Examination of Witnesses (Questions 220-241)
MR ABYD
KARMALI, MR
JAMES CAMERON
AND MR
LOUIS REDSHAW
12 MAY 2009
Q220 Chairman: Good morning and a
warm welcome to the Committee. We have seen at least two of you
before I think, and it is nice to see you again. I think all of
you are supporters of trading and the role it can play in tackling
climate change; however, it has to be said, on the basis of what
has happened in Phase I it does not look as though it has actually
delivered very much, apart from demonstrating that you can have
an international system which covers a lot of countries and a
lot of individual components. What would you point to as being
the actual contribution it has made so far in cutting emissions?
Mr Cameron: The most important
point is that it has made a start. A system has been constructed;
institutions have been built; a value for carbon established;
an awareness of the value inside the business mind; investment
decisions are being taken in key industries that now routinely
take account of the price of carbon in their forward planning.
There is a narrative about how you invest to reduce greenhouse
gas emissions; that narrative includes many of the key factors
that need to be involved in the solutions to climate change globally.
It is a very remarkable achievement to have done all of that in
a relatively short period of time, given that, if you like, the
true market has only been running since 2008. It has certainly
managed to channel very substantial amounts of money into reducing
greenhouse gas emissions; not least in some countries where you
would not have had that kind of investment but for the market.
Just to pick our own particular fund—one of our funds in
the business has invested over a billion dollars in China in the
last couple of years; it would not have happened without the carbon
market. We have made investment to places like Pakistan; and there
are lots of reasons why you would not want to do that just at
the minute, but the carbon market gives you a reason. I regard
that as a success. One wants to qualify it with all sorts of experiences
that tell you that improvements have to be made. You can measure
tonnes of carbon reduced. It is very early on in the game to be
sure whether the total amount of tonnage is extracted out of the
global economy through the carbon market. Do not forget, we have
got several years to run in the first commitment period, until
2012. It is a bit early to be making the sort of judgment you
did in your question; but I think when you add up all that has
been done to construct a regime that values carbon and to involve
players that need to be involved in the collective action effort
to resolve a collective action problem, it has been a success.
Now really it is a question of ensuring that we improve and expand
the system. It only has one objective after all, which is to take
tonnes of carbon out of the atmosphere. That is how it should
be judged. Whether it is a bit early today or in 2012 or in 2020—that
is how it should be judged.
Mr Karmali: I think James has
touched on many of the key points, but maybe just to add a bit
more granularity in a few areas. What we have seen emerge in the
past few years is that places like China and India, that absolutely
need to be part of the solution, are developing their own clusters
of low-carbon technology. We see leading wind turbine manufacturers
coming out of India. We see leading Chinese solar companies listing
themselves on the New York Stock Exchange. I think this is a very
important contribution that the carbon market has made, and one
that is often not discussed. I would also point out that the existence
of a price of CO2 in the European marketplace has catalysed action
not just at the entities covered by the scheme, the 11,000 installations
across Europe, but also in fact installations, companies who are
electricity-intensive and energy-intensive. They have seen a knock-on
effect on the price of electricity because of the links between
the carbon markets, the fuel markets and the power markets; and
I think that has catalysed a significant degree of interest in
energy efficiency amongst companies who otherwise would have had
a bit more time to think about their reaction to climate change.
Those would be some additional points I would like to make.
Mr Redshaw: It is obviously a
shame that Phase I ended up the way that it did. The over-allocation
highlights the problems of deciding or setting out how much companies
should get as a free allocation. On the positive side of that,
what Phase I has done for the whole world is provide a set of
examples of things to do and things not to do, probably
more importantly. Obviously over-allocation is something to not
do; and to counter industry complaining about their allocation
or even getting more than they need, politicians can point to
a failing or a failure by Phase I and its over-allocation as a
factual example rather than a conceptual one. Of course it is
a pity and money, arguably, has been wasted, but it does have
those benefits. During Phase I we have obviously traded a lot
with companies that are facing compliance obligations. It is clear
that they are optimising their portfolio of assets throughout
the process. Even though it was over-allocated throughout Phase
I, the companies were facing up to their economic responsibilities.
When the price was €30 you can be sure there were companies
doing quite a lot to reduce their emissions and cash in on €30.
Okay, so the price came down later on but that emission reduction
has now taken place and is permanent. There were utilities, for
example, moving from lignite to hard coal and from hard coal to
natural gas. Finally, like the UK led the way with the UK Emissions
Trading Scheme and helped build capacity within the systems—so
I am talking about accountants, lawyers, as well as trading companies
and financial intermediaries—the European Emissions Trading
Scheme has put Europe, and London as a consequence, at the centre
of global emissions trading as the trend picks up.
Q221 Chairman: We are obviously at
a very important stage now in negotiations about what happens
post-Kyoto. Nick Stern identified the need to accelerate moves
towards new technology, reduce the barriers to behavioural change
but also, crucially, to get a carbon price whether that is through
taxes, regulation or trading. Looking ahead, how much importance
do you think we should place on trading, given at the moment the
EU has got the only system that is really up and running—there
are one or two things, RGGI and so on in America, and Australia
are putting it back a bit? Do you think we should be getting on
the map on training as a key component in the future framework?
Mr Cameron: I think this is a critical
question that needs resolving very clearly very early on. There
is no doubt that in our type of economy this problem is very hard
to reach with single instruments. The climate change problem is
really all about everything. We are all involved; we are all implicated
in everything that we do. Decisions are taken every day all across
the country, small and large, that make a difference to climate
change. You have got to think of what policy mix can best reach
the widest range of most important decisions that affect what
our emissions are in this country, and of course beyond this country.
