House of Commons Environmental Audit Committee

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

Second Report of Session 2007–08

Report, together with formal minutes, oral and written evidence

Ordered by The House of Commons to be printed 19 February 2008

HC 354 (Incorporating HC 1073-i-iii, Session 2006–07) Published on 10 March 2008 by authority of the House of Commons London: The Stationery Office Limited £0.00

The Environmental Audit Committee

The Environmental Audit Committee is appointed by the House of Commons to consider to what extent the policies and programmes of government departments and non-departmental public bodies contribute to environmental protection and sustainable development; to audit their performance against such targets as may be set for them by Her Majesty’s Ministers; and to report thereon to the House.

Current membership Mr Tim Yeo, MP (Conservative, South Suffolk) (Chairman) Gregory Barker, MP (Conservative, Bexhill and Battle) Mr Martin Caton, MP (Labour, Gower) Mr Colin Challen, MP (Labour, Morley and Rothwell) Mr David Chaytor, MP (Labour, Bury North) Martin Horwood, MP (Liberal Democrat, Cheltenham) Mr Nick Hurd, MP (Conservative, Ruislip Northwood) Mark Lazarowicz, MP (Labour/Co-operative, Edinburgh North and Leith) Mr Ian Liddell-Grainger, MP (Conservative, Bridgewater) Mr Shahid Malik, MP (Labour, Dewsbury) Mrs Linda Riordan, MP (Labour, Halifax) Mr Graham Stuart, MP (Conservative, Beverley & Holderness) Jo Swinson, MP (Liberal Democrat, East Dunbartonshire) Dr Desmond Turner, MP (Labour, Brighton, Kempton) Joan Walley, MP (Labour, Stoke-on-Trent North) Mr Phil Woolas, MP (Labour, Oldham and Saddleworth [ex-officio]

Powers The constitution and powers are set out in House of Commons Standing Orders, principally Standing Order No. 152A. These are available on the Internet via www.parliament.uk.

Publication The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at: www.parliament.uk/parliamentary_committees/environmental_audit_committee. cfm.

A list of Reports of the Committee from the present and prior Parliaments is at the back of this volume.

Committee staff The current staff of the Committee are: Gordon Clarke (Clerk); Sara Howe (Second Clerk); Richard Douglas (Committee Specialist); Oliver Bennett (Committee Specialist); Susan Monaghan (Committee Assistant); Stella Kin (Secretary); and Elizabeth Gardner (Sandwich Student)

Contacts All correspondence should be addressed to The Clerk, Environmental Audit Committee, Committee Office, 7 Millbank, London SW1P 3JA. The telephone number for general inquiries is: 020 7219 6150; the Committee’s e-mail address is: [email protected]

References In the footnotes of this Report, references to oral evidence are indicated by ‘Q’ followed by the question number. References to written evidence are indicated by page number as in ‘Ev 1’.

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 1

Contents

Report Page

Summary 3

Introduction 5 The Climate Change Levy package is made up of four main elements 5 The CCL package is the second largest measure in the UK Climate Change Programme 6 Issues tackled in this report 6

Effectiveness of the Climate Change Levy 8 It is hard to isolate the impacts of the Levy 8 Most of the Levy’s impacts were established before it came into operation 10 Other views on the size of the Levy’s impacts are more sceptical 13

Effectiveness of the Climate Change Agreements 15 Evaluating the impacts of the CCAs is extremely complex 15 The process of complying with Agreements has led to energy savings 19 The use of a tax discount has been key in capturing business interest 21 The stringency and value for money of the CCA system should be increased 22

Recycling CCL revenue 26 The effects of the cut in NI Contributions are complicated and controversial 27 The work of the Carbon Trust should be expanded 28 Evidence for the effectiveness of Enhanced Capital Allowances is mixed 31 Hypothecation of revenues should be more transparent, and funding increased 34

Levy exemptions for renewable energy and combined heat and power 36 The exemption on green electricity has increased demand but not supply 37 The exemption on combined heat and power has had limited effect 38 Both exemptions are compromised by the Levy discount for CCA participants 39

Economic impacts and administrative complexity 40 The CCL package does not impose a damaging burden on UK business overall 40 Businesses face a complex tangle of overlapping climate change policies 42

Further options for reform 46 Refocusing the Levy on carbon would be difficult and of questionable benefit 46 Agreements should be based on absolute cuts in carbon emissions 49

Overall lessons for climate change policy 50 Businesses have not always acted according to economic theory 50

2 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

Conclusions and Recommendations 51

Formal Minutes 57

Witnesses 58

List of written evidence 59

List of unprinted evidence 60

List of Reports from the Committee during the current Parliament 61

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 3

Summary

The Climate Change Levy package is the second biggest element in the UK Climate Change Programme, by estimated size of carbon savings. In design, it is a bold and innovative suite of policies. In practice, notwithstanding the difficulties in (and disagreements over) measuring its impacts, carbon savings appear to have been significant; but were strongly front-end loaded and have eased off since soon after its introduction.

According to the evaluation accepted by the Government, the Levy will reduce annual UK

CO2 emissions by 12.8 million tonnes by 2010. But according to this work, these savings have come mainly from the effect its announcement had on raising awareness of the potential for energy savings; most of these savings were therefore the result of actions taken before the tax actually came into operation. The Levy itself (i.e., the amount of tax it imposes on energy use) has had relatively little effect on business emissions, especially in the case of SMEs and large but non-energy intensive organisations.

The Government believes that Climate Change Agreements (CCAs) will reduce annual

CO2 emissions by an additional 7 million tonnes by 2010; although businesses covered by Agreements tend to argue that CCAs are more effective than the Levy. It is extremely difficult to evaluate the effectiveness of CCAs for a number of reasons; for instance, different economic sectors have been allowed to choose different baseline years from which to measure their progress. Anecdotal evidence suggests that the process of complying with CCAs has galvanised business interest in finding energy savings, and that key to this has been the incentive of the tax discount they offer. CCA targets have not been tightened since the first set of performance results (2004) revealed the extent of early overachivement; they should be made more stringent in the 2008 review period.

The Government says that it recycles all CCL revenues to business in the form of a 0.3% reduction in employers’ National Insurance Contributions (NICs), dating from 2001, and through funding for the Carbon Trust and related programmes. This argument is complicated and controversial, not least because NICs were raised by 1% in 2003. In any case, funding for low carbon investment and advice to business should be significantly increased.

The exemptions on the Climate Change Levy for ‘green electricity’ and combined heat and power have had minimal effect on the construction of new renewables and CHP capacity, essentially because they are worth too little money.

The CCL package does not impose a damaging economic burden on UK business overall, and may in many cases be positive, through encouraging greater resource productivity and stimulating energy efficient industries.

Businesses face a complex tangle of different climate change policies. To an extent, however, this is a result of the efforts of Government to tailor its policies to the needs and drivers of different types of business, in the understanding that one size of instrument does not fit all. The Government is also currently consulting businesses on ways to streamline and simplify these policies. Despite the range of different business-oriented climate change

4 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

policies, there is still a shortfall in policy for small businesses.

While it might have been preferable for the Government to have introduced an economy- wide carbon tax, once it implemented the Levy as a ‘downstream’ tax, the scope for basing it on carbon rather than energy was greatly restricted, and its benefits made questionable. Climate Change Agreements, on the other hand, should be reformed so that their targets are in the form of absolute reductions in carbon emissions, rather than relative improvements in energy efficiency.

The CCL has not worked quite as expected. According to economic theory, businesses should have acted rationally by seeking to reduce their costs through increased energy efficiency. In practice, they appear to have needed an extra stimulus to change their approach to energy use. This has profound implications for climate change policy more widely. If even large companies require additional policies to drive behavioural change, this must be all the more true for small businesses, public bodies, and private households. The Government should report on how it is applying this lesson the across the whole of the UK Climate Change Programme.

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 5

Introduction

The Climate Change Levy package is made up of four main elements 1. The Climate Change Levy (CCL, or the Levy) is a tax charged on the energy used in business (and the public sector), its aim being to encourage organisations to use energy more efficiently, and thereby to reduce greenhouse gas emissions from these sectors below the levels they would otherwise have reached.

2. The Levy emerged from recommendations in the Marshall Report, published in 1998.1 The policy was then announced in Budget 1999, legislated for in the Finance Act 2000 (as part of the initial UK Climate Change Programme), and came into effect in April 2001. Different rates are charged for different fuels (Box 1), based on their energy content; electricity attracts the highest rate because of the proportion of the energy used to generate it which is lost in combustion, transmission, and distribution. Levy charges appear on organisations’ fuel bills, with the revenue collected and passed on to HM Revenue & Customs by power companies, in the same manner as VAT.

Box 1 CCL rates on different fuels (for 2007–08)

The Levy is charged on energy delivered to business and public sector users as follows:

• Electricity, at 0.441 penny/kilowatt hour (kWh); • Gas, at 0.154 p/kWh; • Coal and coke, at 1.201 p/kilogram (kg); and • Liquefied Petroleum Gas, at 0.985 p/kg.

Note: From 1 April 2008, all rates will be increased in line with inflation. Source: HM Treasury, Budget 2007, Pre-Budget Report 2007 3. In outlining plans for the Levy, the Government stressed the need for special consideration for energy-intensive industries exposed to international competition.2 The result was the introduction, alongside the CCL, of Climate Change Agreements (CCAs, or the Agreements), enabling companies in a number of industrial sectors to claim an 80% discount on the Levy in return for agreeing to meet certain energy efficiency targets. As of 2007 there were Agreements covering 51 different industrial sectors, comprising around 4500 ‘target units’ (a facility, or cluster of facilities, owned by one company and sharing a single target).

4. A further element of the CCL package is the use of Levy revenues to accelerate energy efficiency. Budget 2001 was clear that: “All [CCL] revenues will be recycled back to business”.3 One element of this was through a 0.3% reduction in employers’ National Insurance Contributions (NICs) from April 2001. The second element was through the

1 In March 1998 the then Chancellor appointed Lord Marshall, then President of the CBI, to investigate ways in which economic instruments could be used to drive reductions in greenhouse gas emissions. Lord Marshall reported in November 1998, making a number of policy recommendations designed to reduce emissions without harming business competitiveness. Among the policies implemented from these recommendations were the CCL package and the UK Emissions Trading Scheme. HM Treasury, Economic Instruments and the business use of energy: A report by Lord Marshall, November 1998. 2 HM Treasury, Budget Report 2001, March 2001, para 6.22 3 HM Treasury, Budget Report 2001, para 6.20

6 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

creation in 2001 of the Carbon Trust (to provide carbon reduction investment, loans and advice to business); as well as an Enhanced Capital Allowance (ECA) scheme, administered by the Carbon Trust, to encourage the purchase of energy efficiency equipment.

5. The fourth main element of the package is a total exemption from paying the Levy on alternative energy sources in order to encourage their development, chiefly:

ƒ Electricity generated from renewable sources (with the exception of large-scale hydroelectric power plants with a declared net capacity of more than 10 megawatts); and

ƒ Energy used in ‘good quality’ combined heat and power stations, and electricity generated by combined heat and power.4

The CCL package is the second largest measure in the UK Climate Change Programme 6. At the time the revised UK Climate Change Programme was published, in March 2006, the CCL and CCAs were projected to be two of the three most important contributions towards the Government’s 2010 target of a 20% reduction in UK CO2 from 1990 levels. Since then, projections of their impacts have been reduced slightly, but the CCL still features as the second biggest measure on its own, with a projected annual saving of 5 12.8MtCO2 (million tonnes of carbon dioxide) in 2010 (Table 1). Between its announcement in 1999 and the end of 2005, the Levy alone is estimated to have saved a 6 cumulative total of some 60.5MtCO2. The Government projects that the Levy and Agreements together will be responsible for around a third of all the carbon savings achieved by UK policy by 2010.7

Issues tackled in this report 7. Notwithstanding its importance to the UK Climate Change Programme, the CCL package has from its beginning been the subject of some controversy. For instance:

ƒ a number of organisations, including the Royal Society, have criticised the way in which the Levy is charged on energy use rather than carbon emissions directly; they have argued that this reduces its impact on carbon emissions, and leads to some anomalies and perverse outcomes;

4 In addition, the exemption also applies to other alternative energy sources: electricity generated from coal mine methane; fuel used in certain processes using recycled materials which compete with dual use processes; and waste Liquefied Petroleum Gas, low value coal and solid fuels re-sold. 5 To be precise, the figure originally published by the Government was 3.5MtC (million tonnes of carbon). Recently, the Government has begun expressing all carbon emission figures in terms of carbon dioxide; this report follows suit, converting original Government figures from carbon into CO2 where necessary. One tonne of carbon is contained in approximately 3.67 tonnes of carbon dioxide; 3.67 (or more precisely, 44/12) is the ratio of the molecular weight of carbon dioxide to the atomic weight of carbon. To convert an original savings figure of 3.5MtC into CO2, one multiplies by 44 and divides by 12, yielding 12.83 MtCO2. 6 HC Deb, 24 July 2007, col 1000W 7 “Speech by the Rt Hon Gordon Brown MP, Chancellor of the Exchequer, to United Nations Ambassadors, New York”, HM Treasury press release 31/06, 20th April 2006

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 7

Table 1 The CCL and CCA were two of the top three policies in the 2006 Climate Change Programme 2006 CCP measure Estimated annual 1 (Top five in order of size of reductions in 2010) reduction in 2010 (MtCO2) Phase II of the EU ETS 29.3

13.6 Climate Change Levy (since reduced to 12.8)2 10.6 Climate Change Agreements (since reduced to 7)3

Renewables Obligation 9.2

Voluntary Agreement package (including reform of 8.4 company car tax and graduated Vehicle Excise Duty) Notes: 1 All figures originally expressed in million tonnes carbon. Here converted into million tonnes carbon dioxide by multiplying by 44, and dividing by 12. 2 The estimated savings from the CCL are taken from a 2005 evaluation by Cambridge Econometrics. The report assumed the Levy would rise with inflation from 2005, rather than 2007 as has happened; thus this estimate

was slightly overstated. The Government now uses a revised savings estimate of 3.5 MtC (12.8MtCO2) in 2010. 3 The estimated contribution of the Agreements has been reduced because of rising market energy prices: this suggests the Agreements’ energy efficiency targets would have had less impact in themselves, given that higher energy prices could be assumed to drive energy efficiencies and carbon savings in any case. Sources: Climate Change: The UK Programme 2006, Defra, March 2006; NAO, The Climate Change Levy and Climate Change Agreements, August 2007 ƒ environmental groups have argued that the terms of the Levy have been too weak, not least because the rates at which it was charged remained frozen for the first six years— meaning that in March 2007 Levy rates were around 15% lower in real terms than when originally introduced;8

ƒ business groups have complained that there is a profusion of different policies targeting the business sector, and that this can lead to excessive administrative burden, especially where the same firm is subject to multiple regimes;

ƒ concerns have also been raised about whether the targets and auditing arrangements of the Climate Change Agreements are sufficiently stringent, and thus the extent to which the CCAs offer value for money.

