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

Examination of Witnesses (Questions 1-27)


31 MARCH 2009

  Q1  Chairman: Good morning and welcome. Sorry we are running a few minutes late. I am also sorry that we are quite tight for time today so we are going to try and get through by 1 o'clock. We will try and keep our questions concise and how far we get will then depend on how concise you can be with the answers. WWF are obviously very old friends of this Committee and we have seen you before, but Sandbag is a relatively new organisation, so could I just ask you to kick off by saying what Sandbag is trying to do and what progress and impact you think you have had so far.

  Ms Worthington: Thank you. We were set up to focus on trying to create a link between civil society and emissions trading because we felt that emissions trading was a really central policy but very little understood by the general public. Our aim is to educate people about emissions trading, to lobby for improvements around emissions trading, and to create links between civil society and the market so that people can use the market to create more impetus for change on climate change. We were set up in September, we are grant-funded by a number of leading environmental foundations, and we are starting to recruit staff and buildings, so we are a small organisation but growing.

  Q2  Chairman: That is certainly a very important but quite challenging task, I guess, and I wish you every success with that. Looking now at the EU ETS, and in particular at the proposed cap for Phase III, do you think that is compatible with what we know we have to do by 2020? The Government is quite ambitious for that and it has been reinforced by the Committee on Climate Change as well. Looking at what Phase III might imply, in particular if we are allowed to use our full quota of project credits, do you think that it is going to be sufficiently ambitious?

  Ms Worthington: No, in a word. Obviously there are many things that have changed since the proposals that the Commission put forward. The target of a 20% reduction by 2020 is inadequate. If you look at the recent suggestions from the IPCC that developed countries should be reducing by between 25 and 40%, we are not even at the bottom end of that scale with that target, and then you consider that Europe is now going to find it easier to meet its targets thanks to the current economic climate, and we have this influx of cheap permits from overseas projects, the total effect of the scheme is going to be almost negligible, and for a so-called central policy it should have a lot more ambition within it and the targets should be significantly improved post a Copenhagen deal being reached.

  Dr Allott: I think we would agree with that. I would highlight particularly the use of offset credits not just in the ETS but across the economy as a whole. When you allow for the projected influx of credits, Europe's own emissions from the EU27 may fall by as little as 5-6% from current levels by 2020, which does not exactly look like strong climate leadership from where we are sitting.

  Ms Clough: At the same time you have the power sector which it is clearly recognised needs to be almost decarbonised by 2030, it was acknowledged in the Climate Change Committee Report, so just to re-emphasise what has been said, the EU ETS current targets are nowhere near significant enough to have an impact on investment decisions that need to be made.

  Chairman: If the EU commits to a 30% target at Copenhagen, if other countries do as well, what effect will that have on Phase III? Will that mean that we will have to have a much tougher cap in Phase III? If that is the only way that the ETS can be made compatible with this more ambitious target, how can Britain influence that?

  Ms Worthington: It is absolutely clear that a deal at Copenhagen should then lead to a tightening of the EU cap. We would argue that, irrespective of what happens at Copenhagen, the EU must tighten its cap and that the UK should be pushing for that. The way that the Directive is now set up, there was a deal reached at the end of December last year and it will be opened up again post-Copenhagen. I think it is important that all Member States send the message that for our own EU purposes and to decarbonise our economy and to help support our own adaptation to industrial policy and decarbonisation of Europe's industries, we need tighter caps. If a deal is not reached and we have another period of time with a hiatus, Europe should nevertheless tighten those caps because otherwise the scheme ceases to have a purpose.

  Ms Clough: It is also in the UK's interest to be seeking to tighten the caps. Given that we have an 80% cut in place in the Climate Change Act by 2050, we should be seeking much greater cuts by 2020 to make sure that Europe is in line with what we want to do in the UK.

  Q3  Chairman: Phase III runs for a longer period than Phases I and II, if the science goes on getting more and more worrying, is there also scope for a mid-term tightening of the cap during Phase III to reflect what will then be the latest scientific evidence?

  Ms Worthington: There is an opportunity for reviewing the annual rate of reduction within five years, so there is a built-in mechanism for tightening and absolutely, yes, there should be an expectation that caps are only ever going to tighten in those review periods.