I would very much support Nick Stern's views on this. I would
place emissions trading in the essential category of policy responses.
My experience as a negotiator in the climate change negotiations
over many years representing the small island states tells me
that as an idea it works to connect the people you need to connect
to solve the collective action problem that we have. It works
better, for example, than a global carbon tax; which was something
we tried early on in the negotiations and failed, and failed dismally:
but it would be quite wrong to assume that emissions trading is
a panacea—that it is the only measure that we have—or
that somehow it exists exclusively, removed from other measures,
like taxation for example. Of course you could combine fiscal
measures with a cap-and-trade system. There are some sectors of
the economy where you know very well what the answers are; yet
we have plenty of experience and knowledge of what works to say,
"I can command that solution. I, the politician, the public
policymaker, the administrator, have enough knowledge and experience
to say, `We will have this outcome'". In trying to
understand what emissions trading can do to solve a global problem,
you have to think of it as being essential in the toolbox; absolutely
not the only thing that is available to you; it has got to be
able to cross borders to galvanise effort beyond your jurisdiction;
and it needs to engage a very wide range of responses across an
economy. I think Nick Stern has got it about right. He does not
pretend that it is the only measure to be adopted. We have to
think of clever ways of combining what is a price signal and a
new set of values in our economy—reducing greenhouse gas
emissions is a value in itself—with the other measures that
we know can work, without being wholly dependent upon one; because,
let us face it, there is a lot of learning still to do about how
to make emissions trading the effective instrument that it should
be.
Mr Karmali: Clearly emissions
trading, from our Association perspective, is one of the
most critical instruments to address climate change in a way which
is most cost-effective for society. We have to remember that the
premise of the market—and the success of the market so far
has demonstrated this premise—is that it is going to deliver
emissions reductions at lowest cost to those who have the compliance
obligation: but clearly every government is going to have its
own mix of policies and measures which reflect its own trade-offs
amongst the need for economic efficiency, the need for intrasectoral
equity, and competitiveness considerations. So we will inevitably
see a mix of complementary measures which need to fit with emissions
trading. Our concern as an Association is that we clearly want
to avoid an outcome where public sector intervention through some
of these other policies and measures crowds out the investment
decisions that would have been made through having a price of
CO2 in a market. That is one of the issues that needs to be resolved
as other measures come to the fore. I would also say that the
experience in the negotiations is that emissions trading is complex,
but in fact is the one instrument that is easiest to implement
given the difficulties in reaching international consensus on
taxes or international consensus on performance standards; as
well as of course the potential interrelationship between having
standards and the need to have free trade through WTO. Emissions
trading, from our perspective, is the least complex: there are
many improvements that can be made to take us into the next phase
of trading; those need to go hand in hand with a serious reduction
commitment, because otherwise the system is going to fail regardless.
Mr Redshaw: Of course the obvious
benefit of trading—versus, the other obvious market mechanism,
tax—is that the cap will be achieved under an Emissions
Trading System; bearing in mind our requirement is to reduce emissions
and not to just make things more expensive. Clearly that has to
be foremost in people's minds and in the policymakers' minds.
My colleagues have mentioned the clear benefits of trading, being
efficiency to the economy. What I would urge though is that people
do not confuse the conceptual purity of trading and the European
Emissions Trading Scheme; because you have a constructed market
that has inherent inefficiencies built into it. Trading will deliver
the lowest cost solution to the problem, but only if it is allowed
to do so by having a well constructed trading system. An obvious
example is the over-allocation of Phase I, but between us we could
come up with a very long list of other examples of things that
could be made better. One glaring omission, yes, emissions trading
should be at the core of the solution to the global warming problem,
but Barclays' view is that actually it should be the vast majority
of the solution to the problem. At the moment something like 45%
of carbon emissions are covered by the Emissions Trading Scheme
in Europe. The US is already going a very big step further—that
the current most popular bill is looking at 85% coverage. We have
long advocated as an organisation the inclusion of the entire
economy in Emissions Trading. Yes, if you put the trading obligation
on individuals the administrative cost would be onerous; but you
do not have to put the obligation on individuals. I notice in
the National Audit Office Report the average cost of audit is
something like £35,000 per year. Companies that have a small
obligation, all the way down to individuals, should have the opportunity
to opt out of trading and allow their fossil fuel supplier to
make good their obligation. At the moment you have got a complete
distortion in the market. You can buy fuel for domestic consumption
and you have no carbon liability; whereas if you buy electricity
for domestic consumption you are paying a lot for it because you
are paying the carbon cost on top. That is just an example,
but road users are the same: you are not paying for the cost of
carbon in road fuel use, yet we are talking about paying for the
cost of carbon in aviation and in other products that we all use.
An economy-wide emissions trading set-up would be considerably
more efficient and avoid distortions, compared to what we have
at the moment.
Q222 Colin Challen: Just following
on from that, does that mean that you would agree with the position
taken about two years ago when we had the DTI advising ministers
going to Brussels not to commit to too much effort supporting
renewable energy, because that would damage the ETS? Is that your
position too?
Mr Redshaw: I do not say it would
damage the ETS as such, but if you are looking to reduce emissions
of the economy, putting in an extra subsidy for a pet technology
will distort the market, so I do agree with that. It will make
the cost of reducing emissions, assuming the renewable investment
is purely about reducing carbon emissions and not also about security
of supply—but you will be crowding out other investments
if you subsidise renewables over and above the benefit they are
going to get from the carbon price.
