Examination of Witnesses (Question Numbers
130-139)
Mr Murray Birt, Mr Matthew Farrow and Mr Dwight Demorais
9 JULY 2008
Q130
Chairman: Good morning and thank you very much for
coming on this beautiful summer day! I am sure that you would
prefer to be inside rather than out! May I explain a couple of
matters formally. This is a formal evidence taking session, so
a transcript will be made. That will be circulated to you as soon
as it is available, so you can have a look through it and see
if there are any errors and slips that have came in and correct
it. It is also being webcast, so there is a slight possibility
that somewhere in the ether somebody may be listening. As I always
say, we have never ever had any evidence that that is the case.
I do apologise for keeping you waiting; we had a few matters to
tidy up before we reached this session. Again, thank you very,
very much for coming. Would you like to begin firstly by introducing
yourselves and then, if you would like to make a general comment,
we can get on to questions and answers.
Mr Farrow: I am Matthew
Farrow; I am Head of Environment and Energy at the CBI, so emissions
trading falls within my area of responsibilities. I will make
a statement in a moment and let my colleagues introduce themselves
first of all.
Mr Birt: My name is Murray Birt; I am
Senior Policy Adviser for Energy at the CBI.
Mr Demorais: I am Dwight Demorais; I
am Public Policy Adviser to Lafarge Cement UK and also the British
Cement Association.
Mr Farrow: I will keep this short as
I am conscious that your lordships will want to get into the detailed
questions. The starting point is to say that the CBI clearly sees
climate change as a huge threat to the economy and to UK society.
For a good time now we have supported strongly binding national
targets and we are very clear that business needs to play its
role in meeting those targets. Last year we produced a report
of our Climate Change Taskforce which set out a detailed set of
proposals showing how we felt that the UK could get back on track
to meet its long-term 2050 target and in that report, as in our
previous statements on climate change, we made very clear that
we felt that emissions trading should be one of the core policy
tools, if you like, to generate a carbon price for the economy
and to encourage least cost abatement options at the same time
while being able to set an absolute cap on emissions which is
particularly important. We are very clear that EU ETS has a major
role to play and we are also clear that it needs to be improved
from the learning phase, Phase 1, and indeed from Phase 2 of current
phase. We feel that the Commission's proposals are broadly on
the right lines but, in our policy paper which I think you will
have seen, we have set out our own thoughts on how those proposals
could be improved and we are very happy to discuss any of those
aspects.
Q131 Chairman: May I begin by raising
the point of certainty because what comes through very strongly,
not just from you but from a number of other witnesses, is the
need to have certainty and, once there is certainty, people can
start planning, they can start committing their investment levels
and they know where they are. Firstly, do you think that the Directive
as it currently is gives us an adequate degree of certainty? Secondly
and I suppose to tease you a little, you actually say that the
movement from 20 per cent to 30 per cent ought to be dependent
upon and, as soon as you use words like "dependent upon",
you are introducing an element of uncertainty.
Mr Farrow: A great question! What I will
do is give the general CBI perspective on this and then Dwight
might want to say a little about, from an individual company perspective,
how important certainty is. Business certainly does want more
certainty. We accept that you never get absolute certainty in
life or in business, but I think that the Directive does go a
good way towards providing a certainly much improved level of
certainty, so having a longer phase up to 2020, making very clear
what the cap will be, and setting out a projection for the cap
after 2020 gives business some indication of the longer term proposals
for the Commission. We feel that it is certainly a big step forward.
On your point about whether we are trying to have it both ways
in a sense by the point about the move from 20 to 30 per cent,
what we are trying to do with that proposal is introduce some
certainty around business concerns such as suppose an international
agreement is done in Copenhagen next year but actually it turns
out to be a fairly loose and weak agreement but the political
enthusiasm means that the politicians say, "It's the best
deal we have, it's the best we can do and it should be ratified
straightaway", the risk is that business is then exposed
to a sudden uprating of the targets and a sharp tightening of
the ETS cap against the background of an agreement which actually
may not achieve very much internationally. We certainly hope that
there will be a sound, strong agreement in Copenhagen but we felt
that it was important to debate the question of supposing that
the agreement is actually quite a weak one and we felt that it
was important to guard against the risk that that instantly leads
to the uprating of the targets. That is why we raised the question
of, would it not make sense to have quite rigorous scrutiny of
what comes back from Copenhagen and possibly a co-decision procedure
in order that we can all be assured that, if we are going to go
up to a 30 per cent target, we have the right international background.
