Memorandum submitted by Steve Sorrell,
Senior Fellow, Sussex Energy Group, SPRU, University of Sussex
EXECUTIVE SUMMARY
This submission proposes a hybrid emissions
trading as an attractive alternative to Personal Carbon Allowances
(PCAs). It argues that a hybrid scheme provides most of the benefits
of personal carbon allowances, but is likely to cost much less
to implement and is more likely to gain political acceptability.
Most importantly, the hybrid allows an effective interface with
the EU Emissions Trading Scheme (EU ETS) and the global carbon
market.
This document is based upon evidence submitted
in August 2006 to the EFRA Select Committeee inquiry on Climate
change: the citizens agenda. In addition, the Annex to this
document is based upon follow-up evidence to the EFRA inquiry,
submitted at the request of the Clerk in December 2006. At the
time of writing (July 2007), the EFRA Committeee has still to
publish its final report.
The main message of this submission is that
personal carbon allowances should not be investigated in isolation.
Potential alternatives need to be considered, together with the
interaction of such schemes with other existing and proposed policy
instruments. These interactions may preclude the introduction
of either a hybrid scheme or a personal carbon allowance scheme
within the short to medium-term. However, given its potential
benefits, I recommend that the government investigate a hybrid
scheme as a possible basis for UK climate policy in the long-term.
INTRODUCTION
Interest in a Personal Carbon Allowance (PCA)[8]
scheme has grown in recent years, encouraged through research
and advocacy work by Mayer Hillman of the Policy Studies Institute
(Hillman, 2004), the Environmental Change Institute at Oxford
University (Fawcett, 2005) and the Tyndall Centre for Climate
Change Research (Starkey and Anderson, 2005). The proposal has
gained widespread media attention, with strong views being expressed
both in support of the idea and in opposition to it.
The government commissioned a scoping study
on PCAs in 2006 (Roberts and Thumin, 2006). This noted how researchers
had focused excessively upon the operational minutiae of specific
schemes and neglected assumptions about public responses and political
feasibility (Roberts and Thumin, 2006). The 2007 Energy White
Paper promised a programme of further research on PCAs, but highlighted
concerns about the practical viability of such a scheme and the
implications for social equity. Both of these issues are addressed
in this submission.
Given the radical nature of the PCA proposals,
it is encouraging that the government should show such an interest
in the idea. However, concerns over the cost, practicality and
political feasibility of PCAs may be well founded. In investigating
a PCA scheme, it is essential to ask whether there are simpler
and more practical alternatives that could provide comparable
economic and environmental benefits, as well as be introduced
within a shorter period of time. I believe that a hybrid emissions
trading scheme provides such an alternative and deserves serious
consideration.
This submission describes the basic elements
of such a hybrid scheme and compares it with the PCA scheme under
five headings: economic efficiency; environmental effectiveness;
social equity; administrative costs; and political acceptability.
It concludes that, overall, the hybrid scheme provides the more
attractive option.
BASIC ELEMENTS
OF A
HYBRID SCHEME
In the design of a carbon trading scheme, there
is a basic choice between a downstream scheme, in which fossil
fuel users surrender allowances for their emissions, and an upstream
scheme, in which fossil fuel producers (or suppliers) surrender
allowances for the carbon content of the fuel they sell. The EU
ETS is a downstream scheme confined to the largest emitters, while
PCAs are a downstream scheme for all emitters, including households.
An upstream scheme places a cap on carbon emissions from the whole
economy, while most downstream schemes only cap the emissions
of a subset of the economy. What is unusual about the PCA proposal
is that it combines a downstream scheme within economy-wide cap.
The EU ETS is already in place and is likely
to remain in its present form for the foreseeable future. In this
context, both an upstream trading scheme and a PCA scheme would
face potential problems of:
Double regulation: EU ETS participants
could simultaneously face two sets of carbon prices for the fuel
they consume (ie the EU ETS price and the PCA/hybrid price), while
all electricity consumers could face two sets of carbon prices
for the electricity they consume (because the EU ETS carbon price
is reflected in the wholesale price of electricity).
Double counting: A single abatement
action could lead to two separate carbon allowances being soldone
in each scheme (Sorrell and Sijm, 2003).
Proponents of the PCA s scheme have not provided
adequate proposals for how these problems would be addressed.
However, with an upstream scheme these problems could be avoided
relatively simply through a hybrid approach (Hargrave, 2000; Mazurek,
2002). In this, the EU ETS would operate alongside an upstream
scheme that covered all other fossil fuel CO2 emissions,
including those from households, non-domestic buildings and transport.
In a hybrid scheme, fossil fuel producers or
suppliers would be responsible for the carbon content of fuel
sold to downstream consumers that are not participating in the
EU ETS. The upstream participants would include oil refineries,
oil and gas importers and coal companies and the relatively small
number of companies involved should keep the administrative costs
low. These companies would need to surrender an allowance for
each tonne of carbon contained in the fuel sold to eligible customers,
and would pass these allowance prices on in fuel prices. The incentive
effect for downstream consumers would be akin to a carbon tax.
To avoid double regulation and double counting,
the system would need to ensure that the fuel purchased by EU
ETS participants did not include the price of carbon allowances
in the upstream trading scheme. This would require a "paper
trail" to be established to track fossil fuel sales along
the supply chain, via wholesalers and intermediaries to final
consumption. Upstream producers would require allowances for all
the fuel sold, unless they could demonstrate that a participant
in the EU ETS ultimately consumed the fuel.
The UK could introduce an upstream scheme in
parallel with the EU ETS to create a hybrid that covered the majority
of CO2 emissions from the UK economy. This could accommodate
the expansion of the EU ETS in Phase 2 and beyond by simply modifying
the accounting system for fuel sales (ie extending the exemptions)
and adjusting the cap in the upstream scheme.
If the upstream scheme used free allocation
of allowances, fossil fuel suppliers would receive large windfall
profits. These firms will raise fuel prices to reflect the opportunity
cost of allowances, while only incurring expenditures for any
net allowance shortfalls. This is similar to the current situation
in the EU ETS, where free allocation of allowances has allowed
UK electricity generators to benefit from windfall profits of
the order of £1 billion/year (Sijm, et al, 2006).
Hence, in an upstream stream, the great majority of the allowances
should be auctioned and the revenues redistributed to fuel consumers
to compensate for the higher prices they face. As with carbon
tax proposals, the overall scheme would then be revenue neutral.