Q223 Colin Challen: That is a sort
of built-in institutional bias against new technology, is it not;
because what the ETS encourages then is going to be a greater
reliance on older technologies, coal and nuclear perhaps, which
perhaps could be tweaked a little bit but supports a vibrant carbon
allowance trade?
Mr Redshaw: Renewable electricity
would be sufficiently supported, probably at current prices actually,
for some technologies; but for some of the more exotic technologies
you might need to see higher carbon prices. The bottom line is,
if you are looking to reduce emissions and there is a cheaper
way to do it than an exotic renewable technology, other than the
capacity-building that might justify an extra subsidy for one-off
or five-off demonstration projects, if it is cheaper to do it
through another technique, via energy efficiency in industry,
in the home or wherever it needs to be, to be cheaper than an
exotic renewable technology, then it should be done elsewhere.
There is no point in causing that extra cost to everybody.
Q224 Colin Challen: It is really
a question about the domestic effort we make in the European Union
and how the ETS actually supports the domestic effort to reduce
our carbon emissions. I understand the argument a tonne of carbon
is the same here as it is in Kenya, but there is more to it than
that. That is a very simplistic way of looking at it. We have
to have a domestic effort, do we not, which should be compatible
with the EU's targets of containing a temperature increase to
2o. What is your estimate of our efforts in the EU ETS in achieving
that 2o containment increase?
Mr Karmali: There is an initiative
which has been underway for the last year called "Project
Catalyst", which is some very, very detailed analysis backed
with involvement from some negotiators, scientists and people
from the financial community, myself included. It is looking at
essentially: what is this mathematical challenge? How do you keep
the increased temperature to a maximum of 2°? Working backwards
from that: what is the ppm that is required in the atmosphere
to stabilise the temperature; and, working back from that, what
are the emissions reductions that would be required vis-a"-vis
the baseline—the business as usual scenario? The answer
is I think quite revealing, in that it would require in the order
of 17 gigatonnes of CO2 to be reduced by 2020; and that is assuming
of course that society is going to pick the cheapest reductions.
That 17 gigatonnes takes you up to €60/tonne. Within that
17 gigatonnes if you break it out you get roughly five gigatonnes
only in all of the OECD countries. So the question is: where does
the residual 12 gigatonnes come from? The answer is: eight gigatonnes
from actions at the low end of the cost curve, if you like, in
developing countries, improving energy efficiency in some of the
lower-cost renewable energy improvements, as well as forestry
and agriculture; and then the rest is carbon offsets. The rest
is roughly four gigatonnes; so what that implies is that up until
2020 there has to be a healthy carbon offset market in order for
us to achieve the goal that you have outlined here at home. We
cannot do this alone; or rather, let me rephrase that, we can
do it alone by focussing on domestic reductions but, let us face
it, the cost is going to be far too prohibitive for UK industry
and UK society.
Mr Cameron: Can I attempt to bring
the two questions together in one answer. There are reasons for
supporting renewalble energy technologies that go beyond their
CO2 savings. There are reasons for supporting innovation in technology
generally, particularly in the energy and transport sectors, beyond
their CO2 reductions. It is perfectly possible to combine an economy-wide
emissions trading system that is focussed exclusively on CO2 or
the other greenhouse gases, that is all about finding efficiency,
lower cost, making big relative shifts, maybe involving some of
the old industries that are going to be around for a while; and
layer on top of that particular incentives, because a decision
has been made that it is good for our society, it is good for
the diversity of supplies, it is good for the security of supply,
it is good for employment creation around innovative new technologies.
I would encourage you not to see these as a pure trade-off so
that renewable energy is exclusively supported by the carbon market
or not; or that new technologies need only rely on the carbon
price. To my mind it is vitally important that we look at all
the ways in which we can encourage innovation, not least in small
businesses, in entrepreneurial businesses that are going to be
the creators of the solution to the future, the ones that we do
not know about yet. At the same time, this is a global problem
and it is foolish to consider domestic action as if it were in
some way superior to action taken overseas. When an investment
is made through the carbon market in China several things happen
at once which are good that we need to build upon. Firstly, money
goes into a developing country to solve a collective action problem
that we created. There is a morally important gesture being made
in the investment that takes place in that country. Secondly,
every tonne of carbon that is reduced there is, as you say, the
same as a tonne of carbon reduced in Cambridge; but it has the
benefit of also helping a US citizen and a Peruvian citizen in
solving the problem too. Every tonne of carbon reduced there is
not just in the interest of the Chinese citizen but ours and others
in the rest of the world. That global market, in reducing greenhouse
gas emissions, has a moral purpose and delivers a public good.
I do not like the phrase "offset" because it encourages
people to think that it is a zero sum gain; that a tonne taken
out in China is an excuse for having an additional tonne in Europe—it
is not. The firmer we can be on this the better we are going to
find the solution to this problem. The obligation to reduce creates
the value in reducing emissions in China. It comes to an international
agreement and you get a protocol; the European Union has implemented
it; and we have our own domestic version—but it is not a
free lunch. We occasionally get very lazy; we get lazy in the
media. The media loves to talk up how somehow investing in China
is an escape; it is not doing what we should do at home. No, it
is not; it is a real reduction done in the public interest; but
it is also not the answer on its own. We have to have innovation
in our own economy. There are reasons for doing that, but you
cannot expect the carbon market to cover every single one of these
goods that public policy should be focussed on.
Q225 Martin Horwood: I would love
to have a discussion about what you have just said. Surely, if
it is important to decarbonise our own economy, especially so
that we come out of recession without a false sense of how much
progress we have made, in a sense every other tonne offset somewhere
else is a tonne of offsetting or tonne of reduction that is not
actually happening in our own domestic economy?
