Examination of Witnesses (Question Number
80-99)
Mr Niall Mackenzie, Mr David Capper and Mr Martin
Bond
2 JULY 2008
Q80 Chairman: That will be the first
time ever!
Mr Mackenzie: On this issue; so now you
can test it!
Q81 Chairman: Can we have a look at where
we are and where the revision of the ETS is and the negotiations
at the Council and the Parliament, and they are underway now.
Could you give us an indication of what progress has been made,
what issues have been resolved, what remains outstanding and where
the position of Her Majesty's Government is on the outstanding
issues; and where do you see the time table going at the moment?
Mr Mackenzie: Naturally we have a formal
public consultation going on at the moment on the Emissions Trading
System and its changes, so the government has not adopted any
final positions on anything to do with the Emissions Trading Scheme
because of that; and realistically we do not anticipate difficult
negotiations, let me say, until September time—that is when
it will start working. So in actual fact how the negotiations
have been going so far is in the Council working groups officials
have been effectively walking through the texts; Member States
have been asking lots of questions of the Commission as to what
exactly does it mean. One or two Member States have been putting
down particular positions or concerns and the UK has been playing
its part in that. So, for example, there are some areas that have
been indicated in the consultation paper where we are fairly clear
what we think is the right position; so, for example, the idea
of a single EU-wide cap, we think that is a good idea and so we
have said that in the working group, whilst stressing obviously
that all of this is subject to consultation and indeed the parliamentary
scrutiny process. There are other areas in the consultation exercise
where we are genuinely asking questions in terms of we have not
reached even an initial thought, so we are welcoming views from
industry, environmental NGOs, the public, Parliament and others.
An example of that might be rates of auctioning for different
sectors, different industrial sectors, what would be the right
approach; is the Commission's proposal a sensible place to start?
In terms of the overall timescale the Council of Ministers made
clear earlier this year that we want a first reading deal between
the Council and the Parliament by December, if at all possible;
and by the latest March/April next year. Obviously the European
Parliament rises next year and particularly true of the Emissions
Trading System proposal is that if we did not get agreement to
that by April next year the scheme would not be clear for industry
to base their investments on until late 2010 and 2011, which for
a new arrangement starting in 2013 is quite late. So this particular
investment priority is in terms of getting the decisions agreed
across Europe this year, but also the aspiration to get the whole
package, the Renewables Directive, the Effort Sharing decision
and the Carbon Capture and Storage Directive all agreed in that
similar timescale.
Q82 Chairman: Are you at the stage even
now to identify what you think will be the contentious issues
come September?
Mr Mackenzie: It is hard to say, and
indeed a lot will depend from the UK perspective where we end
up on our policy. If we agree with the Commission and lots of
others do not then that might be less contentious than if we disagree
with the Commission and lots of other Member States. Because the
French Presidency are committed to trying to get this first reading
deal with the European Parliament there will be parallel negotiations
almost in Council and with Parliament, so the views of MEPs will
be quite important; and they are just beginning to produce their
initial reports on the Emissions Trading Scheme. So we will have
to watch what they create as contentious issues as well. So I
think it is a bit hard at this stage. The obvious areas from the
media coverage and the feedback we get from industry in particular
are things like allocation methodology, the balance between free
allowances and auctioning; the risk of carbon leakage, on which
you may have more questions, and the idea that carbon pricing
in Europe might force industry to relocate outside Europe to avoid
the carbon price. I think one of the main things we are very keen
to push—although there seems to be quite a lot of support
in Europe—is better regulation principles. The scheme at
the moment covers quite a range of installations and it is quite
a heavy regulatory burden being in the Emissions Trading Scheme,
and so we want to try and take out the smaller installations,
provided that they are caught by some domestic arrangements. We
are confident in the UK that they would be caught by the carbon
reduction commitment and other measures in the UK, and we would
look to other European countries having similar domestic measures,
and that is currently in the Commission proposals. So that seems
a very sensible de-regulatory approach.
Q83 Chairman: We will be asking about
carbon leakage later but carbon leakage is a function of increased
costs. Has any work been done on the cost impact of the scheme?
The extent to which European industry would be competitively disadvantaged
by adopting this sort of approach?
