Examination of Witnesses (Questions 49-84)
MR MATTHEW
FARROW, MR
MURRAY BIRT,
GARETH STACE
AND MR
IAN RODGERS
21 APRIL 2009
Q49 Chairman: Good morning. Welcome.
As you know, this is the second evidence session we are having
in this inquiry. We looked at emissions trading a couple of years
ago and we thought it was timely to revisit the subject. Both
because of the potential discussions at Copenhagen but, also,
because the United States are now looking at it quite seriously
as well, it seemed to us to be very topical. When we reported
two years ago, we concluded that Phase One of the EU ETS showed
that you could have a workable system across a group of countries
which had not done much to reduce emissions. Hopes obviously rose,
that Phase Two was going to be tougher and would produce some
cuts, but would you say now that perhaps that was an overly optimistic
conclusion for us to draw?
Mr Farrow: Thank you, Chairman.
Good morning. I think it is worth perhaps saying, to kick off,
why the CBI has been such a strong supporter of emissions trading
carbon markets, as Members will be aware. I think it has particular
advantages as a policy tool. The science shows us that we need
to make a set amount of reductions in a set time scale and with
a cap allowance you can do that, of course. Also, ETS creates
a carbon price, which means you can get very wide incentives across
the economy to make least-cost reduction. I think the least-cost
point is important because, if you look at what the Climate Change
Committee says about the carbon budgets—could increase fuel
poverty by 1.7 million households, obviously concern from business
about the costs—I think holding to this point that emissions
trading pushes least-cost abatement is particularly important.
In terms of Phase Two, our view would be that we are making progress,
the market is functioning. That is important. I think there is
a lot of concern at the moment about the low carbon price, and
our starting point would be that a particular set of factors have
come together at once to depress the carbon price: you have obviously
the recession (and colleagues may want to talk about that); you
have the companies selling allowances to raise cash. Those factors
are depressing the carbon price at the moment. Our view is that
those factors are unlikely to persist together and there are various
indications which would suggest the carbon price will pick up.
Our view at the moment is that we should persist with Phase Two;
we should look at ways to increase confidence in Phase Three and
Phase Four going forward; but a knee-jerk reaction at this point
is something we are not convinced about.
Mr Rodgers: I certainly would
agree with that. It is far too early to draw any conclusions.
We have had only one year in Phase Two and the data are only now
becoming available for the first years' emissions. The fact that
the market price has started picking up recently suggests that
in fact the market believes that we have not been over-allocated
in the first year. An analyst's report I was reading only this
morning was suggesting that emissions in the first year of Phase
Two were 4-5% below the 2007 level. Bearing in mind that the scope
has changed as well, that we now have more enterprises, more units
within the scope of the scheme than we did in Phase One, again
it is very difficult to make any rapid, hasty decisions.
Q50 Chairman: The price may have
to go up a bit but it is still less than half of what it was last
summer. Is that fall in the price and, indeed, is the reduction
in emissions more to do with the recession and the consequences
of that for the manufacturing industry than it is to do with Phase
Two?
Mr Rodgers: I am not sure how
you can quite analyse cause and effect in that way, but certainly
the recession has been a major impact. For the steel sector it
has had a major impact on our output. By the end of last year,
output was down by about 50% compared with normal levels, so clearly
the recession has had an effect. Now the data is being released,
the fact that carbon prices are rising, in the midst of the deepest
recession we have seen for a long time, suggests that the scheme
is having some effect.
Mr Farrow: The recession clearly
has had a huge impact, and it has hit the steel sector, as Ian
says. In cement, as well, production is down significantly, and
there is data about that. There is some evidence from New Carbon
Finance which suggests that as well as falls of production due
to the recession, there has been an energy efficiency impact in
firms through ETS in improved energy efficiency and that has pushed
emissions down. Because more general credit markets have been
so glued up, as it were, firms who have held allowances have in
some cases chosen to sell them, and maybe buy options for future
allowances, just to raise some working cash, and the sense we
get from talking to traders in the market is that that phase is
probably coming to an end and that selling of allowances just
to monetise them has slowed down. Obviously it was a sort of short-term
stopgap measure some companies took, and, again, as that slows
down, you would expect the market to start to increase. I do not
know, Murray, if you have anything else you would like to add.
Mr Birt: No, I think that is right.
Barclays, especially, recently had a note analysing it and showing
that some companies were selling current allowances and then buying
an option for allowances in 2012, almost like a loan, and the
price between them was the effective interest rate for the loan,
and because they could not have issues with the overall financial
market.[12]
But of course that rests on somebody willing to sell them the
option and the individual from Barclays, the analyst, was saying
that that is perhaps closing down now.
Q51 Chairman: Disentangling the effects
of the recession and the policy, the Phase Two, is going to be
quite challenging. I accept that it is very hard to do that issue
for the Committee on Climate Change when they are looking at carbon
budgets and so on. On this question of companies selling allowances
to raise cash, they would be companies clearly under cash flow
pressures at the moment. Looking ahead is there a risk that that
may then produce a subsequent spike? If demand in the economy
picks up and these companies then need more allowances, they will
be forced back into the market. Could you see a sort of artificial
increase in the price coming along in a couple of years' time?
Mr Farrow: I think it is possible.
Whether it would be a spike, I am not certain about, but I think
you would naturally assume, if the recession ends, as we hope
it will, and production starts to pick up, companies need to supply
those allowances to surrender them. That suggests you would get
this fluctuation. I think this is a market that has some flexibility
within it and, therefore, would naturally get that fluctuation.
It seems to me it suggests that, rather than an instant reaction
to say that the price has suddenly dropped and we need to intervene
to prop up that price, we should see how the market unfolds in
the next couple of years. I do not know if others have a view,
but, I think, rather than a price spike, you would simply see
a firming up of prices as the recession ended.
Mr Stace: As different sectors
recover from the recession at different times, I would have thought
we would not be seeing a spike there. We are also seeing further
investment in carbon abatement with companies. We are even seeing
that now, with the carbon price as it is, where the carbon price
is one factor that that will enable a company to bring forward
an investment decision. One of our member companies at the moment
is investing £60 million in a project that will reduce emissions
by 300,000 tonnes. Carbon would have been a factor there, whereas
really the major factor was the price of energy. However, also
the price of energy is related to the price of carbon in terms
of the pass-through costs from the electricity generators.
