Examination of Witnesses (Questions 400-419)
MR ANDREW
PERRINS AND
MR MARTIN
JOHNSON
10 MAY 2006
Q400 Chairman: Let me just stop you.
You used the word "key". How do we rank in the various
stratagems the use of biofuels?
Mr Johnson: There are different
measures that Government has used, both in the Energy White Paper
in 2003 and then in the review of the Climate Change Programme
this year. You can look at measures like the lifetime cost of
carbon abatement per tonne of carbon and I think that would be
the key measure that you would use. If you take in that measure
things like domestic or business energy efficiency would score
very highly. They would have a positive net present value. Things
like onshore wind would score better than offshore wind, for example,
and then you would have a ranking perhaps within transport where
biofuels would be relatively competitive compared with, for example,
the latest assessment of hybrid technologies or the use of hydrogen
in internal combustion engines.
Q401 Chairman: Is that ranking that
you have described in relation to a trade-off of carbon savings
for every pound of the public purse that is used to stimulate
the development of the particular area that you have described?
Mr Johnson: It is not so much
the public purse; it is the resource cost to the economy so it
is, if you like, regardless of whether it is from the general
taxpayer or through consumer payment or whatever the funding route
is. It is a measure of the resource cost and that is the analytical
basis on which this is looked at.
Q402 Chairman: For example, when
Sheffield Hallam did their work on looking at the relationship
between what you got for each pound of public money spent on energy
savings, loft insulation was streets ahead. You have talked about
different returns. Is there a piece of paper on which somebody
ranks all of these returns so that we can see where in the pecking
order bioenergy comes? The reason I ask that question is that
if you look at the second annex of the Biomass Task Force report
there are two pages of itty-bitty little schemes stimulating this,
that and the other thing. There are no outputs against it, in
other words, what is the rate of return for this, what are we
trying to achieve, how much carbon are we saving from the use
of biomass in that context? Therefore, in terms of policy I am
left wondering whether this is seen by the Treasury as a bit of
a nuisance but something you have to do because it is all bitty
and very difficult, whether it is an environmental necessity because
you have to have a broad portfolio of routes in to reducing greenhouse
gas emissions or whether you think there is a strategic benefit
because it does affect energy security. I am still not clear where
in that ranking the use of bioenergy comes. Can you shed a little
more light on it?
Mr Johnson: The commitment to
biofuels from the Treasury is very real. We brought in the duty
incentive for biodiesel in 2002 and for bioethanol in 2005, and
I think Treasury ministers, along with those in the Department
for Transport, Defra and DTI, have been very much at the centre
of the policy development process and the Renewable Transport
Fuel Obligation announcements, both in the PBR[1]
and then at the time of the recent Budget, have been symbolic
of the Treasury's engagement with biofuels. That is the first
thing: the Treasury commitment on biofuels is genuine. In 2008-09
the cost of the 20p duty differential is expected to be about
£300 million based on a market share of 2.5% biofuels. Just
on that point, I think the commitment is real. In terms of the
ranking point, you made the point about loft insulation. My understanding
is that what you said is right: it is one of the very best things
that you can do, but there are only so many lofts that you can
insulate and you do need a broad range of policies, some of which
deliver now, some of which deliver now but also—and this
is the case for biofuels I think—should deliver more savings
in future more cheaply, and that is where there is a strategic—
Q403 Chairman: You can see why I am asking
the question, because one of the things we have to derive from
the report is to talk about whether in fact we think the amount
of support to pump-prime and stimulate this innovative and interesting
area of energy is sufficient but it is very difficult for us to
do that in an informed way unless we have something that enables
us to rank it in terms of what we get for the expenditure. If
there is any information you can give us to help us put into context
what you have just said it would be helpful. You mentioned the
20p duty derogation. Why did you decide 20p was the right number?
Mr Johnson: The 20p has been there
since 2002. I think the assessment that ministers made was that
20p was the right level which would balance on the one hand giving
enough incentive so that you will begin to move the market, because
if you do not do that then it is not worth having, but on the
other hand balancing what is felt to be an acceptable cost to
the Exchequer in exchange for the carbon savings.
