Examination of Witnesses (Questions 165-179)
DR ANTHONY
WHITE AND
MS KATHERINE
HAMPTON
28 NOVEMBER 2006
Q165 Chairman: Good morning and welcome
to the Committee. Thank you very much for coming in. I am sorry,
we are running over time. Would you like, by way of introducing
Climate Change Capital, just to say a word about what the organisation
does and, in particular, the kind of projects that you invest
in?
Dr White: Certainly. We are a
banking company. We buy products and services to governments,
corporates and financial institutions all associated with climate
change. We have three parts to the company. We have an advisory
bit, which I lead, where we provide advice to governments about
how to design policy to make you meet your objectives rather than
the law of unintended consequences in the environmental area,
we advise companies on raising money for bio-fuel refineries,
we have recently advised Progressive Energy on the advanced coal
power station with combined carbon capture and storage, so I was
interested to hear those comments there—that is happening—and
we advise companies on energy efficiency measures as well. We
also have a markets fund that has almost a billion dollars under
management to invest in clean projects under the Kyoto Protocol
and maybe under voluntary arrangements to invest in emission reduction
rights which we can then sell. Also, in order to get the rights
you sometimes find you have to invest in the projects themselves,
and then you have got to also invest in the development companies
to get the projects in the first place, and so we are quite heavily
invested in China, India and Brazil. Then we have a small investment
arm where we run Ventus, which is a small venture capital trust
for small renewable projects in the UK ultimately. We started
off three years ago with four of us; we now employ 100 people.
Q166 Chairman: That is impressive.
The City of London published a report not long ago which was very
bullish about the potential growth in what was described as "the
climate change industry", in a broad sense. I guess you probably
share the optimism which that expressed. Do you think that is
yet reflected in the level of investment that has taken place
in low-carbon technologies.
Dr White: No. Shall I expand?
Q167 Chairman: Yes; do.
Dr White: There is investment
going in, but I think one of the problems we are facing is the
Emissions Trading Scheme in Europe, which is a great scheme, I
believe, and I think it is what we should work on; but the first
phase of the scheme only had three years visibility and the rest
of the scheme was only out until 2012, and it is difficult to
find investments within Europe that would give you a sufficient
return in that short period. So what has happened is, even though
it was our submission that said there has been very little change
in behaviour in Europe, next to no investment in Europe, driven
by a carbon price, we have seen the investment in the developing
world because it is much cheaper to invest in carbon, and so you
can get a return within three years, or certainly within seven
or eight years, and so that is where the money has gone. What
we need is a longer-term visibility on the price and then I think
we would get the investment, but here is where I may part company
with other people. I think, even if I had my dream to think we
had a world carbon price administered by some world organisation
that bought and sold allowances according to where the price was
going to meet some overall objective, I am not sure that would
be fast enough. The reason for that is that we have oil prices
of $60 a barrel, or higher, maybe a bit lower, but nobody invests
in oil projects that need $40 or more to make a financial return.
In other words, people take a haircut on the price, and I expect
that to be exactly the same for carbon. There is nothing wrong
in that, but I think over the next 10 years we will be doing quite
a lot of investment, particularly in our electricity infrastructure,
which I know a bit more about, and I am worried about making investments
where the carbon signal is not getting through and we end up with
the wrong kind of technology, and once it is built it is built
and can last 30, 40 years. So, I am keen for us to have something
else to augment the current EU ETS price to get people to be more
willing to invest.
Chairman: Incidentally, we are grateful
for the memo which you sent the committee, on which I drew very
heavily for a speech I had to make in America the other day, but
what you have just said I think leads quite naturally on to what
Martin is going to raise now.
Q168 Mr Caton: WWF have submitted
evidence to us on the use of Clean Development Mechanism and Joint
Implementation credits in the EU ETS. They argue that unless use
of these credits is tightly limited, there will not be enough
investment in carbon abatement in the EU. What are your views
on the use of these credits and how do you see the Commission
approaching this issue in their current review of the scheme?
Ms Hampton: There are a couple
of things that you have to bear in mind. One is that supplementarity
is required by the Kyoto Protocol, and so the Commission is required
by international law to enforce limits on the use of the flexibility
mechanisms. That is the first point. The second point is that
it depends what kinds of projects you are looking for. Originally
the Clean Development Mechanism was designed to have two objectives:
one of those was abating carbon and the other one was sustainable
development. It certainly achieved the objective of abating carbon
equivalents around the world by hoovering up the lowest cost reductions,
but on the issue of sustainable development, because there was
so much low-hanging fruit that you could achieve through end of
pipe solutions, the longer-term infrastructural change, or waste
managements projects, or other projects through the CDM have not
yet materialised, for the same reasons that Tony was explaining,
lack of long-term visibility. Again, when you are talking about
infrastructural change in developing countries, you also need
long-term signals for those projects. So, what applies to the
EU ETS in terms of lack of visibility also applies to the CDM.
