Memorandum submitted by the Chemical Industries
Association
EXECUTIVE SUMMARY
1. The CIA is the leading representative
body for the UK chemical sector, with 150 member companies from
multinationals to SMEs. The UK chemical industry employs some
185,000 highly skilled people directly and supports several hundred
thousand jobs throughout the broader economy.
2. The chemical sector is highly energy intensive
and exposed to international competition so potentially exposed
to carbon leakage risks by EU ETS.
3. Until there is globally inclusive emissions
trading it is vital that measures are taken to ensure a sustainable
business environment as energy intensive sectors have a strong
contribution to make to both wealth creation and also the greening
of the economy.
4. We support the use of emissions trading
as a prime instrument to address climate change, but agree with
Stern that a carbon price alone cannot drive the development and
innovation of step-change carbon reduction technologies that will
be needed.
5. We believe that emissions trading is
more effective than a carbon tax. The current UK climate change
policy mix should be simplified to avoid overlap and distortion.
6. For business certainty, it's important
that the carbon market does not suffer unpredictable policy interventions,
we are therefore opposed to calls for a floor price.
7. It is crucial that policy makers, including
the UK government, give full recognition to our at risk sectors
as the detailed implementation of the EU ETS is worked over the
next 12-24 months.
8. Assessment of carbon leakage should be
conducted on a timely basis and at a sufficiently aggregated level
to take account of the integration and interdependence of activities
across chemical sector value chains.
9. We support the use of free allocations
to address the risk of carbon leakage (of production and investment)
from energy intensive sectors exposed to international competition.
10. It is vital that compensation to indirect
emitters exposed to significant risk of carbon leakage from the
pass-though of carbon costs to electricity is operated on a consistent
basis to ensure a level playing field both within and without
the EU.
11. The post-Copenhagen Co-Decision process
should pay full regard to the degree to which the new international
agreement is inclusive, and to progress in implementing equivalent
measures.
OVERVIEW
Potential contribution of international emissions
trading to delivering a global greenhouse gas stabilisation target,
consistent with the UK's goal of limiting global warming to 2°C
12. CIA supports the use of emissions trading
as a prime instrument to address climate change. This is because
emissions trading is a flexible mechanism which offers the least
cost, and therefore the most efficient route, for achieving specific
emissions reduction objectives.
13. However, for emissions trading to effectively
release the lowest cost abatement opportunities and contribute
towards addressing climate change, it needs to be implemented
on a global basis. Until this is achieved measures will be needed
to address the risk of carbon leakage from energy intensive sectors
exposed to unregulated competition from other market blocks. It
is vital that measures are taken to ensure a sustainable business
environment as energy intensive sectors have a strong contribution
to make to both wealth creation and also the greening of the economy.
For example: in the chemical sector, continuous innovation means
our products provide solutions to climate change. Chemical sector
emissions are easily exceeded by the emissions savings from using
our products, eg: materials for wind turbine blades, photovoltaic
cells, fuel cells, insulation for housing, low-weight cars, low-rolling
resistance tyres and low-temperature detergents.
14. In addition, while the carbon price can stimulate
diffusion of cost effective technologies, it cannot alone drive
the development and innovation of step-change carbon reduction
technologies that will be needed to make the reductions being
targeted for 2050. These ventures are potentially risky and very
expensive so, as the Stern Report recognizes, there is also a
need for closer collaboration between government and industry
to stimulate a broader portfolio of technologies and increased
public spending on research.
Whether, and under what circumstances, emissions
trading ought to be supplemented or replaced by tax or regulation
15. On balance, we do not believe that a
carbon tax would be more effective because, unlike emissions trading,
a tax will not guarantee that emissions fall according to a specific
cap. While its possible a tax could provide carbon price certainty
(though see paragraph 20), it does not directly drive companies
to measure their CO2 emissions and measurement is a key platform
for managing and improving performance. Finally, a tax is less
capable of being extended on a global basis at a single rate as
national sovereignty issues are bound to arise.