8. The Environmental Audit Committee has monitored the development and impacts of the Climate Change Levy package, and the criticisms made of it, since it was first proposed in 1999; but this is the first report we have devoted entirely to it. In 2006 we summed up the views expressed over a number of Committee reports:

EAC has in the past expressed concerns about the Climate Change Levy and its associated negotiated agreements—in particular, the failure to increase the rates of the Levy since its introduction and the size of the savings which the Government claims have been achieved through Climate Change Agreements. The evaluation conducted by Cambridge Econometrics and published a year ago suggested that the

8 HM Treasury, “GDP deflators at market prices, and money GDP”, 20 December 2007, www.hm-treasury.gov.uk

8 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

Levy was not having a significant impact on industry. It concluded that energy efficiency improvements within industry might well have occurred in the absence of the Levy, as a result of technological change and the relative decline of UK energy- intensive sectors; and that, if the Levy had had an effect, it was likely that this was simply due to its announcement rather than to the ongoing impact of Levy rates. The recent Budget has at least increased the rates, though it remains to be seen whether the scale of the increase will have any significant impact.9

9. In July 2006 we asked the National Audit Office (NAO) to carry out a study into the effectiveness of the CCL and CCAs. In August 2007, following publication of the third set of biennial results from the Climate Change Agreements, the NAO published its report (Box 2). This found that both the CCL and CCA had driven genuine carbon reductions; but that the impact of the Levy was now harder to discern, and that CCAs were now forecast to achieve less than formerly projected.

10. Drawing on the work of the NAO, plus the evidence we received from a variety of sources, in this report we attempt conclusively to address these issues. The overarching questions we examine in this report are:

ƒ How effective has the CCL package been in reducing carbon emissions?

ƒ What have been the economic impacts of the CCL package on UK business?

ƒ Should the CCL package be reformed, and in what ways?

• What are the wider lessons to be learned from this policy: both about reducing emissions from the business sector, and about climate change policy more generally? Effectiveness of the Climate Change Levy

It is hard to isolate the impacts of the Levy 11. The Climate Change Levy is simple in principle: as its architect, Lord Marshall, put it, taxes like it “work through the price mechanism, incentivising reductions in the emitting activity by raising its cost.”10 Working out how much emissions reductions the Levy has delivered in practice, however, is complicated. The first reason for this is that organisations do not necessarily respond to rises in energy costs by reducing their energy use by a proportionate amount. This can be because of a variety of reasons, for instance:

ƒ improving an organisation’s energy efficiency may require an initial investment of resources that has to compete with other business priorities, especially given that major capital investment tends to be made in periodic cycles—meaning that if a firm has recently invested in new machinery, it is unlikely to replace it immediately even if more energy efficient alternatives become available;

9 Environment Audit Committee, Sixth Report of Session 2005–06, Keeping the Lights On: Nuclear, Renewables, and Climate Change, HC 584-I, para 37 10 HM Treasury, Marshall Report, para 40

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 9

Box 2 Report by the National Audit Office: The Climate Change Levy and Climate Change Agreements In July 2006 we asked the NAO to carry out a study into the effectiveness of the Climate Change Levy package. The NAO interviewed key personnel from Government, AEA Energy & Environment (the consultants who operate the Agreements with Defra), and certain industrial associations subject to Climate Change Agreements. The NAO further analysed the results reported for the Agreements’ milestone period assessments, and undertook a survey of businesses and sector associations. The NAO’s report was published in August 2007.

Overall findings The Climate Change Levy has driven energy efficiencies and emissions reductions since its announcement in 1999; but its early impact is easier to identify than its ongoing impacts.

Businesses subject to Climate Change Agreements have overachieved against their original targets; this was the result of genuine improvements in efficiency as much as weak targets. However, CCAs are now forecast to achieve less than was originally planned against business as usual projections.

Businesses are unconvinced that the Levy has driven emissions reductions, and are divided over the effectiveness of Agreements.

In more detail, the NAO found:

Climate Change Levy The announcement of the Levy contributed to a significant refocusing of business attention on energy use in the years after 1999. This has driven energy efficiencies and emissions reductions relative to business as usual in both energy intensive and less intensive industries.

The extent to which the Levy has continued to drive further energy efficiencies in more recent years is harder to discern, especially as it has been joined by other policies and drivers since its introduction. Econometric analysis suggests the Levy has permanently raised managerial awareness. However, its impact on energy prices has been limited. Results of the NAO’s survey, conducted in early 2007, suggest it is no longer seen as a major driver of new energy efficiency improvements.

The carbon savings achieved by the Levy across the economy cannot be measured; only estimated. The balance of qualitative evidence broadly supports the major assumption which underlies the most recent estimate of annual savings of 3.5MtC in 2010.

Climate Change Agreements Sectors subject to Agreements have made energy efficiencies and emissions reductions. The negotiation of Agreements and the development of monitoring regimes to measure progress against Agreement targets raised awareness of the potential for energy efficiencies. These efficiencies were then made.

Not all Agreement targets were stringent, but early overachievement against them was the result of genuinely significant improvements in efficiency as much as weak targets.

As with the Levy, the effect of the Agreements in terms of emissions savings can only be estimated. The NAO found no evidence which would undermine the most recent estimate of 1.9MtC. Source: National Audit Office, The Climate Change Levy and Climate Change Agreements, August 2007

10 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

ƒ for most companies energy is a relatively minor component of their business costs; and

ƒ for most users energy demand is relatively inelastic (i.e., they are committed or simply habituated to practices and activities that consume a certain amount of energy, almost irrespective of the cost).

12. The second reason why its impacts are hard to measure is that the Levy is only one factor among many others which affect the amount of carbon emitted by the business sector. Notably, movements in the underlying price of different fuels will be a major factor, often outweighing the changes to energy costs made by the Levy itself. Another significant complication is the changing ‘carbon profile’ of electricity. Leaving to one side electricity generated from renewable or combined heat and power sources, businesses have little control over the fuels used by their suppliers to generate the electricity they use. Since the Levy has come into effect, gas has become more expensive relative to coal, meaning that electricity generators have increasingly switched from one fuel to the other. Since burning coal emits more CO2 than burning gas, this has led to electricity becoming more carbon intensive. This in turn means that even where businesses have responded to the price signal of the Levy by becoming more efficient in their use of electricity, the impact on their carbon footprint will necessarily have been reduced by the rise in the carbon intensiveness of the electricity they purchase. Given the intrinsic difficulties involved in calculating its effects, and in order to improve transparency, we recommend that the Government should give an estimated range of uncertainty for its projections of the Levy’s impacts.

Most of the Levy’s impacts were established before it came into operation 13. Before the Levy came into effect, the Treasury estimated in 2000 that it would reduce annual emissions by some 7.3 MtCO2 by 2010, based on projections of its effects on energy prices and hence demand.11 The most important attempt so far, however, to tease out the effects of the Levy from other factors and estimate its impacts on carbon emissions was carried out in 2005 by Cambridge Econometrics (CE)12 for HM Revenue and Customs, and published alongside Budget 2005. This study drew on actual energy and emissions data in the period since the Levy had been announced, comparing this with projections of what business as usual (BAU) energy use would have been if the Levy had not existed. These projections were made using what the NAO describes as “one of the most sophisticated macroeconomic models of the UK economy available”, built up using historical data on energy use and intensity across different economic sectors.13

14. The study’s conclusions were that the Levy itself (i.e., independent of other factors, including the impacts of the Climate Change Agreements) led to a reduction in annual emissions of 11.4 MtCO2 in 2002 from business as usual projections; and that by 2010 these annual savings would increase to 13.6 MtCO2. In reaching this latter conclusion the study assumed that the Levy would be raised in line with inflation from 2005, rather than from

11 National Audit Office (NAO), The Climate Change and Climate Change Agreements, August 2007, p 14 12 Cambridge Econometrics (in collaboration with the Policy Studies Institute, Westminster University, and the Department of Applied Economics, University of Cambridge), Modelling the Initial Effects of Climate Change Levy, March 2005 13 NAO, The Climate Change and Climate Change Agreements, p 14

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 11

2007 as has actually happened: accordingly, this estimate has since been revised downwards to an annual saving from BAU of 12.8 MtCO2 in 2010. This is the savings estimate endorsed and relied on by the Government.

15. These estimated carbon savings were attributed by Cambridge Econometrics to two separate factors: the ‘announcement effect’ and the ‘price effect’. The second of these is straightforward; as the NAO paraphrases, the price effect “recognises that from 2001 the Levy made energy more expensive and should therefore have reduced demand. Higher prices affect decisions regarding output and investment.” The announcement effect is more interesting; this “assumes that simply the announcement of the Levy in 1999 focused the attention of businesses on achieving energy efficiencies. The result was a reduction in energy demand even before the Levy raised energy prices in 2001.”14 On this, Professor Paul Ekins, one of the lead authors of the Cambridge Econometrics study, told us:

From looking at both the negotiation process for the Climate Change Agreements and the very long lead-time that went into the actual implementation of the Climate Change Levy—a full two years between the report of the Marshall Commission and when the tax was actually levied (during which time the CBI waged an absolutely relentless campaign against the Climate Change Levy, which I remember very well)—there was an enormous information effect, such that with this issue of energy prices, […] we found boards taking an interest in this issue for practically the first time in their lives. It was no surprise to me to find that, in the event, they discovered they could actually save quite a lot of energy in a cost-effective way, and they then went about and did that.15

16. The NAO explained that the carbon savings estimated by Cambridge Econometrics are different to those in the Treasury’s 2000 study for essentially two reasons. First, the Treasury only took the price effect of the Levy into account, whereas CE in addition estimated the impacts of the announcement effect. Second, CE gave a different weight to the price effect than the Treasury. Most interestingly, Cambridge Econometrics attributed most of the impact of the Levy to the announcement effect rather than the price effect. In other words, according to the evaluation of the Levy relied on by the Government, most of the impacts of the CCL were already established before the policy actually came into effect in 2001, and have only marginally increased since then.

17. The National Audit Office report on The Climate Change Levy and Climate Change Agreements presented some evidence which supported the basic premises behind Cambridge Econometrics’ findings. On the evidence for an announcement effect, the NAO stated that a majority of the businesses it surveyed had said that the imposition of the Levy had refocused their attention on energy use; and drew attention to a business survey carried out in 2002 by Green Alliance, which reported similar findings.16

As for the relative insignificance of the price effect, the NAO analysed the impact of the Levy on energy prices as a whole (Figure 1). This showed that when first introduced the

14 NAO, The Climate Change and Climate Change Agreements, p 15 15 Q192 16 NAO, The Climate Change and Climate Change Agreements, p 15

12 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

Figure 1 Fuel price indices for the industrial sector in real terms1 including the Climate Change Levy

Index (1990=100) 200 Gas3 180

160 2 Coal In 2001, the year 140 the Levy was imposed, coal and 120 gas prices rose but electricity fell 100 Electricity 3

80

60 The 1990s were a period of falling energy prices Gas and electricity 40 prices have risen significantly since 20 2003

0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Notes: 1 Deflated using the GDP implied deflator at market prices. 2 Indices based on a survey of the prices (excluding VAT) of fuels delivered to industrial consumers in Great Britain, with the inclusion of an estimation of the amount of Levy paid. 3 Indices based on the average unit value (excluding VAT) of sales to industrial consumers. Source: National Audit Office, The Climate Change Levy and Climate Change Agreements, August 2007 18. Levy’s impact “was not that great a change in the context of historic prices”. On top of this, the Levy is set at a flat rate rather than as a percentage of energy prices; given that market energy prices have increased since 2001 while Levy rates have not been adjusted upwards proportionately (and indeed were completely frozen until April 2007), this means the proportion of energy costs made up by the Levy has been declining since it was first introduced. In other words, in terms of its impact on energy prices, the Levy was introduced at a relatively low level, and has only declined since then. The NAO backed up these findings by citing the results of their survey, which revealed that “companies do not recognise the Levy as a major decision driver”:

All of the Levy-only organisations we surveyed indicated that the Levy currently has no discernible material effect on investment decisions. Those that had invested in energy efficiency were unable to quantify how much of an influence the Levy was in such decisions, if any.17

This led the NAO to conclude: “These results suggest that the Levy was not set at significant rates initially, and has become less significant over time.”18

17 NAO, The Climate Change and Climate Change Agreements, p 17 18 NAO, The Climate Change and Climate Change Agreements, p 17

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 13

Other views on the size of the Levy’s impacts are more sceptical 19. The headline conclusion of the Cambridge Econometrics study, that the CCL had been responsible for significant emissions savings, has received criticism from a number of business groups; although, in making this argument, they have tended to concentrate on the impacts claimed for the announcement effect, while endorsing the finding that the price effect has been very limited. The NAO, for instance, found that of the seven Levy- only businesses it surveyed only one believed the Levy had driven emissions reductions. The UK Emissions Trading Group (UK ETG) told us that while business sector emissions may have fallen below business as usual projections after 2001, this could partly be explained by factors other than the Climate Change Levy, not least the weather (more temperate weather reducing demand for heating or air conditioning). Ray Gluckman of UK ETG argued: “it is believed there were a couple of very mild winters after the announcement of the CCL and that that weather effect was not properly taken into account [by Cambridge Econometrics].”19 EEF and UK Steel also suggested that an economic downturn in the British steel sector in the early years of this decade contributed to the reduction from BAU projected emissions, and that a failure to properly take this into account also skewed Cambridge Econometrics’ findings.20 These broad sentiments of business groups towards the effectiveness of the Levy were shared by Andrew Warren, director of the Association for the Conservation of Energy, who told us: “I really am very dubious as to whether the arrival of what was not a very heavily publicised Levy upon ordinary businesses’ bills […] has made more than a marginal difference.”21

20. A strong theme to emerge from the evidence we received was that, whatever the impacts of the Levy have been overall, its impacts on small and medium-sized enterprises (SMEs) and larger but less energy-intensive organisations (for instance, retail chains) have been less significant. According to the NAO:

The saving brought about by the announcement effect is likely to have been concentrated amongst large rather than small businesses. This is because small businesses generally have fewer resources with which to monitor government policy so are less aware of new announcements. […] Outside of energy-intensive sectors, there is little evidence of the price effect having led to a significant improvement in energy efficiency.22

On this theme, the Federation of Small Businesses drew our attention to research it carried out in 2002 and 2004, which showed that “For small companies, technical problems and the cost of changing production processes are barriers to increasing efficiency but so too is a lack of quality information and advice”, and thus that “uptake of energy efficiency measures [among SMEs] in response to the levy have been negligible.”23 These findings were substantiated by a major study published in 2005 by the Carbon Trust, The UK

19 Q60 20 Q3 21 Q91 22 NAO, The Climate Change and Climate Change Agreements, p 16, p 17 23 Ev 132

14 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

Climate Change Programme: Potential evolution for business and the public sector. As Professor Michael Grubb, Chief Economist at the Carbon Trust, told us:

[I]n the course of our study we received a lot of indications that for the less energy- intensive parts it was not a very effective instrument. It was better than nothing but essentially the price signal of the CCL on its own for organisations which were either very, very small SMEs or which were not energy intensive and totally focused on other things was pretty modest.24

21. Significantly, Professor Grubb explained that this study not only found that the Levy was essentially ineffective for smaller and less energy intensive firms, but that:

[I]n a way the bigger finding in our study or the more, if you like, newsy item was that about half of total emissions associated with business and public sector use were from non-energy intensive sectors—light industry, the commercial sector, the public sector, also many SMEs […]25

As a result, the Carbon Trust’s report recommended the creation of a new mandatory auction-based trading scheme to target these sectors (excluding smaller organisations, falling below a certain threshold for energy use); and in response the Government is planning to introduce the Carbon Reduction Commitment from January 2010.26 This represents a considerable evolution of Government thinking, given that the Marshall Report had specifically justified implementing a tax such as the CCL because it would be more applicable to the majority of businesses than a large carbon trading scheme:

Even when the international trading scheme is fully developed, it is unlikely that all businesses will be involved. Indeed, I doubt whether it will ever be practical for the majority of small and medium sized enterprises (SMEs) and less intensive users in industrial and commercial sectors to participate in the international trading scheme. Taken together, these firms account for around 60% of total carbon dioxide emissions from business, and may offer scope for significant improvements in energy efficiency and reductions in emissions.

