Memorandum submitted by E.ON UK
SUMMARY
— E.ON UK supports the use of the EU ETS
as the EU's primary carbon reduction instrument. We also welcome
the EU's commitment to reduce greenhouse gas emissions by 20%
by 2020 (or 30% following the successful negotiation of an international
climate deal).— Uncertainty surrounding the global economic
downturn and the outcome of COP 15 in Copenhagen in December this
year is influencing the current carbon price. Confidence in the
carbon market is best maintained by a commitment from UK Government
to the EU ETS, avoiding additional GHG restrictions on the UK's
domestic traded sector and supporting the supplemental use of
project credits within the EU ETS.— Whilst accepting that
relatively limited emission reductions were achieved within Phase
I of the EU ETS, the initial phase was a success. The first three
years of carbon trading represented a critical learning period
which established confidence in the scheme by demonstrating robust
compliance procedures.
— The EU ETS is not the only driver for
climate and renewable targets. Specific support is required for
pre-commercial technologies such as CCS and other policy mechanisms
are more appropriate on the supply side to encourage energy efficiency.
— E.ON supports the proposed auctioning
date in 2011 for Phase III allowances. However, we note the potential
for serious financial risks (which could undermine the objectives
of the EU ETS) in the event that the auctions are delayed.
— E.ON supports the currently proposed
level of access for CDM (project credits) in Phase III of the
EU ETS. It is important that access is harmonised across the EU
and that credits which have been approved by the UN processes
are not retrospectively deemed invalid for the EU scheme.
1. E.ON UK is one of the UK's largest retailers
of electricity and gas. We are also one of the UK's largest electricity
generators by output and operate Central Networks, the distribution
business covering the East and West Midlands. In addition, our
E.ON Climate and Renewables business is a leading developer of
renewable plant in the UK.
2. E.ON supports the Commission's initiative
to create a harmonised emissions trading scheme across the EU
and believe that a market mechanism represents the most efficient
way to address the release of anthropogenic greenhouse gas emissions.
THE EU EMISSIONS
TRADING SCHEME
Potential contribution of international emissions
trading to delivering a global greenhouse gas stabilisation target,
consistent with the UK's goal of limiting global warming to 2°C.
3. Cap and trade schemes such as the EU ETS
have a number of economic advantages over alternative emission
reduction strategies which were recognised in the Stern Report.
They provide environmental certainty by ensuring that emissions
are kept below a progressively reducing cap, while providing flexibility
for participants in the scheme to determine how to meet the cap.
Cap and trade schemes can also equalise the cost of carbon across
economies, allowing abatement to occur where it is most efficient
for it to do so. It also offers flexibility by crediting emission
reductions in States outside of the scheme (through the Clean
Development Mechanism (CDM)), which can play a key role in the
negotiation of a global reduction target going forward. Reduction
caps can also be amended over time, to make sure that they are
in line with the latest scientific consensus.
4. The EU's cap and trade scheme covers approximately
40% of EU greenhouse gas emissions and is already playing an important
role in delivering the required emission reduction to limiting
global temperature rises. The EU ETS Amending Directive provides
for a 21% reduction in these emissions by 2020 compared to 2005—considerably
more effort than will be achieved in sectors not covered by the
EU ETS which will look to reduce emissions by 10% compared to
2005 over the same period. Together these reductions equate to
a 20% GHG reduction across the EU (compared to 1990). Should a
comprehensive international agreement be reached following the
Copenhagen negotiations the EU will look to increase the 2020
reduction target to 30% compared to 1990. The Commission believes
that this level of reduction is commensurate with the objective
of limiting the overall global annual mean surface temperature
increase to no more than 2°C above pre-industrial levels.
5. Cap and trade schemes have or will be implemented
in other developed countries (such as the US and Australia). There
is scope for joining these schemes to create a wider, increasingly
global market, which will generate further efficiency savings
and bind more countries into an overall cap. This should, however,
only occur if the schemes have comparable levels of ambition so
that the effect of merging schemes is not to weaken the carbon
price and reduce investment incentives.
6. International emissions trading can of course
only deliver the required reductions in the sectors covered by
them. In the EU, 60% of EU emissions are from the non-traded sector.
It is imperative that these sectors are subject to equivalent
incentives and penalties to ensure that EU emissions as a whole
are reduced to the level necessary to avoid dangerous climate
change.
The record of Phase II of the EU ETS, and prospects
for the success of Phase III
7. Recently there has been a significant fall
in the price of Phase II allowances. The current economic climate
has forced industry to reassess output levels over the course
of the Phase and it has been a logical reaction to sell the unexpected
surplus allowances back in to the market. Nevertheless the market
is functioning properly and the cap required by Phase II will
still be delivered.
