UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 248-i

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

TREASURY COMMITTEE

 

 

CLIMATE CHANGE AND THE STERN REVIEW:

IMPLICATIONS FOR HM TREASURY ON TAX AND THE ENVIRONMENT

 

 

TUESDAY 23 JANUARY 2007

 

PROFESSOR P EKINS

 

MR R WILTSHIRE, MR A KERSHAW, MR A BARKER and MR B HUMPHREYS

 

MS K HAMPTON and MR S ROBERTS

Evidence heard in Public Questions 1 - 127

 

 

USE OF THE TRANSCRIPT

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Oral Evidence

Taken before the Treasury Committee

on Tuesday 23 January 2007

Members present

John McFall, in the Chair

Mr Colin Breed

Mr Andrew Love

Kerry McCarthy

Mr George Mudie

John Thurso

Mr Mark Todd

Peter Viggers

________________

 

Witness: Professor Paul Ekins, Head of Environment Group, Policy Studies Institute, gave evidence.

Q1 Chairman: Professor Ekins, welcome to the Committee. Thank you for taking the time to come and give evidence to us in the first part of our inquiry into climate change and the Stern Review. To start off with a general question, what are your views on the Stern Review? How far has it taken the debate forward? Given that in July 1997 the Government announced their intention to reform the tax system to increase incentives to reduce environmental damage and shift the burden from good to bad, as they called it, what more could they do to make the fullest possible use of taxation instruments as a mechanism to achieve their environmental targets?

Professor Ekins: Chairman, it is a pleasure to be here and thank you for asking me to come. I think that the Stern Review took matters forward a very great deal, especially in a political sense. Those of us who know the economics literature will probably be aware that most of the arguments rehearsed in the Stern Review have been out there for some time. Some of the novelty of the Stern Review was in his choice of emphasis. He focused first very much on the science of climate change, which does not always happen when economists look at that subject. He then focused in the first two chapters very much on the equity and social justice issues, which again does not always happen. Yet in my view that is the correct way to start because these are very important public social as well as economic issues and it is important to get them on the table. He then worked through the economics in quite a lot of detail. There has been a fair bit of controversy about how he arrived at his overall damage costs, in particular with the use of a discount rate that some perceived to be too small, and he justified that use. There will continue to be debate about the right value of such things. I think that his broad conclusion, which is that the damages from climate change if allowed to proceed unabated will greatly exceed the costs of doing something about it and reducing the level of emissions and therefore the degree of climate change in future, was absolutely right. I think that his argument that there is a strong economic case for serious and determined abatement of emissions internationally is the right one. Broadly, I am in agreement with that. On the subject of the tax shift, in this country since 1997 the proportion of taxes and GDP that comes from environmental matters has fallen which, on the face of it, implies that there has not been a very great movement. Again, I believe that that statistic gives the right impression of the situation. In my view, what happened was that the Government started with very good intentions. The statement of intent on environmental taxation was, though short, a very innovative document and one which, had it been followed thought through, would have been something of an international first. For the first few years the Government seemed to pursue that agenda quite vigorously, but a combination of events, of which probably the most important was the fuel duty protests in 2000, caused them to lose political heart. Obviously, it was not helped in that what seemed to have been cross-party consensus on that particular tax, namely the fuel duty escalator, broke down at that time. As you know, that had been introduced by the Conservatives in 1993. Both parties had broadly backed it until 1999 when the Conservatives changed their policy and it made it very difficult in the face of the fuel duty protests for the Government to hold their nerve. Since then the real tax on fuel has fallen. If one looks at the share of environmental tax in taxation generally one sees that it peaked in about 1999 and since then has declined quite substantially.

Q2 Kerry McCarthy: You say that you broadly agree with Stern's conclusions. Do you agree with his view that there is about a 1% GDP cost to stabilise greenhouse gases as against the 5% to 10% potential loss in global GDP if climate change is allowed to continue?

Professor Ekins: You probably know that a number like that is derived from fairly complicated - some would say sophisticated - economic modelling. There is enormous uncertainty about the way economic models are constructed, the theoretical bases on which they are founded and the relationships that they are posited to have. There are very different economic models which come up with different results. The Stern Review quotes what is called a meta-analysis of all of these studies to show that there is a wide range of estimates of GDP impacts from reducing emissions by 20%, 60% or 70%. Most of those estimates fall within about 0.5% to 2% of GDP. If one had to pick a single number that seemed to be representative of those modelling results 1% would be a reasonable choice. Obviously, those economists who are responsible for and believe in the models that have come up with higher estimates will say that that is too low. I have looked at the models and the kinds of modelling of these sorts of issues that I favour suggest to me that 1% is about right. On that basis, I agree that that is a reasonable estimate.

Q3 Kerry McCarthy: When one is looking on a global basis at these estimated costs and losses, how easy is it to move from that to doing cost benefit analyses for the UK in terms of bringing in new environmental taxes here?

Professor Ekins: Any kind of cost benefit analysis of an issue of this kind is fraught with difficulty, and I for one am very glad that Stern did not really attempt it. For a country like the UK the first question one has to ask is: to what extent is this global action and to what extent is it action purely in the UK? If it is the latter obviously global emissions and the damage costs from climate change will fall rather little and the cost to the UK through the effects of competitiveness if the policies are not implemented particularly well could be quite substantial. But if one assumes that there is an international framework in place, that all countries reduce their emissions so that the effects of competitiveness across countries are not pronounced and one looks at the damage costs that Stern projects, particularly the significant risks of catastrophic costs - the single biggest change in the science over the past 10 years since I have been looking at the issue is the way in which scientists now perceive catastrophic costs to be much more possible in the reasonably short term - then it is possible to conclude, as Stern did, that the overall cost of mitigation is much less than the risk of very high damage costs and that the cost benefit analysis, if one could carry it out - Stern did not - would mean a significant return from carbon abatement.

Q4 Mr Love: If I may carry on logically from what you have just been saying, you said that Stern had estimated a 20% to 60% reduction, but that leaves considerable ambiguity about the cost of adaptation. Do you believe that in this country there is a supportive environment in government and other circles to recognise the costs of adaptation in future?

Professor Ekins: I think that Stern's perception about the degree to which we need to reduce emissions is much closer to the 60% than 20%. I was quoting that the studies had looked at reductions of between 20% and 60% and come up with different ranges of mitigation costs. Even at 60% emission reductions globally, or at least in developed countries, there will be considerable climate change and we will need to adapt. These adaptation costs are likely to be very different in kind and the public will perceive them very differently. Some of the effects will be direct physical ones on the UK, such as increased flooding and increased cost of home insurance against that risk, if we decide to do it through the private market. I do not think that the public will have a great deal of choice about that. We are already increasing the cost of flood defences against these kinds of events. That is money to be spent by taxpayers which obviously cannot be spent on something else. There will be other much more difficult kinds of costs if there are very wide international effects from climate change. If, for example, some of the low-lying deltas of the world with very large numbers of poor people living in them were to become uninhabitable those people would have to go somewhere else to live. Countries like the UK might be asked to take very large numbers of migrants from something like climate change. I can imagine that that in a sense is not a financial cost because they may be very hard working and in due course add to GDP, but we know that that would be a difficult political issue. In a sense there would be a perception of cost, and for the people displaced from their homes it would be a very real cost that would be very difficult to value in financial terms.

Q5 Mr Love: You rightly highlight the fact that climate change will probably have much greater impact in the third world than it would in either Europe or the United States. Just looking at the United Kingdom, there is already controversy. The insurance companies are saying regularly to government that they are not putting enough aside for flood protection and therefore they will not insure; or they are not doing enough on coastal erosion. Would there be a benefit to the Government in trying to bring together all the current expenditure to show the public just how much is being spent but, projecting into the future, how much is likely to be needed to be spent on some of the things that you have just been talking about?

Professor Ekins: Given the problem of climate change and public perception, the fact that it is a very long-term issue which is well outside most people's daily thoughts - indeed, the worst effects will not be felt by us but by our children and grandchildren - and that there are lots of other things which have claims on people's attention, anything that can make these costs real to people, given that they are real costs, is of very great benefit. One of the reasons that the public and people generally are not convinced about climate change is that they do not see it as an immediate issue that is a result of some part of their actions which will impose costs on them and their children in future.

Q6 Mr Love: An increase in what the Government term environmental taxes has been criticised because the money raised is not used either on mitigation or adaptation. Should we treat environmental taxes in a different way from the ordinary taxation system to highlight just what we are doing in terms of both mitigation and adaptation?

Professor Ekins: In general, I do not believe that is desirable. A much stronger argument is to say that governments need revenue and in general it makes sense to raise that revenue from taxing bads rather than goods. In some cases it may be that where there is a case for public expenditure it can make the tax more palatable and politically acceptable to link a particular tax with a particular form of spending, but if that principle became widely established in government all sorts of desirable public expenditure would not find suitable sources of money to finance it. I think that a much better approach is to say that government has a certain revenue requirement and to get it from activities that cause social harm is in general better with other considerations than getting it from other sources. Indeed, that was broadly what the statement of intent on environmental taxation in 1997 said.

Q7 John Thurso: Both Stern and the Government as well as many sectors of industry regard carbon emission trading schemes as the best way forward to tackle climate change. Do you regard these systems as the best way forward, or do you think it is just a way of looking good and kicking it into the long grass?

Professor Ekins: As with practically every policy of which I am aware, its goodness depends almost entirely on the detail. There are lots of theoretical arguments - indeed, the Stern Review rehearses a good number of them - about the relative benefits of tax and trading in particular and regulation in other circumstances, but what one sees is that the schemes introduced because of the political pressures of getting any kind of policy brought in at all often bear very little relation to the textbook expositions of these taxes and trading. In principle, as I understand what the Stern Review said - this is broadly what emerges from the academic literature - with a problem like climate change one wants a long-term stabilisation target in terms of emissions, because it is in the long term that they build up in the atmosphere and cause climate change and therefore one wants to put a cap on it. Therefore, in the long term an emissions trading scheme would seem to be an effective way to do that, but in the short term because of the relative shapes of the marginal abatement and damage costs one probably wants to make use of a price mechanism, ie an environmental tax, or in this case ideally a carbon tax. Therefore, one would have a carbon tax adjusted in order to deliver a long-term quantity of emissions trading.

Q8 John Thurso: In other words, you would almost certainly need both?

Professor Ekins: Indeed. It would be desirable to think in terms of both. Whether one would need both would depend on the extent to which one found that the policy was effective given all sorts of imperfections operating in the various markets. For me it is a matter of great regret that the proposal of the European Commission in the early 1990s to introduce an EU-wide carbon tax did not capture support at that time. That would have established the principle of a tax early on in the climate change issue. We would have what people knew was a carbon price which did not go up and down with the short-term vagaries of the permit market, as it does at the moment. You are probably aware that as we speak the carbon price is at its lowest level ever, so the people who made investments on the basis of some carbon price even six months ago would be rather disappointed by the performance of those investments. Had we had that kind of price mechanism in place we could have decided then whether as well we needed an emissions trading scheme in order to give some kind of long-term surety about the overall quantities which would be emitted.

