Select Committee on Environmental Audit Minutes of Evidence


Examination of Witnesses (Questions 190 - 199)

TUESDAY 30 OCTOBER 2007

PROFESSOR PAUL EKINS

  Q190  Chairman: Welcome back to the Committee. As one of the authors of the Cambridge Econometrics study of the Climate Change Levy, would you just like to tell us about how that study arrived at its conclusions?

  Professor Ekins: Good morning. It is always a privilege to be invited to give evidence to you. As you are probably aware, econometrics is a statistical technique which on the basis of theory, economic theory in this case, seeks to arrive at statistical relationships between different variables, in this case particularly the price of energy, including taxes, and the demand for energy from which you can get carbon emissions if you know the carbon emission factors involved. The way one normally models the imposition of something like the Climate Change Levy would be ex ante, in other words you have your statistical relationships between the various variables in the model; it is a large-scale economic model; it has 50 different industry sectors; it has households; it has the government sector; it has taxes—obviously; it has relations with the outside world. It is intended to include many of the statistics produced by the Office for National Statistics and to represent the kinds of dynamic effects that take place in the world on the basis of estimated statistical relationships that have applied in the past. You arrive at your estimation of the various relationships involved; you then impose the tax; and in theoretical terms you have estimated that if you increase the price of something you are likely to reduce the quantity and that then will show you the likely effect of that tax as it rolls out into the future. The study that was done in 2005 obviously was done some years after the tax had been implemented so, instead of looking forward and doing it in the way I have described, what we did was to take what we call "the base case", which was the economy as it had developed using the statistics from the then DTI DUKES, Digest of UK Energy Statistics, and the Office for National Statistics and external factors such as the oil price, over which the UK Government does not have any influence. They are all in the model, so we had the base case which was how the economy had developed, including the Climate Change Levy, and then we removed the Climate Change Levy from that base case and saw the extent to which that made a difference to the energy use and the carbon emissions. That, in a nutshell, is how it was done for the Climate Change Levy. For the Climate Change Agreements, which are much more complicated, we had to combine that kind of technique with much more detailed analysis of industrial sectors, because obviously the Climate Change Agreements are concluded with particular industrial sectors, industrial associations; they do not map very closely onto the industrial sectors in the model; and so there were quite a lot of assumptions and manipulations necessary to get the Climate Change Agreements and the energy reductions which they were thought likely to deliver on the basis of the technologies to map onto the industrial sectors.

  Q191  Chairman: The econometrics obviously analyses the stats which have taken place and the changes, but people behave in different ways for different reasons. It has been suggested by some of the other witnesses we have had that actually a lot of these savings would have been achieved by those businesses regardless of whether there had been any Climate Change Levy or any Climate Change Agreements. In other words, it was pushing at an open door; and that businesses were interested in moving in this direction anyway?

  Professor Ekins: I would certainly not be of that view. I think that businesses have an absolutely explicit obligation, which they frequently remind us of, to maximise the returns to their shareholders; and to invest in technologies which are not cost-effective in order to achieve public goals, public goods, such as reduced emissions, is not normally part of mainstream business strategy. It is something that businesses sometimes do when they feel that there are reputational benefits to be gained; when they feel that they need to make impressions on either policymakers or consumers; but it is certainly not normally part of mainstream business behaviour. From looking at both the negotiation process for the Climate Change Agreements and the very long lead-time that went into the actual implementation of the Climate Change Levy—a full two years between the report of the Marshall Commission and when the tax was actually levied (during which time the CBI waged an absolutely relentless campaign against the Climate Change Levy, which I remember very well)—there was an enormous information effect. This meant that this issue of energy prices, which before had been very, very close to the bottom of most mainstream businesses' business agendas, because energy prices had been cheap, and accounted for a very low proportion of most companies' costs and was not something that occupied the time of any board member—during that process of implementation, both with regard to the Levy itself and the Agreements, we found boards taking an interest in this issue for practically the first time in their lives. It was no surprise to me to find that, in the event, they discovered they could actually save quite a lot of energy in a cost-effective way, and they then went about and did it.

