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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 70-i House of COMMONS MINUTES OF EVIDENCE TAKEN BEFORE ENVIRONMENTAL AUDIT COMMITTEE
THE EU ETS: LESSONS FROM PHASE I
Tuesday 21 November 2006 MR JIM GRAY, MR MARTIN BIGG and MS LESLEY ORMEROD DR KEITH ALLOTT, MS KIRSTY CLOUGH MR JOHN LANCHBERY and MR MARTIN HARPER Evidence heard in Public Questions 1 - 95
USE OF THE TRANSCRIPT
Oral Evidence Taken before the Environmental Audit Committee on Tuesday 21 November 2006 Members present Mr Tim Yeo, in the Chair Mr Martin Caton Colin Challen David Howarth Mr Nick Hurd Dr Desmond Turner Joan Walley ________________ Memorandum submitted by the Environment Agency
Examination of Witnesses Witnesses: Mr Jim Gray, Head of Regulatory Development and Deputy Director of Environmental Protection, Mr Martin Bigg, Head of Process Industries Regulation, and Ms Lesley Ormerod, Policy Adviser, the Environment Agency, gave evidence. 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. Mr 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 per cent 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 per cent 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. Mr 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 on the carbon, there has been little adjustment by industry and, unless there is a significant tightening up and tightening of the price, we do 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? Mr 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 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 ten years away or 15 years away? Stern is talking about doing things, very, very starkly in the Stern Report, in less than ten years. Are we going to get real, positive results in that period? Mr 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? Mr Bigg: Yes, we do, we have got 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 three per cent tighter than the Phase I plans and I do not think three per cent 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. Mr 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 being given. Our concern is that it is being delivered and the allocation is being determined in very different ways in different states, so 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. Mr 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 see that these are 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? Mr 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 coal switching. Most of that was on the power generators. Mr Bigg: It basically comes down to the price of fuel and, with the price of gas going up, a significant burn 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? Mr Bigg: The straight answer is yes, if there is a real market. I cannot predict or even 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. Mr Bigg: This is very detailed methodology spelled out from 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 have 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. Mr Bigg: The large emitters contribute around 70 per cent 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 of it which Defra have built into their scheme is to provide more favourable allocation for CHP plant. Q20 Colin Challen: That is interesting because I want to look at a couple of examples which I think will be pretty small fry in what you have just described in terms of the big emitters. In the first year of Phase I, the Queen Elizabeth Medical Centre emitted 7,500 tonnes more than it had been allocated and St James Hospital in Leeds, which I know very well, went over by 5,000 tonnes. The think-tank, Open Europe, has estimated that this cost in the first case of the Queen Elizabeth £90,000 and the Leeds Hospital £60,000. In Phase II, are you confident that public bodies, such as hospitals, will be more accurate in their assessments and that they will have an accurate, verified figure to work on? Mr Bigg: We are similarly concerned about the proportionality of the impact of the EU ETS and a study we did identified that 45 per cent of those within the UK EU ETS contributed less than one per cent of emissions and the cost on them was proportionately significantly higher such that whereas the cost of the scheme to the larger operators may have been about a penny per tonne of CO2, for the smaller operators it may well have been between £1 and £2 per tonne of CO2. We have lobbied strongly with our Defra colleagues to exclude from the subsequent schemes or phases these smaller operators and we believe that Defra have similarly taken that message to the Commission, so we strongly support a far more apportion-based approach to the delivery of the scheme and certainly exclusion of the smaller players. Q21 Colin Challen: That suggests that particularly the smaller players, and hospitals in particular with all their other financial burdens, have found it difficult to mitigate their emissions and that they are just finding it too much of a burden. Mr Bigg: Yes, the room for manoeuvre we see for the smaller operators is significantly less and the cost of doing so higher, so both from an administrative and an environmental viewpoint, we believe there is a very strong case for the smaller operators being excluded from the EU ETS. Q22 Colin Challen: What sort of cumulative impact will that have on the integrity of the whole scheme if we start excluding small emitters? Mr Bigg: If we exclude 45 per cent of the smallest operators, that will knock out less than one per cent of the emissions within the scheme, so the impact will be negligible. Mr Gray: There is a very long tail. You have got the big power stations emitting a lot of CO2 and then you have got this big, long tail of smaller emitters. You could take 45 per cent out of the total installations and you have still got 99 per cent of the CO2. Q23 Colin Challen: I realise it is small. Mr Gray: We have made this loud and clear. I think the one thing I am going to take from this is to kind of go back and challenge my colleagues in the Agency who are doing the calculations with Defra and DTI. The kind of figures you are saying there of 90K for these smaller operators, that does not sit comfortably with us. It certainly does not sit comfortably with me, and I see my colleagues nod, but I am certainly happy to go back and look at that and check. Q24 Colin Challen: It would send out the wrong signal, would it not? If we start saying that certain people would be excluded, especially at a time when the Government is considering even individual responsibilities for reducing carbon, and saying that these, by our standards, quite big emitters with 7,500 tonnes over their allocation, which sounds a lot to me just for one installation, whereas in the great scheme of things, it is not very big, the signal that that would send out surely is going to be rather more damaging? Mr Gray: Sure, but I think our position is just practicability. Do you want to regulate half the number of people who discharge 99 per cent or do you want to double the number that you regulate who discharge the other one per cent? It is where do you draw the boundary. The Commission threshold is, I guess, I do not know if it is an arbitrary figure, Martin, but they just pick a threshold and everybody involved gets it. Mr Bigg: Our aim at the end of the day is precisely identifying awareness and that clearly needs to be applied to everyone, but also proportionality in terms of response and of course the cost associated with it. Our concern is particularly about the environmental outcome and, as I touched upon earlier, if we have 40 sites which generate 70 per cent of the emissions, then that is clearly where we need to devote the maximum amount of effort to achieve the maximum number of gains. Conversely, climate change is an issue which applies to us all and, therefore, we need to ensure that we maintain that awareness without imposing unfair burdens on those individuals. Chairman: The question about whether your figures are different would be very helpful to us if the figures we have quoted here can be challenged. They came from an outside source to us, so if it appears that the estimate that we have been given is wrong, that would be useful to us to have. Q25 Joan Walley: Could I just press you a little bit more on the methodology about the individual installations because, in response to Mr Challen's question about the emissions from the hospital and the medical centre that you have just referred to in Leeds, what I am not clear about is how you arrived at deciding which individual installations would be included in it. You could, for example, take a whole local authority or you could take the whole of the NHS estate and if you sort of put them all together, you might well find that you have a whole number of different installations which cumulatively together would emit a lot of emissions. I do not quite understand what the methodology is in determining which installations are included. Given that we are in the process of great regeneration at the moment and rebuilding so many, for example, hospital sites, I would secondly be interested to know what kinds of discussions there have been with the Treasury in terms of embedding the implications of this methodology in respect of PFI agreements and new building agreements. Mr Gray: I would just say that we did not calculate the Phase I allocations, but it was Defra and DTI. Ms Ormerod: In terms of coverage and determining which installations are in, the Directive which was transposed into the UK Regulations sets a threshold for inclusion in the scheme which is 20 megawatts for a combustion installation, which is what we would be talking about with a hospital. There are also some aggregation rules which mean that any smaller sources which add up to that 20 megawatts would bring the whole site in. Q26 Joan Walley: So is it site-specific? Ms Ormerod: It is on an installation basis of an individual installation. You do not aggregate emissions from different installations. You may aggregate sources on one site, one installation, because that one hospital might have a number of boilers and then the capacity of all of those boilers would be aggregated and if that came above the threshold, then that hospital site would be in, but you would not say for the whole local authority area ---- Q27 Joan Walley: Why not? Ms Ormerod: It is the way that the scheme rules are designed. It is set out in the legislation which defines ---- Q28 Joan Walley: But what I want to get at is whether or not that design of the scheme is simply a matter of how Defra have constructed it and if it would be open to the UK, if there was a will to do it, to reconfigure it in a different way? Mr Gray: I do not think so because the 20 megawatts is prescribed in the Directive, and 20 megawatts is quite a lot of power. It is not aggregated across a whole local authority, but it is within the fence of an installation. Q29 Joan Walley: But should it be? Mr Bigg: At the moment, we are delivering the EU Directive which has been transposed directly into UK Regulations and then we, as the regulatory authority, are delivering it as it stands. There is room for changes in the future and, as far as we understand at the moment, expectations in individual Member States are that there will be few changes next time round for Phase II, but an opportunity to add in other activities in Phase III. There is a case clearly for changing what is in it in terms of identifying other significant sources of greenhouse gases and, similarly, excluding small-scale activities, but it is a sizeable scheme with a lot of obligations. My colleague, Lesley, mentioned earlier the monitoring and reporting requirements and, if we are going down to smaller-scale activities, then the question is whether you need such onerous requirements, so in terms of ensuring awareness of carbon dioxide and addressing carbon dioxide or greenhouse gas emissions, it may well be that other schemes are more appropriate for small-scale activities than the EU ETS. Mr Gray: We will check out, as you suggest, the position on the Queen Elizabeth Medical Centre and the St James Hospital in Leeds. If they have had to buy allowances and it cost that amount of money, the thing that strikes me about them is that if the allocations were made on a business-as-usual basis, then something has happened where they have either upped their production or done something, I guess, which was over and above maybe what they were doing before. Mr Bigg: Perhaps the other cost of course is the cost of third-party verification. That clearly is beyond our control and it is very much dependent on the commercial agreement between the hospital and the verifier they employ. Q30 Joan Walley: Is that then not a matter for whatever the PFI arrangements are? I am assuming this is a PFI contract. Mr Bigg: It is a matter for the operator, so in this particular case it may well be the PFI contractor. Chairman: Well, if you could shed some light on that, that would be helpful anyway. Q31 Mr Hurd: Can I take you back to the vital rule of the European Commission in tightening up the Phase II NAPs. What is your view on the degree to which these NAPs need to be cut and what is your view on the level of competence of, and confidence that, the