The redistribution of funds could take place
through the existing tax and benefit system, or a separate system
could be established. A commonly cited model is the Alaska Permanent
Fund, which distributes mining and drilling royalties on an equal
per capita basis to all Alaskan citizens. An equal per capital
allocation has the advantage of simplicity and should minimise
administration costs.[9]
However, the rules could be modified to reflect a variety of distributional
objectives, including compensating the fuel poor. The impact of
the scheme on fuel prices should be identical, whether free allocation
or auctioning is employed.
ECONOMIC EFFICIENCY
By putting a price on carbon, both schemes encourage
economic efficiency in fuel use and emissions reduction. The PCA
scheme encourages fuel consumers to engage directly in trading.
If a consumer chooses to use more fuel than her PCA allocation
allows, she must either purchase additional allowances or pay
a premium on the fuel pricethereby foregoing the consumption
of other goods and services. Conversely, if she chooses to use
less fuel than her PCA allocation allows, she may sell her surplus
allowances and use the money in other ways.
The incentives in a hybrid scheme are entirely
analogous. Fuel is more expensive since it embodies the carbon
price, but consumers are allocated a lump sum from the auction
revenues with which to compensate. If a consumer chooses to use
more fuel than her lump-sum allocation (of money) permits, she
must forego the consumption of other goods and services. Conversely,
if a consumer chooses to use less fuel than her lump sum allocation
permits, she has additional money available to spend.
The key point is that if the cap (and hence
carbon price) is the same in both schemes and if the rules for
allocating PCAs are the same as those for allocating auction revenues,
then the economic impact on individual consumers is the same in
both schemes. As a result, the economic incentive to reduce fossil
fuel consumption should be the same. It should be noted, however,
that consumers would need to engage in trading in the PCA scheme
if they wished to convert their surplus allowances into money.
In a hybrid scheme, consumers would be given the money directly.
Business and the public sector face a uniform
carbon price in both schemes and would seek to include this in
the price of their goods and services. The extent to which they
can do so will depend upon the extent to which the relevant goods
and services can be imported from outside the UK from companies
that do not face a comparable carbon price. Again, if the cap
and allocation rules are comparable in both schemes the impact
on the price of goods and services should be broadly the same
in the two schemes. In practice, the price impact will also depend
upon the administrative and transaction costs of the scheme and
the manner in which they are distributed between different participants.
As argued below, these costs are likely to be higher in the PCA
scheme than in the hybrid.
The economic efficiency of either the PCA or
hybrid scheme could be increased (at least over the short to medium-term)
if there was scope for trading allowances with other schemes,
including the EU ETS. Such "links" should equalise allowance
prices in the two schemes, which means that allowance prices in
the PCA or hybrid scheme could either rise or fall. If credits
from Joint Implementation (JI) and Clean Development Mechanism
(CDM) projects were allowed to be imported into the PCA or hybrid
scheme, allowance prices would probably fall, thereby reducing
compliance costs in the UK. As Box 1 shows, there are legitimate
concerns over whether such short term cost reductions may actually
increase the cost of reducing emissions over the long-term. This
highlights the difficult trade-offs that need to be made in the
design of any emissions trading scheme. Both a hybrid and a PCA
scheme face the same trade-offs, but the scope for linking is
greatly constrained in the latter because of the risk of double
counting emission reductions. In particular, links with the EU
ETS may not be feasible. A hybrid scheme avoids these difficulties
since there is no double counting of emission reductions.
Proponents of PCAs have argued that, when faced
with a personal carbon allowance individuals may respond by engaging
"more fully" in the task of identifying emission reduction
opportunities, thereby reducing the cost of carbon abatement (Starkey
and Anderson, 2005). Comparable arguments have been made by the
Carbon Trust in support of the Carbon Reduction Commitment for
business and the public sector (Carbon Trust, 2005b). These propositions
deserve further research, since neither the Tyndall Centre nor
the Carbon Trust cite any empirical evidence in their favour.
Moreover, any efficiency benefits that do result need to be set
against the greater administrative cost of the PCA scheme.
Box 1 Open or closed trading schemes
The ability to trade carbon allowances between
different trading schemes is known as "linking". An
"open" trading scheme allows linking while a "closed"
trading scheme does not, although in practice there will be a
range of choices over which links are established and with what
restrictions. The Linking Directive allows credits from Joint
Implementation (JI) or Clean Development Mechanism (CDM) projects
to be imported into EU ETS and it is envisaged that the EU ETS
will be linked to other regional or national trading schemes in
the future. Hence, the potential for linking UK trading schemes
with the EU ETS and with schemes in other countries needs to be
seriously consideredespecially over the long-term.
As argued by the Stern Review, linking should
reduce the overall cost of compliance in the two schemes, help
prevent the abuse of market power, improve liquidity and reduce
allowance price volatility. In addition, links to the CDM may
allow investment finance to be channelled to environmentally beneficial
projects in developing countries, thereby encouraging technology
transfer and sustainable development.
Linking should equalise the allowance prices
in the two schemes, or at least bring them closer together. Hence,
if a UK trading scheme is linked to a scheme with lower allowance
prices, the allowance price in the UK will fall. While this will
reduce compliance costs for UK participants, it will also reduce
the incentive for developing or adopting low carbon technologies.
There may also be concern about the stringency of the caps in
the linked schemes, the implications of design features such as
non-compliance procedures and the environmental integrity of emission
reductions achieved through project-based mechanisms such as the
CDM (Ellis, et al, 2007). Some of these concerns are reflected
in the Kyoto Protocol requirement that international trading be
"supplemental" to domestic action, but this requirement
has yet to be operationalised in an effective manner.
Trading schemes that are relatively "open"
can minimise abatement costs in the short-term by maximising the
flexibility to trade. But if this flexibility is combined with
uncertainties over long-term carbon prices and relatively unambitious
caps, the incentives for structural change, innovation and investment
in low carbon technologies will be undermined. The consequent
lock-in to carbon intensive technologies and infrastructures could
make it prohibitively expensive to achieve deeper emission cuts
in the long-term as well as reinforcing the political opposition
to such reductions.
In contrast, trading schemes that are relatively
"closed" will increase abatement costs in the short-term
by restricting the ability to trade. But if these restrictions
are combined with greater predictability over long-term carbon
prices and more ambitious caps, the incentives for structural
change, innovation and investment in low carbon technologies will
be increased. The drawback is that the consequent increase in
short-term abatement costs and could make it correspondingly more
difficult to agree ambitious short-term targets.
ENVIRONMENTAL EFFECTIVENESS
The environmental effectiveness of the scheme
depends upon the stringency of the overall cap. In principle,
this could be the same in both schemes. The PCA proposals typically
include a "carbon budget" that gives some long-term
(eg 20-year) predictability in carbon targets, and hence indirectly
in carbon prices. Since this is very similar to the proposals
contained in the Draft Climate Change Bill, it suggests that a
PCA scheme could provide a straightforward means of implementing
the Bill's provisions. But this applies equally to the hybrid
scheme, since both can provide an economy-wide cap on emissions.
