Memorandum submitted by Alcan Aluminium
UK Ltd
SUMMARY
1. The aluminium sector is at significant
risk of carbon leakage. This is because the price of aluminium
is set on international exchanges, therefore we cannot pass on
any extra cost of carbon as this would immediately make us uncompetitive
with our competitors who produce aluminium in countries with no
carbon constraints.
2. We regard Phase II of the EU ETS to be a success,
due in a large part to the process of grandfathering of emission
allowances. We have significant reservations about the prospects
for Phase III as the method of allocating allowances may make
our business uncompetitive in the UK.
3. Whilst the recession has resulted in a reduction
in the carbon price, it has also more than halved the price of
aluminium. Therefore the cost of carbon still represents a further
degradation of our ability to sustainably produce aluminium.
4. We have significant reservations about
the method of free allocations based on ex ante benchmarks, which
at this stage leaves several key questions unanswered. We do not
feel this will protect against carbon leakage because it will
still mean at least 90% of aluminium production in the EU would
get fewer allowances than they require, increasing costs which
could not be passed on.
5. The proposed directive sets out measures
for financial assistance from Member States. Again this leaves
several questions unanswered such as the nature of these financial
measures and the emissions factor that will be used in determining
the level of assistance. If an emissions factor other than for
coal fired power generation is used it unfairly discriminate against
our business operations, and significantly increase the risk of
carbon leakage.
6. We welcome developments in the formation
of cap and trade schemes around the world but we foresee a number
of key issues that would need to be addressed before an equitable
global carbon market could come into force.
Whether, and under what circumstances, emissions
trading ought to be supplemented or replaced by tax or regulation
7. Rio Tinto Alcan continues to support
the development of global negotiated agreements as the most cost-effective
and efficient means of controlling carbon emissions on a global
scale. The primary aluminium industry is dominated by a few players
who all operate globally. Creating such an agreement would require
cooperation from all of the international partners. This would,
however, create a level playing field for all producers and would
eradicate the chance of carbon leakage from the primary aluminium
sector.
THE EU EMISSIONS
TRADING SCHEME
The record of Phase II of the EU ETS, and prospects
for the success of Phase III
8. So far we regard Phase II to be a success
but we have significant reservations about the prospects for Phase
III. The success of Phase II is largely a result of the process
of grandfathering emission allowances and recognition of early
action to reduce CO2 emissions. Due to the nature of our industry,
where the price of aluminium is set on international exchanges,
we cannot pass on any extra cost of carbon as this would immediately
make us uncompetitive with our competitors who produce aluminium
in countries with no carbon constraints. This is different from
many other industries where there is no international exchange
and therefore world price, and consequently producers can pass
on any CO2 costs in their price. As a result we regard the process
of grandfathering to determine allocations as being the key to
success of Phase II as it provides producers with an incentive
to maximise their energy efficiency and hence reduce their emissions
and it doesn't undermine their international competitiveness as
it imposes only a reasonable economic burden.
9. However, as mentioned above, we have concerns
over the success of Phase III. Under the proposed directive it
is likely the aluminium industry will classified as "at risk
of carbon leakage". Consequently it seems likely we will
be allocated a certain amount of free allowances, based on ex-ante
benchmarks. However, at present it is unclear how these benchmarks
will be calculated and therefore there is uncertainty surrounding
how many of the allowances we require will be freely allocated
and how many we will have to purchase. If the number we have to
purchase is sufficiently high, it is likely it will make our business
in the UK uncompetitive, which ultimately will lead to the very
carbon leakage our classification would seek to avoid. We have
provided further detail on the issue of free allocation below.
Uncertainty surrounding the competitiveness of our business, especially
in the current economic recession, is a major concern to us.
Extent to which the carbon price will be sufficient
to drive low-carbon investment, in particular decarbonisation
of energy
10. During the period 1990-2006 investments in
the Lynemouth plant provided thermal efficiency improvements from
36.2% to 39.7%, which along with other investments, including
the HALE project, resulted in a carbon intensity improvement of
30%, from 22.47 tCO2e per tonne of aluminium to 15.72 tCO2e. Consequently,
Lynemouth Power Station is the most efficient coal-fired power
station of its kind in the UK and indeed, we know of no more efficient
plant of this kind anywhere in the world. In terms of our PFC
emissions, the situation is similar and we expect to be operating
at Best Available Technology (BAT) by 2012. Consequently, we have
already implemented the technologically mature decarbonisation
measures, and in order to continue in this manner we will require
a step-up in terms of the technology deployed, for instance installing
Carbon Capture and Storage (CCS). This is something we have considered
and have discussed with ministers, partly due to our close proximity
to the North Sea oilfields, which are seen as having excellent
storage potential.
Impacts of economic recession on the workings
of the EU ETS
11. Clearly the impact of the recession can be
seen in the workings of the EU ETS, with a falling carbon price
following a decrease in industrial output. However, from Rio Tinto
Alcan's perspective, the impact of the recession can also be seen
in the price of aluminium trading on the London Metal Exchange,
which has more than halved in the last six months, falling from
~$3,200 per tonne to less than $1,400 per tonne. This global aluminium
price is not sufficient to allow sustainable production. Even
with a high price, such as during 2006, all of Europe's main competitors
had lower estimated operational costs, according to an IEA report.[6]
This was largely due to lower power prices elsewhere around the
world. Therefore, the impact of the recession is more pronounced
in the European aluminium sector than it is for other producers
in the world market. Consequently, whilst some analysts may comment
that a low carbon price is a sign that the system is failing,
the cost of carbon represents a further degradation of our ability
to sustainably produce aluminium.
