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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 70-iii House of COMMONS MINUTES OF EVIDENCE TAKEN BEFORE ENVIRONMENTAL AUDIT COMMITTEE
THE EU ETS: LESSONS FROM PHASE 1
Wednesday 6 December 2006 PROFESSOR MICHAEL GRUBB and MR JAMES WILDE Evidence heard in Public Questions 198 - 247
USE OF THE TRANSCRIPT
Oral Evidence Taken before the Environmental Audit Committee on Wednesday 6 December 2006 Members present Mr Tim Yeo, in the Chair Colin Challen David Howarth Dr Desmond Turner Joan Walley ________________ Memorandum submitted by The Carbon Trust
Examination of Witnesses
Witnesses: Professor Michael Grubb, Chief Economist, and Mr James Wilde, Head of Strategy, The Carbon Trust, gave evidence. Q198 Chairman: Good afternoon and welcome to the meeting. Thank you for coming in again. You are familiar with everyone on this side of the table. Before we actually get into the nitty-gritty of emissions trading, given the experience you have now had of working with business, I wondered if you would just like to say a word about how much awareness there is in the business community now of climate change and, as we would see it, the very urgent need to start cutting emissions? Mr Wilde: Yes. Awareness levels have really been rising over the last couple of years. I was looking at press mentions in the media and three or four years ago there were about a thousand quotes of climate change per quarter and that has gone up to about 6,000. So that has created a huge amount of emphasis upon this issue. The business sector have taken that to heart because that is going to affect the way their investors are looking at them, the way their customers are perceiving their products and also the way their employees are perceiving them. So we do track quite carefully awareness levels within the business community of these issues, and also of the Carbon Trust, and over the last two years we have been a big increase in awareness. If one looks at the Footsie board and non-board, awareness levels of climate change have gone above the 80 per cent level and the propensity for action, a real commitment to do something about it, is very high. Professor Grubb: One other thing I would add is that there is still some difference between the larger companies and the SMEs where, not surprisingly, there is much, much less focus on information. Q199 Chairman: Yes. You mention a commitment to action. Is it actually being translated into actual implementation of changed policies, or are there some barriers which are still preventing that? Mr Wilde: Yes, there are barriers. In a sense the drivers are exactly this, the kind of corporate social responsibility, and also the financial costs savings which companies can make, and then the regulatory drivers. But in terms of barriers, one way of looking at it is moving straight from the kind of pure financial cost benefit of the investment, so companies need to find the investment cost up front, and then there are the transition costs of changing their systems which need to be overcome, things like shutting the system down, actually spending some time to understand what to put in place. Then there are some market failures. Things like form billing and metering affects the propensity to act. Also, within the building stock there is a landlord/tenant serious kind of split incentive in the market where the landlord owns the building and would be required to invest to improve the asset, but the benefit goes to the tenant in the form of lower energy costs. So there is a kind of friction there, but then all the way down to the behaviour aspects. So sometimes people might not be aware of the opportunities for improvement. Even if they have that kind of awareness, they need to do something. Sometimes the senior level champions, the level at which this issue is taken seriously, is increasing but one needs a real senior level champion. When one looks at the materiality of energy costs, if one moves away from the energy-intensive part of the market to the less energy-intensive, energy costs are a small proportion of their overall costs base so if they need to reduce costs or strategically focus, this can sometimes fall off the radar screen, and they will use different criteria to look at investments and it will not get to that same level within the organisation. So they are some of the barriers and drivers. The barriers which are prevalent vary quite a bit across the market and in an energy-intensive industry we are sectors that are covered by the Emissions Trading Scheme. I think the key ones are the cost benefit because with these sectors their energy costs can be over five per cent of their overall cost base. But also there is an awareness issue even in that part of the market. So something like the Emissions Trading Scheme helps to impact both those barriers, improve the cost benefit through the price of carbon but also the process of measuring your emissions, coming up with a strategy around trading and a long-term carbon management plan helps to really focus management attention and help people think through options for improvement. Q200 Chairman: In terms of you and I investing in companies which are developing low carbon technologies, what are the kinds of businesses and what sorts of technologies are getting the most take-up? Professor Grubb: I can say that we have got quite a wide range of technologies under the innovation and investment programmes at the Carbon Trust. It is hard to focus because we do consider proposals from a wide range of things. Some of the notable successes, certainly ones which have gone on to be floated on the open market, include two fuel cell companies, for example. Carbon Trust Investments has established a separate company involved in waste heat piping between industrial heat emitters and industrial heat consumers. There are still significant opportunities in what is not the highest tech end of the market, we find, but it is hard to answer the question because it is a very broad area. Q201 Chairman: We saw Climate Change Capital last week and they said that although there is a tremendous potential for what I think the City of London Report called the Climate Change industry, but they do not think there is enough investment going into low carbon technologies as yet. Is that your view as well? Professor Grubb: I think I would agree with that, and certainly any of these areas require balance, I think, between market push and supply support with technology and investment support, but the major private finance will come to bear when people are convinced there is a market out there for low carbon technologies. One of the limitations at present of the trading scheme is that the financial sector feels it is not sufficient solid in its longer term prospects to be willing to bank against that future. Q202 Chairman: Yes. Are there any other steps, apart from obviously a higher carbon price - and we will come on to the ETS in a moment - which can be taken to build up that confidence or optimism from the point of view of the investors? Professor Grubb: I think in some areas there are some instruments. The Renewables Obligation including its more recent evolution in the Energy Review attempts to give some of that kind of security for renewable energy technology and electricity production technology. I think it is hard to put one's finger on any equivalent for industrial energy efficiency technologies or heat technologies, for example, where I think there is a lot more uncertainty about whether and what kinds of supports may be coming forward or whether they just rely on a carbon price which, as I say, at present is hard to predict in a way in which you would want to put a lot of money against it. Q203 Colin Challen: We have seen the emissions publication, with the first ten National Allocation Plans for Phase II. What is your reaction to those decisions? Professor Grubb: I have to say I thought it was a very good decision in the round. We had done quite a lot of analysis in the Carbon Trust about the state of the National Allocation Plan and come to two broad conclusions, one of which was the collective impact was going to be too weak to sustain a credible carbon price during the 2012 period and that one would need to see a collective cut-back of at least ten per cent in order to be really confident that there was going to be a robust carbon price signal emerging. The other conclusion is that the cut-backs proposed of the surplus across the different allocation plans were very varied. It was not a simple case of all countries being too lenient, there were some much more lenient than others both in terms of cut-backs and relative recent emissions and in relation to Kyoto targets, and I think the approach the Commission took was to take both of those criteria into account. I think it had the courage to take on ten Member States out of the first clutch and to do so in a way which was clearly differentiated according to what they felt would establish fair criteria in a more level playing field. So I thought it was a good decision. Q204 Colin Challen: I guess you could say it is a good decision. It is trying to get European countries to meet their Kyoto targets. One question is, do you think that this will actually achieve that? I would also add, perhaps, as a rider that since we now know that Kyoto is inadequate perhaps the Commission should have been tougher still? Professor Grubb: The Commission is toeing a fine line. Various discussions could be had ultimately, which would have been the responsibility