Q9 John Thurso: I want to ask you about the carbon emission scheme in a moment. First, we have received suggestions that carbon trading schemes may be more effective if they are based on the individual; in other words, if individuals have a personal carbon account. They would have either their own carbon allocations which they would sell to business when they did not use it or their own account so that they would purchase carbon every time they took a flight or used something that used energy, or whatever. What do you think of those schemes as a way forward, and what would be the difficulties for government?

Professor Ekins: I think that the main difficulty is the very considerable difference between the theoretical attraction of such a scheme and its practical implications. If we had a general population that understood what carbon was and was prepared for a system that used carbon as money in its purchases, and if there was an evolving market which allowed individuals easily to make those kinds of transactions so that businesses could get access to the carbon emissions they needed to go about their daily business - we may evolve those institutions and general level of information and awareness - I think that personal carbon trading might have something to commend it. But I believe that we have a long way to go before we get there. Businesses are now much more aware of the issue of carbon trading than they used to be thanks to the EU emissions trading scheme, and I think that is a very good start. Were one to proceed down the route of personal carbon allowances it would be desirable to keep businesses and individuals distinct for the time being so that businesses continued to trade among themselves. Personal carbon allowances would cover the personal use of fossil fuels and perhaps transport and aviation while the business trading schemes continued to be developed. Doubtless you will be aware that the Government have a proposal to introduce a trading scheme for large commercial organisations alongside the EU emissions trading scheme. It seems to me right that bit by bit we gain experience in these rather complicated businesses which effectively create new money, which is what carbon trading represents.

Q10 John Thurso: For a carbon trading scheme to work there must be a robust market which means that the market must be sufficiently liquid and regulated so it is real and we are not buying and selling carbon that is not there. It also needs a real price. You have already alluded to the drop in price which has rather undermined what is sought to be achieved. Do you think that the EU trading scheme offers these criteria?

Professor Ekins: I think that for the 40% to 50% of carbon emissions that are within the scheme it could offer those criteria, and it almost entirely depends on the quantity of emission allowances that are permitted to go into the scheme. I believe that the European Commission is absolutely right to take a tough stand, insofar as it is doing so - it is taking a tougher stand than it might otherwise have taken - on the second phase of the national allocation plans submitted, because as submitted there is a very great danger that those plans would not support a robust carbon price and encourage people to make low carbon investments. Indeed, they might encourage people to go on thinking that they could make high carbon investments which would not prove to be a liability in future. As the whole purpose of that scheme looking to the future is to incentivise low carbon investments so we are in a much better position to reduce emissions in the long term, that seems to me to be the key issue. Of the 10 to 15 allocation plans that have been submitted, only one has been passed so far and nine have been rejected. My numbers may not be bang up to date, but it is of that order. I think the Government deserve some credit that it is the UK's scheme which has been passed by the Commission. I think that we have an obligation to argue that other countries should be judged by the Commission to be doing as much to reduce their emissions as they have judged us to be doing.

Q11 John Thurso: The Treasury hopes eventually to move to a global emissions trading scheme. Given your comments on some of the problems within the European scheme, would that not be a rather difficult thing to foresee in the medium term?

Professor Ekins: Clearly, it will take time. I think that it easily offers the best hope of some kind of global accommodation with the carbon constraint, and therefore I very much hope that governments everywhere that are convinced of the problems of climate change will pursue it. There are already straws in the wind that suggest how it might develop. The EU scheme is already linked to the mechanisms of the Kyoto protocol that are generating carbon credits. It is obviously very important that the mechanisms for generating carbon credits are robust, and it is probable that those evolved for the clean development mechanism and joint implementation are as robust as they could be. If other countries and perhaps even individual American states such as California evolved their own robust emissions trading schemes that delivered emission reductions in principle there would be no reason why those permits should not become tradable across borders as well. There are all sorts of institutional issues to be resolved, not least what is to be done if states effectively have a kind of money that is internationally tradable but different from that of the federal government as a whole. Those are issues that will still need to be resolved.

Q12 John Thurso: As you have said, effectively one is creating a kind of currency, or tradable commodity, which is very difficult to quantify in real terms. Therefore, is there not a huge opportunity for fraud?

Professor Ekins: There certainly is an opportunity for fraud, and a very great deal of effort has been invested in the kind of monitoring and verification mechanisms both in this country and in Europe and to some extent elsewhere in order to try to ensure that that does not happen. In principle, it is quite easy to calculate how much carbon is released when one burns a certain quantity of fossil fuel because it is known how much carbon is in it and all of it will go into the atmosphere. The difficulty arises when one starts to allocate allowances on the basis of estimated base lines. What would have happened if one had not done certain things? The "what would have happened" - the counter-factual - is always an uncertainty and people have vested interests in arguing that base lines are different from what they would have been. That debate that has dogged the whole issue of how one might take into account reductions in deforestation. Mechanisms to deal with these issues have been evolved and I believe that in the European context they are reasonably robust. Easily, the biggest problem with the European scheme is that governments are allocating too many emissions allowances rather than monitoring and verification.

Q13 Peter Viggers: The Treasury has quite a narrow definition of "environmental taxes" and refers to the climate change levy, the aggregrates levy and landfill tax, whereas the Office for National Statistics uses a much broader definition of "environmental taxes" which includes energy taxes and taxes on road vehicles. The Treasury explains this by saying that it is concentrating on the aims behind the introduction of the taxes, whereas the Office for National Statistics is looking more to the effects of taxation. Do you think the Treasury takes too narrow a view of environmental taxes?

Professor Ekins: I was not aware that it was as definite as that in terms of definition, but if it is it certainly is too narrow a view. The evolved international consensus as expressed by bodies such as the OECD, which has done an enormous amount of work on environmental taxes and has in a sense standardised what we mean by those taxes and how they should be thought of - it has created a huge international database for environmental taxes - is very much in line with the definition of the Office for National Statistics. That seems to me to be the definition that makes most sense. Where one has a tax on good or a service that cause a serious environmental effect irrespective of why that tax was introduced, or the historical genealogy of it - for example, fuel duties were introduced well before anybody was thinking hard about environmental matters - that does not seem to be so relevant as the fact that one can use that tax in order to have an environmental benefit. That seems to me to be the relevant definition.

Q14 Peter Viggers: You refer to the use of the tax for an environmental benefit. Are you implying that there should be hypothecation of the environmental tax?

Professor Ekins: By no means. It is a simple illustration of the law of demand which is that if one puts up the price people will demand a lesser quantity. That is the way in which classically environmental taxes are perceived to work. Therefore, I am of the opinion that we had much less both local and global air pollution because of the fuel duty escalator in the 1990s than we would otherwise have had. Indeed, there is robust modelling to suggest that emissions from road fuels would have been quite a lot higher had we not had that tax instrument. That seems to me to be the environmental benefit from the tax. One may then decide to spend some of the revenues from that tax or from others on ways further to improve the environment, but that seems to me to be a different decision and effect from the effect of the price mechanism itself.

Q15 Peter Viggers: How do you rate taxation against regulation in terms of coercing or encouraging people to take appropriate action? You can regulate so that people will not do things or tax them so they are discouraged from doing things. Do you have a view on that broad issue?

Professor Ekins: I think that a complex society such as ours needs both. Regulation sets standards, and there are some areas of life where standards are important. For example, I am very glad that drinking water is subject to regulation and not taxed on the amount of pollution that can be put into it. On the other hand, there are many environmental issues that respond well to price signals where those physical effects are not absolutely critical and perhaps the cost of abatement is relatively high. We may not know what the cost of abatement is and we can suck it and see, because a tax effectively places a cap on the cost of abatement because no one will spend more to abate when they can simply pay the tax. It has been very interesting to watch the evolution of the debate on the relative merits of these policy instruments. Back in the 1980s the profile of environmental taxes was very low and the way that environmental agencies normally proceeded was through regulation. The literature then started to suggest that in some instances environmental taxes would be a cheaper and more cost-effective and efficient way to proceed. Initially, everyone thought this was a jolly good idea because they could get the regulators off their back, but they then realised that taxes were fairly ineluctable. Once a tax is levied one pays the tax on the full environmental effect, not only on the bit that is above the regulated amount. There has now been a very interesting swing of perceptions against environmental taxes, and certainly governments have found them very difficult to introduce. That means that on the whole we do not have enough of them and in general I would favour the introduction of environmental taxes much more commonly, and in particular for their introduction on an escalating basis. In this country we have had some experiences of tax escalators. The fuel duty escalator and landfill tax escalator are currently in place. In my view they have shown themselves to be remarkably effective.

Q16 Peter Viggers: Do these need to have a global or perhaps European element, or are we justified in approaching this on a national basis? To what extent must there be an international ingredient?

Professor Ekins: At the moment there cannot be an international ingredient because even with a body like the European Union tax policy remains very firmly at national level, and any prospect of the 27 countries agreeing that it should be anywhere else is pretty remote. One has to evaluate this at national level. For a problem like global carbon emissions it would be highly desirable to have a global carbon tax. Similarly, if one had a proxy for that it would be highly desirable to tax aviation fuel at a global level, but there are all sorts of international dissents on that and, in the case of aviation fuel, treaties that prevent it from happening. I think that governments must evaluate these things at national level and in doing so they must be aware of factors such as possible effects on competitiveness. But governments must raise revenue from something and practically anything that it taxes in terms of an input into production, such as labour, may well introduce an effect on competitiveness. Indeed, we have very great debate about the cost of social security systems when they are funded by taxes on employers, for example. I believe there is very great scope for a tax shift within that general sector and removing some of the taxes that have competitiveness effects on labour and putting them on bads like pollution. That was something that people like me thought might be happening on quite a wide scale as a result of the statement of intent, and indeed did happen on quite a small scale when the climate change levy was introduced. Generally, I thought that that was a good thing.

Q17 Mr Breed: I take you back to what you said right at the beginning of your evidence about the proportion of environmental taxation as against total tax revenues. We know that there has been a reduction over a period if time. It is currently at the lowest level it has been over the past 10 years. Is that due solely to abandonment of the fuel duty escalator or are there other contributory factors?

Professor Ekins: It is due more or less entirely not only to the abandonment of the fuel duty escalator but the failure to update fuel duties in line with inflation in each year since 2000. I think they have been uprated in line with inflation twice. One was the most recent Pre-Budget Report. That has very largely resulted in that effect because the great majority of environmental taxes currently come from energy and transport-related taxes. That is the major change in taxation.

Q18 Mr Breed: Bearing in mind what you have just said, you seem to indicate that were there a wider spectrum of environmental taxation in other areas rather than just the fuel duty escalator the effects observed over the past 10 years or so might not have been the same?

