Budget 2011 and Environmental Taxes

Written evidence submitted by EDF Energy

Summary

· EDF Energy welcomes the Government’s announcement of a carbon price floor. Greater certainty in the future long-term price of carbon will form an important and significant part of the electricity market framework required to increase investment in cost effective low carbon generation.

· The carbon price floor will also act to reduce the emissions from the existing plant mix by ensuring that a stronger price signal is factored into day to day operational decisions. It will have a positive impact on investment in existing low carbon plant and will support investment in energy efficiency upgrades, increased biomass co-firing and will also be a factor in the investment decisions for life extensions of the UK’s existing nuclear fleet.  

· The removal of specific exemptions in the Climate Change Levy will ensure that the most carbon intensive fuels are penalised the most and this is consistent with the ‘polluter pays’ principle behind such environmental taxes.

· The introduction of the carbon price floor helps restore the long-term price signal that the EU ETS was expected to achieve. This will provide much needed price stability for investors in low carbon generation.

· The proposed trajectory that sees the carbon price floor being introduced from April 2013 and reach £30/tCO2 in 2020 (and then £70/tCO2 in 2030) strikes the right balance between mitigating any impacts on customers in the short term and providing the right incentives for future investment.

Response

1. EDF Energy welcomes the Government’s announcement at Budget 2011 to introduce a floor price for carbon, as part of its reforms to drive low carbon investment. The introduction of a carbon price floor has been discussed widely between industry and Government for some time, and is consistent with the commitment made in the Coalition Agreement.

2. Establishing a carbon price floor now, with a clear trajectory, is a fundamental component of a package of wider electricity market reforms that are needed to deliver the UK’s energy policy objectives and for us to move forward with our multi-billion pound low carbon generation investment plans. It is a measure which has been advocated by the Committee on Climate Change (CCC), and it will serve to drive both decarbonisation and long-term economic growth in the UK.

3. We welcome the proposed path announced, such that the carbon price floor is introduced from April 2013 and reaches £30/tCO2    in 2020. We believe that this strikes the right balance between mitigating any impacts on customers in the short term and providing the right incentives for future investment. A gradual and relatively linear trajectory would provide sufficient time for carbon-intensive users and generators to adapt to the new low carbon environment. This is preferable to a sudden and sharp rise if introduced later, for example in 2018, which would additionally expose investors to greater, and perhaps unacceptable, political risk.

4. Investors require a robust, long-term carbon price signal, and this needs to be part of a coherent set of complementary measures that provide sufficient incentives to investors to deliver energy security and investment in low carbon generation. Without this carbon price certainty, there is a risk that investors will continue to concentrate investment in unabated fossil plant. This would increase the risk that the UK’s long term emission reduction targets would not be met, as we lock in the higher carbon emissions from these new assets and so significantly delay the decarbonisation of the UK economy.

5. We support the methodology that has been chosen in setting the carbon price support rate. As the tax will be set according to the carbon content of the fossil fuel, this method will ensure that the tax penalises the most carbon intensive fuels. This is consistent with the Pigouvian economic principle behind environmental taxes, i.e. where the objective is to restrict market activities that generate negative externalities. The mechanism, as established, will also help fulfil HM Treasury’s statement of intent to ‘explore the scope for using the tax system to deliver environmental objectives’ and in line with the above, help to ‘shift the burden of tax from "goods" to "bads"’ [1] .

6. As a mechanism for providing a long term price signal, we recognise that any tax may be subject to political risk, but we believe that this may be mitigated by strong cross-party political support and evidence of support ‘from the top’. Both factors would further help demonstrate to investors the genuine political commitment towards creating a low carbon economy, and will assist in providing long-term assurance that the current intended price trajectory will be implemented over the coming decades. We would in particular welcome greater cross-party political support for a firm commitment to the proposed carbon price floor of £70/tCO2 in 2030. This is the minimum carbon price that many, including the Government, believe is consistent with the ultimate environmental objective of limiting the global temperature rise to two degrees Celsius. We also believe that investors would value the additional certainty gained by having the trajectory scrutinised and monitored by a credible independent body such as the CCC. Such an approach could help ensure that the trajectory chosen is commensurate with the carbon emission reductions being sought through the UK’s carbon budgets.

7. We believe that introducing the carbon price floor by removing some of the exemptions in the existing Climate Change Levy is an efficient means of delivering a minimum price of carbon that will require little new legislation, and will not interfere with the broader operation of the EU ETS. The UK Environmental Accounts compiled by the Office for National Statistics already classify the Climate Change Levy as an environmental tax, as it is ‘collected on a physical unit with a proven negative impact on the environment, such as the combustion of fossil fuels’ [2] .

8. EDF Energy endorses the use of environmental taxes in decarbonising the economy where it is appropriate to do so. We note that the commitment in the Coalition Agreement is to ‘increase the proportion of tax revenue accounted for by environmental taxes’ [3] . However, care should be taken to ensure that environmental taxes are applied as part of a coherent policy framework to meet specifically targeted objectives, as is the case with the carbon price floor, rather than simply to meet arbitrary revenue targets.