8. Investors considering major low-carbon capital
investments will be looking at the carbon price which will apply
when those investments commence operation. For example for nuclear
plant this will be the price prevailing in the latter part of
the next decade. It is therefore important to ensure that the
Phase III cap delivers the level of reduction that is consistent
with the required reduction in global temperatures and that there
is a commitment to continue to reduce the cap over a longer timescale
at least to 2030. The level of the Phase III cap and action beyond
2020 are dependent on the outcome of COP 15 in Copenhagen and
uncertainty around this is affecting the carbon market adversely.
A comprehensive international agreement will go a long way to
restoring confidence in the carbon price as an important driver
of low-carbon investment.
Auctioning
9. Auctioning of carbon permits has been a new
feature of the EU ETS in Phase II and the UK has been one of the
first countries to initiate an auctioning process. Regrettably
the auctioning arrangements were not consulted on adequately.
This resulted in an unsatisfactory auction design which required
all direct bidders (primary participants) to bid on behalf of
other parties if requested and this may have restricted participation
as many potential direct bidders do not have the capability to
handle third party transactions in this way. We hope these issues
will be addressed in future auctions.
10. In terms of EU wide Phase III auctions we have
consistently argued that all sectors should follow the same trajectory
to full auctioning in 2020, as this would have encouraged the
deployment of cost effective abatement technologies across the
EU economy. Nevertheless, we support the move towards full auctioning
for all sectors by 2027. It is essential that auctioning arrangements
are harmonised and we believe that the proposals in the amended
directive will help to achieve this objective.
11. In Phase III all power sector allowances
in the UK and other western countries within the EU will be subject
to auctioning. It is essential for auctions to occur at the earliest
possible opportunity as delay could pose significant financial
risks for large compliance buyers, especially those who have to
hedge well in advance, ie energy companies. E.ON supports the
proposal to auction allowances by mid 2011, but, given that many
Member States have yet to implement auctioning even for Phase
II, UK negotiators must work hard to ensure that the Commission
and other Member States understand what will be required to implement
auctioning by this date.
Extent to which the carbon price will be sufficient
to drive low-carbon investment, in particular decarbonisation
of energy
12. Companies like E.ON factor their long-term
expectations about carbon prices into their evaluation of alternative
investments. A high carbon price will tend to incentivise lower-carbon
technologies, although other factors such as expected fossil-fuel
prices and the need to reduce risk by avoiding over-reliance on
one fuel source are also relevant. The EU can strengthen the role
of the carbon price by agreeing an ambitious cap for Phase III
and later Phases. Whilst the carbon market is an important factor
in incentivising low-carbon investment, pre-commercial technologies
such as offshore wind and carbon capture and storage require significant
levels of additional financial support, although the level of
subsidy required will vary inversely with the expected carbon
price.
13. There is a concern that the current global economic
slowdown could act to delay low-carbon investments. The carbon
market has recently seen downward pressure on the price as industry
revises output figures and sells a corresponding proportion of
their emission allowances. However, it is important to note that
the carbon market continues to operate as originally envisaged
and the environmental integrity of the scheme is unaffected. It
is rational for participants to sell excess allowances, which
ensure that reductions in the most efficient manner within the
overall carbon cap agreed at the outset of the scheme. Investors
in new projects will be looking at the carbon price which will
apply when new investments come on stream. For most generation
investments this will be the carbon price that applies in Phase
III as discussed above in paragraph 8.
14. Given the current uncertainty about the
long-term carbon price, it is tempting to propose alternative
measures aimed at achieving the same goal. In general we are concerned
that these proposals, such as plant emission standards, will be
seen as substituting for the EU ETS and will thus ultimately render
it irrelevant. The impact would also be to raise the cost of compliance
to UK plc without any demonstrable environmental benefits and
send a message that the UK does not believe that a carbon market
can deliver the necessary GHG reductions. In our view the priority
should be to make the EU ETS a success rather than devising alternatives
to it. That is not to say that member states cannot introduce
policies that will incentivise emission reductions in the traded
sector but these should aim to work with the grain of the EU ETS
rather than against it. An example of this would be the provision
by Government of a contract for difference on the carbon price
to help fund CCS demonstration.
Impacts on and responses by UK firms covered by
the EU ETS
15. Although many business covered by the EU
ETS will already have identified opportunities for savings in
energy costs as part of their normal business, carbon cap and
trade scheme provides a financial incentive for businesses to
assess their own carbon abatement curve and allows businesses
flexibility in how the targets are met. To maximise the opportunities
created by the ETS, businesses must formulate carbon strategies,
an essential process in internalising responsibility for the reduction
of greenhouse gas emissions.
16. The extent to which low-carbon strategies have
been discussed and agreed at Board level will be in part determined
by the level of exposure to the carbon price. Where sectors have
not been subject to a shortfall in free allowance allocation,
thereby requiring the purchase of EUA's, one might expect company
wide low-carbon strategies to have been less rigorously developed
than would otherwise be the case. It is precisely for this reason
that we believe that all sectors should move towards full auctioning
at the same rate such that all EU ETS participants are equally
incentivised to establish which abatement possibilities are available
for them to adopt at the earliest opportunity.