We are very much of the view that if you are investing in carbon
abatement projects, it does not matter where that happens in the
globe, but what you have got to work out with policy-makers is
what is your objective. Is it to achieve the lowest cost reductions
at high volume and low-cost, or is it to achieve the slightly
more complicated investments where you are using carbon price
as a carbon finance tool rather than as an offset mechanism; and
if you are seeking to do that, then you need to have integration
with energy policy and you need longer-term signals. If you just
have the ETS and the entire burden of climate policy is resting
on this one instrument, it will force out the lowest cost reductions.
It has been very effective at doing that. When it comes to setting
caps on Clean Development Mechanism projects, for instance, within
Europe, the question is: what are you trying to achieve? By just
setting a cap on the use of CDM because there is a lack of long-term
visibility, you will force up the price of reduction within Europe
without driving long-term investment. What you need is a combination
of supplementarity signals, on the one hand, which show you where
Europe is trying to send its money, and, on the other hand, long-term
signals that mean that the investments, either in Europe or overseas,
lead to long-term infrastructural change.
Q169 Mr Caton: Are you saying that
the WWF, in calling for tighter limits on credits, have oversimplified
things?
Ms Hampton: I think it is oversimplifying
things, but I think that their attachment to the supplementarity
principle under the Kyoto Protocol and the leading enforcement
of that is something that the Commission is bound by. Of course,
the Commission does have to set those caps, but we believe that,
without a long-term signal, setting those caps will not actually
result in the objective that they are intending to achieve.
Q170 Mr Caton: Another concern that
has been raised with us about CDM credits is that a lot of the
investment is going into reducing emissions of exotic gases such
as HFCs. You have addressed this in your submission to us and
said that the opportunities for abating exotic gases are likely
to dry up. Can you tell us a bit more about that and what it is
likely to mean both for the CDM and the ETS?
Ms Hampton: HFC23 destruction
is a big volume of projects. Basically, when you produce an ozone
depleting gas HCFC22 you have this by-product called HFC23 which
has a very, very high global warming potential, thousands of times
more powerful than carbon. In overall emissions terms it is actually
quite small, but the individual molecules of the gas are very
powerful, and so, obviously, that provides you with a little bit
of investment and very, very high returns because you get a lot
of carbon credits that you can sell from it. A lot of those projects
are very easy to do, they are less than 20 cents a tonne to reduce,
very, very high volume projects. They will dry up, but that will
depend, in part, on a decision that will be taken in the context
of the UN climate change negotiations, which has been delayed
from Nairobi to the next one, which is about compatibility between
the Montreal Protocol and the Kyoto Protocol. I can go into that
in detail if you are interested, but in a nutshell the door is
not quite closed on more of those projects coming into the pipeline.
If they do, those will clearly delay investment in things that
are further up the abatement curve, that are a little more costly
and maybe are more in line with sustainable development.
Dr White: One other thing that
I would add to that is that these HFC23 type projects deliver
tens of millions of tonnes each. When they have gone, you have
then got to look to projects that are doing one or two million
tonnes a year each, much, much smaller; so the upfront cost of
developing these projects gets a lot more difficult, and that
is why you are looking for the CDM Executive Board maybe to do
more of a programmatic kind of CDM where, once you have got the
methodology done and you have got this kind of process approved,
then you can turn the handle and these things will pop out. Otherwise,
if you have got to start looking at very small projects, it is
going to be much more difficult to justify the overheads for getting
those emission reductions. So it is a concern, and I am concerned
about that.
Q171 Mr Caton: Can you give us a
ball park figure for the timescale for the dry up?
Ms Hampton: It depends on the
decision that will come out of the UN Framework Convention out
of the Kyoto Protocol negotiations. If they decide that new HCFC22
plant should not be eligible for CDM crediting, then there are
still quite a few projects out there and those projects will probably
dry up in the next couple of years. If there is an open door on
that, and that depends on negotiations under the Montreal Protocol
as well as the Kyoto Protocol, then those projects could go on
for a long time, and most of us think that would have a detrimental
effect on the carbon market, not just because of the high volume
of credits and it delaying other investments, but also because
it could encourage greater production of ozone depleting substances.
Q172 Joan Walley: I have to admit,
listening to some of the evidence that we have heard this morning,
it almost seems as though we are all having to learn a new language
and a new way of understanding the world, so please bear with
me. What I am trying to get to the bottom of is that there are
some commentators, and I think the City of London recent report
was one, which say that there has been a lot of trading, and yet,
from the evidence that you have given to us, my understanding
is that you are saying there has not been anywhere near enough
trading and that there is a real reluctance by those who have
allowances to actually use their excess allowances for what the
scheme was aimed at in the first place. Could you perhaps help
me to understand this in layman's terms?
