House of Commons - Environmental Audit

Select Committee on Environmental Audit Second Report

Recommendations for Phase III and the European Commission review

86. There are currently no concrete plans for the third phase of the Scheme. However, as Defra put it to us: "The EU ETS has no sunset clause, the existing legislation ensures that the EU ETS will continue to operate post-2012 and its key future role in delivering emissions reductions has been repeatedly confirmed in European Council Conclusions."[102] Indeed, the Commission has recently announced a European Climate Change Programme review aimed at improving the functioning and cost-effectiveness of the scheme post-2012. According to its terms of reference, this review will focus on issues such as the scope of the Scheme (including whether smaller emitters should be removed, and other sectors and gases included); increasing harmonisation (including whether there should be a single EU-wide cap instead of 25 separate NAPs); and arrangements for linking the EU ETS to other schemes (including measures for assessing and enhancing the effectiveness of CDM and JI projects). The Commission has invited submissions from interested parties, and the review is scheduled to report by 30 June 2007.

87. The UK Government is certainly playing a high profile role in seeking to drive forward this debate on how the EU ETS should be shaped post-2012. Most recently, the Environment Secretary has begun holding talks with stakeholders from business and environmental NGOs, with a view towards shaping what he has referred to as a UK manifesto for the EU ETS. This approach is spelt out in a document entitled "Emissions Trading: UK Government Vision", issued jointly by HM Treasury, Defra, and the DTI on 30 October 2006, which explicitly states that the Government "hopes to develop a widely shared UK approach to the future development of the scheme and to use that consensus to help take forward the debate with our EU partners."[103] To this end, the document establishes a number of the Government's preferred positions, and solicits the comments of UK stakeholders. Overall, there are perhaps two themes which stand out in this "Vision": that there should be definite EU-wide emissions reductions targets to establish long term certainty as to the levels of effort required; and that, in the interests of both efficiency and effectiveness, the Scheme ought to be expanded in scope and geographical coverage.

88. In this section, we set out recommendations to the Government in relation to Phase III, in terms both of its approach to those firms and sectors covered by the EU ETS within the UK, and its input into the ECCP review as to the shaping of Phase III overall. In doing so, we also give our responses, where appropriate, to the Government's call for comment on the positions outlined in its "Emissions Trading Vision" document.

Increasing the effectiveness of emissions caps

89. The central feature in determining the environmental effectiveness of the EU ETS is the aggregate cap it sets on emissions. There was near unanimity from the submissions we received that, in the first two Phases of the Scheme, the effectiveness of the caps have been undermined because Member States, in setting their own National Allocation Plans, have tended to favour their own economies in a competitive "race to the bottom". On this point, RSPB argued to us that the ETS Directive ought to be amended to become far more prescriptive in its requirements for Member States to draft National Allocation Plans so as to meet their Kyoto targets.[104] Several memos, however, notably the Environment Agency's, went further in arguing explicitly for the introduction of an EU-wide cap to take cap-setting out of the hands of individual governments.[105]

90. A number of submissions argued further that it is not just the size of the cap that is crucial but also its duration. Several submissions, in particular from power companies, argued that Phase III and other phases beyond that should be lengthened, to perhaps 15 to 20 years. This, it was argued, would incentivise investments in carbon abatement technologies by providing assurance as to the payback potential from such investments. The Commission itself, in its Communication setting out the terms of reference of the ECCP review, seems certainly to endorse this assessment of a problem to be addressed:

Being in theory able to go back to the drawing board prior to each allocation period means that certainty can only be given for up to five years ahead. This is considered by many as too short to give sufficient predictability for investment decisions in sectors which are capital intensive and result in installations intended to be operated for decades. The Commission shares these views and regards further harmonisation of the cap-setting and allocation process, as well as increased predictability, as key strategic issues.[106]