Mr Cameron: We could come back
to it. It depends on how you set the system and what other methods
you use.
Q226 Martin Horwood: My other question
is: in terms of subsidising and trying to bring forward renewables,
there are reasons which are not to do with domestic effort or
even the kind of society and other type of reasons. Surely in
order to get those technologies to the point where they are competitive
within the carbon market, as the Carbon Trust has been telling
us for years, you have to remove barriers to development, and
you have to encourage and subsidise them surely. So subsidy is
actually in the end an aid to a competitive carbon market, is
it not?
Mr Redshaw: By way of an example,
I was once involved in an energy from waste project where there
was an innovative combination of different technologies. The idea
of combining boiler X with steam generator Y and turbine Z with
the waste stream coming, it had never been done before—the
idea of energy from waste is nothing particularly new, but this
combination was new. Because it was new it could not get insurance;
because it could not get insurance it could not get financing;
because it could not get financing from the more regular markets
because of lack of insurance it had to make a greater return that
was so high that it could not work even under the Renewable Obligation
Scheme which is very generous. In that set of circumstances, yes,
there is a case for moving that project over the barrier to entry;
because once it is proven it will then get insurance for the next
time it gets built; but to blanket provide such a large incentive
to these projects probably is not the most efficient way.
Q227 Martin Horwood: Even something
like offshore wind, which clearly needs some subsidy to be competitive
now, if that subsidy is provided and it becomes competitive surely
that would be part of a healthy functioning market in the future?
Surely we should give that subsidy now in order to get it to that
stage because the market will not deliver, will it?
Mr Redshaw: Yes, and perhaps if
the subsidy is required to improve technology to get it over that
barrier on a one-off basis or several-off basis then that would
make it cheaper in the future. What I am saying is, if the price
of carbon reflects the cost of reducing emissions and that cost
of emissions is too low for offshore wind because the marginal
reduction in emissions is made by a much cheaper technology, then
why would you chase after something that is more expensive?
Q228 Martin Horwood: Because in the
long term it could be just as cheap, and that is actually more
important in the long-term, if not in terms of your spot price
right now?
Mr Redshaw: Yes, I absolutely
see your point of view but the spot price now is a function of
the certainty that we have got in the future of this market; and
right now we do not have long-term certainty that provides strict
enough targets that provides sufficient price to subsidise your
example of an offshore wind farm. Do not forget, the wind farm
gets the benefit of a carbon price via the electricity price.
The electricity price completely reflects the cost of carbon on
any given day in the UK. If the carbon price is higher because
the target is strict enough, then offshore wind will become viable
because it is getting rewarded via the higher carbon price; but
if with the targets that we have set ourselves, which are presumably
scientifically based with some form of cost-benefit analysis to
say that we should be reducing by this much, if we can achieve
that by other technologies that are cheaper then that is what
we should do.
Q229 Martin Horwood: I do not want
to dominate the Committee's time, but you are not just talking
about these becoming competitive because the price goes up; you
are talking about them becoming competitive because you have got
the costs down, which requires investment, does it not; and that
requires subsidy, not on a one-off or four-off basis but on an
industry-wide basis?
Mr Redshaw: There is merit therefore
in making that investment initially to get the cost down; but
to give a blanket subsidy to the entire industry until the end
of time would not be an efficient use of government money.
Q230 Martin Horwood: I am not sure
anyone suggested doing it until the end of time.
Mr Karmali: One of the challenges
we always face in talking about different energy technologies
is that the reality is the existing mature technologies all have
very significant subsidies at every stage of the value chain:
whether it is the mining, whether it is the extraction, whether
it is the transport, whether it is the distribution, there are
subsidies direct and indirect at every stage of the way. If I
was sitting here in the capacity of someone from a renewable energy
company I would probably be making the case that my particular
technology also deserves some form of subsidy to level the playing
field: I am not, so I will stop there.
Mr Cameron: It makes perfect sense
to build capacity as well in clean energy technologies, to spend
money on the infrastructure that will enable clean energy technologies
to flourish. That infrastructure exists for the fossil fuel industry;
it does not, to a sufficient degree and with the right opportunities
available, to the clean energy technologies which are out there.
Q231 Joan Walley: I just want to
pick up something you touched on just now, Mr Cameron, in relation
to the Stern Report. You said that emissions trading was not a
panacea and it was really part of the policy mix. In the evidence
we have had, it seems to us if you take what Lord Stern has actually
said that there will be less need for emissions trading as we
get nearer to 2050. My question is: as well as this policy mix
that you refer to, how do you inject the kind of constant rebalancing
and reconfiguration that needs to be taking place? Therefore,
how much do you accept that analysis of Lord Stern? Can you see
that emissions trading would effectively need to cease long before
2050 in order for countries to concentrate on the carbon reduction
at home? How do you see this panning out?
Mr Cameron: I think Lord Stern's
analysis is really quite insightful because it tells you immediately
the value of an instrument that you can learn from and that over
time, if it is really successful (and one has to emphasise that
it would have to be supremely successful) it causes its own redundancy;
because the values associated with reducing greenhouse gas emissions
are so completely absorbed in our economy that it is not necessary
to use this instrument any more; it has made the transformation
to the lower-carbon economy by 2050. It is true that the carbon
market has the capacity to adapt and respond to scientific input
at one end, information about how the market is behaving—supply
and demand—and the public policy obligation that creates
the market. They can all be tuned from time to time. One of the
difficulties we have at the moment is learning at what point we
can do fine-tuning if we set allocations for a period of time—especially
if we give them out for free or we get the allocation wrong. How
do we correct that so that it fulfils its sole purpose, which
is to reduce tonnes of carbon from the economy at lowest cost?