Dr White: I think you have to
differentiate between trading and people changing their operating
behaviour and actually emitting less greenhouse gases. Yes, we
are seeing a lot of trading whizzing around the markets. A short
anecdote: I did not understand why the carbon price was only 20
or 30 euros a tonne when calculations said it should be 60, and
I said to my trader, "Why is this?" and he said, "Well,
you guys pay us to come here and trade and if we do not trade
you think we are not working, so if the gas price moves a little
bit, I move the carbon price a little bit and do some trading,
or if the coal price moves I do some trading." You are not
actually changing people's behaviour when that goes on. So, you
are seeing a volume of trading going across the carbon markets,
but in terms of people radically changing their operating behaviour
across Europe or making large investments in Europe, you are not
seeing much of it. Does that answer what you are about?
Ms Hampton: I think the question
you were asking was about the industrials that are sitting on
their allowances, which kept the price artificially high in Phase
1, and that was because there are two types of actors. You have
got the power companies, which are used to trading, they trade
gas, they trade power all the time, and so adding EUAs on to their
trading platform is not very complicated, but then you have got
the industrials, individual installations, and they may have a
compliance officer whose job is to ensure that particular installation
does not fall foul of environmental regulation and is not incentivised
in any way to trade. So, even though a lot of these installations
received surplus allocations, they never ended up selling them
and so the price stayed artificially high. Now we are starting
to see the price come down as people realise that there is massive
over-allocation in the first phase, but, of course, that problem
would be significantly reduced if the emissions reductions in
Phase 2 are actually brought in line with Kyoto targets.
Dr White: I think it is fair to
say that the utility companies on the whole were not given enough
allowances to meet their emissions, which was the whole idea,
and yet the people who have got more are some of the industrial
companies who are not used to trading. The people who know about
trading are the ones who need to buy allowances because they are
short; the people who are not used to trading are the ones who
have got too much. The music will have stopped by the end of next
year, by which time we expect the price to have collapsed to zero
in the first phase.
Q173 Joan Walley: Am I right in thinking
that the whole purpose of trading is to, somehow or another, incentivise
the investment which is needed in the new technology that is going
to reduce the carbon emissions, and, if so, how do we reach that
point?
Dr White: You do not have to trade.
All that a company needs to know is that if it emits carbon dioxide
there is a penalty. That is what you have got to know. If you
emit carbon dioxide you have to give up one of these allowances—that
is what you have got to know—and the amount of money you
are giving up, if you like, is the price of the allowance. In
order to get people to change their behaviour, they need to say:
"If I burn a little bit more gas and a little bit less coal,
then I have got some allowances which I can sell, so I am changing
behaviour, so it is working", or, "If I think the price
is going to be above 15 euros for the next 10 years, then I will
build my advanced coal power station or I will shut my old coal
station and build a gas station", or something like that.
That is how you want people to think about it. What people are
doing on day-to-day trading, I think, is neither here nor there.
It is: are they changing the way they operate their plant? Are
they investing in new kinds of low-carbon intensive plant? The
carbon price will give them the signal whether to do that or not;
our difficulty is the carbon price is too volatile and it is not
visible enough into the long-term.
Ms Hampton: There is a significant
human capacity element that I think you are referring to, which
is that it takes a long time for people to understand that, and
we have noticed in our business talking to clients that there
is a significant learning curve, and this is why some of the companies
that participated in the UK ETS were more comfortable with the
EU ETS when it came in and why European companies will be more
comfortable in Phase 2 than, say, the Japanese if they start trading.
There is a significant understanding. You need to put teams in
place, you need to train staff and all that takes a long time.
Industrial companies are now starting to understand that, either
by hiring intermediaries or by training up their own staff, but
that process takes a while. I think a lot of companies were hoping
the EU ETS would go away, and there was an onslaught to get rid
of the EU ETS about a year ago, but now that people realise that
it is here to stay, I think you will see them behaving slightly
more seriously in the future.
Q174 Joan Walley: When we are told
that there is 20 billion euros of trading going on, it does not
mean that much if the penny has not dropped, especially if we
have not got a new corresponding phrase for whatever the penny
is when we are trying to understand carbon trading.
Dr White: Basically, people have
been given free allowances of that kind of value, and either they
have to hand them in or they can swap them with other people.
That is what you mean by a market of that size.
Q175 Mr Hurd: Coming back to what
you said before about the ETS being here to stay, in your view
does that run across Europe? Is that a comment specific to the
UK? We have picked up signals, particularly from some of the utilities,
that this is across Europe? For example, attitudes in Germany
are completely different.
Ms Hampton: I work also on the
High Level Group that was referred to earlier, and have spent
quite a lot of time in Brussels of late, in Germany and in other
places. I think that there is greater acceptance in the UK than
maybe in other countries because we have a history of emissions
trading. We also have liberalised energy markets which makes it
more comfortable, people understand some market-based instruments
more. This is also true for the Netherlands, clearly, and Scandinavia.