Commission will actually achieve this? Mr Bigg: To answer the second question first, we have a high level of confidence from the indications we have seen so far that the Commission are concerned about the national returns that they have received and are assessing at the moment, and we look forward to their response in the next month or so. As far as what the level should be ---- Q32 Mr Hurd: Concern is one thing, but actual ability to do anything about it is another thing. What is your view about that? Mr Bigg: I am afraid I cannot speak for the Commission, I can only reflect on the representations which, I understand, the UK have made to the Commission in terms of the importance and, I think, a recognition within the Commission that there are issues here that, unless it is tightened up, as we touched upon earlier, the scheme will not deliver. As to the precise price that will make a difference, I am afraid I have to refer back to what we were saying earlier, that we have seen indications in terms of what the market has done which means that companies have started taking action, but when the price dropped again, we saw, if anything, those actions being reversed. Q33 Mr Hurd: But in terms of percentage reductions and allocations, I think you were talking before, Mr Gray, about Phase II may be three per cent tighter than the first phase, if I understood you correctly, and that appears to be inadequate. What sort of percentage, in your view, is actually a more appropriate target to take us closer towards the 30 euro price which you suggested was actually ---- Mr Gray: I could not give you a figure even now, but it strikes me though that if I were in the Commission, the way I would be looking at this, I would be saying, "The EU ETS covers 50 per cent of the CO2 emissions. What is our Kyoto target?", and I would be trying to align what they are looking for in Phase II NAPs with what they are trying to achieve through Kyoto. Intuitively, three per cent, and the Fraunhofer Institute has been looking at these and that is their figure, intuitively it does not seem as though that will do the trick, but I do not know what the figure is and I think that is really in the hands of the Commission to look at what is the Kyoto target, what do they expect the sectors covered by the EU ETS to deliver and how do they then set that in a meaningful way. I do not have a feel for what that figure should be. Q34 Mr Hurd: You talked in your memo about the need to move to a single EU-wide cap, if I remember correctly, as an important requirement of the scheme's future success. How realistic is that, do you think, in terms of national governments giving up their power effectively? Mr Gray: I do not think that is particularly realistic. Ms Ormerod: It is an option that the Commission will be considering in their review of the Directive. It is one of the options they have stated they will consider. In terms of political will across the Member States, I am not sure. Mr Bigg: I think what we are looking for in the more short term is greater transparency in the methodologies that the various national governments use to derive their caps. If we can get transparency and a consistent approach, we are well on the way there. Q35 Mr Hurd: Are we not kidding ourselves? Is not the whole problem of the first phase the lack of political will and we seem to be drifting into a second phase which shows exactly the same symptoms? Is it not actually time to be bold and actually say that it is the politicians who are the problem and this needs to be set independently across Europe? Mr Gray: I would not like the Environment Agency to judge that. How the NAPs for Phase I landed the way they did, you say there is a lack of transparency and I think we would agree with that, but it is their own projections that countries have had for the growth, so there are a lot of underlying assumptions in arriving at those which are peculiar to Member States. I think it is outside our competence really to comment on those other than the obvious things we have said before, but I agree with you on the transparency and I think the reasons come down to some of the underlying assumptions about economic growth, et cetera, which they have said. Our National Allocation Plan for Phase I was very strongly scrutinised and challenged by the Commission and one can only presume they have done the same with the other Member States and why would they not? Maybe they did it on a proportionate basis. You can imagine they would spend more attention on the bigger nations than the smaller ones, but they certainly scrutinised us quite carefully and we felt that. You have to kind of assume that they did it for the others, but somehow or other things have changed and it never landed that way, but I would not like to speculate from the Environment Agency viewpoint as to what the remedies and issues are, but we do agree with some of the comments you have made. Q36 Mr Hurd: Can I ask you about what you are seeing in terms of willingness to harmonise implementation of the scheme, which is what you are responsible for, and specifically on issues such as the number of allocations to be auctioned or the proportion of CDM and JI credits that can be used? Ms Ormerod: Again they are issues that are government issues. They come within the national allocation plans rather than the practical implementation harmonisation work that we are doing, so again that is at government level. Q37 Joan Walley: But you are leading it. Ms Ormerod: Leading? Q38 Joan Walley: You are leading the discussions to harmonise. Ms Ormerod: On the practical implementation issues, not on issues like the proportion of CDM or JI credits or on the percentage of auctioning. That is at government level, that is not at our level. Mr Gray: We are working with other regulators in Europe to ensure that we are monitoring CO2 emissions the right way, not the verification rules. It is the practical compliance, how do we find compliance. We are not working at the level of, "What's the approach to auctioning or JI credits", that is the government level. Mr Bigg: What we have stressed through our European contacts is the importance of having a common methodology and a transparent approach to the allocations, but, as Jim says, the key role we have got is to ensure that, once we have got those frameworks in place, they are delivered consistently across Europe. Q39 Mr Hurd: How is the thinking evolving on the question of sanctions against Member States that are behind track, which is an implementation issue? Mr Bigg: Again the Emissions Trading Scheme laid out very clear rules within which countries operate and the initial allocations, as I say, are according to those rules, but the only real role that I can talk about is when it comes to, once we have got the allocations, ensuring that individual installations comply with, and submit adequate returns against, those allocations. That is clearly our role as regulators, but everything else in terms of the national allocations and the methodology used is very much for national governments and we have no means of influencing that either as a national regulator or even as a group of European regulators. Mr Gray: Your question about sanctions against Member States, it sounded to me as if you are asking whether the Commission would take sanctions against Member States. I guess you would ask the question, "Sanctions for what?" because if the Commission agreed the Phase I allocation plans and the members are working within that and, okay, there is then a surplus of allowances, I do not know, I do not have my finger on the pulse of what the Commission are thinking here, but I am struggling to think of what kind of sanctions they would take for that situation. Where they may consider sanctions is where Member States are not properly implementing it and again we are seeing that there is fairly good implementation at the EPA level. There is fairly reasonable compliance of companies across Europe, so whilst I do not know the answer to your question, I am not clear that there is a position that I easily see where the Commission would be certainly taking sanctions for Phase I. Phase II is their opportunity to get the right caps, but that would not be in the form of sanctions. I think where sanctions come in is where companies do not comply and then do not surrender their emissions or do not have their allocations allowances in the first place and then there has to be some kind of regulatory compliance action, and that is at a different level from what you have suggested. Q40 Chairman: Well, one sanction might be to cut their National Allocation Plan. Mr Gray: Yes, it could be exactly and it would be interesting to see what Phase II does. Q41 Chairman: I understand your caution about not wanting to get into policy-making, but there is something inherently irrational about a country which has a Kyoto target of X per cent reduction and who sets their National Allocation Plan for a half of X. It seems to me to be that the sort of minimum target set under the National Allocation Plan should be one that achieves the Kyoto target for that particular nation. Given that it covers almost half of all emissions, if they have a less-demanding target, they are making incredibly optimistic assumptions about the least-regulated part of the whole emission process. Mr Gray: I do not think we can add, but we can only agree with that, I guess. Q42 Chairman: Good! We are coming on to a very important part of the discussion, but the truth is that there would not need to be any national allocation plans if we had a system of 100 per cent auction permits and an EU-wide target. All those problems would disappear. Mr Gray: Yes, agreed. Q43 David Howarth: Could I ask you to comment more on the idea of 100 per cent auctioning because, in your memo, you say that should be a long-term aim of the scheme, to have 100 per cent auctioning, but you also say that you could have a 50 to 70 per cent reduction of permits without affecting profitability. I am a bit puzzled by what that means because, on the one side, if the scheme is not threatening the profitability of firms, how is it going to have any behavioural effect either at the level of the firms themselves or at the level of the barters where it encourages investment in the form of economic activities which do not use so many permits? Are you saying that we can have 50 to 70 per cent of auctioning without any effect because that would be slightly pointless, would it not? Mr Bigg: Can I turn it round the other way in terms of why auctioning in the first place? We have assessed the overall impact and are advocates of auctioning in comparison to grandfathering or benchmarking on the basis that, in principle, it actually internalises the cost of the pollution, in this case the carbon dioxide, so you start with everyone actually having to take account of the costs, but then using the funds raised from auctioning to support particular areas of new technology, cleaner technology which then will deliver additional benefits over and above the market. That is the most straightforward way of doing it and, in that way, you are actually returning the costs back into the emitters in one way or another. When it comes to any figure less than that, yes, there is a debate as to whom you advantage and disadvantage and the costs. Our concern is, as I say, that the environmental costs are taken into account and that there should not be additional distortions over and above those which bring environmental benefit, so for international trades we would like to see the same approach applied to the same type of activity in each individual country so that, say, a steelworks is subjected to the same costs of carbon in whichever country it operates. Whether we go for a lower proportion of auctioning is, I think, a matter of debate and detail, but our principal concern is that the costs of carbon are actually built in to the costs of operating the particular installation. Q44 David Howarth: Could I just press you on this 50 to 70 per cent figure and how it was arrived at? Ms Ormerod: The 50 to 70 per cent figure came from some work that we commissioned which focused specifically on options around auctions in Phase II up to ten per cent and it is fair to say that the modelling that that was based on made some assumptions around things like the industry sectors, it is not across all industry sectors, but it was focused on specific industry sectors and a carbon price and things like that, so it was a very specific bit of work. Q45 David Howarth: Do those assumptions include an assumption that firms are not able to adapt beyond a certain level of carbon price? Ms Ormerod: Possibly. Q46 David Howarth: The other thing which was interesting about your proposal is what to do with the non-auctioned bit, how to set benchmarks. I think you have put forward the principle that you should operate on the basis of the most efficient and the best in Europe, the kind of BATNEEC sort of technique. Just as a sort of matter of interest, how would the UK fare if that principle was put into operation? How near to the best-available technology, not entailing excessive costs, are we? Mr Bigg: In terms of controlling emissions of CO2 particularly? Q47 David Howarth: Yes. Mr