Select Committee on Environment, Food and Rural Affairs Minutes of Evidence

Letter to the Committee Chairman from Mr John Healey MP, Economic Secretary, HM Treasury

  Thank you for giving me the opportunity to appear before the EFRA Select Committee on 17 September to explain how we are using fiscal policy to encourage the development of a biofuels market in the UK.

  I undertook to let you have details of what the Treasury sees as the underlying principles in making fiscal decisions on biofuels, and how we reached the conclusion that a 20 pence per litre incentive for biofuels is appropriate. The committee raised some other questions which I promised to look into before reporting back, and I hope that this reply and accompanying information help the committee to understand the principles and factors used by the Government in establishing policy in this area.

  The starting point and foundation stone of Treasury policy on alternative fuels is the environment. Where there is evidence of environmental benefit, we will consider appropriate measures. The main environmental challenges facing the transport sector are air quality and climate change, where emissions from vehicles are significant contributors to both problems.

  On local air quality, the regulation of emissions from vehicles has been successful in reducing emissions by 50% over the last 10 years and we expect tighter regulations to cut emissions from transport further by around a third over the next decade. Nevertheless, hot-spots of pollution in our urban areas will remain a problem and the Government is doing a considerable amount through the Department for Transport's PowerShift and Clean-Up programmes to target action at these areas.

  Equally, the Government is not ignoring the climate change challenge faced by the UK. We are arguably the world leader in making climate change the focus of our policies. The Energy White Paper published earlier this year placed carbon emissions at the very centre of the UK's strategy on energy and set the UK on a course toward reducing our carbon dioxide emissions by 60% by 2050.

  Tackling emissions from the transport sector has to be an integral part of that strategy. Transport causes over 25% of our national carbon dioxide emissions, the vast majority of which is from road transport. Reflecting this challenge, we were the first major country to base our mainstream vehicle taxation system—in other words, company car tax and Vehicle Excise Duty—on carbon emissions.

  The Government recognises the contribution that can be made by biofuels in reducing the carbon emissions of transport. The reduced duty levels for bioethanol and biodiesel of 20 pence per litre below the mineral petrol and diesel rates reflect this.

  In calculating the environmental benefits of biofuels, we took as a starting point the estimate of the social cost of carbon from the Energy White Paper, which set a figure of over £70 per tonne. The calculations (set out for the committee's information in Annex A), as I explained in my evidence on 17 September, suggest that about three pence per litre of the duty cut for both biofuels is justified by carbon reductions. This figure is based on a life-cycle saving of 55% from biofuels. Some studies have suggested that savings could be nearer 70-80%, giving a carbon benefit of closer to four pence per litre. Using the three pence per litre figure translates approximately to a cost of £500 per tonne of carbon saved (£350 per tonne when 80% reductions in CO2 are assumed). Importantly, this figure underestimates the carbon abatement cost for liquid biofuels, since it takes no account of the added expense of the subsidies received for cultivation of the feedstock crops. Notwithstanding this, the costs are high when compared to other carbon reduction options such as renewable energy from wind or wave power or, most pertinently, biomass energy crops.

  It is worth stressing that this is a framework for decision-making; in the Treasury we are pragmatic about applying these ideas. We think it important not to be so attached to economic theory as to be detached from reality, and we will always consider the full range of social, economic and environmental issues.

  Clearly, the Government has a duty to ensure that the duty forgone in promoting biofuels is achieving value for money. In doing this, the industry suggests other factors—such as the diversification of the energy and agricultural markets—should be given a greater weighting. There is no denying that these benefits exist. However, we must remember that other sectors claim similar indirect benefits from their industries, and equally strong arguments might be made for greater support in each of them.

  The committee mentioned the costings that had been received from companies involved in the biofuels industry and asked whether the Treasury agreed or disagreed with them. It may help if I elaborate more on the factors that we might consider when assessing such costings. Obviously, companies in the industry have been keen to put arguments to us that will make as strong a case as possible for an increased incentive. We have also recognised that the extra costs of production for biofuels will vary from company to company, depending on their own particular circumstances, and we are not in a position to question the commercial detail of the estimates we have received from companies such as Cargill and British Sugar.

  Nevertheless, there are universal accounting rules which will affect these figures—for example, the period over which capital is written down. Both British Sugar and Cargill use estimates that assume an amortisation period of five or six years. As I explained to your committee, this was considered to be a very short period over which to absorb such significant capital costs: a 10 or 15 year period would be more common, and this would, of course, have a material effect on the figures. Also, most assessments did not take any account of the effects of capital grants on costs even though a number of Regional Development Agencies have indicated that they are keen to support the development of biofuels.