  Ms Clough: Combined with that, clearly, the access to offsets acts to inflate the cap anyway, so we should be looking to dramatically reduce our access to offsets now really. There is a provision—this does not apply to the EU ETS—within the Climate Change Act which allows you to tighten the budget within a budget period if something significant happens, so you could also argue that the same provision should be made within the EU ETS Directive.

  Dr Allott: Perhaps I could just say something about the overall ambition. I think this needs to be viewed in the context of a global carbon budget. We are now used to the idea of a UK carbon budget, thanks to the Climate Change Act, but we need to be looking at a global carbon budget and how it is apportioned. One of the difficulties that we have now got structurally is that we are used to a concept where we have a cap for developed countries along with an offset mechanism which allows emission reductions in developing countries to count towards that developed country cap. Even if you believe that the offset mechanism is 100% perfect, which we do not think it is, it is a zero sum game. Beyond 2012 we need to be moving to a world where we are having very aggressive emissions reductions from developed countries and also very substantial decarbonisanation in developing countries. In that context, the whole idea that an offset mechanism is somehow helping developing countries is not the case. The offset mechanism is a cheap way of us meeting our developed country targets. We need also to be finding ways of helping developing countries decarbonise in addition to the offset mechanism. The current way that the policy has been constructed confuses the debate.

  Q4  Dr Turner: As a mechanism for reducing CO2 emissions, so far the ETS does not seem to have had an impressive track record. There does not seem to be any very clear evidence that it has reduced carbon dioxide emissions to any extent whatsoever. Nonetheless, governments, including our own, have set great store by this process as one of the principal instruments of achieving our carbon reduction targets. Yet it seems to have some very perverse elements in its mechanisms because if we actually succeed in beginning to decarbonise our economy by increased energy efficiency and greater deployment of renewable energy, we leave more space under the cap, as it exists, for polluting industries to take up those carbon credits. Do you think that this is a fatal flaw in the mechanism and can you see any way round it?

  Mr Burke: I think the comments you make there are right in terms of the cap and the floor. It is one that is not being much debated in the EU. Germany has started to take notice and Australia is having a hot debate on that at the moment. There are mechanisms around that but before we get to that I would like to briefly outline that where you talk about effort in sectoral changes allowing carbon emissions in other sectors, to an extent, that is not a bad thing if you are going to get higher and better use (and that is what the market can lead you to) but if individuals and local governments and national governments want to take action over and above the caps, or if they deem that the Copenhagen targets are not aggressive enough, then their efforts will also not lead to any reduction, so individuals engaging in energy efficiency in the UK can simply be leading to increased carbon offshore within the EU. In terms of the mechanisms that we have investigated as to how you could alleviate the issue, it is the terminology of cap and slice, so the cap is deemed to be a worst-case target and then you use the ability to slice off the cap through structural mechanisms and set aside permits. This is something that is already being used in the US RGGI scheme, so within the states they set aside, depending on the different legislation, a certain number of permits capped at 1 or 2% where consumers or businesses who purchase green power have additional abatement opportunities there and they cancel those caps from the allocations. We can see steps where you could use that cap and slice methodology to incentivise civil society as well as business and local government to engage in actions that are not mandatory, and through that set aside that would be reducing the emissions, if you structure them properly, by reducing credits in the market and AAUs so you tighten the overall EU and UK cut.

  Q5  Dr Turner: But at the moment as it stands the ETS does not have any such provisions?

  Mr Burke: It does not.

  Q6  Dr Turner: Can you see any evidence either on the part of the Commission or European governments to appreciate that problem and to seek to introduce such mechanisms at an early stage of the ETS or not? If not, how do you suggest we start to go about it because without it, it seems to me, at any rate, the ETS is never going to deliver anything except failure?