  Q192  Chairman: I think what you have just said actually rather weakens the initial part of the answer. If you say that businesses operate primarily in the interests of maximising the return to shareholders—if indeed, as you are quite right, a lot of the measures that were taken as a result you say of the Climate Change Levy relate to energy efficiency—that of course is directly in the interests of shareholders. It may be that businesses needed a stimulus to think about the potential for greater energy efficiency, but undoubtedly investment in energy efficiency is one of those areas where the environmental and economic advantages precisely coincide?

  Professor Ekins: Indeed. One of the curious things which economists and others have spent quite a lot of time trying to work out is why there is such compelling evidence that, with regard to energy efficiency in particular, people do not make cost-effective investments off their own bat. I think there are very different reasons why that happens in business and in households; but there is compelling evidence in both those sectors that that is in fact the case. What I think the evidence suggests is that businesses are more driven by price signals than households, because that particularly is what they are interested in; but that energy is not something that has traditionally occupied core managerial time. When it starts to occupy core managerial time then they become very interested in the fact that they can very often save money, which they had not realised before—that the board members were much too busy before that dealing with what they regarded as strategic business issues of market development and sales etc and were not focussing in that particular area. I think one of the major impacts—both the Climate Change Levy through what we call the "announcement effect" in our work for Treasury, and in subsequent academic work that I did on the Climate Change Agreements, what I call the "awareness effect" of the negotiations that were carried out—was that business people who normally are very interested in reducing costs (that, after all, is what a very large portion of a MBA is all about) had suddenly discovered there was a whole area of potential cost reduction which they had not been paying attention to, and they started to take advantage of that.

  Q193  Joan Walley: Recently you have been the joint author of a paper which argues that sectors subject to Climate Change Agreements have gained an advantage in respect of international competitiveness. It would be helpful if you could perhaps summarise the findings and conclusions of that report for us?

  Professor Ekins: It was a very interesting piece of work for me because the whole area challenges a lot of the assumptions that economists tend to make about the way businesses work. You will remember that the Climate Change Agreements targets were set on the basis of calculations by the then AEA Technology of all cost-effective possibilities for energy saving. The Agreements were never entered into in the thought that they would cost companies money, because they were calculated on the basis of what AEA Technology thought were all cost-effective energy savings. Then of course there was negotiation between the Government and the businesses concerned. Not surprisingly many businesses thought that AEA's Technology's assessment of all cost-effective savings was rather greater than their own. The outcome was that the actual targets represented some compromise between the initial assessments of all cost-effective savings and then the companies' assessment of that. That was the basis of the targets. If indeed it is true that all the energy that was saved by those companies was through the implementation of cost-effective measures, and that was the explicit basis on which those Agreements were set up, then what you would have obviously is that companies would reduce their energy consumption in a cost-effective manner, this would reduce their cost base in a cost-effective manner and that would be likely to increase their competitiveness. Those were the kinds of calculations that we did. Then of course there were the ex ante calculations carried out before the Agreements were introduced. Now we have had not one but three target periods reported on; and, indeed, the companies are reporting that they are managing to achieve energy savings in excess of the targets which they were set and it is very unlikely that they would be doing that if in fact it was not cost-effective for them to do so, because they will get their 80% rebate on the Climate Change Levy by just meeting the targets; in some work I did on the 2002 target period it transpired that 15 of the then 44 sectors had achieved their targets for 2010 in 2002. You would be unlikely to do that unless these achievements were being done in a cost-effective way for good business reasons. Therefore, I would conclude that they were good for the competitive position of those companies because it reduced their expenditures on energy.

  Q194  Joan Walley: Does that mean then that we can conclude the Agreements have outlived their purpose? Now everybody is focussed on energy efficiency savings, good practice, cost-effectiveness they have served their purpose and there is no need for them anymore because everyone is aware; good managers now know what savings can be made?

  Professor Ekins: Something where I slightly disagree with one of the points made in the previous evidence is I think technology develops; low-hanging fruit once picked is inclined to grow again, especially if there are price incentives to encourage it. The 80% rebate on the Climate Change Levy is a very significant incentive for an energy-intensive company. For as long as that rebate exists then it is likely that managers, especially once they have started focussing on the issue, are going to be looking for further opportunities for cost-effective energy savings. While I think a new generation of Agreements could perhaps involve rather tighter targets—because there is no evidence to me that the targets in the original Agreements were really part of what drove the business response—I think that kind of incentive is likely to be useful to keep managers on the ball and to keep them focussing on the new technologies that come down the track. Obviously you have got an 80% rebate; you have got much higher oil prices now than when the Climate Change Levy was introduced; you have got other incentives working in the same direction. All that suggests to me that we will be more likely to move closer to the real economic optimum of managers investing where they can save money than if these instruments not in place.