You are quite right to say that that is going to extend the timescale
and introduces some uncertainty of process, but we felt it important
to try and give business some certainty that they would not just
be left exposed with a weak agreement and suddenly rushing more
sharply uprated targets. Dwight, I do not know if you want to
say something from a company perspective about certainty.
Mr Demorais: Certainly in terms of business
investment cycles and how we plan our investment, as a company,
Lafarge were taken somewhat by surprise at some of the vagueness
of the proposal and, as a result of that, our Chairman and Chief
Executive announced publicly that the company would suspend one
billion euros of investment into Western Europe until we had greater
certainty on which sectors are likely to be designated as subject
to carbon leakage. In the UK, that affects us very starkly because
we are currently planning the building of a brand new state of
the art cement works in Kent that has a budget of about £200
million. That investment unfortunately is on hold right now and
our company is saying, "We are quite used to managing business
risk but this is a political risk too far; we simply do not know
whether, if we spend £200 million in the UK or £1 billion
in Western Europe, we are suddenly going to be subject to imports
from non-carbon constrained countries because the Commission have
not told us". From a business certainty point of view, there
is no question but that it is affecting our investment decisions.
Picking up on what Matthew said, the move from 20 to 30 per cent
is clearly also an issue of planning for us. If we have a broad
agreement in 2009 out of Copenhagen, that will be great but how
do we transpose that into hard targets and certainty? If, say,
we do not get to that point until 2017-18, does that mean that
we move from a projected target of 20 per cent to 30 per cent
which we are going to have to achieve in two or possibly three
years? We are simply not clear exactly what we are aiming at here.
Q132 Chairman: What would you need to
know to unlock the hold on your £200 million investment?
Mr Demorais: What we need to know is
whether cement is likely to be designated as a sector subject
to carbon leakage because, if we can see that there may be equalisation
in the system in place that allows us to compete on a level playing
field with non-carbon constrained countries, that would help us
to make that decision. At the moment, we do not know whether we
are or we are not. The Commission have suggested that maybe cement
is not an energy-intensive industry subject to carbon leakage
and we would argue very strongly against that.
Chairman: That nicely prepares the way
for the next series of question from the Earl of Arran, which
is simply tell us what you know about carbon leakage.
Q133 Earl of Arran: It is a massive and
I have found very complicated subject. Taking some points from
your positioning paper, I really have three questions. Firstly,
are you able to elaborate on the set of criteria that you propose
should be used to determine susceptibility to carbon leakage?
Secondly, in your opinion, how likely is it that the Commission
will be able to produce their recommendations in time to agree
them as part of the Directive? Thirdly, would you explain how
your preferred policy for dealing with the risk of carbon leakage,
that of free allocation to vulnerable sectors, should be applied.
Mr Farrow: Perhaps I could begin and
again my colleagues might want to add some detail. We feel that
the key criteria is whether a company within emissions trading
which is bearing a carbon cost can pass that cost through to their
customers without losing market share internationally and/or undermining
their ability to attract investment if they are an international
company. We feel that the sort of criteria which are going to
be needed to assess that are going to be factors such as, what
is the cost of carbon at various possible levels under the system,
what does that represent in terms of a proportion of a company's
profit margins, what it is value added and what is the trade exposure
of the company? Is the company trading pretty much within a European
market where all companies would face the same cost of carbon
or is it trading very significantly in an international market?
Is that market price sensitive? Those are the sort of criteria
which we think are significant. The Draft Directive, from memory,
hints at similar sort of set of criteria but does not go into
a lot of detail. Defra in their consultation spell out more closely
a set of criteria which actually I think are fairly close to the
ones we pick up in the brief and we are certainly very clear in
our mind that this needs to be as far as possible an evidence-based
discussion. Many sectors will feel, rightly I think, that they
are potentially vulnerable and a decision has to be made under
the scheme so that it will give certainty to companies like Lafarge
and we think that it needs to be an evidence-based process as
far as possible. Can it be done within the Directive in that timescale?
