Memorandum submitted by The UK Emissions
Trading Group
INTRODUCTION
This response provides written evidence to the
House of Commons Environmental Audit Committee in relation to
the inquiry into the roles played by the Climate Change Levy (CCL)
and Climate Change Agreements (CCA) in reducing carbon emissions
and energy use by the UK business sector. This inquiry follows
a new study by the National Audit Office (NAO), prepared especially
for the Committee.
BACKGROUND TO
THE UK EMISSIONS
TRADING GROUP
The UK Emissions Trading Group (ETG) is a body
that represents numerous companies and organisations that are
involved in CO2 emissions trading schemes. The ETG has 112 members
including individual companies and Trade Associations that represent
relevant industry sectors. Both Defra and BERR have had regular
input into ETG meetings since the organisation was founded in
1999. The ETG has provided the UK Government with an enormous
amount of practical help in relation to the implementation of
emissions trading.
The work of the ETG has included input into
4 important CO2 trading schemes, including:
3) CCAs (Climate Change Agreements, which
rely on trading for effective operation).
4) The proposed Carbon Reduction Commitment.
ETG membership includes representatives of companies
that have over 94% of all UK emissions in the EU ETS and also
includes Trade Associations responsible for a large proportion
of the companies in CCAs.
One of the ETG Working Groups (WG 1/2) concentrates
on issues surrounding the interaction of CCAs with the other trading
mechanism. WG 1/2 has members that have been fully involved in
the development and implementation of CCAs since they were first
announced by the Chancellor in 1999. This body of expertise is
possibly unique, and forms a useful basis for input to the current
deliberations of the Environmental Audit Committee. Approximately
40 members of WG 1/2 have debated the NAO report at a meeting
on September 19th 2007. This written evidence is based on the
key outputs of that discussion.
GENERAL COMMENT
ON THE
NAO ASSESSMENT OF
CCA EFFECTIVENESS
The general tone of the NAO report was that
CCAs have failed to deliver what was originally promised. Members
of the ETG strongly disagree with this view. We have had over
six years of experience of CCAs and believe that they have been
a policy that has had a very positive effect on energy intensive
industries in the UK. The establishment of CCAs has led to:
1) Tangible energy efficiency improvements
well beyond Business-as-Usual (BAU) in many CCA industrial sectors.
2) A significantly raised awareness of energy
issues at board level. In particular, there has often been a greater
involvement of Finance Directors due to the tax saving implications.
In many CCA sectors this improved awareness has helped lead to
the development of much bigger energy efficiency investment programmes.
3) The creation of much improved data in
many industrial sectors due to the CCA requirement for annual
reporting of energy and production data. In 1999 only a small
number of industry sectors had voluntary schemes in place for
collection and interpretation of annual energy data. In most cases
the datasets only represented a proportion of the whole industry
sector. Under CCAs there is now at least seven years worth of
annual data for almost all factories in each industry sector.
This data provides a powerful platform for improved understanding
of energy saving opportunities.
4) The creation of strong industry sector
networks, based on the requirements for a Trade Association to
manage each CCA. These networks have led to improved sharing of
energy saving ideas and have formed a new platform for dissemination
of new technologies eg via Carbon Trust funded Network Projects.
5) Better interaction between Government
and each industry sector, through the negotiating process and
the on-going reporting of Milestone data. This has provided both
Government and industry with an improved understanding of the
energy saving potential and has helped industry understand how
Government can try to achieve GHG emission reductions.
The NAO report has not done justice to these
positive aspects of CCAs.
The ETG recognises that there are some aspects
of CCAs that have caused problems over the last few years. However,
these are relatively minor administrative issues that can be attributed
to teething problems of a new Government policy. The introduction
of other major climate change policies such as the Direct UK ETS
and Phase 1 of the EU ETS had far greater initial problems, which
actually negated the environmental benefits of these schemes.