9. EDF Energy supports the EU ETS as the primary means to meet the EU’s emission reduction objectives, but recognises that the prevailing energy policy landscape differs between member states and that the EU ETS cannot be expected to efficiently meet specific energy policy and climate change mitigation objectives in individual member states. Although many had hoped that the EU ETS would have put a reliable long-term price on carbon dioxide emissions, it is clear that it has not done so for a number of reasons. These include the lack of international consensus on sufficiently ambitious carbon reduction targets, the relative immaturity and operational imperfections of the EU ETS market, and the inherent short-term nature of this market.

10. Carbon pricing is not new policy and electricity generators have been aware of carbon prices for almost a decade, since the inception of the UK Emissions Trading Scheme in 2002, and then the EU ETS in 2005. It is therefore reasonable to assume that carbon prices will have influenced investment decisions since that time. Indeed, as pointed out by Grubb and Neuhoff, one of the justifications for allocating free allowances in the first place was as ‘part of a transitional process towards a strategic objective of fully internalizing CO2 costs’ [4] and so mechanisms have been place for some time to help companies make the transition to carbon pricing.

11. Carbon prices in Phase I of the EU ETS consistently moved in the range €20-30/tCO2 soon after its launch, before crashing in Spring 2006 when verified emissions data showed that there had been an over-allocation of allowances by Member States. The emissions caps in Phase II were adjusted to correct for this, and it was as recently as 2008 that market participants were exposed to a carbon price of around €27/tCO2, before they fell significantly as the result of the global recession. This reflects a weakness of the EU ETS in that it has not been able to correct for supply side shocks. We do not believe that the carbon price support levels that have been announced should be seen as being unprecedented, or unexpected, by market participants as the carbon prices under consideration have already been demonstrated in a number of different periods.

12. We believe it is correct that the carbon price floor should start by reflecting the price that the EU ETS was previously expected to achieve. For example, in July 2009, DECC published five independent long-term model based forecasts of the EUA price in 2020, including from the European Commission, and these forecasts ranged from €27.3-€36.8/tCO2 (in 2009 prices) [5] , and this is consistent with the Government’s announcement of a target price of carbon of £30/tCO2 in 2020.

13. EDF Energy supports initiatives that would help remedy some of the defects of the EU ETS at the European-wide level, and would encourage the Government to continue to pursue these. However, it has to be recognised that the UK needs to move faster to renew its infrastructure than other countries in Europe, and there is a serious risk that a delay could expose UK consumers to volatile and probably higher energy prices.

14. Our recent investment decisions have been based on the assumption that the carbon price will be material. However, recent market prices have not reflected the true underlying value of carbon abatement. We do not believe that investors are making decisions on the assumption that long term carbon prices will be low. Instead we believe that investment decisions over the last decade have been influenced by the expectation that Governments will maintain their commitment to the need to act to mitigate climate change and that this will lead to a policy framework that establishes a credible carbon price. EDF Energy believes that there is widespread acceptance by both Governments and participants in the EU ETS that such a credible price is some way above the current EU ETS price. The carbon price floor mechanism is a positive step forward in formalising this implicit assumption and will provide greater certainty for investors.

15. The specific impact of the carbon price floor on individual generators depends on the carbon intensity of their plant mix. It penalises those companies whose generation mix has a higher-than-average carbon intensity, and who as a result have higher carbon emissions. As we have highlighted above, this is exactly what such environmental taxes are designed to achieve. The range of technologies that will benefit from the introduction of the carbon price floor includes all low carbon technologies, such as nuclear, renewables and fossil plant with Carbon Capture Storage (CCS). It is generally accepted that all three technologies are likely to be required for the country to make the transition to low carbon economy. If the carbon price floor works as intended, then it will simply be maintaining the price signal that the EU ETS was meant to provide.

16. The carbon price floor will not only encourage investment in new low carbon generation, but will also support investment in a range of measures, including energy efficiency upgrades and increased biomass co-firing. It will also be factored into our investment plans for the life extension of our existing nuclear fleet. For example, EDF Energy’s objective is to extend the lives of our existing AGR nuclear fleet by an average of five years (as we announced last year for Heysham 1 and Hartlepool) and Sizewell B by 20 years. This will entail investment of around £300m per year. Further plant life extension could help avoid around 4GW of new fossil generation required in the UK before 2018, and has the added benefit of retaining a skilled operational workforce.

17. The carbon price floor will also act to reduce the emissions from the existing plant mix by ensuring that a stronger price signal is factored into day to day operational decisions, and this is consistent with the environmental aims of the proposal. Like many generators, EDF Energy operates a diverse portfolio of generation assets, including coal, renewable and nuclear generation. As the carbon floor is introduced, and our investment in a new, highly efficient CCGT gas plant in Nottinghamshire comes on line, we will expect to use our existing coal stations less, and our low carbon generating assets more.

20 April 2011