Environmental Audit CommitteeWritten evidence submitted by WWF-UK

Summary

The latest science indicates that it is still feasible for the world to prevent global average temperatures increasing by more than 2ºC compared to pre-industrial average, the stated objective of the international negotiation process to avoid dangerous levels of climate change. However, the window of opportunity for doing so is rapidly closing and substantial shifts in investment towards energy efficiency and low-carbon technologies have to happen over the next five years.

This is also a critical time for climate and energy policy in both the European and international arena. Despite the poor signal sent to the rest of the world following the European Parliament’s recent vote against a proposal to marginally strengthen the carbon price under the EU Emissions Trading Scheme, discussions have started at EU level on a possible package of climate and energy legislation for 2030 (and a Green Paper has been published). Internationally, the objective remains to reach a global deal at the United Nations Framework Convention on Climate Change (UNFCCC) summit in 2015 on reducing greenhouse gas emissions for the post 2020 period. With two of the next three summits taking place in the EU, pro-active UK and EU leadership is likely to be crucial to the success of these negotiations, as it has been since the inception of the UNFCCC in 1992.

The UK’s Climate Change Act 2008 is seen by many countries across the world as landmark legislation and it has become a model for similar legislation in countries such as Mexico and South Korea. It is therefore imperative that the UK be seen to take robust action domestically to deliver on its emission reduction commitments, which will give it the credibility and reputation to positively influence critical international developments. On the other hand, being perceived as backtracking on commitments, watering down legislation or ignoring the best available scientific evidence would do untold damage to the UK’s reputation and undermine the much needed momentum required to deliver an ambitious global deal on emissions by 2015.

This is therefore not the time for the Government to dilute the greenhouse gas emission reduction ambitions set out in the Climate Change Act and the first four legislated carbon budgets set following the advice of the Committee on Climate Change (CCC). It must be recalled that these represent the minimum ambition that the UK needs to aim for as part of a global effort to keep the increase in average temperatures below 2 degrees, which in the case of the European Union has been estimated to require emission reductions of 80% to 95% by 2050 compared to 1990 levels. If anything, the UK’s emission reduction commitments should be strengthened and this should certainly be the case for the UK’s second and third interim carbon budgets, as recommended by the CCC.

The UK economy could greatly benefit from being an early-mover in the transition towards a low-carbon economy. However, Government divisions in recent years over the future direction of climate and energy policy have resulted in a decision to review the Fourth Carbon Budget in 2014. Since the Committee’s previous inquiry, this has also been followed by an agreement to postpone a decision on both a power sector decarbonisation target and the inclusion of aviation and shipping emissions in the UK’s carbon budgets until 2016 at the earliest. This has created significant investment uncertainty in the low-carbon sector, which risks not only undermining one of the very few areas of growth of the UK economy but will also severely undermine the UK’s ability to meet its commitments under the Climate Change Act.

WWF-UK urges the UK Government to accept the CCC’s initial recommendations for the Fourth Carbon Budget in its 2014 review, make a decision now to set a decarbonisation target for the power sector for 2030, accept to include international aviation and shipping emissions into the carbon budgets and increase ambition for non-traded sector emissions from the “interim” to the “intended” level of the second and third carbon budgets, that is, to—42% by 2020 as in Scotland and comparable to Germany’s target of 40% emission reductions by 2020.

We agree that any detrimental impacts of climate and energy policy on energy intensive industries should be taken seriously. WWF-UK believes that the risks faced by this small group of companies can be managed through appropriate policy tools and the CCC’s latest report on competitiveness indicates that the UK Government is taking satisfactory steps to address current impacts. However, the UK should learn the lessons from international experience and avoid the mistakes that have occurred in Germany and under the EU Emissions Trading Scheme by ensuring that only those sectors genuinely at risk of carbon leakage are proportionally compensated for any detrimental competitiveness impacts on the basis of firm, publicly available evidence.

The framing of the policy discourse should also recognise that UK-based energy intensive companies could stand to benefit from the substantial economic growth opportunities created by ambitious UK climate and energy policies. These policies should therefore not just be portrayed as a negative cost on those industries.

