Examination of Witnesses (Questions 453
- 459)
TUESDAY 8 JULY 2008
Mr Steve Read, Ms Coralie Laurencin and Dr Karsten
Neuhoff
Q453 Chairman:
Welcome to Dr Neuhoff from Cambridge University and to Coralie
Laurencin and Steve Read from Climate Change Capital; thank you
for spending some time with us this afternoon and thank you to
Dr Neuhoff for your written answers to our questions, which arrived
a little late for us to have read them but they will be useful
to have on record. Feel free to answer the questions anyway when
they are put to you. Please may I start and ask you does renewable
energy deserve any support, in your view, beyond that of setting
a realistic price for carbon? Would carbon reduction be achieved
more economically by setting a carbon emissions target rather
than a renewable energy target?
Dr Neuhoff: I think if you want to look
at this question it really is a question of where we want to go
with this policy altogether. If you start from the IPCC recommendations,
you want to reduce European CO2 emissions probably by 70 to 80
per cent to deliver global emission reductions of 50 per cent.
If you want to deliver these emission reductions by 2050 there
are various options on the table. We certainly would have a lot
to do on the energy efficiency side and we can hope for some contribution
from nuclear fusion, but it is very uncertain whether that comes
forward. There might be some contribution from nuclear energy
but again it only can deliver a share of the overall energy, and
some people think that carbon capture and sequestration can play
an important role but again as a bridging technology. Altogether
I think we will require a large share of renewable energy if we
want to deliver against our climate change objectives. Therefore
the 2020 targets are a question of transition, where do we want
to go by 2050, and then to see how do we have to frame the market
arrangements to create the right incentives to support this transition.
Will the carbon price signal by itself provide all the right incentives
for this? I think not. There are three main concerns that I would
have. The first one is that if we want to take a lot of renewables
forward we need a portfolio of renewable technologies. Various
of these are at an early stage and we will need a lot more learning
about these technologies in order to get them to the quality and
the quantity that we want. Many of the renewable energy technologies
are at the stage of the Ford Model T—to use a comparison
from the car industry—but we want to have energy technologies
that can compete with current cars. That will require a lot of
learning and internationally a lot of production of these technologies,
even though they might currently be more expensive. In the energy
sector it is very unlikely that technology companies or utility
companies will upfront that investment because at the end the
new technologies deliver the same products so why would they go
for the more expensive technology. We cannot use patents to protect
the learning by doing, because it does not seem to work in the
engineering sector. Also, electricity produced from renewable
technologies is the same product so product differentiation which
we use for mobile phones to create incentive for innovation does
not work either. With non of these traditional approaches to innovation
working, the public has directly provide incentives and pay for
technology learning. The second reason for specific renewable
targets is that to get to those larger shares of renewables we
have observed—and the recent renewables review has just
published documents on this—that it is going to be a challenging
transition. It does not only imply building a few wind turbines,
it implies, as we have discussed in the previous session, changing
the market design and changing some of the great infrastructure
and operation, but it also implies training a lot of engineers
and people that actually can operate the system, so we have to
slowly start and we cannot do that too quickly. 15 per cent renewables
by 2020 is a good start. Thinking of the overall objective and
drawing any trajectory to where we want to go by 2050, the 2020
target is not a very ambitious objective but more a minimum requirement
of for a renewables trajectory to 2050. The third motivation for
a specific renewables target is related to the question who will
take forward these investments, and there I have a certain concern
especially in the power sector. Incumbent utilities have made
a lot of money with their existing assets. Across Europe only
in Spain an incumbent utility was very active in investing in
renewables—that was because they had a growing electricity
demand with growing GDP so they went forward very actively to
take that forward.[6]
Across the other countries it was mainly the entry of new project
developers facilitated by support schemes that brought forward
renewable technologies on a larger scale. So we need to provide
a framework that allows for new entrants to compete in the market
even if they do not co-operate with the incumbents. There is also
a big role to play for the incumbents. People in incumbent utilities
that want to take forward renewables have to be able to show to
their management and stakeholders that only by competing in the
renewable sector they can make profits in the future. If they
do not compete in the renewable sector then new players will come
into this sector and can take forward projects, so I think that
is where they need the support.
Q454 Chairman:
Does Climate Change Capital share those views?
Ms Laurencin: We completely share those
views and in our view the most important part of what Karsten
said is that the carbon price is too low to deliver some of the
technologies that we do need to deliver the targets, it is not
just about the onshore wind which may be competitive at today's
prices and with today's carbon price. There are other technologies
which need more maturing, need more support—biomass is one
that is definitely on that list—and if you add to that the
fact that there is implied volatility in the electricity price
and in the carbon price you do not have the visibility that today's
prices will last for the investment timeframe so renewables do
need more support aside from the carbon market. Maybe the one
last thing I wanted to add to what Karsten said is that renewables
provide added benefits which we have not discussed so far, they
provide security of supply and they do provide emissions reductions
but they also provide jobs and industrial building. All of those
are valuable things and justify the added cost that the renewable
policy would provide.
