Memorandum submitted by the Chemical Industries
Association
The Chemical Industries Association (CIA) Climate
Change Agreement (CCA) covers around 300 sites in a sector which,
in total, has 190,000 employees across every region of the UK.
The sector is one of the UK's most important industrial sectors,
accounting for 11% of manufacturing gross value added and is the
only major sector to maintain a significant positive trade balance,
typically registering a surplus of £5 billion annually. The
chemical industry faces global competition with UK assets predominantly
owned by companies that are headquartered overseas.
The industry converts both mineral and plant
based raw materials into key intermediates for use by other manufacturing
sectors as well as its own final products for households, ranging
from paints to detergents, fragrances to pharmaceuticals. We buy
our raw materials and sell our bulk products at global prices
with energy representing a high proportion of the conversion cost.
As well as being major consumers of both gas and electricity for
heating and power, our members use gas and oil as feedstocks—for
some companies energy represents 30% or more of their total costs.
As we are both energy intensive and exposed
to international competition, the impact of the Climate Change
Levy (CCL) on our business could have been significant, had the
CCA commitments not provided a means for securing relief. Under
the CCAs we have a good track record for improving our performance
while the use of relative targets has ensured there is no disadvantage
to production growth it is on an energy efficient basis. Unfortunately,
overlaps and duplication have arisen with other instruments eg:
the EU Emissions Trading Scheme (EU ETS).
After the current CCAs run their course, we
see a continuing role for a CCA-type instrument suited to energy
intensive sites which fall below EU ETS coverage which, unlike
the proposed Carbon Reduction Commitment (CRC), qualifies them
for relief from the energy tax (currently the CCL) as provided
for by the Energy Products Directive. While effectively targeting
continued improvements in performance, it is important that this
instrument:
— Minimizes competitive impacts;
— Does not incentivize displacement
of activity to countries which are not carbon constrained;
— Avoids administrative complexity
arising from overlaps or coexistence with other instruments on
the same site;
— Ensures that operators receive a
single and predictable carbon price signal.
OVERALL COMMENTS
ON THE
CONTRIBUTION OF
THE CLIMATE
CHANGE LEVY
AND AGREEMENTS
TO EFFICIENCY
IMPROVEMENTS
There should be greater recognition that the
CCAs are a success story. In the chemical industry the CCAs have
further built on our already good record for energy efficiency
improvement. Over 1990-98, the sector's voluntary energy efficiency
agreement with DETR produced an 18% efficiency improvement and,
since then the sector's CCA has contributed 20%: in total this
is a 34% improvement from 1990 to the 2006.
We firmly believe that the CCAs that have raised
awareness and generated beyond business as usual improvements
both through the challenging but achievable targets that have
been negotiated but also through instilling a greater ethos of
measurement to manage to improve. Top level involvement has been
stimulated through the requirement to implement the qualitative
requirements (an energy policy and plan) and the need, in many
companies, for board level sanction for emissions trading decisions.
We believe that increased awareness is being sustained because:
— Companies are required to maintain
their CCAs and report progress: this includes continuing to meeting
the qualitative requirements and an obligation to review targets
every 4 years—in the 2004 review chemical sector 2010 targets
were tightened by an average of 4%.
— Our large companies and many of our
SMEs include the price UK Emissions Trading Scheme (UKETS) allowances
in their investment and other business decisions.
There are a number of findings in the National
Audit Office (NAO) report on the CCL and CCAs which we would like
to comment on:
— Business is divided over the effectiveness
of the CCAs—this is credible in the context of many
targets being imposed "top-down". Whereas CCA targets
in the most intensive sectors, like chemicals, are developed on
a "bottom-up" basis according to what is challenging
and achievable at site level, many of the less intensive sector's
targets have been set on a "top-down" basis in which
all sites commit to an average sector improvement. Clearly, a
top-down approach will be tough on some and easier for others
and will therefore appear less meaningful.
— DEFRA's latest modelling suggests
that CCAs have contributed less emissions reductions than originally
estimated. This is on the basis that business as usual improvements
have increased over original quantifications, although NAO recognises
that the results of such econometric modelling are subject to
a high degree of uncertainty. While there is no doubt that the
more competitive global environment together with energy price
rises have helped to drive increased efficiency, it would be counterproductive
to vary climate change commitments with every change in business
as usual as this would create administrative burdens and uncertainty.