91. There is a significant potential problem with extending the duration of future phases, however. As Climate Change Capital (CCC) outlined to us, "Investment likes certainty, yet democracy requires that politicians can change laws." Notably, if unforeseen factors meant that a cap was proving much less challenging than expected, or if new science indicated that steeper cuts were required than previously realised, then politicians would surely be pressed to intervene and change the terms of the cap, rather than wait out a number of years before the beginning of a new phase. Indeed, according to CCC, "Investors recognise that trading regimes that are not delivering policy objectives will be changed," meaning that simply extending the duration of a phase would not necessarily generate the desired long term certainty in carbon constraints and allowance prices. For this reason, "a mechanism needs to be developed that allows, on the one hand, investors to be given a framework for trading that could last into the long term, yet may also be altered if these objectives are not being met."[107] CCC have outlined such a mechanism, whereby Member States might use variable carbon taxes to supplement the price of carbon within the EU ETS if it dropped too low. Another such mechanism has been discussed by Ofgem, who suggested that if the carbon cost "turns out to be lower than expected, governments or other agencies can buy allowances from the market and retire them in order to cut emissions even further."[108] The Carbon Trust, however, have argued strongly against such "ex-post government interference", warning that this may increase uncertainty and thereby undermine the incentive for companies to invest in carbon abatement; and also that such actions might be challenged by legal action. The Carbon Trust's preferred alternative is for governments to auction a substantial proportion of allowances at a fixed, minimum price, which would in effect help to set a predictable minimum price for allowances throughout a phase.[109]

92. Several submissions argued that, in the absence of or opposed to very long running phases, the most important thing would be the adoption of a series of clear EU-wide targets indicating the carbon reductions pathway for Europe to follow over the long term, and to which future ETS caps will need to conform. On this point, the UK Government is being very active, suggesting in its "Emissions Trading Vision" that the EU ought to adopt targets of reducing its greenhouse gases by 30% (from 1990 levels) by 2020, and by at least 60% by 2050, in both cases "including domestic action and contributions made by EU companies and Member States to the efforts of developing countries, for example using the Clean Development Mechanism".

93. In the interests of making the EU ETS more effective post-2012, the Government should argue for the introduction of a single EU-wide cap to replace the current system of National Allocation Plans. To complement this, it is vital that the EU adopts a series of future carbon-reduction targets. Future ETS caps should be reduced in line with these targets, according to a robust and transparent formula which should be specified in an amended ETS Directive. The Government should also evaluate a range of proposed mechanisms for effectively modifying caps and allowance prices within phases, in order to ensure that the Scheme is able to respond promptly to new circumstances, and to give further certainty as to the long term level and trend of carbon prices.

94. The Government should be commended for pressing the case for such EU-wide emissions targets for 2020 and 2050. However, given that it has described these as targets for "greenhouse gases" as a whole, and has explicitly referred to the use of Clean Development Mechanism credits as a means of meeting them, we are unsure as to the stringency and effectiveness of these proposals. In particular, we note that the proposed target for 2050 would appear much weaker than the Government's own target for the UK, which refers solely to carbon dioxide. The Government should rephrase these proposals, specifying the minimum amounts by which carbon dioxide should be reduced from within the EU itself.

Improving the allocation of allowances

95. After the overall cap on allowances, the single most important feature to the effectiveness of the Scheme is the process of allocating allowances to separate economic sectors and the individual installations within them; this can affect both how many allowances a firm receives, and the cost it has to incur to acquire them. There are essentially three ways in which allowances can be allocated: grandfathering, by which a mixture of historic and projected BAU emissions are used to calculate an allocation; benchmarking, which calculates allocations according to an average or "best in class" installation; and auctioning, in which firms are not allocated allowances but must buy them upfront. There was a broad consensus in the evidence we received against grandfathering, the strongest argument being that it could create perverse incentives for installations to overstate their emissions or even actually emit more in order to benefit from higher free allocations in the future. Those who made this argument tended to see benchmarking as a means of eliminating this danger, although firms such as Shell and lobby groups such as EEF were quick to point out the practical difficulties in trying to calculate and apply benchmarks across whole sectors containing varied individual installations.[110]

96. Strong arguments in favour of auctioning were made by organisations such as the Carbon Trust, Climate Change Capital, and environmental NGOs. Essentially, these arguments were that auctioning would: i) raise revenue which could subsidise low carbon research and development; ii) reduce the complications and administrative burden associated with calculating grandfathered or benchmarked allocations; and iii) by forcing companies to incur upfront costs for their allowances, gain the attention of company boards, and lead them to build the price of carbon into all their business plans. The views of firms subject to the Scheme were somewhat more reserved, however. While there was a broad acceptance of the principle of auctioning among power companies (with Climate Change Capital reporting to us that "the idea of full auctioning in Phase 3 is now gaining acceptance among the large utility companies"), several argued that it should be extended to all sectors. EEF, meanwhile, strongly argued that auctioning was unsuitable for industry, as it would merely impose an additional cost burden without yielding any additional environmental benefits.[111] Aside from this, concerns were expressed as to what the Treasury would do with the revenue, with Shell also making the point that unless the money were promptly recycled to contributing firms it would actually reduce the amount of capital they had available for making low carbon investments.[112]