Professor Ekins: That would obviously be the case. If one introduced more environmental taxes that had a relatively broad tax base one would expect to get more revenues from them. In environmental taxes it is important to distinguish those which are purely designed to change behaviour, and indeed at the limit might change it to such an extent that they generated no revenues at all. One might think of the plastic bags tax in Ireland in that context. The use of plastic bags has, I understand, fallen by over 90%. Therefore, that tax is not raising a very great deal of revenue. One distinguishes those taxes from other taxes such as those on fuel where there is certainly a demand effect. People use less fuel than they would otherwise use, but certainly demand does not drop like a stone and it remains an enduring revenue base. Energy is certainly the clearest example of that, but there are others. One can imagine, for example, that however high the aggregates tax one would still want to use some aggregates and the revenues that one gets from such a tax are the price times quantity. If one raised the price, unless the quantity fell by an equivalent amount - in other words, the elasticity is one, but most elasticities are less than one - one would increase the revenue, even if demand fell somewhat.

Q19 Mr Breed: When we are considering the success or otherwise of the Government's environmental policies as a whole how legitimate is it to focus almost solely on the proportion of environmental taxation against total revenues rather than widen the whole aspect to a significant extent?

Professor Ekins: I certainly would not want to focus solely on that. I am aware of the Treasury's argument that this is a bad indicator and should not really be used because if environmental taxes were effective one would have the behaviour changes and one could therefore have a reduction in tax revenues. That is true for some environmental taxes and, therefore, one needs to look behind the indicator and see what is driving it. In the case of the UK, what has driven that indicator over the past five or six years is not the fact that people's behaviour is changing to such an extent that revenue is falling but the fact that the tax rate has been lowered in real terms and that is why one gets less revenue. That argument in that particular instance is not the case. One cannot put that forward as a reason why the tax shift does not appear to have taken place.

Q20 Chairman: You have written some very good material about the social impact of environmental taxes and the crunch point for the Government. You mentioned that a carbon tax on household energy would be politically problematic at best and probably unfeasible. What is your view on assisting low income households which according to your research would be the losers if there was a carbon tax?

Professor Ekins: That is not quite correct, in the sense that the research we did showed that there is a very wide range of energy use even among very low income households and it is therefore very difficult to compensate all of them, even if one redistributes all the revenues from the carbon tax, including revenues from non-poor households. But what it showed was that one could certainly have a redistribution scheme which meant that 80% of those households were no worse off, and many low income households would be much better off under that redistribution scheme than the status quo. It is therefore a political judgment.

Q21 Chairman: But one would need to have compensation for poor households, would one not?

Professor Ekins: Yes, but one can have such compensation through the social welfare mechanisms that currently exist in order to ensure that at least 80% of low income households are not worse off than they currently are, and some would be much better off. It is then an issue as to whether the effects on the 20% of low income households, which currently are very high energy using - each household uses six to 10 times as much energy as others in the same income decile - should be allowed to thwart the policy as a whole both on environmental and social grounds because one could make the other 80% of households that much better off. One of the matters that is changing over time with the various energy efficiency policies that are being put in place is that increasingly low income households do not need to use all this energy in order to keep warm, because the energy efficient commitment and Warm Front policies are very substantially improving the thermal quality of households, especially low income households, on whom these schemes tend to be targeted. Over time the hope is that these potential regressive effects would be easier to remove through compensation schemes and that would make some kind of carbon tax more feasible politically than it currently is.

Q22 Chairman: It seems quite complex, and perhaps that is the reason it has not appeared on the political agenda at the moment. You mentioned a climate change surcharge imposed on households that failed to implement within a year cost-effective energy efficiency measures identified by the audit. How would that scheme effectively abolish fuel poverty?

Professor Ekins: We also recommend that those who are in fuel poverty would have those measures paid for, as indeed they do at the moment through the Warm Front scheme. In a sense one would hope that it would make those households more likely to come forward and ask for assistance to improve the thermal efficiency of their homes than they do now. Most households in fuel poverty qualify for free insulation and household improvements; it is just that lots of them do not ask for it and so do not get it.

Q23 Chairman: In a word, what should government do? Government seems to be timid in this area, does it not?

Professor Ekins: It is certainly timid on the pricing side of it. On the home energy efficiency side it has proved to be much less timid because we have big home energy efficiency schemes that are orders of magnitude greater than anything we saw in previous years. But we need a statement that the entire housing stock will be upgraded overtime and that in due course price instruments will be used in order to ensure that households become more aware of the real cost of energy, but that those who are in fuel poverty will have the necessary cost paid for them in order to bring their houses up to scratch. I emphasise the anomaly that the UK represents internationally in this regard. Other north European countries routinely have 15% to 25% VAT on household use of energy, plus any carbon or energy taxes that they may have decided to introduce. The energy use of households not only because of thermal efficiency but also because of the price tends to be rather lower than it is here.

Chairman: Professor Ekins, thank you for your excellent evidence in starting off this inquiry; it has helped us enormously.


Memoranda submitted by the British Air Transport Association, British Airways,

easyJet and Virgin Atlantic Airways

 

Examination of Witnesses

Witnesses: Mr Roger Wiltshire, Secretary General, British Air Transport Association, Mr Andy Kershaw, Senior Manager for Environmental Affairs, British Airways, Mr Andrew Barker, Planning Director, easyJet, and Mr Barry Humphreys, Director of External Affairs & Route Development, Virgin Atlantic Airways, gave evidence.

Q24 Chairman: Good morning, and welcome to this evidence session. Starting with Mr Humphreys, perhaps you would introduce yourselves for the record.

Mr Humphreys: I am Barry Humphreys, director of external affairs and route development at Virgin Atlantic Airways.

Mr Wiltshire: I am Roger Wiltshire, secretary general of the British Air Transport Association.

Mr Kershaw: I am Andy Kershaw, manager of environmental issues at British Airways.

Mr Barker: I am Andrew Barker, director of planning at easyJet.

Q25 Chairman: We sent out invitations to everyone. We are glad that easyJet has come along. Mr Michael O'Leary of Ryanair decided that he did not want to appear with the rest of you. I do not know the reason for that. I sent him a nice letter explaining to him that House of Commons committees had the power to call any witnesses it wished, but considering that easyJet has been keen to come we are delighted to see its representative here. Maybe we will have Michael O'Leary here at another time. This inquiry is about the Stern Review and environmental factors. I know that a number of you have been and are exercised about the passenger duty, but this session is not concerned with that; it is to do with environmental taxes. You will know that in our Pre-Budget Report we questioned the Chancellor on that matter. We shall be releasing that report and our comments on that issue in the next day or two, but it is forward-looking. This matter started with Sir Nicholas Stern's review on climate change. You probably heard from the previous witness that the issue of climate change on the political agenda is one that has to be yet developed. There are pro and anti camps in terms of that review. If I may quote Mr O'Leary, he said recently of Sir Nicholas Stern's review that a lot of lies and misinformation had been put about by eco-nuts on the back of a report by an idiot economist. Do you consider Sir Nicholas Stern to be an idiot economist?

Mr Wiltshire: I will not respond directly to that.

Q26 Chairman: I am asking you to respond to it because it is very important to our debate.

Mr Wiltshire: If you do not mind my introducing our position, that would automatically deal with it.

Q27 Chairman: I am asking you to respond to my question, and then you can put your position.

Mr Wiltshire: The UK aviation industry has a very responsible attitude to environmental matters. We have been leading in that field.

Q28 Chairman: I understand that. I am asking you about Sir Nicholas Stern. If you answer that you can come on to your position.

Mr Wiltshire: We welcome the Stern Review; we think that it is a very considered view.

Q29 Chairman: Do you think it is a measured report?

Mr Wiltshire: Yes. A very important point to make is that we are predominantly an international industry. Nine out of every 10 air journeys from the UK are international. We compete in the international industry. The Stern Review put the spotlight on the fact that to address a global issue like climate change one needed considered and economically efficient international measures.

Q30 Chairman: So, it is a measured report by a well-respected economist?

Mr Barker: Chairman, perhaps I may say that in your introduction you referred to easyJet relative to Ryanair. We endorse that fully. When Sir Nicholas Stern announced and presented his report to the Royal Society before Christmas our chief executive, Andy Harrison, made a presentation alongside him and had a very good discussion with him afterwards. We think that it is an excellent report.

Q31 Chairman: That is a good start. Do you believe that the Stern Review makes a strong enough case for the UK Government to adopt a system of taxation and incentives to combat climate change? If not, what are the major weaknesses of Stern?

Mr Wiltshire: I believe that the Stern Review addresses the issue and the way it should be dealt with structurally, internationally and in an economically efficient way, which means fairly sophisticated instruments. It does not ignore taxation but it does not necessarily recommend it as a way forward internationally. It points to emissions trading as the most efficient way to deal with international issues. As we are an international industry, we believe that this is the right way forward. As the Government are taking a lead internationally in trying to persuade other countries in aviation to be part of an emissions trading scheme, we in the UK industry are taking the lead in persuading our colleagues in the rest of the industry that this is the right way forward.

Q32 Mr Breed: The Stern Review suggests that while aviation CO2 emissions account for 1.6% of global greenhouse gas emissions the impact of that activity is two to four times higher than the impact of CO2 emissions alone. First, do you agree with that analysis? Second, it is undoubtedly true that aviation is a growth industry and therefore Stern's projections suggest that aviation's contributions to global greenhouse gas emissions will be 2.5% by 2050. Have the airlines funded or undertaken any research at all into the non-CO2 impacts of aviation?

Mr Kershaw: There is no doubt that there are other effects in addition to CO2 emissions. Those effects are different in nature. They are, for example, over a much shorter lifetime. Equally, the scientific understanding of those impacts is far less than we have for CO2 emissions. In addition, the metric used to generate multiples of CO2 has recently been questioned by the scientific community as an appropriate way to quantify those non-CO2 effects. While undoubtedly there are other effects and the industry takes the view that it needs to address them appropriately, there is a lot of uncertainty surrounding them. What is of prime importance for those effects is to improve the scientific understanding. The industry is involved in programmes to take forward that understanding. For example, there is an EU-funded programme called IAGOS in which British Airways and Airbus look to improve the way we collect information about the atmospheric chemistry and some of the processes that occur in the atmosphere. These issues could be important. We need to understand them better. Once we have understood them better we can assess the most appropriate mechanisms to manage those effects. As to the growth projections you mentioned, certainly aviation is expected to grow in future to meet the demand for international air transport. I do not think we disagree with the projections outlined by Stern, apart from saying that any assumptions about growth in the distant future must have uncertainties associated with them. We will not know precisely what levels of emissions from various sources will be in the future, and I think that does depend hugely on the policy measures put in place and the way the international community deals with the issue of climate change.

Q33 Mr Breed: But it is not an unreasonable assessment at the present time?

Mr Kershaw: I do not think it is unreasonable.

Mr Humphreys: Even if one accepts that there is a double multiplier effect taking it from 2.5% to 5% one is still left with a relatively small proportion of total emissions accounted for by aviation, which is a very different impression that one often gets from press reports in which, to be honest, aviation has become a bit of a whipping boy. We are delighted to see that in the Stern Review there is a more considered approach to that.