This is certainly not the case for CCAs. The initial targets for
some CCA sectors were found to be too easy to achieve, but this
problem was addressed in the 2004 target renegotiation. With the
availability of better data (see point (3) above), industry sectors
could recognise that they had a greater potential to make savings
than had first been thought. At the 3rd Milestone in 2006 most
CCA sectors were making adequate progress against the renegotiated
targets, and most parties involved in CCAs accepted that the sector
level targets were challenging but achievable.
On balance, most high energy intensity industry
sectors feel positively about the structure of CCAs and believe
that a similar structure should be adopted after the end of Milestone
5 (in 2010), which is the last Milestone of the existing CCAs.
ETG members believe that a number of important changes can be
made to reflect the lessons learned over the last 7 years and
also the changes that have occurred in the Government's wider
climate change policies. However, without the current structure
we believe it would be impossible to devise a policy that suits
energy intensive industries and that delivers all the benefits
described above.
SPECIFIC COMMENTS
ON ITEMS
IN THE
NAO REPORT
A. Page 4, Key Conclusions Box
On the opening page of the Summary is a Key
Conclusions box that shows the CCL itself had a very positive
environmental benefit (3.5 MtC in 2010), but that the CCA mechanism
did not deliver as much saving (1.9 MtC). We believe this is wholly
unrepresentative of the savings achieved by energy intensive industry.
The assessment of CCL savings is made via the work done by Cambridge
Econometrics in 2005. The modelling is believed to be flawed as
it did not take into account the impact of mild winters. Also,
the "announcement effect" of CCAs has been included
in the apparent savings achieved by the announcement of the CCL.
This leads to an optimistically high figure for the savings from
CCL alone. Conversely, the figure for CCAs is believed to be an
underestimate as it exaggerates the BAU impact and also does not
fully account for factory closures and sector rationalisation.
There is anecdotal evidence that the CCL by
itself is not an effective instrument. It often goes completely
unnoticed in non-energy intensive businesses. It provides none
of the secondary benefits of CCAs (eg better data, better networking
etc.) and provides such a small price signal that it is not surprising
that it has little impact in markets with a relatively inelastic
response to energy prices (ie low energy intensity businesses).
There is robust evidence that illustrates the
level of engagement in energy efficiency by CCA companies. Almost
all eligible companies have signed up to CCAs and the vast majority
have managed to achieve recertification at each of the first three
milestones, including achieving the often much tougher MS3 targets
that are based on the 2004 renegotiations. This could not have
been achieved if the majority of companies were not making efforts
to achieve savings.
B. Page 5, 1st Bullet on CCAs
This states: "It is also the case that
some businesses have benefited from the tax discount despite failing
to meet their targets: they have done this by relying on the overachievement
of others within their sector."
This statement shows a significant lack of understanding
of the way that CCAs work. The vast majority of businesses with
a CCA take steps to ensure that they meet their targets, either
by achieving the required energy savings or by taking part in
emissions trading. Very few businesses are "relying on the
overachievement of others within their sector". The NAO have
misunderstood the way that emissions trading operates within a
CCA. In almost all cases, a business that overachieves against
its target retains "access" to this overachievement
through emissions trading (either selling the surplus or banking
the surplus for future use). In these circumstances the sector
does not benefit from the overachievement.
It is worth noting that a very small number
of sectors operate their CCAs in such a way that overachievement
is shared amongst all companies in the sector. However, this is
the exception not the rule and it is a mechanism originally suggested
by Government, not by industry.
It is also worth noting that the original 1999
design of CCAs gave more emphasis to the sector level target.
During 2000 the OFT intervened to ensure that Defra allowed any
overachiever to retain its overachievement, via the emissions
trading process. This requirement made the sector level target
much less important in most CCA sectors.
C. Page 6, 2nd Bullet
This states: "Only a proportion of the
reported results are actually additional savings achieved by Agreements.
. . .. Of the 4.5 MtC annual savings reported to December 2006,
revised business as usual projections suggest that only 1.9 MtC
can be considered additional savings achieved by the Agreements."
The analysis behind this statement requires
careful scrutiny. The 4.5 MtC figure is considered an underestimate
as it does not fully account for site closures linked to industry
rationalisation. These closures are part of the BAU improvements
that are taking place in industry. To attribute only 1.9 MtC savings
to CCAs is thought to be double counting much of the BAU improvement.