Hence, my conclusion is that there probably is a role for a tax if businesses of all sizes and from all sectors are to contribute to improved energy efficiency and help meet the UK’s emissions targets.27

22. Overall, it seems that the Climate Change Levy has not worked as originally planned —particularly for less energy intensive firms and SMEs. Before the Levy was implemented, the Treasury expected that its effect on the cost of energy would drive

24 Q 142 25 Q142 26 The Carbon Reduction Commitment (CRC) is a mandatory auction based emissions trading scheme for the large non- energy intensive business and public sectors. Emissions that are covered under Climate Change Agreements and direct emissions included in the EU Emissions Trading Scheme will not be covered by the CRC. In addition, firms with more than 25% of their energy use emissions in CCAs will be completely exempt. Participants will be required to purchase allowances corresponding to their emissions from energy use, and then surrender them at the end of the year. Government will cap the total energy use emissions by setting a limit on the number of allowances available for auction at the beginning of the year. The auction revenue will be recycled to participants, so the scheme will be broadly revenue neutral to the Exchequer. The earliest the CRC will come into force is January 2010. 27 HM Treasury, Marshall Report, p 2

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 15

significant emissions reductions, and that a tax such as this would be especially suited to being applied to small businesses and larger but non-energy intensive firms; but neither appears to have been the case. The Treasury did not make an estimate of the impacts of the ‘announcement effect’ prior to implementing the CCL, but it now accepts that the majority of the Levy’s impacts came from it. We are left with the impression that the Levy’s reported impacts on carbon emissions have been to an extent unforeseen and serendipitous.

23. While concerned by the weaknesses of the Levy, we welcome the fact that the Government has not ignored these problems. In responding to the recommendations of the Carbon Trust by bringing forward plans for the Carbon Reduction Commitment, the Government is targeting some of the sectors for which the Levy has proved less effective. This shows a commendable flexibility of approach and ability to learn through doing. Effectiveness of the Climate Change Agreements

Evaluating the impacts of the CCAs is extremely complex 24. As with the Climate Change Levy, the idea of the Climate Change Agreements is simple: firms in certain economic sectors (e.g., steel, chemicals, cement, etc.), selected essentially because these industries are both more energy intensive and exposed to international competition, are simultaneously incentivised to become more energy efficient and protected economically, through being offered an 80% discount on the CCL in return for agreeing to energy efficiency targets. As in the case of the Levy, however, what is straightforward in theory is complicated in practice.

25. The most recent figures for carbon emissions from the sectors covered by CCAs were published in July 2007. These show that as of December 2006 emissions from businesses covered by Agreements had gone down by 16.5 MtCO2. However, one cannot treat this figure as representing the amount of carbon savings attributable simply to the Climate Change Agreements. This is firstly because, as with the Levy, the Agreements are one among several other factors affecting firms’ carbon emissions. These include changes in the absolute levels of output in different sectors, reflecting wider market upturns and downturns; as well as changes in energy efficiency driven by rises in energy costs— including the effects of the Climate Change Levy itself (or in this case, the 20% of the Levy paid by businesses covered by CCAs).

26. Secondly, particular aspects of the design of the CCA system make it impossible accurately to compare the performance of business sectors covered by Agreements over time. Principally this is because the progress of firms under the CCAs is not measured from a single baseline year. As the NAO explains:

Sectors report on progress against targets against a range of baseline years, rather than since 2001 (the start of the Agreements); each sector was permitted to choose its baseline year. In allowing this Defra sought to allow credit to be given for early actions and to avoid penalising businesses that were already making efficiencies of

16 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

their own volition. The choice of baseline years was also determined by the quality of data available and consideration of significant events in the industries. […] 32 of 46 sectors opted for a baseline year of 1999 or earlier: at least two years before the Agreements began. This means that the total savings [of 16.5 MtCO2 …] are not a measurement of carbon reductions from a single point in time, and include savings achieved before the policy was implemented or even announced. In most cases there is no detailed information for the years between the baseline year and the first milestone year, 2002.28

27. It is not just that the years from which baseline emissions are taken vary from sector to sector; the baseline emissions figures themselves are subject to ongoing revision. This is to reflect the changing composition of each sector as new firms join or old firms or factories are shut down: baselines are adjusted at each biennial target period to reflect the estimated energy use in the baseline years of the participants currently within the Agreements. Between 2002 and 2004 baselines changed in 31 of 46 sectors—in 13 of these, by more than 10%.29 As the NAO states: “Wherever there have been changes, it is meaningless to compare the original baseline set in 2001 with the current energy performance of a sector.”30

28. Another way of evaluating the effectiveness of the CCAs would be to focus on progress of participants against their specific targets under the Agreements. Overall, progress has been very impressive: by 2004 businesses covered by the CCAs had achieved annual emissions savings of 8.8 MtCO2 in excess of their targets, and according to the NAO the results published at the 2006 milestone indicate that progress is being maintained such that CCAs should deliver their overall projected impact on emissions in 2010. However, this in itself cannot give a full picture of how effective the Agreements are as a carbon reduction tool: the significance of progress against targets obviously depends on the stringency with which the targets have been set. On this the NAO comments: “it seems likely that some proportion of Agreements targets have not been as stringent as possible.”31 From its survey, the NAO found that 24 businesses subject to Agreements considered their 2010 targets to have been set at “achievable” levels, and that 10 firms were willing to indicate that their milestone targets had been “relatively simple to achieve” thus far.32

29. One reflection on this is that CCA targets were specifically set by the Government at levels calculated to yield ‘cost effective savings’—in other words, firms should save more money from reduced fuel bills than they spend in implementing energy efficiency measures to achieve such savings. In this sense, it would hardly be surprising that businesses had achieved good practice against their targets.

30. Some observers have argued that it may not have mattered whether CCA targets were strict or not, in that these targets may not have been the prime motivation for participants to reduce their energy use in any case; instead, they argue, the Agreements have led to

28 NAO, The Climate Change and Climate Change Agreements, p 27 29 NAO, The Climate Change and Climate Change Agreements, p 28 30 NAO, The Climate Change and Climate Change Agreements, p 28 31 NAO, The Climate Change and Climate Change Agreements, p 27 32 NAO, The Climate Change and Climate Change Agreements, p 29

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 17

changes by a general raising of business attention on energy saving. This would obviously render progress against targets less meaningful as a measure of the CCAs’ success. The NAO observes: “A lack of stringency in the targets may not have limited the effectiveness of the policy: the overachievement […] may be due to better than expected efficiency improvements as much as weak targets.”33 Professor Paul Ekins argued that Agreements had genuinely helped to focus participating firms on finding extra energy savings, while telling us “there is no evidence to me that the targets in the original Agreements were really part of what drove the business response”.34

31. A further complicating factor in seeking to evaluate the CCAs on the basis of performance against targets is that most targets are set in terms of relative rather than absolute reductions in energy use. As the NAO explains:

Where targets are relative, the Levy discount can be secured even if there is an absolute increase in energy use and carbon emissions, providing efficiency has improved sufficiently. This could be the result of production output increasing at a faster rate than increases in energy use. Unsurprisingly, relative targets were the more popular amongst businesses: only four sectors have umbrella Agreements based on absolute targets […]35

Indeed, as of 2006, 10 sectors saw rising carbon emissions, while managing to improve their carbon / energy efficiency per unit of output.36

32. Finally, CCA participants have been able to use certain ‘flexing mechanisms’ in order to be counted as meeting their targets even where in fact they have not been able to do so through their own actions. Under one of these mechanisms firms were able to have their targets adjusted if they had changed the energy intensiveness of their output; this was used by 2.5% of target units in the 2006 milestone period, though it will not be allowed in future periods. The main mechanism used in these circumstances so far, and almost the sole mechanism to be used from the 2006 period onwards, is carbon trading. In the 2006 period, a third of target units bought carbon credits in order to make up a shortfall to their targets.37 These trades were made via the UK Emissions Trading Scheme (UK ETS), which ran from 2001–2006. Until the end of 2006, credits for use in meeting CCA targets came from two sources: (i) firms operating within the UK ETS, where these emitted less than their allocated levels they were able to sell surplus emissions credits, and (ii) other CCA participants, where these had overachieved against their targets and were thus able to sell credits equal to this overachievement.38 (Following the closing of the UK ETS, its trading mechanism continues to operate but solely for CCA participants; thus (ii) above is now the only source for CCA credits.)

33 NAO, The Climate Change and Climate Change Agreements, p 30 34 Q192 35 NAO, The Climate Change and Climate Change Agreements, p 21 36 British Meat Federation, Ceramics – fletton, Craft Baking, Eurisol [Mineral Wool], Glass, Gypsum Products, Poulty Meat Processing/Feed, Printing, Rendering, and Slag Grinders. NAO, The Climate Change and Climate Change Agreements, pp 41-2 37 NAO, The Climate Change and Climate Change Agreements, p 23 38 NAO, The Climate Change and Climate Change Agreements, p 23

18 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

33. While in theory the use of carbon trading has no adverse effect on the amount of carbon savings generated by the system as a whole, this depends on the stringency of the original targets: if some targets are weak, then the firms to which they apply may be able to overachieve relatively easily, and thus provide a high volume of cheap credits with a concomitantly lesser effect in driving emissions reductions. Regarding the UK ETS, the first source of credits up to 2006, a Defra report from 2007 describes it as having provided an “over-allocation of allowances […] linked to generous baseline setting and the inclusion of non-CO2 GHGs [greenhouse gases].”39 This points to a serious weakness in the rigour of the CCA system so far, and underlines the fact that in all carbon trading schemes it is the level of the cap, rather than the trading mechanism, which is the key element. It also makes looking at the number of firms and sectors which have passed their Agreements targets an even less useful measure of the environmental impacts of the CCA system.

34. The Government’s main assessment of the CCAs’ impacts avoids the problems listed above; though it is not without problems of its own. What the Government has done, the Treasury first at Budget 2000 and subsequently Defra following the 2004 and 2006 milestones, has been to try to isolate the impact of the Agreements by projecting what business as usual emissions from participating firms would have been in their absence. At Budget 2000 the first round of targets were projected to yield annual savings of at least 9.2 MtCO2 in 2010 against BAU. These projected savings were then increased in 2004 to 10.6

MtCO2 in 2010, based on updated BAU projections, more stringent CCA targets set after the second milestone period, and the inclusion of twelve new sectors within the Agreements system. However, the most recent projection, made in July 2007, is for the impact of the Agreements to go down again, to 7 MtCO2 in 2010. The essential reason for this downward revision is the rise in energy prices in recent years. Updated projections of business as usual emissions are now lower, to take into account the effects these higher prices will now be having on energy demand and efficiency; this means that the added impact on emissions of the Agreements is now considered to be lower. To put it another way, BAU modelling now assumes that firms would have made more efforts to save energy anyway, even if the Agreements did not exist. The NAO’s comment on this is instructive:

The reduction in forecast impact does not mean that businesses are failing to achieve their targets, but it does illustrate the volatility of forecasting. Estimates of impact can change significantly even though businesses party to Agreements are entirely on track to meeting their targets. This ‘shifting of the goal posts’ applies to any policy whose success is measured against business as usual.40

35. In summary, it appears to us that isolating and enumerating the impacts of the Climate Change Agreements is even more complex and uncertain than accounting for the impacts of the Climate Change Levy. It is remarkable that the performance of most sectors is measured from a variety of different starting points that predate the start of the Agreements, in three cases stretching all the way back to 1990. While measuring the impact of Agreements by reference to business as usual projections avoids some of these problems, it also creates new ones of its own: as we have argued in previous

39 Defra, Climate Change Instruments: Areas of overlap and options for simplification, October 2007, p 65 40 NAO, The Climate Change and Climate Change Agreements, p 24

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 19

reports,41 BAU projections intrinsically lack certainty, and depend very much on the quality of the assumptions and data used to generate them. For these reasons we recommend that, when reporting figures for the impacts of the Agreements, the Government gives a range of uncertainty attaching to them.

The process of complying with Agreements has led to energy savings 36. The same 2005 Cambridge Econometrics study on which the Government relies for its assessment of the Climate Change Levy also made an evaluation of the Climate Change Agreements. This was slightly less positive in its assessment of the CCAs, however. While stressing the uncertainty of their results due to some intrinsic limitations in the modelling, the authors suggested that the majority of businesses would have met their CCA targets whether or not the Agreements existed. They came to this conclusion based on assumptions as to the continuation of historic downward trends in emissions from the business sector, due to a “combination of technological change and relative decline in UK energy-intensive subsectors of manufacturing”.42 The study also found that, aside from the continuation of these historic trends, the price effect of the reduced-rate CCL (i.e., the 20% of the Levy paid by business covered by Agreements) would have been sufficient, on its own, for the majority of sectors to improve their energy efficiency in line with their targets, even if they had not actually been set such targets.43

37. At the same time, the CE authors were keen to stress that “it should not be interpreted from this that the CCAs were ineffective.” In related research, one of the study’s lead authors, Paul Ekins, suggested that, judging by the very significant over-achievement against the CCA targets at the end of the first target period (2002), the Agreements might indeed have stimulated additional energy savings: “The argument is that the CCAs had an ‘awareness effect’ analogous to the CCL’s announcement effect”.44 As Ekins and Etheridge put it in their study: “Industrial managers were not generally aware of the extent of these opportunities before the process of negotiating the Agreements, but became aware of them during this process”. According to this interpretation of events, “industrial managers persuaded […] the UK Government […] that cost-effective measures were limited, and then went on to prove themselves wrong”.45 The overall conclusion from CE and Professor Ekins is thus that firms would have improved their energy efficiency simply in line with their CCA targets even if the Agreements had not existed, but that Agreements stimulated them to exceed this performance.