Introduction

1. WWF is the largest environmental network in the world, with projects in over 100 countries. One of our key aims is tackling climate change, and we have been active in UK and global energy policy discussions for over a decade. We are strongly committed as an organisation to helping prevent the worst impacts of climate change and in particular preventing temperatures from rising above 2ºC compared to pre-industrial levels.

2. The Climate Change Act 2008 is a fundamental tool to guide the UK’s transition to a low, and eventually zero, carbon economy. It establishes a legally binding target that the UK must reduce greenhouse gas (GHG) emissions by at least 80% below 1990 levels by 2050, underpinned by a framework of five-year carbon budgets, set out on a minimum 15-year time horizon.

3. The closely related Scottish Climate Change Act is another landmark piece of legislation. In some respects, it is superior to the UK Act as it commits Scotland to reduce emissions by at least 42% below 1990 levels by 2020, and unlike the UK budgets, includes Scotland’s share of international aviation and shipping emissions within this ambition. The Scottish Act also includes a requirement for annual, as opposed to five-year, targets.

4. A fair, ambitious and binding international agreement remains essential to adequately address the global nature of climate change. However, given the slow progress towards a legally binding agreement, strong national frameworks are urgently needed not just in their own right, but also to rebuild political momentum and trust in international negotiations. This is particularly important today given the international community’s objective to reach an agreement in 2015 on a global deal to reduce GHG emissions for the post-2020 period.

5. Our response focuses on the following key questions raised by the Committee:

(I)Are the emissions reduction targets in the Climate Change Act still valid as an appropriate UK contribution to avoiding dangerous climate change?

Operation and management of the carbon budgets: have the Environmental Audit Committee’s previous concerns and recommendations been addressed?

What should the Government response be to the CCC’s 2013 progress report and should the carbon budgets be relaxed?

I. Are the emissions reduction targets in the Climate Change Act still valid as an appropriate UK contribution to avoiding dangerous climate change?

The latest climate change science calls for urgency of action, not further delay

6. A range of reports published at the end of 2012 from the World Bank,1 the International Energy Agency2 (IEA), the United Nations Environment Programme (UNEP)3 and Pricewaterhouse Coopers (PWC)4 show that the challenge of tackling GHG emissions is as urgent as ever. Key points from these reports show that:

If current trends continue, the world is currently on track for a warming far in excess of 2ºC, with the World Bank warning that “even with the current mitigation commitments and pledges fully implemented, there is roughly a 20% likelihood of exceeding 4ºC by 2100” and “if they are not met, a warming of 4ºC could occur as early as the 2060s”.5 UNEP notes in particular that current global emissions of GHGs are considerably higher than the maximum level of emissions that could be allowable in 2020 (44Gt CO₂e) to stay within a “likely” chance (greater than 66%) of preventing temperature increases of more than 2ºC.

WWF-UK is aware that a recent article published in The Economist6 suggested that the recent apparent slowing down of average global temperatures may indicate that the climate is less sensitive to accumulations of GHGs in the atmosphere than previously thought and that therefore the high upper end of temperature increases contemplated by the Intergovernmental Panel on Climate Change’s (IPCC) models (ie with warming in excess of +4.5ºC) are less likely to occur than previously thought. Whilst this is a possibility and further research is required, this article under-estimates that recent warming may have been masked by other factors such as heat being redirected into deep oceans instead of the atmosphere, the temporary cooling impact that aerosols might be having by reflecting sunlight back into space and the fact that only looking back at temperature variations in the last 15 years could mask longer trends in warming which tend to evolve in a step-like rather than linear fashion. In addition, the latest evidence still confirms the validity of the IPCC’s central estimation that a doubling of carbon dioxide in the atmosphere compared to pre-industrial levels will result in average global temperatures increasing by a range of 2ºC to 4.5ºC.7

The current concentration of carbon dioxide in the atmosphere is already unprecedented with the World Bank noting that “the present CO₂ concentration is higher than paleoclimatic and geologic evidence indicates has occurred at any time in the last 15 million years”8 and UNEP observing that GHG emissions in 2010 were some 20% higher than in 2000.