His insights are very, very valuable here. We have got to build
a system that is capable of responding to scientific knowledge
as it comes in. You have not set the target at the right level.
Supply and demand dynamics—which we have to assemble through
experience and through the work of people like Louis and his colleagues
in the trading community, and people like us who are investors
so we can tell you, "Well, this works and that does not work",
to cause money to flow into reductions—that poses a severe
institutional challenge to us. How do we take all that information
in and make sure that we have got it constantly rebalanced so
that it does the job of protecting our society from the risk associated
with climate change? I think in the system we have got today we
have got a reasonable start. It also tells you how important it
is not to have gentle sloping starts. Quite contrary to the evidence
you generally get from industry, who tell you, "Be gentle
on us to begin with. Give us a gentle curve. It has been very
successful recently in Australia. Don't touch us now that the
economy is in trouble", actually the reverse is true. You
really want emissions trading to confront you right away with
a significant challenge to make you face up to the obligation
to reduce—the imperative to reduce—and get cracking
with the investment decisions that are necessary as a result.
If you do that, and you do it in an effective way, you set the
right targets; and the efficiency managers—the people who
trade to deliver public policy, because that is what they do—they
frequently get criticised for somehow doing their job; they are
doing the job of the administrators of the system; they are finding
the efficiencies; they are delivering your public policy; that
is what the traders do.
Q232 Joan Walley: Two questions arise
out of that. Firstly, when might we be seeing the phasing out
of emissions trading if all of that gets successful? Would you
hazard a guess?
Mr Cameron: I really do not know.
There is a long way to run. We have got a big system to create.
Mr Redshaw: I am not sure that
it phases out, because you make the transition to a different
kind of economy with different technologies; if you make carbon
pollution free again then you become incentivised to become more
polluting again. So emissions trading never goes away; it is always
there; it has to be there in order to manage the resource.
Q233 Joan Walley: You see it as a
transitional building block?
Mr Karmali: Yes, the reality is
that the quantum of carbon budget is decreasing over time. That
is the rationale of the market. As Louis rightly points out, you
cannot suddenly lift off the lid, because then you have a potential
for a reversal and the carbon budget will increase: so you have
to keep the lid there but probably keep it at quite a low level,
consistent with whatever the science is.
Mr Cameron: My point is, if it
is really successful, it has done its job and got lots of technologies
flourishing and it becomes the normal way of using energy and
transporting people, then you have cracked it.
Q234 Mr Hurd: James, I completely
shared your analysis of the downside of the softly, softly approach.
Do you think that with Phase III we have finally got to the point
where the scale of emission reductions required are going to force
companies to change the frame and think beyond "business
as usual"?
Mr Cameron: Louis can tell you
more from inside the market. Our experience as advisers and investors,
rather than traders, is that it is already having an effect on
executive decision-making in the key industries you want to change
or to redirect; but there is still a significant uncertainty over
what happens in Copenhagen at the end of the year, or what happens
in the US domestic legislative process; whether additional demand
will be created by Canada, Australia and Japan around 2012-13.
There are still very big uncertainties that make a profound difference
to how much you commit to that vital period beyond 2012 up to
2020. Of course, the European Union like others have got these
conditional targets that can be ratcheted up if there is global
agreement. Certainly, if you are looking at a 30% reduction in
that period—and there is not a lot of time left before 2012
to make investments that would reduce demand in that period; a
lot is going to be held back until post-2012—then there
is a huge capital requirement in Europe alone, to deal with the
problem. As Abyd correctly says, we do not have a chance of protecting
our own citizens from climate change unless that demand is there
and in much larger amounts in the so-called developing world.
Emissions trading is one of the ways in which that demand can
be created. If you analyse where we are at the moment, we do not
have a capital problem in the global capital markets. We have
a capital flow problem—whether it is to try and get a loan
to develop a project, or whether it is to find clean technology
investments in a developing world. The system we are talking about
now is an aid to capital flow into the right places; but it has
got to be at the right scale and at the moment it is not. The
next phase, Phase III in Europe, looks a lot better, but really
we want it to be conjoined with a global agreement, some more
incentives in China, some more incentives in the US and then we
are looking at the right scale of reaction.
Mr Karmali: I can maybe rephrase
some of that. I think what we are facing between now and certainly
December 2009 and possibly a little bit further than that is the
height of policy uncertainty, which means from an investor perspective
there is a massive risk premium associated with any investments
that are made. From my experience, companies are taking a real
options approach; valuing the option to wait and see how the policy
unfolds before they commit their capital. Once some of these critical
decisions are made, hopefully in December, possibly some of the
key roles thereafter will then begin to see the flows of capital
into some of the lower-carbon technologies.
Q235 Joan Walley: I just wanted to
follow up what you just said about the current recession and about
the opportunities for innovation. You obviously feel that more
needs to be done to encourage companies wishing to get through
the recession to look at this from a different perspective. That
seems to be one of the things you were just saying?
