Memorandum by the Office for the Regulation
of Electricity and Gas (CC75)
INTRODUCTION
This submission is a response to the press notice
58/99-99 of 4 November. As requested it consists of two parts:
— Part I: the Climate Change Levy
effects on Northern Ireland; and
— Part II: measures which could
be taken in Northern Ireland to promote CO2 reductions.
BACKGROUND
Northern Ireland has the potential to make a
substantial contribution to the UK's strategy for meeting the
Kyoto targets. Policy measures should be designed to ensure that
they reduce emissions and do not have unintended perverse consequences.
Part I: THE CLIMATE CHANGE LEVY AND NORTHERN
IRELAND
THE CONTEXT
The Northern Ireland Energy market is very different
from the energy market in Great Britain. The following are the
most important differences:
— in 1998 gas had less than one per
cent market share compared to 35 per cent in UK;
— in 1997 per capita electricity consumption
was 81 per cent of UK average;
— electricity consumed per £1
of GDP produced is 94 per cent of UK average; and
— NI must compete with another EU Member
State on the same island which customises its fiscal regime to
its own requirements.
With the exception of oil, energy costs are
substantially higher in NI than in GB and incomes lower. Electricity
generation costs are 40 per cent higher.
The Trade and Industry Select Committee said:
"The Government must pay attention to the
regional as well as the sectoral, effects of the Climate Change
Levy especially in relation to Northern Ireland, which has an
entirely different energy market to that operating in the rest
of the UK."
The Government's response was as follows:
"The Government is taking account of the
potential effects of the Climate Change Levy on all parts of the
United Kingdom in developing its proposals for the levy. In particular,
it is aware of the differences between the energy market in Northern
Ireland and those in other parts of the United Kingdom. The Government
will consider design options for the levy alongside these differences
in order to get the design right."
THE PRE-BUDGET
CCL RE-DESIGN
The re-design of the CCL increases its attractiveness
as a means of stimulating CO2 reductions while minimising
the damage to the international competitiveness of large industrial
users. I welcome the reductions in the amounts of the levy, the
improved rebates for energy intensive industries and the exemptions
for CHP and renewables. However, none of these makes a significant
impact in Northern Ireland where:
— CHP is still under-represented (about
25MWs).
— Non NFFO renewables barely feature
(perhaps 3MW).
— Large Energy Users are under-represented
in the industrial base.
— The public sector will not now be
allowed to spend on programmes—or even on energy efficiency—their
savings on National Insurance Contributions.
The redesign of the CCL worsens the position
of Northern Ireland relative to other UK regions. This is because
of the entirely different energy market here and is illustrated
by the following distinctions:
(1) The CCL per kWh of electricity is 0.43p.
The weighted average CCL paid in Northern Ireland will be close
to 0.43p. The weighted average paid in Great Britain will be lower.
This is because energy intensive industries will now receive an
80 per cent rebate on CCL instead of the proposed 50 per cent
rebate. Since a lower proportion of the industrial and manufacturing
base in Northern Ireland is in energy intensive categories, the
CCL will have a relatively greater impact on Northern Ireland
manufacturing because it will not share the same relative volume
of rebates. (Work is currently being undertaken to show the impact
of the larger rebates on the relative sectors and will show that
the effect of the rebate in terms of GDP reduction will be less
pronounced in Northern Ireland. This analysis will be presented
later in an annex to this paper).
(2) CHP plants will now be exempt from the
levy. Northern Ireland will benefit much less from this as it
has proportionately less installed CHP capacity than Great Britain—at
present around 25 MW compared to 3,800 MW. The abolition of CCL
on CHP will save Great Britain over four times more per capita
than Northern Ireland.
(3) A similarly less than proportionate dilution
of the levy will occur in Northern Ireland because of the exemption
of renewable generation. Like CHP, renewable generation forms
a smaller part of total generation in Northern Ireland compared
to the rest of the United Kingdom. The first NFFO generators in
Great Britain are now able to sell to industrial and commercial
customers. The effect of the exemption of renewables is therefore
relatively less pronounced in Northern Ireland and therefore relatively
more of the burden of the CCL will fall on Northern Ireland energy
users who cannot avail of the same level of renewable generation.
(4) The relatively smaller scope for energy
efficiency improvements will mean that Northern Ireland will not
benefit pro-rata from the increased fund for energy efficiency.
