To be published as HC 1476 -ii




Energy and Climate Change Committee

The EU Emissions Trading System

Tuesday 11 October 2011

Mark Brownrigg, Damian Ryan, Professor Joanne Scott and Dr Andre Stochniol

Imtiaz Ahmad, Miles Austin and Trevor Sikorski

Evidence heard in Public Questions 67 - 131



This is a corrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.


The transcript is an approved formal record of these proceedings. It will be printed in due course.

Oral Evidence

Taken before the Energy and Climate Change Committee

on Tuesday 11 October 2011

Members present:

Mr Tim Yeo (Chair)

Dan Byles

Barry Gardiner

Dr Phillip Lee

Albert Owen

Christopher Pincher

John Robertson

Sir Robert Smith

Dr Alan Whitehead


Examination of Witnesses

Witnesses: Mark Brownrigg, Director General, UK Chamber of Shipping, Damian Ryan, Policy Manager, The Climate Group, Professor Joanne Scott, University College London, and Dr Andre Stochniol, Expert Consultant for CAFOD, gave evidence.

Q67 Chair: Good morning and welcome to the Committee. I am afraid we are running slightly behind time, so we will skip the formalities of introductions, if you don’t mind. We know who you are; you know who we are, I hope. I need to begin, in the spirit of the times, by drawing attention to my entry in the Register of Members’ Interests. I have financial interests in the energy field.

Can I start by asking, in the light of what we have learned in Phases I and II of the EU Emissions Trading System, do you share my view that it is very disappointing that we are not going to auction all the aviation allowances from day one?

Damian Ryan: From an environmental perspective, yes, I think that is true. I think it is because if we have all the airlines in, there is no reason not to auction from a strictly economic and a rational point of view, and environmental point of view, but that is the ideal situation. In the real world in which we exist, for political reasons it is necessary to start, I guess, relatively slowly with the auction allocation versus auctioning set-up, so that we basically build that political support from within the industry for wider action. But I think the long-term goal has to be 100% auctioning. That would be my position.

Professor Scott: Could I add something to that? I do not disagree, but I do think then it would be important to take into account the principle of common but differentiated responsibilities and respective capabilities-CBDR-in the sense that if Indian airlines were to have to pay a significant amount of money to the EU, that would seem to be contrary to the idea of "no net incidence", which is a key idea in international climate change discussions. Therefore, one possibility would be to hypothecate the revenues, so that the revenues that flow from the poor countries to the rich countries find their way back somehow to invest in adaptation and mitigation projects there.

Q68 Chair: Even though the obligation would only arise because Indian airlines were flying to the EU?

Professor Scott: I still think the idea that developed countries take the lead is important, and the prospect of reasonably significant amounts of money flowing from India-which is one controversial example, but also even poorer countries than India-to the EU would not be helpful to the EU in maintaining its international position and prestige in global climate change negotiations.

Damian Ryan: I would agree with that hypothecation point, but I also think it is important to differentiate between the different needs of Governments and states and the need for the airline industry to maintain a level playing field. It is important to ensure you have equal treatment of airlines, recognising that you need to treat countries differently in order to get the political support for the EU to take the action that it wants to.

Q69 Chair: Given that we are not starting with much auctioning, however, is it not the case that the airlines are going to get nice windfalls from this system at the start?

Damian Ryan: I guess that is a risk with the system. We saw it in the earlier phases of the EU ETS. I am not an expert and I haven’t looked into this particular issue in any detail myself, but I do know that the airline industry has said that, because of the highly competitive nature of the industry, it will be very hard for them to pass on costs; they will have to absorb them. Perhaps the risk there is lower for the aviation industry, but I couldn’t speak with any expertise on that.

Q70 Chair: What proportion of any reduction in emissions that result from this will actually occur within aviation and what proportion will be offset? Any feeling about that?

Damian Ryan: My gut instinct is that most of it will be offset. The absolute emission reductions that can occur right now are fairly limited in terms of technology. We are stuck with the existing fleet that we have, which I think takes 15 to 20 years to turn over. We are seeing the new generation of aircraft coming in now-the 787 Dreamliner, 20% emission reductions-but that is going to take time to filter through into the whole industry, which means that, yes, they will have to buy offsets in terms of dealing with the emissions above their growth rate.

Professor Scott: Could I add a couple of points to that?

Chair: Yes.

Professor Scott: One is my understanding is that the aviation sector cannot sell its surplus emissions to other covered sectors in the ETS. The second is that I think there is general agreement that the aviation sector will actually absorb some of the surplus from the Phase III cap-not enough, but some of it. They will become buyers rather than sellers.

The other point is that there are quite strict rules on the availability of CDM-Clean Development Mechanism-offsets in the third phase. I did some reasonably quick back-of-the-envelope calculations that suggest that only a relatively small number of the bought permits-the allowances that the aviation sector will have to buy-will be able to be acquired through offsetting in developing countries.

Q71 Chair: Looking at the effect of all this on aviation, do you think the airlines will try to alter their routes to dodge this?

Damian Ryan: I am sorry, could you just repeat-

Chair: Will the airlines alter their routes in order to try and minimise the impact of this system?

Damian Ryan: I think that is a concern for some of them, which is why they would prefer a global agreement to ensure that there isn’t the ability to dodge routes. I can’t speak with any authority, but my understanding is that a lot of routes are based on bilateral air service agreements, so it is actually very difficult for some airlines to switch from one route to another. That actually increases the distortion because if you have that set in stone, it means that some airlines will benefit from however their routes are set up and others won’t be able to move in and make those changes. That is my understanding.

Dr Stochniol: I don’t believe that they will change their routes. It is a red herring. The cost for the airlines will be so small that they can easily pass it on. It is driven by the demand: I do not expect that passengers from London would suddenly be trying to take a plane from Belarus or Moscow-it is impossible. The cost is really minute: even if you put the full price, full auction, at $25 per tonne, the cost on fuel would be around 6 cent per litre of fuel, so basically very small. Obviously this fuel is not taxed right now, so complaining about the cost is a red herring.

The EU ETS currently is doing two things wrong. The first one is that it does not charge for the environmental damage by the sector, which is under-taxed. The second is that it keeps the revenue and therefore does not address the issues of some of the developing countries that could, indeed, be affected and should be compensated.

Q72 Sir Robert Smith: Just to clarify on this changing of routes, with the growth of the Middle East hubs, for long-haul flights to the Far East presumably someone could reduce their exposure to the emission trading costs by just taking one sector to the Middle East and then another sector onwards, rather than a direct flight from within the EU?

Damian Ryan: Yes, the concern from the airlines that we work with is that if you are flying to Australia, for example, from London you have a number of different routes that you could take. The EU ETS is only covering the first segment of that total route. You can minimise your costs if you fly, for example, through to the Middle Eastern hubs rather than flying that longer distance to Singapore. Those airlines that are able to go through that shorter first route therefore save and so become more competitive on that London to Sydney route. That is why the group that we are working with, the Aviation Global Deal Group, is arguing for the global deal in order to cover both legs of that route and minimise the distortion.

Q73 Chair: But there have been suggestions that effects on price are not that great anyway.

Damian Ryan: My understanding from the Commission’s impact report, which I think is 2003 or around then, was up to about €100 or £100 on a long haul flight, and then short haul flights, and I am sure you will know this better than I do-

Professor Scott: Between $11 and $56 on a long haul flight, but that is premised upon 100% auctioning in 2020.

Q74 Sir Robert Smith: If the impact is not that great financially, is the impact that great in terms of emission reductions?

Professor Scott: My calculation, using DECC figures on international aviation emissions, is that the scheme will cover emissions that amount to 60% of all international aviation emissions. The coverage is broad and the cap is high-97% and then 95%. If you put those two things together, the impact is not huge, but the potential, the capacity of the EU to extend its European Emissions Trading Scheme to cover 60% of international aviation emissions is extraordinary-higher than in maritime transport, which would be around a third, and much higher, incidentally, than in relation to energy-intensive products like steel or concrete. Of all the sectors, aviation is the one where the EU can achieve the most.

Sir Robert Smith: As the Chair did, I should remind the Committee and the witnesses of my entry in the Register of Members’ Interests related to the oil and gas industry.

Q75 Barry Gardiner: How serious are the legal challenges to the inclusion of aviation into the EU ETS?

Professor Scott: They are serious. There is room for serious discussion and argument about whether the scheme is lawful or not. My own view in the end-with the kind of appropriate lawyerly qualification that you can’t ever be sure-is that the aviation extension will resist legal challenge. The Advocate General of the Court of Justice came out with that view last week.

Q76 Barry Gardiner: Although, of course, her view is not binding on the judges.