The carbon price will depend upon both the stringency
of the cap and the balance of supply and demand. A shortage of
allowances could push the carbon price to a high level, which
could be politically unpopular. This disadvantage is balanced
by the advantage that (unlike with a carbon tax) both schemes
could guarantee attainment of a particular CO2 target.
This price/quantity trade-off is central to the choice between
carbon taxes and carbon trading (Weitzman, 1974). One way of mitigating
the allowance price risk would be to introduce a "safety
valve" in the form of a relatively low penalty price for
non-compliance (Mckibbin and Wilcoxen, 2002). The penalty price
would set a ceiling on compliance costs and allowance prices.
If abatement costs are higher than anticipated, and the price
of allowances rises above the level of the penalty, participants
will prefer to pay the penalty rather than purchase allowances
from the market.
A "safety valve" could improve the
political acceptability of both schemes, but it would remove the
guarantee of meeting a particular emission target as well as creating
an obstacle to linking to other trading schemes (Ellis and Toirpak,
2006). An alternative therefore may be to establish a link to
the EU ETS and/or other emissions trading schemes. The resulting
expansion of the market should reduce price risk and volatility,
andin the case of the hybrid schemereduce the potential
for the exercise of market power by fuel suppliers.
The key point, however, is that the risk of
high allowance prices is an issue for both schemes. While this
risk could be mitigated in both schemes, there is greater scope
for doing so with the hybrid scheme since there are few obstacles
to linking.
SOCIAL EQUITY
Research by the Tyndall Centre on PCAs has paid
particular attention to social equity, with a focus on the philosophical
rationale for allocating allowances on an equal per capita basis.
A difficulty with this approach is that it could hurt the fuel
poor. Research by the Policy Studies Institute has shown that
low income households vary widely in their energy consumption,
owing largely to wide variations in the energy efficiency of housing
(Dresner and Ekins, 2006). As a result, an equal per capita allocation
would be regressive. While the impact could be reduced through
the allocation of additional allowances to fuel poor households,
in practice these are difficult to identify.
A hybrid scheme faces similar problems. Dresner
and Ekins (2006) have shown how the regressive effect such a scheme
could be mitigated through recycling the revenues through the
existing tax and benefit system. However, this would not prevent
a worsening of fuel poverty for 20% of the poorest households,
including those who are already most badly affected.
Fuel poverty is therefore a generic obstacle
to both types of scheme. The accelerated elimination of fuel poverty,
coupled with the development of compensation schemes to protect
low-income households is likely to be an essential prerequisite
for the introduction of either. However, such compensation may
be much simpler to administer with the hybrid scheme, since it
would simply involve modifying the existing tax and benefit system.
In contrast, the PCA scheme requires allocation rules for a newly
created currency of carbon allowances.
The Tyndall researchers have also argued that
allocating emission rights to individuals gives them additional
"control" over those emission rights compared to the
lump-sum recycling of auction revenuesincluding choosing
to whom to sell (or not sell) units and choosing to retire units
(Starkey and Anderson, 2005). But consumers could also choose
to purchase and retire allowances in the hybrid scheme, using
their lump-sum allocation. Decision rights over allocated allowances
may potentially be valuable for a small group of "ethical"
consumers, but is likely to be a marginal concern for most.
ADMINISTRATIVE COSTS
The PCA proposals amount to establishing an
entirely new currency in which 45 million citizens will be participating,
together with all of business and the public sector. Individuals
would primarily participate through a new electronic card system,
similar to existing credit/debit cards or the proposed ID cards.
The Tyndall Centre has argued that this is administratively feasible,
but has not been able to estimate the associated costs. It seems
reasonable to assume that these will be large. Business and the
public sector would participate via auctions. Interestingly, research
on PCAs has tended to focus disproportionately on the mechanics
of individual participation, and has paid relatively little attention
to the implications for energy-using organisations. Research into
the proposed Carbon Reduction Commitment for non-energy intensive
organisations in the business and the public sector has suggested
that, for smaller sites, the transaction costs can easily exceed
the benefits of participation in emissions trading schemes (Radov,
et al, 2006). As a result, the government has raised the
proposed size threshold for participation (DEFRA, 2007).
In contrast, the administrative costs associated
with a hybrid scheme should be relatively small. The total number
of participants should be less than 50, monitoring and verification
arrangements would be straightforward and the recycling of auction
revenues could be implemented relatively easily through the existing
tax and benefit system or some other means. The requirement for
a "paper-trail" for fuel sales would impose administrative
costs on the fuel supply chain, and would require independent
auditing and verification. But while these costs require further
examination, there are parallels in the current electricity market
with the use of Levy Exemption Certificates. In general, it seems
reasonable to conclude that a hybrid scheme would be substantially
cheaper to set up and administer than a PCA scheme.
POLITICAL FEASIBILITY
Both schemes are likely to attract opposition
from both households and business. As argued above, the carbon
cap and hence the carbon price could be broadly equivalent in
each scheme, together with the mechanisms for compensating badly
affected sectors or individuals. Hence, what matters is how the
two schemes are likely to be perceived by different groups.
From the perspective of consumers, a hybrid
scheme is similar to a carbon tax. However, instead of a fixed
and visible tax rate, the carbon price will be variable and largely
hidden within the price of fuel. In some respects, the scheme
would resemble the existing Renewables Obligation and Energy Efficiency
Commitment. The cost of these is recovered through household electricity
and gas bills, but the premium is not explicit and the instruments
remain uncontroversial, partly because the price impacts are relatively
small (although not trivial) and partly because their implications
are poorly understood. However, this may not be the case for a
hybrid scheme if the cost implications are much greater. Potential
mitigating measures here include the use of a relatively weak
cap at the inception of the scheme (gradually tightening over
time), the inclusion of a safety valve provision and the scope
for reducing carbon prices by linking the scheme to the EU ETS
and the international carbon market.
For the perspective of consumers, a PCA scheme
is similar to rationingindeed, "carbon rationing"
is Mayer Hillman's (2004) preferred term. Of course, a hybrid
scheme also amounts to rationing, but since it is indirect and
less visible, it may also be less controversial. With its connotations
of wartime austerity, the notion of "carbon rationing"
could prove unpopular in many quarters.
Proponents of PCAs argue that individual allowances
should encourage greater awareness of the threat of climate change,
provide a more tangible "share" of a common resource
and generate a sense of common purpose in tackling the problem
(Starkey and Anderson, 2005). However, it is equally likely that
this level of awareness is a precondition for the acceptance of
PCAs in the first place. The relative acceptability of the two
approaches should be a priority for further researchtogether
with the measures necessary to improve the acceptability of either.