THE CCL AND
THE GAS
INDUSTRY
Northern Ireland has a new natural gas industry
which at present is limited to the Greater Belfast area. Ofreg
is currently considering proposals for expanding the gas industry
outside Belfast. The natural gas industry in Northern Ireland
differs from the natural gas industry in Great Britain in a number
of key respects:
— it must bear the additional cost
of bringing gas across the undersea pipeline from Scotland which
adds about 25 per cent to the beach price of gas;
— it must bear the cost of constructing
a natural gas network from scratch whereas in Great Britain there
was a smooth and more timely transition from the old Towns Gas
system;
— the Great Britain system was largely
financed with public finances but the private sector requires
the return on its investment to be recouped over 20 years, which
is less than half the effective lifetime of the infrastructure;
— it must give a return to the private
sector investor reflecting market perceptions of risk, which in
the case of Northern Ireland is in excess of the return required
by the public sector. Also the returns to the public sector include
non-financial benefits and externalities which could never be
captured by a commercial venture;
— it is being developed in a more mature
and challenging energy market;
— it faces lower customer densities
than in most parts of Great Britain;
— technological advances eg, more efficient
boilers, mean lower gas throughputs for specific required outcomes,
which raises average transportation costs; and
— it must be competitive against more
polluting incumbent fuels which ironically are lower priced than
in GB.
Expanding the natural gas industry outside Belfast
would reduce CO2 emissions by an estimated 730,000
tonnes per annum by 2010 through fuel switching and CHP opportunities
created. It would also reduce fuel poverty and enhance regional
competitiveness.
The natural gas industry represents a long-term
investment and it must be capable of operating with negative cash
flows for a number of years. It requires at least a 20-year horizon.
Until its capital investment has been amortised the cost of transporting
gas to a corresponding customer in Greater Belfast is significantly
greater than in GB, ie by a factor of three or four plus the transportation
costs of landing gas in Northern Ireland.
The effect of the CCL is to extract 4.4 pence
per therm from the cash flow. This adds substantially to the number
of years which it will take for the industry to move from negative
cash flow and reduce prices to GB levels. In Belfast, if the accumulated
cash-flow under-recovery were to be recouped only from CCL paying
gas customers it would take an additional 12 years beyond the
current 20-year capital recovery period. If the accumulated cash-flow
under-recovery were to be recouped from all customers (domestic
as well as CCL paying customers) it would take 18 months but this
would result in domestic customers picking up 83 per cent of the
under-recovery. Effectively, domestic customers would pay 83 per
cent of the CCL accumulated over that period. Since this will
be the effect, even with the reduced gas levy in Belfast where
there is a sunk investment it will deter anyone from investing
in a natural gas industry outside Belfast.
Moreover, if this were not bad enough, there
is the added uncertainty about the future. The CCL might be increased
in the future, further worsening the position. As a consequence
of the reduced viability of the project and the increased risk,
investors would probably seek a higher return.
In my view the CCL in its present form would
make the expansion of the natural gas industry in Northern Ireland
highly unlikely.
Consequently the UK's CO2 emissions
would be higher by 730,000 tonnes per annum than they need be.
THE CCL AND
THE ELECTRICITY
INDUSTRY
Northern Ireland shares a single market with
the Irish Republic and must compete with the Irish Republic for
inward investment. Both share the attractiveness to an investor
of being English speaking areas within the European Union with
broadly similar skill levels in the workforce. The Irish Republic
can offer substantially lower electricity prices estimated at
28 per cent lower per unit for industry last year. The CCL at
its revised rate widens this gap to 33 per cent.
Moreover insofar as high prices are intended
to be a stimulus to consume energy more efficiently it can be
demonstrated that this already applies in NI.
Finally, on electricity prices the high cost
of electricity in Northern Ireland arises largely from the way
in which the industry was privatised when the money raised per
MW of generation capacity sold was twice the amount raised in
GB. For Government to compound the high prices which it forced
on customers in Northern Ireland by a further price rise is callous.
Conversely, if Government placed electricity customers in Northern
on comparable terms to customers in GB I cannot see any grounds
for objecting to the CCL applying to the electricity industry
here.
NORTHERN IRELAND'S
SHARE OF
ENERGY TAXES
Northern Ireland's different fuel mix means
that it at present pays a disproportionately large share of energy
taxes. This takes several forms:
— About three times the proportionate
share of Heavy Fuel Oil (HFO) consumption results in disproportionate
contribution to the tax raised. Energy users in Great Britain
using gas have hitherto paid no equivalent tax.
— Coal represents 23 per cent of final
energy consumption in Northern Ireland compared to seven per cent
in the rest of the UK. Energy users in Northern Ireland pay approximately
£10m per annum in rates and landfill taxes for ash disposal
and this must be at three times the rate it should be if gas penetration
had achieved GB levels.
— The high cost of electricity is a
direct result of the way the industry was sold at privatisation.