Professor Scott: It is not binding, no, and there is no guarantee. Also of course what the Court of Justice says may not be the same as what the International Court of Justice says or the WTO Appellate Body says. There are many forums in which challenges can be mounted. My best guess is that the aviation decision would survive in all of those fora, but it is not absolutely inevitable.

Q77 Barry Gardiner: Do you think that the inclusion of aviation could lead to this tit for tat trade conflict that we have begun to see sparked off with China?

Professor Scott: I think the EU has been really taken by surprise by the strength of reaction that the aviation decision has provoked. I think some of the threats are very real: the Chinese threat not to buy Airbus A380 aeroplanes; anecdotally, India is threatening to block certain European contractors from infrastructure projects. I think the EU really has been taken by surprise, but I think the US has been very effective at working the diplomatic channels, working the back rooms and getting a global coalition against the EU. I won’t keep going on about it, but it brings me back to the CBDR point. I think the EU made a mistake in not taking this idea seriously, because I think it has allowed for the formation of a global coalition. A number of countries are beginning to make submissions to the FCCC.

Q78 Barry Gardiner: I would like to pursue that, but just before I do can I ask you: you have laid the charge very firmly at the US’s door as being the militater behind the scenes; what evidence would you like to put forward to-

Professor Scott: Anecdotal evidence.

Barry Gardiner: Anecdotal evidence, okay. Any juicy anecdotal evidence that we can be entrusted with?

Professor Scott: I am not going to name names, no. In a sense, it doesn’t matter. What really matters is that there is a global coalition emerging where you have these strange alliances, with the US and India and China and South Africa all on the same page. I think the EU could have played the thing differently, and then it would have been harder for that to have occurred.

Dr Stochniol: I think what Joanne quoted before, 60% coverage of emissions, gives you a slight answer to what the problem is. If only the departing flight was covered, that would be 30%. This is proportionate to the economic position of the EU across the world based on imports, GDP, et cetera. If we cover both flights, departing and arriving, then we have 60% and that is strange, right? This is what the developing countries and the USA are saying-that the EU overstepped the mark by covering both legs of the travel. The EU did try to use a stick to get the other countries to start similar measures on their side and this stick is somehow backfiring.

The other part is the question of compensation for some developing countries, although the de minimis criterion goes towards addressing some of the countries, especially in Africa. The coalition is quite strong. I talked to a couple of parties in Panama and they referred to the meeting in Delhi that was done at the same time when it was the ICAO Council in Montreal. I think 27 countries participated. There was a declaration and centrally enough the USA was part of that meeting, although I am not sure that they were part of the declaration. The declaration is strongly worded.

Professor Scott: Andre and I don’t disagree about this, but I am sure you will already know that, for flights arriving in the EU from abroad, the EU Emissions Trading Scheme will apply only until such time as the country in question itself takes measures to reduce the climate change impact of flights. There is a contingency. What the EU has done is said, "There is no international agreement on how to allocate responsibility for emissions from international aviation. We are going to take a unilateral decision to say it is departing countries that are responsible and only contingently will we take responsibility for emissions from flights that arrive". As Andre said, that is in an effort to galvanise other countries to take steps themselves.

Q79 Barry Gardiner: Do you believe that that galvanisation is taking place? It seems that what we have had is a broad coalition now to block what the EU is doing instead of a broad coalition to say, "Actually, yes, we really should try and get a global view here". Is there any evidence that there will be a broad coalition to get a global view?

Professor Scott: No. It is not absolutely clear. What I would say is that in the area of EU environmental law, this is not the first time we have been here. The EU is constantly doing things that provoke very strong reactions. When the EU adopted its chemicals regulation the world was going to fall in. It did not happen. It turned out that other countries adopted legislation that looks very much like the EU’s regime. At the moment, there is no evidence to suggest that other countries are taking steps, although-and Damian Ryan will know the answer to this; I do not know the answer-perhaps there is some evidence that ICAO is having more serious discussions about the formation of the global market-based mechanism as a result of what the EU is doing.

Damian Ryan: I think the work that we have seen in ICAO over the last, say, five years even, and particularly in the last two or three, has accelerated as a result of the EU coming and being a leader and saying, "Look, we need to see action now." We had an Assembly meeting this time last year, which came out I think with three main points of agreement. Initially, all of this was based on voluntary action and a lot of countries made reservations to these actions, but an agreement to aim for or aspire to 2% efficiency improvements and carbon neutral growth from 2020, I think, and to work towards market-based measures. So I think there is an acceptance within ICAO that the tools that the EU has come up with are the right tools. There is just this continuing political disagreement about when these tools should be implemented and who should be taking the lead.

Q80 Barry Gardiner: Has the Chinese proposal of 22% reduction by 2020 been spurred by the EU proposal in any way, do you think?

Damian Ryan: I would have thought so, yes. I would have thought that would have had an influence on it. Whether that is the main driver I am not sure.

Q81 Chair: Isn’t the truth of the matter that if the EU had not taken an initiative in this area, the aviation industry would quite happily have gone along for decades without doing anything about it at all?

Damian Ryan: I think there is a fair amount of truth in that. The thing with aviation you have to remember, though, is that they can put their hand up and say, "We have done a lot already," which is true, because the price of jet fuel has always provided them with an incentive to be as economically efficient as possible. If you look at the technology within aviation, it is cutting edge. They are extremely efficient. The problem is absolute growth in airlines and the fact that it is very difficult to move away from fossil-based fuels for aviation. You can’t plug a Boeing 747 into a socket and charge it up on electricity. These are the physical constraints on which aviation has worked. It has done a lot. It is now moving in the right direction, but I definitely think that the policy push from the EU has helped move the aviation industry forward. We have seen that in the new targets that it has come out with in the last couple of years. They still need to move further, but the policy push from the EU has been very important.

Q82 Albert Owen: If I could just move on to shipping, in general, do you think that there is any particular difficulties in including shipping in the ETS?

Mark Brownrigg: Yes, in a word. Shipping is global by nature-you will know that-and it is more multilateral than any other trade that we are looking at, including aviation. In concept, our position is that what is required here is global regulation through the International Maritime Organization. Even the EU accepts that that is the preferred route to take. The starting point in principle is we don’t think that shipping should come within the EU ETS, but moving on to practicality, we don’t quite see how it can come within the EU ETS, although we do have supporters in our membership for a global trading arrangement. There are just many ways in which that multilateralism makes it very difficult.

Q83 Albert Owen: Could you just expand on that? As an ex-seafarer, I understand about the old tramp shipping where you go from different continents. When you say it is global, is that what you are suggesting-that you have fixed routes for airlines but you could have shipping coming from the Far East that would pack cargo in North Africa and go into Europe, and that kind of thing, and the ETS would not be able to monitor that?

Mark Brownrigg: Absolutely, and there is a wider picture of competition between companies that are involved in part-EU, total international, not in the EU at all but international, or solely within the EU. I think there are complexities there, but the next point really is how you then allocate shipping emissions to either an individual country or an individual region. That gets extremely complex at that stage and-

Q84 Albert Owen: Can I just cut across? You said that your members were split on it and there were some that were in favour of an ETS. Could I ask you whether those members that are within the European Union are more in favour than those that are not?

Mark Brownrigg: No, I do not think-

Albert Owen: I think it is a fair question.

Mark Brownrigg: It is a totally fair question. I don’t think there is a split falling in that way. When we began our work on this three years ago, we were very much promoting an emissions trading concept, but a number of very large companies within our membership have, as the debate has continued-at least within industry, because it is not yet pressing ahead at governmental level-felt more drawn to a different version of market-based measures, which is a form of contribution fund.

What we have done in the last year is produce two practical demonstrations-manuals by another term-which show how each of those two major options for market-based measures could operate, in order to promote understanding. The difficulty is that there is little discussion. There is a certain amount of background discussion, but no central discussion on how to take this forward at the moment as a result of political pressures.

Albert Owen: I see. Anybody else?

Dr Stochniol: Let me clarify the complexity. Basically, the biggest difference is that ships can come and fuel anywhere in the world and it is economic for them to do it wherever it is cheaper. For airlines, you always take the fuel before the flight departs, or nearly always. Therefore the legal responsibility, where you can charge for emissions or for a tax on fuel, is joined to the place where you can enforce the responsibility. If a ship arrives in Rotterdam or in Folkestone, it doesn’t have to bunker. Indeed, in the UK there is very little bunker fuel sold. Therefore, it is very complex to put the legal responsibility either on fuel or on emissions because you don’t know where the fuel is being bought. If you put the responsibility-as the experience with California tax showed about 15 years ago-you lose the bunker industry. The ships buy the fuel somewhere else. That is one point.