38. The amount of carbon savings attributed to the Climate Change Agreements, especially relative to the CCL, was a source of much controversy in the evidence we received. Many business groups argued vehemently not just that the Agreements were responsible for significant carbon savings but that they were far more decisive in driving reductions than the Levy. In doing so, however, such groups strongly endorsed the diagnosis of an

41 Notably: Environmental Audit Committee, Seventh Report of Session 2006-07, Beyond Stern: From the Climate Change Programme Review to the Draft Climate Change Bill, HC 460. 42 Cambridge Econometrics, Modelling the Initial Effects of Climate Change Levy, p 7 43 Cambridge Econometrics, Modelling the Initial Effects of Climate Change Levy, p 7 44 Cambridge Econometrics, Modelling the Initial Effects of Climate Change Levy, p 7 45 Paul Ekins and Ben Etheridge, in NAO, The Climate Change and Climate Change Agreements, p 30

20 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

announcement effect for the CCAs. The memorandum we received from UK ETG was typical in arguing that Cambridge Econometrics had simply got things the wrong way round: “the ‘announcement effect’ of CCAs has been included in the apparent savings achieved by the announcement of the CCL. This leads to an optimistically high figure for the savings from CCL alone. Conversely, the figure for CCAs is believed to be an underestimate”.46

39. UK ETG and many others argued that what could be referred to as the CCAs’ announcement effect really applied to the entire CCA process: not just the process of negotiating targets but, even more, that of putting systems in place to monitor and improve progress towards them. The Manufacturers’ Climate Change Group (MCCG), for instance, said:

It should be acknowledged that the success of the agreements has not only come from the quantitative targets and the resulting reduction in energy usage, but also the qualitative requirements, that required business to develop energy management systems […] CCAs have managed to push energy management near the top of the Boardroom agenda, at a time when energy prices were significantly lower than they are now.47

Gareth Stace of EEF expanded on this theme in evidence:

[We] have seen a huge shift from 1999, when we started to negotiate the agreements, where we would go and ask companies for data in order to form a base year and they would find it very difficult to get that data—you might talk to an engineer and he might have the data in an oily book but he does not see the bills, the finance departments have those. We have seen a huge shift in those companies, where almost every one within that company is aware of the current efficiency of their facility, how that is improving, what they can do to improve it, with new schemes within their company to drive efficiency improvements to meet their Climate Change Agreement targets.

Then we meet companies within the EEF membership who do not have agreements, who cannot get Climate Change Agreements, and the story is very different, and, in my mind, we are almost still back to that place in 1999 where you ask about energy efficiency and it is not really there. I think that is why we are really strong believers in Climate Change Agreements, both for the actual emissions reductions that are taking place […] but also, as I keep saying, for driving this up the agenda and helping those companies […] going beyond their targets and realising that they can do more.48

40. The argument that the CCAs have played a key role in improving companies’ internal awareness of their energy use was endorsed to us by AEA Energy & Environment, the consultancy contracted by Defra to help design, evaluate, and audit the CCA system: “When we started this process many sectors did not really have a clue what their energy performances were like, they did not have good baseline data [… T]he sectors have many

46 Ev 19 47 Ev 121 48 Q14

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 21

more years now of much better quality data”.49 In this context, AEA raised the point that the sector associations, responsible for co-ordinating the relationships of participant firms with Government, including negotiating umbrella Agreements, played an important role in spreading good practice and improving the quality of information on energy use.50 This was echoed by UK ETG, who referred to the way in which the Agreements system has led to the building up of networks within industry, focusing on energy efficiency and carbon emissions, as an “enormous benefit”.51

41. Although there are difficulties in arriving at a firm evaluation of the carbon savings driven by the Agreements, the anecdotal evidence suggests that the process of complying with CCAs has had a very positive effect, leading to a widespread improvement in energy management systems, greater sharing of good practice, and a general raising of energy efficiency as a boardroom priority among participating firms.

The use of a tax discount has been key in capturing business interest 42. Another viewpoint shared by AEA Energy & Environment and UK ETG, as well as a number of others, was on the peculiar effectiveness that appears to derive from the way in which the Agreements are based around a tax discount. Robert Bell of AEA remarked:

We had been working in the field of energy efficiency obviously for many years before the climate change agreements came along, and it is certainly my firm belief [… that] the whole game changed with climate change agreements; there was something about the psychology of getting the tax back that changed. We had been producing case studies and help for industry for many years which showed cost- effective savings were there, but it was not taken up. [… T]he bottom-up nature of climate change agreements where you are forcing people to think of concrete things they can do and in return they get the carrot, that cuts across a lot of the economic theory.52

43. What such evidence highlighted was that, according to economic theory, companies should have been more active in pursuing energy efficiency improvements in any case, in order to benefit from reduced fuel bills. The introduction of the Climate Change Levy was in keeping with such economic theory; it simply sought to add to the existing financial incentive to cut the wasteful use of energy. Given that the targets under the Climate Change Agreements were specifically set by AEA Energy & Environment at levels calculated to achieve cost-effective energy savings, economic theory would again suggest that this would be enough on its own to stimulate significant action. And yet, AEA and others told us that it was the extra financial incentive of claiming a tax discount that was key in making companies act.

44. This was a point made particularly strongly by Andrew Warren, director of the Association of the Conservation of Energy (ACE):

49 Q118 50 Q118 51 Q58 52 Q128

22 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

I suspect that probably one of the reasons why the Agreements delivered savings in the way in which, if you like, one would have anticipated that rational man might have delivered because they were quintessentially cost-effective in the first place, was just simply that it is much more fun saving money from the taxman than it is just saving money. I think it does concentrate minds if you are being told you can save money in that way. I think we have seen this in the residential sector too in the way in which people have sought to deliver the energy efficiency commitment by dint of using ostensibly money off the council tax. It does concentrate minds in a way which you would not get if you were merely making the very rational argument that there is an awful lot of cost-effective energy saving which at the present moment is foregone.53

ACE has for a long time, in fact, argued that simply relying on a price signal alone is not enough to drive behavioural changes in energy efficiency, at either an organisational or personal level. Indeed, describing the interrelation of the tax, discount, and measures required to receive that discount, Mr Warren went so far as to describe the Climate Change Agreements as:

the first example of an integrated policy approach in this context, combining ‘carrots’ (80% discounts), ‘sticks’ (the threat of full payment for non-compliance) and ‘tambourines’ (drawing management attention to energy consumption), which this Association has long described as absolute prerequisites for any successful energy efficiency scheme.54

The stringency and value for money of the CCA system should be increased 45. Certain questions were raised during our inquiry on the extent to which the Climate Change Agreements were sufficiently stringent. A key criticism is that CCA targets were too generous when initially set, have so far been tightened only once since the system began—in 2004, but before the performance data on the first milestone period, from 2002– 2004, were known—and that they were still too generous even after this revision. The Environmental Industries Commission, for instance, wrote to us: “EIC’s Members, who have great experience advising business on energy efficiency, have regularly informed Ministers since the introduction of the Agreements that the potential for savings in the sectors covered is much greater than reflected in the Agreements.”55 Certainly the NAO is clear that there is room for targets to be made more stretching: current CCA targets “are forecast to maintain a steady annual level of additional carbon savings, but will not drive energy efficiency to the next level.”56

46. As the NAO describes, a lack of information, both before the initial targets were set, and during the process of setting revised targets in 2004, hampered the Government’s ability to take a tougher position in negotiating sectoral Agreements. The result was that

53 Q85 54 Ev 49 55 Ev 111 56 NAO, The Climate Change and Climate Change Agreements, p 31

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 23

after setting revised targets in 2004, intended to be tougher and to drive further efficiencies, the Government discovered that many sectors were making more rapid progress than expected—to the extent that 10 sectors had already improved performance enough to pass their newly revised targets for the next three milestone periods, all the way to 2010.57 At the 2006 milestone period the number of sectors that had already met their 2010 targets had increased to 25, very nearly half of all sectors. On this progress at the 2006 milestone Defra has written to us: “This suggests that targets can be further tightened in the 2008 target review”.58 However, while we are reassured by this, we are surprised and disappointed that 2008 represents only the second opportunity for targets to be reviewed since the beginning of the Agreements.

47. We are highly surprised that the Government has not tightened the Agreement targets since data from the first milestone period revealed that both the initial set of targets, and those revised in 2004, were too lax. We recommend that CCA targets should be reviewed at every milestone period.

48. A further concern was raised about the value for money offered by the Agreements. According to Cambridge Econometrics, the 80% discount on the Levy given to CCA participants represented a cost to the Exchequer, in terms of CCL revenue forgone, of approximately £350 million in 2003–04.59 Andrew Warren asked whether the current CCA regime was sufficiently rigorous in terms of driving emissions reductions to justify tax rebate of this size.60 This was particularly appropriate to ask, he felt, given that the Marshall Report had suggested:

[...] that we would get just as much of an incentive there to companies to look at this if the discount was 50% rather than 80%. […] By dint of having a reduction of 80% rather than 50%, there is certainly about £120 million extra that has been forgone […] If you were to ask me whether or not that £120 million which the Treasury have not taken in could perhaps have been better spent in terms of delivery of the end objective, which is improved energy efficiency and improved carbon savings, I have to say the answer would almost certainly be yes. I am dubious as to whether it was strictly necessary to be as generous as the Government turned out to be in the end.61

We might add to this point by drawing attention once again to the fact that CCA targets are meant to have been set at ‘cost-effective’ levels, thus that meeting them ought in itself save companies money.

49. The questions this raises are how far CCA targets should be toughened, as well as whether the size of tax discount provided under the Agreements should be reduced. This in turn partly hinges on the question of how much can be asked of firms under the Agreements without seriously damaging competitiveness. That is to say, how much further potential is there within energy intensive industries to make ongoing energy and emissions

57 NAO, The Climate Change and Climate Change Agreements, p 30 58 Ev 137 59 NAO, The Climate Change and Climate Change Agreements, p 61 60 Q102 61 Q103

24 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

savings, and when and to what extent will ‘cost effective savings’ start to dry up—i.e., when might new levels of energy savings begin to cost more money to achieve than they save in fuel bills?

50. AEA Energy & Environment argued that there was still considerable room for efficiency savings, even from energy intensive industries:

We do not necessarily hear exactly what companies do in order to meet their targets, they are not required to tell us, but my feeling is that at the start of the agreements, in 2001/2002, once companies knew that the game was on and it was going up to board level people found more savings, probably much more low-hanging fruit than they actually anticipated [… C]urrent activities have mainly been directed more at the utility side of energy use and there is scope in many sectors for more energy-saving capability on the process lines—heat recovery, […] installing more efficient motors, but generally looking at “how am I making it, and indeed why am I making it?”, rather than just looking at a new steam system or a new compressed air system. There is still a lot of that basic stuff to be had but there is also another level of thinking which is yet in some areas to be had, saying “are we doing this processing in the most efficient way or can we schedule it differently?” or whatever. That is why I think there are more savings to be had.62

This opinion was echoed by Paul Ekins, who declared that “technology develops; long- hanging fruit once picked is inclined to grow, especially if there are price incentives to do that.”63

51. By contrast, representatives of several business groups argued that the pursuit of energy efficiencies was either naturally subject to diminishing returns; or if it were to be continued, would require major technological innovations, in turn requiring significant amounts of time and money to develop. Ray Gluckman of UK ETG argued that while “there is enormous low-hanging fruit still available” in smaller and non-energy intensive organisations outside the Agreements, and “some low-hanging fruit available” in some industries within CCAs, in “that top band of highly energy-intensive industries—steel, cement, glass, and so on—the low-hanging fruit is long gone.”64 Steve Bryan of SABIC Europe, an international plastics and chemicals company, argued that for much heavy industry further increases in carbon savings, along the lines recommended by the Stern Review, will require step-changes in technology; “they are not, if you like, a natural continuum of the process we have been discussing under the existing agreements.”65 EEF and UK Steel also argued that for energy intensive industries such as “the steel sector, there have always been substantial drivers towards improving energy efficiency because energy is such a huge part of our costs”, implying there was little scope for further incremental improvement. (We would observe, however, that this argument seems to rather contradict EEF’s point about the value of the Agreements, and the way in which CCAs raised energy management from “oily book” to boardroom.)

62 Q140 Mr Huddlestone 63 Q194 64 Q82 65 Q82

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 25

52. We also received evidence on this issue from Dr Ian Bailey, lecturer in economic geography at the University of Plymouth, and the author of a number of papers on industry’s responses to carbon reduction instruments. He told us:

I have spoken to an awful lot of business leaders over the course of the last ten years. […] The issue of the actual existence of technology seems to be a lesser issue for most of the energy intensive sectors that I have spoken to. The greater issue is the affordability of that technology and the various either internal company financing requirements or the need to go out on to open capital markets and persuade other investment organisations to invest in things which have got a very long pay back lead-time.66

The conclusion he drew was that more public funding should be made available for industries to make such investments.

53. Given both that targets have been readily overachieved so far and that meeting them should have saved participating firms money, and given the overall imperative to accelerate carbon reductions, we recommend that targets are considerably toughened at the next milestone period. To help preserve a constructive relationship with industry, protect competitiveness, and accelerate emissions reductions, the Government should increase public investment in low carbon technology, as well as grants or loans to aid its procurement.

54. A further theme in our inquiry on the subject of the value for money of the CCA system concerned the extent of auditing of and compliance with targets. At the time of our inquiry only 9% of target units had been audited to ensure they had achieved the performance against targets they had claimed—and that in nearly one in five of these audits serious errors had been found. Andrew Warren commented on this: “To have only done less than 10% of these is really not sufficient to give one complete confidence that these tax breaks are justifiable.”67 AEA Energy & Environment, the consultancy which carries out the audits, was more relaxed, arguing that audit coverage will increase with time, and that most of the errors found so far are related to poor quality base year data, and thus not of ongoing concern.68

55. Perhaps more worryingly, the NAO report highlighted that some 6% of target units were treated as having passed their 2004 milestone, and as a result had their 80% discount on the Levy renewed, despite failing to meet their efficiency targets. This is because if a sector overall is judged to have met its umbrella Agreement, then all units within it are treated as having passed, even if some of them may have failed individually; Defra/AEA initially look at sector performance, and only drill down to the level of individual target units if the sector as a whole has failed to meet its target. This claim was contested by UK ETG, who said: “We have some rather strong views here. We think that the NAO have misunderstood the way that most of the Climate Change Agreements work. [… V]irtually all businesses with Climate Change Agreements either meet the target by saving the energy

66 Q168, Q179 67 Q102 68 Q119

26 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

as required or they meet the target by purchasing CO2 allowances in the emissions trading mechanism.”69

56. We would respond to this criticism by stating that the NAO is not referring to target units which did not reach their own Agreement targets, but which bought carbon credits to make up the difference; this, after all, happened in 27% of cases in 2004, not 6%.70 Rather, the NAO has drawn attention to a significant number of businesses which have both failed to meet their CCA targets through their own actions, and failed to make up the difference to these targets through other mechanisms such as carbon trading—and yet which continue to enjoy their CCL discount. Regulations should be tightened to ensure that this cannot continue. The trading mechanism established within the CCA system should make this straightforward: any firm that does not meet its target through its own actions should be required to purchase credits to make up the difference, or lose its Levy discount. Recycling CCL revenue

57. One of the central features of the Government’s design for the Climate Change Levy package has been the recycling of CCL revenue, with the explicit aim of further incentivising emissions reductions. This recycling has taken two main forms: an offsetting reduction in employers’ National Insurance Contributions, and a channelling of revenue to fund the work of the Carbon Trust and related programmes. The Government’s design was spelt out particularly clearly in a speech given at the United Nations by the Prime Minister, when Chancellor, in 2006:

Central to our approach has been our willingness to take the difficult decision to introduce a Climate Change Levy […] and the hypothecation of its revenue to goods —cutting business taxes on jobs and new carbon reducing measures.

