Examination of Witnesses (Questions 1-19)
MR JIM
GRAY, DR
MARTIN BIGG
AND MS
LESLEY ORMEROD
21 NOVEMBER 2006
Q1 Chairman: Good morning and welcome
to actually our first evidence session on the EU ETS. Would you
like to introduce yourselves to the members of the Committee and
explain your positions.
Mr Gray: Thank you very much.
I am Jim Gray. I am Head of Regulatory Development. I am also
Deputy Director of Environmental Protection and I am representing
the Director here today.
Dr Bigg: I am Martin Bigg. I am
Head of Industry Regulation at the Environment Agency.
Ms Ormerod: I am Lesley Ormerod.
I am Policy Adviser working on the EU Emissions Trading Scheme
in Martin's team.
Q2 Chairman: Thank you very much. Would
you like to say how you think the scheme is going so far?
Mr Gray: Maybe I could kick off
with a few words and Lesley and Martin can join in. I think the
first thing is to understand our role and then we could give you
some views on how we think the scheme is progressing so far. You
may know this, but it is worth running through it anyway. The
Environment Agency is the competent authority for the ETS in England
and Wales, so we have issued all of the carbon permits, we look
after the monitoring, reporting and verification of the emissions
and we also have enforcement powers, and we run the emissions
trading registry which is the electronic registry which keeps
track of the emission allowances. We do not determine the caps
or the allocations; that role is done by government. Defra is
the lead on the National Allocation Plan and DTI is the lead on
the allocation methodology, so we work very closely with government
and although Defra and DTI lead on the caps, in Phase II we are
doing the calculations on the Phase II allocations for Defra and
DTI to their methodology. In terms of how we think it has gone
and what has been positive, we think the mechanics of the scheme
are in place and working well. There were very tight implementation
timescales which we met, so we think the mechanics of the scheme
are working well, we think industry has engaged very well, we
think the ETS functions as a market and the volume of trades has
grown quite steadily. We recognise that it is the only cross-border
trading scheme in the world and we think it has been successfully
operating. The UK operators, as I said, have engaged well and
they have also been very compliant. We have had 99.6% of operators
submitting their verified emissions reports around allowances
for last year and they did that in April, pretty much on time,
so there is 99.6% compliance in the UK. In Europe, the compliance
is probably not as good, but there is still pretty high compliance
across Europe with something like 6.5 billion euros traded in
2005 across Europe, so I think in terms of the mechanics and the
mechanisms of the scheme, from our perspective, that has worked
pretty well. I think the real issue is about whether there is
scarcity of emissions and how the market develops from here, so
I think that would be our summary of how we see things, unless
my colleagues want to add anything.
Dr Bigg: I think our concern at
the moment is what is actually delivered in the short term and
what it is capable of delivering in the long term. Clearly with
the uncertainty and low price of the carbon, there has been little
adjustment by industry and, unless there is a significant tightening
up of allocations and tightening of the price, we will not see
any significant change in the performance of industry. If anything,
at the moment, with the expectations around the scheme and some
of the changes and investments which have been made, we are actually
seeing some movement to previous positions.
Q3 Chairman: Are there any documented
cases where a particular business has reduced its emissions because
it has been in the scheme?
Dr Bigg: In the short term, no.
What we have seen is some companies, for example, Drax, has invested
time and money in putting in facilities for the burning of biofuels.
But, because of the low carbon price, at the moment I understand
that has actually almost stopped because there is little incentive
to burn fuels other than coal.
Mr Gray: I do not think it is
clear whether we are really seeing any environmental benefits
just yet, but I think it is early days and really this first phase
of the scheme was about bedding the scheme in and getting the
scheme running properly. What it does really bring out is that
the scarcity of emissions and scarcity of allocations is really
the crucial thing. The fall of the trading price, it is down to
about nine euros at the moment per allowance and it was 30 euros
in April and obviously the over-allocations in a number of Member
States is all part of this, so I do not think we are seeing environmental
improvement right now, but it is very early in the scheme of things
right now.
Q4 Chairman: Given that is the case,
are you really saying that Phase I, therefore, will have to be
regarded, the whole of Phase I, as an experimental period and
the earliest we can really hope to see any actual reduction in
emissions being driven by the scheme is in Phase II?
Mr Gray: Yes, I think that is
pretty much the case. I think we have to look towards Phase II
and it is really down to the Commission now to apply pressure
on the plans, the national allocation plans, across Member States
for Phase II. I think that is pretty crucial. The Member States
have all submitted their allocation plans for Phase II back in
August and the Commission have got three months to scrutinise
those, and I think whether we see the benefits largely relates
to how the Commission approaches those Phase II national allocation
plans.