Regarding the ETS and emissions and bunker levy, there is a difference that people very often don’t understand. The proposals for the ETS that are in the IMO, by the UK, France, Germany, Norway, none of them allocate emissions to individual installations-ships-because it is so complex. Therefore, this is equivalent to a levy but paid in emissions certificates-paid in a different currency. Currently the shipping industry, as I understand, most of them say, "After looking under the bonnet of these schemes, we prefer a levy because, at the end of the day, we have to pay either in dollars or in emissions certificates that we have to buy in the first place."

Regarding the parties, only the parties in the IMO that proposed ETS are currently supporting these schemes. That means the UK, Norway, France and Germany. There are alternative schemes proposed by Denmark and there are other schemes proposed by observer organisations for a levy, and these levies are supported by countries that have not proposed these schemes. That includes South Korea, Greece, Russia and other countries. They are thinking that a levy would be simpler for practical reasons, and emissions trading schemes for shipping would be equivalent to a levy but may be politically more acceptable in some countries.

Q85 Albert Owen: I appreciate that. Before I move on to the regional versus the global, can I ask you in general again whether you believe that an ETS on shipping would displace the cargo on to other modes of transport that are less carbon and energy efficient-for instance, short sea trade, lorries going across the Continent? Is that what you see if that was imposed?

Mark Brownrigg: It is possible, but I think actually the role of sulphur emissions is going to play a greater part than GHGs, basically.

Q86 Albert Owen: Moving straight on, then, to the regional versus the global. Is it a fact that a global agreement isn’t coming soon, and this is just kicking things into the long grass and that the IMO as a body is not really grappling with this? How would you respond to that?

Mark Brownrigg: I think that is a fair statement. Progress in IMO has been slow, but you do have to look behind that to see why it has been slow. There you see immediately the political stalemate that exists in the UNFCCC over-spilling into the IMO. The countries that are blocking progress-if that is not too strong a word-or blocking the possibility of deeper debate in some of these areas are those newly emerging economies who wish to reassert the CBDR principle we heard about earlier on, in a forum where the ‘no more favourable treatment’ principle has always applied. The equal treatment principle is applied within IMO so there is a conflict of principles there. The fact is that you cannot, I suggest, sensibly try to impose safety regulations in a differential way. IMO has applied that same principle to the environmental measures it has taken to date and it is applying that-correctly, in the judgment of the UK and indeed the international industry-in the climate change debate, too.

I think the difficulty is that that even came very close to blocking the good achievement that was made in July this year, when the design index and the operational indices were adopted and put in place, which is the first step of that nature that has been adopted in an international sector. I think that uniqueness has been recognised, certainly in correspondence between the UNFCCC Secretariat and the international shipping industry.

Professor Scott: Just a couple of quick points. I think the analogy between safety regulation and greenhouse gas emissions regulation is problematic here, because the principle of CBDR applies only to the latter and not to the former. Perhaps more importantly, it is often said, and not entirely without foundation, that you have to treat all countries in the same way otherwise you breach the principle of non-discrimination. I think legal reality is a little bit more complicated than that, because the principle of non-discrimination is a very fluid concept. It can mean different things in different settings. It would have to be interpreted in the light of the CBDR principle, the WTO Appellate Body has said you can treat differently situated countries differently without that amounting to discrimination, so it is only discriminatory if the countries are situated in the same way. Developing countries and developed countries are not situated in the same way, so as a lawyer I would find it possible to make a really quite plausible and I think quite strong argument that there is room for differential treatment, based on that principle, in relation to greenhouse gas emissions.

Q87 Albert Owen: Isn’t there an added complication of a flag of convenience as well? A nation that has very good safety and things could actually lead to registering offshore and undermining of particularly safety, but I am looking to broaden it.

Mark Brownrigg: Let me say on the flag of convenience issue, if I may, that it is worth recalling that actually all flags are covered by international regulations, whether you term them ‘convenience’ or not. This can be a long debate as to who is a so-called ‘flag of convenience’ and who among the non-flag-of-convenience states might have what you might think flag of convenience states might have in terms of worse conditions, which I don’t think applies. I think the IMO establishes-and indeed the ILO established-provisions for seafarers that are applied evenly across the piece to all registers and therefore all shipping.

I think the danger of confusing or entering into the discussion on CBDR from a development angle is that the practical reality out there is that, to the degree that a shipping company is placed at a competitive disadvantage to another or is placed in a position that goes to the way in which standards of ship operation are applied, is quite problematic from our perspective and, indeed, also from the perspective of IMO.

The fact is that the market-based measures that are not yet on the front table within the governmental discussions, but which have been looked at by some Governments and, indeed, looked at by the industry, all have ways of trying to assist and help the CBDR principle through the allocation of funds. I think there is a strong consensus across the industry, and certainly I would say across EU maritime governance, if we come back to that, that this needs to be dealt with on an equal treatment basis.

Q88 Albert Owen: I am conscious, Chair, of the time and I have one more question. What assessment have you made on the price of carbon that would be necessary to achieve the energy efficiency improvements in existing ships or the new technology for new ships?

Mark Brownrigg: Similar to what Damian was saying about aviation, we believe that the price of fuel has created a commercial imperative over time, which has meant that companies have focused on improving their fuel consumption, which is what most people link directly to emissions. We believe that, combined with the use of technology that is available now, really there is not much more that can be achieved. Now that doesn’t answer your question in terms of imperative or incentive. I think we need Governments, in whatever form, to determine what target they wish to achieve for shipping. The industry is waiting for that so it can then try to apply itself as to how to meet that. The difficulty with pitching a carbon price here or there is that the carbon price does fluctuate and, unless you have a way of matching that in some way, you don’t know how to price your incentive.

Q89 Chair: Mr Brownrigg, you describe the progress by the IMO as slow. Would it not be more accurately characterised as glacial? Isn’t it true the IMO is a trade body masquerading as a United Nations organisation, completely captured by producer interest, and that shipping is the most polluting industry in the world? If we leave it to the IMO to make any progress we will be waiting until the 23rd century.

Mark Brownrigg: I think that is a little unfair and I am sure it was intended to be polemical. If I may say so, shipping is not the most polluting industry at all. By comparison with road, air and others it is significantly-I can give you quite extensive or sharp figures on that-by far the least polluting in greenhouse gas terms. I agree that it is slightly different in other areas.

The progress, as I tried to explain a moment ago, is not being halted within IMO, per se, but by the wider political considerations that have also bedevilled the wider discussions in UNFCCC. It is a fact that the newly emerging economies are bringing those political considerations to IMO. The fact that they were overruled in order to achieve the design and operating efficiency measures that were adopted in July by majority, which is very rare within IMO, shows that actually IMO was prepared to push through on this one. As I say, that is the first international sectoral agreement of its nature.

Chair: I think to most outsiders the IMO makes the airlines look like a bunch of tree-hugging zealots.

Q90 Albert Owen: One final comment on efficiency. Isn’t it the case that one of the measures used by shipping companies is to slow down to use less fuel, so that goods take longer to get to market and then that is passed on to the consumer so that, by using that efficiency method and not putting new technology in, it is actually a greater cost to the consumer?

Mark Brownrigg: I am not sure it becomes a greater cost, but it certainly is true that slow speeding or slow sailing is a primary way to reduce consumption and thus emissions. In the same way, on the motorways, if you drive at 50 miles an hour instead of 80 then you will emit less, too. I personally don’t like to get into the comparison with aviation-

Chair: Not surprising.

Mark Brownrigg: If I may say so again, it is not necessarily a reflection of what is out there. I think that the shipping industry is trying-

Q91 Albert Owen: But you will be able to produce some facts and figures for the Committee of comparisons with other modes of transport?

Mark Brownrigg: In terms of the impact of emissions?

Albert Owen: Yes.

Mark Brownrigg: Yes, and relative to aviation, it is in tens or hundreds.

Q92 Chair: If ship owners had to pay the same fuel tax as most car drivers or lorry drivers do, do you think that might have some effect on what they do?

Mark Brownrigg: I think they are going to be asked to, aren’t they, in the context of this in some way, whether it be through a trading regime or through a levy arrangement. But I think with any exporters, you enter into different types of tax-

Chair: We are not talking about that.

Mark Brownrigg: Sorry. I don’t think it applies.

Q93 Sir Robert Smith: You mentioned you wanted Governments to set targets for the industry. Isn’t the whole point of the emissions trading that the market drives the most efficient routes rather than Governments picking something out of thin air?

Mark Brownrigg: Yes. But do not Government or one of the international organisations set the cap and then you are obliged to relate to that? That is what the international and the UK industry acknowledge could or should happen, so that the international industry can try to respond to what is identified as a global need.

Q94 Sir Robert Smith: On efficiency, if someone is taking goods from Hong Kong to here in a brand new ship or a 20-year-old ship, what is the different ballpark figure for the emissions? What is the efficiency improvement?