  Ms Worthington: I would just say more generally that a mechanism like this is important but it is only important if your caps are set at the point where it is marginal as to whether they are really enabling tough action on climate change. The tighter the caps the less likely it is that you are disempowering civil society because then voluntary action helps to reduce the price. It really is all about the targets and where they are set. There is a lot of evidence that says that in setting up a scheme like this you should err on the side of precaution towards the environment, ie you go for quite tough caps initially because you know that the likelihood is there is a lot of cheap abatement out there, that is yet to be found. The fundamental failure of the ETS is that it has taken too cautious an approach to the setting of the caps. That is because of the sectors to which it has been applied and the fact that we have had a very vociferous and vocal lobby from heavy industry in Europe that has basically watered down the effect of the whole cap. If it had been on power alone you would see that the caps were very tight. There is some evidence that there has been some marginal fuel switching within the power sector because many of the big players are substantially short in their allocations. You see in Germany the switch between brown and black coal, which is probably the cheapest form of abatement that is possible in Europe. Until we get through that, we are not going to see investment in any more expensive alternatives, so it is all about where the cap is set, and it has been set too leniently.

  Q7  Dr Turner: The caps are simply not challenging and they seem to bear no relation certainly to our own carbon budgets or even to the EU's carbon reduction targets. This link somehow has to be made, so would you agree we need to start now to tighten not only the Phase III caps but we need to do something about the existing caps on an interim basis. Can you detect any signs of such urgency within the EU at all?

  Ms Clough: Not at the moment, but I think the framing of this type of approach is extremely problematic because it takes the ETS as an end in itself rather than a means to an end and it also takes quite a narrow view of how EU climate policy will hopefully develop in the next few years. So, placing it within context, the carbon market is perhaps one part of the solution but there are other mechanisms like the Renewable Energy Obligation we now have. There are debates coming forward on emissions performance standards for the power sector which are gaining weight within Europe, particularly within the European Parliament, and also within the UK potentially. So whilst it is a very kind of specific argument to say if we make additional reductions here that just leaves Germany or other countries allowing them to increase their pollution further, we have to take a stand at some point. Someone has to take the lead in this. Why should the UK not take the lead? The UK has a Climate Change Act with targets set out to 2050. Surely we should be seen to be taking a lead in putting in place national policies and measures that really start driving down emissions, and that will hopefully lead on and influence other European states to follow suit.

  Q8  Dr Turner: Given the unreliability of the carbon price resulting from the operation of the ETS so there is only a very, very weak investment incentive being created by that, do you think that perhaps rather than going through the very complicated and difficult process of trying to change the structure and mechanism of the ETS to tighten caps on a short-term basis, it might be simpler and more effective to introduce some floor mechanism for the carbon to create a reliable carbon price or, put in other words, a carbon tax, to underpin effectively the ETS to make sure that there is in fact effective emissions reduction?

  Dr Allott: I think we need to look first of all at the level of the caps, that is a fundamental issue, but then also the fact is that there are other policies and measures which already exist and many other policies and measures which we need to be introducing to support the carbon price, as Adair Turner suggested. Renewables policy is what is really driving investment around Europe. The Renewables Directive and policies on energy efficiency are all things that are happening anyhow, and we believe that a policy such as emissions performance standards would also drive investment in clean power, over and above whatever the carbon price happens to be in the ETS. A more ambitious cap could help as well but there are also issues to do with the auction which Kirsty could perhaps raise.

  Ms Clough: I think there is already a price floor set in the UK auctions. The UK had its second auction last week. I do not know what that price floor is or whether it is anywhere near sufficient. The risk of setting a price floor across the whole market is that you re-open the debate on price ceilings, which happened in the negotiations on the energy package last year. It is a judgment as to whether you want to do that and who would win and if you did have a price floor whether it would be set sufficiently high enough anyway. Clearly there will be political negotiations to try and keep it as low as possible.

  Q9  Chairman: Is not the central question though to get people to face up to the fact that the only way that we are going to have a serious reduction in emissions is by making sure that energy is much more expensive? High-carbon energy has got to be priced out of the market. Until people face up to that fact, whatever mechanisms you use, whether it is EU trading or worldwide trading or carbon taxes, if half the effort is devoted to how to reduce the impact that has then we are barking up the wrong tree. Should you not be saying very clearly that the future is really expensive energy?