97. For its part, as Defra's memo outlined, "The Government's long term goal is the full auctioning of allowances so the cost of carbon will be fully taken into account when making investment decisions."[113] On the point as to how the Treasury will use the revenue raised from auctioning allowances (including the 7% of Phase II allowances which the UK is auctioning), the Government continues to be somewhat reticent, however. While the Environment Secretary announced the creation of an Environmental Transformation Fund at the same time as announcing the UK's Phase II NAP, he did not explicitly say that it would be funded through auction revenue, nor what its actual objectives would be. The Minister for Climate Change was not able to clarify these points in his session with us.[114]

98. The Government should be commended for auctioning a higher percentage of allowances in Phase II than any other Member State. Moreover, it is right to press for full auctioning of allowances throughout the Scheme in the future. In Phase III it should auction 100% of the power sector's allocation, as such firms should be able to pass these costs through without fear of international competition; indeed, this will stop them from making windfall profits. For exactly the same reasons, it should also press hard for the aviation sector—whose sectoral allocation will be set at the EU rather than Member State level—to be subject to a 100% auction across the EU from the time it enters the Scheme. For all other sectors, the Government should introduce at least a significant proportion of auctioning, with a commitment to increasing this proportion in successive phases; and with the remainder of their allocations being made on the basis of best available benchmarks.

99. The Government should carry out and publish detailed reviews of the best uses of auction revenue, based around the principle of speeding the development and take-up of new low carbon technologies, but also around the benefits gained by recycling revenues to businesses and individuals in the form of reductions in other taxes[115] - especially where this is with the explicit design of shifting consumption patterns to a more sustainable basis, for instance by reducing VAT and VED on low carbon cars. There are dangers in not hypothecating the use of auction revenues in these ways, notably that it may be treated simply as a tax, both by contributing firms and the Treasury itself, with a growing resistance to it from the one and dependency on it to meet general spending commitments from the other. The latter would represent a serious missed opportunity, given that, as we have previously observed, investment in low carbon technologies is seriously inadequate.[116] More specifically, with only a year to its scheduled commencement, the Government should urgently clarify the funding and objectives of the new Environmental Transformation Fund. Among other matters, this should feature detailed evaluations both of where its funding will be most effective, and of what the impacts of incurring these costs will be to contributing firms (including to their potential investment in new low carbon technology) and how this might best be mitigated.

Streamlining and harmonising the running of the Scheme

100. A number of further points, relating to the efficiency of the Scheme as well as its effectiveness, concern the need for greater harmonisation. Clearly, the most significant case for greater harmonisation is that, already discussed, of replacing the 25 separate nationally-set caps with one EU-wide cap. However, there are several other aspects of the Scheme, currently subject, to one degree or another, to control by individual Member States, which can both affect the overall effectiveness of the Scheme and the relative competitiveness of different economies. For example, the CBI argued that the use of auctioning in the UK should not be out of step with other member states as this would increase competitive distortions, and pointed to the fact that Sweden, Germany and Finland had already declared that they would not be auctioning any allowances in Phase II. The CBI was also far from alone in expressing its concern that "the UK's 8% limit on the use of JI/CDM credits [in Phase II] is one of the strictest amongst the member states (compared with 10% in France/Italy, 12% in Germany, 20% in Sweden and 50% in Spain/Ireland)".[117] Scottish Power drew out the implications of this discrepancy in CDM and JI limits in assessing that it will "encourage arbitrage of project credits by companies in other Member States where caps are much less restrictive, which could potentially allow foreign-owned generators to cross-subsidise their operations to the detriment of locally owned generators."[118]

101. It is imperative that the Government presses not only for a single EU-wide cap, but for harmonisation of the way in which this is broken down into national and sectoral allocations. Chief amongst these priorities should be harmonisation of: i) the proportions of allocations to be auctioned; and ii) to be made up by CDM and JI credits. The Government should also engage stakeholders, within the UK and abroad, as to the potential benefits and practicalities of introducing EU-wide sectoral caps, which might automatically harmonise such aspects across the Scheme.