Implications of the EU ETS for business competitiveness,
and how to address them
17. There are some sectors where global competitiveness
is a critical issue. In limited cases this may necessitate a different
allocation methodology (as a transitional measure) in order to
maintain the credibility and fairness of the EU ETS. E.ON has
argued that in advance of binding global GHG reduction targets,
there may be a need to support a few sectors on an exceptional
basis, where they could prove to be at risk from carbon leakage.
In the event of a comprehensive international climate change agreement,
the number of sectors at risk will be much reduced.
18. The Commission's criteria to determine those
sectors that are genuinely exposed to a high level of risk from
international competition must be carefully defined and strictly
enforced. The effectiveness and efficiency of the EU ETS depends
upon all sectors moving towards full auctioning at as close to
a uniform rate as possible. Without an equitable transition to
full auctioning, low-cost abatement opportunities could be lost.
Effects of the expansion of the EU ETS to encompass
aviation
19. E.ON UK welcomes the proposals to include
aviation within the EU ETS. Furthermore, it would have been in
the interests of the scheme to ensure that all sectors including
aviation were subject to the same transition to full auctioning
as the power sector. Protecting the aviation sector from internalising
the true cost of carbon does seem a little counterintuitive given
the reductions required from the traded sector, especially given
the forecast emissions trajectory for this industry.
20. The overall trajectory of transport emissions
generally continues to rise and it is clear that a mechanism is
required to reduce the impact of this sector. However, E.ON recognises
that the dynamics of the road transport sector probably means
that the EU ETS is not the most efficient instrument to attain
the necessary GHG reductions in a timely and cost effective manner.
Nevertheless, it is important to ensure that this sector is subject
to equivalent harmonised reduction provisions across the EU. Failure
to internalise the cost of carbon within a sector of this size
and growth trajectory would have serious consequences for the
prospects of achieving the EU's GHG reduction target.
DEVELOPMENT OF
A GLOBAL
CARBON MARKET
The robustness and effectiveness of "offset"
schemes (ie those without a cap), such as the Clean Development
Mechanism (CDM), and the issues around linking them to cap and
trade schemes
CDM
21. It is important for the credibility of a
global climate regime, and associated regional GHG reduction schemes,
that UN processes for accrediting and verifying project credits
are demonstrably robust. Generally we do consider this to be the
case and we are confident that the UNFCCC CDM Executive Board
is the appropriate organisation to ensure that this continues.
22. We are pleased that the Amending Directive has
continued to recognise the benefits of the Clean Development Mechanism
(CDM). The mechanism promotes environmental technology transfer,
contributes to the economic sustainability of developing nations,
lowers the compliance costs and increases the liquidity of the
EU carbon market without diluting the environmental integrity
of the scheme. CDM access has been carefully designed to make
sure that financial flows from Europe can contribute to bringing
developing nations to the negotiating table to discuss how the
global reductions that are necessary to address climate change
can be shared equitably in future years.
Linkage
23. E.ON agrees with the EU Commission's support
for linking the EU ETS with other GHG trading schemes. A global
GHG reduction scheme will increase access to the most efficient
abatement opportunities and will therefore reduce the compliance
cost of meeting an international emission reduction target. Expansion
of the EU ETS scheme could also create an economic opportunity
for the EU if it is successful in becoming the centre of a global
carbon market.
24. It is however, important that linkage to new
schemes does not result in a dilution of the environmental integrity
of the EU's current cap and trade scheme. It is also essential
that linkage to a new scheme should be signalled to the market
well in advance and should be progressed in a way which minimises
disruption to the current market.
UK CARBON BUDGETS
The relationship between emissions credits and
the UK carbon budgets set up under the Climate Change Act
25. E.ON UK supports the use of UN certified
project credits as part of an international climate change agreement.
Supplemental use of CDM helps the EU achieve cost effective GHG
emissions, and the associated financial flows also serve to involve
developing nations in the fight against climate change.
26. Emissions in the traded sector are essentially
controlled at EU level by the EU ETS. It is important that the
EU ETS and carbon budgeting system introduced under the Climate
Change Act are consistent to preserve the efficiency and integrity
of the scheme and to avoid imposing additional costs on the UK
economy with no environmental benefit. In this respect we welcome
the Government's proposal that all carbon units under the Kyoto
Protocol and the EU ETS should count towards the net UK carbon
account. This correctly recognises that an additional emission
allowance purchased by a UK EU ETS participant represents real
and verifiable emissions saved elsewhere.
27. E.ON recognises that a substantial proportion
of greenhouse gas reductions should be achieved within the EU
or domestically. E.ON UK agrees that in advance of a global deal,
at least fifty per cent of the EU's emission reduction requirements
within the traded sector should be met within the EU. We note
that the Committee on Climate Change (CCC) has already provided
views to the Government on the appropriate use of CDM access for
both the traded and non-traded sectors and we support their proposals.
March 2009
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