Q404 Chairman: With respect, Mr Johnson,
you have not actually answered my question. You said that ministers
had decided. Ministers do not decide anything unless somebody
gives them some information to make a decision upon, and somebody
in your area of the world must have sat down and done a calculation
because, for example, at the pump the price differential of biodiesel
versus ordinary diesel is perhaps a pence or two a litre, hardly
any difference between the two, notwithstanding the fact that
there is a duty derogation of 20p. Some people suggested at the
outset that it should be 27p or 30p; that was rejected, but I
have never understood why 20p was deemed to be the right number.
Mr Johnson: Without wanting not
to answer the question, I must say I was not in post at that time
but my best guess would be that an assessment was done on the
additional resource cost of biofuels and that 20p was viewed to
be an approximation of the additional cost of production and therefore
a fair duty discount to offer.
Q405 Chairman: That is an ex post
rationalisation of it and it is not a bad stab but it might be
the case that some could have argued that you needed to be a little
more generous at the pump to encourage people prior to the arrival
of the Renewable Transport Fuels Obligation to use this material
against a background where, of the sectors where greenhouse gas
emissions were rising, the domestic sector and the transport sector
are the two which have been going up. If you cannot answer it
now because you were not in post I fully accept that, but I think
the Committee would find it very helpful to have a little more
detailed information as to why 20 was deemed to be the right number
and why, in terms of encouraging the uptake of this ahead of the
RTFO, nothing more than 20p was given. Against that background
you were very generous on LPG and as a result got an infrastructure
in place and then gradually backed off the amount of discount,
but you have not done that with biofuels and I think the Committee
would be very interested to know about that.
Mr Johnson: I am happy to provide
a note on that, and also, in terms of the ranking of policies,
there is material that has been published but again I am happy
to provide a note on that one which draws together the best material
that we have on that.[2]
Q406 Chairman: You have taken a pretty
hard line view on unprocessed biofuels. You have given no discount
to encourage uptake of that at all. Why?
Mr Johnson: The requirement to
get the 20p discount relates to the legislation in the Hydrocarbon
Oils Duty Act. That legislation sets out a definition of "biodiesel"
and it has four parameters. One is that the fuel must be of diesel
quality; secondly, it must have an ester content of 96.5% or more;
there is a sulphur limit, and also it must come from biomass sources.
We announced at the Budget that we would review the definition
as it stands but, to try and answer your question directly, the
concern is on the one hand to reward fuels that offer an environmental
benefit because we want to encourage those for the climate change
benefits that they give you, but on the other responding to concerns
that there might be, both from car manufacturers worried about
engines, and indeed motorists, and then other biofuel producers
who may have concerns about quality and a level playing field.
You will be aware that there have been MPs, companies and others
who have questioned the current interpretation that Revenue and
Customs have made of the legislation in certain parts of the country.
Plymouth Biofuels are one company in that position, with whom
I had a meeting this morning as part of this review, but we said
at Budget that we will look at this and we expect to do that over
the summer.
Q407 Chairman: What is the Treasury
stance with reference to flexible-fuel vehicles? Ford and Saab
have got these vehicles available. Ford are making them more generally
available in the United Kingdom. Here we are moving to bioethanol
as opposed to biodiesel and there is a novelty in the technology
that is available: there are not warranty issues, the car is £200
more expensive than a normal one. Hardly an inducement to buy
cars like that is given through the duty discount in terms of
the road fund licence It is a bit half-hearted in response to
a bit of really good technology. From the Treasury standpoint
why are you not giving it a bit more of a push?
Mr Johnson: In countries like
Brazil principally and Sweden increasingly within Europe this
is a technology where the manufacturers and the infrastructure
have responded. We know that in Brazil, for example, the great
majority of new vehicles sold are flexi-fuel vehicles. Companies
like Ford and Saab are now beginning to bring models onto the
market. You have got the Somerset project going on. In terms of
the Treasury's response, the Renewable Transport Fuel Obligation
is the central government response to biofuels generally and the
way that mechanism will work is that it will offer incentives
for E85 as much as 5% blends, in that the way the certificate
trading system works should provide some incentives for E85. To
some extent it is up to the market how that biofuel, that 5% by
volume, is distributed. I know we have had representations just
recently to look again at the company car tax framework and to
look at other incentives. Of course we will look at that, but
one thing I would say is, okay, Sweden is ahead of the game, but
this is a relatively new area within the rest of Europe. It is
something which departments are beginning to look at seriously
now and it is something that we intend to look more closely at
over the coming months. The RTFO is the key mechanism which will
support biofuels generally.