  The cost of feedstocks was also often, in our opinion, at the upper end of the scale. Again, Cargill gave an estimate for use of pure virgin rape-seed oil. However, if they had suggested using a blending of 20% recovered vegetable oil with rape seed oil, overall production costs would be reduced by two pence per litre. The figures also assume continued high levels of support for crops which are unlikely to be met: reform of CAP, for example, will lead to a reduction in the value of sugar crops which in turn should reduce the costs of ethanol production.

  There is further scope for cost savings from the new processes technologies based on lingo-cellulosic feedstocks. Although a number of these technologies are still several years from being applied on a commercial scale, they hold the potential to provide bigger environmental benefits at lower cost. It is important that Government encourages the development of these technologies, while being realistic about the speed and scale of their introduction.

  During my evidence session, Mr Jack mentioned plans that Argent Energy have for a plant that will produce up to 50 million litres of fuel a year from fats and used cooking oils, and asked whether the plant would in fact be built. I explained to him at the time that it is under construction, and he asked me to double-check that, which I undertook to do. I can now confirm that foundations for the factory at Newarthill near Motherwell have been laid and the plant is still on course to begin production of fuels next year. In addition, I am aware of Global Commodities' announcement that it will build a 180 million litre a year biodiesel plant in Lowestoft. These plans for additional capacity, combined with current production of over 2 million litres a month, constitute 1.3% of total current diesel sales (or approximately 0.5% of total current fuel sales). This means biodiesel is beginning to make a significant contribution towards the UK's climate change objectives and enabling a valuable alternative use for waste oils.

  Finally, Mark Lazarowicz asked about the take-up level for the Bioenergy Capital Grants Scheme. This is a £66 million scheme, jointly funded by the Department of Trade and Industry (DTI) and the National Lottery's New Opportunities Fund (NOF). The scheme was competitive and over-subscribed. In total, 21 projects have been offered a grant under the scheme, ranging from the installation of heat cluster technology and small-scale combined heat and power (with electrical output less than 1 megawatt), to larger-scale projects (of over 20 megawatts) deploying state-of-the-art thermal combustion and advanced conversion technology. A priority of the scheme is to increase usage of energy crops, which must account for at least 50% of the fuel mix in some technology areas. Developers receiving DTI funding are required to spend the grant within 3 years, once all consents are in place. Developers offered support by NOF have until 2010 to complete the spend. Planting of energy crops to supply the projects will not take place until the capital grant has been accepted, the main consents are in place and it is clear that the project is likely to go ahead. Only the heat cluster developments have reached this stage so far.

  To summarise, we are at an early stage in the development of a biofuels industry in the UK and although the early signs are encouraging, we want to make sure that the industry develops in a way that is sustainable. It is in everyone's interest, including the industry's, that we avoid the creation of an entire sector dependent on excessive subsidy. That is why the Government is pursuing a policy of appropriate support, which is already yielding rewards in terms of environmental benefits. I hope that the committee will agree that it is important that the Government takes a long-term perspective on a long-term issue.

9 October 2003

Annex A

CO2 emissions from diesel car (Peugeot 206 1.9D): 144g CO2/km
Fuel consumption of car:5.5 litres/100km or 0.055 litres/km
CO2 emissions per litre of diesel:144/0.055 = 2620 g CO2/litre
Carbon emissions per litre of diesel:2620 x 12/44 = 715  g C/litre = 0.715 kg C/litre
Damage cost of emissions from litre of diesel (valued at £70/tonne carbon): 0.715/1000 tonne C/litre x £70 = £0.050/litre = 5.0 p/litre
Biodiesel saves approximately 55% of CO2 emissions, so value of carbon savings is: 0.55 x 5.0 = 2.7p/litre
Carbon saved per litre of biodiesel consumed: 0.55 x 0.715 = 0.393 kg C/litre
Support given:£0.20 per litre
£/Tonne of carbon saved:0.2/(0.393/1000 tonne C) = £509 per tonne C
CO2 emissions from petrol car (Peugeot 206 1.6): 153 g CO2/km
Fuel consumption of car:6.4 litres/100km or 0.064 litres/km
CO2 emissions per litre of petrol:153/0.064 = 2390 g CO2/litre
Carbon emissions per litre of petrol:2390 x 12/44 = 652g C/litre= 0.652kg C/litre
Damage cost of emissions from litre of petrol (valued at £70/tonne carbon): 0.652/1000 tonne C/litre x £70 = £0.046/litre = 4.6p/litre
Bioethanol saves approximately 55% of CO2 emissions, so value of CO2 savings is: 0.55 x 4.6 = 2.5p/litre
Carbon saved per litre of bioethanol consumed: 0.55 x 0.652 = 0.359kg C/litre
Support given:£0.20 per litre
£/Tonne of carbon saved:0.2/(0.359/1000 tonne C) = £557 per tonne C

1   Assumes 55% savings in life cycle emissions of carbon from biofuels. Note that some studies would suggest higher savings than this. Back

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