of Member States, to one of their Kyoto targets and perhaps to consider going further. The Commission's job formally is to enforce the agreement which exists in the form of the Emissions Trading Directive, not to impose tougher cuts per se. I think the cuts imposed were to a substantial degree driven by a judgment about what was required if countries were really going to be seriously on track with their Kyoto targets, and I think that the Commission had a legal mandate to do. I think going beyond that would have been very difficult, both legally and politically, to be honest, for the Commission itself. Its job is not to actually impose environmental limits; that will emerge through the negotiation of Member States. I would just add one other thing: there is obviously a complication around the fact that the EU ETS caps emissions from about half of European CO2 emissions and there are other gases to consider as well. So the Commission cannot guarantee that any allocation will deliver Kyoto targets in total. What it was trying to ensure was that these allocations gave a broadly proportionate cut-back to the industrial sectors covered by the ETS. If countries are falling short of transport, or other areas, they are going to have to go out and make up the difference through international purchase of the use of the Kyoto mechanisms. Q205 Colin Challen: Do you think the effect of the announcements will improve market confidence in this scheme, and indeed will it have much of an effect on the forward trading of allowances in Phase II? Professor Grubb: I think questions about will a decision have an impact on market obviously depend upon expectations prior to the decision. I think there had been so much analysis and criticism of the allocation plans in the run-up to the decision, including our own, that the market was already beginning to recognise the Commission was likely to be tough, so to some extent there was a massive impact. Sorry, the other part of your question? Q206 Colin Challen: That was about the forward trading prices, and so on, of allowances in Phase II. Will it have an impact on those? Have we seen that already? Professor Grubb: It will certainly, as I say, conditional upon the extent to which the market was already expecting that. I have not actually checked the data, but I think for all prices must have gone up somewhat after the decision. Obviously there is residual uncertainty because everyone is waiting to see if the Member States are gong to challenge the European Commission decision. So you cannot say the decision is finalised at all. Q207 Colin Challen: No, indeed, and when we get all 25 NAPs announced you would expect that perhaps for the first ten with an average seven per cent cut that that might change when the review of all 25 has been considered? Professor Grubb: We have done some analysis to extrapolate. The seven per cent was an average across all the countries considered in that round. That included the UK, which had a zero cut-back. If you extrapolate the same method, what you end up with is roughly a ten per cent cut-back in aggregate across Europe. I think there were some pretty clear implications in the Commission's decision that some of the countries still to come forward would be facing pretty hard cut-backs on the basis of their current proposals, such as Poland, for example. Q208 Colin Challen: In the UK's National Allocation Plan we accepted that as proposed and given that I read a headline shortly afterwards which said that some sectors would be allowed to increase their emissions, it does not seem very surprising that we accepted that plan. I wonder if you could comment on that particular point about this increase, which I only read in the press so we have to take it that it may not be true? Could you comment on that particular aspect? Professor Grubb: Yes. First, I would guess and judge that the reason the Commission did not challenge the UK Allocation Plan is firstly because it was actually the only one of the ones they were considering which involved any significant cut-back in aggregate from current levels, and also the UK is on track to meet or accede its Kyoto commitment. So there were not really strong grounds on either of those criteria for rejecting the UK plan. However, it is true very much that the internal structure of the allocations in the plan is to cut back the power sector, which accounts for 60 per cent or more of the UK emissions under the ETS, to cut back the UK power sector by a significant margin but to give the other five sectors everything they are projected to need according to the DTI's best estimate of emissions projections. In nearly all those sectors those represent increases. So yes, it is true that all of the industrial energy-intensive using sectors in the ETS have been given everything they are projected to need out to 2012 with zero cut-backs, and in most cases that represents a significant increase on current levels. Q209 Colin Challen: If our first NAP was considered to be quite tough, and certainly tougher than the rest of the European NAPs, how is it that we can now allow ourselves this luxury of a sort of standstill, if you like? If our competitiveness was not harmed in the first period, if companies manage to achieve the cuts, surely we should be saying we can go further rather than saying, "We've reached a plateau, now let's just take our foot off the accelerator"? Climate change science is saying things are getting worse, so how can we afford that luxury? Professor Grubb: I personally think the decision to grant all the non-electricity sectors a projected increase is not a view I would share. I think they should have had some cut-back. I think the risk is that in a sense the ETS now protects those sectors from having to do or think about anything. They have been given all their allowances they are projected to need. They could choose to ignore the issue. Economically, logically you would expect them now to think, "Well, there is a carbon market out there and if we cut back our emissions we will have some surplus allowances to sell." I think our evidence is a little mixed on the extent to which sectors are adopting that stance. Q210 Colin Challen: What is possible in trying to get the Commission perhaps to insist on a somewhat stiffer NAP for the UK? Can other third parties appeal against it, to try and make it a little tougher? Professor Grubb: I think it would be very difficult to challenge it, particularly after the Commission's broad acceptance last week. I think the Commission did make some reference to wanting to check compatibility with State Aid rules and obviously there has been an underlying discussion as to whether the granting of free allowances, and particularly 100 per cent free allowances, amounts to a government state aid, and the Commission did acknowledge there is an issue there which is being considered. Whether anyone will consider that and apply that at the specific sector level in this case, I honestly do not know. I cannot advise. Mr Wilde: One thing I would like to add in this context is around competitiveness. I think it is absolutely right that all sectors should have some cut-back for the reasons Michael has mentioned, but they need to be proportionate to the ability of those sectors to abate carbon, and also in line with their exposure to international competition. So for certain sectors, if you did have a very strong cut-back there could be competitiveness effects. So I think there should be cut-backs but they should be in line with the exposure of those sectors. Q211 Colin Challen: On that question of State Aid and the Commission's comments on that, which you have referred to, is that the subject of an on-going discussion between the UK Government and the Commission, or has it been resolved, to your knowledge? Professor Grubb: I do not know the answer to that question. Q212 Colin Challen: How do you feel the Commission's decision has been viewed in other countries? What has been the response to that? I think we know a little bit about Germany's response, which is a little bit hysterical, in my view, but what about other countries? Professor Grubb: Maybe I will take other countries first and come back to Germany. I have not seen the full set of responses. There has been concern expressed in a number of countries. I think a couple of the Eastern European countries have been really quite shocked at the severity of the cut-backs proposed and I think there is an underlying tension, perhaps, between how some of the Accession Countries feel about their roles and positions in Europe when now faced with the reality that they are being treated exactly the same as everyone else according to a given formula which applies across all 25 countries and that implies that their view of their projections and allocations was, in the eyes of the Commission, grossly inflated. So I think one source of potential rebellion is from the Accession Countries in Central and Eastern Europe. I think there have been some expressions of concern from one or two other major European countries treated in that first round. We also know the French withdrew their Allocation Plan at the very last minute when it became obvious it was going to be rejected, and they have said they will re-submit very shortly, but there is no question that a lot of the eyes are on Germany and its reaction. I think there are a few things it may be useful to say about that. First, Germany is the biggest country in Europe, the biggest economy in Europe, the biggest emitter in Europe and a lot of countries look to