The impact of projected levels of global warming would disproportionately impact “many of the world’s poorest regions, which have the least economic, institutional, scientific and technical capacity to cope and adapt”.9 These impacts would also severely undermine the provision of ecosystem services on which human society and the world economy are highly dependent. The World Bank notes in particular that “in a 4ºC world climate change seems likely to become the dominant driver of ecosystem shifts, surpassing habitat destruction as the greatest threat to biodiversity. (…) Ecosystem damage would be expected to dramatically reduce the provision of ecosystem services on which society depends (for example, fisheries and protection coast-line afforded by coral reefs and mangroves)”.10

The reports all confirm that it is still possible to prevent temperature increases in excess of 2ºC but the window of opportunity for doing so is rapidly closing, with the International Energy Agency warning in its latest World Energy Outlook report that “if action to reduce CO₂ emissions is not taken before 2017, all the allowable CO₂ emissions would be locked-in by energy infrastructure existing at that time.”11 UNEP notes that even if fulfilled, current pledges made by countries to reduce their emissions of greenhouse gases by 2020 are some 8 Gt CO₂e12 to 13 Gt CO₂e above the level of annual emissions allowable in 2020 to stay on track for having a likely chance to meet the 2ºC objective. To put this “emissions gap” into context, the emissions of China in 2010 were in the region of 10 Gt CO₂e.13

As made clear by the Stern Review in 2006,14 taking early action to prevent temperature increase in excess of 2ºC makes economic sense, with UNEP noting in particular that “the increased lock-in of carbon-intensive technologies will lead to significantly higher mitigation costs over the medium- and long-term”.15 This point was echoed by the IEA in its World Energy Outlook 2011 report, which warned that “delaying action is a false economy: for every $1 of investment avoided in the power sector before 2020 an additional $4.3 would need to be spent after 2020 to compensate for the increased emissions.”16

7. It is therefore clear from a climate change science perspective that despite uncertainties in some areas, now is not the time to dilute the UK’s commitments to reduce its GHG emissions and that the remaining window of opportunity to prevent dangerous levels of climate change should be seized with urgency.

8. It should be pointed out that the carbon budgets proposed by the Committee on Climate Change (CCC) fall short of what is needed to be in line with the UK and EU’s longstanding policy objective to keep levels of warming to less than 2ºC above the pre-industrial average with any degree of confidence. The CCC’s recommendations are based on limiting the central expectation of temperature rise “as close as possible” to 2ºC. In practice, its main criterion has been to select a pathway for global emissions which limits the risk that warming will exceed 4ºC to less than 1%.

Too slow and not enough, but the rest of the world is acting

9. Whilst international action to tackle greenhouse gas emissions falls far short of the action required to meet the 2ºC goal, several countries around the world have started taking positive action to reduce their emissions. Within the EU, countries like Germany (through the “EnergieWende”)17 and Denmark18 have set themselves ambitious emission reduction goals out to 2050 and embarked on a radical transition towards an energy system based on renewable energy and high levels of energy efficiency.

10. Outside of the EU and whilst recognising that more ambitious action is required, major emitting countries such as South Africa (with the introduction of a new carbon tax in 2015) and China are doing far more than they are regularly given credit for. In its 12th five-year plan, the Chinese Government has set itself the following objectives for 2015: reducing its energy consumption per unit of GDP by 15% by 2015 compared to 2010 levels, reducing its emissions of CO₂ per unit of GDP by 17% compared to 2010 levels (and by 40% to 45% by 2020 compared to 2005 levels) and increasing the share of non-fossil fuel energy to 11.4% of its overall primary energy mix by 2015 and 15% by 2020.19

11. In many cases, the UK’s Climate Change Act has already had a role in influencing positive developments in other parts of the world, such as the adoption of a new Climate Change Act in Mexico,20 the development of the Clean Energy Act in Australia (which legislated an emissions trading scheme, an 80% emissions reduction target by 2050 and a Climate Change Authority closely resembling the Committee on Climate Change),21 a White Paper from the Norwegian Parliament22 committing to investigating the need for a climate change act similar to the UK’s and recent consideration given by the Danish Government to develop a UK-style climate change act.

