Memorandum submitted by EDF Energy
Our response focuses on the following areas
of the committee's inquiry:
— the use of environmental or green
taxes that are specifically targeted at climate change;
— the extent to which government uses
environmental taxation to encourage behavioural change; and
— looking forward, the appropriate
role of environmental taxation in the context of the range of
means that Government can use to achieve its environmental policy
aims—for example by means of regulation, voluntary agreement
or a spending measure.
1. CLIMATE CHANGE
POLICY AND
THE EXISTING
FRAMEWORK OF
INSTRUMENTS
1.1 The nature of climate change and its
importance places a huge responsibility on all areas of society
to address its impact. One of the key challenges for the UK is
to develop a comprehensive climate change programme that engages
all areas of society, specifically targets greenhouse gas emissions
and efficiently incentivises reductions in Greenhouse Gas (GHG)
emissions over time to the required level.
1.2 Whilst the existing programme is extensive,
currently the UK's climate change policies do not fully address
the continued growth in emissions from, in particular, the transport
sector. Emissions from gas use associated with space heating are
also largely uncapped. This contrasts with the cap on emissions
(at an EU level) placed on the electricity generation sector via
the EU ETS.
1.3 Whilst energy efficiency measures are
desirable (e.g. agreements with motor manufacturers, appliance
labelling, EEC, etc), where appropriate the best way to ensure
GHG emission reductions is to place a cap on them. The long-term
appropriateness of measures such as Climate Change Agreements
(CCAs), which control emission intensity but do not cap absolute
emissions, will need to be reassessed.
1.4 Existing policies covering the energy
industry (UK ETS, Climate Change Levy (CCL), CCA, Levy Exempt
Certificates (LECs), EU ETS, Energy Efficiency Commitment (EEC),
Renewables Obligation (RO) and the proposed Energy Performance
Commitment(EPC)) have different carbon prices embedded in each
instrument. The variation and complexity in coverage and carbon
price create a number of anomalies and effects. For example:
— domestic consumers using electricity
for space heating are exposed to a carbon price via the internalisation
of EU ETS CO2 prices in electricity costs, whereas
those using gas for the same purpose have no exposure to carbon
price;
— renewable generation benefits from
three climate change instruments—LECs, the RO and the internalisation
of EU ETS CO2 prices in electricity prices; and
— some organisations will have elements
of their activities regulated by EU ETS and CCAs, pay CCL on energy
use associated with other activities, have another CO2
cost internalised in their electricity prices as a result of EU
ETS and potentially for activities not covered by EU ETS be within
scope of the EPC.
1.5 The complexity and discrepancies illustrated
in the few examples above indicate that there is a need to review,
and where appropriate streamline and harmonise, climate change
policies to ensure delivery of specifically targeted greenhouse
gas emissions reductions in an efficient manner. At this stage,
what remains unclear is the likely longevity of individual measures
and the government's ambition for the overall long-term mix of
instruments to deliver its required level of GHG emissions. For
example it is unclear whether it is government's intention to
have a single economy-wide CO2 price or rather that,
even in the long-term, there will be a requirement for different
carbon prices/measures to apply to different sectors.
1.6 The Government will also need to carefully
consider the implications and structure of the proposed statutory
targets in the Climate Change Bill to ensure that they are consistent
and compatible with other UK and EU policy instruments.
1.7 Schemes which create a carbon price
do have the potential to create behavioural change. The EU ETS
has had mixed success in this respect. The UK power sector has
internalised the opportunity cost of carbon in decisions to generate/not
generate electricity from individual power stations on a half-hourly
basis. Other sectors, which receive business-as-usual allocations,
have generally not internalised the cost in their operational
decision-making processes. This demonstrates that the presence
of a carbon price alone is not necessarily sufficient to create
behavioural change but that other aspects of scheme design are
also important in incentivising the correct behaviours, such as
the level of auctioning of allowances.
2. DEVELOPING
A MECHANISM
TO DELIVER
CAPITAL INVESTMENTS
UNDER THE
EU ETS FRAMEWORK
2.1 EDF Energy supports the development
of emissions trading as the key part of the UK and Europe's strategy
for reducing emissions from industry across the UK and Europe.
A well designed and properly functioning emissions trading scheme
provides a means of delivering emissions reductions at least cost,
through the creation of an efficient and transparent market in
emissions allowances. By placing a price on current and future
emissions it should in theory incentivise industry to either improve
its energy efficiency, invest at scale in technologies using low-carbon
fuels, or to develop innovative low-carbon technologies.
2.2 To make this work, the long-term stability
of the EU ETS is crucial for existing participants to have the
confidence to invest in abatement technologies and make significant
emissions reductions, and for the EU ETS to develop into a global
market. The EU ETS, as presently constituted, is not capable of
sending the signals required to deliver investment in lower carbon
technologies in the UK and EU, as a result of the political and
regulatory uncertainty surrounding future carbon dioxide abatement
targets and the structure of EU ETS beyond 2012. Although considerable
efforts are being made to agree long term abatement targets across
the EU, these are unlikely to be agreed in the near future. Furthermore,
it is unclear how such a target would be split between the traded
and non-traded sectors. This uncertainty creates a significant
hurdle for early investment in low carbon technologies. We believe
that the key priority for Government should be to provide political
certainty for investors in future carbon dioxide abatement targets.