And what the levy shows is that by targeting the marginal use of energy, we can provide real market incentives to energy efficiency; and that by taxing bads— emissions—we have been able to reduce taxes on goods—the cut in employment taxes for business.71

58. In the course of our inquiry we heard a number of views on this aspect of the CCL package. The main issues concerned:

ƒ how much revenue is offset via National Insurance Contributions, and how fairly this offset is distributed;

ƒ the effectiveness of programmes provided by the Carbon Trust, and the size of funding available to them; and

69 Q85 70 NAO, The Climate Change and Climate Change Agreements, p 23 71 “Speech by the Rt Hon Gordon Brown MP, Chancellor of the Exchequer, to United Nations Ambassadors, New York”, HM Treasury press release 31/06, 20th April 2006

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 27

ƒ the effectiveness and scope of the Enhanced Capital Allowances scheme, administered by the Carbon Trust.

The effects of the cut in NI Contributions are complicated and controversial 59. Budget 2001 stated that: “All [CCL] revenues will be recycled back to business”.72 In fact, the 0.3% reduction in employers’ National Insurance Contributions (NICs), introduced alongside the CCL in April 2001, has consistently reduced the Treasury tax take by more than it has gained from the Levy. Indeed, as Figure 2 indicates, given that the Levy is a flat-rate charge and was frozen until 2007, the surplus value of the cut in NICs has grown in every year since the Levy was introduced.

Figure 2 CCL revenue vs 2001 cut in employers’ NICs

1600

1400 Approx value of 0.3%cut in employers' NIC s CCL revenues

1350 1275 1200 1215 1185 1125 1000 1035 Revenue £299m £369m £462m £537m £650m gap £264m 800 826 816 771 753 738

millions 700 £ 600

400 NICs cut CCL

200

0 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 Note: CCL figures for 2006–07 are expected revenue. Source: HC Deb, 7 February 2007, col 1051W 60. This is not without complication or controversy, however. The first issue is that, while the cut in employers’ NICs may have meant that the CCL was revenue-neutral as far as the Exchequer was concerned (or, as we have seen, revenue-negative), it does not follow that it was necessarily revenue-neutral for each organisation paying the Levy. Given that employers’ NICs are a tax on labour while the CCL is a tax on energy, the organisations that would benefit most from the offsetting cut in NICs are those with large head-counts and less intensive energy use (more likely to be retail chains and public bodies), with among those least likely to benefit being heavy industry, for the converse reasons. For its part, the Federation of Small Businesses argued that 88% of SMEs pay out more in CCL payments than they save from the cut in employers’ NICs.73

72 HM Treasury, Budget Report 2001, para 6.20 73 Ev 132

28 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

61. More controversially, according to the evidence we received, the other issue here is that Budget 2002 announced a rise of 1% in all National Insurance Contributions, associated with a rise in funding for the NHS,74 coming into effect in April 2003. Andrew Warren was very critical of the impacts of this on the Government’s claims to have made the CCL revenue-neutral:

For one year the National Insurance rate did go down, and it went down so as to make this actual revenue neutral, but the subsequent year it went back up again and that has been the position ever since. In effect, this has been a nice little earner […] Whilst the Climate Change Levy and Agreements have been described by the former Chancellor now Prime Minister as being very much the jewel in the crown of the Climate Change programme, I suspect that one of the reasons why the jewel will shine so well is because the revenues do flow in in rather large measure to the Treasury.75

UK ETG, meanwhile, had this to say:

There is a slightly cynical concern about the history. In 2001, with the Climate Change Levy package, came a .3 per cent reduction in National Insurance Contributions by employers. In the Budget one year later there was a 1 per cent increase in said NIC. It might well have been a 1.3 per cent increase had it not been for the .3 per cent reduction, but that is not very transparent. There is a worry around the industry that there is that lack of transparency about that.76

62. The effects of implementing a cut in employers’ National Insurance Contributions alongside the introduction of the CCL should have been both to win the support of businesses for the idea of the Levy, and to help genuinely change their spending priorities. With the subsequent increase in NICs, announced in 2002, we are far from convinced that these have been the effects. Overall, as we have long recommended, the Government should be far bolder in altering the balance of taxation between ‘goods’ (i.e., things that the Government would like to encourage, such as employment) and ‘bads’ (i.e., things such as pollution).

The work of the Carbon Trust should be expanded 63. The Carbon Trust was set up alongside the CCL in April 2001. Budget 2001 stated that “Over three years, £100 million of the CCL revenues will be directed to the Carbon Trust”, and that the work of the Trust would initially “concentrate on short-term measures in support of saving energy, including providing energy-efficiency advice to business.”77 Since then, the Trust has expanded its range of activities, including an interest free loans programme for small businesses to purchase energy efficiency products.

64. In 2006–07, the Carbon Trust worked with around 300 large businesses covered by Climate Change Agreements and/or the EU Emissions Trading Scheme, leading to

74 HC Deb, 17 April 2002, col 591 75 Q94 76 Q81 77 HM Treasury, Budget Report 2001, para 6.25

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 29

78 implemented annual savings of over 360 thousand tonnes CO2. A recent report on the Carbon Trust by the National Audit Office found that over 80% of organisations were satisfied with the service they received, with 45% very or extremely satisfied, and that 76% would not have implemented the same level of energy or carbon savings without the Trust’s input.79

65. Notwithstanding this, we received a number of anecdotal comments from representatives of energy intensive industries, which suggested that for these firms the services provided by the Trust were positive but not especially insightful in terms of helping them increase their energy efficiency. Matthew Croucher of the Society of Motor Manufacturers and Traders told us:

[M]ost of the advice they have given is fairly generic. When they have had some specialist knowledge put in there, things like compressed air, and things like that, our members have found that sort of help useful but, generally, you are inviting a consultant to come on site for a number of days and you often do not get back much more than you knew already, because a lot of the people on the site know what they are doing. That is what they spend their whole life doing—trying to improve energy efficiency.80

Nick Sturgeon of the Chemical Industries Association echoed this: “they are a bit generic in their focus [… F]or complex specialised sites I think it is difficult for them to provide the expertise.”81 Ray Gluckman of UK ETG agreed that the Trust is more effective on “non- process-specific things” such as providing advice on efficient types of technology to purchase, but that the Trust is “looking at ways of addressing the more complicated technologies with more in-depth reviews of them. So I think they are trying to find the right niche at the complex end of the spectrum as well, but it is difficult.”82

66. The other main aspect of the Trust’s work on which we heard a number of comments was its interest-free loan scheme for SMEs.83 Overall, the scheme seemed to be welcomed, but there were concerns that its size and scope were too small. Some of the representatives of large and energy intensive firms we spoke to regretted that they were ineligible for the scheme.84 Meanwhile Andrew Warren, having made clear his opinion that the Carbon Trust was doing “excellent work”, said:

If I have a criticism of the Carbon Trust on that it is that the number of small businesses to whom this could be applicable who know about it is actually very small; but certainly those who have subscribed to this, and who have got zero interest loans

78 Email from James Wilde to EAC staff, 18 January 2008. 79 National Audit Office, The Carbon Trust: Accelerating the move to a low carbon economy, November 2007, p 6, p 17 80 Q77 Mr Croucher 81 Q77 Mr Sturgeon 82 Q77 Mr Gluckman 83 The Trust has expanded this loan scheme to encompass larger firms in Northern Ireland and Wales. 84 Q 78-80

30 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

payable back at the end of a five-year period to install energy-saving measures, have found that actually it has been a tremendously successful programme.85

67. Interestingly, although we asked for views on the work of the Carbon Trust in our call for evidence, we did not receive any further evidence on this scheme. Perhaps revealingly, the memo from the Federation of Small Businesses made no mention of it, while concluding:

[L]ack of clear advice and information together with the constraints faced by SMEs has prevented most small businesses from taking steps to improve energy efficiency [… M]ore Government investment in technical innovation and in financial incentives on energy efficiency for small businesses would go a long way to improving emissions reduction among small businesses.86

68. Witnesses from the Carbon Trust were themselves very positive about the success of the loans scheme. James Wilde, the Trust’s Director of Insights, told us:

They are actually a very popular and very effective mechanism. Since we introduced the scheme as a pilot, the financial amount of loans committed has doubled year on year until the fourth year, which was last year, and reached £18 million, in which year we gave 480 loans and saved about 50,000 tonnes of CO2. The good thing about those carbon savings is that the persistence is very high because it is associated with capital investments. The persistence is around nine years so we are saving a lot of carbon through this scheme and it is also cost effective. There is an overall net benefit to the economy.87

Mr Wilde stressed that “there is a huge potential to grow the scheme and at the moment we are constrained really by the amount of capital we have. There is loads of demand out there.”88 His evidence is supported by a recent National Audit Office report on the Carbon Trust. This found that some 96% of loan recipients would not have bought the relevant energy efficient equipment otherwise, and confirmed that the Trust had adequate controls to ensure that loans were spent on energy saving equipment and subsequently repaid.89

69. We note that there appears to be significant demand for the Carbon Trust’s SME loan scheme. It is reducing emissions, and it should bring about a net benefit to the UK economy through reducing overheads and increasing the growth of energy efficient products and services. For these reasons we recommend the Government provides funds to expand the scheme significantly.

70. Despite the significant efforts already directed by the Carbon Trust to large firms, some evidence suggests there is a shortfall in provision for energy intensive sectors in terms both of very specialist advice and loans for energy efficiency investment. We were

85 Q95 86 Ev 132-3 87 Q152 88 Q153 89 National Audit Office, The Carbon Trust: Accelerating the move to a low carbon economy, November 2007, para 2.10

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 31

struck by the evidence from energy intensive sectors that the Carbon Trust’s consultants were less able to supply advice on how to make overall production processes more efficient, especially given that AEA Energy & Environment had highlighted this as precisely the area where there might be substantial room for ongoing efficiency savings. We recommend that the Government reviews the needs, for more assistance from the Carbon Trust, of larger and more energy intensive sectors, and assesses how best this demand can be met.

Evidence for the effectiveness of Enhanced Capital Allowances is mixed 71. Another measure introduced alongside the CCL was the Enhanced Capital Allowance (ECA) scheme. This was designed to stimulate investment in low carbon technologies by bringing forward tax relief on capital expenditure on certain energy efficient products, assessed as qualifying for inclusion on an Energy Technology List (ETL). Qualifying companies and products on the List are published on the ECA website, under categories such as ‘Boiler equipment’, ‘Heat pumps’, and ‘Lighting’. Companies cannot claim any more money in tax relief under this scheme than they would ordinarily, but are able to claim the total amount of tax relief in one year rather than over several; as Budget 2001 explained, this means “Businesses […] will obtain significant cash flow benefits because they will receive tax relief for their investment much earlier than would otherwise be the case.”90 The way in which ECAs are meant to work is outlined in Box 3. The scheme is administered by the Carbon Trust, which each year revises the ETL to ensure it reflects current best performance. Budget 2001 estimated the cost to the Exchequer of the scheme at around £70m in 2001–02, rising to £130 million in 2002–03.91

72. We received a number of comments on the ECA scheme, most suggesting that it has not been as successful as the Treasury expected, and urging that its scope be widened. EEF, for instance, told us that “Our industry had great hopes for the Enhanced Capital Allowances scheme”,92 but that “The take up of Enhanced Capital Allowances (ECA) has not been as comprehensive as envisaged.”93 A number of reasons were given for this, by EEF and others:

90 HM Treasury, Budget Report 2001, Para 6.27 91 HM Treasury, Budget Report 2001, para 6.27. These figures must be treated with a degree of caution. They do not represent the overall cost to the Treasury in the long term (i.e., on an accruals basis). Just as businesses gain from the scheme gain, not by being able to claim more tax relief, but by being able to claim the same amount of tax relief in one year as opposed to its being spread over several, so the Treasury does not lose any more money in terms of tax foregone, but simply loses the same amount in one year rather than over a number of years. As businesses gain but only in cashflow, so the Exchequer loses but only in terms of deferred interest. Another reason why these figures must be treated with caution is that they are only forecasts. The Treasury has not to date published figures for the costs and impacts of the scheme in operation. At time of writing, HM Revenue and Customs (with HM Treasury and Defra) has prepared a draft report on the effectiveness of the ECA Scheme, but this has not yet been published. 92 Q42 93 Ev 5

32 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

Box 3 Benefit provided by Enhanced Capital Allowances Enhanced Capital Allowances are given at 100% of expenditure in the first year. This means that the whole of the qualifying investment can be set against tax for the year in which the equipment was purchased. This provides a financial advantage over the normal capital allowance of 25% on a reducing balance basis, which would spread the tax relief over a much longer period.

ECAs do not mean that firms can claim more money in tax relief; but because they are able to claim the total in one year they benefit from improved cashflow, and from avoiding the depreciation of the balance in real terms over a number of years.