Mark Brownrigg: The difference between a new ship and an older ship? I can’t give you that off the top of my head. I can try and work that out and send it to you in future if you wish. It will depend very much on the operational aspects as well. What you have to remember, in making your comparisons with other modes, is that there is no other way of this cargo moving throughout the world. Aviation by and large transports people and a certain amount of high-value cargo, and ships carry 80%-plus of the world’s trade. This is not a simple or an easy issue, nor is the sector as narrowly constructed as the aviation sector. I think this is a complex sector that needs looking at in a global light.

Professor Scott: Let me say, very briefly, that the recently adopted IMO regulations do only relate to new ships; even then, they don’t require any reductions until 2015 at the earliest and there is a possibility for a further four-year delay. I absolutely respect that they are important as a first step as we talked about earlier, but their level of achievement in them is very low.

Dr Stochniol: In fact, our submission quantifying them showed reductions from the energy efficiencies, and it will be around 1% below business as usual in 2020, mostly because the first ships that are going to be more efficient will enter into service around 2017, 2018. So you only have around 2018, 2019. To respond to your questions regarding efficiencies of a new ship, the regulation stipulates that new ships ordered after 2015 would be 10% more efficient than the old ones-than the average. Therefore, it is kind of 10%.

While I am speaking just let me refer to the IMO and why there was that progress on efficiencies. There was also progress on voluntary measures. There was progress because there were ways to address concerns of developing countries-we refer to that in our submissions in point 2.3-therefore NGOs and CAFOD are optimistic regarding global action in IMO provided that concerns of developing countries are addressed, and that relates to financing. The UK has a role to play. Germany and France have already put submissions to IMO on compensating developing countries to create a global scheme. They understand that we can have a global scheme with a global carbon price, with financing generated for action on climate change, but providing that the poorest countries that will be affected most, because they rely more on international trade, can be compensated. These submissions are already in the IMO.

Furthermore, in the Panama negotiations, this idea has been taken on board by a couple of developing countries. The upcoming report by IMF and the World Bank to the G20 Finance Ministers requested by them goes into various details of how to implement that. In section 3 of our submission we describe this approach, which has already been submitted to IMO and which has been picked up by IMF, saying this is the way forward. The same can be applied to aviation, that there is a way to compensate developing countries and you can have a global scheme instead of just local. For maritime, it is extremely difficult to implement the local schemes or regional schemes.

Chair: I should emphasise that my interests include being a shareholder and a director of Eurotunnel, which is a train company in competition with both ships and aeroplanes-just so that everyone is absolutely clear on that.

John, do you have any more you want to cover on this issue?

Q95 John Robertson: I want to really look at the developing countries in general terms. You have answered a number of the questions, perhaps not fully, but if I ask one question, maybe we will develop it. How could shipping emissions be included in the EU ETS without undue harm to developing countries?

Professor Scott: There would be various options, and I am sure Andre will have something to say about this as well. One would be an exemption-based approach where you exempt some journeys: for example, you might exempt journeys from developing countries. In relation to aviation this is actually something people are talking about. Probably a better approach would be a rebate-based approach to ensure that, even though you have equal treatment of ships so you don’t have competitive distortions-and we have to decide how to define a developing country journey-the monies that are paid find their way back to the developing country in question, either through a rebate mechanism or through a more dedicated hypothecation mechanism that finances climate change action in the countries concerned. There are different options. There would be decisions to be made about which options are best, but there would be ways of achieving it that I think would still respect the idea that you need to prevent competitive distortions in the industry.

Q96 John Robertson: I could be wrong, but part of the problem, it seems to me, is the classification of what is a developed country or a developing country. How do they do that?

Professor Scott: It is a problem throughout all of the climate change negotiations, and there is no question there are anomalies as things stand. We use the concept of least developed countries, for example, which is a self-selection mechanism. Maybe we should use the World Bank mechanism of low income countries instead. There would be ways of improving it. Also, we hear all the time about, for example, China and India as these emerging economies. We talk about them in the same breath, and yet when you look at the profiles of those two countries, whether in terms of greenhouse gas emissions or income or status in the human development index, they are vastly different. It is a very serious question and you have to decide and, in order to differentiate lawfully, what you would also have to do is decide what objective criteria you are going to use to differentiate between countries. Emissions profile and GDP are the ones you hear put forward most often.

Q97 John Robertson: Look at a country like Nigeria, which has a great amount of oil and gas and so on and should be rich, but is probably one of the most polluting countries in the world. How would you classify a country like that?

Professor Scott: You would classify it on the basis of the criteria that you choose to apply to all countries, because you need to apply objective criteria consistently and transparently in order to-

Q98 John Robertson: Would it be fair to say we need to throw the book out the window and start afresh and try and really work out exactly who should be getting-if it is a rebate-a rebate, or what the criteria is for that?

Professor Scott: This is controversial because, of course, it makes the EU’s measure more kind of deeply unilateral if the EU says, "We are also going to decide how the rebate mechanism operates, what criteria the rebate mechanism is going to operate on the basis of," but my view is that, yes, the EU should be doing that.

Dr Stochniol: Let me clarify. By chance I am the author of the rebate mechanism. Basically it operates on the way to compensate based on share of imports-not exports but imports. The reason for that is that the least developed countries import more than they export, and that is why they are poor. Secondly, it doesn’t mean that you compensate China; it doesn’t mean that you compensate Saudi Arabia and others. However, to start the negotiations in UNFCCC you have black and white, developed and developing countries, Annex I and non-Annex I. There are two proposals. One is that the richer developing countries would forego their rebate or compensation and that financing would go to south-south collaboration, not to the hundred billions promised by developed countries. The second approach is that you scale down the rebate based on GDP per capita, and this is a very programmatic approach. The richer countries would not get that rebate. The latter approach has not been formally tabled in IMO or UNFCCC, but it is in the upcoming report of the IMF- World Bank. Therefore, it can be investigated.

The reason for compensating some of the developing countries is that they are very reliant on international trade. They may be five, eight times more reliant on international trade than other countries. On average, countries import goods worth 17% of GDP. Countries like Lesotho, Maldives import more than 100% of GDP-six times more than any other country. Whatever we do on international trade, they will be impacted more. Even if the impact is very little, around 0.2% on end user prices, still, because they are poor and they are reliant on international trade, they would be impacted more. That is why the SIDs countries, the small island developing countries, are so insistent that attention is being paid to the impact on them. Now, at least in the discussion in Panama, they say that they see the benefits of a global approach. provided that they are compensated, there is no impact on them, and provided that the financing rates from these emissions, which are outside of national borders, don’t go to national treasuries but go to humanity, go to the Green Climate Fund. That is the equitable approach that CAFOD is lobbying for; Oxfam is lobbying for this approach; WWF is lobbying for this approach; and many other NGOs around the world.

Mark Brownrigg: I think you ask a good question. The definition of developing countries for the purposes of the EU ETS is a problem in shipping, specifically. I think you then have to ask: how do you wish the benefit, or whatever benefit should arise from international shipping, to pass to developing countries? Because a whole load of developing countries have no fleets that will be coming into Europe at all to get any of the benefit from a straightforward application in the way that one might imagine would happen. A far better way would be through a market-based measure and both trading and the contribution fund lead to some form of a fund, which can then be distributed in a way that helps developing countries through the standard processes, either the standard processes of the UN mechanisms that are already there or other ways. I would have thought that if you are trying to meet the ultimate purpose of CBDR, or giving assistance in some way to the developing countries, it is better done that way.

Q99 John Robertson: I think this is one of these subjects, Mr Chairman, which could have a meeting on its own, so I will leave it at that. I have lots of other questions, I have to say, that I would like to ask, but the one I have to ask is: we have CBDR versus IMO, and they don’t really want to agree with each other. Is that fair?

Professor Scott: In what sense don’t they agree?

John Robertson: Incompatible.

Professor Scott: At a political level there is an incompatibility, but I believe there is no inherent incapability between the principle of equal treatment and CBDR.

Q100 Dr Whitehead: One of the issues of the whole question of emissions trading has been its design in the context of the assumption that others would follow. What evidence is there that others are following?

Professor Scott: Everything I would tell you on this I got from your last evidence session, so I will simply agree with what was said then. You got some good examples there of the number of countries that are beginning to institute emissions trading schemes-countries and regions such as California, India and China.

Q101 Dr Whitehead: Following on from that evidence that others are following, and perhaps refining the reasons for that a little, do you think that is happening because of the economic and political clout that the EU has, or that others are doing that unilaterally but just happening to appear to be designing schemes that are compatible with the EU ETS and, therefore, have the appearance of following?