12. WWF’s own work in China shows that the UK’s Climate Change Act coupled with engagement on climate change through the Department for International Development (DFID), the Foreign and Commonwealth Office (FCO) and the British Council in China have played an important role in helping build momentum in China towards prioritising climate change mitigation and low-carbon developments on the political agenda, as well as supporting current discussions around running an emissions trading pilot scheme in China and introducing a possible carbon tax.

13. If the UK were to water down the emission reduction and low-carbon development commitments embedded in its Climate Change Act and its first four carbon budgets, this would send a very negative signal to other major economies and would be detrimental to the building of a positive momentum towards a global deal on climate change in 2015.

The rationale behind the Climate Change Act: the need for long-term stability and early domestic action, not constant chopping and changing

14. When considering whether the emission reduction objectives in the Climate Change Act are still valid, it is important to recall the context behind the Act.

15. A major objective of the Climate Change Act, which was enacted through cross-party consensus just over four years ago, “was to set a target which would not vary with the ups and downs of global negotiations, but would provide certainty within which policies and technologies could develop”.23

16. In line with the economic analysis of the Stern Review, which concluded that “the earlier effective action is taken, the less costly it will be”,24 the Act was also developed on the understanding that early domestic action to reduce GHG emissions was more likely to be cost-effective than delaying action towards the end of the period leading to 2050. This is recognised in the Government’s own analysis in its proposal to set the Fourth Carbon Budget, which states that “pathways with early [domestic] action…are more cost-effective over time than pathways which delay action towards meeting the 2050 emissions reduction target.”25

17. The need for early domestic action is all the more important as the CCC’s own analysis shows that as we approach 2050, there will be very little opportunity to purchase international carbon credits to help deliver the UK’s emissions reduction goals if the world is genuinely taking action to prevent a level of warming in excess of 2ºC: “We need to face the reality that in the long term, reductions in emissions will need to be achieved almost entirely through domestic action”.26

18. Recommendations: A dilution of the UK’s emission reduction commitments under the Climate Change Act would clearly run counter to the political, scientific and economic rationale which led to the cross-party support for the Act just four years ago. WWF-UK therefore expects the Government to uphold the objectives of the Climate Change Act and, as explained below, follow the CCC’s recommendations in relation to the second, third and fourth carbon budgets.

II. Operation and management of the carbon budgets: have the Environmental Audit Committee’s previous concerns and recommendations been addressed?

Overview of key issues identified by the Committee in its previous report

19. In its previous report on carbon budgets, the Environmental Audit Committee expressed concerns in relation to the following key issues:

the climate of investment uncertainty in the low-carbon sector caused by the Government’s decision to review its adoption of the Fourth Carbon Budget in 2014;

the lack of clarity around the Government’s intentions following the CCC’s recommendations to increase emission reduction ambitions in the non-traded sectors from the “interim” budget level to the “intended” budget level;

the need to develop a clearer evidence base on the possible detrimental impacts of climate and energy policies on the UK’s energy intensive companies; and

the current lack of understanding surrounding the treatment and impacts of the UK’s consumption emissions.

20. Each of these issues is addressed in turn below.

The damage caused by the Fourth Carbon Budget review and the delayed decisions on power sector decarbonisation and the treatment of international aviation and shipping emissions

21. In its report on the previous Carbon Budgets inquiry, the Environmental Audit Committee noted that “the prospect of the review changing the budgets in itself undermines the benefit of having a degree of longer-term certainty about Government policy that investors in low-carbon need.”27 This is particularly detrimental given that the CCC has stressed repeatedly that “the level of ambition in this budget should be regarded as an absolute minimum, and more may be both feasible and required as current uncertainties over emissions projections and abatement opportunities are resolved.”28 It should be stressed here that the Fourth Carbon Budget recommended by the CCC, which requires emissions reduction cuts of 46% from 2009 to 2030 (equivalent to emissions in 2030 being 60% below 1990 levels), already pushes back a significant amount of emission reduction actions to the 2030–50 period (a 62% cut in emissions from 2030 to 2050). Therefore, “any less ambitious target for 2030 would endanger the feasibility of the path to 2050”29 due to the improbable levels of emission reduction actions it would require to be taken in the 2030–50 period.