Q52 Colin Challen: It seems to be
quite difficult to me to understand quite how the ETS is influencing
decisions as opposed to all the other things. Pursuing this question,
there is some research that shows that the power sector, for example,
has moved to decarbonising. There has been a switch from coal
to gas, which the research suggests is directly related to the
ETS. Could we just work a little bit more on these concrete examples
of the other sectors and their relationship to the ETS? It seems
to me, with a very volatile price in carbon, plus probably we
can all foresee a trend in rising energy prices, that surely it
is the energy price that is the determining factor for most companies.
How easy is it to separate out very clearly the impact of the
ETS in boardroom decisions?
Mr Farrow: I think it is difficult
to disentangle it. Does that matter? What matters ultimately is
that the economy as a whole is transitioning to a low-carbon world
in a way that protects competitiveness. In a sense, the point
of ETS is to provide a carbon price within the DNA of business
and then you have additional policies where you need them. The
CBI has lobbied for regulation around domestic housing or CCS
support, for example, where we think the carbon price is not sufficient.
But the evidence, such as it is, suggests that it has a direct
impact on companies. Point Carbon did a survey recently in which
they said that about two-thirds of the respondents, companies
in the scheme, said ETS specifically had an impact on investment
decisions. Murray, do you have any examples of specific companies?
Mr Birt: One example is Real*
Tinto* Alcan, where they have increased their efficiency of the
production process quite significantly over the past number of
years, and carbon plays a role in that because it adds to the
cost of energy and so it is sometimes the marginal decision—not
necessarily in all cases, but it is influencing them, as that
survey was showing. Cement companies are putting in place biomass
use and alternative fuels for use in cement plants, doing energy
efficiency programmes in refineries. Companies are taking action
on this. Energy prices are volatile, carbon prices are volatile—actually
somewhat less volatile than overall energy prices—but the
clear indication is that energy prices and carbon prices are rising
over time and that is what creates the business case for companies
to invest in low-carbon technologies.
Mr Farrow: Although there is a
lot of focus on spot price—and that is what the media tends
to focus on and people with concerns focus on, which is understandable—if
you make an investment over a long time scale, if it is a nuclear
power station, for example, obviously you are concerned not about
the spot price now but the likely price from 2015 onwards when
you are trying to earn a return on that asset. Again, if you look
at the projections the Climate Change Committee has done, they
are projecting €40 to €105 per tonne as the price in
2020. Again, there is not a firm forward market to that point,
but companies try those estimates. Again talking to people in
the market, people expect quite a significant carbon price around
2015 onwards, so it is not the spot price, now that necessarily
it is low, that stops people investing, it is more expectations
about the long-term.
Q53 Colin Challen: You might be able
to help me overcome my cynicism to a certain extent, but might
some people say that, yes, they are doing these things because
of the ETS, knowing that the ETS is a very gentle way to try to
tackle climate change, and they might want to do that and say
that to avoid tougher actions, which might range from carbon taxation
to more regulation and all of those things which companies do
not like?
Mr Rodgers: I think we would have
to come back to the point that we have quite a complex mix of
policy measures already. Certainly, talking for the steel sector,
we have had a climate change agreement for getting on for ten
years now, so we have been living, breathing a low-carbon agenda
for some time. The European steel industry is investing many tens
of millions of euros in trying to identify what the new technology
might be for low-carbon steel making—that technology just
does not exist at the moment without research and development—and
is on the verge, now going through to the next phase, where you
are talking about hundreds of millions of euros investing in pilot
plants. This has been on the boardroom agenda for a long time,
but you cannot isolate ETS from the rest of the signals that are
being sent to industry.
Mr Farrow: You were saying in
the question that the ETS is a very gentle mechanism and that
is why companies are saying they can see it having an impact.
I think it is fair to say that in Phase One, and, at the moment,
because of the recession, in Phase Two, low carbon prices are
caps which the economy can keep within. That is true, but I think
any companies which think that Phase Three will be a similar gentle
decline in emissions are being quite naive. If you look at the
way the cap declines, it is an absolute top-down cap. If you look
at the intention in the Directive, that if there is an agreement
at Copenhagen, as we all hope there will be, that cap is probably
going to be immediately cut significantly further; the impact
of aviation joining the scheme, probably being a net buyer of
EUAs, forcing up the price. While no-one can be certain, because
it is a market mechanism, I think Phase One was a learning phase.
One of the things we learned from Phase One was that having Member
States setting national allocation plans does not work in the
long term. You do not get enough tightness in the cap. When I
talk to companies they do recognise that Phase One and to some
extent Phase Two are not indicative of the tightness of the scheme
going forward.
Mr Birt: We should also remember
that the UK second phase cap was set based on an 11% reduction
from business as usual. Unfortunately, the recession means that
we are in business not as usual, and that is part of the reason
for the decline in emissions and the carbon price. The price depends
on analysis of many things: on the policy, on project credits,
and also on fundamentals, things like temperature, weather, seasons,
the ability to switch fuels. The Phase Two cap was set where we
gave most of the under-allocation to the power sector and that
is why we are seeing more emission reductions from fuel switching
and other technologies from the power sector.
Colin Challen: Thank you.
Q54 Dr Turner: All the putative effects
of ETS and company decisions are so far fairly marginal, even
if you can identify them—or at least the ones that you have
quoted, unless I have been hearing you wrong. Of course the National
Audit Office has agreed with us that the price of EU ETS allowances,
which is effectively the carbon price, is not high enough to simulate
long-term investment in low-carbon energy generation. Would you
agree with that? Alternatively, can you cite any examples where
companies have made such long-term strategic decisions to genuinely
low-carbon energy generation for the future?
Mr Farrow: I think there are two
points to make. The first is a distinction between the current
spot price and what companies expect future prices to be. What
we find is that even at current spot price, which is obviously
relatively low, as we have been saying, although it is picking
up a little bit, quite a bit of low-carbon technology, and nuclear
is the obvious example, is economically viable, and so the interest
we have seen in buying the sites at auction, for example, the
amount of money those companies are putting in to buying sites,
shows very clearly the energy industry thinks nuclear is now viable
as a technology in terms of economics, and it is the existence
of a carbon price in ETS that is helping to incentivise that.