Investment over the next 10-20 years will have a profound effect
on UK emissions over the lifetime of these assets, which varies
between 20 and 60 years, depending on technology.
2.3 The EU ETS currently does not provide
equivalent treatment of new investment in low carbon technologies,
such as carbon sequestration and nuclear, relative to new fossil
fuel installations. Although these low carbon technologies benefit
from higher electricity prices driven by carbon prices in the
EU ETS, the provision of free allocations to new fossil plant
provides a subsidy to CO2 emitting plant[43]
relative to low carbon plant. Also, the present time scales of
the EU ETS and the visibility and certainty of future carbon prices
does not match the investment life-cycles of these assets.
2.4 Without the provision of additional
certainty to investors, there is a risk that the necessary low
carbon technology investments to deliver the government's GHG
reduction targets will not occur or at the very least will be
delayed significantly. Instead there will be investment in fossil
plant, thereby locking the UK into higher levels of emissions.
2.5 The options available that can reinforce
the operation of the EU ETS, in order to support investments in
low carbon technologies in the generation sector include:
— carbon generation obligation;
— contracts for purchasing carbon reductions;
and
— contracts for differences securing
a minimum value for carbon abatement—namely, Carbon hedges.
2.6 Carbon Tax—A carbon tax
offers government certainty over the cost of targeting carbon
reductions, but not the outcome in terms of the volume of those
reductions. If the tax is set at the right level, then reductions
will be achieved, but the level that is correct is unlikely to
be observable by government. For investors, a tax does not give
long term certainty over the value of carbon, as taxes can change
every year, particularly if the government believes that the tax
has previously been set at an incorrect level.
2.7 Carbon Obligation—A carbon
obligation certainly offers incentives for investment, and the
Renewables Obligation has delivered much greater levels of renewable
generation than would otherwise have occurred. Potentially such
obligations may require the government to pick technologies and
the extent to which such technologies should be a part of the
overall generation mix. Also, as has been found with the RO, some
technologies may come to dominate under an obligation, and the
government may come under pressure to change the rules and pick
different winners. Obligations may not allow the market to find
the most efficient abatement options by which to achieve carbon
reduction targets.
2.8 Carbon contracts have the ability
to reinforce and strengthen carbon market mechanisms where, like
the current EU ETS, the market mechanism alone does not produce
the necessary long-term price signals. The contract gives investors
the long term certainty they need, without requiring the government
to pick technologies, and can be designed to be consistent with
existing policy mechanisms. Such contracts have the further advantage
of allowing Government to limit its liabilities under these contracts
by controlling the volume of abatement it is willing to underwrite.
The government can further limit its liabilities by influencing
wider policy development and retaining the carbon price within
a reasonable range that minimises its financial exposure. This
liability should in any case be set against the real and increasing
liability faced by the government if action to address climate
change is not taken. A possible problem with a carbon contract
is that if the price for carbon remains high, through the EU ETS,
then a payment through the contract will be in addition to the
carbon element of the electricity price. The solution to this
would be to contract only for the difference between the contract
price and market price for carbon, as explained below.
2.9 EDF Energy's preferred option is the
Carbon hedge, ie a contract for difference to essentially
provide a "floor price" for carbon. If a strong EU ETS
phase 3 emerges from international negotiation, as the government
intends, the value of carbon will remain an important factor in
the electricity market. A carbon price will mean that the cost
of carbon is properly reflected in electricity prices according
to the level of emissions associated with the production of that
electricity. In these circumstances the government would not need
to make any payments to the investor, as the investor is already
benefiting through the wholesale price for electricity. Only if
the price for carbon falls to a low point would the government
become liable for payments. Companies wishing to bid for such
contracts would competitively bid to the government, so that the
level of the floor would be pushed down to the lowest level needed
to secure the desired reduction in CO2 emissions. Such
a bidding process should be open to all forms of low carbon generation
and would be "technology neutral". The government would
then have the option of contracting for as much or as little carbon
reduction as required to fit with the overall carbon reduction
goals.
2.10 EDF Energy believes that commercial
market-based instruments can be used to underpin the significant
capital investment required to lower the carbon intensity of the
electricity sector in the UK. This can be done without exposing
the UK Government to unacceptable financial risks by controlling
the amount of CO2 reductions it commits to in this
way. These instruments can be designed to reinforce the integrity
of the EU ETS and global carbon market in the long term, within
the framework of competitive and liberalised energy markets, as
supported by the UK Government.
January 2007
43 The level of subsidy will be dependent upon the
level of allocation and the extent to which CO2 prices are reflected
in the prices to end consumers. In the UK, the nature of vertical
integration in the competitive market means that in practice tariff
customers are exposed to the cost of purchasing CO2 allowances
to cover generators' short positions rather then the full opportunity
cost. Back
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