102. In addition, several submissions stressed the need for implementation of the Scheme to be streamlined, for instance by omitting smaller emitters, for whom the administrative costs of compliance are disproportionately large. Not the least of these calls came from the Government itself. As Defra's memo outlined, "In 2005 approximately 60% of the installations in the UK emitted less than 5% of the UK's total emissions covered by the EU ETS. This raises questions about whether the associated regulatory burden is appropriate for these installations." In response, the Government has in the short term "scaled administrative charges and established tiered monitoring and reporting requirements to reduce the regulatory burden on these installations, and has suggested means to exclude some of the smallest emitters from Phase II." For the longer term, and to achieve more wholesale changes to the classification which currently captures installations within the Scheme, the Government has indicated that it is targeting changes to the ETS Directive through the ECCP review.[119]

103. This was not the only issue in which we received calls for implementation of the Scheme in the UK to be streamlined, however. The CBI, for instance, complained of firms being subject to the double regulation of multiple emissions reduction regimes. In particular, they argued that where firms are currently subject to both the EU ETS and the Climate Change Agreement (CCA) regime, they should be allowed to receive the 80% discount from the Climate Change Levy without being required to comply with the CCA. Similar concerns were also well expressed by Minesco who, looking forward to the likely introduction of the Energy Performance Commitment (EPC),[120] and to the potential therefore for the same firms to be dealing with EU ETS allowances, EPC allowances, CDM credits, and JI credits, concluded: "The net result is therefore that it is highly likely that they will have to manage positions in at least 4 flavours of carbon [i.e., types of carbon credits or allowances], and could simultaneously be long and short [in] carbon under different schemes. Apart from the risk management complexities this introduces, the potential confusion cannot be helpful in ensuring that a simple cost of carbon emerges against which to assess policies or in developing a clear […] communications message."[121]

104. We welcome the Government's leadership on lessening the burdens faced by smaller emitters, not least because the Government is consulting on introducing the Energy Performance Commitment (EPC), a separate regime into which they will presumably be transferred; this suggests to us that they will not fully escape an emissions reduction regime, but that its administrative demands will be made proportionate to their capacity and impact on emissions. In addition, we sympathise with the concerns expressed as to the possible complications and administrative burdens experienced by firms which may find themselves subject to both the EU ETS and EPC, as well as the Climate Change Levy regime. Calls for such firms to be exempted from all but one regime, however, must be treated with a great deal of caution, considering the potential impact on both the finances and emissions not just of those firms in question, but of their competitors. We will investigate these issues in detail in a future consideration of the Climate Change Levy, and may also look in further detail at some point at the EPC.

Protecting firms subject to the EU ETS from international competition

105. As discussed in a previous section, there was disagreement between industrial groups and others as to whether UK industrial firms would suffer significant competitive disadvantage from the first two phases of the Scheme. However, there was more consensus, comprising not just the manufacturing lobby but observers such as the Carbon Trust, that for at least certain sectors competitiveness would be a real concern in Phase III. The Carbon Trust have outlined three possible mechanisms which could help to protect such industries post-2012 from competition in other countries not subject to the same carbon constraints. One option would be to bypass governments and negotiate international sectoral agreements to incorporate the cost of carbon with firms themselves; such agreements would cover all the major competitors in a particular sector (for example, steel production) throughout the world. Another would be to use border-tax adjustments to compensate industry producing in regions with high CO₂ costs for these costs when exporting, with a symmetric tariff being applied to imports. A third option would be periodically to make ex-post adjustments to firms' allocations according to their relative performance in carbon-efficiency per unit of output.

106. As the Carbon Trust themselves admitted, none of these options is without its problems. Regarding the first option, Professor Grubb referred to the legal difficulties of forming a binding agreement with a sector of the global economy: "who legally is the private sector? Who can sign an agreement on behalf of the steel industry? Who can enforce it on the steel industry?"[122] As for the second option, while the Carbon Trust appears confident it could be designed so as not to fall foul of World Trade Organisation rules, others, such as EEF, have pointed to this as a potential problem. The third option is less favoured by the Carbon Trust itself as it would complicate and weaken the system, and also require amendment to the ETS Directive. For their part, the two business interest groups we took evidence from had contrasting views on these proposals. The CBI recommended that the first two options should be explored. EEF, meanwhile, appeared to favour a proposal of their own by which sectors more vulnerable to international competition would be withdrawn from the EU ETS, and subject instead to an ex-post system financially to reward more and penalise less energy efficient firms.