On the examples Murray was giving about biomass and CHP, I take
the point that they sound quite marginal when you discuss them
as individual examples, but the analysis which we have done and
the Climate Change Committee has done shows that to meet the 2020
targets you need both the big ticket investments, such as nuclear,
but also a huge number of small processes and small scale investments
across the industrial sector and the housing sector. Even at the
current carbon price, a lot of technology is viable, but I think
what is more significant is the fact that expectation was about
the prices in Phase Three. If it was absolutely clear the carbon
price would never get above €5 or €10, then I think,
yes, there would be some very serious questions to be asked: Was
the current model of ETS working at all? Was it flawed? Would
intervention be necessary? But the fact that the Climate Change
Committee projections are €40 to €105 per tonne 2020,
for companies who are thinking about these long-term investments
that is a judgment they are trying to make. Certainly when I talk
to them they are not saying, "We're projecting a carbon price
to stay at this level"—although, even if there were
some big ticket investments have still come through. It is a judgment
about a much tighter cap, going to 30% reductions perhaps, the
economy picking up, aviation being a buyer possibly, and that
is a judgment companies make.
Mr Rodgers: Your question referred
specifically to power generation, but if we look at the industrial
sector, as I have said, in the steel industry, and it is true
of other industries, we are currently reaching the state where
very little additional abatement opportunities exist on current
technology; nevertheless, the NAO report quotes a steel company
that invested £50 million in some energy-saving technology
that resulted in a 1% reduction in CO2 emissions. £50 million
for a 1% reduction is an indication of the order of magnitude
of investment that is needed today to make whatever marginal carbon
savings are still possible. As I have said, research and development
in new technology is where the steel industry in Europe is putting
all of its money currently, because until we get that new technology
we cannot get any step change in carbon reductions.
Mr Birt: We are also just seeing
the first release of the data for 2008, at the beginning of April,
from the Commission. That is being digested and analysed but some
of the initial indications are that for companies that were in
for 2007 and 2008 there is about a 4.2 or a 4.3% emission reduction
and this includes a decline of 13.5% of emissions from coal electricity
generation, with some 3% increase in emissions from gas-fired
generation. This fuel switching is where we are on the abatement
cost curve, and we are moving along, taking that opportunity up
and other energy efficiency opportunities, as has been mentioned.
Q55 Dr Turner: What sort of level
of carbon price do you think is needed to provide a very clear
signal for investment in low-carbon technology?
Mr Stace: I think we need to be
careful that we do not rely on the carbon price within the EU
ETS to provide investments outside of the EU ETS in terms of a
low-carbon future there. We have the cap within EU ETS, and the
cap will be met, whatever the carbon price. And so that is the
aim of the EU ETS. The aim of the EU ETS is not to drive economy-wide
reductions in carbon. It will go beyond those installations that
are caught by it but there are other policy instruments—the
Renewables Obligation and the Climate Change Act and so forth—that
will also drive further investment.
Q56 Dr Turner: But we are talking
about longer-term decisions than that. We are talking about, say,
ten-year time scales, minimum. The ETS caps cannot provide to
that to a sufficient degree. Once again I come back to the carbon
price. By whatever means it is achieved, what carbon price do
you think is needed to be the floor that would trigger long-term
investment.
Mr Farrow: If you take the energy
system or electricity as an example of what you need to do, it
is pretty clear, if you look at the work that the CBI has done,
our Climate Change Taskforce report and the Climate Change Committee
analysis, that you do need to make very significant progress towards
completely decarbonising electricity—good progress by 2020,
shall we say. Although in the electricity market people will make
individual decisions, you obviously need new nuclear, and it is
pretty clear the existence of ETS, and even the current prices
we are seeing, is making nuclear economic. You clearly need a
lot of renewables—
Q57 Dr Turner: Allegedly.
Mr Farrow: I do not think companies
would be spending the sort of money they are on the sites if they
were not pretty convinced. The analysis we did—this is in
our Climate Change Taskforce report, it is public analysis which
we did with McKinsey's*—shows that nuclear is almost economic
at very low carbon prices—and you have to make assumptions
about fossil fuel prices and so on—so even a modest carbon
price would incentivise nuclear. Onshore wind as well, as the
cost of that comes down, even fairly low carbon prices will incentivise
that. With something like carbon capture and storage—which,
again, you clearly have to have as part of the energy mix, certainly
by the 2020s—you would need an extremely high carbon price
right now to make that definitely the thing to do, which we do
not have. That is why I think it is right to say, as we have said—and
we will see what the Government says, maybe this week, but hopefully
they will make an announcement on this—that you have to
have a specific policy to incentivise CCS; involving demonstration
projects, for example. For offshore wind, uprating the Renewables
Obligation is normally seen as the most effective way to drive
offshore wind. Rather than saying that we have to have a carbon
price of €100 or something to incentivise every bit of technology
we need, the best way to approach it, we think, is a functionary
market: the carbon price (as I say, the CCC projection of €40
to €100 by 2020 because of the tightness of the cap), but
then specific policies for specific technologies—marine/wave
technology, for example, where at the moment the carbon price
would have to be at a ridiculous level to incentivise that—which
you could easily generate.
Q58 Dr Turner: Why are you so coy
about naming a price? Is this some sort of general reluctance
and disaffection for carbon pricing? The alternative is regulation.
Clearly there would have to be some sort of combination, but you
do not want more regulation than you have already, do you?
Mr Farrow: In some areas regulation
is a better alternative. If you take particularly domestic housing,
for example, and energy efficiency there, because of the hassle
factor—because for most households, and the same is true
to some extent of some service companies, the energy costs are
a tiny proportion of the household bill or the company's turnover—you
could have a very high carbon price and you probably would not
get the impact you want. On something like energy efficient appliances,
we have lobbied publicly for regulations to improve that. For
something like buildings, again we have lobbied for building standards
that would drive an improvement. We have always been very open
about the fact that, while certainly we want effective regulation,
we do not want regulation for its own sake, it is very difficult
in the economy, we have simply to use carbon pricing in all cases
to drive the sort of change we need, so you need a mix of carbon
pricing and a mix of regulation in some areas. We think the reason
it is not sensible to say that this is the particular price we
need, is that what matters overall is the emission cuts, which
is the cap. You have the cap within ETS sectors and the price
will emerge that will drive the cap to be met, so you have to
make sure you get the cap right up front, which is a crucial issue,
and then, ideally, we should let the price look after itself.