I think that will be tight and I guess that it is difficult to
be certain. The Commission are pushing back quite strongly and
saying, "This is terribly complicated. We are putting resource
into it". I think that the question in my mind is whether
they are putting sufficient resource into analysing the issues.
This is a subject which has been debated certainly in the UK for
some time. Companies, consultants and the Government have produced
various analyses. It may be difficult to get it into the Directive
itself but we certainly feel that the Commission's proposed timescale
which is not to identify the sectors until, I think, June 2010
and not to decide on the measures they might use to protect the
vulnerable sectors into another year after that, does seem far
too leisurely, if you like, and creates just the uncertainty about
which my colleague was talking. I do not know if Dwight wants
to add anything.
Mr Demorais: I think that pretty much
covers it. It is a fact that we have been preparing data and a
number of sectors have been preparing data for submission into
the Commission and they have a huge amount of data. What we are
not clear about is why it has taken the Commission so long to
actually come to the indications. We do not even necessarily at
this moment need firm decisions. I think that we need to be given
an idea of who is likely to fit this category of carbon leakage.
We simply do not know that. It is a real threat. Just looking
at import figures into the EU27 since 1999, in 1999 from non-Annex
1 countries, imports were approximately three million tonnes.
In 2007 it was over 15 million tonnes. That, we believe, will
be significantly increased if there is no equalisation scheme
for those sectors that are actually designated as subject to carbon
leakage. We see anecdotally similar things happening in the Philippines,
for instance. They put a special tax of $10 on a tonne of cement
and imports there went from zero to 40 per cent virtually overnight.
So, we do have illustrations of that which is why it is so important
to get an early indication of which sectors are subject to carbon
leakage.
Q134 Chairman: Can you give us a bit
of guidance using the criteria—and you say that there is
not a great deal of difference between you and Defra—as
to what sort of proportion of UK industry would fall into the
carbon leakage sector? Have you any idea? Clearly, everybody is
trying to get in there, are they not?
Mr Farrow: I am sure that many people
will have a case to make. Defra have not publicly said what proportion
they would expect to be covered by the at risk category. If you
look at research, they commissioned a report, the Climate Strategies
Report, which indicates that two or three sectors appear to be
disproportionately at risk of which cement is one, lime is another
and iron and steel is a third, and those sectors do stand out.
I do not have the figures in front of me, although we can send
them to you, but I think those sectors are a fairly small proportion
of UK economy as a whole. Of UK manufacturing, again they are
of a minority but not all manufacturing is within the ETS of course.
I am afraid that I do not have a figure—I do not know if
Dwight can help—for what those sort of sectors amount to
in terms of ETS emissions. Our feeling is that while it seems
clear from the evidence that some sectors are in a very stark
position, the Climate Strategies Report is a consultant's report
based on modelling and analysis. I think it is quite right that
other sectors perhaps feel that the way in which the modelling
was carried out does not reflect the particular feature of their
industry or feel perhaps that the data used was out of date and
that more recent data gives a different picture. I think it is
important that those sectors should have a chance to make their
case to the Commission and then we would hope that the Commission
would make an objective judgment based on all the evidence that
they have. Certainly some sectors do appear to be in a particularly
stark position.
Mr Demorais: I would like to add one
point to that and that is as to the nature of the data collection.
At the moment, it is all pretty historic. It is looking at what
has happened in the markets in terms of imports in different sectors.
I think that we would be foolish not to take a forward look and
actually model what might happen in the market at different carbon
costs. We can see what has been happening historically but we
need to model what is likely to be, how the markets will behave
and therefore how we will really assess carbon leakage in the
future markets. That has not been asked for by the Commission
and that troubles us.
Q135 Lord Cameron of Dillington:
As we move towards 2020 where you get fully auctionable allowances
which you seem to more or less support, what do you expect to
happen between 2013 and 2020 that is going to overcome the problem
of carbon leakage? How is that going to change?