D. Page 6, 3rd Bullet
This states: "Not all targets have been
as challenging as they could be."
At the first 2 milestones, in 2002 and 2004,
it was shown that some of the targets set were not as challenging
as they should have been. In most cases, this was caused by the
significant lack of information available for many CCA sectors
during negotiations in 1999-2000. Both Government and the sectors
themselves did not have a detailed understanding of energy use
in each sector. The approach taken to initial target setting was,
in some cases, conservative due to the lack of good data. This
can be considered as an initial teething problem for CCAs.
The CCAs had 2 target renegotiations built into
the original 10 year timescale. The first was in 2004, at which
the targets for Milestones 3, 4 and 5 were renegotiated. The second
will be in 2008, at which the target for Milestone 5 will be renegotiated.
The 2004 renegotiations provided Defra the opportunity
to significantly tighten the targets originally set in some sectors.
In all cases there was much better data available by 2004 and
Defra adopted a tough negotiating policy. The new targets for
Milestones 3, 4 and 5 are far more challenging than those set
earlier. Hence it is unfair for the NAO report to criticise the
targets without reference to the fact that the current targets
are quite demanding and that a further renegotiation of targets
is due in 2008.
It should be noted that the lack of data available
in 1999-2000 was a common problem but that a small number of sectors
already had much better data available via existing voluntary
reporting schemes.
E. Page 6, 4th Bullet
This states: "Agreements have enabled
businesses to achieve efficiency improvements, though business
opinion is divided over their effectiveness."
With over 10,000 sites taking part in CCAs it
is almost self evident that business opinion is divided. However,
the major companies and sector Trade Associations that are members
of ETG are almost all very positive about the impacts of CCAs
(the perceived benefits were already described on Page 2 of this
document). CCAs are believed to be a good policy mechanism for
energy intensive industrial sites.
It is worth noting that CCAs give equal emphasis
to creating efficiency savings for both electricity and fossil
fuel (this is achieved by using a weighting factor that recognises
the primary energy use involved in the generation of electricity).
ETG members believe this to be very important. In many industrial
sectors electricity is a significant part of the total primary
energy use. "Upstream" climate change policies such
as the EU ETS do not give a target to make electricity savings.
An important part of the success of CCAs is the inclusion of electricity
savings in the targets.
F. Page 7, Issues for Committee Scrutiny,
1st Bullet
This refers to relative versus absolute targets.
The ETG believes that climate change policy
has moved a long way since the recommendations of the 1998 Marshall
report, which recommended energy efficiency targets (ie relative
targets). The EU ETS and the proposed CRC use absolute CO2 targets.
The majority of ETG members accept that absolute targets may be
better for CCAs in the future.
However, it should be noted that developing
a successful scheme with absolute targets is not totally straightforward—as
illustrated by severe teething problems in both the UK ETS and
the EU ETS. An absolute regime can reward inefficient companies
that are losing market share but, perversely, can penalise growing
companies that are becoming more efficient.
CCAs already have an option for absolute targets,
but in late 2000 the Government set special rules for these absolute
targets because of fears over the impact of site closures. The
"absolute targets" in CCAs are actually quasi-relative
targets, as they are adjusted if the output of a factory falls
by more than 10%. This problem may have been created by allowing
companies to choose between relative or absolute targets. If all
companies are forced to have an absolute target then the site
closure problem would be less severe, although it will not disappear
altogether, especially if production is being lost to overseas
competition.
The ETG recommend that great care is taken over
the design of a future scheme in relation to the use of either
relative or absolute targets, learning lessons from both CCAs
and from relevant emission trading schemes.
G. Page 7, Issues for Committee Scrutiny,
2nd Bullet
This refers to sectors with different energy
intensities.
The ETG believes that the proposed CRC is only
applicable to industrial or commercial sectors with very low energy
intensity. CCAs are more applicable to sectors with higher energy
intensity as the CCA process:
a) Provides a framework for taking sector
specific differences into account, and
b) Provides a vital tax incentive that helps
protect the competitive position of businesses spending a lot
of money on energy.