Q455 Lord Moonie:
Less than half of our greenhouse gases from heat are covered by
the EU Emissions Trading Scheme. Could the ETS be extended, or
some other scheme brought in, to spur the deployment of renewable
heat sources?
Ms Laurencin: From our point of view
it is difficult to imagine that you would extend the ETS to include
heat more widely. We tend to think that heat needs specific incentives
and those have been carried out in other countries so it is interesting
to see what countries have done. We tend to think that heat networks
should definitely be a priority, that everywhere where you are
setting up new industrial developments with maybe residential,
commercial or industrial buildings and facilities it is interesting
to support the development of heating networks. These need some
form of specific incentive and in our view they should be viewed
pretty much as a water product, so they need the type of regulation
that water assets need, so a concession model, a type of regulated
monopoly model that you can work around with the investment. For
renewable heat, specifically in homes, we feel that those require
grants to individual house owners and possibly supply chain support
to make the renewable heat resources available.
Dr Neuhoff: Extending the ETS to the
very small installation would be really complicated because it
creates the same problem we discussed previously with the ROC
trading scheme for small installations. One could go upstream
with the trading scheme. This is clearly not pursued at the European
level and is not in the draft envisaged in the draft Directive
so it would not be possible to do that before 2020. But it would
be in theory possible to implement. Secondly, it is quite important
to have incentives for national governments to take renewable
heat policies forward because it is national governments that
know best what is suitable in their specific circumstances. Hence
that renewable target and policy instruments to deliver the target
need to be kept in the national domain. Part of the policy response
could also be to implement carbon taxes or at least start to abolish
the VAT rebate on the use of conventional fuels in domestic heating.
This question brings back this fuel poverty issue and raises the
a question whether to redefine the measure of fuel poverty. As
long as fuel poverty is measured as a share of income that is
spent on fuel, any increases in fuel expenditure will push up
the fuel poverty index. If instead you compensate and say that
you can provide subsidies to fuel-poor households, then those
households can choose whether they will use the subsidy to pay
for the fuel or for energy efficiency. This would create good
economic incentives. Any government that wants to change this
will also have to change the definition of the fuel poverty index.
Q456 Lord Macdonald of Tradeston:
What expectations do you have for the level of carbon prices in
future years and is anyone currently trading carbon for the period
after 2012?
Dr Neuhoff: Right now they are traded
at €28 per tonne of carbon dioxide, for 2012 it is €32.
2020 is not very much traded but I think you would guess somewhere
around €40. At a recent carbon conference various speakers
suggested it could be in the order of €50 per tonne of carbon
dioxide. This high projection is uncertain and no one would invest
against it. It is like the oil market; over the last years the
oil price was between $50 and $70 per barrel but oil companies
only took forward projects that were viable at $30 per barrel
for oil, so there are uncertainties in there. Part of the uncertainty
comes in terms of what are the drivers? If we continue to have
high energy prices, they will reduce energy demand and CO2 emissions.
Therefore carbon prices could drop quite a bit, but at the same
time if coal prices start to drop earlier we might see a further
shift to coal which has higher CO2 emissions and could push up
the CO2 price. There is, therefore, quite a lot of uncertainty
and we need the carbon price to be flexible enough to respond
to this uncertainty. Thus the carbon price can help to deliver
the emission targets and to create investment certainty for investors
that look at future market shares for their low-carbon technologies.
At the same time we should implement some form of reservation
price or price floor to the carbon price to make sure the carbon
price does not drop below perhaps €15 or €20 and therefore
facilitate some project investments.
Ms Laurencin: If I can add a word, we
also share the expectation that carbon prices will continue to
increase in the future and we base those feelings on the fact
that the proposed directive released by the EU in January which
is currently being debated at the EU level does provide for clear
rules that are very stringent for phase three, so post 2012. Because
there is banking between our current phase which is phase two
and phase three that high expectation of price is feeding back
into phase two, so the outlook that we have is that the carbon
price will continue and become an even clearer signal for investors
and policymakers. That being said, it is not sufficient for investors
in renewables to make their decisions without renewable support
because the clarity is still not there and you cannot hedge yourself
against a carbon price, you cannot find a long term contract.
Even if there are some deals, as Karsten said, there is not enough
market depth for you to be able to have this certainty.
Q457 Lord Lawson of Blaby:
May I ask one particular question of Dr Neuhoff. I was interested
to see that one of the things you are working on at the moment
is border tax adjustment. As the Economic Affairs Committee we
are obviously very interested in the economics of trading, protective
tariffs and so on; is it your view that it is going to be necessary
to have a border tax as indeed President Sarkozy is advocating,
as indeed the abortive Senate ruling in the United States included.