Bigg: Well, if I can focus on the biggest emitters and the example there, our power stations are relatively old, the technology is relatively old and we are in a process of retrofitting gas clean-up for sulphur dioxide to meet the requirements of the Large Combustion Plant Directive which further reduces their emissions. Therefore, to answer your question directly, relative to much of Europe, we do not perform perhaps as BAT or BATNEEC ---- Q48 David Howarth: I suppose it would be BATON or BATNEEC, would it not? Mr Bigg: BAT under the IPPC Directive and BATNEEC under the previous legislation, so yes, particularly from the major power generators, we do have an issue there. In other industries, where perhaps one can say the costs are not so readily passed on to the consumer, there has been a bigger incentive to improve efficiency and we do see new technologies, new approaches and more efficient processes which do mean that the emissions are relatively smaller. Mr Gray: Your question has made me think and listening to Lesley's and Martin's answers has just made me think that there is almost a hierarchy, is there not? It is a bit like the waste hierarchy which you will have come across many times where I guess you have got grandfathering, benchmarking and auctioning and the further you can push the allocations up that hierarchy, I would think the better the market is going to work out a true market, so there is almost a hierarchy there. The reason we are quoting figures like that is that there is a practical element to all of this. We do not think we will get those kinds of figures, but there is a thing that says that if you do take a position as the Environment Agency, you want to see things moving up that hierarchy and the further that happens, then the better the market you get and then the better the environmental outcomes, and that is probably the way we are looking at this. Maybe that is obvious to you, but it came to mind as you were asking the question. David Howarth: That is helpful, thank you. Q49 Chairman: Is it not the case at the moment that the longer we delay introducing a higher proportion of auctions, the more there is a kind of hidden incentive on installations not to take dramatic steps because, if they introduce low-carbon technology into their processes, they will actually be reducing their expected future allocations? Mr Bigg: Yes. Ms Ormerod: In Phase II, the baseline that was used to calculate those grandfather figures was not updated, so it did not take into account first year's emissions data, so there is not an incentive in that respect, but clearly if you are not going to update your baselines, then the information you are using to base your allocations on is becoming less and less realistic the further away you move from that, so there is an argument there that grandfathering is not the way to allocate in the future. Q50 Chairman: It possibly disincentives people? Ms Ormerod: Yes. Q51 Colin Challen: Just moving on from the earlier questions about the disproportionate costs on smaller emitters, the proposed Energy Performance Commitment might be a place for some of these small emitters. Would that not also have a similar cost base for them and it is going to be equally expensive whichever scheme it is surely? Mr Gray: We have seen some figures around for this because we think it would be a lighter touch. A big bit of the cost is the verification cost and we would probably see again on a proportionate basis a lighter-touch verification exercise. If the EPC came into a company that only had one site, then I think it would be cheaper to administer than the EU ETS, but not hugely so, but a bit cheaper, but if a company had 100 sites or 100 shops and it could spread some costs, then the cost per unit drops really quite dramatically, so I think for the bigger companies that may have small installations and would not come into the EU ETS, but they have a lot of them, a lot of supermarkets or whatever, probably the cost across them all per unit would be a lot, lot less than the compliance costs of the EU ETS. Mr Bigg: The point I would emphasise though is that the EPC is out for consultation at the moment, so clearly there are a lot of things which are not known about the final scheme and what we have got in the consultation document are draft indications of the proposed costs, so until realistically the final proposal is put together, we do not know what the precise details would be, except that logically if you reduce the amount of work required and the standard of work required, then the costs will go down. Q52 Colin Challen: It would not be less robust then? Mr Bigg: Logic says that if you have more of a self-assessment process rather than third-party verification, then the level of robustness will be less. Mr Gray: I think the level of robustness will clearly be less, but, because you are dealing with much smaller emitters that aggregate to a smaller amount, you can afford some proportionality in all of this, which is really the way I would look at this, so a small emitter, if there is a ten per cent error and you do not spot it, that ten per cent is minuscule compared to a coal power station and a ten per cent error, so it is just where you focus attention. Those figures that I had in mind before come from the consultation and they kind of show there should be costs going down very markedly if there are a lot of installations or shops or whatever that company has. Mr Bigg: The figures we have from the consultation, just for information, are, we understand, for single sites about £7,000 and for multiple sites you are in the region of up to £30,000, whereas under the EU ETS for the smallest installation, it is, as I touched on earlier, about £11/12,000 plus the fees for your contractor, so there is a pretty significant step-up, but that reflects again the scale of activity and the environmental impact. Mr Gray: And the 30,000 might be split across 100 sites or so, and so it could be quite cheap. Q53 Joan Walley: The review that you were looking at in respect of the ETS Update Project, do you see, arising out of that, other sectors being included, like, for example, coal or aluminium? Ms Ormerod: The LETS Project looked at specific industry sectors and did a feasibility study as to how realistic it was to include them and it made recommendations. Coal-mined methane was one recommendation that the LETS work came up with, so methane emissions from coalmines. I am not sure; I will have to double check. Mr Bigg: There are other parts of the chemical industry. Mr Gray: There is ceramics and there is aluminium as well. There are a few other high energy sectors. Ms Ormerod: Nitrous oxide was one from nitric acid and adipic acid manufacture - it is fairly detailed - CO2 and fluorocarbons from aluminium production and methane from coal mines. Q54 Joan Walley: Wearing my constituency hat, I would be interested in the conclusions on that in respect of ceramics. In terms of coalmining and aluminium, how would it affect the price of coal? Ms Ormerod: We did not look at that. Mr Gray: It is a pretty incomplete picture. In terms of ceramics, we will privately talk to you about that. The big one is coal-mined methane, and may be somebody else does but I do not actually know how you would mitigate methane emissions from coal mines, and there seem to be a lot less coalmines around than there used to be. This is a study that has made some recommendations and we feed this in, but personally, at the end of the day, whether this stuff makes a huge difference I am not sure. Mr Bigg: The key point to emphasise is that if we are looking at greenhouse gases, with methane having 20 times the greenhouse gas potential compared to CO2, then clearly significant sources of methane need to be considered, and mining is a significant source, alongside other activities including land-filling and agricultural sources. Q55 Joan Walley: What would you say are the main recommendations that you have been making from this review and how well received have they been by the Commission? Mr Bigg: The key recommendation is that the Commission looks broader than just CO2. Other greenhouse gases and improvements can be achieved. It particularly mentions methane, any sources of methane (it does not matter where it comes from when it gets into the atmosphere), similarly N2O, and even to look at where changing technologies may be resulting in increasing N2O. For example, putting in gas clean-up on combustion processes actually can increase the emissions of N2O rather than reducing other emissions. What we are keen to ensure is that there is a broad review of all potential greenhouse gas sources. Ms Ormerod: I think the LETS Update Project seems to be have been fairly well received by the Commission, and they actually refer to it as a good source of information in the recent communication on the directive review, so I think they are taking those recommendations seriously. Q56 Joan Walley: Finally, you commented earlier on that you were doing the monitoring, and the enforcement and the policy issues were a matter for government and Defra. Arising out of this review that you have done, it is not that you are detached from the policy-making arena, are you? What mechanism, do you feel, needs to be put in place whereby the work that you were doing on the implementation side could be more closely aligned with the policy agenda that is determining, through Defra and government, what comes out of the EU Commission? Mr Bigg: The straight answer is that we are actually working very closely with Defra and DTI, both in the early stages on the implementation of the EU ETS but particularly now on its operation and, being the front-line regulators, our experience is that we are gaining through the operation of the scheme. So, through our regular dialogues with government departments and our formal representations back to them, our position is very clear, and they in turn, we can see, are reflecting that back to the Commission, but also, as we touched upon earlier, working with our European counterparts as European regulators similarly feeding through other Member States back to the Commission as well. We believe we have got to an effective working relationship influencing them on the workings of the scheme. Mr Gray: Can I add a couple of things to that. The LETS Study that Lesley was talking about, we were essentially, I guess, a contractor, or partly a contractor. We know it was partially European funded and it was with some European partners and it was Commission funded, so we are almost doing it as, I guess, a contractor to some extent, and that is the domain of that. Of course the Commission have been positive about the kinds of things we have been saying. I agree with Martin entirely about the way we are working with government, but I go a step beyond that. I think for us the whole EU ETS experience over the last few years has for me been a role model in how the agency works with DEFRA, it has been one of the good kind of best practice examples, and two things, I think, are part of that. One is being clear about the roles - what is Defra's role and what is our role - but also Defra devolving as much as they can to delivery bodies. They still kept, I guess, the political things like the NAP and the European negotiations, all that kind of stuff, but devolving the delivery aspects to us. I am only saying what Martin said, but I am kind of strengthening it. I think this has been an area where we have worked immensely well with Defra and have been clear about what our respective role in all of this is. Mr Bigg: Particularly, may I say, bearing in mind the timescale that we had to set up the scheme and operate it, the fact that, as far as we are concerned, it has actually worked well and delivered on a UK basis what the scheme was intended to using the market to deliver environmental gains. We see it as a major success. Q57 Chairman: We have covered all the ground that we hoped to, so thank you very much for coming in? Mr Bigg: Thank you very much. Memoranda submitted by WWF and RSPB Examination of Witnesses