The best "change-over" threshold between
CCAs and the CRC is hard to judge. Most CRC companies have an
energy intensity of below 1%[9]
whilst most CCA companies are in the 3% to 10% range. A few CCA
sectors have energy intensities above 10% and a few fall below
3%. The current "energy intensity" CCA eligibility criteria
are considered to be set at too high a level, especially for businesses
that are not subject to international competition.[10]
ETG would prefer to see slightly wider eligibility for CCAs that
would be achieved by allowing any industry sector with an energy
intensity above 3% to be eligible.
H. Page 7, Issues for Committee Scrutiny,
3rd Bullet
This refers to overlap between CCAs and EU ETS.
This is definitely an important issue requiring
further consideration. About 500 out of over 10,000 CCA sites
are in both a CCA and the EU ETS. Although the number of sites
are small, these 500 sites represent a significant proportion
of all the energy in CCAs as they are amongst the 500 largest
industrial sites in the UK.
For these sites participation in the EU ETS
is mandatory and is likely to remain that way for at least the
next five years and probably beyond the end of Phase 2 of the
EU ETS. Participation in CCAs is voluntary, but the CCL discount
is vital for financial reasons, hence almost all eligible sites
are in both the EU ETS and a CCA.
A fairly complex "double trading adjustment"
has been agreed with Defra to avoid emissions trading benefits
for the same emissions in both the EU ETS and the CCA trading
scheme (based on the UK ETS). Many CCA companies would prefer
a simpler mechanism that avoided the same energy use being in
two separate schemes, as this would ease the administrative burden.
However, it is of greater importance that the CCL discount is
maintained.
I. Page 7, Issues for Committee Scrutiny,
4th Bullet
This states: "From the perspective of
the taxpayer and competitive rivals, is it right that some businesses
can be given a tax discount despite failing to achieve their Agreement
targets?"
This is considered by ETG to be a highly "inflammatory"
statement that actually undermines one of the main pillars of
both UK and EU climate change policy ie emissions trading. Alternatively
it shows that the NAO report authors do not understand how CCAs
actually work.
The statement " . . . .some businesses
can be given a tax discount despite failing to achieve their Agreement
targets" is incorrect. Companies are only recertified
for the discount if they meet the target in one of 3 ways:
1) Direct company level achievement of the
target by saving energy within the company.
2) Indirect company level achievement of
the target by use of emissions trading with a company that has
over-achieved their target.
3) Indirect achievement of target via the
sector target (this only applies to a very small number of CCA
sector).
The use of emissions trading is an intrinsic
part of the CCA mechanism, aimed at ensuring that the overall
emission reduction targets are met at the lowest cost to the UK
economy.
The option of sharing savings amongst companies
within a sector is effectively an alternative to trading that
is an acceptable alternative within the current structure of CCAs
although it is only adopted by a small number of sectors.
J. Page 7, Issues for Committee Scrutiny,
5th Bullet
This refers to target renegotiations in 2008.
The statement implies that the 2004 renegotiation
was unsuccessful. The ETG strongly disagree. The 2004 renegotiation
has already put most CCAs onto an achievable but challenging set
of milestone targets. The 2008 renegotiation simply needs to apply
fine tuning to take into account any changes in circumstances
since 2004.
K. Page 7, Issues for Committee Scrutiny,
6th Bullet
This refers to improved estimates of savings.
We would welcome more thorough research into
this issue.
L. Page 7, Issues for Committee Scrutiny,
7th Bullet
This refers to CO2 trading in CCAs.
As already stated, trading is a vital element
of the way CCAs are structured. It is accepted by ETG that the
current price of CO2 Allowances in the UK ETS is too low. This
was caused by imperfections in the design of the direct UK ETS
in 2001-02. Although these imperfections were partly addressed
through the voluntary retirement of Allowances by some direct
participants there is still an excess of supply over demand, leading
to a low CO2 price.
It is worth noting that "learning by doing"
was a clear Government objective in the set up of the UK ETS.