Mr Barker: The Stern Review mentions the targets of the Advisory Council for Aeronautics Research in Europe (ACARE) for aviation in 2020 to which we have all signed up. We intend to participate in the development of aircraft that will reduce CO2 emissions by 50% and N2O emissions by 80%, so we are all fully participating in the developments of the new technologies and we are glad that Stern highlights the potential for them.

Q34 Chairman: The UK aviation sector currently accounts for about 5.5% of the UK's total CO2 output, and it could rise to about 15% by 2030, according to Stern. He also goes on to say - the Government accept this - that the effect of all aviation emissions is at least two to four times greater than the effect of CO2 emissions alone. How seriously does the aviation industry take the problem of climate change given the fact that aviation emissions are at least two to four times greater than others?

Mr Wiltshire: I think the specific response to that is the answer given by my colleague Mr Kershaw when he was referring to multipliers. The industry in this country, the airlines, airports, manufacturers and air traffic control, produced a sustainability strategy in the middle of 2005 called Sustainable Aviation which clearly accepts and describes those effects. Clearly, they are very different from the effects of CO2. We need to understand the science and issues better. We also need to understand the way in which those effects have an impact on the climate. The current metric is not robust enough to enable us to do that.

Q35 Chairman: But the science is that aircraft are responsible for high altitude emissions of N2O and the formation of water vapour, clouds and other things. Therefore, it is that which contributes to the two to four times, so there is in a sense a uniqueness about the aviation industry compared with other industries that emit CO2.

Mr Wiltshire: I think that other land-based industries also have what are called non-CO2 effects. The same metric for radiated forcing that is used to develop the multiplier in aviation is used for land-based industries.

Q36 Chairman: But do you accept that point?

Mr Wiltshire: What we do not accept is that the science points to multiplying the carbon. The nature of the impacts is so different that one cannot readily multiply. I understand that various reports have mentioned the multiplier. We feel that the impacts other than carbon are so different as to require their own specific and appropriate measures.

Q37 Mr Mudie In its paper British Airways mentions Sustainable Aviation. Can you say something about that?

Mr Kershaw: The group that produced Sustainable Aviation is a collection of aviation industries in the UK, so it includes the major airlines, airports, manufacturers and the air traffic control provider (NATS). The strategy was produced in June 2005. It aims to outline steps that the industry can take, together with government, with a view to aviation contributing fully to sustainable development objectives. It outlines action that we believe the industry and government should take in the key areas of sustainability as it relates to aviation, so it includes the climate change impacts, noise and air quality, and it also speaks about the social and economic contributions of aviation.

Q38 Mr Mudie: You mention Sustainable Aviation in paragraph 7, but in paragraph 6 you spell out the key objective of climate change policy. That seems to be straightforward. You mention climate change. Tell us in detail how that aspect of Sustainable Aviation meets paragraph 6?

Mr Kershaw: First, it is important to point out that the industry takes climate change extremely seriously as a key issue that needs to be managed. The aviation industry accepts that it must be part of efforts to manage climate change in the long term and needs to find effective mechanisms to allow aviation to play its part. Specifically in relation to the paragraph to which you referred, the text comes from the United Nations Framework Convention on Climate Change (NFCCC) and refers to the objective that globally we need to stabilise concentrations of greenhouse gases at safe levels. The safe levels are those determined by the scientific community, with stabilisation requiring global effort to limit CO2 emissions and other greenhouse gases. The Sustainable Aviation strategy is that aviation should be incorporated into a framework to achieve that objective. One of the ways that we need to move it forward is to include aviation and the air transport sector in post-Kyoto frameworks to deal with climate change. Currently, aviation is excluded from the Kyoto process and that is not helpful in terms of allowing aviation to play its full part in addressing climate change. One of the principles within Sustainable Aviation is that air transport should be included in a global framework to address climate change. It goes on to point out that emissions trading is by far the most environmentally effective and economically efficient mechanism to deal with air transport CO2 emissions.

Q39 Mr Mudie: A lot of that was words and projecting the future. To be fair, what it comes down to is that you should join with the international body and do emissions trading not within the industry, so the growth of the industry will continue but you will offset it by trading with other industries. Is that a fair reflection? I am sorry to pick on you but your paper was before me. It is the view of the industry that at the moment generally it is doing very little but when it is pushed it will join internationally, not limit its behaviour but trade with other industries globally?

Mr Kershaw: That is the objective of the industry. The UK is leading in bringing aviation into emissions trading and a good solid first step is the inclusion of aviation in the EU emissions trading scheme.

Mr Wiltshire: Referring to our track record, the industry is not doing nothing. It has proved its fuel efficiency over the past 30 years by 50%. As mentioned earlier, it wants to continue that progress in future.

Mr Humphreys: Sustainable Aviation has firm commitments to make substantial further improvements. The report produced in December indicated that the industry as a whole is well on the way to achieving those commitments. They will result in significant improvements.

Q40 Chairman: The EU emissions trading scheme does not come in until 2012, so in a sense you have four years until then. What are you doing in the interim?

Mr Barker: I make two points. First, this industry is an extremely competitive one. It is very unusual for the two of us, for example, to be sitting next to each other. We are each other's biggest competitors. There is an extremely big commercial and economic incentive in this industry to be as efficient as possible. Fuel costs are, as we put in our paper, 29% of our total operating costs. It is far and away our biggest operating cost. We seek any advantage we can to out-compete other airlines to be more efficient.

Q41 Chairman: What I am asking is what you will be doing in the interim?

Mr Barker: I was going to say that that emissions trading scheme now provides us with a target. The proposals provide us with a target. The benchmark is 2005. Any emissions that the industry produces beyond 2005 levels will have to be paid for. We know that that is going to happen and easyJet and myself as director of planning are already configuring investment decisions to offset that.

Q42 Chairman: Motorists pay tax; they go into petrol stations every day. You do not pay any tax on your fuel. What will you be doing in the next four years? What example will you set?

Mr Barker: Obviously, we pay corporate tax, but APD at current rates is 25% of the value of the tickets that we sell. That is quite a high rate of tax that our consumers have to pay.

Chairman: I pass it over to Mr Mudie, but I have no idea of what is happening in the next four years.

Q43 Mr Mudie: Chairman, thank you for making sense of my questions. You did not present a very statesmanlike approach to the DEFRA initiative and the voluntary code. British Airways seemed to be intent on not participating for one excuse or another. Why on earth did you pull out of the launch of this voluntary code simply because of something done in the Budget? It is a bit like throwing your toys out of the pram. Are you reconsidering this, and will you be coming to the table and behave responsibly on this matter, despite, if you wish, the actions of the Chancellor?

Mr Wiltshire: I am sure that British Airways will point out its own track record in offsetting and the history behind this. All I can say in representing the wider range of British airlines is that before the Pre-Budget Report the various airlines in the industry were in dialogue with DEFRA and proposed quite significant and innovative approaches to offsetting. We pointed out to DEFRA, as we do to the Committee, that promotional offsetting is very important because offsetting does not have a good track record or reputation both with environmentalists and others. There has been a lot of criticism of offsetting in the public domain recently. We felt that it was very important to promote it. How possible will it be for airlines to promote offsetting when after the Pre-Budget Report announcement air passenger duty will be paying for far in excess of the carbon cost of that flight? As I mentioned in the BATA submission, we believe that one-fifth of air passenger income would be able to be offset in the sense of European permits in the current market price today, so the whole promotion of offsets is a very important matter. The reason the airlines stood back from getting involved in the launch of the offset initiatives was because there was a totally new game with air passenger duty being as high as it will be from 1 February.

Mr Humphreys: I completely agree with that. To return to the Chairman's question about what we are doing today, we are doing an awful lot. To give you some examples, Virgin has taken the initiative of organising experiments for the towing of aircraft at airports. A lot of fuel is wasted and emissions created by the taxi-ing and parking of aircraft waiting to take off. We have taken the initiative with the airports to see whether it is possible to cut down on that very substantially. So far those experiments are going very well. We are also lobbying and working very strongly with governments because massive amounts of fuel are wasted in Europe every day because of the organisation of air traffic control and the large areas of Europe set aside for military training. But that is not something we can do anything about on our own; we need governments to sort it out, and we are putting a lot of pressure on them to do that. It is not true to say that we are not doing anything; we are.

Q44 Mr Mudie: I did not say you were not. You are here to represent an industry and I am anxious that you put on record what you are doing. To be helpful to you, British Airways said that the APD would total more than 400 million a year. For the same cost using clean development mechanism offsets British Airways could offset the total annual emissions of its entire worldwide fleet many times over. Tell me what "clean development mechanism offsets" are?

Mr Kershaw: The clean development mechanism is one of the Kyoto flexible mechanisms, so it is related to international emissions trading. Effectively, what it means is that we can make investments in projects in third countries where emissions reductions can take place which would not already have occurred. For example, we can offset emissions from an activity in the UK by purchasing the emissions credits from a project to create a renewable energy programme in, say, India. The clean development mechanism is the functionality provided at international level through the UN to facilitate that process. It facilitates the flows of carbon finance from, if you like, the developed world to the developing world and is a very important element in the emissions trading process. It enables the emissions reductions to take place globally at least cost. That was something to which Stern pointed as one of the critical elements in achieving emissions reductions at least cost to the economy. The clean development mechanism is something that we need to develop further and strengthen and realise its full potential in order to make least cost emissions reductions across the economy.

Q45 Mr Mudie: What is the total profit of the airline industry? I am not referring to the individual airlines.

Mr Humphreys: I think aviation has a very low level of profitability relative to most other sectors. It varies and it is of a highly cyclical business.

Q46 Mr Mudie: We can get a figure from the Treasury, but nobody can put a figure on it at this hearing?

Mr Barker: As a quoted company, we currently make a return of between 10% and 12% on equity shareholders' funds. An average UK company would make 17%, so we are much less profitable than the average.

Q47 Mr Mudie: For the layman, can you convert that into a figure? I want to compare it with the figure of 400 million.

Mr Barker: As far as we are concerned, as we put in our paper the current rate of APD would be about one and a half times our profit last year.

Q48 Mr Mudie: You still have not told us the figure.

Mr Barker: Last year's profit was 94 million.

Q49 Mr Mudie: If easyJet made 94 million I presume that the bigger airlines made more than that. You could be doing some of this stuff out of your profit, could you not?

Mr Barker: It is a very capital-intensive industry. We invest in technology. We invest all of our profit back into new technology.

Q50 Mr Mudie: You could be making the Chancellor an offer, for example, "If we trigger this now you can remove the APD"?

Mr Wiltshire: A better option for government when they announced the doubling of APD in December was to have used a portion of that to incentivise the public the use of offsets. That could have been an opportunity to say to the travelling public - over 50% of the UK population take an air trip each year, and some more than that - that they could have a real opportunity to make a difference environmentally. Unfortunately, the Government did not take that opportunity.

Mr Humphreys: It is also important to remember that at present 20% of APD is already hypothecated.