What matters is that targets are met and that any unexpected sustainable
overachievements are factored into the next CCA target review,
planned for 2008. It should be noted that high energy prices also
have a negative impact and, at the 2006 milestone, led to lower
throughput, and reduced contributions from combined heat and power—symptoms
which, together with increased requirements for environmental
abatement, were anticipated to act as a drag on our efficiency
in the 2004 review.
— The announcement of CCL resulted
in businesses making energy efficiency improvements—we believe
that most of the improvements have taken place in the CCAs. This
is because we do not believe that CCL has been at sufficient levels
to drive improvements outside the CCAs of most non-intensive organisations
whereas energy costs are relatively insignificant to the cost
base. The study by Cambridge Econometrics NAO cite, which attempts
to quantify the CCL announcement effect, appears to place a heavy
caveat on its findings when it records that how far the observed
fall in energy consumption is attributable to an announcement
effect or a rise in temperatures is a matter of "econometric
judgement". In relation to the Ineos Chlor case study cited
as evidence of the CCL announcement effect it should be noted
that the intention to negotiate agreements for energy intensive
sectors was also part of this announcement and that Ineos Chlor
are CCA participants whose improvements have also been attributed
to the chemical sector CCA. Other anecdotal evidence, including
that from the Carbon Trust's experience, CBI surveys, and the
NAO's survey, support the view that most improvements have taken
place in the energy intensive sectors covered by the CCAs.
Please find below our comments on the issues
set out in the EAC's call for evidence.
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?
It is important that any future CCL changes
take care to ensure that there is continuity in regulatory incentives
which have driven long term investments. CCL is the foundation
on which several Government incentivisation programmes are built,
eg: exemptions for Combined Heat and Power Quality Assurance (CHPQA)
and renewable source electricity. While we do not therefore support
radical change, we believe that the efficacy of the CCL would
be enhanced if it were developed to reflect carbon emissions rather
than calorific value. This would then be consistent with the need
to make a transition to a low carbon economy. However, if this
change is made, it is imperative that equivalent incentivisation
programmes be put in place to replace those founded upon CCL.
The continuation of access to CCL relief is
essential to sustaining the international competitiveness of intensive
businesses in the chemicals sector—for some of our most
intensive sites, energy accounts for more than 30% of total costs.
We therefore see a continuing role for CCAs. While CCAs already
provide incentives to use low carbon fuels through their link
to the UKETS, we agree it would be sensible to make a full move
to carbon based targets. However, we see a continuing role for
relative targets as this approach directly incentivises reductions
in the carbon footprint of products—until industry elsewhere
becomes carbon constrained, absolute targets at site level risk
driving carbon intensive production to potentially less efficient
locations.
We support the Government's decision to let
the current CCAs run their full course, ie: to the 2010 target,
and that CCL continues until March 2013 as this gives time to
plan their successor. However, we are concerned that formal consultation
on the future of the CCAs is being delayed until 2008. Energy
intensive sectors like chemicals have long asset life cycles so
it is important to have certainty to inform on long term planning
decisions. We would therefore welcome an early indication from
Government on the future of CCL and CCAs.
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)?
Part of the success of the CCAs has been due
to their use of relative targets which ensure that improved energy
efficiency is achieved without imposing a growth penalty. We see
a continuing role for relative targets as this approach directly
incentivises reductions in the carbon footprint of products—until
industry elsewhere becomes carbon constrained, absolute targets
risk displacing carbon intensive production to potentially less
efficient locations. Indeed, carbon efficiency is becoming more
prominent in the Commission's review of the ETS post-2012. EU
ETS review discussions are currently signalling that benchmarks
will be used to maintain free allocations and minimise competitive
impacts—this interest is allied to a recognition that this
approach has the added benefit of giving a performance (energy
efficiency) signal.
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?
There are too many economic instruments and
carbon price signals per company.
We estimate that in combination, CCL, the Renewables
Obligation and the EU ETS have added around 20% to the cost of
electricity in our sector as this includes the full CO2 cost pass
through of the EU ETS (this estimate is relates to the period
before the fall in the price of Phase 1 EU allowances which will
be shortly be reversed with the start of Phase 2). This means
that electricity users are paying for the related carbon emissions
more than once—this is particularly impacting our competitiveness
with non-EU producing regions.
The introduction of EU ETS has also added to
complexities and administrative burdens as sites now have to participate
in two emissions trading schemes and overlaps in scheme coverage
produce the need for a double counting mechanism. To minimise
overlap, Government should consider extending exemption from CCL
to EU ETS participants to reduce the need to participate in both
EU ETS and CCAs. Now that EU ETS is in place we believe that the
pass through of full CO2 costs to electricity prices provides
sufficient incentive for sites in energy intensive sectors to
improve their use of this energy source. Government should resist
any drive for a CCA successor to target improvements in the end-use
of electricity on intensive EU ETS sites. Small emitters should
be excluded from the EU ETS because their participation is not
cost effective; they would be better covered by equivalent schemes
with lower administrative burdens like the CCAs.
