Memorandum submitted by British Energy
KEY POINTS
— Government needs to set meaningful
targets at the national and sector levels for the Emissions Trading
Scheme (ETS); such targets should be developed through extensive
consultation, particularly with industry because it is companies
that will be required to deliver the emissions reductions sought.
— Based on the first year of the Scheme,
the Business-as-Usual growth projections have led to over-allocation
to nearly all sectors, the notable exception being the power sector.
We need to ensure that all participants in the traded sector make
genuine savings in subsequent Phases.
— Free allocation has led to criticism
of the Scheme, particularly as it reduces the need for emissions
reductions. A move towards full auctioning of allowances, perhaps
in stages, would ensure the ETS incentivises the emissions reductions
needed.
— It is too early to say what the implications
for competitiveness are for two reasons: (a) any effect of the
ETS during Phase 1 has been masked by high and volatile fossil
fuel prices; and (b), the Scheme has only been running for just
under two years which is not long enough to establish how companies
are reacting.
— Those working on Clean Development
Mechanism projects suggest that the ongoing uncertainty on the
long-term role for the ETS and the associated carbon price, and
limits on contribution by CDM projects, affect investor confidence
in this part of the carbon market.
— Emissions from the aviation sector
are growing markedly and there is a need, and desire, to address
this issue. However, there are major problems associated with
including this sector in the ETS and they will take time to resolve.
— The EU ETS is the right instrument
to ensure reductions in, for example, sectors with significant
point source greenhouse gas emissions—it is less effective
at dealing with diffuse sources of emissions.
— It is crucially important that the
ETS develops into one of the key EU "climate change"
policy instruments for the long-term but this may require removal
of some redundancy in the "policy space"; for example
it is now appropriate that the Climate Change Levy in the UK be
phased out since it tackles much the same issue.
— Confidence in the scheme will also
grow if an international, post-Kyoto agreement is reached on emission
reductions that involve as many countries as possible. As a minimum
it is important the EU ETS remains not only as an effective vehicle
for emissions reduction in the EU but also provides a vehicle
whereby other countries are engaged through JI/CDM projects, or
by linking to emerging trading schemes.
RESPONSE TO
DETAILED QUESTIONS
Question 1: What are the key lessons to learn
from Phase I of the Scheme
1. Government needs to set meaningful targets
at the national and sector levels, developed through extensive
consultation, particularly with industry because it is companies
that will be required to deliver the emissions reductions sought.
2. The allocation methodology needs simplifying,
and to better represent both prevailing operational practice and
to be better able to address future operational practice.
3. Need to harmonise practice wherever possible
across the EU, but taking care of the markedly different economic
and energy industry structures of Members States (MSs).
4. The EC milestone dates for MS National
Allocation Plans (NAPs) are negotiated at an early stage by officials—some
MSs adhere to the timetable while others do not. Whereas some
latitude is important, the EC response is not strong enough with
those that ignore the deadlines set putting some countries at
a disadvantage.
5. The release of commercially sensitive
information must be better managed than it was at the end of the
first year of Phase 1—the release of data once a year, as
proposed, is the correct way to achieve this, balancing the needs
of the market with the needs of the individual companies involved.
Question 2: How likely is it that UK firms would
successfully reduce emissions by at least 7MtC by 2012, in line
with the proposed Phase II NAP?
6. We believe that UK firms will meet their
obligations as set out by the Phase 2 NAP. They may do this through
their own actions, or by buying allowances on the carbon market,
or through JI/CDM projects which are underway (although there
is an installation limit on these at this time).
7. Companies will take the least-cost option
when deciding how to meet their obligations and this will depend
on a number of factors including:
— The carbon price in Phase 2 which
will depend on the "scarcity" or otherwise of the market;
the Commission will have a big influence on this as it scrutinises
MS NAPs to ensure the Scheme fulfils its task of helping each
MS meet its Kyoto target;
— Fossil fuel prices, and in particular
the relative cost of coal to gas—a low gas price means a
lower coal use, and carbon emissions than the business-as-usual
(BaU) projections; this in turn means a lower demand for carbon
and lower carbon prices;
— The degree to which BaU allocation
to sectors other than the power sector lessens the pressure on
them to reduce emissions;
— The prevailing climate and temperature
which is increasingly being factored into company decision making.
Question 3: What have been the effects of the
method chosen for allocating allowances in Phase I?
8. Based on the first year of the scheme,
the BaU growth projections have led to over-allocation to nearly
all sectors, the notable exception being the power sector.
9. Use of "grandfathering" has
disadvantaged some within sectors—this is because the years
used to establish the allocation tend not to be close to the more
recent operational practice. A "benchmarking" approach,
as adopted for the power sector in Phase 2 of the Scheme in the
UK, provides a more equitable allocation method.
10. Free allocation has led to criticism
of the scheme, particularly as it reduces the need for emission
reductions. A move towards full auctioning of allowances, perhaps
in stages, would allow the mechanism to function correctly ie
to incentivise emissions reductions.
Question 4: Has the Government identified the
correct proportion of allowances to be auctioned in Phase II?
Should these be drawn solely from the power sector's allocation?
What will the effect of this auctioning be on industry and the
price of carbon?
11. The proportion of allowances auctioned
was constrained to 10% by the Directive for Phase 2. The Government
was right to identify auctioning as the long term-direction for
the scheme and the 7% minimum level of auctioning adopted for
Phase 2 is a good first step and will provide much valuable experience.