Q51 Chairman: In terms of APD, you are really back to 1997 levels. It was imposed in 1997 and reduced in 2001 and now you are just back to that. There really has not been any debate within the aviation industry up to that point.

Mr Wiltshire: I must correct one point. On long-haul flights that is not correct, whereas it may be so on short-haul flights.

Chairman: But you agree that generally you are back to the 1997 level, so it is pretty minimal.

Q52 Peter Viggers: Please correct me if I am wrong, but you seem to be reconciled to, even intellectually supportive of, the emissions trading scheme as a mechanism. What are the technical problems relating to its introduction? Do you see any of these as being very serious, or even insoluble?

Mr Wiltshire: A number of issues have been debated in Europe within a working group set up by the Commission. The issues range from the scope of the scheme: which flights should be included? That is an ongoing issue. The Commission proposed a two-stage process, intra-Europe in one year and all arrivals and departures in the following year. The second notable difference under the existing scheme is the allocation process. We have strongly recommended an international, ie at European level, allocation and we see that the Commission has supported that approach, but that is a different type of allocation mechanism from the one under the present scheme.

Q53 Peter Viggers: Stern suggests that it is difficult to assess the effect of aviation CO2 emissions by way of CO2 equivalents. Are the airlines undertaking work to clear up that point?

Mr Wiltshire: We are very keen to see the scientific knowledge improved in the non-CO2 area so that it includes a much better way of measuring those effects. In that way a comparison, if that is desired, can be made with the effect of a long-lived gas with a 100-year life such as CO2 and other much shorter-lived impacts.

Q54 Peter Viggers: How do you respond to reports that to allowing aviation into the European Union ETS will create windfall profits from the allocation of carbon quotas?

Mr Wiltshire: Quite frankly, when we heard that comment we laughed. The only way that an airline in an overall capped scheme could make a profit in this way would be to close up shop and close the business. The emissions relate to the operations under which one wants to conduct business. If one wants to reduce or close the business in theory one could sell on one's permits, but there is no other way that that could happen. I do not see anything in it for any airline, or any industry like the airlines, to sell its emissions and close up shop.

Q55 Peter Viggers: Therefore, quotas would be allocated to airlines according to their operations?

Mr Wiltshire: The proposal by the Commission is that there would be an allocation based on the benchmarked efficiency of the industry. That is one detail that is yet to be worked through finally. The benchmarked efficiency would be used to allocate based on the operations of the airlines, and I understand that the years 2004 to 2006 are the baseline from which emissions are to be calculated.

Q56 Peter Viggers: The Treasury is hoping to move eventually to a global emissions trading scheme. What are the obstacles to achieving that?

Mr Humphreys: Clearly, there is some opposition from foreign governments to the introduction of such a scheme. We certainly have done our best to persuade our fellow airlines around the world that this is the best approach, but there is no secret that in particular the United States is opposed to the application of ETS to its own airlines flying into Europe. That is an issue that will have to be sorted out at government level.

Q57 Mr Todd: You do not like APD. Is there any change that you suggest may make it more effective in terms of an environmental tax? You have argued that it is not effective at the moment, setting aside for the moment hypothecation.

Mr Humphreys: That was what I was going to suggest. The trouble with APD - in Virgin's submission John Healy is quoted to this effect - is that it is a poor environmental tax; it does not achieve any environmental objectives and there must be better ways of achieving them.

Q58 Mr Todd: What are those objectives?

Mr Humphreys: We believe that ETS is far more efficient.

Q59 Mr Todd: Is not another mechanism a tax or charge that is directly related to inefficient technology? For example, in this country if you buy a motor vehicle and it consumes energy in a particular way it is taxed differently.

Mr Barker: We suggest that that is what ETS will do. It is not just the technology that you have but the way you use it, for example the number of seats in the plane and the number of people on the plane. The ETS scheme as proposed will incentivise airlines to operate much more efficiently; otherwise, they will be penalised.

Q60 Mr Todd: But you could apply a direct tool that imposed differential charges on airport usage for some of the clattering old bangers that run on freight-only activities, for example. We do not have a pure freight operator here to defend its corner, but presumably you may have some sympathy for that view.

Mr Wiltshire: The British Air Transport Association represents one pure freight operator based in the East Midlands, which is DHL. I think that it supports the approach on emissions trading and realises that its operation like that of any other operator would be caught up in that. Therefore, its efficiency in terms of emissions per payload tonne would be an important factor in whether it cost it a lot or a little to be part of the scheme.

Q61 Mr Todd: Or you could simply approach it through regulation by saying that no aircraft of a certain kind would be permitted to fly into airports in this country?

Mr Humphreys: I think it is just a question of efficiency. What is the best way to achieve the objectives that we all have? Overall, ETS seems the best way to do it. Undoubtedly, there are other ways, but in our view the most efficient is ETS.

Q62 Mr Todd: You were about to outline your thoughts on hypothecation.

Mr Humphreys: We have already mentioned that we would be far happier with the APD if the money collected by the Chancellor was used for environmental purposes. The principle of hypothecation on that tax has already been accepted by the Treasury, because 20% of the money goes to African development funds. At the moment there is no element of incentive and the public cannot see any environmental benefit directly from that tax.

Q63 Mr Todd: One of the submissions suggested that additional support should be provided for research into more environmentally friendly aeronautic technologies. Should you not be doing that yourselves?

Mr Barker: We are doing that, and we invest very heavily every year. Over the past six weeks I have spent time with Airbus at Toulouse and Boeing in Seattle, and I am spending the rest of this week with Rolls-Royce in Derby, effectively co-operating with them on the development of their next technologies. Therefore, we are spending management time on this matter and also investing capital every year to buy the latest technology.

Q64 Mr Todd: What is the profile of your industry on R&D in this area? After all, most of the aircraft that you operate are, presumably, leased rather than bought and you do not directly engage with aeronautic manufacturers and engine suppliers, do you?

Mr Barker: We directly engage with and buy our equipment from manufacturers.

Q65 Mr Todd: Do you fund R&D with them?

Mr Barker: Yes.

Q66 Mr Todd: To what extent? You mentioned one activity which involved a visit.

Mr Barker: I do not have the Airbus number in my head, but last year Boeing spent on civil R&D $1.3 billion.

Q67 Mr Todd: I entirely accept your point as far as concerns manufacturers.

Mr Barker: That cost is priced onto the planes. Therefore, if we buy the latest aircraft effectively we are paying for their R&D.

Q68 Mr Todd: But you do not do any yourselves?

Mr Humphreys: It is not a very big number.

Q69 Mr Todd: Should you?

Mr Wiltshire: The matter in which we are interested is the atmospheric research mentioned earlier. One of the solutions to some of the non-CO2 impacts may be an operational one which is directly where airlines would be involved, for example avoidance of the creation of condensation trails which is a fairly straightforward procedure. At the moment that would cost us in fuel which in turn would mean more CO2 emissions. Until we have a much better quantification of that impact it would be wrong to take such an operational measure. But operational measures are important. Research and development of the technology of the aircraft are very much at the heart of what the manufacturer puts before us. It is important that they get the right research and development investment and, where necessary, support for what I may call the further out technologies, that is, technologies that are just about on the horizon now but may be pulled into the industry and need that incentive. I think that is where governments across the world can be more helpful.

Q70 Mr Todd: We are familiar with the difficulties of imposing a global tax on aviation fuel. What steps are you aware of to address some of the issues that currently confront its introduction?

Mr Kershaw: As we said earlier, we believe that emissions trading is a far more effective policy measure to address aviation emissions than taxation. At the international level through the International Civil Aviation Organisation there is a piece of work that looks at emissions trading at international level. The guidance for that has just been developed and hopefully will be adopted in the near future. UK industry is heavily involved in supporting that work and taking forward those steps to build the framework to be able to bring aviation into emissions trading.

Q71 Mr Todd: But we have already heard that there are objections to that concept from major American airlines.

Mr Kershaw: There are difficulties in terms of climate change policy globally, aviation and other sectors included. We believe that the appropriate approach is to demonstrate effective policy and technology measures to the rest of the world and in doing so hopefully those states will accept that such measures are cost-effective, workable and sustainable.

Q72 Mr Todd: Which would be more difficult - to introduce a global ETS or to agree amendments to ICAO rules to create flexibility in the taxation of aviation fuel?

Mr Kershaw: I believe that it would be easier to implement global emissions trading purely on the basis that that would be seen as a far more cost-effective solution. The ICAO analysis of taxation of aviation demonstrated that a tax focused on aviation to meet hypothetical targets related to Kyoto would cost the industry in 1992 US$245 billion a year, whereas open emissions trading where aviation would be able to buy and sell outside the aviation sector was estimated to cost between US$1 billion and US$60 billion. The range reflects the fact that one can make different assumptions within emissions trading, but the basic point is that taxation at international level would be hugely more costly. Equally, it would take away from the industry funds that it would be able to invest in new technology. In addition, with emissions trading the money would be flowing to where environmental improvements could best be made globally. At international level the focus is to bring aviation into emissions trading, and the UK and EU have a unique opportunity to demonstrate emissions trading as a practicable solution to address air transport climate change impacts.

Q73 Peter Viggers: Has anyone ever suggested emissions trading for military aircraft?

Mr Kershaw: It has been suggested. I do not know what conclusions have been drawn, but I believe that the current Commission proposal does not include military aviation.

Q74 John Thurso: It has been mooted. When I was a transport spokesman I had the pleasure of meeting many of you in the aviation industry. It seemed that when we discussed these issues you always expressed great concern, and it was always followed up by stressing the market mechanisms, with which perhaps I was broadly sympathetic, and finally the need for anything to be done on an international basis. If one takes market mechanisms and the international basis together it always strikes me that it is a recipe for masterful inactivity because one is unlikely to see anything in the short term. Given that we do need to do something real in the short term, why should we not consider an airplane departure tax as opposed to a passenger departure tax which would have the benefit of pulling in freight aircraft, which currently pay absolutely nothing, and putting that tax cost directly onto the industry rather than the passenger and, therefore, the more people one put in the aircraft the less tax per passenger?

Mr Wiltshire: In a way, that is a small step towards something much more sophisticated like emissions trading. Although it perhaps would capture a different range of aircraft it still does not create an incentive for airlines to invest in better technology. It is really moving around the deckchairs.

Q75 John Thurso: It would if one based the tax on the carbon emissions of the particular aircraft, which would be very easy to do?

Mr Wiltshire: That is a further step towards emissions trading; one is getting closer to the fundamental of emissions trading which is that airlines measure and report their emissions and have the price of carbon built into them. That is exactly what the UK airlines have done in their report Sustainable Aviation in the past two months. That is a way of explaining to the rest of the industry the way forward as far as concern their environmental costs.

Q76 John Thurso: As an industry would you prefer an airplane departure tax to a passenger departure duty?

Mr Wiltshire: We prefer a mechanism based on the emissions from the aircraft which is dealt with like other emitters of CO2, which is the same whatever the source.