Professor Scott: I don’t know the answer to that. What I do think is that organisations like Sandbag, who you heard from, have actually been very effective in appraising the operation of the EU scheme and trying to teach other countries or regions about where the pitfalls lie. I think there has been a good and very commendable process of transnational learning taking place.

Dr Stochniol: I think the lessons learnt by the EU ETS are being applied not necessarily in the same way as in ETS. For example, in Australia we are talking about carbon price. The Bill in the US Senate, Waxman-Markey, was very much on the upstream approach, and for transport fuel it was a levy, more or less, a link to the carbon price. It was actually wider coverage in the proposal than in the EU ETS, with some clever ideas on how to bring extra predictability, because there was also a floor and ceiling on the carbon price. Sure, the EU ETS has lessons. The variability of the carbon price is having an impact and also, in the discussions with the IMO, industry made a simple statement: industry would not respond to the cap, it would respond to price predictability. Having a carbon cap predictability may generate flexibility of price and industry prefers predictability of price because future investments in ships, whose lifetime is 30 years, depends on the price predictability, not the cap. Therefore, there are some lessons going not only to the countries but also to the sectors, like in the IMO, if there is a global approach.

Professor Scott: Can I just add one thing to that? Of course one of the things that is happening now is that the EU has said no new CERs from projects except projects in the least developed countries, unless they come from a country that has signed an agreement with the EU that regulates the level of use. That is code for a sectoral agreement. That is code for the EU will only accept offsets from developing countries other than least developed countries if they have in place a kind of sectoral cap. I think this shift to sectoral agreements is where there is the greatest potential for the EU to actually have an influence-as well as the aviation and shipping, but outside the aviation and shipping- in provoking not exactly an emissions trading scheme in developing countries but something that is on the way to an emissions trading scheme.

Q102 Dr Whitehead: I wonder if you want to say something briefly about, within the EU, the extent to which the new UK carbon price floor or carbon tax-depending how you see it-is likely to move to the EU setting up, for example, auction reserve prices? Or in your view is it regarded as something of a counteraction unilaterally by the UK?

Dr Stochniol: Price predictability is good for investment. As I mentioned, Waxman-Markey had a long-term wedge that was defined regarding the carbon price. I think the floor was rising 3% annually and the ceiling was rising 5% annually. That gave long-term predictability, and for investment in infrastructure, investment in shipping with these 30-year-old ships, in my view this price predictability did really make a difference on investing in a new ship; the engine might be more expensive but it is more efficient beyond the existing regulation.

In other countries, especially in Africa, where we are talking about developing and moving into low carbon pathways, the kind of incentive that would come from future development would also help to develop low carbon economies and low carbon infrastructures. I personally believe that predictability is a good thing with the carbon floor.

Professor Scott: For me, probably the most fundamental problem with the ETS is the lack of flexibility inherent in it. That operates in two ways. It operates at an EU level. For the EU to do anything to respond to the surplus of permits in the third trading phase, it is going to need to amend the directive probably; really, almost certainly. The EU, in order to introduce an auction reserve price, would have to get an amendment to the directive. That is a discussion we could have.

The other lack of flexibility problem is in relation to member states. I have always been a believer in the idea of minimum harmonisation-that some member states can go further and some member states can take the lead. The problem with emissions trading is that that stops being viable, because if one member state goes further it simply suppresses demand for permits within that state and they go somewhere else, so the member state does not achieve anything. That is true with the carbon floor price. That is true with performance standards.

The lack of flexibility is at the EU level, but also in the way that it constrains faster action on the part of individual member states. That is something that, if it does not get addressed, if there is not a way of injecting flexibility into the European Emission Trading Scheme, then we are reaching a point where one has to wonder whether, as an instrument, it is actually working.

Q103 Chair: I think we are going to have to call it a day here. We have another panel to question. Thank you all very much indeed for coming in. We have found this a very valuable session.

Examination of Witnesses

Witnesses: Imtiaz Ahmad, International Emissions Trading Association, Miles Austin, Director, Carbon Market Investors Association, and Trevor Sikorski, Director, Barclays Capital, gave evidence.

Q104 Chair: Thank you for coming in. Again, because time is pressing, I will skip any formal introductions. We know who you are. We are grateful to Mr Ahmad for coming in and substituting for another witness.

Could I start by inviting you to speculate a bit on what you think the price of EU allowances will be at the end of Phase II and what your expectations are for the end of Phase III-or 2020, shall we say-after that?

Miles Austin: I would actually like to not speculate on the price. The reason is that a lot of the discussion around the EU ETS has been focused on the price. The environmental benefit of an emissions trading scheme comes from the cap-the emissions cap-not the price it is operating at. The price is simply reflecting the difficulty of achieving that cap.

Q105 Chair: Let me take you through that straightaway. Obviously the cap is part of the benefit. Indeed, that is the reason why some of us think a cap on trade has advantages, which a carbon tax does not have, and it provides a degree of certainty about the cap. Nevertheless, the cap can be achieved in a variety of ways and if the cap is achieved merely by the purchase of offsets, we are not driving investment in low carbon technology, which some of us think is also an important benefit from an emissions trading system, so I think the price is very relevant to decisions made by British investors in the next 10 years.

Trevor Sikorski: As a carbon analyst, whose main job is to kind of gaze into the future on this, I would say before the end of 2012 we are looking at EUA prices probably around current levels, i.e. somewhere around €12 per tonne probably. Going up to 2020, you are probably looking at that going up to maybe as high as €20/€25 per tonne.

To focus in on Miles’ point on general investment and the importance of the cap, I completely agree with him. The cap is what we are here for: it is the environmental goal of the scheme. I think it is very difficult to disagree or dislike where certain emission reductions come from. Emission reductions have been made. I think a lot of those have been due to the economic recession and the tough times that we are living through, and I don’t know if the scheme does itself any favours by being highly priced in a world where most commodity prices certainly fell in 2008 and 2009 and have been very high during a period of intense, I would say, stress for European industry.

Imtiaz Ahmad: I totally agree with that. From my perspective as a practitioner, someone who has traded and invested, shortage is fundamental; basically a cap works if there is allocated shortage. Certainly that is a challenge for EU ETS. I am here wearing two hats; one on behalf IETA and one in my own personal capacity as a Morgan Stanley practitioner. Certainly, from an IETA perspective, we believe that emission trading is the right vehicle and, I believe that as well as a practitioner, from my own firm perspective. The IETA principles call for shortage and scarcity. For a cap and trade system to work, that is going to have to be there.

Miles Austin: If I can just jump in again. If you look at the position of the EU ETS out to 2020 and the emissions reductions that the cap requires of it, international offsets can cover no more than half of that effort, so the idea that we are flooded with international offsets is erroneous. The other thing is, if the price is at a level that is politically uncomfortable, then it needs to be examined why the price is at that level, which I think is what Imtiaz alluded to. It is partly because of the recession and that emissions have come down due to the recession, which means we are under the cap, which is the point, but given the very different economic circumstances when the 20% cap was set, and the idea that the 30% cap would kick in as and when there is an international agreement, there is a reasonable body of research that suggests that today the costs of instituting the 30% cap would be comparable to the costs of instituting the 20% cap when the original sums were done. Therefore, as an association we would very strongly advocate that we move unilaterally to a 30% emissions reduction pathway.

Q106 Chair: I’m sorry, did you say that Britain should move towards that unilaterally?

Miles Austin: No, the EU should.

Q107 Chair: The EU should. But you must also be aware there is not the remotest chance that you are going to get unanimity amongst 27 countries. That is just in the realms of fantasy, isn’t it?

Miles Austin: No. Chris Huhne seems to think it is doable.

Q108 Chair: What, so Poland is going to put up their hand and say, "Let’s go for a 30% reduction"?

Miles Austin: It is quite possible. They have had a reasonably significant shift in the composition of their Government recently towards more left/green leaning.

Q109 Dan Byles: It seems quite clear that the first two phases have got the cap wrong, and there is no mechanism at all for the EU to revise the cap in the light of changing events. Do you agree with that?

Trevor Sikorski: I don’t know. Would we like a tighter market? Probably, yes-almost certainly-but like I said the cap is a democratically achieved decision and it does represent a very wide democracy covering a number of countries with very different levels of development from the European average. For Phase I, there was just a lack of information and it was very good that that wasn’t bankable, but for Phase II the issue has been that we had a 20% goal; we were happy with the 20% goal. I think the fact that prices are low as long as that 20% goal is being met, we should be happy with and should be reasonably relaxed about.

The reason for moving to 30% I don’t think should be one of cost or anything like that. It should be: is there a scientific prerogative and imperative to move beyond 20% to 30%? If there is, then that is the decision that should be made and then the market can price in that sort of scarcity. At the moment, though, we are living through very difficult economic times; capital is not unlimited, and I would say the market is helping to foster a reasonably efficient distribution of capital, which is scarce.