Q5 Colin Challen: I am a bit disturbed
really because we are putting a lot of faith into the ETS, with
all our eggs practically in one basket and a huge amount of confidence,
so I am just wondering if you can be a bit clearer about the short
term and the long term. What is the long-term success—is
it 10 years away or 15 years away? Stern is talking about doing
things, very, very starkly in the Stern Report, in less than 10
years. Are we going to get real, positive results in that period?
Dr Bigg: Our concern is that with
the initial returns from the national states for Phase II, unless
the Commission takes a very strong line, we will see very little
difference between Phase I and Phase II, so the only hope for
significant change will be at Phase III where there are clear
proposals to increase the scope of the trading scheme both in
terms of number of pollutants and the installations covered. There
is also the possibility, for example, of introducing aviation
into Phase II, but, quite bluntly, unless there is a tightening
up on the market and a real price for carbon, then the benefits
that we are expecting will not be delivered.
Q6 Colin Challen: Do you detect an
appetite for that change in the Commission?
Dr Bigg: Yes, we do, we have indications,
but, unless we see something formal, we will continue to work
with Defra in terms of putting pressure on the Commission to do
something about it.
Mr Gray: There have been very
strong statements from the EU Environment Commissioner about the
scrutiny that the Commission will bring to bear on the Phase II
allocation plans. What we are hearing at the moment is that most
of the national allocation plans in the other Member States, on
average, are about 3% tighter than the Phase I plans and I do
not think 3% tighter will really, given the over-capacity across
Europe in Phase I, deliver the kind of downward trajectory we
need to see. This is a bit anecdotal, but the Commission are looking
to and applying, or certainly we are aware anecdotally of some
very strong pressure that the Commission are applying, to specific
members and very robustly challenging their Phase II NAPs. To
come back to your question, the whole thing turns on the Phase
II NAP, otherwise it is beyond 2012 for Phase III.
Q7 Mr Hurd: Leaving aside the Commission
for a time, can I press you a bit about the attitudes of other
Member States. Meeting with one utility company recently, they
said, "Do not underestimate how fragile the ETS is",
because in this country we talk exactly the language of Martin
Bigg about the need to tighten and toughen, "but in Germany",
they said, "the language is completely different and it is
about whether this scheme is going to be around in 2012".
How fragile is the scheme, in your view?
Mr Gray: It is a good question.
Dr Bigg: Certainly the returns
we see from individual countries suggest very different approaches
being taken by them in terms of how much flexibility they are
giving. Our concern is with what is being delivered and the allocation
is being determined in very different ways in different states.
One of the very strong points we are pushing for is transparency
in the means of determining the allocations as well as robustness
in those allocations and, ideally, a common approach in determining
those allocations across Europe. One of the fundamental questions
is how those allocations are made as well, whether it is grandfathering
or auctioning, as that will have a dramatic effect on the price
and how it is implemented.
Mr Gray: We are kind of hearing
the same things as you have said about the German position, but
there are other countries which are more passionate than that.
The Netherlands, for instance, are a very strong advocate. In
terms of your principal question about the fragility of the scheme,
yes, the caps are the important thing, but we deal with the whole
cross-section of implementers across Europe and we have a network.
These are not the guys that are involved in the caps, but they
are the guys that run the schemes in the various Member States.
There is certainly a pretty strong commitment from the implementers,
the EPAs, in the Member States to deliver this and have a strong
implementation and enforcement, certainly at the level of the
EPAs. I think the comments that you were making about Germany
comes from the industrial push, I think, so in terms of how the
scheme works, the mechanics and the cross-European trading, there
is a pretty strong commitment from the European EPAs and the real
test comes back to, as you say, the politics of the allocation
plans.
Q8 Joan Walley: Could you just give
a little bit more detail about the countries which see it the
same way as we do, the sort of alliances that are building up
in terms of where the tension is between perhaps the more industrialised
countries, and the ones who are looking at it more from an environmental
perspective. Who are we working closely with to share our approach
to take it further forward?
Ms Ormerod: Through our work with
other regulators, we work closely with the Netherlands, and the
German regulators are involved in some work that we are doing.
This is focusing on the practical implementation of the scheme
rather than setting caps or NAPs, it is on the sort of nuts and
bolts of implementing the scheme. There are 17 Member States we
have worked with over the last 12 months, out of the 25, looking
at the practical implementation issues and trying to come up with
common approaches.