If the price is wrong, if the price is too low, as it were, in
terms of the concerns you have, you look at the cap.
Q59 Dr Turner: We do not know what
the caps will be at the times that concern us at this moment.
In any case, the reductions in emissions are an outcome, and in
order to will the outcome you have to have the means. You clearly
would agree that, whether it stands on its own or not, carbon
pricing is definitely one of the means. Would you agree that it
is helpful in terms of investment decisions if companies can have
some confidence in the level of the carbon tax and a feeling of
security that, whatever it is, they know roughly what it is going
to be and can plan accordingly?
Mr Stace: Going forward, in terms
of understanding the market up to 2020, allowances traded now
are still valid up to 2020, so that provides that long-term certainty.
There is long-term certainty in terms of the target to 2020, and
so, in terms of investment cycles, there is some certainty there
and, as we have said, we expect the price to firm up quite a lot
more over the next couple of years, especially as we come out
of recession. Also, aside from the price of carbon, if we look
at the now famous McKinsey cost curve, a significant amount of
carbon abatement can be achieved at very low, or no cost. It is
not the carbon price that is really going to tackle that. We have
had a higher carbon price, and we are still seeing available abatement
opportunities not being taken up. Our studies have shown that
that is really a behavioural change issue that we need to overcome,
both within industry and in domestic emissions. We have called
on the Climate Change Committee, that one of the skills that they
perhaps need to include on the Committee is some form of behavioural
change specialist who can look at why, when the savings are so
obvious, they are not taken up?
Q60 Dr Turner: I have to say, I cannot
remember us ever having a high carbon price, but let that one
pass. Lord Turner has gone further. He has strongly suggested
that there should be a floor to the carbon price and that if it
does not emerge naturally we should put it there by some means.
How do you react to that?
Mr Farrow: The view we take is
that if it became clear that the carbon price was collapsing and
would just not recover, then there is a case for looking at whether
you need to look at ETS to see how you can improve the operation
of the system. When we talk to members about this, they say it
is not the carbon price that matters at the moment; it is the
long-term future of the scheme. They say they expect the carbon
price to firm up, to recover—as I say, the €40 to €100
projection the CCC makes. It seems to us would it not be more
logical, perhaps, to look again at the caps, if it was completely
clear the carbon price was not recovering, because it is the cap
that drives the price and it is the cap that it is the key outcome
of the scheme. Also, there are practical difficulties about setting
a floor price. If you asked everyone in this room, "What
should the floor price be?" we would probably all have a
different judgment about what the price should be. You have to
do it, particularly, for Phase Three, which I think is where our
key concern lies in terms of the long-term investment decisions
you were talking about. You would have to do it at European level,
I think, so you would have to get all the key European Member
States to agree on a set figure. We just think, in practical terms,
with the horse trading that would go on, that you would end up
with a very arbitrary carbon price which would not necessarily
drive the sorts of technology which I think you are very keen
to see come forward. Our view is: let us make sure the scheme
is functioning, let us make sure the caps are right, and we will
drive this part of the economy to make the right contribution
to the 2020 targets going forward.
Mr Rodgers: I would agree with
that, but for the steel sector and for other industrial sectors
subject to international competition I would add the following
point: in effect, we have two ETS schemes. We have a hybrid scheme.
For power generation and other sectors not subject to international
competition, allowances will be subject to auctioning, and clearly
the price becomes a far more significant driver for those sectors
subject to international competition, where, hopefully, we will
be receiving and continue to receive free allocations through
to 2020. And, there, as Matthew has suggested, is the cap that
is the main driver. One of the problems with putting in a floor
price is that you are saying, "Okay, the market is over-supplied
at the moment, because we are in recession, therefore we need
to prop up the market with some new artificial measure."
That is a problem that only arises when you have an ex ante
system for those sectors where allowances are allocated as opposed
to auctioned. If you had an ex post system, which is what
we were advocating for a long time during the run-up to the Phase
Three agreement, you would not have this problem, that fluctuations
in supply and demand based purely on output from those sectors
would cease to have an impact on the price.
Q61 Chairman: Just to be clear, were
you saying, Matthew, that if the price fell to an unsustainably
low level and showed no sign of recovery that you would contemplate
a mid-term reduction in the cap as a better way of driving a sustainable
price than having some artificially imposed minimum price?
Mr Farrow: I think we are talking
about Phase Three, to be honest. In Phase One, clearly the price
collapsed and it was clear that the allocation had not worked
properly. As I was saying earlier on, our view is that this has
not been replicated in Phase Two. You have some particular factors
that have come together to depress the carbon price. We do not
expect those factors to persist and, therefore, we think it would
be wrong to have an immediate, knee-jerk reaction. If, however,
contrary to our expectations the price did collapse for some reason
and was not going to recover by 2020, I think we would recognise
that ETS was not functioning as it was supposed to, it was not
driving lowest cost abatement, and, therefore, we would have to
look again at the scheme. Most people say, "Well, instantly
you need to prop up price; that is the way to do it." Our
view is: How would you pick the right price to get the right reductions?
How could you co-ordinate that at European level? Would it not
make more sense to look at the cap? I think the way that would
be done is, if there was a Copenhagen agreement, the EU Directive
says the cap will be cut—not yet automatically, it does
not specify the level, so there has to be some discussion through
co-decision about that. If the price really had collapsed and
was not recovering, that would be a point at which to do that,
but, as I say, we do not think that this low level of price will
persist.
Q62 Mr Chaytor: Matthew, you mentioned
earlier the importance of other policies as well as the trading
scheme, and of course there has been a longstanding debate about
the value of a carbon tax. It seems in recent months the argument
for a carbon tax has reasserted itself and EEF has specifically
come out in favour of a carbon tax. First, I am curious as to
why EEF has had this change of policy. Second, what is the CBI's
view of carbon tax now?