Can you say something about that?
Dr Neuhoff: I will try to do that very
quickly. I am rather concerned about the way it is currently phrased
by Sarkozy and I am rather concerned about the way the discussions
are going in the US Congress. We have been looking very carefully
at which sectors would really be exposed and at the end it is
only about one per cent of the UK economy where carbon prices,
direct or via electricity prices, would really result in higher
production costs which would be really significant. Only some
of them again would face a leakage risk if carbon prices were
in the order of €30 to €50 per tonne. We talk about
clinker which is £400 million value added in the UK. Basic
steel production is only a very small part of the steel industry,
all the subsequent steps are not very energy intensive so where
you might think that border adjustment is a good idea could be
for very specific commodities, five, six or seven, which really
make up an insignificant part of economic activity. The way border
adjustment is currently discussed and the risk in the political
process is that it might be widely applied to address competition,
not environmental, concerns. Perhaps we find some international
framework for discussing border adjustment, some international
agreement to limit the use of border adjustment. This would offer
the opportunity to restricting the scale and scope of border adjustment
to make sure it does not discriminate against foreign producers
but can be used to allow countries to maintain robust carbon prices.
I do not think it should be implemented unilaterally, by the French
or the Europeans. Border adjustments can only be pursued in discussion
with developing countries and emerging economies so they understand
the purpose. I do not think we have to commit to the use of border
adjustment now. We can discuss them internationally and if we
do not find an agreement we can use state aid or freelance allocation
if specific sectors are concerned about leakage. The decision
can wait till 2010 or 2011 post-2012 if there is a long term expected
difference in carbon.
Q458 Lord Lawson of Blaby:
There is a WTO element to this, is there not?
Dr Neuhoff: I like the rules that come
from the WTO in that you can implement, to my understanding, border
adjustments for carbon on both imports and exports. If you auction
certificates, industry faces a cost increase at least at the level
of best available technology. If you compensate exports at the
level of best available technology then domestic producers are
still worse off than their competitors. So border adjustments
do not discriminate against foreigners and is WTO compatible.
It still provides sufficient protection in terms of avoiding relocation
of production facilities to other parts of the world in response
to carbon price differentials. This is, because domestic firms
compete with new foreign installations that use best available
technology[7].
We can therefore pursue a scheme which is compatible with WTO.
This also has the benefit that WTO rules create strict constraints
that reduce the risk of abusing border adjustment for protectionist
purposes. The impact that is more challenging and more risky is
the political fallout. This could happen if border adjustment
is seen to be pursued unilateral, if emerging countries and developing
countries think that developed countries use an instrument of
climate policy against them—as developed countries have
experienced often enough in the past how these instruments proliferate
and can be used for various purposes in the end. We should not
use it unilaterally therefore, but only in an international framework
with other countries together.
Q459 Lord Lamont of Lerwick:
Do you think that the UK—or presumably any country—should
be allowed to count renewable energy towards its national targets
and related perhaps to what has been said already would it be
possible to trade renewable energy (or would it just be green
certificates) across borders in a way that guaranteed that supplies
were additional?
Mr Read: It is highly likely that that
will happen over time. The carbon market within the EU ETS already
demonstrates that where the policy framework and the legislation
is set there are permissible cross border trading certificates.
I am also aware that there have been certain organisations that
have looked at the legality of substituting green certificates
that have been awarded to generating stations in the EU zone into
the UK renewable obligations system, so supply companies that
have a renewable obligation supply in the UK satisfying that requirement
by installing generating capacity in the EU zone. As a secondary
question to this it does raise the possibility that in a cross-border
trading environment where companies are free to install and substitute
certificates into various individual jurisdictions, it raises
the opportunity for arbitraging where obviously the cost of deployment
in a certain jurisdiction is cheaper than the home territory and
it will also automatically lead to the generation being focused
towards that territory where the cost of delivery is lower. That
for me does raise a secondary issue in the UK context and the
issue is that the UK renewable energy strategy is not just about
the price of energy delivery but also a security and stability
of supply issue for the UK. Given that the UK is becoming a net
importer of electricity, certainly a fundamental plank of the
UK renewable energy strategy should be about long term sustainability
and security of supply from indigenous UK sources and therefore
if the ability to substitute credits in from other EU or global
jurisdictions is allowed into the renewable obligations certificate,
if they have a lower cost of delivery in other jurisdictions that
over time will not create additional renewable energy generation
capacity in the UK.
6 The Spanish company Iberdrola has invested actively
in new renewable power generation. Back
7
Border adjustment is set at the appropriate level for these installations Back
| 