Coverage of sites by IPPC, CCAs and EU ETS leads
to multiple CO2 emissions reporting requirements and frustrations
arise from each scheme using different CO2 conversion factors.
This needs to be rationalised as part of the review of the EU
ETS and CCAs post-2012; change prior to that would bring a burden
as systems are now established for the current CCAs.
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?
UKETS has provided significant early learning
benefits and has made some contribution to CCA overachievements.
We believe trading to meet CCA targets should be allowed because
UKETS is integral to the scheme.
Through the CCAs, UKETS is the first cross manufacturing
sector emissions trading scheme in the world. CCA participants
in UKETS have benefited from early learning and in coming to the
EU ETS many already understood how to trade, how to use a registry,
and had established relations with various brokers. Due to this
early experience, chemical companies have included the price of
UKETS allowances in their business decisions and this has also
lead them to include the price of EU ETS allowances when the scheme
started. Participation in UKETS has helped to incentivise overachievements
against CCA targets although, owing to the oversupply of allowances,
these incentives have been relatively weak. A third of chemical
sector participants have also traded to meet compliance at each
milestone: despite low allowance prices, trading costs have added
to awareness effects at top level within companies where trading
decisions are sanctioned. Low prices have arisen in the context
of UKETS being the original learning by doing scheme; we note
there have been similar problems in Phase 1 of EU ETS—it
is only from experience that these issues can be improved.
By definition, emissions trading mechanisms
work by trading to meet compliance. Trading provides a flexible
mechanism which allows emissions across businesses to be secured
at least cost while ensuring that overall environmental objectives
are met. UKETS is integral to the CCAs and they were signed on
the basis that there was provision for such trading. It is therefore
entirely legitimate for a business to secure continued CCL relief
by trading to meet CCA. Indeed, the EU Energy Products Directive
provides for relief from such energy taxes to be provided to intensive
businesses participating in trading schemes.
5. What have been the economic impacts of
the CCL and CCA on the organisations subject to them, and the
wider UK economy?
The cost impacts of CCL on our members have
generally been muted as most pay after CCA relief at 80%. However,
depending on the fuel and its current price, unrelieved CCL represents
10% to 20% of energy costs. Because our most intensive companies'
energy costs can exceed 30% of their total costs, the loss of
relief therefore represents a significant sanction.
Because of set-up costs and ongoing administrative
requirements, CCA companies tend not to find CCA participation
worth management time if annual CCL savings are below £10,000
p.a. The administrative requirements are therefore not insignificant
and can be complex as they comprise:
— CCA performance monitoring and reporting;
— annual checks on PP4 eligibility
form including the 90/10 rule;
— maintaining claims for CCL on each
account from each energy supplier with reviews at minimum on an
annual frequency;
— participating in UKETS including
the registry, dealing with trader/brokers and trading agreements,
and any third party verification of overachievements.
To understand resource requirements we undertook
a case study of a chemical sector SME. The CCA facility in question
is a speciality chemicals company engaged in manufacture by batch
process. The company estimates that it spends 16 man-days p.a.
on administrative requirements for CCAs at a cost of £7,000
p.a
These figures demonstrate that CCA costs are
not insignificant. However, they are below the burdens imposed
by the EU ETS which the SME is also subject to although its annual
emissions are below 25kCO2 p.a. The company estimates that, of
the 16 man-day spent on its CCA, 13 man-days are on monitoring
and reporting that is also used for EU ETS. But there are an additional
9.5 man-days (cost £3,500) which are EU ETS only and relate
to permitting. In addition, the fees for the permit, permit variations
and verification total £1,800 p.a. It is clear that coverage
by EU ETS adds significantly to administrative burdens and that,
in this respect, the lighter touch of CCAs is a more appropriate
instrument for small emitters in intensive sectors.
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?
It would be sensible to make a full move to
carbon based targets, reduce overlaps with other instruments and
make CCAs and other instruments in the policy mix more consistent
(see also answers to questions 1, 2 and 3).
Simplifications should include the removal of
requirements for third party verification to generate emissions
allowances from CCA overachievements. This requirement makes individual
verification of small overachievements, eg: by SMEs, uneconomic.
