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

Memorandum submitted by the UK Petroleum Industry Association

  1.  UKPIA is the trade association representing the nine major oil refining and marketing companies in the UK. Our members own and operate all nine major crude oil refineries in the UK, supply over 90% of the inland consumption of petroleum products in the UK, and export about a third of their production to Europe, USA and Africa.

2.  The UK has the 4th largest refining capacity in the EU, processing 82 million tonnes per year of crude oil. Between 5 and 7% of throughput is used as fuel to refine the crude oil into products, and this is projected to increase as more energy is required to supply the increasing demand for jet and diesel fuels, as well as future tighter product specifications, such as further reducing the sulphur in heating oils and production of lower-sulphur marine fuels.

  3.  Refineries are stand-alone businesses operating in global crude oil and product markets. Increasingly refining companies are independent rather than integrated oil majors, and three of UK's nine refineries are owned by companies with neither exploration and production businesses, nor retail marketing chains.

  4.  UK and EU refineries need to be able to attract large investment projects in order to adjust output to meet changing demand. The EU is currently reliant on large-scale imports of diesel and jet fuel from Russia and the Middle East, and on large exports of gasoline typically to US, and these imports and exports are projected to increase in a market where US consumption is declining. The EU therefore needs to be able compete successfully for large-scale investment projects to readjust refining output to meet demand changes. If investment is not encouraged, the refining supply to demand imbalance will increase (see figure 1).

Figure 1


  5.  This coincides with the traditional US market for surplus gasoline disappearing as ethanol is added in ever greater quantities to the demand pool (see figure 2).

Figure 2


  6.  UKPIA's views can be summarised:

    — Emissions trading is the best of the currently available policy instruments for carbon-intensive industries operating in a global market, and has clear advantages over carbon taxation.

    — Industries such as oil refining have to compete internationally for investment, and want to be able to do so on level terms with EU and non-EU locations. Hence UKPIA favours a harmonised EU ETS over either UK-only policies or supplemental UK or EU taxation.

    - The flexibility to purchase credits for non-EU reductions is an important way of achieving the same environmental benefit at reduced cost to society, and should be maximised. Project credits through the CDM provide a good way of funding low-carbon investments in developing countries.

    — The EU ETS to date is a success. Although EU ETS allowance prices have been volatile, credibility has been established on how we measure, verify, report and trade allowances. The cap has been delivered, and will continue to be delivered with little damage to EU competitiveness. The likely future cost of carbon has been established across all industry as a factor to be considered in capital expenditure. The prospect of fewer allowances in future and hence higher prices will increase the attention given to GHG abatement.

  7.  In response to the questions posed by the EAC:


Potential contribution of international emissions trading in delivering a global greenhouse gas stabilisation target, consistent with the UK's goal of limiting global warming to 2°C

Whether, and under what circumstances, emissions trading ought to be supplemented or replaced by tax or regulation

  8.  An international emissions trading scheme (ETS) has the potential to deliver a pre-determined "cap" on the future total volume of emissions of GHGs at a minimum cost to society. This is a great advantage over other policy instruments such as taxation, where volumes of future emissions are uncertain.

9.  A further advantage of ETS over taxation is that it provides a means for industries exposed to international competition (such as oil refining) to experience an incentive to reduce emissions at the margin, while still providing a competitive rate of return on investment compared with less regulated locations. This is because the price of ETS allowances depends on supply and demand and does not depend on the system of allocation, and hence industries exposed to international competition can be given free allowances until such a time as there is an international agreement on policy instruments to control GHG, and the risk of "carbon leakage" or "investment leakage" is reduced.

10.  A tax would not be less complex that an emissions trading scheme. For example, both a carbon tax and an ETS require monitoring and verification of emissions and a compliant bureaucracy to support it.

  11.  UKPIA believes that ETS is an appropriate policy instrument for large energy-intensive industries, with significant advantages over taxation. We strongly believe that policy-makers need to choose between cap-and-trade or taxation, and that to use both would discourage investment and lead to substitution of domestic production by imports on a large scale.

  12.  We acknowledge that setting the "right cap" is not easy. If it is set too tight the economy may be damaged, and if it is set too loose there will be reduced abatement, and there needs to be appropriate levels of abatement in the non-traded sectors. However as more verified data is gathered and as other policy measures take effect it should become easier to steer the right course.