Teething problems were likely and we can now build on the lessons
learned.
Had the CCA trading mechanism existed by itself
(ie without the links to the direct UK ETS) it is likely that
a more realistic CO2 price would now prevail. However, in the
early years of CCAs (ie at Milestone 1) there would have been
no market liquidity because no CO2 would have been available for
sale until after the first milestone was completed. This would
have caused great problems.
A future design needs to take these factors
into account. It is also important to consider the impact of the
time period between milestones on an emissions trading market.
For CCAs the milestones are once every two years, whereas as the
UK ETS (direct) and EU ETS operate on an annual cycle. From a
trading perspective this is highly preferable—under CCAs
the trading profile is very erratic, with almost all trades being
completed in a two-three month period once every two years.
M. Page 7, Issues for Committee Scrutiny,
8th Bullet
This refers to the long-term future of the Levy
and Agreements. It also states: "Businesses see long term
uncertainty in government policy as a barrier to improving energy
efficiency"
This is a crucial issue. Business is very keen
to start discussing the future of CCAs and have asked both Defra
and HM Treasury to start this process during 2007. The 5th and
last CCA Milestone in the current Agreements is in 2010. If a
new regime of targets is to follow on directly after Milestone
5 we have relatively little time to agree new rules and new targets.
Business investment cycles are relatively slow—an
early agreement of future targets is considered essential. On-going
uncertainty about the future of CCAs could cause UK industrial
investment decisions to be delayed or cancelled.
The ETG has written to both Defra and HM Treasury
urging an early start to discussions about the future of CCAs,
but we have not yet received any response indicating when such
discussions will begin.
N. Page 7, Issues for Committee Scrutiny,
9th Bullet
This refers to conflicts for energy intensive
products with low life cycle carbon emissions (eg insulating glass).
The ETG recognises that there could be perverse
impacts via both the EU ETS and CCAs for some products of this
type. We welcome further discussion of ways to avoid such impacts.
O. Page 7, Issues for Committee Scrutiny,
10th Bullet
This states: "Does it matter that econometric
estimates of policy impact can vary widely due to changes in business
as usual projections, even if policies are working as expected?
In the case of the Agreements, what are the implications of the
fact that taxpayers are receiving less value for the tax foregone?"
We do not agree that taxpayers are receiving
less value for the tax foregone. CCAs were introduced to avoid
competitive distortions for companies of high energy intensity.
When the CCL was introduced it was made fiscally neutral through
the reduction of employers NI contributions. This mechanism clearly
does not work for businesses with very high energy costs and relatively
low numbers of staff. The CCA tax discount was not aimed at giving
a specific level of environmental cost effectiveness—it
was given to provide fiscal neutrality for energy intensive companies.
FURTHER COMMENTS
ON ITEMS
IN EAC INQUIRY
ANNOUNCEMENT
1. Is it right for the Levy and Agreements
to target energy use, or should they be reformed to target carbon
emissions directly? If so, how should they be changed?
For the future of CCAs it will be important
to consider the scope of emissions. It is important to recognise
that CCAs affect a much larger number of UK sites than the EU
ETS and that many sites are quite small. For effective operation
CCAs must retain administrative simplicity, which will be hard
to achieve if emissions from sources other than energy are included
As stated in Comment 5 in the previous section,
we believe it is very important to include indirect electricity
emissions as well as direct fossil fuel emissions. This provides
much better coverage of industrial emissions than would be provided
by an upstream approach like the EU ETS.
Large process emissions from non-energy sources
(either process CO2 or non-CO2 emissions) are well covered by
the EU ETS. Trying to incorporate further non-energy emissions
from CCAs with small factories could add unnecessary complexity.
Non-energy emissions might be better dealt with under other instruments
(eg F-Gas emissions such as HFCs are already covered by a new
EU Regulation).
2. With the advent of UK-wide carbon budgets
from 2008 (proposed under the draft Climate Change Bill), how
valuable is the focus of the CCL and CCA on the efficiency with
which business consumes energy? Would it be better to have an
instrument which enforced absolute caps in energy use (or CO2
emissions)?