12. It should also be stressed that recession
is not the default position of the European economy. It is likely
that come 2013 and the start of Phase III the economy will once
again be growing. Therefore, we urge caution in any decisions
that are made with the impact of the recession in mind. With the
ability to bank credits between phases we also regard the EU ETS
to be sufficiently robust to be able to cope with a period of
recession.
Impacts on and responses by UK firms covered by
the EU ETS
13. Reduced industrial production across
the EU has led to a surplus of carbon allowances which are being
sold to raise funds. This is a contributor to the fall in the
EU carbon price.
Implications of the EU ETS for business competitiveness,
and how to address them
14. In the UK, we operate integrated aluminium
smelters, meaning that we are capable of generating all the power
that we need. The nature of aluminium smelting is such that it
is a continuous process. Failure of electricity supply for four
to six hours or more endangers this process and the viability
of the site itself so we rely on our autogeneration activities
as a means to achieve security of supply and remove the risk of
grid failure from our business model. Subsequently we own two
hydropower plants in Scotland for our smelter in Fort William
and our own coal fired power station for our smelter at Lynemouth.
15. The international competitiveness of our
aluminium smelting operations would be put in jeopardy should
our electricity production no longer receive a free allocation.
Exposure to the full cost of carbon under an EU-only scheme makes
our business uncompetitive in a global market. This is because
we are unable to pass through any additional costs to our customers,
as the price of aluminium is determined on the London Metals Exchange.
This is in contrast to other sectors which are not traded through
international exchanges and therefore producers are able to pass
on any added cost of carbon.
16. Since the introduction of the EU ETS,
three smelters have closed in Germany, Hungary and France (representing
6.5% of European production in 2006) and two more smelters have
closed in Norway. Further plant closures and production curtailments
are anticipated in the sector.
17. Our preferred method of compensation
in order to remain competitive is a through free allocation of
allowances. This should be based on a plant specific emission
factor rather than a grid average. Further detail about how we
would like the benchmark to be set is detailed below.
ALLOCATION OR
AUCTIONING OF
EU ETS CREDITS, AND
THE USE
OF AUCTIONING
REVENUES
Allocation—Benchmarks for Industrial sectors
18. As mentioned above, in order to remain
competitive within the EU, our preferred method of compensation
is through the free allocation of allowances for our direct and
indirect emissions. The proposed directive sets out the basis
of free allocation through the use of ex-ante benchmarks, which
will be based on "The average performance of the 10% of the
most efficient installations in a sector or sub sector in the
community in the years 2007-08".
19. However, this still leaves several questions
unanswered.
20. Will allowances be grandfathered based on
a certain level of production? What will that production level
be and how will it take into account future growth? As the benchmark
is being set based on data from 2007-08 we feel this period should
be used when taking into account future production, ie we should
be grandfathered a sufficient quantity of allowances to cover
the electricity generation that is needed to produce the same
amount of aluminum that was produced in 2007-08.
21. In addition to this, as a sector expecting
to be classified as exposed to carbon leakage we do not feel this
is adequate to protect against the risk of carbon leakage. Even
if a 100% allocation was provided against this benchmark it would
mean that at least 90% of aluminium production in the EU would
get fewer allowances than they require, increasing costs which
could not be passed on. This measure is counter-productive in
protecting against carbon leakage and, for those sectors determined
as facing carbon leakage; a grandfathering mechanism of allocation
should be retained.
Allocation—Compensation for indirect effects
22. The proposed directive also sets out
measures for financial assistance from Member States, to account
for the indirect effects of the EU ETS on electricity prices,
which may also be based on benchmarks. Again, this raises several
questions.
23. What will be the nature of these financial
measures? We require a definitive assurance from the UK government
that they will compensate sectors exposed to carbon leakage for
the indirect effects of the EU ETS on electricity prices. We propose
that revenues generated from the auction of emission allowances
be used to compensate operators who are at risk of carbon leakage.
24. The proposed directive states that an
emissions factor will be used based on the "CO2 emissions
of the relevant European electricity production mix". As
we are an auto generator and all our electricity supply comes
from hydro power and a "best in class" coal fired power
station, we interpret this in our case as being the emissions
factor for our coal fired power generation. If another type of
emissions factor is used it will unfairly discriminate against
our business operations, and significantly increase the risk of
carbon leakage.
Auctions
25. We are against the principle of auctioning
allowances in a regional trading scheme for reasons of international
competitiveness, however should an auction be deployed the Commission's
intention should be to harmonise auctioning as much as possible
to reduce the potential for inefficiency and arbitrage between
Member State auction design.
26. This should include ensuring that all Member
States provide for fair access to auctioning not just by Small
and Medium Enterprises (SMEs) but also to industrial emitters.
This group will have a significant exposure to carbon pricing
in Phase III and is at risk of auctions—and the secondary
market—being dominated by less price sensitive utilities.
27. In terms of auction revenues we feel
that incomes raised should be returned to the contributors for
expenditure on environmental improvements.
DEVELOPMENT OF
A GLOBAL
CARBON MARKET
Progress of cap and trade schemes in other countries
(notably, the United States), and the prospects for, and practicalities
of, linking between them
28. We welcome developments in the formation
of cap and trade schemes around the world. Ultimately we see this
as the best solution for dealing with the issue of carbon leakage.
However, there are clearly many issues that would need to be addressed
before an equitable global carbon market could come into force,
notably:
29. From Rio Tinto Alcan's perspective, it would
need to be a truly global market. Aluminium is produced in every
industrialised continent around the world and therefore unless
the same rules were applicable to every producer there would still
be a risk of carbon leakage. A cap and trade scheme in the United
States would not prevent carbon leakage to the rest of the world.
30. The rules would also need be equitable and
harmonised. With different restrictions in different regional
trading schemes, there would still be the risk of carbon leakage.
Any compensation to adjust for these different rules would become
increasingly complex as more schemes became linked.
March 2009
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