107. The Government should consult widely in the UK and abroad as to the benefits and practicality of the Carbon Trust's three proposals for protecting vulnerable industries against international competition from firms not subject to the EU ETS or equivalent carbon constraints. In view of the potential difficulties of two of these options, it appears that the use of a border tax adjustment might have the most potential; however, the Government must urgently clarify whether this would indeed pass WTO criteria. We would caution against a proposal made by EEF, as this would appear to require the withdrawal of certain sectors from the Scheme. Moreover, in appearing to be based merely on the relative energy efficiency of a number of firms, it would seem to offer no guarantee of absolute reductions in carbon emissions, nor sufficient incentive pressure to innovate in order to find some.

Expanding the Scheme and linking it with others

108. The Government has expressed a very strong and high profile commitment to pushing for the EU ETS to be expanded. Expansion in this sense means covering more economic sectors and greenhouse gases, and linking or merging with other emissions trading mechanisms, including CDM/JI and other emissions trading schemes emerging in other countries. Notably, the Government has been in the vanguard of moves to include aviation within the Scheme; and has also taken the prominent step of calling, in a letter sent jointly in February 2006 by the then Secretaries of State for Transport, Environment, and Trade and Industry, for the Commission to consider the addition of "surface transport" (or in other words, road transport) in the ECCP review. The Government sums up the case for such expansion in its "Emissions Trading Vision":

The more we can trade emissions reductions across international borders, and the more emissions that are covered, the more cost effective for all it will be to achieve challenging emissions reduction targets. […] Making the carbon market deeper, wider and more liquid will increase its effectiveness in delivering greater emission reductions, and do so at least cost.[123]

109. While we would broadly welcome the Government's efforts to expand the EU ETS towards forming a global carbon market, we do so with some caution given the potential to weaken the Scheme by changing its terms. Our first concern is with the use within the Scheme of CDM and JI credits. As discussed in a previous section, there is plenty of evidence that much CDM investment is currently going into projects of dubious merit, concentrating on the abatement of exotic gases; not only will such investment do nothing to forestall the growth of carbon-intensive infrastructure in developing prosperity, but it will do little to improve their people's prosperity and quality of life. For this reason, WWF argued that the UK should only allow credits to be used within its Phase II NAP where these meet the Gold Standard, an "internationally recognised benchmark which sets important sustainable development criteria for emission reduction projects". Limits on the use of such credits should not just be harmonised across the EU ETS, but the Government should also press for a qualitative limit to be imposed on the use of these credits, to ensure that they are funding genuinely additional emissions reductions, and that they make a contribution towards sustainable development.

110. A further point here concerns the impact, on the carbon price within the EU ETS, of expanding its terms to take in credits from other schemes such as the CDM. There is a potential contradiction here in the Government's ambitions for emissions trading. This was well expressed by the Environment Agency, when they told us that they wanted

to see greater clarity over the UK and EU objectives for the EU ETS. In the Government's recent Green Paper, The Energy Challenge, it reaffirmed its commitment to using the EU ETS to provide UK industry with a long term price signal to drive domestic investment in low carbon technology. At the same time, we are likely to see greater integration of global markets to improve their efficiency and bring down costs. It is difficult to see that both are possible without careful analysis of the supply of CDM credits relative to the EU cap. A scheme that allows unrestricted access to the CDM market will drive down allowance prices making it more attractive to buy allowances rather than achieve domestic emission reductions.[124]

111. We are not sure about the Government's argument that expanding the EU ETS will necessarily "bring about emissions reductions at lower cost",[125] especially given that Climate Change Capital told us that including the USA and Australia, for instance, would by driving up demand for allowances be the best way of ensuring a robust carbon price for the long term.[126] The Government should clarify its own understanding of the range of carbon prices required to stimulate the necessary level of investments in carbon abatement within the EU ETS, and seek to form a consensus on this across the EU. Considerations of the terms on which other sectors, gases, and trading schemes could be linked or encompassed by the EU ETS could then be made with reference to the projected impacts on this model price.