Q408 Chairman: But, for example,
when the Government moved strongly to remove lead from petrol
there was a very clear price signal given in the discount between
the two forms of fuel. Here we have a virtually indistinguishable
discount and nothing much else in the pot, and yet motor manufacturers
have got some proven technology available in the market place.
The point that is being made to us is that if you are going to
get people to move to more environmentally friendly technologies
you have to give them a little bit of inducement because it is
new and novel. I suppose it is about sharing the risk. Let me
ask this question. At Gleneagles it was said that ministers were
going to be moved around in flexi-fuel vehicles. If it was good
enough for ministers then what are you doing with the government
car fleet? Has the Treasury said, "We have got to move to
flexible-fuel vehicles in the government car fleet"? Has
the Treasury got any?
Mr Johnson: I believe the Chancellor
now has a hybrid vehicle.
Q409 Chairman: But not a flexible-fuel
vehicle?
Mr Johnson: No, that is correct,
but any more than that I could not tell you. That would be a procurement
policy issue rather than one that would come to me. Ministers
have certainly purchased greener cars, perhaps not flexi-fuel
vehicles though.
Q410 Chairman: So we are a little
bit behind the weekend at Gleneagles in terms of the Government.
Let me just move to the conclusion of this section of the questioning.
We have a buy-out price for the RTFO. I am interested to know
what economic modelling the Treasury has done to see how much
potential investment money at your 15p a litre discount is going
to be generated as a result of this. In theory, if all the fuel
companies were able to source properly there should not be any
money from the buy-out, but how many do you know are relying on
investment capital from the buy-out? Why did you settle at 15p?
Why was that number chosen?
Mr Johnson: Maybe I can just take
a step back and say a little bit about the package of announcements
and how the different incentives will work together. What we announced
at Budget was first the target levels for RTFO were 2.5% biofuels
in 2008-09, 3.75% in 2009-10 and 5% in 2010-11. We announced that
the duty incentive would be maintained at 20p in 2008-09, and
that is the first year of RTFO. Then we also announced that the
buy-out price would be 15p in 2008-09. That means that in the
first year of RTFO you will have 20p duty incentive and you will
also have an additional incentive of 15p per litre buy-out. What
that means is that where companies fail to meet their obligation
they will have to pay a 15p per litre penalty. That means that
not only do you have a 20p reward but you also have an additional
15p disincentive, and if you take the combination of these two
things that is a significant step forward from simply having a
20p incentive, which is where we are now. We also announced that
that combination, that 35p, would be maintained in 2009-10 before
reducing to 30p in 2010-11 but without specifying how the package
would be split. To answer your question about who is relying on
buy-out payments, the answer to that is that nobody should be
relying on buy-out payments. The mechanism is not designed such
that people should rely on payments. It is more that if people
choose to buy out rather than meet the obligation they will have
an additional penalty, if you like, which is that their rivals
who have met the obligation will receive that penalty money—
Q411 Chairman: That does not actually
answer the question I have asked though. You are doing a very
good job of driving away from the question so let me bring you
back. The question I asked was, why 15p? Why did you decide that
was the right number? Let me add to that. In terms of the length
of time that the capital assets involved in the production of
biofuels would be operating do you consider that the timetable
of the fiscal regime you have outlined is sufficiently long to
give certainty to investors?
Mr Johnson: The way the 15p was
derived was to do with a study which Climate Change Capital did
for the Department for Transport last year. They recommended that
a combination of support within the range of 25-30p was required
to shift towards biofuels to make it economic. That was their
view based on the additional resource cost of what companies needed.
Ministers took the view that rather than just have a combination
of 25-30p duty and buy-out they would go beyond that and offer
a combination of 35p duty and buy-out in the first two years,
so the 15p was added to the 20p that was there and got you to
35p, and that was more than the study that Climate Change Capital
recommended. That was how the 15p was derived. It was based on
the assessment that Climate Change Capital did and that Graham
Meeks, who was with them at the time and I know has given evidence
to the Committee, refreshed that analysis in his new role in January/February,
and he came back to us and that evidence suggested that a package
of roundabout 30p was sufficient. Ministers decided they would
give this mechanism an additional kick-start and go a little bit
further than the 30p with a 35p combination, and that was how
the decision was arrived at.