Witnesses: Dr Keith Allott, Head of Climate Change, and Ms Kirsty Clough, Emissions Trading Policy Officer, WWF-UK, Mr John Lanchbery, Principal Climate Change Adviser, and Mr Martin Harper, Head of Government Affairs, RSPB, gave evidence. Q58 Chairman: Welcome. I think you are all familiar with the Committee and most of the members, so we will not ask you to introduce yourselves, unless you particularly want to, but thank you very much for coming in. I think you heard all or most of the previous session, so we will try not to cover exactly the same ground, although there may be some particular points that you want to mention. Could I start on the Stern Report, which finally saw the light of day three weeks ago and I think has been, rightly, fairly widely welcomed. Before we get on to specifically what Stern said about emissions trading, would you like to give an overall reaction to the Stern Report? Mr Harper: I will kick off, if you like, and then pass on to colleagues. I think the RSPB and others do see it as very much a momentous report. I think that probably the most significant thing is that it has bucked the economic trend in the thinking regarding climate change. So, rather than considering it is economically more sensible to wait and allow human ingenuity to pick up the costs of climate change, it is actually suggesting that it makes economic sense to mitigate now to make sure that we actually prevent experiencing the worst of the damage. There are two other things worth saying. I think that the from our point of view it is great that they have positioned issues such as avoiding deforestation more centre stage (so this is one of the cheaper ways in which you can deal with mitigation) and, thirdly, I think what it does provide is a sense of optimism that, if you do address economic costs now and put in place measures now to tackle the issues, there is a good chance that we can avoid the worst of the problems, but colleagues can expand on this. Mr Lanchbery: To add a little bit to that, obviously I agree with what Martin says, but (and there is a "but" in the Stern Report) he does use a range of emission stabilisation scenarios which are too high. So, the concentration ranges he mentions, which are between 450 and 550 BPM, and he actually uses the 500 to 550 BPM scenario more, will not take us below the two degrees target, which is the EU target to which we all subscribe. Dr Allott: From WWF's point of view, we fully endorse the positive message from Stern. Particularly, I think, the thing which strikes us most powerfully is the sense of urgency which we feel very, very strongly and we feel gives a very powerful of economic rationale for that urgency which we see from other directions as well. Also, the 450 to 550 BPM range (just to spell this out) we feel is the weak spot of the report. Just to be clear about this, 450 BPM CO2 equivalent gives you roughly a 50/50 chance on current science, and the science seems to be going only one way at the moment, which is, unfortunately, in the wrong direction, but on current science there is a 50/50 chance of staying below two degrees. At 550 BPM we are more than likely exceeding three degrees, there is a very significant risk of hitting four degrees. Nick Stern himself in the detail says that 550 BPM is a very dangerous place to be, with deeply unpleasant consequences, so we do ask why he is recommending it as an acceptable boundary. Q59 Chairman: Presumably because anything lower than that as a target would, first of all, greatly increase the urgency, obviously, but might question the message about affordability and economic requirements. Dr Allott: I think the answer to the question is an interesting one, because one thing to take, I think, from Stern is that, regardless of which stabilisation scenario you go for, the message is that we need to have global emissions peaking within the next decade or so. The question then is how quickly we start to fall. So, for the immediate policy, actually the focus should be on peaking global emissions very quickly. Then there is a question about how quickly we could, or should, try to reduce emissions from that peak. Mr Lanchbery: To be fair to Stern, I think there are two reasons why he has not considered the low end of the range. Firstly, there are relatively few studies which cost achieving a 450 stabilisation; that is a sort of fairly major reason. The other one is that he thinks, I think, it might be difficult to do practically. However, it does not necessarily mean that we should not do it if we want to avoid the two degrees, and he says actually that it will be expensive, somewhere in there, to stay at 450 or below but he does not actually justify that statement. It is not justified anywhere in the rest of the report, so you might take him up on that. Q60 Chairman: We are hoping to have a session with him in due course. On emissions trading, he does say that post 2012, post Phase II, the shape of the ETS could be very influential in how global trading might or might not evolve. What is your judgment about how important the success or failure of the ETS is in terms of the global process of tackling climate change? Mr Lanchbery: It is very important. It is the only operational scheme of its size certainly in the world and, as the Environment Agency said, it is the only one that trades between different countries, albeit as part of the Union. So it is very, very important that it succeeds, which is why we have all been very disappointed about the over allocations for the first phases which brings it into disrepute. Dr Allott: I would entirely agree with that. Just to spell it out even more, there are two processes which are now running which will very much determine the credibility of the ETS. Firstly, the decisions on the Phase II Allocation Plans: we are expecting the first results of the Commission's thinking on that within the next few days, and then there is the review of directive for Phase III, both of which are happening right now, and both of those processes will be critical in determining whether the EU ETS is actually going to deliver on what we want it to be seen as, which is, and as Stern sees it, as a nucleus of a future global trading scheme. The basic principles of the ETS are right in terms of the framework of mandatory absolute caps. We are concerned that if ETS fails because of lack of political will, with a short-term focus that fundamental principle, for instance, will be lost and we will then have a global trading regime built on a much slacker framework. Q61 Mr Caton: Can we look at UK emissions targets now. The Government says that Phase II of the EU ETS will save eight million tonnes of carbon a year from the UK, but that is calculated on the basis of business as usual projections if we did not have an emissions trading scheme. What are your views on using those sorts of projections rather than looking for absolute cuts? Mr Lanchbery: We should not. It is a bizarre way of reaching a target to do a business as usual projection, lop a little bit off it and then say you are trying to meet a target. If you are going to meet an emission reduction target, you need an absolute budget of emissions which decreases over time so that your budget in the end is exactly the same as the target you are trying to get to. It is absolutely bizarre to use a projection, except to inform you of how much you would have to do (what is the difference between what you might do and what you need to do), but you need to set allocations to the EU ETS on the basis of an ever reducing absolute budget for carbon. There is not another way to do it. Projections do not take you to your target. Dr Allott: We entirely agree, and I would also point out that continuing to rely on business as usual projections, which assume a business as usual world in the absence of the ETS, is an increasingly bizarre and untenable approach. The ETS exists; therefore it forms part of the business as usual world; they are caught in its logical loop. Q62 Dr Turner: At the moment it seems difficult to think that the operation of the ETS so far has saved a single tonne of CO2 from being emitted anywhere in Europe, let alone determining whether it has been saved in the UK; but when Defra announced the Phase II allocations they said it would help reduce the UK's carbon emissions from the 16.2 level that we are at by 2010 as compared to 1990, in other words, the revised figure in the last climate change policy statement. Was Defra justified in making that claim? Dr Allott: The basis for that assumption is, firstly, that there is a robust emissions trading scheme around the whole system. An emissions trading scheme is only as strong as the weakest link. Every part of that chain needs to be robust. Behind your question there is the issue about where the emission reductions take place and whether they take place within the UK or in another country, and that is a difficult question to reconcile with the national cap. The truth is that once you have an international trading scheme you start to lose control over where your emissions do come from. Whether Defra is justified in making that claim, I think the jury is out, and a lot will depend on what happens in the next few weeks in terms of the Commission holding a line on the allocation plans that we are currently seeing. It is clear that the current overall picture is not good. We are getting positive signals from the Commission in terms of the line they are going to take, but clearly this is a high level political thing. We are getting positive signals from the DG environment, but this is a much wider high level political issue in all the aspects of the Commission, and some parts of the Commission take a different view. Q63 Dr Turner: If the ETS Directive is acted upon literally, the Member States have to accept national allocation plans that are in line with the Kyoto targets, but it does not really actually say how much it would work in practice. What wording or mechanism do you think the UK Government ought to be pressing for the Commission's review of this directive? Do you think it is sufficiently explicit to work? Mr Lanchbery: No. It certainly has not worked, so therefore it is not sufficiently explicit or certainly not sufficiently mandatory. We would like to tighten that up considerably, at least to say that the allocation should be directly proportional to, or better than, that Member State's target. A better way still would be to have an overall EU cap. Let us assume that the EU, as a whole, agreed to a 30 per cent reduction by 2020. If you did that, then that would be the level below the 1990 levels at which the allocation would be set. You would have to have a burden-sharing arrangement of some sort to divvy it up, but you could do that. At the moment, you are right, the directive is quite loose. I think at the time it went through the Council and Parliament they were actually being quite reasonable, and they said this covers about half of European CO2 emissions, very roughly, and there are measures you could take in other sectors. So, in some countries perhaps they really are going to tackle the transport, domestic sectors and make the most of their emission reductions in those sectors so the traded sector would not have to do very much, but, frankly, that was wildly optimistic thinking. The place where the biggest reductions can be made faster is mainly the sector covered by the Emissions Trading Directive and the transport and domestic sector have been politically harder to touch, so it was perhaps a bit idealistic, if not naive, of the original drafters to put the wording in the way that they did. Dr Allott: I would agree with all of that and also stress the importance of the targets, and in fact more than just a single target, which we think would be absolutely necessary, which would be at least a 30 per cent cut for the EU. This is being proposed by at least three major countries at the moment, the UK - Gordon Brown confirmed this at the time of the Stern Report - also Germany and France are supporting this target. The big question will be whether the EU as a whole signs up to it next spring Council. That would provide a very strong framework. We would like to go further than that and actually see an elaboration of the carbon budget idea to give a clear trajectory. Q64 Dr Turner: Given the tenor of your remarks, do you have any optimism at all that the ETS is going to deliver significant carbon savings? Dr Allott: We have optimism that it is the right basic mechanism, but the mechanism is only as good as the targets that are set, and that is a question of political will. It is clear, as you say, that it is not delivering any significant emission reductions, if any, in Phase I. That is to do with the cap-setting process. It is also to do with the fact that the rules for Phase I members were very confusing because there were no Kyoto targets in place in Phase I, the benchmark was that Member States had to show that their cap was set to be on a trajectory to deliver the Kyoto target, so the trajectory can take any shape that you like. Now we have an absolute benchmark, which is the Kyoto targets, and we are really hoping that the Commission will stick to its guns on that and get very tough. It does have a benchmark and this is the crucial few weeks to determine the shape of the scheme. Mr Lanchbery: You mentioned when you were questioning the Environment Agency the possibility of a carbon tax, but in fact what has happened with the EU Emissions Trading Scheme is that because they have set the caps very low, or very high rather, it is the equivalent for the carbon tax of setting the rate at 0.01 pence. It is how you use the instrument properly that is the question and how you set the targets rather than the instrument itself which, like Keith has said, we think is basically sound although it has some deficiencies. Mr Harper: May I add one point about this. I suppose, as the UK Government is toying with the idea of introducing a carbon budget, the ETS is going to be the personification of why it is so important to make sure that the target is linked to caps and therefore the policy measures try to make a contribution to those targets, and until one has that carbon budgeting system in place, then any one policy measure could not necessarily be deemed to be making a contribution. I think the classic case with the Emissions Trading Scheme is that, unless it is directly linked to a target which