Mr Mackenzie: Yes, there are two levels
to this really. In the partial impact assessment that we published
alongside our consultation paper we have set out the costs to
the UK economy of the change from the current Emissions Trading
System to what is proposed over a range of scenarios, ie the Commission
proposal preferred outcome, and that sets out clearly the extra
costs to the UK. In terms of industry-wide across Europe, the
UK commissioned last year a range of studies. Together with BERR
we commissioned Oxford Economics, which did some work which fed
into the Energy White Paper. We also commissioned Climate Strategies
to look at this issue and those reports have been published and
we have asked industry for their views on them. These tend to
suggest that the risk of leakage and moving overseas does exist
but probably only for a limited number of sectors. I think the
clear message that comes through from the analyses that have been
done by those experts on our behalf, and internally within the
departments, is that this is very complex and there are lots of
issues about data quality and how you define an industry. For
example, in the early stages of the Climate Strategies' work they
started looking at the construction industry; it was then broken
down into cement and lime, which have different characteristics
and a different extent of risk. Therefore, the UK position, as
we have outlined in the consultation paper, is we think that we
should have a thorough evidence-based approach to it, addressing
this issue across Europe and we should not rush to pick which
sectors are at risk of leakage; we should build on the analyses
that the UK has done and replicate that around Europe and agree
the criteria as part of the political negotiations this year against
which sectors would be judged, whether they are at risk of leakage
or not, then ministers take the decision next year, the middle
of next year, June 2009, as to which sectors are at risk of leakage,
and then the following year decide what the measures are to protect
those sectors after a deal has or has not been done in Copenhagen
at the end of 2009. So certainly from officials' perspective and
the analysis and the conversation we have had with academics this
is a very complex area and it is better to get it right rather
than to rush to a wrong conclusion.
Chairman: Lord Palmer wants to ask a question on
the auctioning business, so if we take it out of order at this
stage.
Q84 Lord Palmer: Yes, I apologise; and
I also apologise for having to leave the moment you have answered
this question, but I have the widow of a colleague coming to see
me. Some of us last week were absolutely amazed to discover the
actual value of auctioning revenues, and many of those who submitted
evidence to us considered that a certain proportion of auctioning
revenues should be reserved for various climate change measures.
But we understand that this suggestion has not been met with your
approval or indeed that of the Council. Perhaps you can kindly
explain the idea of this debate in Council and outline how you
would propose to use the revenues in the absence of hypothecation?
Mr Mackenzie: Certainly. From the UK
perspective, as I am sure you are aware, it is a longstanding
principle of successive governments, and certainly this government,
that we do not use hypothecation. The principal argument obviously
for that is that it should be more efficient for the government
as a whole to make the decisions on priorities for spending, and
if you hypothecate revenues then you limit the efficiency of the
decisions of the government as a whole. That is effectively why
the UK is opposed to it and indeed why quite a number of Member
States have made that clear in their positions at Council. It
is not an issue about environmental good or bad, or the environment
being a good or bad issue to spend money on; it is purely a public
expenditure issue that it is much more sensible to make the decisions
by each Member State at the national level as to what they want
to spend their public revenues on.
Q85 Lord Cameron of Dillington: Landfill
tax is an exception, is it?
Mr Mackenzie: As with all long-standing
government positions there are always exceptions! And that is
the debate obviously that will take place in the coming months,
to get the right sort of balance between what issues merit hypothecation
and what do not.
Q86 Viscount Ullswater: I suppose, as
a supplementary to that, you would not be in favour of sharing
some of the revenues gained by auctioning with other countries
within the EU?
Mr Mackenzie: No, we have made it quite
clear in our consultation paper that we think this idea of the
ten per cent redistribution of auctioning allowances to other
Member States is not the right mechanism; that the Emissions Trading
System should be about creating the commercial incentives to reduce
emissions, not as a means of transferring wealth around Europe.
Obviously the Commission and a number of Member States have taken
a different view.
Q87 Chairman: Do you think that the government
will be under pressure in negotiations to give some indication
that a share of the revenues would be used for environmental benefits?
Mr Mackenzie: I am sure the government
will be under pressure, but whether the government reacts to it
obviously is something you will probably have to ask the ministers.
It is a very lively debate; we have received a number of representations
already as part of the consultation from the UK industry who thinks
that there should be hypothecation, and there are a number of
European trade associations and other Member States who think
that hypothecation or earmarking is the way forward. But there
will be a wide range of issues on the whole package, not just
on the Emissions Trading System, where we will come under pressure,
and that will be down to the skill of the negotiators and ministers
in the final negotiations to get the best deal for the environment
and the UK.