112. The most significant expansion in the scope of the Scheme already scheduled to take place in the short to medium term is the inclusion of aviation. In December 2006 the European Commission issued a proposal to include CO₂ emissions from all intra-EU flights in the Scheme from 1 January 2011, to be expanded to encompass all flights arriving at or departing from EU airports from 1 January 2012. The Commission has announced that the total number of allowances allocated to the aviation sector will be set at the EU level (rather than by individual Member States), and capped at its average level of emissions in the years 2004-2006. In the initial period of 2011-12, a small proportion of airlines' allocations will be auctioned by Member States, but, as the Commission puts it, "the overwhelming majority will be issued for free on the basis of a harmonised efficiency benchmark reflecting each operator's historical share of traffic."[127] As for the terms under which aviation is included post-2012, including its allocations and the extent to which they are auctioned, the Commission says that this will be reviewed in the light of the current overall review of the Scheme. Regarding the non-CO₂ effects of aviation to global warming, the Commission has said it will put forward a proposal to address nitrogen oxide emissions by the end of 2008, although it has not given a date by which a resulting mechanism would take effect; nor has it proposed any measures to reflect the other non-CO₂ effects of aviation.

113. The Commission's proposal came too late in our inquiry for us to make a detailed assessment of its strengths or weaknesses, and its impact on aviation emissions and the EU ETS overall. However, we have extensively discussed aviation and its inclusion in the EU ETS in previous reports, most recently our study into Reducing Carbon Emissions from Transport, published in August 2006, and we draw on that work here.

114. In this inquiry we received only one memo from an airline, Virgin Atlantic. This stated that Virgin was lobbying hard for the inclusion of aviation to be on the basis of all flights arriving and leaving the EU, not just intra-EU flights. While on the hand this seems impressively disinterested (given that it would pull Virgin, a transatlantic carrier, into the Scheme), we note that the memo also talks of "the need to reach agreement with international partners on this" which may mean that restricting the scope to intra-EU flights in the interim "may present the most practicable solution."[128] The memo was bullish as to the potential for aviation to make fuel efficiency improvements, drawing our attention to Sir Richard Branson's pledge to invest around $3 billion in schemes to develop new renewable energy technologies, and stating in this context: "Whilst alternative aviation fuels remain some way off, their potential should not be overlooked."[129] We would certainly warmly support such investment in R&D, and would be interested in any breakthroughs. However, as we concluded in our recent report, we have profound doubts over the ultimate scope for the aviation industry radically to improve its carbon efficiency through technological advance, at the very least within the timescale meaningful in terms of averting dangerous climate change.

115. While we support the principle of including aviation in the EU ETS, this will only be effective if the terms of its inclusion are such to constrain and ultimately reverse the rise in aviation emissions. However, we have severe doubts as to its effectiveness under current proposals. Notably, the impact on airfares, and hence demand for flying, is projected to be relatively minor. WWF, for instance, has pointed to reports which suggest that under current proposals the Scheme would, by 2020, and depending on the distance covered, raise ticket prices by only €4.6 (£3.10) for a return short haul flight, ranging to only €39 (£26.25) for a long haul return.[130] Meanwhile, a proportion of what increase in prices there will be is expected to lead to windfall profits for airlines, given that their initial allocation of allowances will be given to them almost entirely for free, and as they, like power companies, will be able to pass on the market value of their allowances to customers. The IPPR, for example, has estimated that giving airlines free allocations could lead to their enjoying windfall profits of up to €4 billion (£2.7 billion), while WWF estimates it at €3.5 billion (£2.4 billion).[131] Moreover, there are still no concrete proposals for reflecting the total contributions of aviation to global warming, considered in most estimates to be between two and four times that from CO₂ alone.

116. It is essential, therefore, that the terms of aviation's inclusion are considerably strengthened in Phase III. Notably, lessons should be learned from the way in which the power sector has earned windfall profits in Phase I; as airlines similarly should be able to pass these costs through without fear of international competition, so their allocations should be 100% auctioned. Not only will this lead to a more efficient allocation process and prevent them making windfall profits from the Scheme, it should also focus their attention more on the costs of carbon, and raise valuable revenue. The proportion of auction revenue corresponding to flights within the EU could be earmarked for spending on rail alternatives to short haul flying within Europe. As for the remaining revenues, relating to long haul journeys, the Government and the Commission should make comparative studies of the benefits of the different ways in which these can be used, including using them to fund reductions in other taxes. Equally, the Commission must not waver in pressing for all arrivals and departures, not just intra-EU flights, to be included in the Scheme. The Government must maintain its voluble campaign in support of this principle.