  Ms Worthington: I do not know that is necessarily true because the only thing we have seen so far is that it is really quite easy to hit targets, and the problem has been that there are so many sources of cheap abatement that it is hard to hold a price that is positive. I do not think necessarily NGOs have a very strong view about what the price should be except that the targets should be tough and that we should let the markets tell us what the price is of getting to those targets. In a sense, yes, that might well send quite a strong price signal, but it might be that we do all sorts of other things in terms of regulation that choice edit which mean that prices do not ever need to spike in the way that people are anticipating and there is enough abatement and enough will, to try and solve this problem that we will be able to keep a moderate price. I think it is determined by the ambition that we need to set.

  Q10  Chairman: If you want to incentivise energy efficiency, it is quite clear that historically the only effective way of doing that is by increasing higher prices. There has been no period where people have said, "Oh gosh, yes, let's invest in energy efficiency," without a price signal. That is number one. Number two: if there were lots of cheap sources of low-carbon electricity we would be using them now but there are not, they are all more expensive than burning coal. I think there is something dishonest about saying we will have this mechanism and that mechanism to solve the problem. Yes, of course you need much tighter caps but the consequence of much tighter caps is much higher prices.

  Dr Allott: If you think that the carbon price of the ETS is going to drive forward energy efficiency across the economy, then I do not think that is the most appropriate mechanism to do that. There are much smarter packages of measures, not just a price signal, which you need to discover all the huge energy efficiency options that are out there. In terms of energy bills rising, if you talk about the price per unit rising, that is one question, and perhaps the price per unit will have to rise because there will be transitional costs of moving to a lower-carbon system for renewables, and all the emerging technologies will be more expensive, but if you have a smart package of policies also designed to reduce demand and improve efficiency then the overall impact on bills, which is what matters, will be less. There will be transitional costs, everybody knows that, but those costs are fully justified compared to the costs of doing nothing.

  Q11  Joan Walley: I think the common thread that runs through both of your evidence contributions to us is that there should be a greater political will to bring about tighter and more challenging targets. That is very easily said, but what actually needs to happen for that political will to be there and for that political will to give replies to some of the stronger vested interests that are making the heavy lobbying to which you have just referred?

  Ms Worthington: I think a number of things need to happen. Some of them are happening. One is that emissions trading needs to be better understood and better appreciated.

  Q12  Joan Walley: By whom?

  Ms Worthington: By the public, and in the last few months we have seen (because of the effect of the Heathrow decision and Kingsnorth) that the lobby is now much more aware of the impact that emissions trading is having on policy, so people are joining the dots and realising that individual decisions that are being made that are deemed to be highly political are being linked to emissions trading, and that has not happened before. People are starting to realise that emissions trading is an important policy. The more we can get people's attention focused on this policy so that they can start demanding tighter caps and improvements, the better. There is another point which is that we need more scrutiny. Opposition parties need to be really getting into the detail. This Committee has done fabulous work in making this a policy that is scrutinised, but we are going to see a big release of data tomorrow from the European Union. That data will show how emissions trading is working on the ground. We want the numbers to be better understood and people to see what has happened and what has gone wrong in the past to avoid future problems and make the decisions easier. The final thing is you have to disaggregate the very vocal and obviously defensive lobby in Brussels, which is centred around the industrial industries, from the broader industrial lobby, which is representing renewables, energy efficiency and clean technologies, who do want tighter caps and are employers and increasingly important employers in Europe, and listen to their voices and try to set that off against the inevitable defensive positions of the incumbents within the heavy industry sectors.

  Q13  Joan Walley: Is there not a difference between what governments might say and what politicians might say here as to the difference between that and that actually being understood by civil society out there? How do you actually get this message across?

  Ms Clough: I think there is increasing concern from civil society in tackling climate change. Whether you can directly relate that to emissions trading schemes, I am not sure, but there will be a lot of marches this week. There was a march on Saturday clearly linking jobs with tackling climate change, to incentivise new green, clean jobs for the future. WWF held an event on Saturday night, Earth Hour, which was a global event, where the lights of Big Ben and the Wheel were turned off. We had participation from about 4,000 cities around the world in 88 countries. There is action. You can say these are symbolic actions and are they going to be followed up, but I think they show a growing concern that we want governments to take action and take responsibility.