However, my judgement is that the hybrid approach is likely to
be more feasible in the medium term.
SUMMARY
While PCAs are an attractive idea, I do not
believe their time has come. In my judgement, a combination of
high administrative costs, the inability to link with the EU ETS
and the political difficulties associated with carbon rationing
considerably reduce the attractiveness of the scheme.
However, most of the benefits of PCAs can be
achieved through a hybrid scheme, in which an upstream cap on
fuel suppliers is combined with the downstream EU ETS. This combines
comparatively small administrative costs with (in my judgement)
greater political acceptability, while at the same time delivering
comparable performance in terms of economic efficiency, environmental
effectiveness and social equity. Most importantly, it has the
potential to interface effectively with the global carbon market.
The government has indicated its interest in
including surface transport within the EU ETS, but it could be
difficult to do this in a way that is acceptable to all Member
States. A hybrid scheme provides an alternative means of capping
the emissions from surface transport, as well as from other sectors,
while at the same time achieving other policy objectives and avoiding
the need for EU-wide agreement.
As discussed in the Annex, both the hybrid scheme
and a PCA scheme may run into conflict with other existing and
proposed policy instruments. These interactions may preclude the
introduction of either scheme within the short to medium-term.
However, given its potential benefits, I recommend that the government
investigate a hybrid scheme as a possible basis for UK climate
policy in the long-term.
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Annex: Implementing a
hybrid scheme
INTRODUCTION
This Annex expands upon the practical challenges
associated with implementing a "hybrid emissions trading"
scheme as an alternative to a system of personal carbon allowances.
Many of the issues raised are similar to those associated with
implementing a programme of environmental tax reform as well as
a system of PCAs. One advantage a of hybrid emissions trading
scheme is that it can provide most of the benefits of such reforms
and reduce overall abatement costs by interfacing with the global
carbon market.
THE NATURE
OF A
HYBRID SCHEME
First, I would like to clarify the terminology.
The key element of this proposal is for an upstream carbon emissions
trading scheme in which fossil fuel producers (or importers) surrender
allowances for the carbon content of the fuel they sell. However,
a conventional upstream scheme would lead to double regulation
or double counting of emissions that are already covered by the
EU ETSan outcome that I consider undesirable. To avoid
this, I propose that producers should only be liable for the carbon
content of fuel sold to consumers outside the EU ETS. The downstream
EU ETS would then operate alongside the upstream scheme to give
a hybrid that covered all of the fossil fuel emissions from the
UK economy, while avoiding any overlaps between the two schemes.
Since this proposal differs somewhat from an upstream scheme as
normally understood, I have used the term hybrid scheme. While
the terms "upstream" and "downstream" are
widely used in this context, the term "hybrid scheme"
(for a combination of the two) is less well established.
A hybrid scheme should avoid double counting
of emission reductions, since a reduction of fossil fuel emissions
anywhere in the economy should "free up" carbon allowances
in one scheme or the other, but not in both at the same time.
For example, a reduction in household gas consumption will free
up allowances in the upstream scheme, while a reduction household
electricity consumption will free up allowances in the downstream
scheme (the EU ETS). In contrast, double counting is unavoidable
feature of the current PCA proposals.
In principle, the hybrid scheme should also
avoid the double regulation of fuel consumption. Fuel suppliers
will incur additional costs for purchasing allowances in the auction
and will seek to pass these on in fuel prices. However, the marginal
cost of supplying fuel to EU ETS participants will be lower than
that to non EU ETS participants, since the latter includes the
cost of allowance purchase. Assuming competitive fuel markets
and an adequate system for tracking fuel sales, these differences
should be reflected in lower fuel prices to EU ETS participants.
Hence, fuel prices for individuals and companies outside the EU
ETS should include the price of allowances in the upstream scheme,
while fuel prices for EU ETS participants should not. If allowances
can be traded between the two schemes (ie if the two schemes are
"linked") the carbon prices in the two schemes should
converge, leading to a single price for carbon throughout the
UK economy.
THE FEASIBILITY
AND COST
OF A
HYBRID SCHEME
All existing carbon emission trading schemes
are downstream, in that they regulate emissions from fuel users
directly. An upstream scheme that involves fuel suppliers is therefore
a significant departure from existing practice. Nevertheless,
this approach has been widely discussed within the academic and
policy community for a number of years (Hargrave, 2000; Mazurek,
2002) and several well-developed policy proposals include elements
of an upstream or hybrid approach.[10]
The upstream approach is also a less radical
departure from existing practice than it first appears, because
it has a great deal in common with an upstream carbon/energy tax.
This type of tax has have been implemented in a number of OECD
countries and is subject of a considerable academic literature
(Ekins and Barker, 2001; Zhang and Baranzini, 2004). In principle,
the macroeconomic impacts of an upstream trading scheme should
be broadly similar to those from an upstream carbon tax, as should
many of the practical issues associated with implementation. Generally
speaking, it is the impacts on industrial competitiveness and
income distribution that provide the biggest challenge to implementing
such schemes, rather than practical issues such as monitoring
and verification. But the experience and analysis accumulated
over the last 20 years provides a good basis for the design and
implementation of such a scheme.
The hybrid scheme does involve some additional
design challenges that are not faced by carbon taxes, but again
there is a great deal of relevant experience on which to draw.
For example, the design of the allowance auction can be informed
by the experience with airwave spectrum auctions, as well as by
the experience with auctioning emission allowances in the US Acid
Rain Programme, the UK Emissions Trading Scheme (UK ETS) and the
EU ETS. Similarly, the mechanisms for tracking fuel sales may
be informed by UK experience with Levy Exemption Certificates
and the Renewable Transport Fuel Obligation (RTFO). In each case,
the practical challenges appear significantly less than those
associated with creating an entirely new currency of personal
carbon allowances.
I cannot provide estimates of the administrative
costs associated with establishing a hybrid scheme, since the
relevant research has yet to be undertaken. As an illustration,
the costs of administering the RTFO (which is a tradable obligation
on fuel suppliers to supply biofuels) is estimated to be around
£1 million/year for the government and £2 million/year
for industry (DfT, 2006). The costs are low because only around
20 companies are involved and because fuel sales are already monitored
for the purposes of levying fuel duty (Grayling, et al,
2006).