Germany as an indication of what example might be followed and will that be a dominant view. It also, by its own weight, has a significant impact on the carbon market. Second, the German Allocation Plan in aggregate was, I think, reasonably considered distinctly un-ambitious, which might be a generous way to put it, and more to the point, from my perspective noticeably discordant with the view of the German Government on climate change in general. So at almost exactly the same time they were squaring up with the Commission in order to try and protect an allocation which would have implied an increase in general emissions, unambiguously in my view, across the whole economy, they were calling for 40 per cent reductions at the Nairobi Conference. I think there are two halves of Germany and the government is going to have to reconcile that. The third point I would make is that the very strong statements after the Commission decision were made by the German Economics Minister and made particular reference to the new entrant provisions in the German plan, in other words that Germany had attempted to include a provision which would guarantee new entrants into the ETS free allocations for the next 14 years. The Commission said that is illegal under State Aid Rules. You cannot guarantee that level of protection. We are trying to build a carbon market, trying to factor a carbon price in, and you cannot say any new entrant is going to get that degree of protection, which would actually, from an economic standpoint, have acted as a subsidy to the most carbon-intensive power plants in Europe. Obviously, there had been some kind of understand, shall we say, between the German Economics Ministry and the power sector and new facilities, and it was extremely angry at the Commission declaring that illegal. Q213 Colin Challen: Of course, we famously went to court with the Commission in the first phase when we were trying to revise our allocation at that time. Are other countries, do you think, likely to follow that example if they still do not like their NAP, or find some other way of challenging it? Professor Grubb: Since you mention the example, I was tempted to say earlier when you said we had a strong Phase I plan, we do not have ourselves to thank for that, we have the Commission to thank for it! I do not like predicting exactly what other countries may or may not do. I think what is clear is that the Commission had to act. It had to act in a strong and robust way and it has taken the political gamble that by taking on ten Member States at once and imposing cut-backs on all of them that each individual one will realise it is not being singled out and that everyone is being treated fairly and equally and that if one Member State mounts a challenge it could call into question the whole basis of the carbon market. I do not think anyone really wants to do that in Europe. Q214 Colin Challen: Press reports suggest that Norway is about to join the scheme. Is that likely, do you think? How would that impact on the functioning of the scheme? Would it set a good precedent to get other countries fully signed up? Professor Grubb: I think it would set a good precedent, and Norway is in a rather unusual position in the sense that its electricity market is already linked in with the Scandinavian market and therefore it is already subject to quite a few of the economic influences of the Trading Scheme indirectly. I have not seen the proposed terms exactly of Norwegian engagement, but I think the broad principle is that the wider the carbon market the better. Having said that, adding Norwegian emissions to the European total is going to make an almost imperceptible difference to the scale of the carbon market or its carbon prices, so it is actually the institutional precedent which will be far more important. In that area, actually, it is also worth noting that one of the significant constraints which Europe has imposed on itself for Phase II was not being allowed to auction more than ten per cent of allowances. My understanding is that the Commission has made it plain that will not apply to Norway. If Norway wants to auction more - and it may well because there is a lot of reasons why that would make economic sense - it would be allowed to. Colin Challen: Thank you. Q215 David Howarth: The Commission is currently reviewing the ETS. What do you expect will come out of the review? What are the conclusions you expect it to find? Professor Grubb: How long do we have? James may well want to add some more on this. The Commission review is a pretty wholesale review of the functioning of the EU ETS and its future, so it has focused on lessons from Phase I and emerging Phase II considerations, but I think everyone is really looking at the review primarily with respect to what it may do or say about continuation of the EU ETS post-2012. Let me offer you one unambiguous projection, which is that it will not recommend abandoning the EU ETS, and I think that we are all probably pretty glad. Having got the system in place, the biggest problem is the lack of clarity post-2012 and I think it makes eminent sense for an unambiguous commitment and necessarily, by virtue of timescales, a unilateral commitment by Europe that the EU ETS will continue. I think there are then several areas of topics which will be considered and the Commission has set out a long list of the issues which will be considered in the review, in fact I am getting a little prompting of the various lists which I made. It is going to look at the scope of the directive in terms of the range of installations covered. So, for example, within the current sectors there are debates about the 20 megawatt threshold. That can be re-examined. Also, other gases; currently it is CO2 only. Should it be expanded to include industrial methane or CSE type gases? Within that, carbon caption and storage is another area of scope and coverage. One additional issue is that several countries, but particularly the French Government is pressing for a formalised system of project-based crediting internally so that, for example, is a company which was in the EU ETS wanted to sponsor some emission reduction activity which did not fall within the scope, it could gain the emissions credits for the savings in its retail stores, or whatever. Then I think there is a whole clutch of issues around how the allocation process is working, the various associated debates about the likely strength of allocations post-2012, and potentially the formulation. So people are talking about should actually you have 25 Member States, each proposing allocation plans? In effect, an implicit implication of the Commission's decision last week is leaving it up to 25 Member States clearly has not worked very well, so they have come in with a formula which says roughly what would be a fair proportion in relation to Kyoto targets. Should one go further down the road of harmonisation of allocation processes between Member States? Should it be a five year period again or should it be a ten year period, or something in between, or longer, for the sake of investment security? There is a lot of big questions in that area. Then I think there are some additional issues which get thrown up by concerns about industrial competitiveness. I think it will need to look at how serious are those concerns and what could be done about them. In our own research we have laid out three options which could be considered for how the EU ETS could be continued unilaterally, but changed in order to try and protect the competitiveness of sectors where they have a valid cause for concern. I would imagine that the Commission review will look at those kinds of options. So I was tempted, when I looked through the full list of the communiqués to say that the ETS review is mandated to look at everything. I have realised there is one exception, which is that the Commission's document does not include any plans to look at anything to do with price management, price floors, price ceilings or price stability. I think very much the implicit view of the Commission is that it has created a market and it does not want anyone to interfere. Once the allocations have been set, nobody and nothing should impose any other kind of condition or management of the price. Q216 David Howarth: You have raised a number of issues which I will come back to in a second, but you also mentioned lots of options. Presumably the British Government can have some influence on what comes out of this? You could argue that having the only acceptable NAP puts us in quite a good position, at least in the short term, so what are the key points you think the UK Government should be arguing for which have come out of the review, amongst the various options you have mentioned? Professor Grubb: I think in several areas the UK is in a good position to argue for certain things and I think those would include an increased role for auctioning post-2012. I think the ten per cent limit from an economic standpoint does not make any sense. I am not arguing one should try and jump to 100 per cent and, as James said, one needs to differentiate these things by sectors, but I think definitely in some sectors you would expect to see a much more substantial cut-back in free allocations and you then stabilise the market by reintroducing those allowances by auctioning. So that is one thing that I would press for. I have not yet developed strong views on questions like the timescale because there really are pros and cons. I think there is currently a bit of a rush to say, "Let's have a