Mr Rodgers: I am not sure we have
explicitly come out in favour of a carbon tax. We are saying—and
I come back to this issue that there are a number of sectors subject
to international competition—that particularly for those
sectors, we have found getting something out of ETS which does
not undermine our competitiveness has been very difficult. We
have ended up with some tortuous debates in Europe and we have
ended up with a Directive we think we can live with, but is it
necessarily the most cost-effective way of dealing with the situation
for our sorts of sectors? An awful lot depends on what is agreed
in Copenhagen. If we end up with all major trading partners agreeing
to a cap and trade scheme in Copenhagen, then clearly it makes
a lot of sense to stick with cap and trade. If, on the other hand,
we end up with some major trading blocs, like the USA, going down
the carbon tax route, then the interactions between the two different
types of systems become more complex. All we are saying at the
moment is: let us not totally close the door today to a carbon
tax in the future as a solution, if the outcome from Copenhagen
is one that suggests that may be a more sensible and more cost-effective
way for our sort of sector.
Q63 Mr Chaytor: If in the USA the
move was towards carbon tax, would you then argue that steel,
for example, should be taken out of the Phase Three ETS in 2012?
Mr Rodgers: It is certainly something
we would be looking at. I cannot say today that that is what our
position would be. The advantage of a carbon tax is that you can
exercise control at the borders in a way that you cannot with
a trading scheme.
Q64 Mr Chaytor: Are the two mutually
exclusive? In view of Matthew's comments earlier about the significance
of a different range of policies, why does it have to be either
a trading scheme or a carbon tax scheme?
Mr Rodgers: I would argue strongly
that you only need one system to set the carbon price that we
are all agreed is necessary. The question is which is the more
effective way of doing it. We are living with a hybrid system
already, with the climate change levy in this country and similar
energy taxes in other countries, so having multiple layers of
taxation and trading I think would be just far too complex.
Q65 Mr Chaytor: Matthew, in terms
of your organisation's view of carbon tax.
Mr Farrow: I think people can
make and do make an intellectual case for both alternatives, of
course, and if you go back a decade or so there was a very lively
debate about this. The reason we came down on the trading side
was partly the cap. We felt that science says you have to make
reductions of a certain level by a certain time and no-one knows,
if you set a tax, what outcome you would get, whereas a legally
binding, top-down cap should allow you to be confident you get
those reductions and then the price which emerges should be the
lowest cost way to achieve those reductions. As I say—and
you might expect us to say this—I think cost does matter.
Tackling climate change is not cheap but let us try to make it
not so expensive. It is hard to maintain popular support, whether
that is the costs on business which have to buy allowances and
which we do not want to be off-shored or the costs on households
paying fuel bills. We still think that ETS is the right way to
go. It certainly has proved highly complex, as trading schemes
tend to. I feel it is a little bit that the grass is always greener,
in that because a tax is more of an idea, people think perhaps
that would be simpler, whereas when I talk to businesses about
government tax policy or international tax policy they tend to
throw up their hands and say, "It's so complicated, you could
never get it co-ordinated." It is not obvious to us that
a tax would be a lot simpler and easier to implement, but it is
hard to be clear. We feel that businesses put a lot of hard work
into getting ETS up and running, the cap is functioning in the
carbon market. I think one has to think, as well, what is the
end game here? What are we all trying to achieve? We are trying
to get to a world in 2040/2050 when it is a low-carbon world.
To do that, EU/UK emissions must peak pretty much now and start
declining, and we need to be, at the same time, getting some real
momentum behind abatement in the developing world and they need
to take on binding targets at some stage. We cannot really conceive
of a route map to get to that world that does not involve a strong
ETS that works effectively and has a strong cap, and then is progressively
linked, first of all through CDM and then to other trading schemes
around the world. As Ian says, if the US and other parts of the
world go towards a tax route, one would have to look at other
ways to try to link those systems, but I think we are not there
yet. We have put so much effort into ETS and I think it is starting
to have an effect. The Phase Three cap is going to be pretty tight.
We have found, I think, ways of free allocation to get the right
balance between sectors such as steel doing what they ought to
be doing but not putting them in an impossible position. I just
think that at this stage saying, "No, we should switch to
a tax," would not be our position.
Mr Birt: It is also worth remembering
that Europe was trying to go for a carbon tax as the main mechanism
for tackling climate change and it just was not—
Mr Farrow: Back in the early 1990s.
Mr Birt: —in the 1990s,
and it was just proving much more difficult to get agreement.
You will get other taxes where the EU tries to co-ordinate action
and there is a strong view, not just within Europe but internationally,
that tax is a matter of sovereignty and it proves quite difficult
to try to harmonise taxation internationally. That is a bit of
a barrier. But where tax and ETS do interact, and we have a climate
change levy in the UK, it does get a bit messy. There is a role,
I think, for a carbon tax for sectors that are excluded from the
ETS and providing some sort of incentive to them to show equivalence
of effort, and that will be important for the Phase Three deal
across Europe as well. In the UK we have looked again at trying
to harmonise it and streamline it a bit with the system of climate
change agreements that we have to provide an incentive for sectors
that are not in the ETS.
Q66 Colin Challen: The report we
have had from the National Audit Office concludes that the ETS
has had little impact at all on the competitiveness of UK companies.
Do you agree with that conclusion?
Mr Farrow: I would agree that
it is unlikely to have had a huge impact on competitiveness up
to this point. Not surprising: industrial sectors were allocated
on business as usual quite explicitly in the UK in Phase One and
largely in Phase Two. For individual companies that might not
have been the case, due to the way the individual allocations
were made with the sectors as a whole. Plus, of course, the carbon
price, while it has fluctuated, has had periods where it has been
quite low, so you would not necessarily expect to have had a huge
impact. Having said that, one of our cement members, Lafarge,
again have publicly said that they have put a hold on investment
in the EU until it is much clearer how the benchmarking is going
to be worked out for Phase Three. I think all the analysis that
has been done, whether that is by the Climate Change Committee
or by the Carbon Trust, shows that the competitiveness issue is
real for some sectors. If you look at the impact of the carbon
price on the profit margins, the gross value added, there is a
genuine risk there that if you simply say those sectors should
take whatever carbon price the market throws at them, you will
offshore emissions—which makes no sense at all. We feel
it is vital for Phase Three that there is an appropriate methodology
to try to protect those sectors, and the approach is benchmarking.
Benchmarking is based on the 10% most efficient installations
around Europe. The benchmark allocation is within the cap, so
again it is fixed over time. I think competitiveness is a genuine
issue. It is not surprising there have not been major impacts
yet, but there have been some impacts, but for Phase Three, I
think the deal we have can make sure that EU competitiveness is
not undermined but it is something which we have to watch very
closely.