The total administrative costs for the hybrid
scheme would be greater than this because coal and gas suppliers
(who do not pay fuel duty) would also be included, systems for
tracking fuel sales would need to be established and mechanisms
such as allowance auctions would need to be administered. Nevertheless,
the total administrative costs are likely to represent only a
small fraction of either the total revenue raised from the scheme,
or the turnover of the companies involved. For example, if the
clearing price in the allowance auction was £10/tCO2,
(approx. 15/tCO2) the revenue raised from the
upstream scheme would be of the order of £3 billion.[11]
This compares to approximately £0.8 billion from the existing
Climate Change Levy, £24 billion from fuel duties, £134
billion from income taxes and £483 billion from all forms
of taxation (in fiscal year 2005-06). A hybrid scheme with a carbon
price of 15/tCO2 (broadly equivalent to current
prices in the EU ETS) would therefore allow income taxes to be
reduced by around 2.2%.
The biggest obstacles to implementing a hybrid
scheme are the potential impacts on business competitiveness and
income distribution. Both of these will depend upon how the revenues
from the allowance auction are redistributed. As with carbon taxes,
the revenue raised from the auction may be used to reduce other
taxes that charge forand thereby discouragebeneficial
activities such as employment. As a consequence, a hybrid scheme
has the potential to deliver both environmental and economic benefitsthe
so-called "double dividend" (Bovenberg, 1999). However,
there is likely to be a trade off between economic efficiency
in revenue redistribution and political acceptability. While mechanisms
are available to mitigate many of the adverse impacts on business
competitiveness and low income groups, it will not be possible
to satisfy all the competing claims and attempts to do so could
both reduce the efficiency of the scheme and increase administrative
costs. The relevant issues are briefly reviewed in the following
sections.
THE IMPACT
ON BUSINESS
COMPETITIVENESS
The impact of an upstream scheme on a firm or
sector's competitiveness depends upon a host of factors.[12]
As a result, the impacts are hard to predict, may be greater in
the short term than in the long-term and may easily be overstated
by well-organised and influential lobby groups. If auction revenues
are recycled to reduce labour taxes, many sectors will gain from
the scheme. But energy intensive sectors may lose and may therefore
seek additional forms of compensation.
Claims regarding the potential impact of carbon
pricing on industrial competitiveness frequently lack a sound
analytical basis. For example, recent studies by the IEA (Reinaud,
2005) and the Carbon Trust (Carbon Trust, 2005a; b) have suggested
that, for carbon prices around 10/tCO2, the EU
ETS is unlikely to reduce the profitability of most industrial
sectors and that the anticipated increases in product prices will
be insufficient to make non-EU imports profitable on a large-scale.
While the impacts on individual companies may be greater, this
analysis suggests that the claims made by many industrial groups
during the process of negotiating the National Allocation Plans
were exaggerated. This, in turn, has contributed to the negotiation
of relatively weak targets in Phase 1 and Phase 2 of the EU ETS[13]
and has allowed the electricity generators to enjoy large windfall
profits (Sijm, et al, 2006).[14]
The most energy intensive UK companies are already
included in the EU ETS, or are likely to become included at a
later stage. This suggests that the majority of companies affected
by the proposed upstream scheme will be relatively non-energy
intensive. At present, however, a total of 6000 companies from
54 industrial sectors are signatories to Climate Change Agreements
(CCAs) (a total of 14000 sites). The CCAs provide exemption from
80% of the Climate Change Levy (CCL) in return for meeting negotiated
targets to reduce energy consumption or carbon emissions. The
rationale for the CCAs was that the full rate of the CCL could
damage the competitiveness of these sectors because energy forms
a significant proportion of total costs. In practice, however,
for many of these sectors, energy accounts for a small fraction
(<2%) of total costs.
It seems reasonable to assume that many of the
sectors currently signed up to a CCA will either oppose the introduction
of an upstream scheme or seek special treatment to compensate
for the higher fuel costs that will result. However, there are
at least three reasons why the need for special treatment should
be less than in the case of the CCL:
The proposed upstream scheme only
affects fuel costs, while the CCL covers both fuel and electricity.
Companies are already paying higher electricity prices as a result
of the participation of the generators in the EU ETS, but this
will be case regardless of whether an upstream scheme is introduced.
Fuel costs in turn, are much less than electricity costs for a
large number of CCA companies.
The lack of adequate data on energy
intensity meant that the eligibility for CCAs was based upon the
coverage of existing regulation, which proved to be poor proxy.[15]
But the CCAs themselves have provided considerable information
on energy consumption that may permit a more informed judgment
over whether a sector deserves special treatment.
Exemptions from carbon taxes and
trading schemes are commonly justified as a transitional arrangement,
to avoid high adjustment costs. However, after a nearly a decade
of the CCL the grounds for such exemptions are now weaker.
If there is a case for special treatment, the
most appropriate mechanism would be to increase the amount of
revenue recycled to those sectors and companies that are considered
vulnerable. In general, revenue recycling may take place in a
variety of ways, with different implications for administrative
costs and for the relative burdens imposed upon different sectors.
For example, the £0.8 billion of revenues raised by the CCL
were primarily recycled through a reduction in employers' national
insurance contributions. This meant that sectors that were relatively
labour intensive were net winners, while those that were relatively
energy intensive were net losers. However, reductions in labour
taxes are not the only option available. To compensate vulnerable
sectors for the high fuel costs from the upstream scheme, additional
revenues could be recycled in proportion to best practice benchmarks
of energy intensity, or some comparable measure. Experience with
the CCAs suggests that this type of compensation could be complex
to administer, but at the same time the CCAs have provided a mass
of data with which to build. However, additional recycling of
revenue to energy intensive sectors will reduce the pool of revenues
available to compensate non energy intensive sectors and households,
as well as increasing overall abatement costs.[16]
THE IMPACT
ON INCOME
DISTRIBUTION
In the absence of revenue recycling, an upstream
scheme would be regressive and could have a damaging impact on
the "fuel poor" who spend more than 10% of their income
on energy. However, there are a wide range of options available
to reduce the regressive impact of the scheme, including: increasing
income tax thresholds or reducing rates of tax on low incomes;
raising welfare payments such as unemployment, disability and
child benefit; providing subsidies for energy efficiency improvements
in low-income households; increasing winter fuel payments; and
returning an equal lump sum to each individual (Clinch, et
al, 2006).
Lump-sum redistribution is straightforward and
partially corrects for the distributional impacts because low
income households will receive a higher amount, relative to their
income, then high income households. However, reductions in income
taxes or changes in the benefits system are likely to be more
effective. While earlier studies have suggested that careful targeting
of tax and benefit changes could minimise distributional impacts
(Metcalf, 1999), research by the Policy Studies Institute has
suggested that this is unlikely to prevent a worsening of fuel
poverty for up to a third of the poorest households (ie those
in the lowest income decile), including those who are already
badly affected by rising fuel prices (Dresner and Ekins, 2006).