  Q195  Joan Walley: I am just moving to the international competitiveness which your report singled out was giving people an advantage. I am not sure all the evidence we have had from industrial lobby groups actually would agree with that. Do you feel that lobby groups or large industrial sectors are lobbying against all of this; or do you think they actually appreciate the gains that are being made?

  Professor Ekins: I think industrial lobby groups have a great incentive to argue against taxes of all kinds. I would be extremely surprised to find an industrial lobby group that said anything good had ever come out of a tax that had ever been imposed on them or their sector! I have to say that I am inclined to discount to a very large degree those kinds of statements. We have just finished with six European institutes a research project funded by the European Commission, which has quite an extensive website, called the COMETR Project, which looked in great detail at the six environmental tax reforms that had been carried out by European nations, including the UK with its Climate Change Levy and its Landfill Tax, and we did some very detailed sectoral study of some of the most energy-intensive sectors (indeed some of the ones who had been complaining most vociferously about potential competitiveness effects from these measures in all countries—UK lobby groups obviously are no exception to the general rule in this area) and we could find absolutely no evidence across a range of indicators of competitiveness that there had been any sectoral disadvantage from these instruments at all. I have to say I give that kind of detailed work we were privileged to be able to carry out through funding from the European Commission rather more weight than I do lobby groups' assertions to the contrary.

  Q196  Martin Horwood: You have half answered the question I was about to ask, which was really about whether or not the impact on competitiveness depended crucially on what kind of company you were running. It is fine for a marketing agency, accountancy firm or something like that to be able to cost-effectively reduce their bills and, therefore, gain some competitive advantage; but it is very different with a classic example such as aluminium which is a very, very energy-intensive industry but quite mobile, so you are subject to very easy competition from places like the USA which might not have a price for carbon in the same way. You are confident from the detailed work you have done that even energy-intensive mobile industrial sectors like aluminium would gain some competitive advantage from this kind of regime, are you?

  Professor Ekins: There are always exceptions from any rule or experience that one cares to look at. Aluminium is a particularly difficult sector, in the sense that it is very energy-intensive; it does put a lot of effort into managing its energy use already; and, as you say, countries have very different energy prices in an attempt to woo those sectors. I think it is going to be increasingly improbable in a world that is carbon-constrained that those countries that have commitments to reduce their emissions will be wooing aluminium, unless they have very low carbon sources of energy; and of course we can see that in some instances the aluminium industry already operates from countries that have low carbon sources of energy. One has to recognise that part of the aim of these instruments is to reduce carbon emissions; is to make aluminium more expensive, because aluminium is a very energy-intensive, if convenient, product; and is to encourage people to find lower carbon ways of meeting the same needs.

  Q197  Martin Horwood: That is a slightly different argument, is it not? That argues for a more comprehensive international agreement so that actually an aluminium company could not relocate because there would not be anywhere that was offering the price advantage. That is a different one from arguing, as you seemed to be doing a minute ago, that almost everybody can gain a competitive advantage from being in a more rigid carbon-focussed regime?

  Professor Ekins: What I was arguing was on the basis of the Climate Change Agreements there is evidence that practically all those sectors exceeded their targets on the basis of targets that had been set in an explicitly cost-effective fashion. To the extent that they did that, I conclude that they are more competitive now than they were before the Climate Change Agreements. I have not got the numbers for the aluminium sector in the UK off the top of my head.

  Q198  Martin Horwood: Were they included?

  Professor Ekins: They were included in the Climate Change Agreements; they did have targets; they did meet those targets; and these were presumably cost-effective energy reductions that they made. To that extent they would have improved their competitiveness.

  Q199  Joan Walley: Have you done any cross-research with other companies in other countries that are not subject to the same levies or the same restraints? I am thinking in particular of the ceramics industry.

  Professor Ekins: Across Europe we all have climate change policies and obligations.


 
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