ten year period next time," but the problem with a ten year period is that you have locked yourself in for ten years. So I think the first question is, do we want to do that? The answer is, we do not really want to do that. We would rather have the flexibility of five year steps. However, you then have to say, how do you guarantee investment security for industry, and that might imply that one does need complementary instruments or a credible capacity to say the price in the longer term is going to be in these ranges, even if we have not specified the exact allocations yet. So I think there are some pretty complicated trade-offs to be made there. I think expanding the EU ETS to cover some additional sectors would be desirable. However, it is an instrument which is designed primarily for large industrial facilities and I am not a big fan of suddenly trying to paint everything into the ETS pot. I think there is a case of horses for courses. Auctioning is one unambiguous thing that I would push for, as well as the tools to help a much more rational process of allocations across Member States whether or not it is fully harmonised. I think one other thing I would add from our own work is that there is a pretty deep institutional question underlying this. These are valuable assets. We are talking about hundreds of billions of Euros of assets being given out and we are talking about a situation where the credibility of government commitments, the credibility of longer term expectations and the resistance of government decisions to very short-term lobbying pressures are all very important questions and having the solution that 25 governments will just come up with the plans which suited their political minds at the time is not a good answer. I think to some extent we have been here before and I think there are some lessons to be learned from monetary policy with the debates which led up to independent central banks with very clear criteria, and I hope the Commission will also look at those institutional questions, although I recognise it might be treading on some pretty delicate ground if it did. Q217 David Howarth: To make that very specific, would you support the idea of a single EU cap on emissions? If we start from one and work downwards, rather than try and do it the other way round? That seems to be implicit in what you have been saying? Professor Grubb: I think by the time we are arranging negotiations for the next phase we should be ready for that. Yes, I do, and I think also to build sensibly upon the precedents set in the Kyoto negotiations, which is that also to avoid unimaginable and unbearable complexity in the global negotiations you had a Troika negotiation with the Commission as a permanent part of it which took on a target for Europe along with a legally binding commitment and then go out and distribute that between the Member States. That is how Kyoto worked and I think it would make sense if that is how the next phase of the EU ETS works in parallel. Q218 David Howarth: Moving on from that, you have mentioned several times the kind of global consequences of the EU ETS. Should the review take into account the possibility of the EU ETS being the kernel of a global carbon trading structure, and if so what would that mean? Professor Grubb: I think it will take it into account because I think that is quite possibly the reality facing us to an important degree. I would put on it a caveat, which is that there is understandably a combination of interests and reluctance, and concern, outside of Europe about how exactly to handle this. If one talks to Japan or Australia, it is not at all obvious that the same structure on emissions trading would make sense. Australians, for example, have a very different industrial structure and they are going to be wanting to be much more concerned about competitiveness of energy-intensive export-oriented industries. So I think it would actually be a mistake for the Commission's review to consciously try and think, "We're designing the global trading scheme." They are not, they are designing the European trading scheme, which is the biggest beast on the block and probably will be the biggest beast on the block, and therefore will be a focal point for carbon prices, a bit like Saudi crude, or whatever. The question is, how do other things choose to link to that? I emphasise the word "choose", as recently in New Zealand - and if you are a country on that scale you have got two rather difficult questions to answer. One is, why on earth would we want to shut ourselves out from a global market in carbon? It is a rather small country and generally one wants to be linked with international trade. The other thing is, if you link yourselves to the European market, are you not letting Brussels's decision-makers determine the price of carbon in New Zealand? That is not something which necessarily sounds very good either. So there is a lot to be thought about and I think there is a risk of being too Eurocentric in one's thinking about the EU ETS design. Q219 David Howarth: Can I bring you back to another point you have already raised, which is the point about ex-post interventions in the carbon market, because we had evidence last week from Climate Change Capital about the problem you already mentioned about having a stable carbon past being necessary for investment decisions and the idea of having a minimum carbon price, and the way you bring that about would be where the government would intervene in the carbon market by credits taken and retire them from the market to make sure that the carbon price stayed up. I think in the past you have expressed views against that sort of ex-post intervention. Could you just say what your current thinking on that sort of scheme is? Professor Grubb: Yes, with pleasure, because it is something which I have exercised quite a lot of angst about. I think there are very large drawbacks to ex-post intervention by government. In other words, "If the market does this, we, the government, will intervene to achieve something else. I think there are all kinds of risks which you run about whether governments would do so sensibly, about how the market would then try and gain the decision or gain the expectations and that has generally not been a very happy circumstance when governments have tried to do that kind of thing. On the other hand, I think at least under the kind of structure we have at the moment we do not have any sense of post-2012 certainty and it is not at all obvious that the solution is to suddenly jump to 10, 15 or 20 year commitment periods which will lock us into everything for the next 20 years, whatever, even if climate science becomes radically worse, or if we are in the middle of global negotiations on strengthening, et cetera, and we are in a context of making allocations which, let us be honest, are pretty trivial compared not only with the scale of the problem but also with just the uncertainties in these kinds of projections. The debate around Phase I, in 2005 most analysts and nearly all governments were saying, "Ah, well, you know, our projections are emissions are going up, et cetera. This could be a really tight market, et cetera." I have to say we disagreed with that and I was not at all surprised when the price crashed, because I never believed the projections on which those allocations were based. There is very little sign we have learned very much in Phase II, so again we see a market in which all governments are projecting increases - projections which, in my view, are not fully substantiated by historical evidence or experience - and the cut-backs are still rather small compared with those projections. So the result is you have an intrinsically uncertain and unstable price. To give one very simple example, I do not know if you have had evidence from gas experts here about the gas price, but they will tell you, "We've got a lot of new gas infrastructure coming in. Gas prices could well start falling rather dramatically." If they do, if they take us back to the situation we were in in 2002, the power sector will switch to gas just because it is cheaper and its emissions will go down by several tens of millions of tonnes of carbon. So there is a lot of uncertainty in this market and that is not good if what you are trying to do is support low carbon investment. That was a rather long preface to my answer, which is that we propose a third approach, which would provide not an absolute price floor but a much firmer carbon price base, but which would not involve in any way ex-post intervention or ex-post decision making. The proposal was quite simply that what is in a sense the big weakness of the EU ETS, namely it is an artificial market where the scarcity is entirely created by government, you actually turn into its principal strength, which is to say that government will make available a substantial number of allowances through auctions but at a minimum price, and if nobody wants to come and buy at those prices, fine, those allowances never come into the market. Providing there is a significant volume of auctions and there is some element of coordination across Europe on what that minimum price might be, then in effect you have created a pretty high chance that the price is not going to go significantly below that floor, because if the volume is big enough the market needs some of those allowances. You can also set up a tiered structure, "There will be this number of additional allowances available at this price and this many at this price." I would emphasise that that helps to set