16. We also believe that if, emissions trading
is to be the effective core instrument for driving CO2 abatement,
it is important that it should not be supplemented with overlapping
carbon taxes. This is because an additional carbon tax will distort
carbon price signals and produce a less optimal outcome. For example:
electricity prices reflect the full EU Emissions Trading Scheme
(EU ETS) CO2 cost pass-through by generators, but the carbon price
signal is approximately doubled by additional costs from the Climate
Change Levy (CCL) and the Renewables Obligation (RO) whereas businesses
outside EU ETS only pay the cost of CCL on gas and coal. Though
we recognize that the RO's aim of supporting fledgling renewable
technologies is an important one, this means that there is more
incentive to abate emissions from electricity than gas and coal.
17. We agree that regulatory measures, such
as product standards, are an appropriate alternative where carbon
is too small a cost component to change behaviour. However, in
energy intensive sectors, regulatory measures like Integrated
Pollution Prevention and Control and its forthcoming successor,
the Industrial Emissions Directive (IED), should not overlap with
emissions trading because, as with a tax, this risks distorting
carbon abatement strategies away from the optimal path. The current
Pollution Prevention and Control Regulations exempt EU ETS installations
from their energy efficiency requirements and it is therefore
important that this principle is maintained in the IED.
18. There are a number of existing policy
overlaps which need to be addressed. Foremost amongst these is
the overlap between CCAs and EU ETS. It is therefore important
that the Government implements proposals made in the Climate Change
Simplification Report to extend CCL relief available under the
Climate Change Agreements (CCAs) to EU ETS installations to remove
the need for the same emissions to be covered by both schemes.
We also support the Report's recommendation that Government review
the interaction of combined heat and power generation (CHP) policies
with other instruments, though it will be important to ensure
that there is no erosion of the incentives on which existing CHP
investments depend.
THE EU EMISSIONS
TRADING SCHEME
The record of Phase II of the EU ETS, and prospects
for the success of Phase III
Extent to which the carbon price will be sufficient
to drive low-carbon investment, in particular decarbonisation
of energy
Impacts of economic recession on the workings
of the EU ETS
Impacts on and responses by UK firms covered by
the EU ETS
19. While commentators have rightly pointed
out that companies need a predictable carbon price and this did
not happen in Phase I, it should be recognised that Phase I was
a transition phase and as such did no permit banking of allowances
into Phase II. The same picture does not apply looking forward
as Phase II does permit banking and the framework for Phase III,
finalised at the end of 2008, provides operators with a certain
carbon pathway up to 2025.
20. As the instrument of choice, emissions trading
delivers a specific carbon cap. Long-term certainty about the
supply of allowances helps to make carbon prices, as determined
by the market, more predictable, though prices will vary as relevant
information emerges about demand conditions and abatement costs.
While the recession has clearly weakened allowance prices in the
short term, this is a wider event which has also impacted other
commodity prices—see the chart below.
It's questionable whether a carbon tax could give
more price certainty as policy makers would undoubtedly need to
make adjustments to the rate of tax to ensure longer-term carbon
emissions goals are achieved and there would also be a temptation
to make variations to meet other political objectives. It is therefore
quite possible that a tax would produce a less predictable carbon
price than emissions trading. For business certainty, it's important
that the carbon market does not suffer unpredictable policy interventions;
we are therefore opposed to calls for a floor price for carbon.
21. The full impact of EU ETS has yet to
be realised in the chemical sector as we will not be fully covered
until Phase III. However, through the UK Emissions Trading Scheme,
UK chemical companies have become accustomed to emissions trading
as an instrument. To the extent the sector is covered, the price
of EU allowances is therefore being fully reflected in our business
decisions.
22. It should also be recognised that the
sector is an early starter in targeting its energy performance
and, under the CCAs and a previous voluntary efficiency agreement
with the Government, we have improved our energy efficiency by
35% over 1990-2006. This means that the majority of abatement
options have been addressed and significant opportunities will
only now arise as it becomes economic to replace long-term production
assets—until then it is likely that the carbon price will
mainly drive more cost effective opportunities elsewhere in the
tradeable sector.
Implications of the EU ETS for business competitiveness,
and how to address them
23. Until there is a truly globally inclusive
international agreement, the proposed framework for the EU Emissions
Trading Scheme (EU ETS) post-2012 risks putting the competitiveness
of the chemicals industry at stake. This is because the unilateral
imposition of the full cost of carbon would impose too great a
burden on our energy intensive activities.
