates the perverse effect that gas—the least environmentally damaging fossil fuel—suffers the highest percentage price increase. As a result, it fails to encourage switching from more, to less carbon intensive fuels --switching which could provide a low cost way of reducing carbon emissions for certain industries. Indeed our initial modelling shows that, even with the changes announced in the pre-budget report, there continues to be some switch from gas to oil—a more carbon intensive fuel.

The Climate Change Levy is administratively complex.

  29.  A well designed climate change levy would automatically provide incentives for "good quality" CHP schemes—the greater the emissions savings, the lower the Levy. However, under the Government's original Levy proposals, such encouragement was very limited. While it is welcome that the Government has recognised this deficiency and provided, in the pre-budget report, an exemption for "good quality" schemes, the complexity of the new arrangements is revealing—it highlights the basic flaws in the Government's approach. To receive exemptions, CHP schemes will need to be certified under a new Quality Assurance Scheme that is based on a suite of complex formulae. It is ironic that the introduction of a supposed economic instrument has led to an extension of bureaucracy and regulation in this area.

  30.  A considerable volume of bureaucracy has been created alongside the Climate Change Levy in the form of Negotiated Agreements, which will be extended beyond the original 10 sectors to a total of 41 sectors. These agreements will roll back the incentive of the economic instrument from a great proportion of industry and replace it with a bureaucratic and discretionary contract that runs right through to 2012. These arrangements will greatly reduce the flexibility available to the UK to employ economic instruments to achieve climate change policy objectives over the next decade. Furthermore, the agreements will hide the economic signals of the cost of abatement in these critical sectors. Consequently the Government and the market will not have access to the information necessary to the design of efficient economic instruments.

The tax allowance scheme suffers from the same flaws as the Levy.

  31.  The Pre-Budget Report has extended the use of tax incentives to promote energy efficient investment. However the function of the recycling body and a clear set of guidelines on the class of such investments have not been drawn up. The tax allowance scheme is therefore likely to suffer from the same flaws as the Climate Change Levy: it is a blunt instrument; it is not carbon tuned and it is likely to be based on an arbitrary definition of energy efficiency investment.

REFORMING THE CLIMATE CHANGE LEVY

  32.  BG submits that the Levy can be altered to remove the principal burdens on business, promote economic efficiency and increase its impact on emissions. To this end, we have developed proposals for modifications that could be made to the existing proposals (on the assumption that it would not be an option to rip these up and start again). What follows is a brief summary of these proposals. Further details could be provided if the Committee so requested.

  33.  The main changes that we would propose are as follows:

    —  The Levy rates for primary energy should be "carbon tuned"

    As with the CCL proposals, there would be a single rate for each energy source, but this rate should be set so as to reflect the carbon content of that fuel. This is consistent with Lord Marshall's conclusion that "there is a good case for trying to reflect, at least in broad terms, the carbon content of different fuels in the rates set in order to maximise the emissions savings resulting from the tax". A carbon-tuned system could still retain a single Levy rate for electricity. We have calculated that a switch to carbon tuned rates, designed to deliver an equivalent reduction in carbon emission, would reduce the tax burden on industry by some £100 million or conversely it could also be used to deliver substantially greater carbon reduction for the same revenue raised. This illustrates the inefficiency of the current tax proposals.

    —  There should be a general provision for carbon reduction tax credits.

Carbon reduction tax credits

  34.  Where a company makes an accredited investment in Government designated fields, that results in verifiable reductions in carbon emissions, then it should receive a tax credit against its Climate Change Levy liability. An indicative rate would be £32 per tonne of carbon saved (we calculate that if the current levy were "carbon-tuned" to raise the same revenue as the revised Climate Change Levy, the Levy rate would be approximately £32 per tonne of carbon emitted). This tax credit could continue for the operating lifetime of the savings from the investment. A key element of this is that such investments need not take place within that business—they could be anywhere within the UK. We would encourage the Government to utilise this mechanism to stimulate investment in other key streams of Climate Change Policy. Some examples of designated fields might be:

    —  installation of small-scale CHP;

    —  energy-efficiency (insulation, modern boilers) in domestic homes;

    —  investments in ecologically valuable carbon sinks; and

    —  building of renewable generation plant.

  35.  Such a tax with credits would encourage the most efficient methods to reduce emissions throughout the economy, and indeed would encourage innovation in those methods. It would also enable low cost energy efficiency savings in the bulk of the business sector (with relatively low energy needs) and the domestic sector to be achieved, which otherwise would be unlikely. We would expect that these tax credits would be traded—so the result would be a trading scheme which avoided the difficult issue of allocating (or limiting) carbon savings between the small to medium sized enterprise sectors. In addition to increasing the efficiency of the Levy, the investments encouraged by such a hybrid would also have benefits in terms of other public policy goals. They would provide extra employment, often a type which would be suitable for those on the New Deal; projects in domestic housing could help address fuel poverty; carbon sinks projects would have ecological, recreational and amenity benefits.

  36.  Our initial analysis shows that such a credit scheme could, by 2010, produce double the additional carbon savings from CHP and renewables, while still yielding substantial tax revenues. By the year 2010 such a system could be producing 10 million tonnes of additional carbon reductions, and if the Government were willing to sacrifice some of its tax revenue such a system could deliver twice that amount.

CONCLUSION

  37.  The proposed Climate Change Levy does not deliver the main objective of the Government's climate change programme: to provide a sound and lasting framework for the sustained reduction of carbon emissions. It will impose substantial additional costs on UK industry and undermine other elements of the climate change programme. It will reduce the ability of the gas sector to contribute to the Government's emissions targets and to provide a bridge to reliance on more sustainable energy sources.

  38.  BG submits that the design of the Levy should be improved so that it is more effective at achieving its stated climate change goal. In particular we suggest that there are merits in considering a move towards a carbon-tuned, tax with credits for energy efficiency investments.

November 1999


 
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