a price floor but it does not in any way involve any ex-post adjustment at all, depending upon how the market evolves. It simply says at the beginning, "These are the rules, and if any company wants to come and buy at this price they are welcome, but we are not going to put more allowances into the market at a lower level." We think that is the best compromise. Q220 David Howarth: That is a kind of reserve price of carbon where the government says, "The social value of carbon is at least this much and we are not going to sell for less"? Professor Grubb: Yes. Q221 David Howarth: You have written a piece recently with Jonathan Köhler which seems to say that the carbon price which would induce major change will be something like $100 to $150 per tonne. I suppose the question then is, what do you expect the price to be in Phase II and Phase III, and if it is nowhere near that, is what you are suggesting now the way forward to make sure the price rises towards something which will induce real change in the economy? Professor Grubb: I am pretty sure that figure was tonnes of carbon rather than CO2, but you are right, I think all these numbers have considerable uncertainty. On all my reading of the economics, if I use the units of the carbon market these days, suggests that you need a carbon price of somewhere between €20 (Euros at the time of CO2) and to start making significant change, if you really want to get big reductions which will really de-carbonise the power sector and make significant inroads on the industrial sector overall, over the next few decades you need a price which could rise anywhere up to about €50, and that still will not solve the transport problems at all, but somewhere in the range of 20 to 50 will get you a very long way over the next few decades. Do I expect that price out of EU ETS Phase II? No. We might get to 20, if the Commission sticks to its guns and if it is not subject to a successful legal challenge I think 20 plus or minus something is my best estimate of Phase II prices. As I say, if gas prices go down that could prove to be on the high side. We might get significantly lower carbon prices. So I think it will be a while before we see carbon prices at a level which would drive deeper levels of change. Q222 Dr Turner: Looking at the experience of the first Phase, the financial effects on the UK seem to rather stand out. We were 27 million allowances in deficit and other countries were notably in profit because their allowances far exceeded their actual emissions. So several hundred millions allegedly changed hands, although as far as I can tell there is no actual evidence that a single tonne of CO2 was cut from emissions as a result. How much money do you think it cost the UK for all of those years? Professor Grubb: I think there is some evidence that some carbon was cut as a result, but we could come back to that. There is a paradox here because the only sector in the UK which was short and needed to buy was the power sector, which as you say was short by a significant margin and went out and bought, despite which the DTI's own evaluation is that the power sector made £800 million profit, despite having to go out and buy from European counterparts. Obviously, at the end of the day that is still fundamentally money going abroad as part of the Trading Scheme. I do not, to be honest, know the trading volumes and the prices at which they were traded. I think utilities were a bit short-sighted if they bought very much while carbon prices were at €25, but then they would accuse me of the benefit of hindsight. From a national perspective the amounts of money exchanged were extremely small, but I do not have the number to hand. We made some estimates looking forward and a great deal does hinge upon how much abatement you think the sectors will make. If you think the current UK allocation and proposed cut-back for the power sector will stand and emissions would stay exactly where they are, then overall one is going to be looking at, we estimated, buying about 20 million tonnes of CO2, and if you multiply that by €20 as your best estimate and that is €400 a year. On the other hand, if the power sector gas prices go down or other things lead the power sector to make quite major changes, the UK could end up as a net seller still and make money out of the system. Quite a lot hinges upon those kinds of assumptions and on how much effort countries and sectors make, but at the end of the day we have created an international market. An international market does not exist unless countries are willing to spend money across borders. Q223 Dr Turner: But does the fact that the UK's proposed cap for Phase II has not been tampered with by the Commission and other countries have all been cut back, and France's rejected altogether, suggest that Phase II will be a little more evenly balanced between countries? Professor Grubb: Yes. I think the Commission is making a major effort in that direction and they have avoided the soft option of simply saying, "Here is a load of allocation plans. Let's all try and cut them back by the full amounts." They have been very discriminating on the basis of how serious they think these cut-backs were, and I think the UK has benefited from that. Q224 Dr Turner: Good. Your recent report describes the UK as one of the most exposed countries in Europe when it comes to external trade effects. Obviously energy-intensive industries cannot avoid consumption. Why do you think that is? Why should we be so much exposed? You would expect Germany to be equally exposed? Professor Grubb: I said "one of" but I did not actually go through the trade statistics of the Member States. Simply because we are a maritime trading nation. We are used to doing a lot of international trade. We still have very substantial export and import industries from outside of the EU to a much greater extent than one would expect, say, of Austria or others more in the middle or Europe, or with indeed less easy maritime trade. That was really all I meant. It was not a more extensive statistical analysis. Mr Wilde: One point I could maybe add to your previous question about a level playing field is that I think it is important in Phase II that we have more of a level playing field, but when one looks at the competitiveness of various sectors it is useful for them to have a level playing field as well, so in Phase III harmonisation of approach by sector could be beneficial as well. Q225 Dr Turner: Yes. The engineering employers last week told us that heavy industry has just about made all the serious energy efficiency improvements that it can make without a step change in technology, and there is no evidence of any such technologies, as far as they are concerned, being available. So their argument would be that the ETS is not going to drive any significant carbon reductions from their processes. Would you agree with that? Mr Wilde: When one looks at the available cost-effective opportunities to reduce emissions below the carbon price, even in the energy-intensive industry sectors covered by the Emissions Trading Scheme one would expect them to improve their energy efficiency and reduce emissions by five to ten per cent across most of the sectors. Some of these sectors also have some substantial opportunities which might be helped to be incentivised by the scheme. For example, in cement there are options to use alternative fuels, to use biomass as a fuel source. So I do not think they necessarily have no opportunity to reduce their emissions currently and I think there is a need to help drive innovation to come up with step change improvements in the long term. Q226 Dr Turner: What would be your views on the steel industry in particular? The engineering employers think that steel companies are really approaching their theoretical maximum limit of energy efficiency, but it seems that you suggested that steel blast furnaces are much more power-intensive than electric arc furnaces. Does this mean you think there is still room for carbon reduction from steel production, even with current technology? Professor Grubb: In response to your general point at the beginning first, I think it is actually very hard to know for sure whether companies or sectors have exhausted all the opportunities until there is a real incentive to do so. I think that is actually one of the profound lessons of history in this area. We have had the history of the UK Emissions Trading Scheme, the UK Climate Change Agreements and most of those over-delivered and I think not purely because companies gained the projections and allocations at all. I think in some cases those processes led companies to realise there may be more things they could do and once the incentives were in place they did indeed find they could deliver those. It is very hard to know what all your opportunities are, starting from today. An incentive does obviously encourage you to go and find out more seriously. That said, I think it is true that these are sectors which have faced significant energy bills for a long time by definition, and with energy prices going up they would certainly be a bit foolish if they were not paying very close attention to the opportunities. I would argue that even within the year 2005 under the trading scheme we saw some examples, maybe more in cement than in steel, where actually companies did find they could deliver more than they had really expected, and in fact the cement industry has said very publicly, "Why are we being criticised and accused of over-allocation? People should be congratulating us on