The reason is that low income households vary widely in energy
consumption, owing largely to wide variations in the energy efficiency
of housingand some are very high energy users. Electrically
heated homes and those with solid walls present the greatest difficulties,
and these have been largely untouched by the Energy Efficiency
Commitment (EEC) and Warm Front programmes.
These negative impacts on the fuel poor are
of critical importance for the political feasibility of either
an upstream or PCA scheme. They may make it difficult to introduce
such a scheme within the medium termand possibly for longer
if the elimination of fuel poverty is delayed. This makes the
scaling up of existing energy efficiency measures and the introduction
of new measures in this sector an urgent priority.
Concern over distributional impacts has led
to household gas and electricity consumption being subsidised
through VAT exemptions. It makes little sense to internalise carbon
prices in this sector while such large subsidies remain. Similarly,
if the government continues to exempt all households from carbon
pricing in order to protect the fuel poor, emissions in this sector
will rise making it more difficult to meet carbon targets in the
future. There is therefore a need for a dual approach: to accelerate
the elimination of fuel poverty while at the same time introducing
alternative approaches that encourages improvements in the energy
efficiency of non-fuel poor households. The measures proposed
in the 2007 Energy Review (in particular the Supplier Obligation)
represent a welcome step forward, but it is unclear whether these
will be sufficient.
In contrast to energy use in homes, the impact
of an upstream trading scheme on energy use for surface transport
should be broadly progressive (Dresner and Ekins, 2004). Nearly
two thirds of households in the lowest income quintile do not
own a car, compared to only one third of households overall. However,
the scheme may be regressive among motorists, with larger impacts
for motorists in the rural areas who lack public transport alternatives
(Blow and Crawford, 1997) A 30% increase in fuel prices, for example,
would reduce the standard of living of the poorest tenth of motorists
by around 2%. As with household energy use, there is considerable
scope for reducing distributional impacts through measures such
as abolishing vehicle excise duty (VED), subsidising public transport
and increasing benefits. Dresner and Ekins (2004) found that abolishing
VED was the best method of compensating low-income motorists,
while increasing benefits was the best method of compensating
the population overall.
It is important to note, however, that the increases
in petrol and diesel prices that would result from an upstream
carbon trading scheme will be relatively small. For example, a
carbon price of 15£/tCO2 would increase petrol
prices by less than one pence a litre, which compares with current
duty levels of 47 pence per litre, and total taxation (including
VAT) of 60 pence per litre. The distributional impacts for transport
users are therefore a much smaller concern than those for households.
At the same time, if the price impacts are small,
the incentive to reduce emissions in this sector is correspondingly
small, suggesting the need for complementary policies. Including
surface transport in any wider trading scheme could be problematic,
since the high abatement costs in this sector may push up carbon
prices for other sectors, with adverse effects on industrial competitiveness
and income distribution. However, this issue is broadly the same
whether surface transport is included in a hybrid or PCA scheme,
or within the EU ETS. The government is currently reviewing the
latter option and has encouraged the Commission to do the same.
PUBLIC UNDERSTANDING
AND ACCEPTABILITY
Whatever the impact on competitiveness and income
distribution, an upstream trading scheme could also face more
general problems of public understanding and acceptability. The
nature of these was highlighted in a recent European-wide project
that used interviews and focus groups to assess social responses
to environmental tax reform (Clinch, et al, 2006). This
found that:
People did not trust assurances that
the revenues will be used in the way promised by government and
wanted the use of the revenues to be transparent.
People did not understand the purpose
of increasing taxes on energy while lowering taxes on employment,
and did not accept the double dividend argument when it was explained
to them.
People were aware of higher energy
taxes since they were visible, but were not aware of the lowering
of income and other taxes since they were less visible.
People wanted incentives as well
as penalties and expressed a strong preference for the revenues
to be used for encouraging energy efficiency improvements and
related measures.
These factors will need to be taken into account
in the design of a hybrid scheme. For example, the trust issue
may potentially be mitigated by devolving decisions about cap
setting and revenue distribution to the proposed Committeee on
Climate Change. The understanding issue may partially be dealt
with through a prolonged public information campaign that also
raises awareness about the link between energy use and climate
change and the opportunities available to reduce energy consumption.
The visibility issue may be partially dealt with through the use
of regular lump-sum payments to each household that are clearly
linked to their "share" of the overall carbon cap. Finally,
the incentive issue may be dealt with by using a portion of the
revenue to encourage investment in energy efficiency and renewable
energy projects. None of these approaches are straightforward
and each involves trade-offs with other objectives. The reaction
of the UK popular press to proposals for environmental tax reform
("a green stealth tax") suggest that there is much work
to be done in improving understanding of such measures and in
gaining public support. This again suggests that a lead time may
be required before a hybrid scheme can be implemented.
COMPARABLE BARRIERS
TO A
PCA SCHEME
It is important to note that the barriers described
above apply equally, or to a greater extent, to a PCA scheme.
Moreover, these costs will be in addition to the much higher costs
of establishing, introducing and monitoring a PCA scheme compared
to an upstream scheme.
While households will receive allowances for
free in a PCA scheme, the distributional impacts and hence political
disputes over allocation will be broadly similar. It is also possible
that a hybrid scheme may be able to protect low income households
more easily than PCAs. This is because it allows straightforward
adjustment to existing tax and benefit arrangements without a
loss of government revenue. In contrast, a PCA scheme is more
likely to address such concerns by changing the number of allowances
allocated to different groups (eg giving bonus allowances to pensioners),
which could be more costly to implement. Alternatively, if the
PCA scheme uses fiscal measures to address such concerns, the
government may lose revenue.
With a PCA scheme, approximately 60% of allowances
would be auctioned to banks and other primary traders who would
then sell them on to energy using organisations. The mechanisms
for compensating these organisations for their allowance expenditures
have not been specified,[17]
but could be broadly similar to those outlined above. As with
an upstream scheme, the revenue raised from the PCA allowance
auction may be used to reduce "distortionary" taxespotentially
providing a double dividend. However, while the hybrid scheme
allows the revenue from 100% of the allowances to be used in this
way, the PCA scheme only auctions 60% of the allowanceswith
the remainder being distributed free. This suggests that the aggregate
costs of meeting an emission target could be higher with a PCA
scheme since the available revenues are smaller.
For organisations, a PCA scheme is analogous
to both a hybrid scheme and environmental tax reform, since it
involves additional expenditure on fuel and accompanying reductions
in other forms of taxation. To that extent, it faces similar problems
of understanding and acceptance to those discussed above. For
household, a PCA scheme is analogous to rationing, which has a
variety of negative connotations. As indicated in the main submission,
it is difficult to judge whether an explicit form of rationing
would be more or less acceptable than a hybrid scheme in which
the origin of the fuel price rise is somewhat hidden. This issue
is therefore priority for further research.