Q77 John Thurso: I return to the Chairman's question about radiated forcing. The Royal Commission on Environmental Pollution estimated that radiated forcing was about 2.7. I believe that was the multiplier it used for the impacts of CO2. In your answer you said that you really needed to study all the other gases, but it also pointed out the fact that all the other gases - methane, N2O, ozone and water vapour - could quite easily be converted to a carbon equivalent. If we in this country are serious about something in the order of a 60% reduction in CO2 by around 2050, excluding aviation, we are looking at a fall from 168 to 67 metric tonnes of carbon. Over the same period aviation is forecast to rise from 4.6% to 17.4%. If one then puts in the multiplier of radiated forcing one goes from 4.6% to 17.4%. One has a situation where the country as a whole is aiming for 67 metric tonnes of carbon and aviation is responsible for the equivalent of 43.5 which is 80% of the national level of carbon emissions. Does that not put into perspective the current claim that you are responsible for only 0.1% of global emissions?

Mr Wiltshire: The last figure you gave is accurate.

Q78 John Thurso: Does that imply that the other ones are not?

Mr Wiltshire: No. In the global sense we are 0.1% of CO2 emissions. We recognise the non-CO2 effects of aviation but not the easy mathematical ability to multiply those to come to some sort of carbon equivalent. They are so different as effects that one needs to understand each of the individual impacts. You mentioned methane. We absorb methane; we are a good thing from a climate change point of view when it comes to methane. Aircraft emissions reduce methane. Methane has a certain lifespan. Ozone which is the culprit, if you like, for N2O emissions, has a shorter lifespan. How are we to compare and contrast those two effects from the N2O emissions? That science needs to tell us and at the moment it cannot do so. The science tells us that radiated forcing is a very inappropriate and mathematically incorrect way to do that; it is worse than adding together apples, pears and oranges.

Q79 John Thurso: In that case, why would the Royal Commission on Environmental Pollution have made so much of it?

Mr Wiltshire: I think they used the IPCC diagram which implied that these things could be added up and came up with radiated forcing. The important issue is not radiated forcing but the climate change impact. The radiated forcing is not the metric used to describe, for example, the effect of CO2 on the climate at the temperature of the earth. A different metric is used and as yet no use is made of that in other impacts.

Q80 John Thurso: Even if we go back to the absolute figure projected, which is 17.4 against 67, that still leaves aviation producing an extremely large percentage of carbon emissions. The current projection in the Government's aviation White Paper is a 4.25% per annum increase in passenger numbers and the exponential curve for freight is generally regarded as being pretty similar. Is not the plain truth that the planet cannot afford your growth aspirations as long as you are using a carbon-based propellant?

Mr Wiltshire: Our position is that the industry like many others is a carbon emitter. It currently represents a small proportion of carbon emissions. We want to play our part in dealing with carbon emission problems and helping to stabilise them. If by pricing carbon into people's activities they choose to burn it in a certain way then that is up to individual selection. I do not think we will crack the problem of climate change by taking a sectoral and, even worse, national approach and trying to control individual activities at national level. That is where one gets the 0.1% figure which has been quoted.

Q81 John Thurso: At the end of the day, we will not be able to afford that much carbon for the activity of aviation. Therefore, we will have to ration it and the best way is to have a market mechanism to do that, with which you all agree, but the plain fact is that any increase in aviation that is more than 2% a year means that we are in the red zone.

Mr Wiltshire: It means that aviation emissions may be growing overall, but we need to look at it at a global level and consider how we are to bring down carbon overall. We believe that the best way for aviation to play its part is by way of an international scheme that brings carbon down and caps it overall.

Q82 John Thurso: What I am driving at is the fact that there is no viable likely alternative in a 50-year timeframe to the jet engine as the main propellant for commercial passengers. There is some gain to be had from efficiency, but it is not huge. Therefore, in order for you to operate you will remain a constant and increasing emitter as passenger numbers go up. There are many other industries where there are alternatives to carbon. For example, the whisky industry which is a major consumer of carbon through its distilling operations has opportunities to use non-carbon renewable energy sources and so forth. They can give up carbon and that will be used by you. The question is: how much of our carbon do we give you for aviation, and does the industry not have to accept that it cannot grow at the predicted rate?

Mr Barker: We would like to see most of the forecasts build in the potential for technology. You painted a very bleak picture of efficiency gains in future. The Royal Aeronautical Society has shown that the industry has reduced its emissions per passenger by 70% over the past 50 years, so if we look at 2050 it is likely that the technological curve will continue to allow us substantial efficiency gains. The Stern Review highlights the ACARE targets for reducing CO2 emissions from new aircraft by 50% by 2020 and by 80% for N2O, so if there is a radiated forcing coefficient it is likely to narrow over the next 15 years. This industry exists on technology. It is a very capital-intensive industry and has an extremely good track record of investing in the latest technology to improve efficiency. The commercial imperatives are here today and ETS will raise that imperative still further. The problem with taxation of any kind is that it takes money out of the system. We should be forcing ourselves to invest as much as we can in pursuit of that goal.

Q83 Chairman: Everything is a bit complicated. The Royal Commission on Environmental Pollution is adding up mathematically when it should not do so, or whatever else. Why does the industry not take the initiative and have an industry-wide scheme? For example, the submission by flybe says that shortly it will be announcing a new eco-labelling scheme for aircraft. The concept is to establish "a system using a labelling scheme where aircraft are graded based on fuel burn, carbon emission, noise footprint and total environmental cost. In doing so consumers would be informed about each flight they take." Why does industry not come up with such an initiative? Why does not British Airways, one of the big ones, do that?

Mr Kershaw: There is no question but that it is important that airlines communicate more effectively with customers about the environmental impacts of flying. How does one do that?

Q84 Chairman: There is one example from flybe. Why does not British Airways think of an initiative such as that? I do not hear anything from the industry. I think that in a sense you have been caught in the headlights.

Mr Kershaw: One of the programmes that we introduced in 2005 was the carbon offset scheme which was essentially intended as a way to better inform the public.

Q85 Chairman: What you are saying to me is that you do not really have anything.

Mr Barker: One matter that may have inhibited the industry in the past is its competitiveness nature. This is the first time we have appeared like this together, and we take that responsibility very seriously.

Q86 Chairman: You can thank the Committee for that!

Mr Barker: We do thank you. EasyJet has a similar scheme to flybe. We are about to announce what we call our environmental code where we publish how efficient we are in the air and on the ground and what we are going to do about it.

Q87 Chairman: Say in six months' time you write back to us and say, "Look, ahead of 2012 we are taking this initiative so the consumer is informed", because the previous witness, Professor Ekin, said that the political environmental was not as well advanced as it should be because the consumer is largely ignorant of what is happening in the area. You have a responsibility to educate the consumer, so why not do it ahead of 2012? Why does not Virgin do that? Richard Branson has taken lots of initiatives.

Mr Humphreys: I have already explained that Virgin has taken some initiatives in this area and it is working on others. We would have no problem at all in what you suggest, and maybe the industry should look at that.

Q88 Chairman: Let us take Virgin as an example. I do not see it advertising a new eco-labelling scheme or whatever.

Mr Humphreys: We are in the process of coming up with proposals.

Q89 Chairman: But it is something that all of you could be doing. If you can sit together here for the first time surely you can get together afterwards and come up with something in six months' time. Would you do that?

Mr Kershaw: I think we need to improve the way we communicate.

Q90 Chairman: Would you all sit together, however painful it might be, and come up with something and perhaps write to us in six months' time to tell us what you might be doing ahead of 2012? We are all shy here.

Mr Humphreys: Yes.

Mr Wiltshire: And through the Sustainable Aviation strategy we have ourselves committed to do that sort of thing.

Q91 Chairman: Will you write to us in six months' time?

Mr Wiltshire: Our timescales are a bit longer than that, but we will certainly be doing it and we will be reporting on it.

Q92 Chairman: To refer back my earlier point about doing something in advance of 2012, you stated that there would be a 2004 to 2006 baseline for emissions. Why do you not set a tighter baseline for emissions, say 2002 up to 2012? That is an initiative that you could take ahead of 2012.

Mr Kershaw: That baseline is related to the EU emissions trading scheme and is set by the European Commission.

Q93 Chairman: You are not under any obligation from now until 2012, so perhaps you should take some initiative. Why do you not do that with tighter baselines?

Mr Barker: As individual entities every year commercially we are making huge efforts to reduce emissions.

Q94 Chairman: The answer is no?

Mr Barker: We reduced our emissions per passenger last year by 3%.

Q95 Chairman: But what about a tighter baseline?

Mr Kershaw: The only purpose of a baseline is to operate within emissions trading.

Q96 Chairman: It is to lower emissions.

Mr Kershaw: If you are suggesting that we should create a voluntary emissions trading scheme I am not sure that that would be the best use of our resources.

Q97 Chairman: What I am saying is that you have a free ride up until 2012 and you are doing nothing. You are not obliged to do anything until 2012, so why do you not come up with an initiative and have a tighter baseline?

Mr Barker: Effectively, by 2012 the industry will have grown by then. We will have to pay for any extra emissions that we have produced post-2005. But all of us are trying to reduce emissions as individual airlines every year, and that is a commercial imperative; it is a matter of survival.

Q98 Chairman: Surely, government should maintain some form of taxation up to 2012, and Stern has said it himself. It was repeated in one of your submissions to us. If APD is the wrong tax what is the right tax?

Mr Kershaw: We believe it would be more appropriate to have something in line with emissions trading rather than to base it on taxation which we do not believe is environmentally effective. Equally, we would expect that once emissions trading was in place as a more effective mechanism there would be no purpose in having an APD or other environmental tax.

Q99 Chairman: But up to 2012 it is legitimate?

Mr Barker: The problem with any tax is that it takes money away from us to invest in the new technology that reduces emissions. That is a hard and fast fact.

Q100 Chairman: I understand, but the motorist will tell you that he or she pays tax every day at the petrol station. You do not pay anything.

Mr Barker: If we pay tax it has to be something that forces good behaviour on airlines and achieves the end result of fewer emissions. That must be the case.

Q101 Chairman: Therefore, you do not know what the right tax is but you should be paying some tax up until 2012?

Mr Wiltshire: I think the right tax is one that creates an incentive for the industry on the one hand to improve its technology and on the other an incentive to the consumer to take action himself.

Q102 Mr Mudie: Would not a more effective tax be one that hit you rather than the passengers and therefore gave you the incentive to do something? The passenger's incentive is not to travel, but if the tax is on you as an industry you will be in a negotiating position in which you can say you will do something to save tax. But you are really out of this; it is the passenger who is involved in it?

Mr Kershaw: From our point of view the difficulty is that a tax is not effective in meeting environmental objectives. If what we want to do is reduce climate change impact we need to find effective mechanisms to do that.

Q103 Mr Mudie: One of the suggested ways of doing that, if we accepted it, would mean that you would spend money, not the passengers. But at the moment it is the passengers who are being hit.

Mr Barker: But any kind of tax impacts the money we have to spend ourselves.

Q104 Mr Mudie: You made 97 million last year.

Mr Barker: It impacts us straight away.