  Mr Burke: Linking some of the comments we have had about emissions trading to policy, one of the things over the last few months is there has been discussion around Heathrow and we are going to have emissions trading so we are going to do more in one sector which means that we can build Heathrow. The general view in society is hang on, that is very hypocritical, and just because you have got emissions trading does not mean that all your other policies should fall away. In actual fact, our view is that all the other policies should be analysed in the context of reducing emissions and the impact that that has under an ETS. If the Government were to go for a great new deal and put a lot of money into energy efficiency because of the cap on energy consumption, you would not actually reduce emissions within the EU. It would just be a funding exercise from the taxpayer to other high-polluting industries, which may be cement or other capped sectors. The Australian example is that they are spending billions of dollars on insulation. The Prime Minister has said that that will reduce Australia's emissions, but because energy is a capped sector in Australia it will not reduce emissions under an ETS. As we have these policy discussions and we talk about scrappage charges for cars, we need to bring emissions trading and the perverse impacts that it can have into the debate. Society will start to demand that now, as Bryony said, as they become more aware of the issues.

  Dr Allott: One thing I would say is that I think we are seeing an interesting debate in the US emerging now about the role of cap-and-trade legislation versus other mechanisms. We have seen proposals coming from the US CAP initiative for instance, which is a coalition of NGOs and large corporations with recommendations to the Obama Administration. What is interesting about that is they talk about cap-and-trade but also having regulatory standards for power plants plus a technology development and deployment mechanism. In a way they are overtaking our conceptual framework here. We are hiding behind the ETS too much in Europe to stop real action on the ground. Real action on the ground matters.

  Q14  Joan Walley: When you say real action on the ground, what do you mean?

  Dr Allott: Real action on the ground does matter; decisions like Kingsnorth do matter; decarbonising our power sector does matter. You cannot just hide behind an emissions cap. The actual investment strategy matters in terms of where we are taking the country and Europe in terms of a low-carbon pathway. The Californian delegation which was in London the other week had a very interesting way of putting it. They expressed it in terms of fridges where nobody objects to the idea of having a basic standard of performance that you require with all new fridges, in terms of efficiency and in terms of safety, before you are allowed to put them on the market. Once they are on the market then there may be a role for market instruments to try and incentivise the best, but the danger is that we currently have a system which does not allow you to have a basic standard.

  Ms Worthington: Can I say a word in defence of trading because it is something that is incredibly empowering if you use it correctly because it is a regulated cap. It is not like a tax where you have to try to estimate the level of cost that you need to put in to society and then hope that the price signals deliver change. There is a regulated cap that is enforceable and in that sense the permits that are created are a finite number. If you find mechanisms for removing them from that cap then you are absolutely making an additional impact in terms of buying the cap down. The Government has been up until now only half engaging with trading. It has been using it as a convenient fig leaf to allow decisions to be taken that it would like to see go ahead, but it is not properly setting about understanding the impact of trading and how they can use it to empower people to make a difference. I think the set aside idea of putting permits to one side for civil society to claim so that we can have a role in buying that cap down is a really important principle. It is amazing that it has already been dealt with and implemented in the States in the RGGI system. Australia is actively debating it. There has not a word been spoken about it in the European Union. We have got to change that. I think the other practical policy that we are putting forward that would perhaps engage people in trading is creating tax incentives for individuals and companies who want to take action by taking permits out of the system, so very clear, easily audited, additional action anyone can take, you simply take the permits and you destroy them. There is no incentive at all for anyone to do this. There is a tragedy of the commons because why would you do it when nobody else is. The Government could intervene and create incentives for people to do that and that will engage people in a much broader sense with trading in a more positive sense.

  Q15  Joan Walley: There has got to be that political will and engagement by governments in order to be able to move on this. I just wonder how much of a difference you think that the creation of a new Department of Energy and Climate Change is making to the political will to tackle climate change?