22. Whilst the review of the Fourth Carbon Budget is still expected for 2014, the political dynamics behind the Government’s decision to review the budget has led to further detrimental impacts in two key areas since the Committee’s previous inquiry was held. First, following months of political divisions on the development of the Energy Bill, the Government failed to put forward a binding target to reduce the power sector’s carbon intensity down to around 50g CO₂/kWh by 2030 as recommended by the CCC and a wide range of businesses, faith groups, trade unions and non-governmental organisations.30 Subject to amendments put forward in the context of the Energy Bill, a decision on whether or not to introduce a decarbonisation target for the UK power sector will not be taken until 2016 at the earliest. This is damaging for two key reasons:

First, by failing to provide a clear sense of direction out to the next investment cycle, the lack of a target risks slowing down the significant investments required to make the transition towards a low-carbon power sector. This is concerning given that the CCC estimates that “decarbonising” the UK’s power sector down to a carbon intensity level of 50g CO₂/kWh by 2030 would require investing approximately £10 billion annually in the sector throughout the 2020s.31 The risk of investment hiatus was made clear in a recent letter by leading international manufacturers to the UK Government, which stated in particular that “postponing the 2030 target decision until 2016 creates entirely avoidable political risk. This will slow growth in the low carbon sector, handicap the UK supply chain, reduce UK R&D and produce fewer new jobs.”32

Second, this lack of long-term investment certainty also risks resulting in the UK losing out on important economic growth benefits associated with the development of low-carbon infrastructure. A recent report from the Confederation of British Industry (CBI) noted that “in trying economic times, the UK’s green business has continued to grow in real terms, carving out a £122 billion share of a global market worth £3.3 trillion and employing close to a million people. And in 2014–15, it is expected to roughly halve the UK’s trade deficit” but lack of policy certainty in the green sector could result in “a risk of losing almost £0.4 billion in net exports in 2014–15”.33

A recent report by Cambridge Econometrics also found that if the UK was to invest steadily in offshore wind out to 2030 instead of relying on gas-fired generation, this would increase its annual GDP by £20 billion by 2030, create 70,000 more net jobs, reduce UK gas imports by £8 billion/year and produce power sector emissions that would be three times lower by 2030. These potential economic benefits, which require a long-term and supportive policy framework to materialise, should also be seen in the light of recent research by the Institute for Public Policy Research (IPPR), which suggests that a 2030 decarbonisation target would not result in higher domestic electricity bills in 2030 and would play a key role in reducing their volatility.34

23. The negative political dynamic triggered by the scheduled review of the Fourth Carbon Budget has also resulted in the Government deciding in December 2012 to postpone a decision on whether to include international aviation and shipping emissions in the carbon budgets until 2016.35 This not only undermines the importance that the UK government gives to its commitments under the Climate Change Act but also sends a damaging signal at a critical time where international efforts are trying to influence the adoption of an assembly resolution within the International Civil Aviation Organisation (ICAO) to develop a market-based mechanism to tackle fast growing global aviation emissions.

24. Recommendations: WWF-UK therefore urges the Government to avoid unnecessary and damaging delay, and take the following actions in the very near future:

fully adopt the emission reduction recommendations of the CCC with respect to the Fourth Carbon Budget;

set a decarbonisation target in the Energy Bill in line with the CCC’s recommendations; and

accept the inclusion of the UK’s share of international aviation and shipping emissions in the carbon budgets.

The Government’s lack of progress on tightening up the second and third interim carbon budgets will undermine the UK’s ability to meet the Fourth Carbon Budget recommendations

25. The Environmental Audit Committee noted in its previous report that the Government had rejected other important recommendations from the CCC in 2011, most notably “on making the second and third carbon budgets consistent with the pace of emissions reductions required by the fourth budget”. There has been no movement on the Government’s position on this issue and the emission reduction ambitions for the UK’s non-traded sector (ie emissions from sectors of the UK economy that are not covered by the EU ETS) are still set at the levels of the “interim” second and third carbon budgets as opposed to the higher levels set out in the “intended” budgets recommended by the CCC.