Mr Gray: We see a lot of enthusiasm
at the EPA level. I think, to try and come back to your question
about who is really committed at the political level, clearly
the Netherlands are and they show a lot of leadership, but I was
going to come back and maybe an easier way of answering that is
saying who were the five Member States that had a deficit of allowances
in 2005, the ones who, in order to get allowances, had under-allocated,
and it is probably a pretty good test, I think. Those countries,
and Lesley will check this, were the UK, Spain, Italy, Ireland
and Austria, so I would suggest that if those were the countries
that had a deficit of allowances, they are probably the ones that
are most committed to the overall position, but that is partly
speculation. It is encouraging that there were five, but then,
as you say, there were quite a lot which had over-allocated.
Q9 Dr Turner: Looking at the outcome
of the first year of Phase I, it would look as if the UK is the
only major industrial country which has taken carbon abatement
seriously in this scheme. It has cost us nearly 500 millions,
but has it actually led to any more CO2 abatement at
all or has it simply subsidised the countries who have been over-allocated
and who have not actually had to change their behaviour one little
jot? Has it actually saved a single tonne of CO2?
Mr Gray: Can I just check the
figure you said there? You said—
Q10 Dr Turner: This is the figure
I have in front of me and it may, or may not, be correct and I
would be very grateful if you have more accurate figures.
Dr Bigg: We do not have any detailed
figures of the impact on the UK economy of particular companies.
I would simply draw a parallel, as my colleague Jim Gray has done,
with other countries in similar positions. We are aware that there
are other countries, which have had significant surpluses and
not had to recover, or trade to cover, their costs, but we would
not have learnt from these perhaps shorter-term impacts on the
market. If we get a robust market in place and real trading going
on, then that impact will be more even across the European Union,
which is where it comes back to the importance of setting the
targets and having a real market.
Q11 Dr Turner: Can I come back to
the purport of my main question which is: how many tonnes of CO2
do you estimate were reduced over the whole area of the scheme
in its first year of operation, if any?
Dr Bigg: We have seen no change
in UK performance over the past year and, if anything, the market
has been driven more by the price for fuel than by the cost of
trading CO2, so the answer is no, we have not been
aware of any significant impact.
Q12 Dr Turner: So a scheme which
is designed to reduce carbon emissions has, in its first year
of operation, not had any effect?
Mr Gray: I am not clear. It is
difficult for us to give a very black-and-white answer. Lesley
here is pointing to something else which suggests there have been
some reductions, but of course the cold winter and switching from
gas to coal has an impact on this, so I could not give you a black-and-white
answer on cause and effect, it is much more complicated than that,
and I do not know if it has saved any or not. I know that winter
coal switching is pretty significant because of gas issues over
the winter, so I cannot give you a black-and-white answer, but
I would just come back to that it has to be the longer gain and
the number of nations trading in this. There is no other scheme
in the world where one nation trades with another, let alone so
many in a single European scheme, but it is early days and I cannot
give you an answer in black-and-white terms as to whether it has
saved anything or not.
Q13 Dr Turner: Can you explain what
seems to be the outstanding mismatch between the UK's allocation
and its actual emissions, 27 million tonnes of CO2
more than the allocation?
Mr Gray: I think that was largely
down to the fuel switching. Most of that was on the power generators.
Dr Bigg: It basically comes down
to the price of fuel and, with the price of gas going up, a significant
increase in the burning of coal and, therefore, higher coal consumption.
That was a far bigger driver than the cost of buying additional
CO2 allowances.
Q14 Dr Turner: Given that I do not
remember hearing any squeals of pain from the generators during
this year, it is obvious that the actual effective price of carbon
today is not enough to deter them from whatever they were doing
and certainly not enough for them to invest in abatement. Therefore,
what is your view on the price of carbon? It clearly is not sufficient.
Can the ETS deliver a price of carbon that is (a) sufficient to
influence investment and (b) high enough and stable or remotely
stable and predictable? Can it do that?
Dr Bigg: The straight answer is
yes, if there is a real market. I cannot come up with a particular
figure as to what the price of carbon has to be, but clearly there
has to be a real market where there is a shortage of supply in
carbon and, therefore, real trading such that there is a realistic
price and, therefore, that is taken into account in determining
operating costs, ie, the cost of carbon is internalised in the
processes. At the moment we do not see that happening, so, precisely
as you say, it is not having a significant impact.
Q15 Dr Turner: How many years do
you anticipate it will take to achieve that?
Mr Gray: These are precisely the
questions to be asked and I congratulate you. These are exactly
the questions and one would hope that the European Commission
is asking those same questions in a very robust way. The whole
thing turns on the scarcity and the allocations. My feeling, and
this is a feeling, is that the current carbon price of nine euros
an allowance is not going to drive reduction or abatement. Before
it was apparent there was a market surplus, the April price of
30 euros per allowance or per tonne feels intuitively more like
the kind of figure that would drive reduction because that is
a figure that operators were entering almost blindly without knowing
the market and whether there was a surplus or not. Operators did
not know whether there was a surplus and they were trading on
a commercial value basis and that market was around 30 euros a
tonne. That intuitively feels about right. You will not get that
kind of price without creating the scarcity. The UK Government
can create a scarcity in the UK allowances, but you still need
the whole European position to be a real market and to have the
scarcity, I think.