Mr Cameron: I think you can approach
this from two perspectives. One is that efficiency gains of any
kind at the moment have economic value. Anything that can encourage
people to do what, frankly, they know they ought to but tend not
to—whether it is in their own home or in their business,
or find opportunities to reduce cost associated mostly with energy
consumption—all those spaces for efficiency gains should
be looked at hard. Most business leaders would acknowledge that
they could deal with pressure on their businesses, cost pressures,
and reduce emissions if they had programmes that were focussed
on energy efficiency in particular. We know there are incentives
out there; they could be improved but the trend is to encourage
energy efficiency more and more. We have got to find some better
business models for energy efficiency, but that is a secondary
matter. On the other hand, I happen to believe that moments of
crisis are very good for creativity in any sector—whether
it is the arts or in business. We have some severe pressures right
now in our recession that are forcing us to think differently
about how we do things in our economy. That can be connected to
innovation in science and technology and dealing with the climate
change issue, which is not completely but largely a technology
innovation question.
Q236 Joan Walley: Therefore, how
do you square the need to do that with the other side of the coin?
The evidence we got from EDF last week really put this into stark
context. We are waiting on the one hand for Copenhagen, but then
we are also waiting to see how successful the emissions trading
is going to be, and it is probably not going to be at its optimum
for another 20 years' time. How then do you link that with the
public good which you just referred to? Because the investment
decisions that are being taken by the larger companies in terms
of power and energy supplies are being taken as a result of market
pressures, without necessarily either the regulators or the whole
worldwide system taking into account the public good that we would
need to be arriving at in terms of cutting back on carbon emissions.
Therefore, you are in a situation where you are always cart before
horse, or horse before cart; because you cannot see with certainty,
with the long-term investment decision risks, that they have not
got that information to go ahead and proceed. How does all that
come together in terms of decision-making where investment should
go?
Mr Cameron: My colleagues will
have views from their own experience. We are a slightly unusual
organisation in that everything we do is focussed on this. Our
whole business interest is trying to find the solution to your
question. What is it possible to invest in today that makes a
material difference to climate change; produces an acceptable
risk-adjusted return to our investors, which tend to be large
pension funds, and quite conservative types of investors; and
can enable a business to be sustained over a difficult period?
Allow for, say, three years of this and you realise you have got
to be very careful with the investment judgments that you make.
I think all the efficiency investments look sensible at this stage,
whether they are in a project or companies that specialise in
efficiency. We are finding that investments in renewable energy
infrastructure are good investments to make, whether it as a result
of a subsidy, or through the carbon market in the developing world
through the carbon price. There are good investments that can
be made today, despite the conditions we are talking about. In
fact, pretty much across the whole of the clean technology sector
there are good stories. There is a lot of innovation happening;
there is capital flowing into clean technology; there are
industrial responses being made to the crisis—the twin crises,
if you like, of climate change and the economy—that look
promising and will attract investment. My concern is really following
on from Nick's question, that we have not yet got to the right
scale and we are still underestimating the urgency of time, and
we must not have delay that is really implicit in your question.
We cannot wait until somehow we have sorted out the economy and
then we are going to deal with climate change; that would be fatal.
That is one of the reasons—and I do not want to take time
discussing it here because I think it is a bit lateral—why
I am so keen on special financial instruments designed to deal
with that problem, like the issuing of climate bonds or environment
bonds, where I see some hope of Government stimulating scaled
investment in the infrastructure that we require to reduce emissions
across our economy.
Q237 Joan Walley: On this issue of
your proposals on bonds, have the Committee had details of that
in terms of relative to current financial instruments going through?
Mr Cameron: No.
Q238 Joan Walley: We would be very
interested to have details.
Mr Cameron: I am happy to send
something to you.[1]
Mr Redshaw: I just want to perhaps
look at that problem from a different angle, and ask: how does
the oil industry satisfy itself that it should make an investment?
The oil industry takes a view—with no certainty—that
demand will be maintained and indeed may grow over the investment
time-horizon of their investment. They find a way to find the
money to drill several holes in the ground, and eventually one
of them will come up with oil and they will sell it; and that
costs them a hell of a lot of money upfront. We can take the view
at the moment that governments will legislate to have more and
more strict carbon emission targets; but because this is created
from regulation, industry probably requires more signals that
this is going to be the case, so longer-term signals, and take
the same view as the oil industry when making an investment: but
also, because it is born from regulation, there will be an awful
lot of special needs and special case lobbying.
Q239 Mr Caton: Can we move on to
look at the price of carbon under the EU ETS. The Carbon Trust
told us that, "The series of booms and busts in the cost
of carbon are a problem in achieving the scheme's goals because
it creates uncertainty for firms' investment decisions".
Your submissions seem more sanguine about the impact of this volatility.
Why is that?
Mr Redshaw: It gets back to the
point we were discussing on renewable energy. The market will
deliver. When you have a cap the market will deliver and the price
is what it costs to make that reduction at that point in time.
Volatility is inherent; it can be reduced by various policy changes.
For example, there is disincentive amongst industrials at the
moment to sell an excess, if they have an excess, because they
got it for free and they sit on it; it is not on the balance sheet
and they do not account for it as if they bought it themselves.
As a consequence, they do not value the asset and they do not
perceive it as much of a risk as, say, the utilities who are constantly
optimising and they get a big shortfall in their allocation. The
National Audit Office response supports that, because it says
the board level in industry is generally less interested in carbon
as an issue than the board level in utilities, where it is a major
cost. Volatility could be reduced by a number of means that are
not interventionist, just by designing the scheme better. However,
we should not be afraid of volatility. We should not be afraid
of low prices, because if the price is low that is great. That
is great news, is it not, because we are achieving the objective,
and assuming the objective is based in science and is going to
deliver all we are looking for, then a low price is fantastic
news. If the price is high we should not be afraid of that, so
long as every country has a similar cost to its emissions. Two
steel companies, one in the US and one in Europe, competing for
a contract, there is going to be a distortion because of the carbon
price in Europe: but if Europe and the US and other steel-producing
nations have a cap and they all face the same carbon price then
there is no impact in relative competitiveness terms. Lastly,
price spikes are what cause innovation. The oil shocks of the
1970s, and in fact the oil shock of last year, we saw very high
prices; we saw a massive behavioural change among US consumers
in terms of their desire to buy SUVs, so volatility changes behaviour.