26. The continued failure to endorse the CCC’s recommendations on the second and third carbon budgets will make it harder than necessary for the UK to meet the emission cuts recommended in the Fourth Carbon Budget: “the [Fourth] Domestic Action budget recommended for 2023–27, and the indicative 2030 target, will be difficult to achieve unless the UK enters the 2020s at a level of emissions consistent with the Intended budgets for the non-traded sector, rather than with the less ambitious Interim budgets.”36 As the CCC further points out, “from the third Intended budget to the fourth Domestic Action budget would entail a feasible reduction of 13% over a five-year period: from the third Interim budget to the fourth Domestic Action budget would require a much more challenging 23% reduction.”37

27. As explained above, the insufficient emission reduction ambitions set in the “interim” second and third carbon budgets sit in a context where the CCC’s Fourth Carbon budget recommendations themselves amount to the “absolute minimum” domestic action required of the UK to stay on track for delivering the 2050 emission reduction goal set in the Climate Change Act. In turn, the ambitions of the Climate Change Act amount to the minimum action required of the UK to play its part in a global effort to prevent global average temperature rises in excess of 2ºC.

28. Recommendations: WWF-UK therefore urges the Government to adopt as soon as possible the CCC’s recommendations with respect to tightening the emission reduction ambitions for the UK’s non-traded sector up to the “intended” levels of the second and third carbon budgets.

Energy intensive industries: the need for transparent and proportionate compensation criteria

29. The Environmental Audit Committee recommended in its previous report that “a comprehensive and robust assessment of the actual risk to each sector affected, on a case by case basis, should be made by departments working in concert” and that “measures to help energy intensive industries must be fair and tailored to each sector affected and should keep a strong incentive to reduce emissions.”38

30. In its recent analysis on the impact of climate and energy policies on energy bills,39 the Department of Energy and Climate Change (DECC) estimated that current policies would add between 1% to 14% to the energy bills of energy intensive companies (EIUs) in 2013, with the projected impact of these policies increasing to between +6% to +30% by 2020 and to between +13% to + 60% by 2030.40 The extent to which EIUs are exposed to bill increases arising out of climate and energy policies varies on a case by case basis depending on the share of a site’s gas and electricity use, whether it has onsite combined heat and power generation capabilities (which are often exempt from the cost of climate and energy policies) and the extent to which production processes can be made more efficient. Importantly, the figures above also do not consider the impact of measures that are being considered by DECC to reduce the transitional impact of the EU ETS, the UK’s carbon floor price (CFP) and the introduction of contracts for differences (CfDs) to support the deployment of low-carbon generation.

31. Before looking at the case for compensating EIUs, it is important to put the impacts highlighted above in context. First, EIUs are defined by the Department for Business, Innovation and Skills (BIS) as companies where energy costs account for at least 10% of their gross value added. Whilst they play an important role in the UK economy, these companies are deemed to represent around 4% of the UK’s total gross value added and around 2% of the UK’s workforce. Second, for the majority of UK businesses, the impact of climate and energy policies on their overall costs is expected to be minimal as energy represents only a small fraction of their costs. DECC estimates for instance that energy represents on average less than 3% of the total business costs of the UK’s manufacturing sector and that therefore climate and energy policies are currently adding less than 1% to the total business costs in that sector.41 In its recent report on Household Bill Impacts, the CCC also found that low-carbon policies would add, by 2020, one penny in every £10 spent in the UK commercial sector and six pence in every £10 spent in the UK’s manufacturing sector.42

32. We agree that the risks to UK-based EIUs’ competitiveness should be taken seriously. However, it is important to note that the £250 million compensation fund that was announced by Government for this Spending Review period to protect EIUs against the costs of the EU ETS and the CFP were found by the CCC in its recent Competitiveness Risks report43 to provide adequate protection to EIUs for the period running up to 2020. As explained in the CCC’s report, impacts on EIUs for the 2020 to 2030 period is less certain but DECC announced in November 2012 that it was considering exempting some EIUs from additional costs arising from the introduction of CfDs “where these have a significant impact on their competitiveness” (Para 124).

33. It is important that when developing these policies, the UK Government develops transparent and meaningful criteria that will ensure that only those firms genuinely at risk of “carbon leakage” (the phenomenon whereby industrial relocation shifts greenhouse gas emissions to a different jurisdiction) will receive a level of financial support proportionate to the identified detrimental impact caused by climate and/or energy policies.