Q16 Dr Turner: Is it not fair to
say that this is a very complex and not very transparent process,
somewhat open to abuse, and would it not be simpler and clearer
if we achieved a fixed price for carbon by a carbon tax? Would
it not be much more effective as an investment driver?
Mr Gray: That is for the Government
as the Government issued that scheme, not the Environment Agency,
but inherently, if it is working correctly, the theory is that
trading should give you more reductions per euro than the tax
will because the trading drives the reductions to the lowest cost
and then you can get more reductions for unit cost, so the economic
side of this, and I am not an economist, you would have to ask
the Treasury or the Government, but the economic side of this
really does say that trading would drive it.
Chairman: We will ask the Government
about that.
Q17 Colin Challen: As you have said,
the Environment Agency is responsible in Phase II for calculating
the emissions from individual installations. I wonder if you could
say a bit more about how you would go about doing that. How do
you obtain the information and how do you verify it?
Ms Ormerod: We effectively turn
the handle on the calculations for the Phase II installation level
allocations, but that is done following instructions and in accordance
with allocation methodologies that are provided by Defra and DTI,
so in that respect we are just really number-crunching, if you
will. For the Phase II National Allocation Plan, unless there
were significant changes in installation levels, then baseline
data from Phase I was used and that is independently verified
data. Effectively, Defra would set the overall cap for UK industry
and then that is chopped up into the individual industry sectors.
Q18 Colin Challen: Who independently
verifies it?
Ms Ormerod: Third-party verifiers.
They are independent verification bodies.
Mr Gray: When the operators submit
their returns to us, they have to be independently verified by
a third-party verifier, so the returns we get, we do not go out
and check every single return, but we do some sampling and auditing,
so the returns we get for the emissions from the different installations
come pre-verified, if you like, with independent verification
engaged by the company. That was part of the design that Defra
established, and we do some checks on that.
Ms Ormerod: It is the same for
the baseline data that goes into the allocation calculations.
That is also independently verified by private companies.
Q19 Colin Challen: On the independent
verification, there are enough independent verifiers, are there,
to do the whole job? In the building industry, for example, which
is quite separate, I know, but we tend to find that there are
not enough inspectors to do the job, so these independent verifiers
are able to go and visit sites, to interview people and to take
measurements themselves or do they rely on information which they
may think is correct or not coming from certain installations?
Ms Ormerod: I am not so sure about
doing measurements themselves, but they go in and they audit.
It is fairly detailed auditing of operator records and how they
have come up with their figures, so yes, and they have done it
for Phase I.
Mr Gray: There are standards for
the verifiers that we agree and the verifiers are accredited to
the standards that we have agreed with, and I guess it is with
UKAS.
Dr Bigg: There is a very detailed
methodology spelled out by the Commission as to exactly how this
is undertaken, which we have then added to in order to prescribe
very clearly to operators and verifiers exactly what procedures
they have to follow to ensure consistency across the UK.
Mr Gray: I would come back though
to how we are calculating the Phase II UK cap. As Lesley has said,
it is Defra's and DTI's methodology and I think it is a better
methodology than for the Phase I because there is more benchmarking
in it than previously.
Ms Ormerod: Most industry sectors
have been allocated through the grandfathering methodology for
Phase II which was the same approach taken in Phase I, although
the large electricity producer sector has been benchmarked for
Phase II and there has been some other new entrant benchmarking
done for Phase II as well.
Mr Gray: So with Phase I people
were given allocations virtually based on their history and business-as-usual
projections and part of that is just standard practicality, whereas
in Phase II the biggest emitters are the large power stations
and we are looking more at what is achievable, what is the benchmark.
Grandfathering favours people who have not done so well in the
past and they are just allowed to carry that practice on, so we
are doing more benchmarking for the big emitters. If you look
on a risk basis or a targeted basis, it kind of makes sense to
target the big emitters for the benchmarking exercise because
the big emitters emit, I do not know what the figure is, the majority
of the CO2.
Dr Bigg: The large emitters contribute
around 70% of CO2. It is about 40 individual plants
which make the biggest contribution, so clearly the biggest burden
will fall on them and, proportionately, the biggest reduction
will be coming from that sector. Just to stress one point, although
the whole model for the allocation plan is clearly one for Defra,
another aspect which Defra have built into their scheme is to
provide more favourable allocations for CHP plants.
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