Low prices are great; high prices will create the innovation or
the change in behaviour everyone is looking for and I do not think
we should be afraid of it at all.
Mr Karmali: While I respect the
work of the Carbon Trust, a lot of the analysis inherently has
had to be based on data from 2005-07—the first phase of
the EU ETS. There are at least eight measures I can think of that
will help to mitigate volatility in Phase II and in fact beyond.
Banking: we are finally into a phase now where we can bank allowances
from Phase II to Phase III that will help to smooth some of the
potential spikes. Borrowing: companies are still allowed to borrow
forward from their next year's allowances; or in fact if they
wish to work with a financial intermediary they can follow forward
through longer-term rebuild transactions. We of course now have
verified emissions data; something we did not have at the end
of year one in the first phase. There is greater experience in
the marketplace. I think all of the participants in the market
realise that, yes, there can be short-term spikes but what is
key is to keep an eye on the longer-term trends and the longer-term
fundamentals as well. In addition, we now have auctions which
are beginning to provide some additional liquidity into the marketplace.
Of course, the intention, based on the package that was agreed
in December last year, was that there should be more auctions,
more allowances coming to the market via auction; that will help
to smooth some of the spikes. We have a longer trading period
with moving from a three-year trading period to a five-year trading
period to an eight-year trading period—2013-20. Linking
back to some of the earlier discussions, that allows industry
to plan investments over a longer time-horizon. In many sectors
life of the equipment is well beyond that of the trading period,
so it is important that we begin to stretch out those periods
as well. In addition, there is the potential for links to other
cap-and-trade schemes; nothing actualised yet, but of course with
the emergence of potentially a US cap-and-trade scheme, with an
Australian scheme, we will begin to see linkages, one hopes, and
that will also have an impact by addressing some of the competitiveness
concerns that Louis raised, because everyone is exposed to a more
similar carbon price: but also by broadening the buying base,
the supply side and demand side get bigger and bigger and you
begin to smoothen out all of the abatement cost curves. The final
point is, of course, the linkage with the carbon credit market.
Those carbon credits, needed for the reasons we talked about earlier,
will also provide some supply which will begin to mitigate the
risks of higher price spikes.
Q240 Mr Caton: There does seem to
be a division amongst you. Mr Redshaw feels volatility is entirely
a good thing, and you seem to be accepting the need to smooth
it out at least to some extent?
Mr Karmali: No, let me clarify.
I am simply saying that my expectation is that volatility in Phase
II, and in fact in Phase III, will be less than we saw in Phase
I for the reasons I have mentioned. I am indifferent on whether
volatility is a good thing or a bad thing, because I think it
is not the right thing to do, to focus on the very short-term
price movements; that is not how companies make their capital
allocation decisions. They make investment decisions based on
what their expectations are for the medium-term for CO2 pricing;
and, in fact, if we can get a futures and derivatives market that
goes beyond 2012, they will make decisions based on what the pricing
is all the way up to 2020.
Mr Redshaw: I was not suggesting
that volatility was a good thing; but that we should not be afraid
of it because it does provide signals and incentives. Just to
underline what Abyd is saying, there are various policy changes
we can make and I do not think my example was a particularly good
one earlier. There are policy changes that we can make that will
reduce unnecessary volatility. By linking globally as much as
possible you have a bigger pool from which to draw allowances.
If it was a cold winter in Europe you would pull from a pool of
allowances globally and you would not necessarily cause a price
spike. Having an economy-wide emissions trading system would,
again, deepen that pool of liquidity and reduce volatility. Correcting
the accounting for carbon, which was the point I was making and
has been backed by Abyd in terms of increasing auctioning, would
help. Obviously having experience of emissions trading, the banking
is important; and having a clear long-term regulatory path we
know we are going to follow, will all help reduce unnecessary
volatility: but we should not be afraid of the price moving.
Carbon is a market like every other; every other market is able
to find the investment that is required and, therefore, carbon
should not be any different.
Mr Cameron: Just a small addition
because I think you have had a really good analysis: perhaps marking
up the marginal difference between someone who is more on the
investment side than on the training side is that volatility can
be difficult in early stages of markets where you are not sure
where you might be in several years' time in making investments
over a decade or 15 years or so, especially for infrastructure.
It is very difficult to finance when you really are not sure at
all what the band of pricing would be. However, I do believe we
are getting to the stage where it will be a lot easier to make
those kinds of judgments; and that the real challenge is to set
the market at the right level of demand. I would agree with my
colleagues, rather than focus on volatility itself as if it were
a bad thing, one should really concentrate on how you get the
system to deliver much larger reductions over a longer period
of time; and then such volatility as there is would at least be
consistent with a significant effort to reduce over a long enough
period of time. Large amounts of capital can be deployed to the
solutions rather than getting over-excited about the trading patterns
in the very early stage of this market.