the abatement we made," and to some extent you can trace that in their operations. You have asked specifically about the steel industry and different steel making technologies. I am not an expert in the field. I think one thing we pointed to briefly in our study is that there are different steel making processes. They involve very different carbon intensity and questions about whether the trading scheme really gives the right incentive to move towards the more efficient techniques of electric arc. One of the responses which has been put to me by the steel industry is that that is not really a fair comparison because an electric arc furnace requires scrap. You cannot run an electric arc on bore, so actually they are not really substitutable. Q227 Dr Turner: It is also displacing the carbon output to the power industry? Professor Grubb: Well, it is, but the point is the mechanism is so much more efficient that it is still a net substantially lower emitter because you are not having to reduce the base ore in part. I think there is also a lot of truth in that, but then there are also issues - I do not know the scrap industry, but I have been told in the United States the impact of high steel prices has actually meant the whole industry has developed to driving around the countryside picking up old cars and taking them to recycling units or electric arc units. So to what extent there are more opportunities there, I do not know. I think a lot of these things get characterised in a rather black and white way, "We cannot do any more. We have done everything," versus, "There's lots you can do," et cetera. I suspect in several of these sectors the answer is they have paid quite a bit of attention to their energy costs. Carbon costs will make them pay more attention. They have thought of a lot, but they have not thought of everything, and certainly we still see proposals coming through the Carbon Trust on various energy efficiency technologies, energy management systems for companies like this which would still make a useful contribution. Q228 Dr Turner: So you think that if the carbon price went up significantly they might find something? Professor Grubb: Yes. How much is very hard to tell. Q229 Dr Turner: You also talk in your recent report about the potential for participants to gain profits from passing on the market value of their allowances where they have been allocated for free. You go on to say that "competitiveness is not a serious concern in terms of the direct impact of Phase II EU ETS costs. Rather, Phase II is likely to be a phase in which most of the participating sectors can accrue profits from the EU ETS, that can be used to assist investment, for example in low-carbon technologies." What businesses which you have looked at in the scheme bring you to that conclusion? Professor Grubb: The sector for which we have, I think, unambiguous data is the power sector. Some of the studies we have published have tracked electricity prices. You can see the impact of carbon within the electricity price and you can do the net calculation and, as I say, the DTI's own assessments also indicated that sector was making profits. I do not think that is necessarily a bad thing, but let us put that debate aside. The underlying mechanism is universal, namely if the cost of carbon is factored in by companies in a profit-maximising way such that their sales price of their product reflects the opportunity costs of carbon allowances - if they are making more, they have got to go and buy allowances; if they make less, they can sell those allowances - and you give companies a significant amount of free allowances, they will make the profits. That is very straightforward mathematics for most of these sectors. There are two constraints on that. Foreign trade is the most obvious and the other is, for something like aluminium where actually most of its cost exposure is on electricity price rises and it is not getting free allowances to cover those because those have gone upstream to the power sector, so actually the room for manoeuvre for aluminium is very limited, although to some extent it is protected by current contracts for the next few years anyway. The foreign trade issue is much, much more complicated. It works in the power sector because no one is going to import electricity from outside of Europe into Britain because of the EU ETS, so the power sector does not have to worry about that. Do other sectors have to worry about it? The answer is, yes, to some degree, depending upon the specific product, the specific market, the specific nature of competition. In our more recent work we flagged and illustrated with a very, very detailed study - and the cement sector is one which I think illustrates this very well - that if you are in an internal inland cement region it is not cheap to haul that stuff over land in large quantities. You can pass the carbon costs through to some extent in cement prices. Whether or not you choose to is a function of lots of other things, of how does the sector really work and get together and how the cement sector tries to determine what kinds of prices it is putting on its product, or how the cement companies determine that. But in principle, if companies are profit-maximising they will set prices in relation which reflect carbon costs. They are getting free allocations. The net result is they make profits. A cement company near a port, however, may find that if it does that and it reflects that cost in its cement price, actually it is jacking up cement prices by ten per cent and that is enough to attract foreign imports. Will they come in overnight? Probably not. Will they come in over a period of several years if that price differential is maintained? Yes, they probably will. A ten per cent difference is enough to drive significant cement imports if you are near a port which can handle cement. So what would the sector do? Well, they would probably in reality think in terms of the strategic market rather than short-term profit, maximisation, and decide they were not going to pass all the carbon costs through. They will keep their cement prices down. With the kinds of allocations and prices we have at present, they could add maybe two per cent to cement prices and they will cover their losses and break even, compared with the situation without the ETS. My guess is one can usually sustain a two per cent price differential without losing a significant market share. But as I say, it is a grey area. What we were really trying to fundamentally say is that the logic which underpins the electricity profits does apply in principle to other sectors but they do face different sects and magnitudes of constraints. Q230 Dr Turner: Yes. We know the electricity companies, the power companies, did very nicely by this, in fact some people have described their opportunity of profits as scandalous, but can you think of any other UK business or business sector which has actually made a profit out of the first year of the scheme? Professor Grubb: I do not have any data on price. To answer that question you would need to know two things. One way of making profit is just by having surplus allocations and selling them. I am not a sufficient market-tracker to know exactly who has been selling what, but I do know that every sector other than the power sector had a surplus in 2005. Frankly, if they did not sell it at prices of €20 to €30 per tonne they have no one to blame other than themselves. So if they have not made a profit, they have only themselves to blame for that fact, given the allocations. The other way through which they made profits is through product pricing, and for that I would need data on pricing in 2005 to try and differentiate that from the thousand mile impact on product prices, and frankly I confess I have no idea if there is any proof that other sectors have behaved and made money in that kind of way. Q231 Joan Walley: Just on UK businesses other than the power sector which might be affected one way or another, you have not mentioned the ceramics industry? Professor Grubb: No, I confess I have not studied the ceramics industry. I know very little about it. Q232 Joan Walley: Do you think there would be some point in actually looking at the situation it is in, given the competitiveness opportunity which it has from where it is produced outside of Europe, unlike the power sector? Mr Wilde: I was just looking at some numbers actually for the glass and ceramics industry as a whole. Michael mentioned before the potential value at stake and for the glass and ceramics industry it is actually relatively small. Q233 Joan Walley: I am sorry, what is small? Mr Wilde: The net increase in costs produced by the scheme over their current value at - and that fraction is actually the value at stake that they have got - is very small, it is under one per cent of their profits. The cost increase represents under one per cent of their profits. But you are right, in terms of the other metric that Michael was mentioning, international competitiveness, it is relatively high, so trade intensity from outside the EU in the glass and ceramics industry is around seven and a half per cent on aggregate. So they are one of the sectors more exposed to international competition. Q234 Joan Walley: So in terms of sectors which are more exposed to international competition and in terms of what needs to be done in respect of Phase II, of the three suggestions you put forward in your paper, which I think included cross-border, perhaps looking at some kind of international sectoral agreement, what