Q88 Baroness Sharp of Guildford: If we
go back to the general principles of the ETS. The revised ETS
is one pillar in the EU's climate change and energy strategy.
One of the witnesses we have heard suggested that perhaps the
UK was putting too much emphasis on the ETS alone to promote the
transition to a low-carbon economy. Could you tell us what are
the other pillars in the government's strategy for achieving its
emission reduction targets? And what would you identify as the
remaining market barriers to the long term infrastructure investments
that may be required across the economy, and what flanking measures
might be needed to remove them?
Mr Mackenzie: Certainly. Ministers have
made clear repeatedly that the Emissions Trading System is a principal
means of incentivising the transition to a low-carbon economy,
but it is only one mechanism, and the extent to which it is above
all others I think is always open to debate, and we like a mixed
economy. As an example I would cite the fact that the government
is introducing the Carbon Reduction Commitment. The Emissions
Trading System puts a price on carbon on the electricity that
is generated—or the generation of electricity—but
then the Carbon Reduction Commitment, which will start in 2010
will add a further incentive to businesses to use that energy
efficiently. So you could say that carbon is being priced twice,
but that is because it is to encourage people to use their energy
efficiently. There is a range of other measures already in existence;
obviously the Climate Change Bill, which you will have debated
already in this House and is currently in the other place, sets
a framework for further measures in addition to Emissions Trading
and other measures. We have the Climate Change Levy and Climate
Change Agreements, which have been very successful in incentivising
industry to reduce emissions. There is the Renewables Obligation
and zero carbon homes in terms of building regulations, again
encouraging private individuals to have more energy efficient
homes. The Carbon Trust and Energy Saving Trust give advice to
business and customers. So there is a whole range of mechanisms
that are used, and indeed we keep these under review. The Energy
White Paper last year set out our current range of policies and
measures; but depending where debates on the Climate Change Bill
go and the EU negotiations, obviously further measures may be
required to move us more quickly to lower carbon levels. But these
are the kinds of issues ministers continually consider and indeed
will be very happy to debate with you.
Q89 Viscount Ullswater: Perhaps we could
turn to the level of the agreement, the 20 per cent and the 30
per cent. It was put to us by a previous witness that taking the
decision to work for the 30 per cent reductions now, which I know
is dependent on seeking international agreement, would offer business
more of the certainty that it requires to make long term investments.
What is your view on that?
Mr Mackenzie: I understand the concern
that industry has fully and we are very engaged, both officials
and ministers, in discussions with industry. It is what kind of
certainty; industry always wants certainty, we all do, and they
are very good at managing risk and managing uncertainty. The government's
job is obviously to minimise the scope for uncertainty. The package,
as it is currently framed, the proposals from the Commission give
certainty on the 20 per cent and provides a mechanism whereby
we move up to 30 per cent on the conclusion of an international
deal. The uncertainty is the international deal, not the proposal.
Indeed, the UK is very supportive of this trigger mechanism in
the proposals whereby once an international deal is ratified we
automatically move up to the 30 per cent and do not seek to renegotiate
it amongst 27 Member States, because that would increase the uncertainty
even further for industry, and it is principally because of that
concern that we have that we favour the stepping up. If we started
on the 30 per cent now we could either take a unilateral decision
to say that the UK will do 30 per cent or Europe will do 30 per
cent, come what may, which would give the certainty industry want,
but that is going beyond what ministers collectively around Europe
have agreed should be the unilateral starting point of Europe,
which is 20 per cent. And you then get into the tactics of how
you play Europe's position versus the world in negotiations, which
is not my area of expertise, but it would obviously be clear that
if we started saying that we are going to do 30 per cent come
what may then our interlocutors in the global negotiations would
ask for a higher figure. So if the Committee or indeed industry
have ideas on how to give greater certainty we are very open to
receiving them, but we think that the Commission's proposal as
it stands is the best mechanism that we can see for committing
unilaterally to 20 per cent, providing no room for re-jigging
things once an international deal is done. Whatever the deal ratified
is, Europe then steps up to the higher level and industry is certain
that there is not another year of negotiation within Europe to
decide what the UK does versus Germany, and that gives the certainty
industry needs.