So, those countries that operate in a similar way to us have the
same kind of understanding. Of course, in countries where their
energy systems are run in a different way, the understanding is
slightly different, and you have countries like Germany and France
where they have an a priori support of environmental regulation,
and they have done good things in certain areas but their industrial
base has not yet really accepted the idea of emissions trading,
and it does differ between sectors and it does differ between
companies. For instance, if you talk about RW or EON you will
get a slightly different approach. You cannot say that some countries
are for or against, and that is also borne out in the ministries
of different countries. In Germany, for instance, the environment
ministry understands emissions trading, so does the finance ministry.
The industry ministry does not like it and the chancellery realises
that it is more important but is looking for more support from
businesses, and I think we are starting to see that emerge. You
probably heard about the Corporate Leaders Group yesterday. We
are starting to see more European businesses engage, we are starting
to see the emergence of business leadership also in Germany, and
then you have those countries, like Spain, for instance, which
are very fast growing and have very, very tough Kyoto targets,
and I think there the business mood depends very much, again,
on who you talk to. Some companies that are cleaner, that have
more modern plant, like Iberdrola, for instance, in Spain, are
very much in favour of emissions trading and the slower, dirtier
companies are against, and those interests are naturally part
of the political process that governments are trying to deal with.
Over time, as you move away from grandfathering to a system with
more auctioning, it will put people again on more of a level playing
field going forward, so some of those difficulties will start
to iron out as you get more familiarity. Across the Commission
now there is certainly widespread acceptance that the ETS is here
to stay, even Vice President Verheugen, the Industry Commissioner,
has managed to discuss with a number of his trade associations
the need for the EU ETS to be here to stay, and I think there
is now growing acceptance of that within Europe. That does not
mean, of course, that a lot of sectors want the EU to move too
far ahead of others. There are those that believe that the EU
can gain a significant first-mover advantage and you have to lead
in order for others to follow, but there are still those that
say you cannot lead without followers and we need to slow down
a bit. I think a lot of that depends, not on your strategy but
on your tactics in terms of how you think you can get the US,
China and others to move and so I think the disagreement is really
at that level at the moment.
Q176 Chairman: While we are in this
rather frustrating phase of moving towards less allocation and
more auction, do you think there should be a direct relationship
between a country's Kyoto target and the limits under its National
Allocation Plan Phase 2?
Ms Hampton: A direct relationship
between Kyoto and NAPS, yes.
Q177 Chairman: Some of your members
have got much tougher Kyoto targets that others. Should that be
reflected in the National Allocation Plans?
Ms Hampton: Absolutely. You have
got three options in your National Allocation Plan. You can either
make your traded sector reduce more, you can introduce other measures
that take some of the pressure off the traded sector—say,
for instance, in the domestic sector or transport—or you
can buy in credits from overseas, either through the private sector
or the public sector. The problem is that the other measures,
often transport and measures in energy efficiency, and so on,
do not tend to deliver very much and so the EU ETS is the easiest
way to ratchet down emissions, and, for the reasons that Tony
explained, most of the money is flowing out into emissions reduction
projects around the world—that is the way the system is
designed—but there has to be a direct link between national
allocations and Kyoto targets because, from an investor's point
of view, you want to speed up the time between which politicians
give signals and investors invest money and so politicians commit
to targets. They committed to Kyoto targets in 1997, those were
rolled into EU targets in 2001 through the burden-sharing agreement,
but it really was not until recently that companies actually started
investing. We do not have that much time to wait looking forward
between political signalling and investment, so consistency is
absolutely essential. If the EU is not consistent with existing
political agreements, then investors will say, "Why should
we believe your 2020 targets? We might as well just wait until
2015 and see if you are serious", so that is not a situation
which we should replicate.
Q178 Chairman: Does every country
accept the logic of that argument and are some still trying to
say, "Well, actually, we do not have to make such big cuts
in the areas not covered by the ETS. We can go for a fairly easy
target for our Phase 2 NAP"?
Ms Hampton: If they can justify
that, but to my knowledge very few countries have been successful
in reducing emissions in other sectors.
Q179 Chairman: What I am really asking
is do all the countries, therefore, accept that they are going
to have to have Phase 2 targets which do reflect their Kyoto target?
Ms Hampton: It depends which ministry
you talk to. A lot of the ministries of environment lack power
within their own countries and so they farm out the responsibility
of setting caps to the Commission because the Commission is more
powerful than the Ministry of Environment within their jurisdiction,
so it depends very much on the country. The Commission realises
that it has the legal and political authority to do this and will
have to do it. Bad news come from Brussels, right, that is the
easy cop-out for a lot of countries, and the UK has not got a
brilliant track record that either.
|