Taking the example of a large company, paying 30% corporation tax and making an investment of £10,000, the table below shows the cashflow benefit of the ECA compared to ordinary capital allowance. 2006 CCP measure Capital Allowance ECA Corporation tax rate 30% 30% Percentage of 25% 100% expenditure to which allowance applies Nominal investment £10,000 £10,000 value Amount set against tax 25% * £10,000 = £2,500 100% * £10,000 = £10,000 First year tax recovery @ 30% * £2,500 = £750 30% * £10,000 = £3,000 30% tax ECA cashflow benefit in £3,000-£750 = £2,250 first year Balance brought forward £10,000 - £2,500 = £7,500 £0 to year 2 Amount set against tax 25% * £7,500 = £1,875 £0 in year 2 Second year tax relief 30% * £1,875 = £562.50 £0 Time to set full > 10 years 1st year investment against tax Source: Gambica / REMA, Making the Most of the Climate Change Levy Package, 2002 ƒ Ignorance of the scheme: Gareth Stace of EEF told us: “I think it is not as well publicised as it could be […] I think a lot of our members are very unaware of the Enhanced Capital Allowance scheme.”94 On this theme, the memo we received from United Closures and Plastics Ltd., stated: “as the UK’s largest manufacturer of injection moulded plastic caps (closures), not only are we ignorant of the enhanced capital allowance scheme but also the supplier of the machines to our group have no knowledge of this scheme.”95

ƒ Insufficient financial benefits: EEF suggested that the financial benefit of being able to offset 100% of the cost from taxes in the first tax year actually only represents around 5- 10% of the product cost—while qualifying products may often be more than 10% more expensive than less efficient alternatives. The Environmental Industries Commission

94 Q42 95 Ev 121

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 33

suggested that take up would be boosted if ECAs were to offer 150% tax offsets against purchases from the ETL.96 EEF suggested this could be raised to 200%.97

ƒ Only profit-making companies can benefit: By its nature, only businesses that are in profit can use the scheme; firms which are for a period making a loss—and thus, one might suppose, in most need of such financial inducements—are the ones unable to benefit. EEF commented: “This is a major drawback and therefore take up is limited.”98

ƒ Types of eligible technology are too restricted: The scheme is restricted to plant and machinery; this means that all other kinds of products related to energy efficiency are ineligible, both for inclusion on the Energy Technology List and for receipt of an ECA. This includes products related to the fabric of buildings (e.g., insulation, double glazing), as well as most high efficiency lighting. The memorandum we received from Hambleside Danelaw, a building products manufacturer, argued that: “Extending the ECA scheme [to products affecting the fabric of buildings] would encourage businesses that are commissioning the building of new premises, moving to new premises or refurbishing existing facilities to consider more seriously the greener options”.99 Also excluded are whole systems (as opposed to individual pieces of equipment), and equipment specific to individual economic sectors. The Government is currently consulting on which types of technology should be eligible for the scheme.

73. The Carbon Trust made a strong defence of the ECA scheme. James Wilde told us: “Awareness in the target audience is actually pretty high, it is around 40%, and we promote the scheme with a wide range of different marketing activities.”100 He also stressed the effectiveness of the Energy Technology List in its own right:

There are about 14,000 products on that scheme and each year we are trying to raise the bar of what qualifies. It is typically the top 10 to 25% performing products in a given category. Last year, for example, we added 2,000 products and took away 1,200. One of the big drivers within this scheme is the effect it has in transforming the market, so a lot of manufacturers improve the products they are bringing to market just to get on the ETL, whether or not they think their clients are going to claim ECAs or whether they are not. For example, the public sector buys a lot of equipment off the ETL and they cannot claim ECAs, so a big driver for change is that energy technology list in its own right.101

At the same time, he agreed that “there are opportunities to expand the qualifying types of equipment or systems that would allow this scheme to have a bigger effect going forward.”102

96 Ev 111 97 Ev 5 98 Ev 5 99 Ev 134 100 Q156 101 Q156 102 Q156

34 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

74. Some evidence suggests a lack of awareness of the Enhanced Capital Allowances scheme. This could be linked to the restricted scope of the scheme, which excludes many technologies, such as insulation products. We recommend that the scope of the scheme be expanded, to include a wider range of energy efficiency products, including those relating to thermal efficiency of buildings, lighting efficiency, whole systems, and sector-specific products. The Government should also state an estimate of the costs to the Exchequer, and effects on the use of the scheme, of increasing the allowance from 100% in the first year to 150% and to 200%.

Hypothecation of revenues should be more transparent, and funding increased 75. One overall issue which emerged as we looked at the recycling of CCL revenues was the transparency with which their use is reported, and the extent to which they were actually hypothecated. For instance, EEF wrote in their memo:

All EEF members have paid CCL since April 2001 and we are therefore concerned that monies raised by the Levy have not, as announced, been spent on promoting improvements in energy efficiency. When CCL was introduced the government proposed to set aside £50million per year to fund the ECA scheme. EEF would like assurances that this money will be spent in the way proposed, rather than being transferred to the consolidated fund.103

Equally, in arguing that the Climate Change Levy was actually “a nice little earner for the Treasury”, Andrew Warren remarked that the Carbon Trust’s budget was only around 10% of the roughly £¾ billion which the CCL brings in each year.104 To be more precise, in 2006-07 the Carbon Trust’s budget was around 14% of total CCL revenues for that year.105

76. The Government’s descriptions of the uses of CCL revenue are confusing. Budget 2001 stated that “All [CCL] revenues will be recycled back to business through a 0.3 percentage point cut in employers’ national insurance contributions and additional support for energy-efficiency measures and energy-saving technologies”, and the Prime Minister has specifically described “the hypothecation of its revenue to goods—cutting business taxes on jobs and new carbon reducing measures”. This clearly suggests that CCL revenue would fund both the offsetting cut in employers’ NICs and the work of the Carbon Trust and ECA scheme. But as we have seen, the 0.3% cut in employers’ NICs has consistently been worth more than receipts taken in from the Levy, so that it would be impossible for the Levy to fund both.

77. Further confusion is prompted by the website of the Department for Business, Enterprise and Regulatory Reform, which confirms that the Climate Change Levy will continue to fund “awareness raising, advice and consultancy support services on climate

103 Ev 5 104 Q94 105 CCL receipts in 2006-07 are expected to be around £700m, while the Trust’s budget in that year was £100m. (Although the Trust’s accounts state that its “total expenditure” was £87 million, its “total activity” is stated as £100 million; the larger figure includes money distributed in loans, which is not classified as expenditure in the same way, as the Trust expects to receive the money back again in future years.)

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 35

change and resource efficiency”. Moreover, further confusion is prompted where the same webpage suggests that several aspects of the Carbon Trust’s work, including “Carbon Trust energy efficiency loans scheme for small and medium sized enterprises”, will not be funded by the CCL, but instead funded separately as part of the new Environmental Transformation Fund (worth £370m over the three years of the current Spending Review period).106 From the Carbon Trust themselves we heard that “A large proportion of our funding comes through the Climate Change Levy, but we do get funding from other sources such as DBERR and the devolved administrations”,107 and that “the Carbon Trust does get funding from a number of sources and primarily it would not consider itself ‘funded by the CCL’.”108 Professor Grubb of the Carbon Trust also stated that, in his view, the extent to which the Trust’s funding was hypothecated from Levy receipts was not that important.109

78. We note the fact that the Treasury has explicitly accepted the principle of hypothecating funding in the case of the Climate Change Levy. This only makes it more important that the Government be more transparent and consistent about its use of CCL money. We recommend that the Government clarifies whether CCL revenues are offset by the 2001 cut in NICs, or whether they are available to fund low carbon programmes—since Levy receipts are too small to fund both. If the CCL is being used to fund low carbon investments, the Government should report on what it is funding each year, and how much if any revenues are left over to go into the Consolidated Fund.

79. Another issue is the size of funding devoted for energy efficiency and low carbon advice and investment, whether or not it is derived from the Climate Change Levy. We heard calls from energy intensive sectors for much greater public investment in low carbon technology, to help achieve a step-change in emissions reductions.110 In arguing that energy intensive sectors often required new technological breakthroughs in order to make such step-change progression, and that this would require significant capital investment, Dr Ian Bailey suggested to us that “what happens with the revenue from the Climate Change Levy could be as important as the price incentive itself.”111

80. Whether or not the Levy receipts are treated as replacing the tax lost from the 2001 cut in NICs in terms of meeting general spending commitments, we believe that devoting only around 10-15% of the size of these funds to the work of the Carbon Trust is short-sighted. As the Stern Review highlighted, in order to meet necessary climate change targets, much greater public investment is required in low carbon research and development, and in helping to overcome organisational barriers to reducing emissions— precisely the areas in which the Carbon Trust works. Furthermore, we note that the Climate Change Levy brings in around double the amount in each year that the Government’s new domestic Environmental Transformation Fund will spend over

106 “Environmental Transformation Fund”, Department for Business, Enterprise & Regulatory Reform (BERR), www.berr.gov.uk/energy/sources/sustainable/etf/page41652.html 107 Q157 108 Q159 109 Q159 110 Qq 78-80 111 Q185

36 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

three years. We recommend funding for the Carbon Trust and the domestic Environmental Transformation Fund is increased, to match or go beyond receipts from the Climate Change Levy. Levy exemptions for renewable energy and combined heat and power

81. As the CCL taxes energy consumers rather than suppliers, it is not primarily designed to encourage energy generation to be less carbon-intensive. However, one element of the CCL package is aimed at assisting this goal: organisations are exempted from paying the Levy on electricity generated from renewable sources, and on electricity generated by combined heat and power (CHP).112 In the case of CHP, the input fuel used to generate the heat and power is also exempt from the Levy.113 These Levy exemptions form part of the Government’s respective strategies for delivering two key targets in the UK Climate Change Programme: generating 10% of the UK’s energy supply from eligible sources of renewable energy, and increasing UK CHP capacity to 10 gigawatts (GW), both by 2010. Most recent published statistics show that, in 2006, the proportion of the UK’s electricity generated from renewables stood at 4.6%,114 while CHP capacity was nearly at 6 GW.115

82. The effect of the Levy exemptions on renewables and CHP capacity is indirect. To access the exemption, business customers sign contracts similar to the kind of ‘green tariffs’ offered by electricity suppliers to households. The Levy exemptions offer a financial incentive to businesses to select such contracts; if enough demand is created, this should in theory provide generators with an extra incentive to invest in more capacity, so that they can sell more contracts. In other words, the Levy exemptions are designed to increase market ‘pull’ for new capacity, to complement the ‘push’ that comes from other measures (chiefly, in the case of renewables capacity, the Renewables Obligation) which by regulation mandate generators to increase capacity, and through subsidy or trading mechanisms directly incentivise them to do so. Ofgem issues suppliers with a Levy Exemption Certificate (LEC) for each megawatt hour of qualifying electricity generated for consumption within the UK, with suppliers surrendering these LECs to their business customers. This is meant to ensure that suppliers cannot sell more electricity designated as being generated from renewables or CHP than they actually produce from these sources.

112 With the exception of large-scale hydroelectric power plants with a declared net capacity of more than 10 megawatts. 113 All input fuel used in electricity generation from fossil fuels is also exempt from the Levy; the reason for this is to avoid business effectively being charged twice, both paying the Levy rate on the electricity they buy, and paying more to electricity suppliers to cover the amount of Levy they would have to pay on the coal, oil or gas used in their power stations. 114 BERR, UK Energy in Brief, July 2007, p 29 115 Combined Heat and Power Association, www.chpa.co.uk

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 37

The exemption on green electricity has increased demand but not supply 83. In looking at the effectiveness of the exemption on electricity from renewables, it is important to differentiate between its effects on the market for ‘green tariff’ contracts, and the effects that this in turn has on the construction of new windfarms, biogas plants, solar installations, etc.

84. The evidence we received suggested that demand for ‘green tariff’ contracts among business customers had increased markedly in recent years. The memo from E.ON was clear that the Levy exemption had played a decisive role in this: “our experience in the business to business retail market indicates a positive impact on renewable products.”116 EDF Energy agreed—but at the same time stressed another factor in this rise in demand: “There is a strong and growing demand for levy exempted certificates (LEC) due to the financial benefits of the exemption and the corporate driver to be a responsible organisation.”117 Regarding this latter point, it is difficult to isolate the impact of the Levy exemption from the wider influence of rising business interest in acting on principles of corporate social responsibility (CSR). But it is interesting in this context to note the stress placed on CSR motives in the following guidance for business customers from the Carbon Trust:

For the majority of companies, improving energy efficiency will be the most effective way to reduce the levy they pay.

It is then worth considering purchasing CCL-exempt energy from renewable sources, often referred to as ‘green energy’.

Renewable sources may not be cheaper, as price premiums may offset levy reductions, but they are still good for your company’s reputation and for the environment.118

Where it is the case that ‘green tariff’ contracts are still more expensive than ordinary supply contracts, we might conclude that it is CSR concerns which are driving take-up, with the financial effects of the Levy exemption providing a marginal influence. At the same time, and although we received no evidence on this, we might speculate that the exemption could also function to draw attention to the possibility of choosing ‘green tariffs’, and that this would prove effective for organisations already searching for CSR opportunities.

85. Regarding the exemption’s impacts on the construction of new renewables, the evidence is that it has had minimal effect. EDF Energy’s memo put it bluntly: it “has had little impact on incentivising the development of new projects because the CCL exemption for renewables does not provide a significant financial incentive to develop new projects”.119 This does not, of course, mean that there are not other powerful incentives for adding new

116 Ev 120 117 Ev 59 118 Carbon Trust, Energy Saving Factsheet – Climate Change Levy, p 4 119 Ev 59

38 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

renewables capacity; indeed, EDF made clear that the Renewables Obligation (RO) does have a significant effect. But EDF made it equally clear that the reason why the RO is effective in this respect, while the Levy exemption is not, is because the financial incentive offered by one dwarfs that offered by the other—by around 10 to one. Furthermore, EDF said that they would not take the financial effects of the Levy exemption fully into account when assessing the economic case for building new renewables capacity, because there was uncertainty over how long both the Levy and with it the exemption would remain in operation.120 Although the 2007 Pre-Budget Report confirmed that the Climate Change Levy and Agreements would be extended from 2010 to 2017, it did not confirm that the exemption would also be continued. In any case, EDF said that confirmation until 2017 was still of little use: “even at 2017 you are only looking at about six years of an operational life and that is if you are deciding to build one today. It would not be a significant factor in investing in renewables.”121

The exemption on combined heat and power has had limited effect 86. The impacts of the exemption for CHP appear to be very similar, and for the same essential reasons. The Combined Heat and Power Association (CHPA) stated that the Levy exemption was an important benefit to existing CHP operators. However, on the construction of new CHP capacity, Graham Meeks of CHPA concluded: “The Climate Change Levy itself is probably only having a modest impact.”122 According to CHPA’s analysis, in the period since the operation of the exemption could have had a noticeable effect, the amount of CHP capacity in the UK has only increased by 5%.123

87. CHPA argued that the main reason for the modest nature of this impact was that the financial benefit provided by the exemption was simply too small. As they explained, building new CHP capacity involves “a higher capital cost investment to meet energy needs compared to simple boiler plant and taking grid electricity”, and is thus highly sensitive to expectations of financial returns, from reduced running costs and selling surplus heat and power, over the long term. In recent years, energy price movements have made CHP plants less economic, thus increasing the importance of additional financial incentives such as the CCL exemption.124 But according to CHPA, the exemption:

[…] is a relatively small amount of value that is being added, something as a maximum around £4.40/MWh of electricity generated against the wholesale price that is typically between £30-40. There is a general sentiment around the industry, and of course it does vary depending upon site and application, that in order to incentivise perhaps the sort of levels of investment the Government would be

120 Q105 121 Q106 122 Q105 123 Ev 62 124 It becomes economically more attractive to build new CHP capacity when the price of market price of gas falls below that of electricity; this makes it more profitable for plants which generate heat and power from burning gas to sell surplus electricity to other users. Since 2000, however, gas prices have risen above electricity prices (see Figure 1), reducing the potential profitability of CHP plants.