Chairman: Can we move on to scope and Lord Cameron.
Q90 Lord Cameron of Dillington: You say
that you wish to ensure that there are opportunities for expanding
into new sectors and they are all considered. It would be interesting
to know what particular sectors you are referring to. We have
considered the possibility of including possibly agriculture and
road transport—and forestry is a particularly important
one because forestry probably worldwide is the biggest emitter
of greenhouse gases, albeit deforestation—and whether you
have considered these?
Mr Mackenzie: We have and we continue
to consider these things and how wide the scope should be, and
I think the key issue I would like to make you aware of is the
extent to which how much can be widened how quickly. The ultimate
aim is to have a global carbon market with as many sectors as
can be included as possible because that then makes sure that
the emissions reductions are done at the least cost in the most
economically efficient manner. But there is an issue about the
impact on the current scheme. It is very focused on heavy industry
at the moment, therefore the Commission's proposals to include
N2O emissions from adipic acid and nitric acid production and
CO2 emissions from petrochemicals are all very similar to what
is in the current scheme, so they are an incremental approach.
When you get to other areas such as surface transport, agriculture
and forestry there are different problems and issues to be considered.
The Commission at this stage have said for all those sectors that
they do not think the time is right now and further analysis is
needed. The UK Government as a whole has done quite a bit of analysis
on these sectors already and we are doing more. At this stage
it is unclear the extent to which we would have concrete enough
proposals to share with the Commission and the rest of Europe
to feed into these negotiations.
Q91 Lord Cameron of Dillington: Is the
de minimis threshold set at the right level at the
moment, in your view?
Mr Mackenzie: Again we are consulting
on that. The Commission had proposed 10,000 kilotons. I think
our consultation paper suggested that 25,000 might be a better
number.
Q92 Lord Cameron of Dillington: Because
you have raised it.
Mr Mackenzie: To a slightly higher level,
yes. But, again, just again from consultation and discussion with
industry we know that there are some sectors where this drives
a line through the sector; so half the sector would be in and
half out, and what are the competitiveness impacts for that? Are
they relatively small or would you be creating a perverse incentive
to encourage industry and installations to be a certain size just
to get around the regulations. So there are lots of issues we
have to look at to make sure where the balance and the advantage
lies. I say that there are two separate issues: that de minimis
is about better regulation and the correct level of burden for
an EU regulation, but a widening scope is about creating incentives
to other sectors. The Department for Transport spent quite a bit
of time last year looking at surface transport. There are details
on their website of the analysis done so far on that, and we can
send the Committee details, if that would be helpful[1].
Again, the Commission is not yet comfortable with how that would
be integrated into the system. I do not think we are yet as a
government collectively agreed as to whether that is the best
incentive for road transport. Similarly, on agriculture and forestry
Defra obviously has done quite a lot of work on agriculture and
we are continuing to do more work about incentivising emissions
reductions and whether a market-based mechanism is the right way
to do it. Again, we have a problem with agriculture obviously
if you have lots of small farms—25,000 tonnes or 10,000
tonnes a year of CO2 emissions, there are not many farms at that
level. But there may be other ways of doing it. New Zealand obviously
is looking at a different approach; they are looking at agriculture.
So we are looking at this and doing a further analysis.
Q93Lord Cameron of Dillington: Where does Carbon
Capture and Storage fit into the whole ETC programme?
Mr Mackenzie: The principal issue with
Carbon Capture Storage is that under the current directive if
you buried or sequestered the CO2 under the current regime you
would still be required to surrender the CO2 allowances. So the
essential thing in the review of the Emissions Trading System
is to make sure that if you bury it and sequester it you do not
then have to surrender the allowances, and that then provides
a good commercial incentive to enable people to make money by
burying the carbon—they can do commercial arrangements with
those who are producing the CO2 to either take their allowances
or some other consideration. There is obviously separately the
whole issue about incentivising CCS demonstration projects, but
that is a separate issue as opposed to the pure Emissions Trading
System, which is just making sure that the trading system does
not penalise Carbon Capture and Storage.
Q94 Lord Cameron of Dillington: Do you
have support for that view, for the Carbon Capture and Storage
being of benefit?