sense have you got of how well received they are in Europe and what kind of discussion is there going on about this? Professor Grubb: That does move us into some pretty big terrain, because I do not think any of the three options we have outlined are simple, and none of them may be needed for some of the sectors. I think one does have to make a case that a sector has a competitiveness problem, but as I say the longer the timescale, the higher the carbon price, the longer there is a unilateral carbon price difference and obviously the stronger the problem becomes, particularly with respect to new investment. What reactions have there been? I think in the international discourse, by which I mean broadly the sorts of discussions one has in the corridors of negotiating sessions, informal exchanges between European countries and some others about how to move forward on climate change, in the research community underpinning some of that I think there is considerable interest in sectoral agreements. There has been a number of think-tanks which have proposed the idea, or variants of it. Some industries have started to express interest. It is my understanding that at least some parts of Arcelor before it was bitten by Mittal was expressing interest in the global steel sector agreement around carbon, and it does, I think, solve a number of potential problems depending upon the structure. But obviously it is difficult, potentially it is very difficult, and you also have a legal question about what kind of agreement you are trying to strike with whom. Are you actually talking about some kind of deal with the private sector? In which case, who legally is the private sector? Who can sign an agreement on behalf of the steel industry? Who can enforce it on the steel industry? So there are some very big questions indeed underpinning the practical implementation of a sectoral agreement which has teeth, shall we say, as opposed to a voluntary agreement in which the sector says it is going to do its best. Q235 Joan Walley: So would it be fair to perhaps conclude that the proposals which you put forward do not have that much currency inside Europe? Professor Grubb: Well, let me continue. I am saying that I think there is a significant constituency which thinks that could be the most desirable way forward and wants to explore whether it can be done, and if so where and in which sectors. I think the second area is border tax adjustments and I have to say again I think it is one which one should approach with considerable caution, but there is increasingly open talk about it and I notice that the high level group on competitiveness had not ruled out the possibility of exploring border tax adjustments as a way of dealing with competitiveness issues. I think there are some pretty strong arguments on both sides, but I do not think it should be ruled out of consideration in the context of a wholesale review. Q236 Joan Walley: But if those proposals are going to go forward, they are going to have to be driven by somebody, are they not? Professor Grubb: Yes. Q237 Joan Walley: Is it the case that you are not driving them forward in Europe at the moment, or do you believe in them so much that you are trying to get support and trying to pursue them? Professor Grubb: I am not sure who you mean by "you". Q238 Joan Walley: But you have an advisory role in terms of the Government, do you not, in terms of your remit? Professor Grubb: I personally do not have a formal advisory role. Q239 Joan Walley: Sorry, the Carbon Trust. Professor Grubb: The Carbon Trust has published its analysis and recommendation, which is that all three opportunities should be explored in depth, and since we ourselves have not done any additional work subsequently I cannot really add to what we have already said, and I maintain that view. We should be exploring all three options in depth. Q240 Joan Walley: When we spoke to the employers, when they submitted evidence, they put forward a proposal which, as I read it, is about having a sort of separate energy efficiency reward and penalty scheme after the manufacturing or whatever has taken place. Do you have any views on the proposal they have put forward? In doing so, they would remove certain sectors from the ETS, so there is presumably some derogation there and then some separate arrangement? Professor Grubb: Yes. I do have a view. I think from within any individual sector there are always special circumstances which need to be considered. It always appears possible to propose something which looks like it might lead to a number of gains without the pain or the perceived pain of a carbon price and a mandatory system. There are two reactions to that. One is that the track record is mixed. I do not say the track record is bad, but it is very definitely mixed. Sometimes more slightly quasi or softer agreements look like they have delivered things; at other times it is quite plain one has just ended up rewarding companies and sectors for pretty much business as usual. But I think there is a second, quite big consideration, which is that if you think about what we are trying to do (i.e. what we are trying to do is a 60 per cent reduction by mid-century) that is a big change. That is not tweaking energy efficiency in a few individual sectors who continue to sell exactly the same kinds of products at exactly the same kinds of prices, just for a little bit more effort on energy efficiency around the margins. This is a structural problem. This is a macro-economic challenge and any economist worth his salt says that one of the fundamental factors in an efficient solution is that you have to change relative prices. You say there is a problem with carbon. It should be more expensive. It should be more expensive not only to encourage sectors to be more efficient in how they produce materials, but also so that consumers see some signal about what involved more or less carbon and its manufacture, and where there are sensible opportunities to substitute there are appropriate economic signals to do so. I do not see how the kind of proposal you have mentioned in any way reflects that. On the contrary, I think it tries to protect the status quo in terms of any pricing and you lose the sort of fundamental, if you like, the economist's efficiency of having a carbon price in the economy which allows people to shift around effort according to our carbon reductions, the most cost-effective. Joan Walley: Thank you. Q241 David Howarth: Bringing us back to the power sector, could I just raise one point about the issue which Des Turner raised about the windfall profits, £800 million according to the DTI. I think your estimate was slightly lower, 60 to £70 million, but it is still a lot of money. Is there any evidence that the investment plans of the power companies changed as a consequence of having this money? In other words, is this just pure deadweight or is it actually inducing them to do more of this sort of thing? Professor Grubb: I do not think I could point to any very specific evidence, specific decisions and in so far as there is evidence, it is of a rather different nature and it actually comes back to other problems or other issues in the power sector, which is one reason why I said that to some degree making profits is obviously what industry wants to do, but in the energy and electricity sector we have created a big problem for ourselves which does not appear to be being automatically fixed, namely the privatised sector has not really done much investment of anything in recent years and we are looking at growing concerns about whether there is enough investment. That is partly because the sector says with a short-term spot market in electricity there is no reserve with which to fund new investment. The markets determine the short-run operating costs. The prospect of shortfall does not drive enough income to justify putting a billion pounds into a new power station. So you have a sector which claims it is not getting enough revenue really to fund new investment and we now have an instrument which is certainly giving it a significant amount of revenue. It is still not investing. Why? Partly because of uncertainty, and if you are faced with big uncertainty very often your ration choice is actually to sit there and wait, and I think that is what the power companies are doing. I think they are saying, "It is too risky to build gas because there may be regulations. We are not sure about gas prices. We may not need it yet because we can build gas plants damn quickly when we have to. It is too risky to build coal, although that is the cheapest because this beast called the ETS exists, and the problem will be the carbon price, which is enough to make us wary of making new coal investment." In Germany they tried to get a guarantee to protect it and that has now been ruled illegal. They might invest in renewables to the extent that the renewables support mechanism helps it, but basically the fundamental response of the power sector is to sit there transfixed while the number of uncertainties stare them in the face. Until we resolve that uncertainty and we resolve it in a low carbon direction and in a way which enables the sector to have enough resources to risk a few billion pounds here and there in new stations, we will continue to have problems in the power sector. Mr Wilde: One thing I would add to that, though, is that it is not an indefinite situation. When one looks out to 2015 there is quite a looming capacity gap of around about 15 gigawatts in the best case scenario because of the retirement