This is dealt with in Comment F in previous
section
3. How well do the Levy and Agreements fit
together with other existing and proposed climate change policies,
and what can be done to ensure maximum impact from complementary
policies with minimum administrative burden and overlap?
This is dealt with in Comment H in previous
section
4. Businesses are able to use carbon trading
to meet their targets under the Climate Change Agreements. What
have been the impacts of trading so far? Should trading be allowed
in this way, or how should it be controlled?
This is dealt with in Comment L in previous
section
5. What have been the economic impacts of
the CCL and CCA on the organisations subject to them, and the
wider UK economy?
This is impossible to answer without undertaking
a wide-ranging study.
6. Should the Climate Change Agreements be
reformed in any way? For instance, should the Agreements be simplified,
or the sectoral targets made more stringent?
As already discussed in the previous section
the ETG is a strong supporter of the CCA mechanism. We recognise
that the current CCAs were a ground breaking policy when they
were set up in 1999-2000 and that with hindsight it will be possible
to create a better design that eliminates some administrative
burden and that maximises the future environmental benefits. Examples
of improvements include widening the "90/10 rule" to
capture more energy savings and changing the rules applied to
absolute targets under a mechanism referred to as CCA 16.
The ETG has many CCA and emissions trading experts
and can provide a useful forum to discuss the future of CCAs with
Government. We welcome the early start to such discussions.
7. What are the main barriers to accelerating
energy efficiency in the business sector? How can these be overcome?
This is another question that requires a "report
sized" answer! Some historical barriers are being removed
with the significant increase of realisation that climate change
is such an important issue to address. A massive change of attitude
in both the general public and in business leaders has been evident
over the last two years. For many industry sectors this changing
attitude will lead to much more investment in energy efficiency.
However, it should be noted that for the most
energy intensive industry sectors that energy forms such a large
percentage of production costs that energy efficiency has already
received massive investment over many years. Some of these processes
are already reaching the thermodynamic minimum energy consumption.
For processes of this type energy efficiency is no longer an effective
option—the only way of making further CO2 emission reductions
in such circumstances is to use methods other than energy efficiency,
eg renewable energy supply, nuclear power, CCS etc.
8. Products which can increase energy efficiency
(such as insulating glass for windows) can be energy-intensive
to manufacture. Policies such as the CCL and CCA can penalise
manufacturers for making such products. How big an issue is this,
and what, if anything, should be done about it?
This is briefly dealt with in Comment N in previous
section. This requires more investigative work.
9. Alongside the CCL, the Government introduced
the Enhanced Capital Allowances, to further encourage firms to
make energy saving investments. How well is this scheme working?
How well does it fit with other existing or proposed climate change
instruments?
In the original CCL package announced in 1999
a significant sum of money was allocated to ECAs. However, it
is not clear how much ECAs have actually cost HM Treasury and
whether they have been widely adopted. A more direct and transparent
method would be preferable. ECAs on some major systems such as
CHP are believed to be helpful, but they have limited financial
impact on many types of energy efficiency investment (and no impact
for companies making a loss or organisations in the public sector).
10. The Levy exempts electricity from renewables,
though so far this appears to have had little impact. Should it
play a greater role in incentivising the growth of renewable electricity,
and, if so, how?
The ETG believe that the Renewables Obligation
and the EU ETS should remain the main policy tools to encourage
use of renewable energy. Heat only renewable energy is already
incentivised via CCAs. Any on-site generation of renewable electricity
is usually used to sell ROCs—with current ROC prices this
is more financially attractive than using the electricity as a
way of meeting a CCA target.
26 September 2007
9 Energy intensity is usually defined as the ratio
of the annual cost of energy to the annual turnover of the business. Back
10
The eligibility for CCAs is either based on PPC processes or uses
one of two energy intensity thresholds. Any sector with an energy
intensity of over 10% is eligible. Sectors falling between 3%
and 10% are only eligible if they also meet a high international
competition threshold (50% of the UK market for the relevant product
must be imported). Back
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