  Dr Allott: I think the jury is still out. There have been some positive shifts. It is hard to disentangle how much of the shift is to do with the shifting of personnel at the top of the Department versus the creation of a new Department. I think it is fair to say that we have some of the same fundamental mind-set problems that have held back progress on energy policy in particular in the former DTI and BERR and we have some of those problems still now within DECC. We will have to wait and see how the dice land. We are now at a very interesting stage in the debate. Over the past two months we have had a new department created. We have had some positive signals from Ed Miliband in terms of shifting the balance of the debate about driving forward government regulation. We have had the Turner Report, the Climate Change Committee Report, which begins to talks very clearly about the need for decarbonising the power sector in particular. Meanwhile, the view of market mechanisms in the outside world has had a bit of an interesting time generally recently, over and above carbon trading. I think the whole debate is now very live but whether DECC is going to come down on the right side of the debate, we will have to wait and see.

  Q16  Joan Walley: How much do you think that the different policy issues are between different departments, so for example the analysis that goes on with the Treasury in terms of the Green Book, how much of that is linked to the planning considerations that come under the new agency that is going to be established and how does that all fit in with DECC, in terms of fitting all of that to get the political understanding about these decisions when it comes to reducing emissions?

  Ms Worthington: In a sense that is the purpose of having a carbon budget, that suddenly the whole economy has a price attached to every tonne that is emitted, and it ought to be a centrally organising idea within government to which each department adheres. I believe that it is true that in terms of thinking about how they are going to meet their carbon budgets, each department will have a strategy that acknowledges that there is a finite amount of emissions that can come from the sector that it looks after, so this will be a radical shift. Until recently, transport policy was about encouraging and facilitating transport, not managing a carbon budget, so this will be quite a big step forward. It is interesting, I do not know yet where responsibility lies within government for the pulling together of the carbon budget and measuring out who has done what and the accounting side of it. Is it the Treasury? It would be good if it were. Traditionally, they have tried to focus on pure fiscal systems but in this sense it would be good to have their analytical brains applied to this problem. Every tonne now has a price attached and therefore Treasury should be interested. It needs some co-ordination within government. I do not know if it sits within DECC or within the Treasury but we need to know who is accountable and how it is being organised.

  Dr Allott: There is an important point to understand as well about the carbon budgets. One concern we have, and I know that we flagged it up in our written evidence, is that it is not clear how the Government intends to apply the carbon budgets after 2012. At the moment in the current first carbon budget we have a UK cap under the EU ETS because we had a National Allocation Plan. After 2012 we will no longer have a UK cap because the cap will be set centrally. The Government's recent consultation on how it is going to account in future for carbon budgets failed to answer that question.

  Q17  Joan Walley: On that point, should the UK Government or European Commission intervene on Phase II to tighten the cap and raise the carbon price?

  Dr Allott: Our view is that the carbon budgets need to be expressed in terms of the UK's actual emissions, with an envelope around those emissions to allow for some flexibility with trading rather than setting a cap. The problem with having a cap is that it means the UK carbon budgets may be much less of a powerful tool than we thought, for obvious reasons, because once you have a cap you could have complete decarbonisation of our industry and you would not be accounting the benefits under our carbon budgets. Equally, if you build lots of Kingsnorths that would still appear as the same number. We have not got an accounting process for doing it after 2012. Our view is that the Climate Change Act needs to be focusing on the real emissions from the UK with an envelope for trading.

  Q18  Chairman: Is not the central problem the fact that the caps are still much too loose and the danger is that trading, which I agree with Bryony has the advantage that it sets an absolute limit and therefore, unlike the carbon tax where you do know what the effect is, we do what the limit is and the limits on it are so hopelessly loose that we are in danger of getting the concept, which is rather a good concept in terms of mechanisms to address climate change, a bad name because it is so patently ineffective?

  Ms Worthington: I could not agree more. In response to the comment is it just too complicated to tighten the cap; not at all, we have a perfect opportunity. The Directive itself is being re-opened post-Copenhagen. Let us hope that we get a deal at Copenhagen but even if we do not, let us make sure that that re-opening tightens the cap. The effect of that will be to push prices up in this phase because if there is an expectation of shortage in the next phase that will affect the price in this phase. They are linked by banking, so we have got the prize and we can go for it. It is going to be decided next year. Unlike the round of negotiations we just had in December, let us hope that civil society is engaged and calling for tighter caps, not simply being excluded from the debate. We have got to hope that this year the focus on Copenhagen delivers us the right political conditions going into the next discussion where we can significantly tighten that cap, and not just in terms of the overall number but in terms of the number of offsets that come in. I think we have got everything to play for. It will require civil society and commentators getting involved in the numbers and calling for change.