34. The risk of over-compensating some industries is a very real one as the latest developments in Germany illustrate. According to a recent report from Arepo Consult,44 the lack of clear criteria in German legislation to determine whether a firm is genuinely at risk of a loss of competitiveness has resulted in 75% of electricity use from the industrial and agricultural sector receiving varying degrees of compensation. The total amount of compensation provided to these sectors amounted to some €9.1 billion in 2012 alone, which the report suggests is significantly out of proportion with the actual impact of climate and energy policies on German industry and is unnecessarily increasing costs for domestic consumers in Germany.

35. A recent report from CE Delft also suggests that the criteria developed by the European Union in 2009 to assess the risk of carbon leakage caused by the EU ETS are far too lax and are resulting in far more firms and sectors receiving compensation (in the form of free carbon allowances) under the scheme than should be the case. The criteria developed in 2009 were based in particular on the assumption that the carbon price in the EU would reach €30 by 2020 (it is now unlikely to exceed €12 by that date) and that carbon emissions from the sectors identified as at risk of carbon leakage would exceed their free allocation of carbon allowances by some 60% (a figure of 20% now seems more likely). As a result, CE Delft argues that “if the 2009 allocation had been based on more realistic assumptions, the sectors deemed at risk of carbon leakage would have fallen from the current 60% of sectors representing 95% of industrial emissions, to a mere 33% of sectors accounting for only 10% of emissions.”45 ^, 46

36. Concerns over the robustness of EU criteria to assess carbon leakage are important in the context of this inquiry given that they are influencing the proposals that are being developed in the UK to compensate EIUs for the indirect costs of the EU ETS, the CFP and (potentially) the introduction of CfDs. A recent consultation response from the Centre for Climate Change Economics and Policy and the Grantham Research Institute on Climate Change and the Environment47 expressed concern that the UK proposals to focus on a sector’s “carbon intensity” and “trade intensity” as a means of identifying risks of carbon leakage were likely to give rise to over-compensation.

37. Based on a report from the Centre for Economic Performance,48 which interviewed the managers of 761 manufacturing firms in six European countries to analyse the effectiveness of the EU’s carbon leakage criteria under the EU ETS, the response recommended that the following issues should be taken into account when developing carbon leakage criteria in the UK:

“The large heterogeneity among firms in terms of relocation risk suggests that further efficiency gains could be reaped by providing compensation at the firm level, rather than at sector level”;49

With the exception of those firms carrying out high levels of trade with emerging economies such as China, trade intensity (the share of exports with third countries in a company’s gross value added) was a poor indicator of vulnerability on its own. The report from the Centre for Economic Performance (which made the following observation from an EU rather than UK perspective) found in particular that “by not exempting trade intensive sectors but the ones that are at least moderately carbon intensive as well, European governments could raise additional auction revenue in the order of €6.7 billion every year”. The report also argued that a change in the definition of the trade intensity criterion in the EU that focused more on a sector’s intensity of trade with emerging economies such as China “would raise an additional €2.8 billion in auction revenues per year.”50

In order to minimise job losses and prevent an unequal distribution of compensation awarded to different industries, compensation criteria should take into account the size of a firm’s workforce.

38. Whilst the UK’s proposed criteria to compensate UK EIUs for the introduction of the CFP (which results in UK EIUs paying a higher carbon price than their European competitors especially pending a structural reform of the EU ETS) includes both a trade intensity criteria and a carbon intensity criteria, the consultation response from the Grantham Research Institute considers that the proposed threshold for trade exposure for UK EIUs (10%) may be too low and may need to be reviewed upwards.

39. Finally, it is important that UK policy recognises that ambitious climate and energy policy represents an important opportunity for the UK’s energy intensive sector, not just a cost. The most recent figures published by BIS show that the UK low-carbon and environmental goods and services sector had sales of £122.2 billion in 2010–11, growing 4.7% from the previous year and placing the UK sixth in the global league table. As highlighted above, a recent report from the CBI also found that the UK’s “green business” could have the country’s trade deficit by 2014–15.51 Ambitious domestic climate and energy policies can therefore create a significant market for UK-based energy intensive companies to support the necessary deployment of low-carbon energy supply and energy efficiency infrastructure. This issue, which was recognised in a recent joint report from the TUC and the Energy Intensive Users Group52 and a report from the manufacturers’ association EEF,53 should play an important role in the way the UK develops its overall policy towards EIUs.