of coal plants and nuclear plants. So they will be investing and it is all about making sure they invest in the right things. Q242 David Howarth: You have mentioned coal. I can guess your answer to this, but it would be good to have it on the record anyway. Can I just put to you two suggestions made to us by the Clean Coal Task Group to encourage coal to come on-stream. One is to give coal stations larger allocations in the first place to reflect their larger emissions. The second is to deal with carbon capture by allowing companies which do that to effectively sell the carbon they have captured as accredited to the market so that they would be able to get an allocation equivalent to the amount of carbon dioxide they have captured. What are your views on those two suggestions? Professor Grubb: I think the first one, certainly if it is applied to new investment, is basically calling on the UK to have rules such as Germany tried to do. This falls into the camp of what I call one of the universal laws of policy making, which is you try and introduce an instrument to change something and the political reaction is to try and undo it so that it does not change anything. Q243 David Howarth: That is absolutely right. Professor Grubb: What they appear to be asking for is actually really nothing to do with the EU ETS other than to say, "We don't really believe there is a carbon problem, so we want to go on building coal power plants. So please protect us from the incentive you have just created to de-carbonise." I think that really has no credibility in a world in which we know there is a carbon problem. The idea of building new coal infrastructure which will generate carbon for many, many decades ahead is contrary not so much to the ETS but just contrary to the basics of the climate change problem. I think that is the problem with the German proposal. It is this completely two-handed situation where half the government is saying there is real problem and the other half is trying to say, "We want to pretend there isn't a problem, and re-write the ETS rules to conform with that view." I think carbon capture and storage is interesting and it is one of the topics under review as part of the ETS review, I think appropriately. It is quite clear that coal plants with carbon capture and storage will not be emitting anything like as much carbon, therefore they will not be exposed to the carbon cost. Should they still be given lots of free allowances, much higher than they are actually going to emit in order to try and deliberately subsidise? I remain rather sceptical. What I would like to see, frankly, regarding all the new entrants to the power sector, is that any new generating plant should, if it is going to get any free allowances, should get exactly the same amount as every other new power plant per kilowatt hour produced. If you can get below that average, great, you have got a surplus and you can sell it. If you are above that average, you have got to go and buy and reflect the fact that you are building a more carbon-intensive plant. That is the only rational approach in this sector. Q244 Chairman: You mentioned options earlier on and we had some discussions with the Commission earlier in the week about optioning. I think most of those we have talked to are keen to move towards a much higher proportion of options. One of the obstacles is people's suspicions about what happens to the revenue and whether this is another stealth tax. How is that best overcome? If we are going to recycle the revenues to something like the environmental transformation, how do we achieve the level of confidence needed that that is really going to happen? Professor Grubb: I tend to regard that question as not really being about emissions trading per se, it is about how government uses money and the extent to which it wants to hypothecate money from one source towards particular ends. To that extent, I do not have a great deal of knowledge or insight to offer. I would make the general point that solving the climate change problem is a very big endeavour and it is going to require some government funding as well as market-based incentives. I firmly believe that and the idea that we just set a carbon price and then walk away and everything will be delivered is nonsense. I think to set a carbon price is absolutely fundamental, but there are various other things which need to be done which will require money, including technology development, including perhaps support of particular sectors in particularly exposed areas or where there are low carbon ways of, for example, making steel which have not yet come into the market. I think there are lots of valid things one could make a case for where government needs to spend money. How credible is that? How does government do it? I guess that is a question which one could ask the Carbon Trust. You could certainly ask the Treasury. The Treasury itself has announced plans for various expenditures. Would it make sense to use some auction revenues for those expenditures? Quite possibly. I have noted with interest that the announcement of the Environmental Transformation Fund was made at more or less the same time as the announcement about auctioning, but the two are not formally linked or hypothecated. I think in some European countries, and certainly in Japan, they would be much more willing to just say, "Well, that pot of money is linked to this problem and the money will be used for that, as opposed to going through general expenditures." Q245 Dr Turner: I want to follow that point, because as it is the money produced by the sale of allowances in the market does not get invested in actual carbon reduction investment, whereas if the auctions were allowed that would be effectively tantamount to a carbon tax and a carbon tax credit system, which others (including myself) have advocated over the years, which would actually hypothecate but it would show that the money was actually going into carbon reduction technologies? Professor Grubb: Yes. I think there is a lot to be said for that. As I say, I do believe that solving this problem will involve expenditure as well as market incentives. Given that fact, I see no fundamental objection to linking revenues from economic instruments to some of those expenditures. Q246 Dr Turner: Of course, everybody wants to see aviation in the ETS now, except the Americans, the Japanese, the Australians and a few others. How soon do you anticipate that aviation will be included in the ETS and what impact do you think it will have on the scheme when it is? Professor Grubb: I should have made sure I had in front of me some evidence that we submitted to the Climate Change Programme Review eighteen months ago or so. We listed four questions at the end of that evidence which I think have to be addressed. One is, if you take the kinds of prices we are looking at in the EU ETS, say 20, 30 or even more Euros, and apply that same carbon price to aviation, how much difference do you think it will make? That is the first question I would like to see an answer to. The second question was, if you look at 60 per cent reduction and make some estimate of what you think an acceptable role of aviation emissions within the relatively small pot that is left should be, what kind of carbon prices do you think you would need to drive aviation down to those levels, and do you think the rest of the UK and European industry would bear those kinds of carbon prices? The answer is very high compared with the numbers we have been talking about. I think there is a third area surrounding the non-CO2 emissions from aviation which probably account on aggregate for something like as much as the CO2 again, but much more uncertain, much harder to monitor, dependent upon flight paths, flight levels, et cetera. My understanding is that the idea of including those emissions in the EU ETS accounts has been dropped, but I may be wrong. The fourth thing was simply that one legal distinction is that all the ETS emissions at present fall under the remit of Kyoto protocol and Kyoto protocol targets. International bunker fuels do not fall under the remit of Kyoto protocol targets, so what are the legal implications of trying to include in the ETS something which has no match at all across the Kyoto targets? You will gather from that that I have set down four questions I would like to see clear answers to before I am ready to join the fan club of including aviation in the EU ETS. Q247 Dr Turner: In that case you will probably give an even less enthusiastic answer to my next question, which will be the last one, which raises the fact that our erstwhile Secretaries of State for Environment, Trade and Industry and Transport wrote to the Commission urging the inclusion of surface transport emissions in the ETS. Do you have any feelings about how this might work out in practice and what are your views on whether it should or should not be included? Professor Grubb: I do not think that surface transport should be included in the EU ETS. It is not designed for distributed sources of that nature. The prices will make zero impact relative to current petrol prices anyway. It would vastly complicate the EU ETS system. I would love to see the reasoning. Chairman: I think that accords with our view about this issue actually. I do not think there is much enthusiasm for doing it, but I am grateful for your confirmation in such a clear way about it. Thank you very much for coming in and I have no doubt we will see you again. This will remain a highly topic for quite a long time to come. |