Mr Mackenzie: Yes. I do not think there
is anyone in Europe is opposed to the core provision that if you
bury the CO2 you do not have to surrender the allowances. Evidently
it is a sensible way to do it.
Q95 Viscount Brookeborough: Is it that
the integrity of the scheme is very important and therefore by
widening the scope to areas which is difficult to monitor or difficult
to verify because there are not at the moment any measurements
taking place—and I include transport and things like that,
which might go across EU Members boundaries—that that might
dilute the integrity of the scheme?
Mr Mackenzie: That is one concern and
it is a real concern. But most of these integrity issues can be
address through time, so if you think forestry is a good example
of that, although there are real concerns about the temporary
nature of forests that if you chop down trees then you have to
have a system for making sure that you accurately and robustly
record the amount of CO2 sequestered in sinks. But it probably
is all doable in time and that is what we are looking at and we
are spending quite a bit of time looking at the way to do that.
If you include a big sector like forestry or transport it will
have an impact on the price of allowances in the Emissions Trading
System, so you have to be clear that the way in which you frame
a new sector coming in is done to minimise the price impact. We
would not want a sudden price drop because of expanding to a new
sector because industry will have made their investments on certain
assumptions. And that is the beauty of the Commission proposal,
that it is giving certainty to investors by setting a long term
signal as to where the carbon price is going, by gradually reducing
the cap. If you bring in a sector which effectively weakens the
cap unknowingly then that will destroy the signals you are giving
industry. So it is how you manage that.
Q96 Viscount Brookeborough: To get back
to auctioning, the Commission proposes that there should be 100
per cent auctioning allowances in the power sector from 2013 onwards,
and levels of free allocation in other sectors reducing from 80
per cent in 2013 to zero in 2020. In your EM you note that you
support greater use of auctioning generally, but would need to
asses the Commission's proposals for specific sectors. What has
been the outcome of those assessments and how should free allowances
come into operation?
Mr Mackenzie: The Chancellor obviously
announced in the last budget that the UK was in favour of a 100
per cent auctioning for the electricity sector and electricity
generation sector. Other than that we have not finished our assessments.
Q97 Viscount Brookeborough: And this
is 100 per cent in the future, 100 per cent auctioning after free
allocations are given should a sector come into it?
Mr Mackenzie: How it would work under
the Commission proposal—and David will correct me if I get
this wrong because emissions trading is not the most simple to
explain, and I hope I am being clear—the Commission proposal
decides what are the levels of options in the three categories.
There is auctioning for the power sector. Other industry and those
sectors requiring protection because of carbon leakage might have
different arrangements. The electricity sector's allowances will
be based on the number of allowances that they would get as their
share of the overall emissions, and that would then be auctioned.
Have I summarised that correctly?
Mr Capper: Yes, essentially they will
get no free allocation, is the way that it is described in the
draft directive. So if you are an electricity generator as defined
by the directive you will just receive no free allocation, which
often we describe as 100 per cent auctioning, which amounts to
the same thing—it is just a different way of saying the
same thing.
Q98 Viscount Brookeborough: So in the
future if new businesses or new industries come into it they would
not get a free allocation.
Mr Mackenzie: For the power sector, yes.
Q99 Viscount Brookeborough: Sorry, from
beyond the power sector.
Mr Mackenzie: For other sectors it is
not yet decided. The Commission proposal is ramping down from
80 per cent. The UK has not yet formed a view on this; it is part
of the issues we are considering. It seems a reasonable starting
point for the debate, which seems to be our view, because the
reason for free allocation is because people have sunk assets.
People have made investments without a carbon price and if you
then charge them for carbon immediately and you set up the scheme
in 2005 and there is a risk of stranded assets. The extent to
which that argument then continues by the time you get to 2013
right down to 2020 when the scheme has been running for such a
period is then debateable. But these are the kinds of discussions
we are having within government and with industry and seeking
people's views as to what the right reasons for setting the levels
of auctioning should be. The longer you have free allocation you
are at the mercy of bureaucrats such as me operating a system
which may make wrong judgments about what the right level of allocation
for industry is. If everyone has to buy allowances they will only
buy the allowances they need. The issue then is the pace at which
industry takes on these costs and whether it is too fast, and
that is the judgment on which we will advise ministers and ministers
will have to take a decision.
Mr Capper: Were you also asking about
new entrants; was that part of your question? You were asking
what happens if there is a new installation?
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