24. The UK chemical industry is one of the most
energy intensive sectors, accounting for 22% of total UK industrial
consumption. It is also highly exposed to international competition:
our businesses compete in global markets and pricing of basic
chemicals is very similar across Asia, North America and Europe.
As UK manufacturing's number one export earner the chemical industry
exports the large majority of its production and half of this
is destined for non-EU markets. In addition, about 70% of sites
are headquartered outside the UK (2/3rds
of these outside the EU), so we also compete for investment with
other production locations.
25. For example:
— Cost impacts from direct emissions of
CO2 (ammonia) and N2O (nitric acid) on the competitiveness of
fertilizers are highly significant: energy accounts for 80% of
costs, so the cost of carbon is many times larger than profits.
Fertilizers are also exposed to import competition from producers
in countries which enjoy low gas costs, eg: the Ukraine and Russia
(anti-dumping duties are imposed on these two countries). UK production
of ammonium nitrate would largely be replaced by Urea based fertilisers
so the Government would fail to meet its commitment under the
EU National Emission Ceilings Directive to reduce ammonia emissions.
— The European chlor-alkali industry believes
that it will not be possible to pass the indirect carbon costs
passed through to electricity prices onto its customers, and that
the cost of carbon will exceed the industry's operating margins.
Without compensation for indirect carbon costs, no new plants
will be built in Europe to replace mercury-based plants which
must close by 2020. This will lead to chlor-alkali and chlor-derivatives
production moving outside Europe, almost certainly to China, and
global emissions will increase as a result, eg: PVC manufacture
in China is nearly five times more carbon intensive than that
in the UK.
— The products of the UK petrochemicals
sector are largely derived from the fractions produced by cracking
Naphtha or LPG in a steam cracker (or ethylene cracker). Derivatives
of the key fractions, eg: ethylene and propylene are traded commodities
and priced internationally and the market is contestable with
plans for significant investment in new capacity in low cost,
competing regions. Significant addition of export capacity in
the Middle East means that the region is increasingly becoming
a natural arbiter between the Asian and EU markets such that regional
commodity prices are converging. This means that integrated EU
producers would be unable to pass on the cost of carbon from which
represents a major portion of cash margins.
26. The final amendments to the post-2012
EU Emissions Trading Scheme include measures to:
— provide for 100% free, benchmarked allocations
to energy intensive sectors which are assessed to be at risk from
carbon leakage;
— allow individual Member States discretion
to compensate exposed electrically intensive activities for the
pass-through of carbon costs to power prices; and
— increase the exclusion threshold for
small emitters to enhance cost effectiveness.
While we welcome these measures, we are concerned
they will prove insufficiently robust and embracing to prevent
carbon leakage and damage to industry competitiveness.
27. Amongst our major concerns are the following:
— The directive's stipulation that there
be no free allocation to electricity production (including self-generation
in CHP) means that free allocations will only be made in for heat
related emissions. Self-generation of electricity by efficient
CHP, which is part of our carbon exposure, will therefore not
receive free allocations.
— Setting the benchmark starting point
at the average top 10% standard means that many installations
in sectors assessed to be at risk from carbon leakage will remain
substantially short of receiving sufficient free allocations to
prevent that risk. Indeed, there is the real risk that the majority
of operators in some exposed sectors will remain financially burdened
at above the EU's adopted exposure threshold. This cannot be an
intended or acceptable consequence.
— The possibility of inconsistent approaches
being adopted by member States with respect to compensating electrically
intensive activities risks inequity and uncompetitive market distortion.
28. It is therefore crucial that policy
makers, including the UK government, give full recognition to
our at risk sectors as the detailed implementation of the EU ETS
is worked over the next 12-24 months. In particular:
— Assessment of carbon leakage should be
conducted on a timely basis and at a sufficiently aggregated level
to take account of the integration and interdependence of activities
across chemical sector value chains.
— There should be full consultation with
sectors on the development of EU-wide benchmarks. Our EU federation,
CEFIC, is already at an advanced stage in coordinating the development
of benchmarks for the large homogenous chemical processes listed
in the directive. The Commission should fully harness this sector
expertise.
— It is vital that compensation to indirect
emitters exposed to significant risk of carbon leakage from the
pass-though of carbon costs to electricity is operated on a consistent
basis. We are concerned that the revised EU ETS directive leaves
this compensation to member state discretion. The threat to key
sectors with indirect emissions is very real (see chlor-alkali
example above). It is therefore essential that the UK Government
takes positive action by giving assurances that it will give financial
compensation to industries who demonstrate at pan-EU level that
they meet the qualifying criteria, and that the level of support
will be no worse than that enjoyed by EU ETS participants in other
member states.