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

Implications of the EU ETS for business competitiveness, and how to address them

Effects of the expansion of the EU ETS to encompass aviation

Allocation or auctioning of EU ETS credits, and the use of auctioning revenues

  13.  Despite the volatility of the prices of allowances, the ETS is a success because the cap has been delivered, and will continue to be delivered. Credibility has been established on how we measure, verify, and report emissions and trade allowances. The likely future cost of allowances is a factor for all industries to consider in their operational and capital planning and investment. The design of the EU ETS allows industries exposed to international competition to remain competitive and attractive locations for investment, and it is vital to preserve this.

14.  Decarbonisation of energy will be driven by the cap and hence the likely future cost of allowances.

15.  A great advantage of ETS is that the cap will be delivered regardless of whether the economy is in recession or not. In times of recession allowance prices are likely to be reduced, and hence the cost to society is reduced.

  16.  The refining industry is very aware of the EU ETS and the need to consider the likely future cost of carbon in business planning. UK refineries emit significantly less CO2 than the baseline established for Phase I by verified historic emissions, despite the need for extra energy use to manufacture fuels to the latest EU sulphur-free specifications.

  17.  The incentive to invest to reduce emissions is provided by the likely future price of allowances, and is not dependent on how these allowances are allocated. Until there is a global agreement on carbon reduction policies the EU has correctly decided to issue allowances free to industries exposed to international competition and carbon leakage. In this way the ETS has succeeded in providing clear incentives to invest to reduce emissions, without unnecessary damage to competitiveness. Those reductions which can be made benefit from the full value of carbon. It is important to maintain this policy.

  18.  The expansion of the ETS to include aviation will provide a similar incentive to airline operators to reduce emissions. If demand for jet fuel continues to increase within a given cap, there will have to be compensatory decreases in carbon emissions elsewhere.

  19.  Auctioning of allowances (like a carbon tax) does much more than provide an incentive to reduce emissions at the margin. It has a huge and direct impact on cash-flow. In some industries it may be possible to pass the cost on to the end-consumer—as it largely the case for the electricity supply industry. However, in industries which are exposed to international completion and import substitution, such as oil refining, the ex-refinery product prices are set by the global market, and whether or not there is cost pass-through the remuneration on investment at EU refineries will be much less than at comparable non-EU facilities. UKPIA is strongly against auctioning of allowances to exposed industries until comparable policies are implemented at non-EU facilities. The use of auctioning revenues is a matter for national Governments.


Progress of cap and trade schemes in other countries (notably, the United States), and the prospects for, and practicalities of, linking between them

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

  20.  The development of a global carbon market is to be encouraged as a means of capturing environmental benefits at the least cost to society. As more jurisdictions adopt carbon markets or other mechanisms to price carbon, the need for exposed industries to be protected will decrease.


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

  21.  It is key that the UK Carbon Budget remains consistent with the overall targets of the EU ETS. This is essential given the global nature of the oil refining business, UK refineries have to compete with others in the same corporation for investment in order to remain competitive and meet changing demands.

22.  The proposed Carbon budget for the period 2018-22 in the traded sector is 800 tonnes, equivalent to 160 tonnes/year in 2020. The stated aim of the ETS is to reduce CO2 by 21% versus 2005 level. According to DEFRA the cap was 215 mteCO2 in 2005 hence 21% reduction would be 170mte CO2, some 10mte above the Carbon budget. However, the CCC recommend that there "should be no limit on the extent to which the UK could meet its budgets via the purchase of European Union Allowances" ie for the traded sectors, allowances purchased through the ETS are valid; it is only in the non-traded sector that trading is limited.

23.  It is also important that any additional burden (eg from increasing aviation emissions which may have to be compensated by reductions elsewhere within the ETS) is evenly spread and not disproportionally allocated to the refining sector.

  24.  In order to deliver the reductions in the most cost effective way, we would encourage flexibility to count the purchase of emission credits (& offset schemes) as decreasing emissions from the UK in a transparent way. A mechanism for this could be a register similar to that used to trade the existing EU ETS allowances.

February 2009

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