determines the cap, as the Chairman said in his statement to the Environment Agency, then I think it will have its credibility undermined, which I think we all fear but we are all optimistic that there will be the political courage coming from the different Member States to try and put that in place. Q65 David Howarth: Can I go back to the question of auctioning allowances. I will be interested in any comments you might have on the exchange of the Environment Agency, but also there is one specific thing in the WWF memo to us about how much money the Government might make out of auctioning allowances, and I would like to put on record how much you expect the Government to make out of auctioning allowances and what might be the best way of spending that money? Dr Allott: The first principle of auctioning is that it is clearly the most environmentally and economically efficient way of sorting out this allocation process. We have got ourselves into a terrible mess, and what was initially designed to be a simple market mechanism has become incredibly complex and bureaucratic: because as soon as you move away from auctioning you have to start having all sorts of special rules to deal with new entrants, plant closures, plant modification, a whole range of other things start coming in which makes the system very complex. You have perverse incentives from grandfathering, you have the difficulty of benchmarking, a whole range of things come in. Auctioning is clean and simple, it does also provide, as the Environment Agency was saying, an internalisation of the carbon cost into all decisions, both existing plant and for new plant, which is precisely what we need to see in terms of influencing behaviour and sending long-term signals to companies when they are making investment decisions, and so, on all those bases, we think it ticks an awful lot of boxes, if not all of them. In terms of the revenue raising aspect of this, the positive side of that is that if you assume an EU allowance price of about 15 to 30 euros, which at the time we submitted the memo seemed a reasonable amount - clearly this moves up and down, but if you assume that range - with seven per cent auctioning as proposed by the UK Government, that would generate between roughly 250 and 520 million euros worth of revenue per year in Phase II. Clearly, there are very interesting questions about how you use that, though in the statement the Government also announced the Environmental Transformation Fund, although the linkage in the text was not direct. We are not quite clear whether all of that money is going to be spent on those things the Environment Trust mentioned, but we think that is basically the right way forward: to recycle the money so you have a positive feedback. You are using the revenues from pollution to pump, prime and start the solutions to this problem, the lower carbon technologies. There is a debate to be had, especially when you move to higher levels of auctioning, about the need for compensation for some sectors which may be exposed to international competition, and we fully accept that there are some sectors, although we think it is greatly overplayed, where it is an issue and I think, subject to state aid rules, there needs to be some creative thinking about the use of the revenues. Mr Lanchbery: Can I add to that, the reverse of auctioning, of course, is grandfathering, which is what we mainly have at the moment, although not entirely grandfathering for Phase II. That has led to massive windfall profits, particularly for the generators, which has not really caused a scandal here, but it has in Germany. They are furious about the huge profits they have made from giving away the allowances, especially when there is an excess of them, so it is a bit scandalous. The second point is that generators in the UK are increasingly coming round to auctioning - not the German generators, I hasten to add, although they are the same companies, so you do wonder why they have one opinion in the UK and another one in Germany! Nevertheless, the UK generators are tending towards that view, for all the reasons Keith outlined. If you do take early action, then you are rewarded for it; you do not have all these perverse incentives to keep a plant open longer and longer. Dr Allott: One notes also that if you have anything less than 100 per cent auctioning, at least for a particular sector, then you lose many of the benefits, because one of the big benefits is the simplification. So, if you were to have 50 per cent auctioning across the board, then you are not getting rid of the issue of how you deal with new entrants and planned closures. You may be thinking of putting up auctioning for the power sector, for instance, and then that sorts that sector out. There are ways through this, but I think 100 per cent auctioning for a sector is the way to think about this. Q66 David Howarth: And you produce an enormous return on lobbying, do you not, so the rules become very important, and lobbying becomes more important than economic activity? Can I turn to the Environmental Transformation Fund. I suppose the simplest way to look at the question is: is that a misnomer? Is the amount of money that the Government is going to make on its seven per cent auctioning enough to justify the name of the fund, assuming there is a connection between the two? Dr Allott: We would like to see the details of how much money they are actually planning to spend on the Environmental Transformation Fund and more details about how they are going to direct it. Clearly, if they spend all the revenues that we have tried to put a ball park figure on in supporting non-nuclear low-carbon technologies (I think is the definition), then clearly that could make a very significant difference. Q67 Chairman: Given the importance of making this whole scheme work properly and given the enormous obstacle that anything other than auctioning represents to making it work properly, do you think there is a realistic chance of getting to 100 per cent auctioning in Phase III? Mr Lanchbery: There is a chance. I am not sure if it is highly realistic, but there is a chance. The UK's position is for 100 per cent auctioning - they certainly favour auctioning - and a number of other states are coming round to that view, partly because of what Keith said. I was talking to an Austrian person on the way back from Nairobi and he was finding just doing all these things, like providing a new entrants reserve, and all that sort of thing, administratively terribly unwieldy from the Austrian Government's point of view. It does not really benefit industry in particular. Although it gives them initially a windfall, it does not benefit all industry, who also, as you were discussing earlier with the Environment Agency, find it administratively hard, especially small installations, and so you would just remove all their benefits. I think governments are increasingly finding that it would be rather worthwhile, certainly from their point of view, to get rid of all these very difficult, tricky things they have to implement with not auctioning. We live in hope, but I am not quite sure how much hope. Q68 Chairman: Where is the resistance? First of all, these difficulties were not exactly unforeseeable. They may not have been foreseen, but they certainly were not unforeseeable. What was the objection in the first instance to having auctions and what is the resistance now to moving very swiftly towards it? Mr Lanchbery: I know it is primarily a business, but particularly some groups who have a reasonable wealth, like the energy intensive people who use a lot of energy, whose emissions are high, they would be quite hard hit by an auction because they feel that they cannot reduce emissions. Having said that, a lot of them say they have in the past made their organisations more efficient. In that case auctioning will reward them for their past behaviour, but they have tended to take a very blanket, overall industry view and say, "No, no, no, we want reward for our historical emissions", which is what is meant by grandfathering. Dr Allott: I think there is a chance of us getting towards 100 per cent auctioning, we are certainly pushing it very strongly, but within that there is a debate. I think it is quite important to separate out the business group into the power sector, electricity supply industry and the manufacturing industry. They are very different in terms of their size, their exposure to international competition, their ability to pass on costs and make windfall profits. I think, as a bottom line, we would want to see 100 per cent auctioning for the power sector which is, as John said, making huge windfall profits across Europe, and we are starting to see some movement within that sector. There is another debate to be had about the manufacturing industry where they are exposed to international competition, but for me the way through that is to have a discussion and a debate about the use of the revenues. Q69 Mr Challen: Carbon emissions have risen from the power sector by 14 per cent since 1999, largely due to the increasing use of coal. Do you think that allowance prices should rise in order to make coal more uncompetitive? Dr Allott: I would like to see that. Q70 Mr Challen: How much would you have to go? Mr Lanchbery: As the Environment Agency people put it, to get a high price you need a tight cap. A tight cap would dominate the market. What has happened so far is there has been a market failure, the instrument is not working. If the instrument were properly applied, then it would dominate the market and it would dominate the effect of increases or decreases in fossil fuel supplies, but it does not. As the Environment Agency guy said, the difficulty is that fossil fuel prices are far more dominant in the market than the very small effect of the EU ETS, which is again making the case for a much tighter cap on the scheme. Dr Allott: I would like to point out an interesting point about the UK's return to coal. The UK is one of the countries in Europe where there is the greatest potential for fuel switching between gas and coal - this is one the of the stranger things that have happened - which has allowed the UK to position itself as having done very well and been one of the more aggressive countries in Phase I because our emissions were above our allocation, unlike many other countries. The reason for that is that we have rushed back to coal with a vengeance because we were able to, because of the scope for fuel switching, and they did that in the full knowledge of the carbon price, in the full knowledge of their cap, and they decided it was still economically justified to do that. So, to turn it round, the UK's claim to be the good guys is just that the power sector has rushed back to burning coal. If you look at the detail, again splitting up the power sector from the manufacturing industry, the manufacturing industry in the UK was just as over-allocated as everywhere else in Europe. The emissions from the manufacturing industry, which were based on a business as usual projection, were considerably below the actual allocation. In other words, we over-allocated, as did as everybody else, because we relied on business as usual projections, and the UK's slight halo on this in terms of, "We are the good guys in Phase I", is simply because we rushed back to coal and so our emissions were higher. It is a slightly perverse situation. Q71 Mr Challen: Looking at coal a bit more in the context of security of supply, that is a very important issue, very often on the lips of DTI ministers, there is equal importance given to that as to climate change issues. How should that issue be managed within the Emissions Trading Scheme particularly in relation to coal? Mr Lanchbery: I should say, as a preface, that a lot of the coal burnt is not ours. I cannot remember the ranking exactly, but it is the Digest of UK Energy Statistics produced by the DTI, and the three biggest importers of coal, the three biggest suppliers of coal into the UK are Russia, South Africa and Poland, so it is not our coal. If we are talking about security of supply, I am not sure if we are any more secure importing coal from Russia or South Africa than we are using imported gas, which comes from Russia or Algeria. Q72 David Howarth: Norway actually. Dr Allott: I think an issue on the future of coal is that coal does have a role. The existing power stations and their lifetimes have recently been extended to an extent which has surprised everybody by the number of power stations which have opted in to the Large Combustion Plant Directive. This means that they have decided to fit sulphur dioxide abatement equipment, which allows them to run at an unrestricted load factor for as long as they like. Because of an unfortunate combination of circumstances, including very perverse signals in the UK allocation plan detail, they have been encouraged to opt in to the Large Combustion Plant Directive which means that we are now committed to burning more coal to justify those very heavy investments in abatement. That is the first point to make. The second point is that, if coal does have a role, and think it is a very open question in the future as to how it should look, it should be on the basis of clean