Mr Farrow: The concern is that it may
not and the Commission proposal is that the power sector can cope
with auctioning from 2013 and we broadly accept that. The Commission
then argue that two further categories of company, those which
are at risk of carbon leakage and those which are not at significant
risk of carbon leakage, and the ones which they deem are not at
significant risk they feel should have a transition towards full
auctioning over that timescale and we think that that is acceptable
because, if they are not at risk of carbon leakage, they need
time to adjust, clearly, before they bear a full carbon price,
but that should be the aim. The Commission then argue that the
third category of sectors that are at risk of carbon leakage should
receive possibly free allocation or possibly broader adjustments—and
we can debate those two options perhaps in a moment—over
that time period if there is no international agreement in place.
The Commission's hope is that international agreement will solve
carbon leakage problems. As I say, we think that that is clearly
the ideal and is something we should all work towards but, if
that does not happen, we feel that free allocation against a good
technology benchmark would be required for the at risk sectors
up to 2020 and quite possibly beyond.
Mr Demorais: When we talk about free
allocation, it is not 100 per cent free allocation. What we have
accepted is that, from 2013, we will have a reduced cap which
would reduce by 21 per cent. So, when we talk about the 100 per
cent, it is not really 100 per cent, it is more like 80 per cent.
Mr Birt: There is another subsequent
issue in terms of electricity consumption. Some sectors such as
aluminium or chloralkali, some of the chemicals industries, use
a lot of electricity and, because the electricity sector is having
full auctioning, the current price will be in place in electricity.
So, that needs to be taken into account when sectors are being
judged at risk of carbon leakage as well.
Q136 Chairman: Otherwise, the whole of
the aluminium industry comes out of Iceland.
Mr Birt: Yes.
Q137 Lord Brooke of Alverthorpe: Which
sectors are in this stark position that you describe, Mr Farrow?
Mr Farrow: We have not given an absolute
view ourselves because we feel that it should be an evidence-based
discussion. We do not have all the evidence as an organisation.
If you look at the Climate Strategies Report which Defra commissioned
and to which they always point as one of the best pieces of evidence
around at the moment, I think that suggests that cement certainly,
iron, steel, lime I believe and potentially parts of the chemical
sector, appear to be sectors, on the evidence of that report put
together, for whom the carbon cost is a pretty big proportion
of their gross value added, the denominator they used, and also
sectors that trade internationally on a price-sensitive basis.
As I say, it does appear from the evidence that those sectors
are particularly exposed. We feel other sectors which may be more
marginal according to that report should have the opportunity
to come forward if they feel that they have a strong evidence-based
case to say, "Actually, we feel that we are at risk as well".
I think it is important that sectors have an opportunity. We recognise
that not all sectors will be equally at risk and that a decision
has to be made.
Mr Demorais: In fact, in terms of the
cement industry being recognised, certainly reports like the Climate
Strategies Reports, did say that, but the European Commission
take the view that actually cement is quite expensive to ship
around the world and therefore we are probably not subject to
carbon leakage because of being too expensive to bring it. That
is not the case. It is on-land transport that is the costly part.
You can move it probably economically within a 200 kilometre radius
of its import point and, if you draw circles around the UK import
terminals, that covers the whole of the UK. It is actually very
cheap to put it on a barge and ship it around the world.
Q138 Chairman: There is something going
on my brain that I cannot get around. Clearly, the definition
of carbon leakage is that you cannot pass on without you losing
market share, but that is not a stable situation. That depends
upon market conditions in the market at any particular time.
Mr Demorais: Absolutely.
Q139 Chairman: It is a dynamic, it is
not a given. That makes things extremely complicated.
Mr Farrow: I think that is partly why
the Commission are saying that it is going to take them quite
a long time to work it out. The point worth making is that, as
an organisation, we do accept that it is difficult, that a decision
has to be made and that it is impossible to provide absolute guarantees
to companies within the scheme that they can be protected, if
you like, against all risks of carbon leakage. Against that, we
accept as an organisation that, given the threat of climate change,
we do need an Emissions Trading Scheme with an absolute cap if
we are actually going to be serious about meeting new targets
and tackling the issue and therefore there is a trade-off to be
made and we feel that our proposals around how you can guard against
carbon leakage give us a good chance of providing an acceptable
adequate level of protection for sectors most at risk, but I think
that business collectively is swallowing hard and recognising
that there are no absolute guarantees but it still feels that
we have to progress with ETS as being the best tool that we have
to try and drive a cost-effective Commission's programme.
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