Mr Rodgers: I agree with everything
Matthew has said. We argued strongly in Phase Three that in order
to protect our international competitiveness we needed free allocation.
It looks like we will continue to receive free allocations, so
there is no internalisation of the cost of carbon for sectors
subject to international competition. Second, the other factor
is the size of the cap. Currently, "thanks" to the recession,
if that is the right word, we are not short of allowances. Going
forward into Phase Three, there is a worry that the constantly
reducing cap could act as a brake on output if we enter another
period of sustained improvement in global steel demand. But that
is for the future. We do not know what the future holds. Certainly,
as of today, I do not think it has had an impact on competitiveness.
Q67 Mr Caton: You have all just repeated
your welcome for the proposal to increase free allocations to
be handed to industry in Phase Three, agreed in December. What
are the advantages of giving away free allowances over other ways
of protecting industries vulnerable to carbon leakage, such as
a border tax on certain imports?
Mr Rodgers: We have always had
concerns—and there is perhaps common ground with the CBI
on this point—about linking ETS with a border tax. First,
it would become very complex to administer because you are not
dealing with a constant price, you are dealing with a variable:
the price of allowances varies every day, so how you will apply
that at the border becomes complex to start with. Second, where
you have to, in effect, treat imports in exactly the same way
as domestic production, making it WTO compliant becomes virtually
impossible. The other argument is that for sectors which are substantial
exporters—and the steel industry is one such—applying
a tax at the border would not offset the impact on the international
competitiveness of our exports. It could only work in terms of
offsetting loss of competitiveness against importers. It basically
fails on both counts when part of an ETS.
Mr Farrow: We agree with that.
Border taxes in some ways are quite an elegant solution to part
of the problem but in practical terms it is just hard to see how
they would work. Just to pick up one point you made: you referred
to the benchmark allocation as such as an increase in free allocation.
We would see it as a decrease because, of course, hitherto, those
sectors have had free allocation on a business as usual basis.
So this new proposal is not an increase in free allocation, it
is a tightening of it, but it is rightly, I think, focusing the
free allocation on sectors which genuinely could not cope without
some free allocation.
Q68 Mr Caton: I think it is an increase
in the sense of what was originally envisaged.
Mr Farrow: In the original Directive
proposal? In the original Directive proposal I think the Commission
had said there is this issue about carbon leakage. They accepted
that, and I think from memory they floated different options at
which you could have border taxes or you could have the method
we have gone for. In all the negotiations leading up to the deal
in December, they came down on having basic criteria to decide
which sector has free allocation or not. We felt that at least
they had used an evidence base to do it. You can argue, perhaps,
that the final deal was a bit too cautious, in including some
sectors on which, on some of the analysis, the impact is pretty
small, but, as I say, the Commission was always clear up front
that you would need some approach which would either be border
taxes or free allocation.
Mr Rodgers: For carbon leakage
sectors, the initial draft said free allocation of "up to
100%." Now it says "100%." I guess you could argue
that that was potentially a loosening, but, equally, it was potentially
no difference at all.
Q69 Mr Caton: I accept what you have
just said, that you are not proposing a carbon tax but it is something
you think should be being considered, but, as I understand it,
in your proposal to at least consider it you talk about a carbon
tax being applied at the borders. Does that have fewer problems
than the alternative?
Mr Rodgers: Look at it like VAT,
for example. VAT is applied to domestic sales and it is applied
to imports at exactly the same level. Equally VAT is rebated for
exports. You could apply a carbon tax in the same way. I agree
with Matthew, it would not be easy at all. It would be a very
complex set of calculations that you needed to do to get exact
equivalence between the treatment of domestic production and the
treatment of foreign production, but in WTO terms it becomes a
lot more acceptable because you are dealing with a tax—
Mr Stace: Bear in mind that what
we are really looking for is a truly international agreement,
where there would be no need for a border tax adjustment: all
sectors in whatever geographical region in the world are sitting
on a level playing field where a tonne of carbon from one region
is the same as a tonne of carbon in another region.
Q70 Mr Caton: You have all pointed
out, I think, that these vulnerable industries are not to be given
all the allowance that they want. They will have to face some
increased costs by buying extra allowances or investing in new
technology to reduce emissions. How big a factor will these costs
be? Which industries will be particularly affected?
Mr Rodgers: We cannot predict
which industries will be particularly affected today because it
will depend on global supply and demand within each individual
sector. Remember that at the time that we started talking about
Phase Three, world steel demand was increasing by 3 or 4% a year.
Obviously that is not the case any more. Fundamentally, we see
no reason why that should not return once the recession is over.
If you have a constantly declining cap of 1.7 something per cent,
I believe it is, and a constantly rising demand of 3 or 4%, obviously
you get quite a tight squeeze in terms of European operators being
able to take advantage of that increase in demand. That is what
our concern was. Sorry, I have not answered your question, because
I honestly do not know.
Q71 Mr Caton: If you do not know,
you do not know.
Mr Stace: When we look at the
steel sector from 2005 to 2020, we have seen from our studies
that there may be a reduction of 20% in emissions. That would
be between 1 and 2% per annum, but that would be at a cost of
€1 billion. Also, that is without any breakthrough technologies
that Ian has mentioned earlier. That is for the steel sector.
When we look at the ETS as a whole, the targets are applied across
the board and each sector is going to have very different abatement
opportunities from one another. For the steel sector we believe
there is not that much in terms of abatement opportunities available
and in terms of the way steel is made. Ninety per cent of the
emissions are process emissions; they are unavoidable; they take
place in blast furnace. Without a breakthrough technology or changing
the laws of chemistry you are not going to be able to tackle those
emissions, so you are looking at the 10% that is available to
you to reduce emissions.
Q72 Mr Caton: In your memo[13]
the CBI argued that industries which consume a lot of electricity,
such as the aluminium sector, will suffer due to increased auctioning
in the power sector, since this will lead to higher electricity
prices, but in our last inquiry we have heard that auctioning
allowances to the power sector should not make any difference
to electricity bills, since power companies are already adding
the market value of allowances to their prices—and earning
windfall profits, incidentally, as a result. Are you telling us
that power companies are going to put their prices up again?
Mr Birt: As it moved to full auctioning,
the price will be passed through fully. There is some pass-through
in power prices currently, but as carbon prices increase, the
direct impact on companies will also increase. That is why the
Phase Three Directive provides some allowance for Member States
to give state aid to particularly electro-intensive industries.