117. Even if the terms on which aviation is included under the Scheme are toughened in Phase III, we still have severe doubts that the Scheme itself will be responsible for any significant improvements in the carbon efficiency of the overall fleets of aircraft affected, given the costs and technological difficulties in doing so. Rather, the chief potential contributions of the EU ETS regarding aviation would appear to lie more in simply increasing the costs of emitting carbon within the Scheme. This could have a direct effect on the aviation sector by increasing the costs to airlines and hence to passengers and freight distributors, thereby helping to dampen demand for flights. It could also have an effect on the rest of the Scheme through raising demand for and thus increasing the scarcity of allowances, thereby helping to maintain a predictably strong carbon price; this would help to incentivise long term low carbon investment in sectors where abatement is more feasible. But this depends on there being a strong cap on aviation emissions. If the cap is too weak, then its impacts—on airfares and demand for flights, and on the wider price of allowances—may be equally undermined.

118. Under current proposals, the allocation given to the aviation sector will be capped at its average level of emissions in 2004-06. In discussions regarding the level of the cap set for aviation emissions in Phase III, it would not be a surprise if airlines argued strongly that the initial allocation should be updated, and set at a baseline taken from years closer to 2012. It is vital for the integrity of the cap on aviation, and with it the integrity of the Scheme as a whole, that the Commission resists such calls. Furthermore, the Commission should put in place a clear commitment to reducing— even if gradually—the allocation set aside for aviation from its initial level. It would risk fatally undermining the effectiveness of the EU ETS—both directly, and indirectly through provoking opposition from other sectors—if the overall cap set by the Scheme was reduced in each phase, but the sectoral cap given to aviation was allowed to rise or even simply stay the same.

119. However the terms of aviation's inclusion in the Scheme are reformed and strengthened, complementary measures will be needed and must be introduced or intensified, aimed at constraining the growth in air travel and reflecting its full external costs, including all its non-CO₂ contributions to global warming. In addition to the "upstream" focus of the EU ETS—that is, directly affecting the airlines—the Government, and other Member States, should continue and increase their focus on "downstream" measures, designed to affect private and business decisions as whether or not to fly. Moreover, the Government must work to progress the development of an EU-wide measure to tackle NOx emissions, and should also lead the way in developing measures that reflect the remaining non-CO₂ effects.

120. Finally, now the Commission has published its proposal on aviation, there is no excuse not to include the greenhouse gas emissions of EU flights within the proposed targets for EU emissions reductions to 2020 and 2050. The Government must clarify that its proposed EU targets include aviation emissions, and should also revisit its UK target for 2050 to include the emissions of all flights arriving at and departing UK airports.

121. Regarding surface transport, although the Government has taken a very high profile stand within Europe on its inclusion, it has not revealed anything in the way of a concrete proposal. Neither the letter sent by the three Secretaries of State to the European Commission last February, nor the Minister for Climate Change when he appeared before us in December, offered any details as to the proposed basis on which surface transport might be included.[132] From our considerations, however, and the evidence we received, it would appear most likely that it would be included on an "upstream" basis, meaning that the cap would be placed on fuel suppliers, rather than a "downstream" basis which, by placing emissions caps on individual car owners, might simply prove impractical. The consensus of evidence we considered was against such a move. One concern was over the ownership of emissions in such a scenario, it being wholly unclear how upstream fuel companies would be able to influence the behaviour of the downstream users. Another was over the impact it would have on allowance prices, given the likelihood that, in the short term at least, road transport would function as a large net buyer of emissions credits from other sectors, possibly raising prices considerably. Not only might this have adverse consequences for those industrial sectors within the Scheme and subject to international competition but, as WWF suggested, the fear of such a prospect might lead to fuel companies being given a weak cap.[133] Third, we heard concerns that the inclusion of road transport might lead to greater opposition from road transport industry and users against all other existing and mooted measures, such as fuel duty rises.

122. As yet we have not been convinced by the case for the inclusion of surface transport within future phases of the Scheme. The emissions from this sector can more effectively be tackled through other measures, such as motoring taxes, road charging, and mandatory fuel efficiency agreements with car manufacturers. Moreover, in view of the practical difficulties involved, we believe that it is not just less preferable that surface transport is covered by the EU ETS but conceivably quite unlikely that it ever would be. There is a danger, then, in the Government's mooting it as a possibility, that it may function as a red herring, and confuse or retard debate on other means of reducing emissions from road transport. At the very least, the Government must finally publish some details of its proposal, and show how it might deal with these reservations.