  Q19  Chairman: So if there is one single thing you would like this Committee to say it would be that we need a much tighter cap and much greater control over the use of credits?

  Ms Worthington: Yes, Phase III, and that Phase III tightening will have an impact on this phase.

  Q20  Mr Chaytor: Could I ask Keith about the price of carbon. Recently it has dropped to about €10. What should the price of carbon be if it is going to work effectively to generate new renewables and, specifically, what should it be if nuclear is going to become economically viable?

  Dr Allott: I do not think we have a particular view on what the right price of carbon needs to be. Our concern is having a package of measures which will drive forward the outcome that we need to see if we are going to avoid dangerous climate change. The whole point about the carbon market, if it is working properly, if you believe the theory of the carbon market, is that the price will go to the level that is necessary. Our view is that you need to have a whole package of supporting policies and measures to deliver the transformation in our energy systems. Let us face it, we are talking about the need for an urgent transformation in the way that we run our economies. That cannot be done purely by a price signal alone. You could take an economic view that there is an implicit price in regulation and other measures, and those all need to be brought together. We do not have a particular view as to what the right price needs to be. I can tell you that the price it is at the moment is not going to deliver that transformation.

  Q21  Mr Chaytor: What is your understanding of the assumption by wind companies or nuclear companies as to the price they need for wind and nuclear specifically to be economically viable, because that surely is the key issue, is it not?

  Dr Allott: I have no understanding of what nuclear power companies are up to and we do not support nuclear power. In terms of wind and other renewables, wind and renewables are being driven forward not by the emissions trading scheme, or by other policies but by the Renewables Obligation. It is not just us saying this. There was a recent presentation from a guy from Deutsche Bank saying that the only thing that is driving real clean investment in Europe is the renewables target. It is not being driven by the carbon price. I think it is really important to distinguish that. The real driver for investment is the renewables legislation, not the carbon price. There is an implicit carbon price within that legislation but it is not set by the ETS.

  Q22  Mr Chaytor: Secondly, could I ask Bryony about emissions standards for power stations. How important do you think this is in the package of measures that we need and what is the attitude of the major power companies towards this, from your experience?

  Ms Worthington: This is one of the suites of packages of policies that you need underneath the cap. I think Keith's analogy of fridges makes it easy to understand. Essentially, there are some things that are just too risky to allow to happen. I think unabated coal falls squarely into that category. It can perfectly well co-exist underneath the cap. You just adjust the targets downwards to compensate for the fact that you are going to be bringing up the standard of power station emissions across the piece with legislation. I would say that you need to be careful how it is implemented. A perverse effect might be that you prevent new build and allow old build to carry on running. Coal stations have an amazing capacity to keep living well beyond their sell-by date so you just have to be careful how it is implemented. Fundamentally, it is a good policy to bring the floor up for everybody. In terms of my experiences in the power sector, they are at the moment waiting to find a clear signal from government as to what to build. Their natural tendency at the moment would be to choose gas. There is an interesting build in CCS but it would need a supplementary policy and something much more substantial than the current competition, which I think most people think is ineffective. The Government has got an opportunity to get them to build the right things, either through introducing dedicated policies to bring on CCS or through performance standards, but it is just that the devil will be in the detail. There is no fundamental reason why they cannot do that as well as having the EU ETS functioning. It is wrong to say we just put the cap in and then sit back. You always still do need a dedicated energy policy and that is what that would do.

  Q23  Dr Turner: Bryony, just on that point, given that DECC is the licensing authority for power plants, would it not actually be quite simple and give an absolute direction towards investment if DECC were to set a maximum emission level per megawatt over the whole life cycle, including construction et cetera, of a generator, at such a level that nothing emitting more than a carbon capture-equipped station would qualify? That would cover the question of new build very clearly and as to existing time-expired power stations, it could put a time limit on their licence. That way, by simple regulation, we could achieve far more than years of negotiation over trading price mechanisms. What is your reaction to that?