There are really only a couple, and from our view they are probably
aluminium production and chlor-alkali production, and perhaps
some others. For instance, in the chlor-alkali industry, increasing
costs of 10% or more would be the result, and that represents
in excess of its profits over the last five years. That increase
from auctioning in the power sector could have that impact unless
there was some sort of compensation view, and our view is that
kind of compensation mechanism should take place until there is
a level playing field for those industries globally and on a level
playing field for Europe.
Mr Rodgers: To add to Murray's
list of sectors: electric arc furnace steel making, which is also
electro-intensive. All we are saying is that provision now exists
in the Directive for Member States to provide state aid to electro-intensive
industries. If the UK finds that the Spanish, Italians, Germans
or whoever are subsidising legitimately their electro-intensive
industries, then the UK would have to follow suit or our competitiveness
would be very seriously interrupted.
Mr Farrow: In terms of whether
there will be an increase in energy costs, electricity costs,
our view is that it is quite likely. If you look at the Government
renewables consultation last summer, when that came out it had
some pretty sobering figures towards the end of it about the projected
increase in gas and electricity costs for industry due to existing
climate change policies, of which ETS is one, and due to the costs
of meeting the renewables target on top of that. I do not have
the figures to hand but we could help your officials find them.
As I say, they were quite sobering, multiples of 10%, so the expectation
is that climate change policies and costs pass-through will lead
to additional electricity cost impacts. As Ian was saying, rightly
I think the Directive allows Member States to compensate for that.
There is clearly a level playing field issue. This would be a
year in which we would urge the Government to keep a close watch
on that as necessary.
Q73 Mr Caton: Thinking about those
windfall profits, are you aware of any other industries which
have made a profit by raising their prices to capture the market
value of their carbon allowances?
Mr Farrow: No, is the answer.
There is a lot of debate about the windfall profits' analysis
and all the different parties to that debate have given their
own views on it, but, no, I am not aware of any other sector where
it has been discussed.
Q74 Joan Walley: Could I apologise
for having missed all your evidence because of problems on the
West Coast mainline this morning. In relation to the scope that
you have just covered about the whole issue of carbon leakage
and other industries, could I ask Mr Farrow what scope you think
there might be for detailed research into intensive industries,
such as the ceramics industry, which I know are particularly concerned
about the need to look at ways of doing this in sectoral way rather
than on a geographical basis. How do you think that the two issues
can be balanced in terms of meeting the carbon emissions but at
the same time retaining the UK ceramics industry?
Mr Farrow: In terms of international
sector agreements?
Q75 Joan Walley: Yes, and the fact
that it could be much easier to produce offshore, where there
are not the same restrictions.
Mr Farrow: The whole carbon issue
is a significant issue, as we were saying. Ceramic industry companies
are in many cases CBI members and I do hear a lot of deep anxiety
from them. In terms of within ETS, we have always made clear that
this is a real issue. If you look at the work which has been done
by a range of bodies, such as Climate Strategies, while not all
sectors involved would agree with the precise details of that,
that sort of analysis very clearly shows that a range of sectors,
such as ceramics, are generally affected, and so within ETS we
have pushed very, very hard for what has been the outcome: an
evidence-based process where industries like ceramics can make
their case with the Commission and say, "We need a benchmark
free allocation." Having said that, I think there is a lot
of interest from sectors, including from steel, of course, in
the role of these international agreements, where in principle,
I think, if those agreements could be devised in a way where they
were rigorous, and they were properly monitored and verified and
they guaranteed a comparable emissions restraint that you get
under EU ETS and similar actions elsewhere throughout the world,
then there could well be possibly an easier way to deliver the
same environmental outcome while protecting competitiveness. So
we are interested in global sector agreements. We talk to a number
of our members about them. We tend to leave it to the sectors
themselves to do the work with their counterparts across the world.
Clearly they must be rigorous, as rigorous in terms of outcomes
as alternatives, but if they can be developed then we would support
them.
Mr Stace: Within the EU ETS Directive
it is for the sectors to prove that they are at risk of international
competition and therefore should be seen at risk rather than the
other way round. My advice for the ceramics sector is, as Matthew
says, they should be feeding into the Commission's current data
trawl for the Commission's study. We in the steel sector, slightly
over a year ago now, commissioned an independent consultant to
look into this very subject and to see if the Steel sector was
indeed at risk of international competition. Again, in terms of
global sector approaches, for the sectors to take a lead there
to show they can develop a sectoral agreement globally. In the
steel sector, that is what we are doing, working with the World
Steel Association, formally the international Iron and Steel Institute,
and making very good progress there in terms of bringing in countries
or regions of the world, such as China, in developing data collection
that had never taken place before, discussions of benchmarks and
global agreement that we would not have seen before.
Q76 Dr Turner: You are obviously
familiar with your sister organisations in other countries who
are clearly going to be having an input in Copenhagen. What is
your assessment of the prospects of Copenhagen in terms of producing
binding targets on all major emitting countries or, alternatively,
on major sectoral emitters?
Mr Farrow: That is a big question
to throw in towards the latter stages of the session and the honest
answer is we are all speculating because there are so many physical
factors at play. In terms of our sister organisations, I suppose
there are two points I would want to make. One is we have seen
it as part of our role to work with those other organisations
to try to explain why CBI and UK business has taken what is seen
by some of those organisations as a relatively progressive stance
on climate change. We talked to them about our own taskforce work
and the Stern work and so on and how we are convinced, although
it is going to be very difficult, we can meet these targets in
a way which is compatible with a functioning economy. We felt
it was part of our job to do that and we have a lot of contact
with other organisations. Certainly, talking about the US big
organisations, if you go back to, say, 2004-05, we wanted to run
a big event with one of the big American business organisations
on emissions trading, not about the politics of it but trying
to share views on the technical details and how it would work,
and we could not get any interest. They just did not want to go
there. Now that has completely changed. Richard Lambert goes out
to the US—he was out there a couple of weeks ago, I think—and
we have meetings with the administration, with the US Chamber
and so on, and we find there is a completely different discussion
going on. What that will mean in terms of Copenhagen is very hard
to suggest. We have published some work on what we would see as
an acceptable outcome for Copenhagen which we will certainly send
in to you. We have said the EU is right to have this sort of dual-track
tactic of saying 20% cuts if the rest of you do not step up to
the plate but it will go up to potentially 30% if there is a meaningful
deal. That seems a reasonable attempt to play the tactics. I guess
we are concerned that, if a deal is done of some sort, there is
proper scrutiny, just to make sure that there are significant
comparable commitments by other countries before we instantly
say that the whole carbon leakage issue has been solved because
we have these signatories on board, but I would be cautious to
speculate the actual outcome.