coal, and that means carbon capture and storage. We and other environmental groups have very serious issues around carbon capture and storage. We think it may have a potential role as part of a global solution to the climate change problem we are facing, but the first question is: is it going to work? If it is going to work, we need to find out as soon as possible. If it is not going to work, we need to find out as soon as possible so we can devise alternative strategies. So we see a role for it, especially for countries like the UK to be at least making sure that we are exploring the technology and finding out if it is a runner. The question then will be whether the ETS is a vehicle to make sure that this happens or not. We do not think it is. I think the way that we would like to frame this would be in terms of----. We have talked about the Large Combustion Plant Directive which sets timelines for abatement and emission limits for sulphur dioxide. Maybe we need to think in terms of a new Large Combustion Plant Directive aimed at carbon dioxide with absolute deadlines for fitting abatement plant. Any new plant would have to be fitted with carbon capture from the outset and maybe deadlines for phasing in carbon capture for existing plant if they want to carry on running. This is not necessarily a pro carbon capture and storage position at all, it is an anti-unabated coal position. Especially in the industrialised countries, where we need to be moving towards very significant cuts in our emissions of 80 per cent or more by 2050, we simply should not be building unabated coal-fired power stations. Mr Lanchbery: I should add that CCS is seen in general, I think, as only an interim measure, it is at best an interim measure, so it would always be wiser to go for energy efficiency or renewables of some sort, and, of course, they are far more secure. Energy efficiency is ultimately secure, of course, and so are renewables because they are all domestic. So that is our concern, that CCS might divert people's attention away from the real long-term options, although, as Keith has said, it is absolutely clear that China and India are going to use their coal, because they have got an awful lot of it, and so the problem does have to be addressed abroad as to whether or not they use CCS, and one suspects they probably should. Dr Allott: I fully agree with that point. Q73 Mr Challen: Somebody is going to have to use it. Forty per cent, I believe, of our generation comes from coal, I might be slightly out on those figures, but it is a huge percentage and will be for quite some time. You were expressing doubts about CCS. Is that on a technical basis or for some other reason? Mr Lanchbery: It is mainly that if the industry were prepared to develop the technology and deploy it, then that is fine. If they want to do that, that is okay. What we are concerned about is that they are mainly asking for government or international money from the World Bank to develop these programmes and we are concerned that there is always only a finite pot of money and if they put it into CCS they will not put it into renewables and energy efficiency, that is all. Q74 Mr Challen: There are a lot of things we do not want to put into money into, and nuclear is another competitor for that honour. Mr Lanchbery: Indeed. Q75 Mr Challen: Forty per cent of the UK's electricity generation, as I understand it, comes from coal. We have heard about the one gigawatt a week in China, and I do not know what the figure is in India. We are going to have to have CCS whether we like it or not, regardless of these other strategies, so should not the ETS encourage that through carbon credits rather than us taking a sort of sniffy line about it and saying, "We do not really like it because it is just a filling in"? Dr Allott: I think the response to that would be to say that it may be the ETS might not be the vehicle. If you do want to have CCS coming into play, the ETS may not be the vehicle to deliver that. The analogy I would draw would be on the model I suggested in terms of having some regulation to remove unabated coal from the market, for instance, with energy efficient appliances, perhaps having some regulation which could remove the least efficient appliances from the market and then some fiscal incentives to encourage people to buy the more efficient appliances that are still on the market. That would be the model for regulation to rule out unabated coal, and then the ETS would provide the incentive within the acceptable boundaries defined by that regulation. Just to come back to the security of supply point, I think there are some issues buried in your question which are to do with this energy gap question and coal's role and the role for nuclear. Various pieces of work that we did for the Energy Review showed very clearly that the energy gap is actually a political choice. When we talk about "energy gap", it is always an electricity gap. This is part of the problem that we have got in terms of energy policy in this country, but, just talking in terms of electricity, serious policies to curb electricity demand and to also deliver on the stated targets on renewable energy would essentially make that electricity gap, rather than energy gap, virtually go away, both in terms of coal and gas, without leading to ridiculous degrees of overdependence on imported gas. Mr Lanchbery: As to whether the EU ETS should encourage carbon capture and storage or, indeed, nuclear, it is an interesting point in that, of course, if you built a new plant and it is genuinely a zero carbon technology, then your allocation under grandfathering would be zero; or, indeed, if you are going to auction, then you would need to buy no credits, and so it depends how it is introduced. If you are talking about encouraging it through the clean development mechanism, that is another matter, although I would not see CCS or, indeed, new nuclear plant coming on within the period of the second phase of the EU ETS. Q76 Dr Turner: You do not seem to have much confidence in ETS making any contribution to encouraging CCS. The Carbon Capture and Storage Association tell me that they have a raft of big projects ready to go which would be greatly accelerated if the fiscal conditions were right, and at the moment they are a rather cloudy screen. I am still not quite clear why it is you think that putting in place a credit system for carbon capture and storage in the ETS could not be part of that picture and could not be useful? Mr Lanchbery: If you had auctioning it would not so much credit it as it would not debit it. So, if you are going to build a conventional coal-fired plant, then you would have to buy a lot of allowances and, if you were going to build a plant with CCS which had no emissions, then, of course, you would have to by no allowances. So it would, in that sense, incentivise it. It would not penalise it, in other words, rather than incentivise it, but it amounts to the same sort of thing; so there would be a benefit, yes. Q77 Mr Caton: Both your organisations have close links with sister bodies in other European countries, and so I guess you are in a good position to give us a bottom up international perspective. Can you give us a picture of the level of pressure on tackling climate change in other European Union countries and, in particular, the state of debate on the future of the ETS? Dr Allott: One general observation. I think it is rising very rapidly. John and I were at the UN Climate Change Conference in Nairobi last week and in Germany (and we will come on to Germany and talk about their allocation plan, which is much less good than we might have liked) one of the things that was very striking there was that the German Environment Minister got by far the biggest round of applause (four minutes) - much more than David Miliband - when he stood up and gave very strong support for the EU as a whole taking on a 30 per cent reduction target by 2020, and he said that if the EU did that Germany would take on a 40 per cent target. So there is real movement happening around Europe on this, and we just need to see it translated into real, hard decisions on things like the ETS. I do not know if John has any general comments, but Kirsty has got a very good picture of some of the individual ETS related aspects. Mr Lanchbery: In general we have worked on WWF's work, and I know WWF have done quite a lot of work on this, where you all belong, with most of the big development groups, to a grouping called Climate Action Network Europe. We have worked through that and that has been active in most of the big countries and quite a lot of the small ones, but it is more active, as in most environmental areas, in the northern European countries - the Scandinavians, the Brits, the Dutch, the Germans - and the activity declines as you go down, generally speaking. There is very little activity in Spain, some in Portugal though. Most northern European states have been pressurised to a greater or lesser extent by the environmental groups and to some extent by the development groups actually, and most southern European states have seen little or no pressure. Ms Clough: Following on from what Keith has said about the German NAP, Germany is now looking at its NAP, I guess on the basis of what was said in Nairobi last week, but also there is an indication from the Commission that it is likely to be rejected in the next few days anyway. There are issues, I guess, with all the NAPs that have been submitted, but some strong caps have been set by Spain. The Italian cap in its initial draft was quite strong; that has now been watered down somewhat, but it is still looking quite good. To highlight an activity that WWF did, we created a statement that was then signed by 50 economists across Europe showing support for emissions trading as the best way to tackle climate change, and that was delivered to the Commission a few weeks ago to try and show consensus amongst that sector of the community. I can talk about some of the other NAPs if you would like to hear about those. Q78 Mr Caton: If we could have that in writing it would be useful for the Committee? Ms Clough: Yes, sure. Q79 Mr Caton: From your knowledge and perspective, is there anything the UK should be doing now to influence the Commission and perhaps the more reluctant Member States to move forward at this time? Dr Allott: On emissions trading specifically? Ms Clough: On the Phase II scheme? Q80 Mr Caton: Yes. Ms Clough: There is a decision on the first eight or nine NAPs in the next few days, but the decision on the remaining NAPs, I assume, will not happen for a couple of months; so I think there is still some time to be putting pressure on other Member States to improve their NAPs and also on the Commission to keep the robust line. Mr Lanchbery: The UK has been having consultations with both the environmental groups and the business groups together on developing a manifesto for the post 2012 phase, which has been very welcome: because I think we can probably agree with the big business people a number of headline issues on which all, or most of us, would agree, and Mr Miliband is hoping to take that forward into Europe and use it as a manifesto, as he calls it, within Europe, although we are not quite sure how he is going to use it, nevertheless it is an interesting idea. Q81 Joan Walley: Following on from how much the UK can influence what is happening in the European Commission at the moment, I wonder whether or not you would see a role for more cross party working of environmental audit committees such as ours, working with parliamentarians in other parliaments at another route, at another level, somewhere between what a government is doing and what is happening at the local level? Dr Allott: Absolutely. I think this is a crucial issue in terms of whether countries are serious about their Kyoto targets under the EU burden-sharing agreement, and I think that this is a very serious issue for public debate and political debate that needs to be held up to scrutiny. I fully support it. Mr Harper: I would agree with that. I think that any extra pressure that we can secure from the domestic parliaments, particularly if you were successful in developing a similar manifesto along the lines John has described Mr Miliband has tried to do with businesses and NGOs in the UK, then I think that would give much more confidence to the decision-makers when they come to Council to consider the evolution of the directive, because I think that on the outside, notwithstanding all the technical details, it is slightly perverse that there are targets, and therefore there is an expectation that the Emissions Trading Scheme will actually help to meet those targets and at the moment they are not, and, therefore, that undermines the credibility of this, which is the central pillar to tackling climate change that we have at our disposal at the moment. Sharing that concern about the lack of trade credibility amongst colleagues in other domestic parliaments, I think, would be incredibly powerful and hopefully give our leaders a little bit more stomach to go that extra mile. Mr Lanchbery: There is also scope for working with the European Parliament, of course. We had a very good meeting about three or four weeks