At the moment it embodies the democratic desires of the wider European Union, and I think that is a good thing. It would be great if the desire was to put more importance on moving forward but on a scientific basis rather than on a pricing basis.

Miles Austin: To take the two phases separately, the Phase I cap was set at a time when we didn’t have independently verified data. It was data that was largely taken from growth projections from industry. Historically, growth projections always tend to be slightly overoptimistic and consequently we had an overoptimistic emissions pathway. The Phase II cap was based on independently verified data at an installation level, so given what the percentage reduction was supposed to be, and given that it was based on good data, the cap is exactly where the political process decided it should be.

Imtiaz Ahmad: The EU ETS is somewhat unique: it exists because of politics and regulation law essentially; in commodity markets there is a natural underlying demand-oil, electricity, and so on. In all markets, when you have a change, you see supply and demand adjust effectively. In the steel sector, for example, you get rationalisation on the supply side as well as the demand side. In the EU ETS, the supply side is fixed essentially across the period, so when demand is altered or fundamentally changed, as has happened, then yes that does lead to a supply overhang, which then leads to a long system. That then means that there is a need to look at the overall target.

My view very simply is to look-as Miles pointed out-at the overall cap demand, which would be the neater solution, but I take the point raised by the Chair that that might prove somewhat politically challenging. Then the EU need to consider what to do with the EU ETS if they want an instrument that works and to be a world leader, or if they want something that is essentially oversupplied and won’t deliver, but I do believe it is the right instrument as long as the correct target is there.

Trevor Sikorski: One of the interesting things that we haven’t mentioned, but Tim alluded to in his initial question, is the role of offsets. Imtiaz has said the cap is fixed and, therefore, that broadly gives you some certainty on supply, which is something you don’t have in a lot of commodity markets, but the supply of offsets hasn’t been fixed. The supply of offsets per se should respond to the price signal, and what we have seen this year is more offsets come than we have ever seen before. Already this year, 250 million tonnes of CERs has been issued by the UNFCCC into the market. That is against last year’s issuance of 132 million tonnes, so you are on this year to be probably double, but it was more than double what it was last year, so a massive increase in supply. That massive increase in supply of offsets is one of the reasons why prices are as low as they are today. I think prices would be low anyway because a number of other factors around, but they are certainly a number of euros lower because of the supply of CERs into the market. If we didn’t have any offsets, if all we were trying to achieve with EU ETS was European abatement, prices would be a lot higher with no offsets having been allowed into the EU ETS to date. The reason they were put in was cost containment and it is providing that cost containment. It is doing what it said it was going to do. So in that sense, the market is doing exactly what it said it was going to do. I think most of the forecasts of offsets say this isn’t going to slow down even with CER prices now below €8 a tonne-very low. We still see a lot of issuance coming in.

Q110 Dan Byles: Before I come on to you, Miles, do you think that we are going to see a problem where we are going to be hitting our targets in the short-term but because of the low price and high number of offsets, there just isn’t the incentive there to invest in the low emission technologies to ensure that we are going to continue to hit our very challenging targets much further down the line? Are we buying time now and, with that, effectively not doing the hard work now?

Trevor Sikorski: Price signals are kind of saying, "Don’t do investment now, do it a bit later." That is basically what it is saying, and people don’t invest really on today’s prices because you are not going get first cash flow, regardless of what your investment is, some ways down the line. In our evidence we showed how people have, particularly in the utility space, changed how they have invested Europe-wide in what they are building and certainly a massive shift towards renewables. I think in the first half of the last decade you were looking at, across Europe, maybe 5 gigawatts of renewables coming-it was all small scale stuff, small plants. All of a sudden, the utilities are seeing what looks like big liabilities coming along, and those liabilities are going to get much bigger in 2013. Even if the price remains modest, they are going from having been given about 70% for free to being given nothing for free. So all of a sudden there is a pretty big bill coming along. They have been investing and all of a sudden the renewables are 20 gigawatts a year, and we are forecasting that that is going to happen for the next four or five years. That is kind of doable. You also have complementary policies that help that along, but I think one of the big incentives is those future liabilities and those future liabilities are actually pretty close.

The other thing is, nobody will build a new coal plant now. Some of the new coal plants that are being commissioned at the moment, the financing decisions were being made back in 2003, 2004-it does take a while to build these things-and that was when the German Government were talking about prolonged free allowances for coal plants and this kind of thing. Now, with advanced development, I think, it is 90% gas, and that goes across Western Europe so that is not just the UK. The UK is very keen on building gas and only gas. That is in some of the places that traditionally would build coal, particularly like the German markets. So it has changed.

We are getting the benefits of almost the lower hanging fruit and what the market will do. Again, the reason you are doing ETS rather than tax is that it allows people to take advantage of the lowest cost abatement. The lowest cost abatement at the moment is you build a gas plant rather than you build a coal plant. Bang, you probably have a 60% emissions reduction. That is going to take us out to 2030 easily, 2040. It meets those goals.

When you look further, yes, we have some pretty challenging targets but those targets are looking increasingly challenging beyond, say, 2025, 2030 and that is when maybe some of the more expensive technologies will come in. You would expect prices in the second half of this decade to start reflecting that future concern much closer to the time when those concerns become real.

Miles Austin: I want to clarify something Trevor said about offsets in case it was misconstrued, and that is that the use of offsets is capped within the EU ETS. No matter how many offsets there are floating around the wider world, their use within the EU ETS has limits and those limits are 50% of the effort that it has to make.

In terms of the EU ETS driving investment, I think Trevor is absolutely correct that the current crisis is not going to make you decide to build a large wind farm, but the fact of the EU ETS’ existence, and the fact that it is going out to at least 2020-and more than likely far beyond-will drive those decisions. Even during Phase I, when the price was very low, there was research by Point Carbon that showed that something like 60% of the companies within the EU ETS were basing their decisions around projected carbon prices. To give an idea again, from a little piece of research from Energy Centre, Netherlands, of the kind of signal that the EU ETS does send, even at a price of €1 a tonne, it sends a signal for efficiency switching between different modes of generation. So obviously you don’t get a lot of efficiency switching at €1 a tonne, but whatever the price is, it is sending signals out to particular installations that are affected by it.

Q111 Sir Robert Smith: I suppose some investors like uncertainly because they think that it gets them faster than the others, but where possible, if you had a more flexible system for setting the cap, would that send signals that could undermine other agendas, like security of supply and insuring long-term investment decisions?

Trevor Sikorski: That is a very good point. A lot of people do play up the importance of predictability or certainty in pricing. If you look around the world, there is a lot of good evidence that markets do one thing pretty well and that is create capacity, because there is a price signal and people think they can make money out of it, so they go and build things, and those prices are rarely predictable. I was doing price forecasting back in 2000, and our long-term oil price forecast was it was going to be around $25 a tonne. Oil companies were still going out and spending on oil sands because maybe they knew something different, but the whole industry was forecasting that almost. I remember when prices broke out of that and started going up to $30, then $40, then $50, it was like everything has changed and it was kind of, "What has changed here?" Well, China changed and India changed. Was that predictable? I don’t know. The main point is you will get a lot of investment and you get a lot of investment with price uncertainty. That is just the environment in which people operate. To be honest, for the ETS, like Imtiaz said, you can have a pretty good handle on supply; you just have to work on demand to get some feeling of whether the world is going to be scarce of this commodity? Should I be investing to do something about that kind of scarcity? I think it is that promise of long-term scarcity rather than any kind of predictability of price, which price investment.

Imtiaz Ahmad: To merge the questions both by Dan Byles and Sir Robert Smith, I can see the similarity and answer from a practitioner’s point of view, infrastructure investment is very important. When you are investing today, you are locking in infrastructure 20, 25 years into the future. That is fundamental in terms of climate change and in terms of clean energy, whether you are going to invest into inefficient energy or clean energy, whether here, in Europe, the UK or elsewhere in the world. So the carbon price today is very important because our clients come to us and they hedge against the forward curve as far as they can go on the visibility, so they are looking forwards. Forecasts are forecasts; I am not going to say who can forecast well or not. I think it is a perfect tool with hindsight but, at the end of the day, there is a practical side, which is investments need to be made against the market today and what it is signalling.