Instead, allocations should be made based on self-certified data,
though this should be backed by an increased number of sample
audits. This would be consistent with the self-certification principle
included in the Government's CRC proposals. We would also favour
some relaxation in the 90/10 rule as this bars a number of our
sites from including all their activities under a CCA and thereby
taking a holistic approach to targeting efficiency improvements.
The current CCAs already include provision to
review targets every four years to take account of changes in
circumstances, eg: new technological developments. The review
conducted in 2004 strengthened the chemical sector relative energy
target for 2010 by 4% and this greatly reduced the overachievement
at the 2006 milestone. The Government has confirmed that next
review set in the agreements, for 2008, will go ahead as planned.
With reference to the final bullet in paragraph 3.32 of the NAO
report, it is clearly correct that emissions allowances built
up from overachievements in previous milestones should not be
factored into the review. This is because, under the principles
of emissions trading, these form part of the payback for the improvement
measures in question. It is also entirely correct, of course,
that any unexpected, but sustainable overachievements are factored
into the next CCA target review.
We would support the new, independent Climate
Change Committee advising Government on the review to ensure the
right balance is struck between contributions from early starters
in CCA sectors and other sectors of the UK economy, where there
may be more cost effective potential.
7. What are the main barriers to accelerating
energy efficiency in the business sector? How can these be overcome?
In the chemical sector, an acceleration in energy
efficiency will require significant process change/plant replacement
or the development and innovation of step change technologies.
This is because the sector is an early starter in improving the
energy efficiency of its existing assets and much of the "low
hanging fruit" has been addressed. Over 1990-98, the sector's
voluntary energy efficiency agreement with DETR produced an 18%
efficiency improvement and, since then the sector's CCA has contributed
20%: in total this is a 34% improvement from 1990 to 2006.
Economic barriers therefore include availability
of cost effective energy efficiency projects, capital to fund
them, and asset life cycles. Plant supporting our most energy
intensive activities tends to have long life cycles (eg: ethylene
crackers, where equipment can be continuously upgraded and refurbished
within a framework laid down 20 or more years ago). While market
based instruments like emissions trading can help to improve the
payback on complete replacement, it would need an unsustainably
high carbon price to provide sufficient incentive to replace plant
mid-way through its life. What's more, a multilateral approach
to emissions trading is a pre-requisite for a high carbon price
as, until industry elsewhere becomes carbon constrained, this
would risk displacing carbon intensive production to potentially
less efficient locations.
There are also barriers to innovation. In the
above context, as Nick Stern recognizes, additional sources of
coordination and support are needed to work alongside carbon markets
to ensure the development and innovation of the step-change technologies
that will be needed to move us towards our ambitious long term
climate change goals. In this respect we feel more needs to be
done to support commercialisation and demonstration of step change
technologies.
Finally, uncertainty about the future climate
change policy mix also represents a barrier to improving energy
efficiency. In the longer term it is difficult to anticipate additional
changes as a result of climate change policy. There is considerable
uncertainty about the future shape of EU ETS and CCAs post-2012
and whether these systems will be part of a multilateral or unilateral
framework for addressing climate change. This uncertainty is inhibiting
investment decisions
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?
Chemical sector products also provide some of
the solutions to climate change, eg: materials for wind turbine
blades, silicon for photovoltaic cells, fuel cells, insulation
materials for housing, low weight materials for cars and other
applications, synthetic rubber for low rolling resistance tyres
and low temperature detergents.
It would be very complex to recognise the contributions
of these innovations in schemes aimed at improving plant efficiency.
A key thing that can be done is to avoid penalising these technologies
by providing for their coverage by relative targets which are
consistent with their realistic carbon intensity—until industry
elsewhere becomes carbon constrained, absolute targets risk displacing
such production to potentially less efficient locations.
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?
The ECA scheme provides information benefits
because it helpfully identifies energy efficient equipment. Whether
the 100% depreciation allowance in the first year is significant
to an energy project depends on the extent to which it comprises
eligible technologies. The Budget 2007 decision to extend equivalent
financial benefits to companies that have not generated a profit
will help to increase the take-up of the scheme and is very much
welcomed.
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?
Renewable electricity enjoys sufficient incentives
from the combination of Renewables Obligation Certificates (ROCs)
and Levy Exemption Certificates awarded to relevant schemes. Indeed,
the banding proposal in the Energy White paper will increase the
ROCs allocated to technologies which need higher levels of support
to be economic. There is also an incentive from the full pass-through
of EU ETS CO2 costs to electricity prices. There is therefore
no need to increase the incentive from CCL.
2 October 2007
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