Q105 Mr Mudie: There are bigger players here and there must be a lot of money in this industry.

Mr Barker: The tax already is one and a half times our profit and the amount of money we spent on new aircraft last year, 70% of which was to reduce emissions. Therefore, that money just goes away from us; it affects us directly.

Q106 Chairman: You are happy to pay tax - or do you not want any tax at all?

Mr Barker: We are responsible entities and we are happy to pay tax, yes.

Q107 Chairman: I get the feeling that you are advocating zero tax.

Mr Barker: We are talking about environmental matters.

Chairman: We need to read the evidence to get some idea of what the airline industry is about. I think that you are effective in your message elsewhere; you get people on planes to go here and there, but your message in terms of environmental taxation is pretty dense. I get the feeling that you have been hauled to the table. You have shown no initiative yourselves and anything that you have to do will be very complex. If you could write to us in six months to say what initiatives you were taking that would help us. Thank you for your evidence this morning.


Memorandum submitted by the Centre for Sustainable Energy

Examination of Witnesses

Witnesses: Ms Kate Hampton, Policy Manager (Advisory), Climate Change Capital, and Mr Simon Roberts, Chief Executive, Centre for Sustainable Energy, gave evidence.

Q108 Chairman: Good morning, and thank you for appearing before us. Perhaps you would introduce yourselves for the record.

Ms Hampton: My name is Kate Hampton, vice-president and head of policy at Climate Change Capital.

Mr Roberts: My name is Simon Roberts, chief executive of the Centre for Sustainable Energy.

Q109 Chairman: How would you characterise the Government's broad environmental strategy? Is it joined up across different government departments? Can business be confident that it is both predictable and effective?

Ms Hampton: I can speak to the climate change and energy piece, not the environment in the round. I think that we are starting to see an improvement in the joined-up nature of the Government's policy. Certainly since the EU and G8 presidencies last year government departments have started to work together a lot more effectively on these issues. We are also starting to see that within the EU. Various bits of the European Commission are working together a lot better as evidenced by the EU's energy package. Therefore, I think there is an improving trend, but I do not think it is right to say at this stage that policy is predictable and provides the kind of long-term visibility that investors need. I think that policymakers are beginning to realise that it is a problem.

Q110 Mr Love: I turn to some of the controversies surrounding the Stern Review. I start with the controversy about the so-called discount rate and intergenerational fairness. Mr Roberts, could you start by giving your view on whether or not the very low discount rate that has been set by Stern in his report is appropriate, or is it biased against the current generation?

Mr Roberts: In a way, given the precise details of his calculations, bearing in mind the conclusions to which he came, we could have a very erudite discussion about whether or not he had used the right discount rate. We would end up with a discussion as to whether he had got it exactly right or exactly wrong. I think his conclusion that we need to act now is roughly right; it is economically advantageous to act sooner rather than later. We have 10 years in which to act, not 10 years to get our act together as a number of people seem to believe, as evidenced by the previous witnesses. But one can go into a very detailed assessment as to whether or not he has got the economics exactly right. The danger is that as a piece of work to persuade other economists it may fall foul of that, but in terms of its overall impact and message I think it is very clear that whatever discount rate is used - no matter how low - the costs of inaction far outweigh the costs of action. On that basis, even if one almost entirely ignores future generations the assumption is that the people now alive still conclude that it justifies significant immediate action in relation to climate change, rather than worry too much whether it should be x% or y%. That would be a level of focus on a specific that ignored the broad conclusion that action is needed now rather than later.

Q111 Mr Love: I hear what you say but that is what the Treasury Committee is about, if I may say so. Ms Hampton, Stern set it at .1%. Almost no other economist producing any kind of report about the future would set it that low. While I accept what Mr Roberts says about the need to take action now, do you think that the balance is right between generations? Are we asking this generation to do too much based on Stern?

Ms Hampton: I would say that the present generation is not doing enough and encouraging it to do more is a good thing. I agree to some extent with Mr Roberts that the exact percentages of the interest rate are open to debate. It will always be a value judgment. Ultimately, one has to decide whether or not one wants to err on the side of intergenerational equity. At the moment, effectively the costs to future generations are just not factored into our accounts. Most political decisions are taken on an incredibly short-term basis, even as we have seen in the carbon market. The fact that decisions are taken on a five-year basis does not provide the long-term investment signal. We need some way to provide a long-term decision-making framework. One way of doing that is to provide a low discount rate, but it is not the only way. I believe that that, complemented by a really hard look at turnover rates of capital stock and the time lags involved in introducing a political signal and for that signal to translate into capital moving into different technologies and so forth, in addition the climate system's inertia, tells us that we need to find ways to encourage decision-makers to take action now. The discount rate is one factor in the cost benefit analysis. There is a broader risk assessment and it should not be looked at in isolation.

Q112 Mr Love: Another concern that has been raised is that Stern does not seem to differentiate between how it will impact on the poor as opposed to the well off and his system is not biased towards redistributing to the poor. How do you respond to that, recognising that as far as most people are concerned the impact of global warming will be much greater on poorer countries than on richer ones?

Ms Hampton: There are two reasons for that. The first is to do with their climate systems and the vulnerability of tropical eco-systems and so on; the other is the vulnerability of communities, in that people who live on the flood plains of Bangladesh do not necessarily have the adaptation opportunities open to somebody who lives in Florida. Everybody recognises that. For example, the IPCC second assessment report went the other way, in that the value of life in poorer countries was put at a fraction of that in rich countries. That was overturned eventually in the final analysis. One can focus a good deal on that kind of information, but what is essential now is to focus on the solutions. It is clear that there are massive equity issues associated with climate change and that the global public good and expenditure that has to be made to address the problem must fall on the shoulders of those who created it. If one has a price for carbon that price must be met by the biggest polluters, both historically and currently. Potentially, that is the best way to deal with those equity issues.

Mr Roberts: I believe that as an economist he did a reasonable job in highlighting that issue and trying to weight it into his analysis. It is very clear from the study he considers that the fact it impacts on the poor more significantly is something that needs to be weighted in the context of how important it is to take action and how rapidly action is needed.

Q113 Mr Love: But the criticism is that, to take Ms Hampton's point, since it is the developed countries which have created most of the problem and the poor ones which will be affected by it that means it should be weighted even more towards those less well off?

Mr Roberts: If one looks at the overall analysis, there are all kinds of places where he has got it exactly wrong, but the most important thing is the fundamental direction in which he takes the analysis which is absolutely the fact that the poor will suffer more and therefore it is the responsibility of rich countries to lead. Maybe we will come on to some issues about how that was communicated. I think it gave the sense that there would be no point in doing anything unless everyone acted, in particular China, India and the US. I think that that creates the false impression that there is no value in an individual country doing its own thing and taking a lead. It is characterised elsewhere in the following terms: if one is in an international discotheque where there are diplomatic negotiations on climate agreements it is quite important for someone to take to the floor and dance well to show other people how to do it. That is not a question of economics; it is a matter of political science. There are no international agreements that have not been the result of one or a few countries taking a significant lead and bringing others with them rather than sitting round a table and trying to negotiate something where one party says he will not do anything until someone else does. Even though he has not quite weighted it right and all the rest of it, it is to his credit that he has broadened it in terms of the underlying policy direction that he pushes and the emphasis on the need for immediate action, co-operation and work on technology development, not simply relying on carbon pricing. There is always a tendency for an economist to resort to the easy, if impractical, option. We should not say that because he has not got it completely right we should not start anything and exactly the right answer is needed before anything is begun, and the uncertainties far outweigh any certainty that he might have been able to nail down. I believe that irrespective of what number he has chosen he has moved it in roughly the right direction.

Q114 Mr Love: While I accept that comment, he set himself up for that criticism because this was meant to be a comprehensive report that looked at all the issues and went into the sort of detail for which he has now been criticised.

Ms Hampton: At the moment it is the most comprehensive report, and that is the best we can do.

Q115 Mr Love: I should like to pick up one matter that has been written by the Centre for Sustainable Energy. It is almost a criticism of Stern being an economist who looks on everyone as being rational in terms of the way they will act economically. You have made particular criticism of that in relation to ordinary individuals who do not always act as rational economic beings. How valid do you think that is as a criticism of what Stern has said?

Mr Roberts: I think it was the Archbishop of Canterbury who said that the economy was a wholly-owned subsidiary of the environment, which is nice phrasing. I think it can also be said that economics are a wholly-owned subsidiary of the totality of human knowledge. There are lots of other things we understand about why people do what they do and why settlements exist as they do and economics cannot explain all of that. Yet in policy-making circles one tends to resort to economics above and beyond a lot of other things that point in slightly different directions about how behaviour might be changed. I think particularly about the psychology and understanding of social norms, habits, traditions and so forth which need to be affected where economics are only part of the description of the system which causes that and need to be broader than that. One ends up with a situation where there is a tendency to rely on economics alone.

Q116 Mr Love: We are limited for time. What are the implications for policy? Does it mean that what Stern has said is only partially relevant and there are other factors that we have to take into account?

Mr Roberts: A very quick answer is that I believe one area which has been swept aside as almost a third issue is education and awareness-raising. I believe that that is more fundamental than some of the other things he has talked about in terms of building up an understanding and creating a carbon consciousness in society. He has not looked at the policy implications of other things he is doing and how effective they are in doing that. One of the points we make is that taxation does not do that particularly well compared with trading systems and other things.

Q117 Peter Viggers: I want to try to get carbon emission trading schemes in perspective. How important are they in the scheme of things and the weapons we have?

Ms Hampton: They are very important. The carbon emissions trading scheme that we have in the EU at the moment is the first of its kind and it is very ambitious in international terms. Because the EU has stuck to its guns on this other parts of the world are starting to follow. We see emerging action in the United States. I am involved in what is happening in California, for example. Clearly, emissions trading is not the only instrument, as Stern recognised. He talked about taxation, regulation, investment in R&D and so on. I think that that is absolutely right. Even though we as a company are focused very much on economic instruments we realise that there will be areas where market mechanisms just cannot be used to deliver the outcomes desired. For instance, matters like appliance standards have to be done through regulation; one cannot really do it in trading. A lot of the energy efficiency stuff is better done through regulation. Emissions trading can deliver very large volumes of reductions, as we are starting to see with the EU ETS and its impact on investments in the developing world through Kyoto's clean development mechanisms. Those large reductions would not otherwise be happening, unleashing the private sector's ability to go out and discover the lowest cost reductions. Therefore, we are really getting the most efficient pieces first. But the emissions trading scheme will always start with the cheaper stuff and if one wants to change long-term investment decisions one will need a whole range of other instruments to underpin the carbon price in terms of energy policy. I could go into particular technologies in more detail.