ago in the European Parliament, which was attended by 25, 30 odd members of the European Parliament (which was very good bearing in mind that the EU ETS was not up for discussion at that point) from all parties. Obviously the Greens were there, but there were conservatives, socialists, and so on and so forth, and they were very interested in the topic indeed. The Parliament has been very good on this issue over the years, and so it would be useful if you could co-ordinate with your European colleagues as well. I am sure they would welcome it. Q82 Joan Walley: That is an avenue that certainly this select committee could explore, and if there was anything further that you wanted to share with us on that I am sure we would gratefully receive it, particularly when we have such a limited amount of time in which to deal with this and we need as many parliamentarians and as much pushing that is going on focused on this agenda really. Can I turn to the issue of industrial competitiveness, which certainly is a matter of concern to those with constituencies with energy intensive users. The comments that you have made, or not so much that you have made but which the Energy Intensive Users Manufacturing Lobbying Group have made, that so far most of the low-hanging fruit (if I can put it that way) of energy efficiency has already been taken up and that if we are going to go ahead and make further carbon reductions, there would need to be heavy investment in new kinds of technology. It seems to us that may be the EU ETS scheme would not allow those incentives to be there in that. I just wonder what you say to this and how you see this being taken further forward? Dr Allott: We quite often hear that the potential for energy efficiency has already been exhausted, we hear that in all sorts of different sectors, and, frankly, experience suggests that is not case. Firstly, to draw attention to a study that we have recently completed from ECOFYS into the Emissions Trading Scheme, this study estimates that there is a very significant, very short-term emissions reduction potential of about 110 million tonnes of CO2 per year within the manufacturing industries covered by the ETS and a third of that, 35 million tonnes, would be achievable at zero or low-cost. That is a very significant debate which is just sitting there waiting to be tapped which is not yet being met. The point is that on current very low carbon prices, if we had a reasonable carbon price the energy efficiency potential is that much greater. Behind that though, clearly there are issues of competitiveness, and we have been reading with great interest a lot of the work that has been done by the Carbon Trust on this which makes very clear that, with the exception of a handful of very exposed sectors, most notably aluminium, which is actually outside the Emissions Trading Scheme at the moment, they are hit by the second effect in terms of impacts on electricity prices. Q83 Joan Walley: Which are the industries in that handful? Dr Allott: The key sectors identified by the Carbon Trust are, in descending order, aluminium, which is quite exposed because of its high electricity consumption and, therefore, any increase in electricity price, however small, they feel very strongly, then steel, then cement. We can refer you to the Carbon Trust studies in later correspondence, if you would like. Those reports make clear that these competitiveness issues are not real issues for Phase I or Phase II of the Emissions Trading Scheme. They may become significant issues beyond Phase II, particularly for those sectors, and that very much depends on what happens in terms of the move towards a global framework where there is everything to play for at the moment in terms of the international negotiations, and the Carbon Trust recommends various strategies to deal with an outcome where there is not a full global carbon market to help protect those sectors which may be exposed. These options would include things like a border tax adjustment. For instance, if the US were to stay outside a future framework, there is a case to seriously explore looking at a tariff for imported goods. Q84 Joan Walley: How would that be compliant with WTO rules? Dr Allott: There are different views, it depends which lawyer you talk to on this, but there are enough lawyers out there who say it is perfectly doable. Interestingly, one message is, if we move to auctioning, it is much more likely to be compliant with the WTO rules than if we do not move to auctioning. Mr Lanchbery: I should add that, as you probably know, all of the emission reduction potential is taken from the generators in both Phase I and Phase II. So, the energy intensive users and everybody else gets a business as usual increase in allocation, so they are not directly hit. If electricity prices go up slightly as a result of the targets the electricity producers have to reach, then that cost will be passed on to their customers, which includes the energy intensive users. So, we are not talking about the overall allocation affecting these companies, it is just the knock-on price of the electricity, and, as Keith implied, the very big firms are affected by other things in addition to the knock-on price of electricity. Cement, for example, obviously produces stuff in vast bulk and you simply do not build all your cement-producing plant in China and then ship it to the UK, and so, when we have the Olympics here in a few years' time, they will build a large cement plant somewhere near London; they will not ship it in from abroad. Q85 Joan Walley: You would apply that to cement, but how would that apply to ceramics, which are much easier to carry round the world than large quantities of ceramics? Mr Lanchbery: It may be applied to ceramics. So in the case of ceramics, yes, there may be a case to be made. I am not saying there is no case to be made, I am just saying there are a number of exaggerations; so ceramics may be the exception, and glass perhaps also. Dr Allott: Just to elaborate on John's perfectly correct point about the business as usual allocations to the manufacturing industry, in real terms what that means is if you look at the allocation that is proposed for Phase II per year, say in 2010, that means that the emissions from the manufacturing industry will be allowed to be 19 per cent higher than they were in 2000. This is over a period where we are meant to be getting emissions on to a serious direct downward trajectory. The Government is on course for its carbon reduction targets and yet a very significant sector of the economy is being allowed to increase emissions by 19 per cent simply because of these issues about competitiveness. This goes back to the heart of the question about relying on business as usual projections to underpin your allocation, and I just raise the question of whether that is an appropriate approach in the carbon constraining world as set out by Stern. Q86 Joan Walley: Finally, you have been very confident in what you have said that groups such as the Energy Intensive Users Group and the CBI have been really exaggerating the threats to British industry and to competitiveness. Is the justification for that mainly based on the work that you referred to earlier that has been done by the Carbon Trust? Dr Allott: The Carbon Trust, and there have been a couple of other reports as well. There was a report done for Ofgem some time ago as well. I would agree that there is a lack of independent, rigorous analysis of this question and we would like to see more of it, but I would say that the CBI and other groups in the debate over Phase I and in a more muted way, I think it is fair to say, the debate over Phase II have still been playing this card on the basis of no concrete evidence. During the debate on the Phase I Allocation Plans, I think it was before this Committee where Digby Jones from the CBI himself said that there was no evidence that any UK company had closed down as a result of any environmental regulation, which seemed very hard to square with the general message that he was giving. Q87 Joan Walley: Given what you have said about this handful of industries, and you have admitted that ceramics is one, would you recommend some kind of further research to look at how the interface is with this handful of industries which perhaps would not be within the big umbrella? Mr Lanchbery: It would be useful to have some independent research, certainly. I should add that, although we sometimes criticise the CBI, the CBI has been rather more advanced in its thinking than its equivalents across Europe. The BDI in Germany is just awful, frankly. Q88 Chairman: Can we turn to the CDM. The theory is that the CDM and joint implementation credits are supplemental to the domestic cuts. If the concept of emissions trading is to direct resources to where you get the most cost-effective reductions in emissions, why should we not allow unlimited use of CDM and JI credits? Dr Allott: There are two levels to that. The first one is the credibility of the CDM and the whole basis of it, which is that, on a project by project basis, you are trying to justify that you are reducing emissions below a notional business as usual baseline. It is inherently counterfactual, there is the fundamental problem that you are always going to have business as usual projects getting in under any CDM project based approach, so it is not as robust as a national cap and trade scheme. That is the first point. Then, within that, whether the rules as currently applied on additionality are as strong as they should be, certainly there is strong to pressure to weaken them even further, which we are concerned about. I think there is also a fundamental question as to what you are trying to achieve with an emissions trading scheme. At the moment, and under the Stern perspective as well, there are two objectives. One of them is to deliver a reduction in our own, or Europe's own, emissions and to get us on to a low-carbon trajectory. The other one, especially post Stern, is to use it as a mechanism to leverage finance to help developing countries move on to a decarbonised pathway. If you are trying to do two different things with the same policy, I would say that means you need to have a clear operational rule to make sure you deliver both objectives. For us that means you have to have a very clear set of rules for limiting the number of CDM credits that you can import into the UK, or the EU, which is applied in a harmonised way across all countries that would make the supplementary principle real rather than a vague concept which is being ignored in the breach. Mr Lanchbery: We take a rather more purist view in that, within the EU ETS, we would prefer there to be no project-based credits, simply because if you have project-based credits in any cap and trade scheme you necessarily inflate the cap, so the target is sloppier than it would otherwise have been. In Kyoto we do support some use of credit, but it is an interesting balance between the two. Unless you have tight caps on developed countries, the price of carbon will be insufficiently high to drive decent projects in developing countries. So it is a chicken and egg thing. If you flood the market with very cheap credits, with credits from developing countries, they will necessarily be cheap - that is why you buy them, you buy them because it is cheaper than doing it at home - so it is a difficult question to answer. Most of the CDM projects that you get, for example, the favourite at the moment is cutting HFC emissions because that is cheap - it is about half a dollar a tonne or CO2 equivalent - so everyone goes down that path, but that is the sort of thing that should be regulated out, frankly. It should not generate credits anywhere; it is ridiculous. Generally speaking, we favour the EU Emissions Trading Scheme being intended for reducing emissions at home. It is also, from a leadership point of view, in the international negotiations. If we do not reduce our emissions in the European Union, it is going to be very difficult indeed to persuade developing countries to limit their emissions in any way at all. It is very difficult to argue that you are reducing your emissions when, in fact, you are buying all your emission reductions from somebody else, notably in their country; so there is a sort of moral argument to be made for taking a leadership role by reducing your own emissions and whether we believe in moral arguments or not, a lot of the big developing countries do and they take them very seriously. Dr Allott: I agree with a lot of what John has said. I think our only slight difference is that we see a role for a small reliance on imported credits but that should be compensated by having correspondingly tighter caps. The key to this, as always, is having sufficiently tight caps, otherwise the whole thing falls apart. There is a specific issue to do with stuff like the tariff, which is live and now under the Phase II NAPs, and perhaps I could bring Kirsty in on a study we have just completed looking at the degree to which Member States are trying to restrict the use of CDM credits or not. Ms Clough: This is the study that Keith referred to earlier by ECOFYS, which essentially assesses the quantities of project credits that Member States