The certainty aspect is very important, because you are talking about large sums of financing that are required. If you look at the IEA, for example, and they forecast-okay, it is a forecast but it is quite a well stated and accepted one-that from the period 2010 to 2050, in order to hit the 50% reduction targets, we are looking at US$46 trillion of expenditure required in clean energy. Of that, half can be new energy as investment and the other half has to be redirecting away existing planned energy that is planned to go into the dirtier side, into the higher emitting side. So certainly, a carbon price is very fundamental in terms of influencing the long-term signals. Ultimately, it is you, who are the political masters, who set those targets and that framework, but certainly certainty and long-term visibility will be very fundamental if you want to affect the investors’ decisions, CFIs and CERs and the big utilities and industrials who are planning these investments.

Miles Austin: Just to jump in again, I think certainty around the cap is the key thing. I think if we know that what our emissions constraint will be as a society 20, 30 years down the road, then that will send the investment signals that are needed. Certainty on the price is probably far less important. Markets are very good at dealing with uncertainty around price.

Q112 Dr Lee: Forgive me if I misinterpreted what you just said, Mr Sikorski, but are you saying that in 2000 it wasn’t predictable that China and India would have a greater demand for fossil fuels?

Trevor Sikorski: No. I was saying people were not predicting it.

Q113 Dr Lee: But it seems extraordinary. It is pretty obvious we have an increasing population-we just hit 7 billion earlier than we were predicting. People are not going to want to walk around on bare feet and ride bikes. They are going to want to drive cars as they progress. China is progressing, India is progressing. Are you honestly saying that so-called informed insight in the City predicted that China and India were not going to increase their demand for fossil fuels? I am absolutely flabbergasted.

Trevor Sikorski: If you look at the last decade, we had a last decade of China growing at 10% per annum. Nobody was forecasting that. Nobody was forecasting that kind of sustained growth from China-no one was.

Q114 Dr Lee: No one forecast a financial crisis in 2008. I am just amazed, absolutely amazed, that no one expected significant demand. Putting figures in is difficult but you are paid far more money than me to make those judgments. I just cannot believe that people did not perceive that there would be significant increase in demand. It just confuses me. It makes me less likely to invest, actually.

Trevor Sikorski: It was kind of illustrating a point that there is a huge amount of uncertainty and you invest under uncertainty; that is what people do.

Q115 Dr Lee: But of course there is uncertainty about how much it is going to increase, in the same way there is uncertainty about how quickly climate change is going to take place, but the trajectory? If you had asked me, sat down in the Dog and Duck in 2000, "Will China and India have a greater demand for fossil fuels in 2010?" I would have said "Yes."

Trevor Sikorski: Undoubtedly people would have, but I think if you had sat down in 2000 and had a conversation on the oil price, would it have focused on Chinese and Indian demand? I don’t think it would have. I know it didn’t, because I was in those discussions back in 2000. It was all about: where is US demand going? Where is OPEC investment going? Those are still-

Q116 Dr Lee: But it is a resource. I do not understand. We have the population going up and oil going down. We can argue about when peak oil takes place-it may have taken place-but that is a simple equation that points to increased prices, increased demand. If we can get that wrong, I mean, honestly!

Q117 Chair: One of our witnesses, Professor Grant, suggested that you could have an auction reserve price. What do you think of that idea?

Trevor Sikorski: I was probably going to answer in a fairly unsatisfactory way to say that they will put in an auction reserve price. That is both possible and doable, but the auction reserve price that is going to go in, as I understand it, is not really to provide, let’s say, price support but to more reflect where prices currently are and to ensure that the auction does not clear up prices significantly different from prevailing market prices, i.e. there isn’t something that has just gone wrong in the auction.

I think probably what you have in mind is more like a pre-known auction price, which would provide price support and a price floor in that. That is a doable and something that the market can deal with. If you look at some of the examples, the regional greenhouse gas initiative-possibly not a great example but an oversupplied market with a reserve price- basically prices have just collapsed to that reserve price and haven’t moved for about six months. It certainly takes away and interferes with the price discovering mechanism of markets. Like I said, would the market be more or less politically broadly acceptable across the EU if prices are kept kind of artificially high by a reserve price in very tough economic times? We are certainly living through some of those.

Miles Austin: The auction reserve price tends to crop up when there is a discussion on the need for potentially price floors and price ceilings, to both of which we are fundamentally opposed: price floors because if you had had a price floor in Phase I of the EU ETS you would have been giving a financial value to something that had little to no environmental value, because the system was over allocated so you would have been hiding that fact; and price ceilings because if you have a price ceiling basically at some point you have to inject more EUAs into the system if you are going to maintain a price ceiling, and then you start to undermine the environmental goals. An auction reserve price is distinct from those two things and if there is an overwhelming political desire to have some kind of price intervention then, of all the various evils, the auction reserve price is probably the lesser of them. My understanding is the UK has been running an implicit auction reserve price; it hasn’t told anyone what it is, but it has had an implicit auction reserve price with the auctions that it is been running during the second phase. So we already have one in place, we just don’t quite know what it is, although we can guess what the range is.

Q118 John Robertson: Which emissions trading scheme in developed countries might be suitable for linking with the EU ETS?

Imtiaz Ahmad: There is a lot of work going on. Certainly the original hope from the EU was the US, in particular, and of course there is hope with California going forwards. Nonetheless, in terms of emissions, we know China, India and Brazil have been looking at their domestic situation. Certainly China has been making a lot of noises; Brazil as well in the background. We know that South Korea, who are technically transitioning to be an industrialised country, are looking at EU ETS as well. So there is the ability for the EU to continue its leadership role and look at linkage, but compatibility issues will be key and monitoring and verification reporting will be very fundamental, so that you are comparing apples with apples.

Q119 John Robertson: I noticed Mr Austin and Mr Sikorski smiled when I asked the question. Why?

Miles Austin: The short answer at the moment is probably none of them are quite ready. There is a significant body of work that has been done by the European Commission on the circumstances in which we can link. Most of that was done in the context of linking up to a North American Federal cap and trade system, which still seems to be far away as it ever was. There is a danger with linking to different schemes and the key one is that if you link to a scheme that is not as environmentally ambitious or has a significantly lower price, then you will lower the price in the EU ETS and raise the price in the other scheme. That raises the question that was the key worry about potentially linking to a North American scheme. In the unofficial discussion in the EU, during Phase III the Commission was hoping to have an operating floor price unofficially of about €30 a tonne, whereas in the US they were getting profoundly nervous about anything that would go over $20 a tonne. Given that the first thing that would happen when you linked those two schemes is that the EU price would come down and the US price would go up; why would they link?

Trevor Sikorski: Yes. I fundamentally agree with Miles. I think the question is quite important because linking, in terms of the theory, is absolutely desirable. What you want is a global carbon price and everyone more or less responding to the same price of carbon. The devil is always in the detail and that is certainly the case with linking. The great disappointment for those of us who have been in the market for a long time is the failure to get US Federal legislation. We had something out of the House of Representatives. Australia looked very close with their carbon pollution reduction scheme. So we came very close with a number of trading schemes, and those trading schemes will probably need a couple of years of experience before the EU could be in a position to say, "Yes, this is good thing, a good scheme and a compatible scheme to link into." What that means with the very late starts-California not starting until 2013; fingers crossed, if everything goes okay in Australia, you are looking at a similar time period; and the first two years is a tax, so you are really looking at post-2015-linking now seems something that has gone from being something we could hope for in the first half of this decade to something that may be we should consider in the second half of the decade, so it is looking a long way away despite its inherent desirability.

Q120 John Robertson: Is North America still as important as it was?

Trevor Sikorski: North America would be wonderful because, one, it is very developed and two, very high in emissions, both in absolute terms and in per capita terms. It is another developed country, another trading partner. It ticks absolutely all the right boxes in terms of what you want to accomplish through linking-way more so than, let’s say, China does, which is at a different level of development and emissions intensity. North America is almost the holy grail of the Emissions Trading Scheme. It would be the big one that would really kick into being a very big global commodity market, which would be watched by everyone. It would be capable of generating massive amounts of investment. It remains the one thing we are hoping for. As Miles said, it is completely off the table now politically. That debate has just gone absolutely the wrong way, so it looks to us that the best we can hope for is California and some Canadian provinces linking together.

Q121 John Robertson: So we have our eggs in one basket in California, have we?

Trevor Sikorski: It is the great hope of North American trading.

Q122 John Robertson: What happens if it doesn’t work?

Trevor Sikorski: If it doesn’t work, then that would poison the debate in the US for a very long time. The debate isn’t great in the US at the moment on this, so there is a long way to get it back to even where we were in 2008 when there were not party differences on this. Both Obama and McCain were pro-cap and trade trade. There was cross-party support but we didn’t get it, and now you can’t find a Republican anywhere who will say cap and trade is a good idea.

Q123 John Robertson: Could limited linking to schemes with lower prices be an effective way to manage prices in the EU ETS?