— The post-Copenhagen Co-Decision process
should pay full regard to the degree to which the new international
agreement is inclusive, and to progress in implementing equivalent
measures. This is crucial to reviewing the level of the EU ETS
cap and the need for benchmarked allocations to address continuing
carbon leakage risks. Post-Copenhagen, we favour the continued
use of benchmarked allocations and oppose a CO2 border tax as
this mechanism cannot adequately address leakage.
Effects of the expansion of the EU ETS to encompass
aviation
29. It seems that the inclusion of the aviation
sector in EU ETS will do little to curb their emissions as we
understand their cost of abatement is high. In view of the expected
increase in air travel we are concerned that the inclusion of
this sector in EU ETS could effectively make the scheme even more
stringent for other participants.
Allocation or auctioning of EU ETS credits, and
the use of auctioning revenues
30. Once there is global participation in emissions
trading auctioning will be the most economically efficient method
of allocating emissions allowances. However, until then, we support
the use of free allocations to address the risk of carbon leakage
from energy intensive sectors exposed to international competition.
The use of free allocations under these conditions should not
diminish the effectiveness of emissions trading as the emissions
cap will still be met. Under free allocation, emissions allowances
have a market value so businesses will still factor in the cost
of carbon into their business decisions.
31. There are significant merits to using benchmarks
to make free allocations to large homogeneous processes. This
is because, allocations by EU-wide benchmark send a strong performance
signal and will more accurately meet the needs of efficient installations
than other methods of free allocation. It is important that benchmark
allocations are based on recent production levels, eg: an updating
three year rolling average, rather than a distant fixed period
to ensure that allocations are relevant to current operations
while avoiding perverse incentives.
32. Where allowances can be auctioned without
creating the risk of carbon leakage we believe the Government
should spend much more than the equivalent of the minimum level
of 50% of revenues, to address climate change. This should be
additional to existing levels of spending to address climate change
and particularly focussed on ensuring the right technologies are
developed in the UK. We also think there's a strong case for spending
on investment in UK demonstration projects other than Carbon Capture
and Sequestration. In view of the current economic climate it
would be appropriate to ramp up these programmes now to help increase
the contribution of green business to our economic recovery and
to ensure we are well placed to address our emissions reduction
challenges up to 2020.
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
33. We welcome the development of trading
schemes in other regions because the linking of schemes will help
to increase liquidity and therefore the efficiency with which
emissions reductions can be achieved. However, as highlighted
by an Emissions Trading Group paper, before deciding whether and
how to link schemes there are a range of criteria which need to
be considered including: comparative stringency, standards of
monitoring, reporting and verification, levels of transparency,
coverage, allocation methods and access to CDMs.
The robustness and effectiveness of "offset"
schemes (ie those without a cap), such as the Clean Development
Mechanism (CDM), and the issues around linking them to cap and
trade schemes
34. Until there is a fully inclusion of all market
blocks under common but differentiated responsibilities which
include quantitative emissions targets there will be a role for
CDMs to play. Provided CDMs unlock reductions that would not otherwise
occur in regions without targets we believe that it is appropriate
to allow access to these credits from EU ETS in line with Marrakech
Accord principles. By doing so, EU ETS and other ETS linkages
ensure these credits have a tradeable value and so support the
transfer of resources and technology to developing areas. It also
means that targeted emissions reduction can be achieved on a cost
effective basis.
UK CARBON BUDGETS
The relationship between emissions credits and
the UK carbon budgets set up under the Climate Change Act
Transparency of and justification for counting
the purchase of emissions credits (especially from "offset"
schemes) as decreasing emissions from the UK
35. We note that the Committee on Climate
Change's recommended 2020 targets show leadership over even the
EU's requirements. We believe it is legitimate and therefore highly
appropriate to use credits to meet the UK carbon budgets. However
its important that the credits used are based on reductions are
verifiable, additional and will be sustained. Provided these principles
are met then use of credits should maximise the cost effectiveness
with which climate change can be addressed (see also paragraph
34).
March 2009
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