are proposing to allow in and, if they do allow in all these credits, it could essentially mean that no emissions reduction takes place with the EU during Phase II, it will be exported overseas, which is quite a significant finding and quite worrying from our point of view. Q89 Chairman: Have you put a figure on the percentage that you think is acceptable? Ms Clough: Currently we are saying significantly less than 50 per cent of the effort that an industry is required to make to meet that reduction target. Q90 Chairman: What was the objection to HFCs counting? Mr Lanchbery: It was an artificial way of generating credits and, as people have known HFCs and CFCs have an effect on the atmosphere for many decades now, you should not have allowed these plants to be built to produce them, and stopping them is dirt cheap anyway, which is why people get credits for them. There is a slight suspicion that the same thing is happening in that area as happened under the Montreal Protocol when some countries were deliberately building CFC production plants in order to get the money to close them down, and one begins to feel this may be happening again. Dr Allott: The economics of this are such that if you were to build a new HCFC refrigerant facility in a developing country and then fit a very cheap one million dollar abatement incinerator to destroy the HFC by-products from the HCFC production, the revenue from destroying the greenhouse gas pollution would be far greater than what you get from selling the product from the factory. In other words, you are building a carbon credit factory rather than a refrigerant factory, and you can just pour the refrigerant down the drain, which is, to our way of thinking, slightly perverse, to put it mildly. Q91 Chairman: On forestry, and the World Bank has issued a report about this, what is your reaction to the idea that we need to have a financial value on preserving an existing product? Mr Lanchbery: We support that very strongly in principle. Obviously there is carbon value to not cutting down trees and releasing the emissions into the atmosphere and there are equally obvious biodiversity and human benefits. The way forward is not as clear. The mechanism proposed by Papua New Guinea, Costa Rica and a group of rain forest nations where you would have a commitment to limit your rate of deforestation which, if you did better than that limit, you would get credit for it in the and international trading market would seem instinctively the way to go, because that would raise significant amounts of money if it was part of the Kyoto scheme. On the other hand, there are other ways of doing it, there is the so-called fund-based approach that Brazil has proposed, but it is very hard to see how you would get countries to put sufficient money into a fund to pay the countries with the rain forest not to cut them down. Another approach would be to use existing project-based mechanisms. A lot of countries at the end favour instinctively the approach proposed by Papua New Guinea, Costa Rica et al, but there are difficulties with it, and one that came up in Nairobi was that the Congo Basin Group, who belong to the coalition that is formed round Papua New Guinea and Costa Rica, point out that they do not actually deforest much, for various reasons, at the moment and they have not for a long time. If you are going to give credit for reducing your rate of deforestation, what does the Congo Basin get out of this and what incentive would you give them? In the extreme case of Costa Rica itself, where they are actually increasing their forest, they would not get anything either. So, it is quite an interesting time at the moment on the avoiding deforestation front. Everybody agrees it is a very important problem and it needs to be solved, but there are many different policy approaches to doing so, and nobody is quite sure, which is the best one, frankly. Mr Harper: What we are sure about is that trying to develop a process under the Kyoto Framework is the best game in town, given that there are not other international forestry conventions which are driving forest protection at the moment, so getting this right is crucial. As I understand it there is going to be a workshop in March to try and explore some of these issues in a bit more detail so that we urgently have a new process whereby those states that have large amounts of rainforests are rewarded appropriately for keeping them intact. Q92 Dr Turner: Both your organisations agree that you want aviation to be brought into the ETS, but what you do not agree on is how you treat the non-CO2 effects of aviation. Could you each set out your positions on that, the pros and cons? Mr Lanchbery: We would advocate the use of a multiplier on CO2 emissions, that seems to be the most practical solution. Having said that, estimates of the extra effects of non-carbon dioxide, I was going to say emissions but that is not correct, are debateable. The IPPC a few years ago said there were something like three or four times the effects of CO2 alone. More recent studies done by the European Union indicate that it is perhaps two to three, so you cannot be absolutely sure what size multiplier you use. However, this sort of difficulty has occurred many times internationally about estimating things and you can always take a reasonable value of, say, in this case, perhaps two and a half and then review it every five or ten years. If the science shows it is more or less than that you use that but we think it would be a big mistake to take into account the effects of CO2 only because that would not take into account the environmental impact on the atmosphere. Ms Clough: I agree with what John just said but I guess our initial preference would be for there to be a separate charge, a nitrous oxide emissions charge, to take account of the initial effects. If that does not happen by the time that aviation is included in the scheme then we want to see a multiplier of CO2 emissions. There was a leak last week from the Commission about the aviation proposal which ended up in a few newspapers and they indicated that they would be looking at tackling possibly additional effects of nitrous oxide as well. It sounds like they might be thinking about a multiplier approach. Chairman: I am going to have to slip away, Joan Walley is going to take the Chair. In the absence of the Chairman, Joan Walley was called to the Chair Q93 Dr Turner: The final question before you can escape, both our Secretaries of State for the Environment and Transport and, indeed, DTI have urged the Commission to include surface transport in future phases of the ETS scheme. How do you think this would work in practice? What are your views on whether it should be included and how it should be done? Dr Allott: I think the first question to ask is who you place the cap on. There are three basic candidates. There is the motorist, there are 250 million motorists around the EU and given that the ETS is meant to be for the big boys, as we heard earlier on in the hospitals, we do not think that is a starter. Maybe in a future world we will go to EU-wide personal carbon credits, but we are quite a long way from that at the moment. The other candidates are a cap on the fuel suppliers or a cap on the car manufacturers. A cap on the car manufacturers is very difficult because it is to do with an assumption on the future emissions from a new car. No-one knows how far a car will be driven, how well it will be driven or what fuel will be used. A cap on fuel suppliers appears, as far as we can gather, to be the Government's favoured option. The problem with that is that the fuel suppliers do not have an awful lot of influence on the actual emissions, they do not have an influence on the choice of purchasing decisions of motorists or on the technology decisions of car manufacturers. The only thing they have some influence on is the actual fuel composition where they could increase the proportion of biofuels, for instance. We already have a Renewable Transport Fuel Obligation and Biofuels Directive which is aiming to achieve that objective already. We are not quite sure what the added-value is. We think that what it would lead to would be a small, it would be helpful but a small increase in essentially road fuel taxation which, for political reasons, appears to be why the Government is flirting with it because after the road fuel protest they are frightened to do anything direct on road fuel taxation. The big concern in Government is that it crowds the political space for a much more focused, targeted action which would lead to reductions from the road transport sector. At the moment there is a consultation going on about replacing voluntary agreements on fuel efficiency with the car manufacturers. It is a well-known fact that these are failing to deliver, and there are ideas to replace them with a system of mandatory standards which we fully support, again, provided the standards are sufficiently rigorous. The DfT recently consulted on options for replacing voluntary agreements. Those options included more voluntary agreements, which we do not think is a good idea, mandatory targets which we support or putting car manufacturers under the Emissions Trading Scheme which we think is a total wild card and will fail to deliver any technological transformation in the sector. Mr Lanchbery: We largely agree with that, and I think the only way to do this would be at the tax point, for example, an upstream allocation where the fuel comes out of bond which is essentially the same as Keith said. We would be interested in seeing the proposal fleshed out rather more to see if the DfT do have anything to add on it. Frankly, we do not see the proposal getting anywhere in Europe, the Europeans we have talked to have just sort of sniggered. They do not think it is on at all, but they could change their minds. At the moment it does not look like a runner. Our favourite for the transport sector would be a well-to-wheel, or more correctly a well to carbon tax, which would be, we think, targeted in just the right place. That would replace all other instruments if you did that, but we think that would be simple and target precisely what we are trying to get at with Co2 emissions. Q94 Dr Turner: Clearly, the ETS has distinct limits to the things which it can address. It is not capable of being a universal carbon making mechanism. Mr Lanchbery: It is unlikely. In practical terms, it was very administratively difficult to deal with more than a few thousand of entities, whatever they are. It was hard to see how schemes that included small businesses and indeed, individuals would actually work. Government does not administrate at that sort of level and the costs of administration would be huge. Generally speaking, you are after big boys or agglomerations of units or you try somehow to sneakily do the allocations upstream so the ideal Emissions Trading Scheme in a way would be to put the allocation on where the fuel comes out of the ground or at the point of entry into your country, but that is taking it too far. That would be the ideal thing, then you only have a couple of players. Dr Allott: Clearly I agree, and emissions trading is hugely important but it is not the silver bullet. Transport is one illustration but another illustration would be the power sector. There are two strategies for reducing carbon emissions from the power sector, one is de-carbonising your generation mix and one is reducing demand. The ETS only in the very bluntest of ways begins to tackle demand, you need to have complementary measures in other sectors. There are whole issues to do with infrastructure which the ETS does not begin to touch, to do with behaviour of change, so it is a very important component in the overall mix, but there is a danger that it is being seen in some quarters as being the only show in town and it is not. Q95 Joan Walley: It has been a long session and it is our first session and I think all four of you were here at the very start of our inquiry this morning. Just before we finally finish, can I ask you, given the importance of all of this, and the added weight we now have with Stern, one thing that we have not touched on is how we engage with the public in getting their support, their awareness and their understanding about how the ETS is going to change and develop over phase two and phase three. Have you got a final passing word on perhaps what Parliament or the Government should be doing on that? Mr Harper: Budgets, budgets and budgets, that is the starting point and the end point. If you effectively establish how much carbon this nation as a whole is prepared to emit and that we have a trajectory which is to decline that budget, then essentially all sectors of society have to make their contribution. What you could say is that what the EU is trying to do through the Emissions Trading Scheme is to drive this down but that requires some changes at the ETS level at the moment. People understand the idea of a finite amount of money that they can spend, I think they are going to have to begin to try and understand that there is a finite amount of carbon that we should be prepared to emit. Joan Walley: I think that is a very good point on which to end. Thank you all very much indeed. |