This costs customers about £80m per annum which in effect
is a form of taxation.
— High electricity costs means domestic
customers pay more in VAT than they would in GB. Next year this
excess VAT will cost customers about £2.4m
The above analysis of the disproportionate impact
of the re-designed CCL on Northern Ireland will exacerbate this.
Northern Ireland while facing the highest energy costs of any
UK region will face the most harsh energy tax regime.
Part II—CLIMATE CHANGE MEASURES IN
NORTHERN IRELAND AND CCL DESIGN
A number of steps have been taken in Northern
Ireland to reduce energy consumption and green house gas emissions;
others have been proposed and more are planned. It is in the nature
of many of these measures that they take some time to have a full
effect. This paper lists only those measures which have been taken
by Ofreg. However, many of the policy initiatives taken by DED
and DOE also contribute to combating climate change.
The following steps have been taken by Ofreg
to reduce or facilitate the reduction of CO2 emissions:
— the introduction of £1 per customer
levy for energy efficiency. This will increase to £1.50 this
year and £2 in 2000 and thereafter rise with inflation and
customer numbers;
— incentivising NIE's Supply business
to achieve energy efficiency savings above target figures. Last
year this resulted in a further 25 GWhs savings;
— incentivising NIE's Supply business
to sell renewable electricity to domestic and industrial customers.
This business is now supporting the construction of additional
renewable plant;
— legislating to allow NIE to recover
specified energy appliances/energy efficiency measures from customers,
including prepayment customers on the electricity bills;
— including an energy efficiency allowance
in Phoenix Natural Gas's price control; and
— changing the Supply Competition Code
to facilitate trading by CHP plants and renewables.
The following are underway:
— changes to the long term generation
contracts which would accelerate investment in new plant and reduce
both emissions and fuel consumption;
— securing access to Scottish generation
with the potential of accessing generation with a lower carbon
content; and
— consideration of responses to Ofreg's
proposal that electricity supply companies should have their licences
modified to require them to progressively reduce over a prescribed
time span the average carbon content to their electricity.
— preparation of a consultation paper—to
be published before the end of November—on incentivising
both domestic customers and NIE Supply to consume energy more
efficiently
— A number of licence applications
to extend the gas network to other towns and cities are being
considered by Ofreg. It is widely believed that a CCL on gas will
make the gas distribution elements of those proposal, unviable.
RECOMMENDATIONS
The most effective contribution which Northern
Ireland can make to CO2 reductions is by rapidly expanding
its natural gas industry. This requires a stable framework and
consistent policy support. The only sure way of obtaining this
outcome and avoiding 730,000 tonnes of CO2 per annum
is by applying a derogation from the CCL to the natural gas industry
in Northern Ireland. The principle of applying a derogation to
an emergent gas region is already recognised in legislation which
applies in the UK since such a provision exists in the Gas Directive.
The second most effective contribution would
be licence modifications requiring electricity supply business
to progressively dilute over time the carbon content of their
electricity. This would force investment in more efficient plant
as well as providing a market for both CHP and renewable plants'
potential to dilute suppliers' portfolios. I am confident that
the electricity generation industry in NI can reduce— despite
demand growth—its CO2 emission to less than 80
per cent of its 1990 levels. This would however be facilitated
by Government either not applying the CCL to our electricity supply
industry or removing some of the cost of previous Government policy.
The third most effective contribution would
be to incentivise customers and electricity suppliers to invest
in energy efficiency. This is less likely to happen if customers
must face the simultaneous penalty of higher prices and the up
front cost of the energy efficiency investments. The amount collected
by way of levy from any electricity customer should be reduced
by the amount which that customer has spent on energy efficiency
measures.
SUMMARY AND
CONCLUSIONS
While the CCL design has been improved for GB
the relative position of NI at this stage has worsened. The CCL
will impose burdens on all sections of society here and it will
be perverse in its effect in that it will lead to higher, rather
than lower CO2 emissions.
Conversely, a well-designed CCL coupled with
complementary initiatives taken in Northern Ireland would make
a disproportionately large contribution to the UK targets.
Accordingly it is recommended that:
— the natural gas industry be given
derogation from CCL;
— the electricity supply industry be
either exempted or industrial customers be assisted to achieve
equivalence with industrial customers in GB;
— the CCL everywhere should be rebated
to the amount of an energy efficiency investment in that year;
and
— appropriate agencies in NI including
Ofreg should be required to commit to implementing complementary
measures which will reduce CO2 emissions to a specified
level.
Douglas McIldoon,
Director General, Electricity Supply for Northern
Ireland
2 November 1999
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