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 39

looking for we should probably need a level of incentive of something around £6- 7/MWh.125

In addition, CHPA argued that the effect of the exemption was further weakened as the electricity generated from CHP plants was sold on via suppliers to final consumers:

To realise the benefit one has to sell the power to somebody else who is paying the Climate Change Levy, thus realising the exemption. Passing any commodity through a series of hands to reach the end customer means that people take a margin on the way through, and so we see an erosion of the value to the person who is actually making the investment as we go through the supply chain. The practical effect is very limited.126

Both exemptions are compromised by the Levy discount for CCA participants 88. The effectiveness of the Levy exemptions has been further compromised by the way in which they interact with the Climate Change Agreements. Given that CCA participants already receive an 80% discount on the Levy in return for committing to meet their Agreement targets, the incentive provided by the exemptions from the Levy is for them significantly reduced. Graham Meeks of CHPA believed this had

[…] been hugely significant. You go from £4.30 to 0.2 […] of that, so 80p if you like becomes the value of that incentive. As I said, in the Government’s own modelling they have seen the impact of that discount and, therefore, largely discounted the impact of the Climate Change Levy.127

89. This is especially unfortunate, given that CCA participants tend by their very nature to have large electricity bills, and thus might otherwise be more attracted by the Levy exemptions than other firms. It is worst for CHP, since this situation will tend not just to affect market pull from consumers of CHP electricity, but market push for providers of it. That is, where industrial firms use gas in CHP plant and sell surplus electricity to other users, they will benefit from the Levy exemption on the input fuel; but this benefit will be largely negated, since industrial sectors will also tend to be covered by a Climate Change Agreement, and thus already benefit from an 80% reduction on this input fuel.

90. It seems clear that the exemptions from paying the Levy on electricity from renewables and combined heat and power plants have had very limited effects on the construction of new renewables and CHP generation. Where the exemptions have had an effect in helping to increase business demand for supply contracts offering electricity generated by renewable sources, this can face the same problems widely reported as facing private consumers who switch to ‘green tariffs’ for their household supplies: power companies may simply brand as ‘green electricity’ a certain amount of their supply contracts, up to the proportion of their overall output already generated by renewable sources, without this necessarily having any real effects on the building of

125 Q105 126 Q105 127 Q110

40 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

new renewable sources. (They should, of course, be increasing this construction as a result of another instrument, the Renewables Obligation; but this does not necessarily justify charging higher prices for a ‘green’ brand of supply contracts.)

91. What effects the Levy exemptions do have are reduced almost entirely in respect of companies covered by Climate Change Agreements, since they already benefit from an 80% reduction in the Levy in any case; this affects CHP particularly badly. We recommend the Government re-examines ways in which to increase the incentives to install CHP plant, or buy CHP electricity from outside sources, available for industrial firms within CCAs. Economic impacts and administrative complexity

92. As the NAO states: “The Levy and Agreements were designed to promote energy efficiency without harming business competitiveness.”128 In our inquiry, we considered a range of evidence on whether this was actually the case, and whether the Levy package needed reforming in any way as a result. We focused on two main questions:

ƒ How significant are the direct economic impacts of the Levy and Agreements on business competitiveness?

ƒ What could or should be done to ease the complications caused by the interaction of different policy instruments (for instance, between CCAs and the EU Emissions Trading Scheme), especially in cases where the same firms are subject to multiple policies?

The CCL package does not impose a damaging burden on UK business overall 93. A number of industrial lobbies and sectoral groups made the case to us that the direct workings of the CCL package imposed appreciable costs; though there was also acknowledgement that this varied considerably among different sectors. The CBI, for instance, cited a survey carried out jointly with EEF which suggested that “manufacturing [was] hardest hit”, with “mining and utilities also negatively affected”. It also suggested that the “service sector made a net gain from the levy (as a whole), although there are individual cases where companies have faced increases in net costs”.129 EEF highlighted the extra costs borne by the steel sector—in their figures, “the mandatory 20% levy adds £8.2million per year to the industry after NI rebate”—and stressed the resulting dangers to competitiveness, given that “Overseas competitors are not subject to this tax on energy.”130 The Federation of Small Businesses, meanwhile, referred us to a report they published in

128 NAO, The Climate Change and Climate Change Agreements, p 36 129 Ev 127 130 Ev 3

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 41

2002, The Climate Change Levy—Another Cost for Small Business, whose title speaks for itself.131

94. More positive evidence was highlighted by the National Audit Office. On the Climate Change Levy, the NAO stated, “The administrative burden […] is estimated to be small”; in other words, it is straightforward to pay, the amount of Levy a firm is required to pay being calculated by their energy suppliers and simply added as another item to their regular bills.132 On the Climate Change Agreements, only 8 of the 33 CCA participants surveyed by the NAO considered their administration a “burden”, with the remaining 25 regarding it as being “simple”. (Furthermore, we heard from businesses ourselves that it is precisely these administrative efforts—the process of complying with an Agreement—that have constituted the value and source of energy savings in the entire CCL package.) The NAO concluded that: “The benefits brought by Agreements tend to outweigh the administrative costs”.133 When we asked a panel of industrial witnesses whether they agreed with the NAO’s verdict, Steve Bryan of SABIC Europe replied, “The short answer is yes”, and this was not contradicted by fellow panellists from UK ETG, the Chemical Industries Association, or the British Cement Association.134 The Food and Drink Federation also wrote to us to suggest that its members had saved around £90 million through energy savings; “clearly a large and valuable cost saving that benefits the profitability and competitivity of the UK food and drink manufacturing industry.”135

95. Finally, the NAO highlighted that while 9 of the 33 firms surveyed said that the CCL package had harmed their international competitiveness, a study led by Paul Ekins had suggested that CCAs had actually improved the international competitiveness of the sectors covered by them.136 As Professor Ekins explained to us:

If indeed it is true that all the energy that was saved by those companies was through the implementation of cost-effective measures, and that was the explicit basis on which those Agreements were set up, then what you would have obviously is that companies would reduce their energy consumption in a cost-effective manner, this would reduce their cost base in a cost-effective manner and that would be likely to increase their competitiveness. […] We have then had not one but three target periods now reported; and, indeed, the companies are reporting that they are managing to achieve energy savings in excess of the targets which they were set […] You would be unlikely to do that unless these achievements were being done in a cost-effective way for good business reasons. Therefore, I would conclude that they were good for the competitive position of those companies because it reduced their expenditures on energy.137

131 Ev 132 132 NAO, The Climate Change and Climate Change Agreements, p 36 133 NAO, The Climate Change and Climate Change Agreements, p 36 134 Q72 135 Ev 103 136 NAO, The Climate Change and Climate Change Agreements, pp 36-7 137 Q193

42 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

Defra also referred us to this and similar research, summing it up as follows: “Overall conclusions are that the CCL/CCA package has been beneficial to the economy.”138

96. Given the relatively limited price impact of the Levy, and the cost-savings that should accompany meeting Agreement targets, we believe that the CCL package has not been a damaging burden for UK business overall. In many cases it may have been good for the economy, given the savings in energy costs available for investment elsewhere, and the stimulus given to providers of energy efficiency products and services.

Businesses face a complex tangle of overlapping climate change policies 97. Beyond the economic impacts of the Levy and Agreements in themselves, some businesses may face costs and inconvenience as a result of the way in which these overlap with other instruments, such as the EU Emissions Trading Scheme (EU ETS) and the forthcoming Carbon Reduction Commitment (CRC). In recognition of these complications, Defra launched a ‘Climate Change Simplification Project’ (CCSP) in November 2006. Its brief has been to review the main climate change policies aimed at UK business, “with a view to eliminating avoidable overlap, simplifying the existing regulation, and ensuring that the regulatory burden on the economy is kept to a minimum.”139 So far this work has resulted in an initial report, published in October 2007, analysing what the problems are and setting out recommendations for improvements. The Department is inviting consultation on this report until March 2008.

98. Some of the main overlaps and areas of conflict include:

• Overlap between ‘upstream’ and ‘downstream’ instruments, or in other words the addition of carbon or energy pricing to the cost of electricity both at the point of generation and at the point of consumption. This overlap arises mainly from the interaction of the EU ETS—which puts a price on the carbon emissions of power stations, in turn passed on in increases to electricity prices140—and the Climate Change Levy, which adds a cost to the consumption of electricity. (The same will apply to the Carbon Reduction Commitment when this starts.)

• Overlap in directly targeted emissions. This relates to CO2 emitted on site, rather than emissions caused indirectly from the purchase of electricity. Where firms are covered by both the EU Emissions Trading Scheme and a Climate Change Agreement, the very same emissions may be regulated twice: under the EU ETS an installation will have to keep its emissions below its allocated allowance or be forced to buy extra carbon allowances from the market, while under a CCA it will have to keep its emissions or energy use within its Agreement target or lose its 80% Levy discount. Major complications arise from the need to avoid double-counting of emissions, and with that

138 Ev 136 139 “Consultation on the recommendations of the Climate Change Simplification Project”, Defra, www.defra.gov.uk/corporate/consult/cc-instruments/index.htm, 18 December 2007 140 Defra’s Climate Change Simplification Project report states that: “Empirical and other evidence to-date indicates a substantial pass-through of EU ETS prices to electricity prices (wholesale and retail)”.

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 43

the potential for companies to receive double the benefits or penalties in both schemes (Box 4).

Box 4 Complexities in complying with complying with a CCA and the EU ETS As part of the consultation on the introduction of EU ETS in 2003, the Government proposed removing this overlap by taking EU ETS energy use out of the CCA targets. CCA participants turned this down, however, requesting that Agreement targets remained intact on the grounds that it would be difficult to split Agreement targets into two, and would remove flexibility in how targets were met.

This necessitated the introduction of a system to prevent firms receiving a double credit or penalty for compliance with both schemes. The current approach is to net off a firm’s surplus under the EU ETS from its performance against its Agreement target. Though straightforward in theory, there are several complexities in doing this which were highlighted by the NAO:

Different timescales. Adjustments are made on the verified performance of the EU ETS data; such verification results in a lag between the schemes. This results in the verified data for 2005 being compared to the 2006 Agreements target period and will result in the verified 2007 data being compared with the 2008 Agreements target period.

Determining allocation and performance for areas of overlap. The EU ETS allocation is based on tonnes of CO2 for the entire installation for each year of the scheme (installation being defined by the scope of the EU ETS coverage and does not necessarily align to an entire site). There is no breakdown of the allocation for different parts of the site. The allocation for the overlap area is assumed to be the percentage of the emissions arising from this area.

Overlap adjustments. Performance of the overlap area is required to determine a surplus or shortfall for each EU ETS reporting year and operators therefore have to record the emissions for the overlap area each year. Where the overlap areas have different boundaries this can introduce further complexity as the operator must separate out the emissions from the overlap area from other emissions and report them separately. The adjustment process can be further complicated if Agreements targets are adjusted via risk management tools. Such adjustment must occur prior to the overlap adjustment.

Reconciliation. The process of reconciliation between the schemes can be complicated for some sites and result in significant efforts and resources being directed at resolving the differences. In some cases the process has resulted in some sites being in compliance with both schemes individually but after adjustment failing to meet the required performance and having to purchase additional allowances, at additional cost.

The scale of these problems is only going to grow: 331 of the 500 installations whose direct emissions fall under both CCAs and the EU ETS were granted temporary exclusion from Phase I of the latter, but this exclusion expired on 1 January 2008 with the advent of Phase II of the EU ETS. Source: Memorandum from Defra; National Audit Office, The Climate Change Levy and Climate Change Agreements, p 34

• Different sources of emissions in the same firms being targeted by different instruments. The most common overlap of this type concerns sites in which direct

emissions (CO2 produced onsite) are targeted by the EU ETS, and indirect emissions (mainly electricity use) are targeted by a Climate Change Agreement. A related problem occurs where a firm is targeted by one instrument, but this only covers a portion of their emissions, with the rest of their emissions not being targeted by any other regime. The Society of Motor Manufacturers and Traders in particular argued

44 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

that partial coverage by one instrument was inefficient and could lead to perverse incentives, with site managers focusing on the one area of their site that was covered, while giving less attention to other opportunities for efficiency gains elsewhere: “it might mean there is some low-hanging fruit in other areas but you are targeting on the CCA area”.141

• Narrow or inconsistent criteria for inclusion in Climate Change Agreements. A number of business groups have raised concerns about the effects on competition between certain firms and products, where some qualify for an Agreement—and the 80% discount on the Levy that comes with it—and some do not. Currently, industrial sectors are eligible for an Agreement where their energy intensity is above 10% (i.e., energy costs account for more than 10% of production costs) or where energy intensity is between 3% and 10%, and where their products are adjudged to face significant competition from foreign imports within the UK. Complaints from business groups have focused on cases where a sector’s processes are relatively energy intensive, but miss out on the other criteria that would guarantee them eligibility.

99. We received a number of detailed comments and suggestions from business groups on how these instruments might be reformed. We did not have sufficient time to examine the merits of each of these suggestions, which would have involved working through the potential implications of each for carbon savings, tax streams, and economic competition. However, we have some overarching comments on the two main themes in these suggestions. A common call from business groups was that the number of different instruments be reduced, with measures such as the Climate Change Agreements and EU Emissions Trading Scheme becoming increasingly consolidated. EDF Energy, for instance, called for the Climate Change Levy to be abolished for electricity, with the EU ETS being relied on alone to perform the original job of the Levy by raising electricity prices.142 Steve Bryan of SABIC Europe went even further:

I would very much welcome a simplification and, ultimately, perhaps, one single common scheme that, in one fashion, had one single value of carbon attached to it, such that we would not see this plethora of different instruments and the overlap problems that they generate for companies captured by more than one of them.143

We would urge the Government to treat these calls with caution, at least for the time being. The early experience of a number of policy instruments such as the EU ETS—in Phase I the carbon price collapsed, once it became recognised that the majority of Member States had issued their industries with too many carbon allowances—raises doubts about the wisdom of relying on new instruments to deliver carbon savings in a predictable manner. On this point we also note that, in its 2005 review of policies targeting the UK business sector, the Carbon Trust highlighted one of the advantages of Climate Change Agreements as being that they “offer insurance from a policy perspective against EU ETS price uncertainties and under-delivery”.144 And as Professor Grubb argued: “there do need

141 Q74 Mr Croucher 142 Ev 6 143 Q83 Mr Bryan 144 Carbon Trust, The UK Climate Change Programme: Potential evolution for business and the public sector, November 2005, p 4

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 45

to be different instruments because the failures and obstacles to energy efficiency are different and are much more complex than just price alone.”145 In the future it may be possible to rely on fewer instruments to set a single carbon price to deliver all the Government’s climate change policy outcomes. Until carbon markets have matured, however, it is wise to continue to target carbon emissions with multiple policies. Furthermore, one of the lessons that the CCL and CCAs teach is that simply increasing the cost of energy (or emissions) may be a necessary component in any attempt to increase energy efficiency, but not enough in itself; in which case multiple instruments will always be necessary.