Another key difference between a hybrid and
a PCA scheme is that the latter includes the emissions from electricity
consumption. But these are already covered by the EU ETS and electricity
consumers are already paying higher prices as a result. This suggests
that a PCA scheme would have a significantly greater impact on
energy costs for all consumers. Moreover, these higher costs would
have no immediate environmental benefit because any reductions
in the emissions from electricity generation that result will
simply "free up" allowances in the EU ETS. These will
either be sold to other participants or banked, and will therefore
be used to cover emissions somewhere in the EU. While it is possible
that UK emissions will be reduced, the contribution to EU and
global CO2 emission reductions will nevertheless be
zero. The coverage of electricity consumption by the PCA scheme
will only lead to real environmental benefits if it contributes
to a subsequent tightening of the overall EU ETS cap (Sorrell
and Sijm, 2003). This important point is frequently overlooked
in policy debates.
THE PROBLEM
OF POLICY
INTERACTION
As argued in the main submission, I believe
that a hybrid scheme is substantially simpler than a PCA scheme
and could therefore be introduced within a considerably shorter
timescale. It also interfaces much more effectively with the EU
ETS and the global carbon market. However, a policy proposal needs
time to gain interest and support, needs "windows of opportunity"
for implementation (such as when an existing scheme come to an
end) and must "fit" within an increasingly crowded policy
landscape. This last issue is problematic for both the hybrid
scheme and PCAs. Both provide a comprehensive approach that caps
the total fossil fuel emissions from the UK economy and the former
offers the potential of a uniform carbon priceas recommended
by the Stern Review. But both also have the potential to interact
negatively with a number of existing and proposed policies that
target different sectors of the economy in different ways. For
example, introducing a hybrid scheme on top of the existing Climate
Change Levy (CCL) would create a "double regulation"
problem, in that fuel purchases would include the carbon price
from the hybrid scheme as well as being eligible for the CCL.
In the case of the PCA scheme, this problem would also apply to
electricity (indeed, if the CCL was retained, the PCAs would effectively
lead to triple regulation of many organisations' electricity useie
PCA, CCL and EU ETS).
Such overlaps already exist in the UK policy
mix and may sometimes be acceptable (Sorrell and Sijm, 2003).
But in many cases, they are likely to increase the cost of meeting
UK carbon targets. If a PCA or hybrid scheme were simply to be
imposed on top of existing instruments, such problems could be
made substantially worse. This suggests that the introduction
of such a scheme may need to coincide with the removal of such
instruments. However, the 2007 Energy Review proposed additional
instruments that are likely to increase the complexity of the
overall policy mix. These include:
The Carbon Reduction Commitment (EPC),
which is a downstream cap and scheme for large organisations in
the public, commercial and industrial sectors that are not eligible
for the EU ETS. Allowances are to be distributed throughout revenue
neutral auction.
The post 2011 Supplier Obligation
(EEC) which may take the form of a cap and trade scheme for gas
and electricity suppliers. The cap could be denominated in either
energy or carbon and will relate solely to the energy supplied
to households.
Expansion of the EU ETS: The European
Commission has published a draft legislative proposal for the
inclusion of aviation emissions in the EU ETS from beyond 2011,
while the UK government is proposing the inclusion of surface
transport as well.
In addition, the Climate Change Agreements (CCAs)
for large industrial sites are expected to continue until 2013.
Companies with CCAs will still be allowed to trade carbon allowances
as part of the UK ETS, even though the "direct participant"
part of that scheme ends in December 2006.
If the above proposals go ahead as planned,
is likely that the majority of UK carbon emissions will be covered
by one or more trading schemes by 2012. It is also possible that
four different types of carbon allowances (EU ETS, CRC, SO and
CCA) will be being traded within four separate markets at four
separate carbon prices. In each case, there will be problems of
"double regulation" of electricity, because the electricity
generators are already participating in the EU ETS and therefore
pass on the carbon price within the price of wholesale electricity.
Each UK market will also lead to "double counting" of
emission reductions, because two carbon allowances (in two separate
markets) will be generated from a single one-tonne reduction in
emissions. This, in turn, will make it difficult or impossible
to "link" the schemes to allow trading between them.
Taken together, this patchwork of policies will not provide a
comprehensive coverage of UK carbon emissions, while at the same
time introducing multiple administrative requirements.
I do not want to argue that the above policies
are without merit: on the contrary, the CRC proposals, in particular,
are the product of much careful analysis (Radov, et al,
2006). However, introducing a hybrid or PCA scheme on top of these
instruments is likely to be costly, unnecessary and unrealistic.
The government has indicated that both the Carbon Reduction Commitment
and the Supplier Obligation will remain in place in some form
until 2020. Hence, in combination, it is possible that the current
policy proposals could preclude the introduction of a hybrid or
PCA scheme for the next 14 years.[18]
This timeframe could be longer than is required to eliminate fuel
poverty. Alternatively, the introduction of a PCA or hybrid scheme
will require the early termination of existing policy proposals.
This leaves the current discussion on personal carbon allowances
in something of a vacuum, as current government policy may preclude
the introduction of such a scheme in the short to medium-term.
THE NEED
FOR A
POLICY MIX
Carbon pricing is a necessary but not sufficient
condition for a transition to a low carbon economy. It is necessary,
because the theoretical benefits of market-based instruments are
strongly supported by empirical evidence. In particular, the inverse
relationship between energy (carbon) prices and energy consumption
(carbon emissions) that it is predicted by basic economic theory
appears confirmed by empirical data (Figure 1).
Figure 1: Relationship between electricity
price and electricity intensity in OECD member states (1998)
Source: Verbruggen (2003).
Notes: The figure shows cross sectional data
from 24 OECD countries for 1998. A double log function ln(Intensity)=a+b*ln(Price),
gives an R2 of 82.3 and a residual standard error of 0.2296. The
estimated elasticity b equals -1.17 (standard error 0.12 and t-value
-10.11), implying that a 1% increase in electricity prices leads
to a 1.17% reduction in long-term electricity intensity.
Carbon pricing in isolation, however, is insufficient
because it only addresses the environmental externalities of fossil
fuel combustion and does not overcome the variety of reinforcing
market failures that inhibit the innovation and diffusion of low
carbon technologies (Jaffe, et al, 2004; Sorrell, et
al, 2004). On its own, carbon pricing is likely to provide
insufficient support for promising low carbon technologies that
are in the early stages of deployment as well as being relatively
ineffective in encouraging energy efficiency in sectors with a
low energy intensity.