  Ms Worthington: I agree, as I said, in principle, I think the performance standard is a good idea. I am not legally aware of what you can do to alter the licences of existing stations. I just counsel that you have two issues: one is the cleaning up of existing stations; and one is the cleaning of the new build, and you need a policy that works to do both. It is not either/or. You should tighten caps because the caps act as your insurance policy against fuel switching because of price differentials that you cannot control. If coal becomes incredibly cheap and gas spikes, which it is likely as it becomes more scarce, you will see people switching back to coal. They will find ways so you need an insurance policy basically.

  Q24  Dr Turner: They would not be able to find ways if they had an absolute limit under the licences.

  Ms Worthington: As long as it applies retrospectively to existing plant, yes.

  Mr Burke: It depends if you want the policy to be differentiating at the margin or whether you want it to be long-sighted and to make this transition quite rapidly.

  Q25  Dr Turner: Obviously we do. Keith, could I take you up on your point that investment in renewables is being driven by renewables targets rather than fiscal incentives. The fiscal incentives of either feed-in tariff mechanisms in other countries or the ROC in this country can hardly be discounted, can they, because they have been a vital factor in their economics?

  Dr Allott: Sorry, I meant targets as a shorthand for fiscal mechanisms and policy mechanisms are what drive investment incentives. The clear outcome and clear framework is what is driving forward investment. Still it is not fast enough and there is real concern about the lack of investment in renewables that is taking place at the moment and the slowdown in that because of the wider economic climate. The sectors which are not covered by renewables, and I draw the analogy with coal in particular, there are 70 gigawatts of new coal stations being planned around Europe, as we speak, many of them in the UK. There is a need for a clear mechanism to prevent that happening. Once that capacity is built we have a lock-in problem.

  Q26  Dr Turner: I am totally in agreement about the need to deal with that problem, but just to change the subject a bit, the Chairman and Chief Executive of the Committee on Climate Change have been before us giving evidence on this inquiry and the Chief Executive suggested that as a result of the way that Phase III would operate under the ETS, what the UK would effectively be doing is paying the power sector in countries like Germany to switch from coal to gas, which would clearly not provide as great a carbon saving as if we were actually using our money to drive investment into proper low-carbon technologies. Would you agree with that? Do you think there is any way of stopping that?

  Ms Clough: I think that just goes to show that currently how the market is structured would possibly incentivise a bit of fuel switching in Phase III, which comes back to the point of why you need supplementary policies like an emissions performance standard. There is growing political support within the UK and within Europe. The Conservatives and the Lib Dems, as you probably know, back an emissions performance standard. Charles Kennedy has brought forward a private Member's bill on the issue and we also have an early day motion, so there is support to bring these other measures forward.

  Ms Worthington: I would just say it all comes down to MAC curves, unfortunately. They are horrible, complex technical things, but essentially the European MAC curve has got a long tail of very cheap abatement, and that is largely because we have an established infrastructure for energy where there is quite a high degree of capacity for fuel switching, not just in the UK but in other key countries like Germany. Until we get a price signal that is consistently strong enough to get that out of the system, trading will not be used to be the driver of investment. That will need supplementary policies. We have talked about the Renewables Obligation and how important that is, and the performance standard, similarly, could avoid the lock-in while we work through this long tail of emissions. You only slow the process down the more you allow foreign credits in. We have a double problem, there is lots of cheap abatement in Europe, lots of cheap abatement in the world, and we have an almost meaningless target so how do we expect that mechanism then to drive investment. You do need supplementary policies and we do have them, that is the thing, they are compatible. We would like to see much more ambition in the caps to drive additional effort from that.

  Q27  Dr Turner: So, we are in agreement then, I guess, that we need strong, clear price signals and the ETS has not delivered?

  Ms Worthington: Without tighter caps it will not.

  Chairman: Unfortunately, we are out of time as we have some more witnesses waiting to come on. Thank you very much for coming in. This is a very helpful start to this particular inquiry. I am sure that we are going to be able to reflect quite of lot of what you have said in our conclusions. Thank you.

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