Q241 Chairman: We are running out
of time, unfortunately. Let us conclude with one question, if
we can deal with it reasonably concisely. Some of the advocates
of carbon tax as a preferable route to cutting emissions, preferable
to emissions trading, such as William Nordhaus, they have said
that the Emissions Trading Schemes—and I guess this would
apply particularly as they become more international—are
vulnerable to manipulation, dodgy accounting and so on; and that
the CDM, although it has, as James said at the beginning, provided
a channel for a lot of investment which otherwise might not have
taken place, is nevertheless potentially a loophole. Do you think
that the transparency and robustness of the existing and potential
trading systems is sufficient to head-off these kinds of concerns;
or could it be that that might be an obstacle to more widespread
adoption of emissions trading?
Mr Cameron: A good question but
with more than one element in it, obviously. I have made my views
known about a carbon tax for the world and how unlikely it is;
and I am often suspicious of those who advocate it. It seems to
me it is going to take so long for such a system to be established
we will have emitted an awful lot of greenhouse gases in the meantime
and we have always got one that limits greenhouses gases today—it
is called cap-and-trade. Reverting now to the other part: clearly
it is in everybody's interests, and maybe particularly those who
invest in it; and do not forget this is risk that we are taking
in the private sector in this market; it is not public money that
is being risked here; it is private capital that is delivering
the public good in the CDM. It is in everybody's interest for
that system to be trustworthy, robust and efficient and, boy,
is there some work to do on that front.
We do not yet have an institution that is capable
of delivering the emissions reductions that we should have through
the CDM, or whatever it becomes in the future, whatever name it
has. We have not built the thing to scale. One of the difficulties
is that it is constantly criticised for things that are, to my
mind, minor infractions in the delivery of the public good. Many
of those people who criticise it do not really understand how
it works and do not understand that much of the material is public.
There have been some very silly scare stores about HFC-23 as if
somebody overnight invented a new atmospheric chemistry and somehow
HFC-23 was not a greenhouse gas all of a sudden. We have had some
very silly scare stories about a young market that is, in some
respects, running an experiment in public policy to see how well
we can do with it. I would join anybody who was steadfastly focused
on improving the capacity of the international system to manage
the flow of capital that we need into investments, especially
in the developing world, where we have no option but to move the
capital that we have in the world to those places to solve the
problem. We do not have adequate separation of powers between
negotiators and decision-makers on the executive board of the
CDM, and we should. We do not have a streamlined process for those
projects that we know full well contribute to the public good
because they support a switch to lower-carbon technologies. We
have got very confused about whether energy efficiency is a good
thing or a bad thing given that it is a cost-effective to do (although
people do not do it) so we have been hoodwinked by the idea that
financial additionality is an important criterion in deciding
what is in the interests of the environment, so we have got a
lot of work to do to make the system function effectively but,
have no doubt, we have got to put that work in and make that system
effective. There is no alternative that is ready. Carbon tax is
definitely not an alternative globally. It can work domestically,
it can work locally, but a global solution it is not. We have
not much time in which to build an international institution that
is competent enough to channel the scale of capital that we need
into the solutions in the next decade.
Mr Karmali: I think Professor
Nordhaus has concerns to do with volatility which we have addressed.
He talks about the potential for manipulation. On manipulation
I think it is worth pointing out that the notional value of the
European market is of the order of two billion allowances times
€20, so €40 billion. The potential US market would be
bigger because of the wider coverage so roughly six billion tonnes
and let us say $20 a tonne, so $120 billion per year. It is difficult
to find players, these days in particular, who would be able to
move the market. I think the reality is that the size of the global
carbon market or even the size of the regional carbon market is
simply too big for manipulation to be a serious threat at all.
On the question of CDM, I just want to reiterate James's points.
I talked about the need for four gigatonnes per year of carbon
credits if we are to reach this scientific target which tells
us that we need 17 gigatonnes of reductions in 2020. That is four
gigatonnes in 2020 as compared with what we are seeing now through
the pipeline of carbon credit projects which if all goes really,
really well will deliver, let us say, two gigatonnes over five
years. We are talking about a scale-up of ten to one that is required,
so, yes, we absolutely need to make sure that the governance of
the CDM is vastly improved and the institutional structures that
go along with it are vastly improved, otherwise we really have
a significant challenge.
Mr Redshaw: In terms of dodgy
accounting, tax is exactly as susceptible to dodgy accounting
as emissions trading may be, essentially. If you are working out
what your emissions inventory is you are as incentivised to dodgy
account for that in a taxation system as you are in an emissions
trading system, so I do not see any difference, and no benefit
of tax over the alternative. Obviously we can talk about the pros
and cons of tax versus emissions trading but the thrust of your
question is on this dodgy accounting and manipulation. To back
up what Abyd is saying, it is too big a market to manipulate.
Beyond that carbon is very much a market of its age. A lot of
trades go through brokers but every single one of those trades
is reported electronically and that information is available to
all participants in the market. The vast majority of the trades
that go through brokers ultimately get given up to an exchange
which take away all the credit implications of trading with lots
of different people. By going on exchange the carbon market automatically
falls on to a recognised investment exchange. The carbon market
automatically falls underneath the UK FSA's regulatory environment
and the risk of unlimited fines and going to jail far outweigh
any benefit that I can perceive of market manipulation, not to
mention the majority of players obviously have very strict internal
controls against that sort of thing.
Chairman: I will resist the temptation
to go down the route of how adequate the FSA has proved itself
to be in relation to other markets! This has been very, very useful
for us. Thank you very much all three of you for coming in. I
hope you will keep in touch as we do our report because I think
a lot of what you have said will be reflected in what we conclude
in due course.
1 Note: Green Alliance: From crisis to recovery
new economic policies for a low carbon future. ISBN: 978-1-905869-23-7. Back
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