Trevor Sikorski: It would provide price containment. A lot of debate at the moment, as I mentioned earlier, is people feel we have had too much price containment. To me price containment would be a good thing, but certainly I think when prices start getting very high, that kind of outlook would be very useful and broadly desirable.

Miles Austin: Again, I make the observation that if we were sat in another country, not in Europe, and we were being asked to link to the European cap and trade scheme and the Europeans wanted to link to our cap and trade scheme to contain their prices, which is to say raise the price in our cap and trade scheme, why would we link?

Imtiaz Ahmad: Though there is negative sentiment at the moment in the US which had been the great hope, notwithstanding what might happen going forward, it is important not to ignore the noises that the likes of the Chinese are making about a national cap and trade scheme, the fact that Chile wants to go ahead with cap and trade, Australia, South Korea, et cetera. Of course they may not be as material but China is the fastest growing country for emissions. Yes, I agree with what Trevor Sikorski says-China is in a different stage of its development. Nonetheless, there is a lot of talk of pilot schemes in maybe 2015, so at least that gives a potential hope for the EU to explore discussions there and in terms of a country whose emissions will be very fundamental in terms of dealing with climate change.

Miles Austin: In terms of cost containment, the CDM has been a very good cost containment tool and it has linked Europe to markets in a large number of developing countries.

Trevor Sikorski: It has fostered investment of a large order. A lot of that investment happened because of European demand.

Q124 Dr Whitehead: We have touched on developing countries. Certainly the question of the extent to which those economies are compatible for a new form of link becomes central. What prospects are there, for example, as has sometimes been suggested, that the EU just go through a link with China over the immediate next period?

Trevor Sikorski: It is such early days for any real view on what Chinese emissions trading, if they have emissions trading, will look like. They are talking about a number of pilots starting by 2013 but we have never seen any rules on what this might look like or what sectors might be contained. Every now and then, somebody will drop a hint that it may be an absolute cap rather than an intensity-based cap. Developing countries tend to like intensity-based targets, and an intensity-based target just means you are getting the carbon content of your GDP growth down basically, so it allows them to grow but they are still reducing emissions within that growth. Those intensity-based schemes are very hard for an absolute scheme to link with, so it raises up some compatibility issues and those compatibility issues and the detail is what is going to drive that political decision in Brussels, and I think we are a long way away from having any idea of what the detail may be.

At one point, it kind of looked like Europe was pushing-well Europe is still pushing-for sectoral targets. Certainly a Chinese national cap and trade scheme, which has been talked about for 2015, goes way beyond sectoral targets and it is way more desirable, but if they have been talking about linking with that, then it does throw up the possibility that that would certainly be considered and I would find it impossible that policy makers won’t consider it.

Q125 Dr Whitehead: Do you think, though, that the infrastructures and the political will to develop such systems in developing countries might be the first or the earlier priority for EU to assist with, rather than going to schemes as such? Is there not an area of mileage of attempting to align development of systems with what is the direction of the EU, rather than trying to match together what may be only limited compatibility in the early period?

Miles Austin: I know that there has been a conversation going on between the European Commission and the Chinese authorities and also the Department of Energy and Climate Change and the Chinese authorities, but ultimately it is down to China how it chooses to design its cap and trade scheme; it is not down to Brussels.

Trevor Sikorski: It will be emissions trading with Chinese characteristics.

Imtiaz Ahmad: Certainly one can’t dictate to China and, indeed, the likes of Brazil and others. Nonetheless, I think there is merit in trying to ensure that apples are apples in verification and reporting systems. A lot of the work has already been done through both CDM and EU ETS, in terms of measuring, auditing and verifying terms of reductions, and so on, and showing that in a transparent manner. So that will be relevant in the system that emerges.

Miles Austin: Imtiaz raises MRV. One of the key questions moving forward within the UNFCCC is what will any future deal, be it in four, five, six or seven years, look like and what will be its key characteristics? One of the things that is clearly on the table is the apples for apples scenario, so that you know when you have a tonne reduced in China you know whether or not it is equivalent to a tonne reduced in the UK, whether or not that is equivalent to a tonne reduced in the US, and the potential for the UNFCCC to act as some kind of hub to undertake that work and to carry out the comparability.

Q126 Sir Robert Smith: Yes. Obviously the EU ETS is the Europe-wide scheme but then we have unilateral actions by the UK. How much concern do you have about leakage; in other words, the other actions by the UK to suppress emissions?

Trevor Sikorski: Both Miles and I would probably say similar things. I think there is an issue when you put any supplementary policy under the cap that then you have issues of what you are effectively doing is reducing demand under that cap and, therefore, allowing emissions to be moved somewhere else. That is just one of the things that will happen because that is the way the system happens. That does not mean the UK cannot do anything, and there are a number of areas that are not covered by the cap. Certainly if you do things in non-traded sectors, those emission reductions are real, they are important. They are not going to be exported per se abroad, because they are not part of that same basic framework of regulation. So, yes, certainly do something on domestic gas supply; we have always said domestic gas supply should be in the EU ETS but it isn’t, so doing something there on carbon would be fruitful-and transportation, of course. We have consistently argued that transportation should be in the EU ETS. Transportation isn’t, nor is agriculture. A large number of sectors in the UK not governed by the cap, and doing things in there is truly meaningful policy making. If you do something that is underneath the cap, you don’t have a real way of controlling it.

Miles Austin: I do agree with most of what Trevor said, as he predicted. The key thing is that when you put parallel instruments into place, be it in the UK or be it Europe-wide, that affect the EU ETS sectors, then you are simply reducing the price of EUAs and putting those into the hands of sectors that aren’t affected by the unilateral measures. With the UK, particularly with the carbon price floor that is coming in, a reasonable way of preventing that from exporting cheaper EUAs to mainland Europe would be to make a reasonably informed calculation of what the effect of that would be on the EU ETS and hold back that number of EUAs from the market, and then you won’t get leakage abroad.

That brings me round to the discussion that is going on that the set aside with the energy efficiency proposal that was leaked from Brussels a few months ago, during the middle of the summer, which I understand has reared its head again. The set aside, as a compensation for energy efficiency proposals, isn’t necessarily a bad thing. It would need to be far more clearly fleshed out than it was in the proposal that came forward, because there are a number of key concerns around that. For instance, if one were to set aside a large volume of EUAs but have the possibility that, at some point, they would come back into the market during Phase III, that would, unless you had a very clear set of criteria for what would trigger that release, potentially be very damaging to confidence in the market. However, if they were set aside or cancelled in a way that the market had confidence in, it would go some way to compensating for parallel measures.

The other key thing is that the less politicised that process is, the more comfortable it will be for the market as well. For instance, if the set aside was placed in the hands of a political body, be it the member states, DG CLIMA or some other part of the Commission, that would be far less comfortable than if it were set into the hands of some kind of independent body that ran on a clear set of criteria and would react predictably; the market would then know why certain things were happening, as opposed to simply, "There has been a calculation with DG CLIMA, and we now think we are going to hold back this amount of EUAs." It would need to be run independently along very clear lines that get a very good signal.

Q127 Sir Robert Smith: Are there any other member states doing anything similar with the carbon price floor?

Trevor Sikorski: Didn’t France do something? But I remember it was outside of the ETS. It was non-ETS.

Sir Robert Smith: Obviously a big difference there.

Trevor Sikorski: Yes, so they had a tax on stuff. Sorry, very imprecise comment.

Q128 Sir Robert Smith: Is there any regulation mechanism that goes tougher within the EU ETS?

Trevor Sikorski: I am not aware of any.

Q129 Sir Robert Smith: Do you think there are any benefits of the UK doing a unilateral, even within the EU ETS, because it might create leadership within that sector of the low carbon industry?

Miles Austin: It makes it tougher for the UK industry. It makes it easier for European industry because you are essentially exporting the EUAs that would have been used by the UK.

Q130 Sir Robert Smith: So in terms of developing the supply side of the low carbon industry?

Trevor Sikorski: It would push up, let’s say, electricity prices to higher levels than our comparable European friends’-certainly power prices would be higher. There is no free lunch on these things.

Q131 Sir Robert Smith: So the reality is if you create a European-wide mechanism and you should really try and make that work rather than-

Trevor Sikorski: I think in terms of policy effort, it’s best spent there, absolutely.

Miles Austin: Yes. That would be another reason to try to move to 30%.

Imtiaz Ahmad: The best way is to make the system work across the EU rather than one individual member state. It is a pan-European market and unlike everything else in Europe, in terms of market-the single European market or the euro-it is pan-European across 27 member states. For the action to be effective it really has to work across the entire EU ETS.

Chair: There were a lot of issues we hoped to cover, such as sectoral emissions and fraud, but unfortunately I think we are now out of time. Thank you very much for coming in. We have much appreciated your answers.

Prepared 7th November 2011