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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