123. The final area of transport to which the EU ETS could be extended is shipping. The maritime sector is responsible for 4% of the EU's CO₂ emissions.[134] Despite this, there is little discussion regarding the inclusion of European shipping, in stark contrast to other transport sectors. This is in keeping with the findings of our recent study on transport emissions, which observed:

There is no international agreement on how these emissions should be allocated to individual states. Thus they do not form part of any country's national inventories of emissions, and no Kyoto targets exist for them. This means that sometimes very significant sources of carbon emissions are being effectively ignored […. O]ur impression is that there may be insufficient attention, from both governments and NGOs, on this issue to generate the kind of pressure on the negotiating process overseen by the International Maritime Organization required to generate a timely solution.[135]

We have previously urged the Government to take the international lead in drawing attention to the problem of international maritime emissions, and, in advance of global agreements through the International Maritime Organization, to press the European Union to pursue an effective EU-wide strategy to tackle emissions from shipping using European ports. We now urge the Government to explore with European partners the potential of including the maritime sector within a future phase of the EU ETS. As a first step, the Government should press the European Commission to commission a detailed study to quantify the emissions and assess the practicalities involved.

Increasing transparency and accountability of the Scheme

124. To date, public reporting on the operation of the Scheme and its effects has been disjointed, and lacking in both parliamentary scrutiny and wider publicity. Notably, it is down to individual Member States to publish details of the annual allocations and verified emissions of their individual installations. While the European Commission does publish aggregate figures of allocations and actual emissions for each country, this is in the form of occasional press releases rather than an official and high-profile annual report. Regarding the more detailed figures for individual installations, the Commission website merely publishes 18 separate links to the national websites of 18 Member States, each of which provides this information solely in respect of its own installations.[136] Not only does this make it cumbersome to obtain detailed information from each country, not all Member States are included.

125. There are some mandatory requirements to produce annual reports under the Scheme, both for individual Member States and for the Commission itself. Under Article 21 of the ETS Directive each Member State is required to submit an annual report to the Commission on its "application of the Directive", paying "particular attention to the arrangements for the allocation of allowances, the operation of registries, the application of the monitoring and reporting guidelines, verification and issues relating to compliance with the Directive and on the fiscal treatment of allowances, if any."[137] Article 21 then requires the Commission to publish a compendium report on the application of the Directive, based on these national reports. The first of these was published in 2006 by the European Environment Agency,[138] and contains some interesting information comparing and summarising the approaches and challenges faced by different Member States on a number of issues, for instance, methods of verifying emissions records, and public access to monitoring reports. However, this report does not contain figures for allocations or emissions; and might otherwise be described as being limited by its being based exclusively on a questionnaire sent to Member States.

126. To aid public understanding of the workings and progress of the Scheme, accountability of individual firms, and parliamentary scrutiny of the roles of national governments and European institutions, there ought to be published a high-profile annual report of the EU ETS. This report should set out the allocations and actual verified emissions in that year, broken down both by Member States and by individual installations. In addition, and in much the same way as a departmental or commercial annual report, it should feature a commentary on important aspects of the Scheme's operation in that year. This might conceivably build on and be added to the more limited annual report, required under Article 21 of the ETS Directive, and currently published by the European Environment Agency. It would offer a much enhanced opportunity for national parliaments, as well as the European Parliament, to scrutinise the performance of the Scheme, and to identify areas of weakness to be addressed. Above all, however, the most important thing is that detailed allocations and emissions figures for all participating states and installations should be published in the same, transparent and accessible, document.

102 Ev 98 Back

103 "Emissions Trading: UK Government Vision", Defra, DTI, & HM Treasury, 30 October 2006, http://www.hm-treasury.gov.uk/media/98D/4B/environment_emissionstrading301006.pdf, p 2 Back

104 Ev 17 Back

105 Ev 4 Back

106 COM(2006)676 Back

107 Ev 68 Back

108 Ev 149 Back

109 Q219 Back

110 Ev 52, Ev 164 Back

111 EEF's argument was that international competition would not allow manufacturing and heavy industry to pass on the costs of allowances as could power companies, and that auctioning allowances would be unrelated to the carbon abatement potential of these firms. Back

112 Ev 163-4 Back

113 Ev 94 Back