40. Recommendations: Risks to the competitiveness of UK-based energy intensive companies arising from climate and energy policies should be taken seriously. However, WWF-UK urges the UK Government to avoid the risk of over-compensating some industries by developing meaningful and transparent eligibility criteria as described above. In addition, UK policy on EIUs should recognise that climate and energy policies provide a unique economic opportunity for these companies.

What should be the role of consumption emissions?

41. Following the Environmental Audit Committee’s previous report on carbon budgets, an inquiry by the Energy and Climate Change Select Committee concluded in April 2012 that the UK’s consumption related carbon emissions, which rose by 20% from 1990 to 2009 according to the Department for the Environment Food and Rural Affairs (DEFRA), should be incorporated alongside the UK’s territorial emissions in the policy making process.54 As made clear in our submission to that inquiry, WWF-UK agrees with these conclusions but would stress that the conventional production-based approach to emissions accounting and regulation is a well-established and powerful tool to guide the transition to a low-carbon economy in the UK—notably in ensuring that we make a well-managed transition always from fossil fuel dependency.

42. This point was reinforced in the CCC’s latest study on Competitiveness Risks, which stressed in particular that “moving to a consumption-based accounting methodology would be disruptive and impractical given international accounting conventions (which are based on territorial emissions and aim to avoid double counting) and uncertainties over measuring and projecting consumption emissions”.55 The CCC also noted that there were fewer UK policy levers that could be used to reduce imported emissions. Therefore, consumption-based emissions should be taken into account alongside (but not replace) production emissions as part of a comprehensive strategy to reduce the UK’s overall contribution to climate change.

III. What should the Government response be to the CCC’s 2013 progress report and should the carbon budgets should be relaxed?

43. As explained in response to question I above, the latest climate change science and economic evidence strongly suggests that the UK Government should follow the CCC’s latest recommendations and should not relax the existing and proposed carbon budgets.

44. In the context of the Fourth Carbon Budget (2023–27), the CCC made clear that the budget could be delivered at a manageable economic cost representing less than 1% of UK GDP by 2025 (with additional costs in the region of 0.1% of UK GDP if the CCC’s more ambitious global emissions reduction offering was adopted). However, the CCC also rightly warned that “planning for a lower level of ambition would carry three risks. It could result in investment in carbon-intensive assets in the period to 2020 which, while compatible with meeting the first three budgets, would impede further progress in the 2020s. It could fail to develop adequately technologies that will be required in the 2020s. It could also fail to put appropriate policies in place far enough in advance of the fourth budget, resulting in limited investments with long lead times and limited supply chain expansion. It could therefore necessitate scrapping of high-carbon assets and/or the purchase of high-cost carbon credits in the 2020s.”56

45. The review of the Fourth Carbon Budget in 2014 provides the Government with an important opportunity to redress the climate of investment uncertainty which has resulted from two years of Government divisions (often displayed in the media) on the future of the UK’s climate and energy policy and to ensure that the importance of the Climate Change Act on policy making is fully understood in departments across Whitehall.

46. To date, there has been one major legal challenge involving the Climate Change Act—the landmark Heathrow Judicial Review of March 2010. This case made clear that some Government departments—in this case the Department for Transport—had yet to take on board the full implications of the Act in their decisions and approach to policy making. It is an open question whether the lessons from this case have been fully absorbed across Whitehall.

47. In the Heathrow case, the judge ruled that the former Government’s entire aviation policy needed to be changed to ensure that it was consistent with the Climate Change Act. Making aviation policy decisions (such as the decision to expand Heathrow) without making reference to climate change developments—and the Act in particular—was deemed “untenable in law and common sense”. It is very likely it would be even more untenable for the UK Government to make future decisions on other policy areas on the same basis.

13 May 2013