The role of carbon markets in preventing dangerous climate change - Environmental Audit Committee Contents


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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