Q412 Lynne Jones: What about the
length of time that it is going to take?
Mr Johnson: Sorry; that was the
other part of the question. You also asked about the long term
nature of this package. I think it is important to say that in
terms of duty the duty incentives are for three years. The view
was taken by ministers, based on what they had heard from the
industry and what they had heard from investors, that three years
was insufficient to deliver in an industry where capital assets
are basically repaid over up to 10 years. That is the key benefit
of RTFO. That is why RTFO is a very significant step forward.
You are talking about a long term mechanism. I think the DfT feasibility
report talks about 15 years. This is a mechanism which gives the
certainty to industry that they said they needed as well as the
financial rewards that should reflect the additional cost of biofuels.
Q413 Chairman: Can I just ask whether
the calculation that you do on these matters is updated to take
into account what must be additional revenue coming back to biofuels
producers by virtue of the rise in the hydrocarbon fuel price?
Mr Johnson: The short answer is
yes, it is.
Q414 Chairman: It is an interesting
question that comes out of this. When the 20p duty derogation
was set, I think some two or three years ago, prices of hydrocarbon
fuels were probably in the mid-70p's. Now they are nudging a pound.
What calculations have you done to show the extra revenue that
is going in? I go back to my point that the pump differential
appears to be hardly any different and yet the margin above where
these differential prices were set has widened perhaps to 10p
or 15p a litre. Have you done any modelling to look at the increased
cash flow? Am I right in thinking there should be increased cash
flow?
Mr Johnson: At first glance you
would think that would be the case. Where the complexity comes
in is that increasingly we have seen the biodiesel market price
start to track the crude oil price. What you have is that as the
oil price rises the biodiesel price tends to follow it, so where
you would expect to see a margin open up it does not necessarily
happen. There is volatility in the biodiesel/biofuel market as
there is in the oil market. In terms of the question on modelling,
yes, it is updated. We do work with Defra, we do work with the
RIA[3]
and we do take account of this, but because of this tracking and
the linkage that you can see between these prices these margins
do not always operate in that way.
Q415 Chairman: But the raw material price
for making the fuel has not followed the oil price, has it?
Mr Johnson: Not necessarily. I
am not an expert on this.
Q416 Chairman: Mr Perrins, can you
help us on that?
Mr Perrins: One factor that has
changed on raw material prices would be the very high increase
in the world sugar price we have seen over the last year which
is a significant factor in determining the bioethanol price.
Q417 Chairman: But not biodiesel.
Mr Perrins: Indeed.
Q418 Chairman: That is the bit I
am interested in because in terms of UK manufacturing capacity
there is visibility on that. There is zero visibility on bioethanol.
Mr Perrins: The demand for biodiesel
as well as bioethanol has also significantly risen on the UK market,
the European market and the world market over this time frame.
We are seeing, for example, very strong demand for raw materials
around Europe, which would be rape seed, for example, or sunflower
seed in Mediterranean countries, to go into biodiesel production
which is moving ahead very rapidly in certain parts of Europe
such as Germany and Spain. That demand increase is clearly impacting
on the raw material prices and as a consequence the price of biodiesel
itself.
Q419 Mr Drew: Speaking as someone
who was persuaded to buy an LPG vehicle, we went through a similar
problem in that the differential never grew because LPG seemed
also to increase despite the fact that it is a so-called waste
product. What is never taken account of is that you get a much
lower level of performance from an LPG vehicle which means that
you use twice as much of it. It is a nice notion that you really
are encouraging the user by giving them a price differential but
when you have got an existing vehicle and you just put biodiesel
into the fuel I wonder whether it makes any difference to the
performance which then counteracts the benefit you might get in
terms of a lower price.
Mr Johnson: I think with biofuels
at 5% blend, which I think is what you are going to see—
1 Pre-Budget Report Back
2
Ev 183, A. Back
3
Regulatory Impact Assessment Back
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