This is particularly the case in the household
sector, where the adoption of cost effective energy efficiency
improvements is hindered by a series of market failures.[19]
The net result is that the price elasticity of energy consumption
is very low in this sector, which means that carbon prices would
need to be very high to have a significant impact on behaviour
and emissions. The associated distributional impacts are unlikely
to be acceptable. At same time, there is no prospect of curbing
emissions in the domestic sector over the longer term without
increasing energy prices.
This points to the need for a coordinated policy
mix that "gets the prices right", overcomes barriers
to the adoption of cost effective technologies and facilitates
and encourages the complex processes of technological change.
This is not an argument for a "kitchen sink" approach,
but does suggest that a range of measures will be required. For
example, I would argue that there is a strong case for traditional
regulatory measures to eliminate standby power and to impose minimum
energy efficiency requirements on electric appliances. Many of
these measures are better focused on the supply chain for energy
using devices, rather than the consumer, and need to be targeted
and differentiated by energy service. The revenue stream from
an upstream trading scheme may be used in part to fund R&D,
demonstration projects, investment subsidies and other measures
to facilitate the diffusion of energy efficient technologies.
Hence, it is not a question of either a trading scheme or traditional
regulatory measures: instead, both are likely to be required.
SUMMARY
This submission has expanded upon the practical
obstacles to implementing a hybrid trading scheme and speculated
on the timescales involved. The key points are as follows:
There are relatively few practical
obstacles to implementing a hybrid trading scheme and the administrative
costs should be relatively small. Instead, the biggest difficulties
relate to its potential impact on business competitiveness and
income distribution.
The impact of a hybrid scheme on
business competitiveness can easily be overstated. The impacts
should be positive for many sectors and with targeted recycling
of revenues, most negative impacts could be substantially reduced.
Revenue recycling may also be used
to minimise the impact of the scheme on low income households
However, the scheme could still worsen the position of a significant
number of households that are worst affected by fuel poverty.
This may make it difficult to introduce the scheme within the
short to medium-term.
Introducing a hybrid scheme on top
of existing and proposed policy instruments could be costly, unnecessary
and unrealistic. Current policy proposals could therefore preclude
the introduction of a hybrid scheme in the short to medium-term.
A hybrid scheme has many similarities
with a programme of environmental tax reform, but at present both
business and the general public have a poor grasp of the implications
of such reforms A variety of measures may need to be taken to
make such changes more acceptable.
A personal carbon allowance (PCA)
scheme will have very similar impacts on business competitiveness
and income distribution. It will also face similar problems of
policy interaction and may face greater difficulties with public
understanding and acceptance. It is therefore even less likely
to be introduced in the near future.
In addition, the aggregate costs
of meeting an emission target are likely to be higher with a PCA
scheme; the administrative costs of establishing, introducing
and monitoring the scheme will be much higher; and a PCA scheme
will not offer the opportunity to link to the EU ETS and the global
carbon market.
While carbon pricing mechanisms such
as a hybrid or a PCA scheme are necessary to reduce carbon emissions,
they will not be sufficient. A range of supporting policies will
also be required.
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8 Also known as a Domestic Tradable Quota (DTQ) scheme. Back
9
Estimates of the total cost of managing a comparable scheme in
the US (the "Sky Trust") have been put at less than
.04% of total revenues. Back
10
Perhaps the best know is the Climate Stewardship Act, proposed
by Senators John McCain and Joseph Lieberman, which would cover
more than 70% of US carbon dioxide and industrial greenhouse gas
emissions. Large installations in the industrial, public and commercial
sectors would participate directly in a similar manner to the
EU ETS. However, transport emissions would be covered through
the participation of refineries and fuel suppliers, who would
surrender allowances for the carbon content of fuel sales. This
is therefore a hybrid scheme, since it includes both upstream
and downstream elements. Back
11
Approximately 300MtCO2 of emissions would be covered
by the scheme. Back
12
Including the stringency and future predictability of the emissions
cap, the timeframe for introducing and tightening the scheme (relative
to asset lifetimes), the contribution of fuel to total input costs,
the carbon intensity of fuel use, the extent to which the relevant
product markets are open to international competition, the extent
to which competitor companies in other countries face comparable
carbon prices, the scope for switching to lower carbon products,
the own-price elasticity of the relevant products and the opportunities
available for abating emissions through energy efficiency improvements
or fuel switching (Barker & Kohler, 1998). Back
13
The aggregate Phase 1 cap was approximately 3% above baseline
emissions and only 1% below official "business as usual"
projections. When verified emission data was released in May 2006
it showed that emissions were a below allocations-leading to a
substantial fall in allowance prices. The caps proposed in the
National Allocation Plans (NAPs) for Phase 2 were sufficiently
weak to create a risk of a zero carbon price in Phase 2 (Rogge,
et al, 2006). The Commission has requested more stringent
targets in most of the allocation plans it has reviewed (a notable
exception being the UK). Back
14
The primary reason for the large windfall profits (ie beyond what
is required for compensation) was that the allowances were allocated
for free, rather than being sold in an auction. Windfall profits
for UK electricity generators during Phase 1 have been estimated
at £0.8 billion/year (IPA Energy Consulting, 2006). Back
15
Eligibility for CCAs was originally based on the coverage of the
Integrated Pollution Prevention and Control Directive, but following
extensive lobbying the eligibility rules were widened to include
other "energy intensive" sectors. Back
16
Another possibility would be to introduce border tax adjustments,
with exports receiving a refund while imports are taxed. This
would need to use relatively crude methods to estimate the carbon
content of imports and must be consistent with World Trade Organisation
rules (Ismer and Neuhoff, 2006). Back
17
Indeed, the disproportionate focus on the implications for households,
rather than organisations, is a weakness of the current PCA proposals. Back
18
The difficulty here is one of inertia. For each instrument, a
legislative framework will be established which may be difficult
to change; regulatory institutions will be established, or responsibilities
assigned to existing institutions; procedures and standards will
be established for functions such as monitoring, reporting and
verification; a network of private organisations become involved
in implementation; and the target groups themselves will invest
substantial time and money in gaining familiarity with the policy
instruments and putting the appropriate procedures in place. All
these activities will cultivate vested interests and encourage
resistance to change. Back
19
These include: the presence of hidden costs (including the opportunity
cost of time, disruption etc.); limited information (about energy
use, cost of measures, benefit of measures); uncertainty about
length of tenure at a property and the associated inability to
recoup any uncapitalised expenses; split incentives (most notably
between landlords and tenants); and difficulties in accessing
capital. Back
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