Q77 Dr Turner: One suggestion that
has been made is for global sectoral caps and trading schemes
to go with them, covering, for instance, all major steel companies
throughout the world. How practical do you think that suggestion
could be?
Mr Rodgers: It is certainly an
approach that we have been advocating. As Gareth was just explaining,
the World Steel Association has brought together most of the major
emitters around the world and has already started collecting emissions
data on a common basis, which is actually quite revolutionary
for our sector and I suspect for any other as well. If you are
going to go further and turn that into a binding international
cap of some nature, that could only be done with the support and
involvement of governments as well. Competition law, apart from
anything else, would require that within Europe and within the
USA. What matters to us is not the extent to which we compete
with the cement industry, say, what matters to us is whether we
are able to compete on an equal basis with the Chinese, Russian,
Brazilian and Indian producers who have the more rapidly emerging
companies around the world.
Q78 Mr Chaytor: In terms of the possibility
of the US trading scheme, would your preference be for it to be
fully integrated with the European trading scheme, if it were
to continue? Is there any advantage in having two separate trading
schemes?
Mr Rodgers: If we continue to
go down the trading route, then the more integrated the trading
is around the world the better. If you have a US scheme that is
different from a European scheme, it may well be that one is biting
harder than the other. One may be internalising the cost of carbon
more than the other. If it is a single one, then you do not run
the same risk of distortion. That is a purely speculative answer.
Q79 Mr Chaytor: In respect of China,
India, Brazil, Russia, I see on my emails this morning that China
has recently now accepted the concept of strict emission targets,
so this may be a first step to a growing interest in China in
these trading schemes. Is there any information you have about
the thinking in these four countries as to the role of trading
in their economies in the future?
Mr Farrow: On the US point, there
is a lot of momentum behind cap and trade and there are various
bills around and solutional schemes. To be honest about it, there
is also quite a bit of scepticism from people who say, "The
European scheme is very bureaucratic and we don't want that here".
I think that is over-emphasised, to be honest, and part of our
work is trying to explain how ETS is working. We cannot really
see an easier route to a global low carbon 2050 which does not
involve regional trading schemes which are linked through CDM
initially, and gradual links more formally. As Ian has said, this
will take time because it would be a huge mistake to link schemes
which are quite different and completely distorted them. I do
not know about China. Obviously there is a developing debate there
and they are thinking about their strategy for Copenhagen. We
will have to see how quickly they are willing to take on binding
targets but that has to be the medium-term goal, and I think linked
trading schemes are part of the argument there because they can
persuade those countries they can meet what seem to them tough
targets in a low-cost way.
Mr Stace: We must be careful we
do not mix apples and pears together in terms of global trading
schemes and linking them up. If we look at China, it is my understanding
they may be looking down the route of more efficiency targets
rather than absolute targets, which would be very difficult to
link with the European scheme. I know Japan is looking at more
energy targets rather than carbon targets. So in the run-up to
Copenhagen and beyond, there is an awful lot of trying to mish-mash
and bring them together to, as I said before, achieving our overall
goal of international agreement which places all participants
on an equal footing.
Q80 Chairman: EEF is in favour of
more Government investment in decarbonising the economy—I
think we probably all share that view—but you have argued
against hypothecating auction revenues for this purpose. Why is
that?
Mr Stace: What we would like to
do is go beyond the auction revenues really, in the sense that
what we are looking at here is a revolution in terms of reducing
carbon emissions, and is a huge step change in the technology
which is used to create products and services which we have in
the UK. To rely on the auction revenues—and we have talked
a lot today about the changing price—really does not provide
that long-term stability and certainty that we believe EEF members
would need to invest heavily in the new technologies. For example,
if the price of carbon is low, our members need that support all
the more, so if it is hypothecated they will be getting less money,
and when they next need that support and the price of carbon is
high, they will be getting more money. So what we want to see—and
we will see tomorrow in the Budget—is more firm, long-term
commitment from Government to enable manufacturers to produce
the products and services which will ensure the UK meets its obligations
under the Climate Change Act.
Q81 Chairman: But against the present
background of the public finances, there are not going to be other
sources of taxpayers' money readily available for this sort of
investment. Would the revenues, even though they might not be
entirely adequate or even completely predictable, not be a good
start?
Mr Stace: They would certainly
be a good start but there are other revenues—the climate
change levy and the landfill tax and the like. If we are looking
at the economic situation now, that I hope would be very different
going forward into Phase 3 when we will see significant revenues
from the ETS. So we are absolutely not calling for the revenues
to go somewhere else, we are saying there should be the revenues
and more.
Q82 Chairman: One of the proposals
from the US administration is that the revenues from auctioning,
if they proceed down the trading route, will be used to top up
the social security budget. That seems to me something which might
get the whole concept of auctioning discredited. At least by using
them for some directly related purpose, would in your judgment
be a better alternative?
Mr Stace: Yes.
Q83 Chairman: What effect do you
think the revisions to the proposals for free allocations in Phase
III will have on the amount of revenue which could be raised?
Mr Stace: It certainly will reduce
it slightly, but the benefits of free allocation, and therefore
avoiding any carbon leakage, would far outweigh the loss in terms
of revenue that the Exchequer would get.
Mr Farrow: We have not done the
analysis of this but if there are few allowances to be auctioned,
that is not a huge difference but actually that might mean the
price at auction is higher than it would otherwise be, so it might
equalise. We have not done the modelling.
Q84 Chairman: We are going to have
to call it a day as we have some other witnesses to talk to. Thank
you very much for your time and your responses this morning and
I hope we can keep in touch with all your organisations as well.
Mr Farrow: Thank you.
12 Note by Witness: The witness meant to say
during the evidence session that "the price between them
was the effective interest rate of the loan, and because they
had issues with the overall financial market. Not could
have not had issues with the overall financial market. Back
13
Ev 43 Back
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