12. Auctioning should be adopted by all
sectors to create the focus for emission reductions. There will
be little management focus on emissions reductions when companies
receive BaU allocations for free.
13. The price of carbon depends on the supply
and demand for allowances in The European market. Although timing
of the auction is important, the long-term run of the cost of
carbon will be determined by the overall scarcity of carbon allowances
in the market place.
Question 5: What have been the effects of Phase
I so far on the competitiveness of (1) business in the UK, and
(2) business across the EU?
14. It is too early to say for two reasons:
(a) any effect of the ETS during Phase 1 has been masked by high
and volatile fossil fuel prices; and (b) the scheme has only been
running for just under two years and with the exception of the
end of year carbon data, there is little transparency on how the
scheme is affecting companies and their activities.
15. It is hard to argue that competitiveness
is harmed in the UK or the EU given the free allocation of allowances,
a surplus of allowances in the market through a generous allocation
methodology, and the ready availability of a measure of relatively
cheap allowances through JI and, in particular, a large number
of CDM projects.
Question 6: What are the key issues for Phase
II in terms of ensuring that emissions reductions from EU states
are not cancelled out by the transferring of industry to developing
economies?
16. There is little evidence to suggest
that the level of caps being set in MS NAPs for Phase 2 will force
companies to locate outside of the EU. The UK has taken the precautionary
step of allocating allowances at BAU levels to nearly all industrial
sectors, with the exception of the power sector, to maintain their
competitiveness.
Question 7: How well are the EU ETS and the Clean
Development Mechanism working together? What needs to be done
to better integrate these markets? Is the CDM funding the right
projects?
17. It is too early to comment. There were
some initial difficulties with CDM Executive Board but this has
not stopped considerable interest in developing CDM projects in
a number of countries. The percentage contribution as set out
in the Directive encourages CDM projects; in the UK this has been
translated to an 8% limit on allowances from this source for installations
during Phase 2.
18. Those working on CDM projects suggest
that ongoing uncertainty on the long-term role for the ETS and
the associated implications for the carbon price, along with limits
on contribution by CDM projects, affects investor confidence in
this part of the carbon market.
19. It is natural that the least-cost CDM
projects will be carried out first and these may well involve
greenhouse gases of high Global Warming Potentials such as the
hydrofluorocarbons and methane rather than carbon. In time, and
with the confidence of a well-functioning ETS, mainstream carbon
reduction projects should be developed.
Question 8: How should aviation be included within
the ETS? What are the latest indications of when it will be included?
20. Emissions from the aviation sector are
growing markedly and there is a need, and desire, to address this
issue. However, there are major problems associated with including
this sector in the ETS—these need to be resolves but will
take time.
21. Since it is unlikely this sector will
enter the Scheme from the beginning of Phase 2—and in fact
it may not be until about 2010—it may be better to introduce
this sector in Phase 3, thus avoiding the disruption of, and uncertainty
in the market it may cause.
Question 9: The Environment Secretary has said:
"we will support the Commission in its efforts to enforce
tough caps". What exactly should the Government be doing
to influence this?
22. The Government must show that it is
"leading by example" and we commend government for setting
a meaningful carbon reduction target beyond its Kyoto obligations,
and by setting its ETS caps in Phase 1 and 2 consistent with this.
23. On the basis of a good record in this
area, the Government needs to support the EC in its endeavours
to ensure other MS produce caps consistent with, at the least,
their Kyoto targets.
24. UK should continue to take a lead role
in this area and make a significant contribution to establishing
a long-term framework for the Scheme with milestone carbon reduction
targets beyond Kyoto an important part of the process.
Question 10: How well integrated are the ETS and
other EU climate change policies?
25. The ETS is the latest and arguably the
policy instrument best able to deliver emissions reductions on
the scale needed, at least in some of prominent sectors. This
means that it is occupying another part of the climate change
"policy space" although there is some overlap with other
policies.
26. The obvious overlap is in the renewables
area. The EC accepts that this sector is heavily subsidised in
MS to help develop the industry. But fuel switching from high
carbon intensity to low and near-zero carbon intensive technologies
is also the result of a well functioning ETS—there is a
danger then of providing a "double benefit" for renewables
(which in the UK means equates to wind power at this time) and
this discriminates against other near-zero emission options.
27. It is crucially important that the ETS
develops into one of the key EU "climate change" policy
instruments for the long-term but this may require removal of
some redundancy in the policy space; for example it is now appropriate
that the Climate Change Levy in the UK be phased out since it
tackles the same issue.
Question 11: What work needs to be done now to
help design a third phase of the EU ETS? How can the experience
of the EU ETS be used to help the design of a post-2012 Kyoto
mechanism?
28. The most important first step towards
a post-Kyoto, Phase 3 of the EU ETS is a concerted effort at MS
and EU level confirming the Scheme will continue for the long-term,
thus providing industry with a measure of certainty needed for
its investments.
29. The EC's Review of the Scheme will be
extremely important in building confidence particularly if some
of the inequities in the Scheme are removed and the way forward
is made clear to the traded sector.
30. Confidence in the scheme will also grow
if an international, post-Kyoto agreement is reached on emission
reductions that involve as many countries as possible. As a minimum
it is important the EU ETS remains not only as an effective vehicle
for emissions reduction in the EU but also provides a vehicle
whereby other countries are engaged through JI/CDM projects, or
by linking to emerging trading schemes.
October 2006
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