Mr Roberts: As we have learned from the first phase of EU ETS, a trading system is only as good as the cap that is set and how tight it is. Often, that is a political decision. I am sure that the witnesses in the previous session will be spending a lot of time to make sure that that cap is appropriate and gives them some room to breathe. There is a political process to that which sometimes is missed in the theoretical understanding of how efficient a taxation system is. The other side is: what does it include? I think that we are moving to a phase over the next five to 10 years where we need to start looking not simply at the slight mess with the EU ETS. In part it looks at the demand side, that is, heavy industry that is causing carbon emissions, but also at the electricity industry which is in part about supplying a demand that is not capped in any way. There is slight confusion over that. It may be that at some point we need to flip it round to look at individual trading schemes.

Q118 Peter Viggers: Can you say a word about personal trading schemes?

Mr Roberts: As we concluded in our report to DEFRA published just before Christmas, we think that it is still too early to embrace them as a practical, feasible option, but because of their potential we have to look at them very seriously in terms of what they can achieve and how they can potentially affect individual decision-making in the market and create a market in which the likes of British Airways and others have to respond to consumer demand. That is what is being driven by the trading system rather than being controlled by some regulated market somewhere else that they can lobby.

Q119 Peter Viggers: How well does the European Union's emissions trading scheme currently provide a price for carbon?

Ms Hampton: I think you have to differentiate between phases 1 and 2. Phase 1 was a learning phase and it was the price of going first. The EU launched into it before it had adequate data. Countries that come later are currently collecting the data in order to develop the scheme. It is in the nature of businesses to say that they will grow a lot next year even if all the historical evidence points to the contrary; and they also want to negotiate. It was inevitable that there would be a price adjustment when the real data came out. Phase 1 has provided a price incentive certainly for the clean development mechanisms but not within the EU. If one looks at phase 2 which covers the period 2008 to 2012, recent Commission decisions provide a very strong price for carbon. We are seeing investment flowing as a result of that.

Q120 Peter Viggers: The Pre-Budget Report in 2006 states that only 7% of allowances will be allocated via auctioning in phase 2. Is this enough, or would you prefer to see more?

Ms Hampton: We believe that you can have 100% auctioning in the power sector because it can pass on the costs to customers and is not exposed to international competition. For other sectors it will depend a good deal on what other countries do and for those one can use a combination of auctioning and efficiency benchmarks. But we need to see a lot more auctioning that is centralised and harmonised across the EU, and the timing and frequency of auctions is quite important to the market. If countries are able to decide how much they want to auction and how they do it that will not be the most efficient way to do it.

Q121 Peter Viggers: It is a global problem. Do we have global institutions which can handle it? There has been reference to the EU. So far in this evidence session there has been no reference to the OECD which has been very active in this field.

Ms Hampton: The OECD does not have the direct regulatory role. I think that it provides very useful input, for example through the annex 1 expert group, on the evolution of carbon trading and international negotiations under the UN framework convention. I think that the institution that is worth focusing on is the CDM executive board which basically acts as a regulator for projects-based reductions which flow into the EU scheme but can also be used by governments in compliance. That particular institution started off as quite politicised; it is now being professionalised. However, the movement of projects through that system is still quite slow. That is being sorted out and the process can be accelerated somewhat.

Q122 Peter Viggers: Given the problems with the Doha round, how optimistic are you about international development?

Ms Hampton: Certainly there are parallels. What we see in the emissions trading world at the moment are national schemes which will bubble up like the EU scheme and they will become linked. But one will always need an international regulator to guarantee that a tonne of carbon in China is the same as a tonne of carbon in the UK. Schemes can develop around that and there will be differences between schemes. There is some flexibility for a range of institutions in the emissions trading scheme, but there must be one yardstick. I am quite optimistic that that can continue because Kyoto sets out that framework of monitoring and verification and the CDM executive board and other institutions do that job quite well. Those institutions are, however, under-resourced both in terms of staff capacity and finances.

Mr Roberts: I am not quite sure I share the optimism. The picture of the kind of institutions that one needs to build is right, but there is now a tendency to say that we have not quite got the institutional framework right and we should not really do anything yet. We come back to the point made earlier by Ms Hampton that some of these emissions are not moveable; they are not subject to competitive pressures, and the need to set up some international system for trading and management is to deny the fact that a lot can be done at country or regional level which can then be joined together. What is important is that one starts to map out what the rules would be for an international system so one build that into it and joins together any more regional systems. One certainly does not need a global system to kick off, as the EU ETS shows. I think that that could go a lot further before we need to worry about it.

Q123 Peter Viggers: There is a risk that rich countries will lecture poor ones who feel they cannot afford to participate. How does one sell that story to the poorer countries?

Ms Hampton: I think that the carbon pricing story and emissions trading piece fall out of a much broader discussion about energy and climate security. There are a number of emerging economies in between the developing and developed world, for example Mexico and Korea, which have recently become industrialised. They are starting to look at emissions trading very seriously and they can take that on. The next group comprises countries like China and India which will probably engage on a sectoral basis to start with, and that is very much where the international negotiations are focused. One may have a one-way target for a particular sector which means that it is one of the proposals on the table and if they over-achieve they can sell that carbon into the global market; if they under-achieve they do not face the same kind of compliance and penalties that, say, the EU would. There is a range of things that developing countries can do on the road to a fully capped system, but I think it is unrealistic to expect most developing countries to accept the cap beyond maybe some sectors that they may want to volunteer, apart from those countries which are in the OECD or are borderline at this point.

Q124 Mr Breed: If we can take a brief look at current environmental taxation, Friends of the Earth has described to us that the climate change levy is the Government's environmental tax success story. What do you believe are the features that has made it a success, if you believe it is? To what extent can that perhaps be replicated in respect of other environmental taxes?

Mr Roberts: I think I will have to pass on that. I do not have enough information available to say whether or not it is a success story. I think that what it did at the time, even though it is not a huge price signal, was signal intent and a government position in relation to things which meant that industry could see where things were going. The significance of it lies not so much in the price signal as the fact that it demonstrates a bias towards low carbon behaviour over high carbon behaviour. I do not think that it would fit particularly well the criteria for a logical and transparent system, but it signals to industry that it wants to see carbon emissions coming down and it is prepared to release it from the tax burden if it can show what it is prepared to do. But one would still want to see what came out in the wash at the end of all these voluntary agreements before one could conclude that it was a success in that respect.

Ms Hampton: If one uses taxation in combination with other instruments one could get some quite useful outcomes. The climate change levy of itself would not have achieved what the entire policy package around it did. One matter mooted by colleagues at Climate Change Capital is the idea that in the absence of a long-term signal from the emissions trading scheme the Government would institute something like a price floor through a carbon levy or tax. Basically, if the international or European price of carbon fell below, say, 15 per tonne it would levy a tax to continue to penalise business at that level. That could provide a long-term signal to drive long-term investment decisions in the absence of a longer-term agreement. There are things that national governments can do through their taxation systems that cannot be done internationally. Looking at the complementarity of those different instruments is definitely something worth exploring.

Q125 Mr Breed: In respect of climate change, what do you think is needed now? If one were to recommend just one thing to bring about wholesale behavioural change what would it be?

Mr Roberts: I think that we need to see far more money going into education both within schools and more broadly. If one looks at the energy saving trust budget, it has been static for five years. That is the main vehicle used by the Government for communicating with individuals about these issues and providing support and advice. One could envisage a huge expansion of that and build into it. As to immediate matters, I think that the Government must get their story straight on the balance. We all want to get individuals, businesses and national bodies working together. Show what it means in practice and be clear about what different parties are bringing to that, and also why it is important for the UK to lead, not because it massages some political ego on the international stage but because it shows we can lead the dancing in the international process of getting negotiation together and take responsibility in relation to that. I do not think we have yet got that. We saw that with Stern. There is no point in acting unless China does it. We saw it with the climate change programme review. It would be nice if individuals acted too as though somehow they did not need to before. I think we need to find a way to go beyond that so we have a clear framework of communication and a lot more resources going into education and awareness-raising, backed up in the medium term with something that really brings individuals into the carbon trading system, raises their carbon-consciousness and makes it part of their major decision-making in terms of both individual behaviour and purchasing decisions.

Ms Hampton: In terms of imminent action, I think that the spring summit in early March where EU heads of government will get together and talk about the EU energy package is potentially a very important political move. The Commission has put forward an ambitious and coherent package which should be welcome, but it could be unpicked by individual Member States as they try to undermine the mandatory nature of some of the targets or take an a la carte approach to the instruments on the table. It would be very dangerous if particularly the UK Government on the basis of subsidiarity started to say that there should not be mandatory renewable standards or for carbon capture and storage at EU level. There is now such a level of urgency and scale required to address the problem that some of these issues have to be dealt with at a point beyond national level. The UK Government could make that moment important by working very carefully with other heads of government so there was less in-fighting between industry ministries and environment ministries, which have plagued the implementation of most climate legislation so far, and there was a firm commitment to long-term carbon signals up to 2025 which have a real impact and do something about the demonstration of carbon capture and storage and the commitment to build 12 plants across the EU by 2015. If we do not take the carbon out of coal we do not solve the climate change problem. In addition to the stuff that needs to be done locally, at national level and by individuals some of the big picture stuff is absolutely essential.

Q126 Chairman: The Stern Review says that there will be costs from climate change and preventive measures alone will not make up for that, so there needs to be adaptation. Is adaptation featured strongly enough in the debate, and could more be done in that area?

Ms Hampton: In the history of the negotiations adaptation has tended to be used as a card played by countries like the US and Saudi Arabia as a way to divert attention away from mitigation. I believe that that has slowed down an intelligent debate on adaptation.
That is one reason why it has not played a big part. Another matter is that it is quite difficult to differentiate between sensible adaptation and just sensible sustainable development. If one looks at water or forestry policy, to do things that are sensible from the point of view of sustainable development also improves one's resilience. There has not been enough attention paid to adaptation. As for a lot of the climate impacts, people do not necessarily have the local resolution in the climate modelling.

Q127 Chairman: What could the Treasury do to highlight the required expenditure on adaptation as a way of raising public awareness of the current cost of climate change?

Ms Hampton: The UK is doing better than other countries through its climate impact programme, but I think that adaptation really needs to be factored into business decisions and local government decisions to an extent that is just not happening at the moment. The water sector has started to think about it but possibly that is the only sector that has. One needs a much broader approach. On the international side, we are not doing anything to tackle the problem that is increasingly being faced by developing countries. Look at the Horn of Africa and other places. We have not even started with that.

Mr Roberts: I agree that there has been to some extent a morally odious use of the idea of adaptation, and in some of the impacts discussion there has almost been a sense that it could be positive. We have heard some discussion in the South West to the effect, "Where are we going to grow the wine?" One can already get some very good wine from Cornwall. In a way, it comes back to communication. The problem is that one already has adaptation costs; one already has to deal with flood defences. Stop building housing in flood plains which planning systems still do not manage to prevent. We also need to communicate those as costs that are already sunk. Some of the environmental groups tend to say that unless we change our behaviour we will have all these costs. That kind of equivalence is not there any more; we have the costs anyway and we need to change our behaviour to stop them rising even further. I still think that we have not managed to get across that point.

Chairman: Thank you very much for your evidence which has been very revealing. It has been a worthwhile morning for us.