100. Another common theme from business groups has been to argue that the criteria for inclusion in each carbon reduction scheme should be widened, so that, for instance, it was easier for businesses to qualify for a Climate Change Agreement, and easier for an Agreement to apply to the whole of a site. EEF, for instance, argued that “the government should improve incentives for energy efficiency in other business sectors by extending the right to participate in CCAs to any sector that can demonstrate a credible plan to deliver efficiency gains.”146 This was backed up by AEA Energy & Environment, who said that easing the entry criteria “would allow more people, more sectors, into agreements and that would be a good thing to widen the scope.”147 EEF also argued that the current rules governing whether the whole of a site was covered by an Agreement ought to be relaxed, so that if 70% of a site’s emissions were eligible for a CCA target, the whole of the site was covered. UK ETG told us of the benefits this would bring: “What we would love to see is, obviously, the whole process just to cover the whole factory. It would make life simpler and it would deliver more environmental benefit”.148 Given the extra progress on energy efficiency which the process of complying with Climate Change Agreements appears to have driven, we recommend that the Government look favourably on such proposals.

101. Overall, we have sympathy for businesses, dealing with a multiplicity of policy instruments; the climate change policy landscape in the UK is messy, and is only going to become more so with the introduction of the Carbon Reduction Commitment. However, we are also aware that much of this complication has arisen from the evolving recognition that one size of instrument does not fit all, and we welcome the constructive efforts of Government to tailor its policies to the needs and drivers of different types of business. We note, for instance, the long consultation on the design of the Climate Change Levy package before its implementation (in which time Government increased the proposed Levy discount for Agreement participants from 50% to 80%), and the extensive consultation still ongoing on the design of the forthcoming Carbon Reduction Commitment. Equally, we note its proposal to exempt all emissions targeted by either the Climate Change Agreements or the EU ETS from the Carbon Reduction Commitment.

145 Q151 146 Ev 1 147 Q118 148 Q74 Mr Gluckman

46 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

102. One aspect of this concentration of the scope of the Carbon Reduction Commitment may perhaps have gone too far, however, or at least left a number of businesses outside any equivalent climate change regime. In its original proposal for the CRC, the Carbon Trust suggested a lower threshold for inclusion; Defra raised this threshold “to further reduce the risk of including participants for whom the administrative cost of participating in the scheme might outweigh the benefits”.149 Without making a detailed study of the preparations for the CRC, we are unable to judge whether this was overcautious or a justifiable case of tailoring climate change policy to the needs of different types of businesses. In any case, it still means that smaller businesses are left outside any regime. As Minesco observed to us:

Whilst complementary regulations have been developed aimed at specific sectors, such as the proposed Carbon Reduction Commitment, we believe that there is a clear policy gap in respect of approximately 4-5 million Small and Medium Enterprises. This sector is notoriously difficult to reach effectively, and as a consequence there is an argument for specifically focusing the CCL to encourage action in this sector.150

The reason given by the Government for introducing the CRC—the inadequacy of the simple price signal of the Climate Change Levy to focus non-energy intensive organisations on reducing their energy use—applies equally to all the SMEs too small for inclusion. The Government must set out what it is going to do instead to help drive down emissions from SMEs while addressing the particular obstacles they face. Further options for reform

103. In looking at suggestions for streamlining the range of climate change policy instruments, we also considered two other major proposals for reforming the structure or principles of the Levy package: changing the focus of the Levy to target carbon emissions directly rather than energy use; and recasting CCA targets in the form of absolute reductions in carbon emissions rather than relative improvements in energy efficiency.

Refocusing the Levy on carbon would be difficult and of questionable benefit 104. The original recommendation for the Climate Change Levy in the Marshall Report had been for a tax based on carbon emissions, and applying equally to electricity generators as well as other sectors. This proposal was only half-accepted by the Government: the CCL was implemented as a downstream tax, thereby excluding electricity generators, and based on energy consumption not carbon emissions. One reason for this, as already mentioned, was the Government’s desire to protect householders, who would otherwise have been affected by the rise in electricity prices resulting from taxing generators.

105. The other main reason was identified by the then Trade and Industry Committee (TIC), when it examined the Government’s early proposals for the Levy package in 1999:

149 “Action in the UK – Carbon Reduction Commitment”, Defra, 26 June 2007, www.defra.gov.uk/Environment/climatechange/uk/business/crc/qanda.htm#5 150 Ev 126

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 47

“the Government’s desire to protect the coal industry […] at least partly, explains the reluctance to link the taxation of energy use to the carbon content of fuels.”151 The point here being, of course, that coal is more carbon intensive than gas; a carbon-based tax which applied to electricity generators would therefore have incentivised power companies to switch from coal to gas. As it is, since 2001 market forces have made coal cheaper than gas, resulting in power companies switching from gas to coal.

106. One of the implications of the focus of the Levy on energy efficiency is that the price differential of Levy rates on different fuels does not match their difference in carbon intensity. Levy rates are currently calculated according to the energy content of different fuels; on this basis, electricity attracts a higher rate, reflecting the energy inefficiency in transmitting electricity through the national grid. This means that the direct burning of coal by industrial users attracts a lower rate of Levy than their use of electricity, even though the carbon emissions from burning coal will be higher than the average carbon profile of electricity (Table 2).

Table 2 Carbon price equivalents for the Climate Change Levy

Climate Change Levy rates (April 2001–March 2007) £ per tonne carbon

Carbon equivalent of Levy on electricity @ 43p / kWh £37/tC

Carbon equivalent of Levy on gas @ 15p / kWh £29/tC

Carbon equivalent of Levy on coal @ 15p / kWh £18/tC

Source: National Audit Office, The Climate Change Levy and Climate Change Agreements, p 13 107. As a result of anomalies such as this, the fundamental design of the Levy package has received considerable criticism from a variety of organisations. Not least, in a report published in 2002 the Royal Society concluded:

We believe the Climate Change Levy, in its current form, is an inefficient way to

reduce CO2 emissions, primarily because it excludes certain energy users (including households and transport) and targets energy use in general rather than carbon emissions in particular. It also acts somewhat crudely on the demand for energy, but fails to provide anything significant for the supply side of the equation.152

108. This passage makes it clear how the call for the Levy to be based on carbon emissions, and the call for it to encompass power companies, go hand in hand. Indeed, once the Government decided to implement a downstream tax, the scope for basing it on carbon emissions was both complicated and restricted. There are two essential reasons for this.

109. The first is the difficulty in calculating a carbon-based rate for electricity—or, more usefully, calculating different rates for different suppliers—given the different and changing proportions in which electricity is generated by different fuels. The then DTI, in

151 Trade and Industry Committee, Ninth Report of Session 1998–99, Impact on Industry of the Climate Change Levy, HC 678–I, para 34 152 Royal Society, Economic instruments for the reduction of carbon dioxide emissions, November 2002, p vii

48 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

its response to the Trade and Industry Committee in 1999, thought it too complicated to set even one average carbon-based rate for electricity, given that “The carbon content of electricity supplied is changing all the time”.153 Some witnesses in our inquiry did consider the possibility that different CCL rates could be calculated for different electricity suppliers or tariffs, reflecting the carbon profile of each; however, the general conclusion was that it would be very difficult to do so, and its impacts uncertain.154 Professor Ekins told us: “Conceivably you would be able to differentiate an electricity tax based on the carbon intensity of that electricity, but it would not be simple and it would certainly greatly [complicate] what at the moment is a relatively administratively easy instrument.”155 His hope, instead, was that the next Phase of the EU ETS would prove more effective in giving power companies an incentive to switch from coal to less carbon-intensive fuels. Professor Grubb was a little more encouraging about the potential effects of differentiating different electricity rates—“I would think that the impact could be non-trivial”—but equally stressed that it “would be pretty complicated to implement, […] and I honestly do not know [about its impacts] until we have looked at it.”156

110. The other reason why there is limited scope to target carbon emissions follows from the first. If there were only a single Levy rate for electricity, based on the average carbon profile of all generators (or even if there were different rates for different generators, but these did not vary significantly), then the differentiating of Levy rates could only really incentivise the switching between different fuels—e.g., between coal and gas, or coal and electricity—rather than between different electricity companies or tariffs. And as the Carbon Trust established when it looked at the likely impacts of differentiating Levy rates in this way: “our modelling studies indicate that this has very little impact on business and public sector emissions. This is because the opportunities for businesses to switch between fuels in response to the carbon differentiation between coal, gas and electricity are in fact extremely limited.”157 Switching electricity suppliers would be simple; but switching from using electricity (e.g., to run lighting and appliances) to buying gas and using that to generate the electricity on site—or trying to substitute electricity for coal in certain industrial processes—would be at best difficult and expensive, and at worst impossible.

111. We have sympathy with the Royal Society’s argument that the Climate Change Levy should have been set up as an economy wide carbon tax (so long as other measures would have ensured it did not exacerbate domestic fuel poverty). Once the Government decided to implement the Levy as a downstream tax, however, the practical scope for basing it on carbon emissions rather than energy efficiency was greatly reduced. Professor Grubb summed it up well: “in a sense, the whole debate about whether the CCL should really be a carbon tax is probably yes in principle, but actually in practice it makes very little difference.”158 We still recommend that the Government should look into the practicalities and potential benefits of basing Levy rates on carbon content, and in

153 Trade and Industry Committee, Eleventh Special Report of Session 1998–99, HC 834, Response to Recommendation m 154 Q39, Q165 155 Q201 156 Q165 157 Carbon Trust, The UK Climate Change Programme: Potential evolution for business and the public sector, p 19 158 Q165

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 49

particular the potential to vary rates on electricity depending on the carbon profiles of different suppliers and tariffs. However, the overall environmental value of the CCL does not depend on its being based on the carbon content of different fuels, and this should not be an overriding priority.

Agreements should be based on absolute cuts in carbon emissions 112. A related proposal is to recast all Climate Change Agreement targets in the form of absolute reductions in carbon emissions rather than relative improvements in energy efficiency. This is a much simpler matter than changing basis of the Levy to carbon emissions, since its effectiveness would not hang on incentivising a switch between different fuels. Already the CO2 emissions of CCA participants are calculated from the amount of energy they consume, with energy usage converted into carbon dioxide amounts using known carbon ratios of different fuels (with electricity usage converted using the average carbon profile of the national grid). These methods could easily be used to refocus CCA targets and monitoring regimes on carbon. Setting absolute targets would be equally straightforward, simply setting a specific cut from a previous baseline. Indeed, the CCA system already allows for targets to take this form; although, as the NAO noted, sectors have been able to choose which form their targets take, and “Unsurprisingly, relative targets were more popular amongst businesses”—meaning that only four out of 51 sectors have absolute targets.

113. AEA Energy and Environment argued that, given the increasing need for achieving year on year reductions in CO2 emissions, and the increasing imposition of absolute carbon caps elsewhere (through (i) the national carbon budgets to be introduced by the Climate Change Bill, (ii) the EU ETS, and (iii) the CRC), “the time is right for carbon agreements”.159 Interestingly, the CBI used this argument as a reason to be cautious about introducing absolute targets. Given that the UK economy as a whole is to become subject to an absolute carbon cap, and given that other areas of the economy may able to deliver cheaper emissions savings, the CBI suggests that “a degree of efficient growth in emissions from CCA sectors is manageable and justified on competitiveness grounds (given the inability of many of these sectors to pass carbon costs through to their customers).”160

114. We recommend that the Government reform the Climate Change Agreements to express all targets in the form of absolute reductions in carbon emissions. This would help to align CCAs with the EU ETS and CRC, and with national carbon budgets; and be relatively straightforward to introduce. We appreciate the concerns expressed about this idea by some business groups, but do not agree with the suggestion from the CBI that some CCA sectors should be allowed room for “efficient growth in emissions”: any sector of the economy whose emissions are allowed to rise exacerbates the problem and increases the pressure on all others to cut theirs. The Government should investigate other means of meeting the concerns of business groups, for example by ensuring that CCA targets were set with reference to the differing scope for carbon reductions in different sectors. Businesses would still be able to use the CCA trading mechanism if they exceeded their targets.

159 Q118 160 Ev 127

50 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

Overall lessons for climate change policy

115. The Climate Change Levy package has been a bold and innovative suite of policies in design. In practice its impacts have been slightly more questionable: the Levy’s impact on energy prices appears to have had little effect on demand and has been declining since it began, while Agreement targets have not been tightened since they were revealed to be too lax. But evidence from different analysts and participants agrees that its main impacts have come about, not directly through the imposition of a tax or targets, but through galvanising business interest in saving money through more efficient use of resources. In this way the experience of the CCL package teaches some useful lessons that could be applied across the range of climate change policy.

Businesses have not always acted according to economic theory 116. Time and again throughout our inquiry, we heard witnesses argue that there was a gap between economic theory and the actions of businesses in the real world. According to economic theory, businesses should already have been focusing far more on the rational goal of reducing their costs by increasing their energy efficiency. The theoretical basis for introducing the Levy was that it would harness this rational interest. Yet we heard repeatedly that on its own this was not enough to capture the interest and innovation of the majority of firms; they require an extra stimulus to create new organisational structures and cultures, focused on energy efficiency. This has obvious implications for climate change policy, not just covering the business sector, but all sectors of society: it says that the Government cannot rely simply on increasing the cost of carbon to achieve incremental reductions in emissions. If even large energy intensive companies require additional policy measures—not just ‘sticks’, but ‘carrots’ and ‘tambourines’ in the words of Andrew Warren—then this must be even more true for small businesses, public bodies, and domestic households. We recommend the Government report on how it is applying this lesson in other policies, across the whole of the UK Climate Change Programme.

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 51

Conclusions and recommendations

Effectiveness of the Climate Change Levy

1. Given the intrinsic difficulties involved in calculating its effects, and in order to improve transparency, we recommend that the Government should give an estimated range of uncertainty for its projections of the Levy’s impacts. (Paragraph 12)

2. According to the evaluation of the Levy relied on by the Government, most of the impacts of the CCL were already established before the policy actually came into effect in 2001, and have only marginally increased since then. (Paragraph 16)

3. Overall, it seems that the Climate Change Levy has not worked as originally planned —particularly for less energy intensive firms and SMEs. While concerned by the weaknesses of the Levy, we welcome the fact that the Government has not ignored these problems. In responding to the recommendations of the Carbon Trust by bringing forward plans for the Carbon Reduction Commitment, the Government is targeting some of the sectors for which the Levy has proved less effective. This shows a commendable flexibility of approach and ability to learn through doing. (Paragraphs 22,23)

Effectiveness of the Climate Change Agreements

4. While in theory the use of carbon trading has no adverse effect on the amount of carbon savings generated by the system as a whole, this depends on the stringency of the original targets: if some targets are weak, then the firms to which they apply may be able to overachieve relatively easily, and thus provide a high volume of cheap credits with a concomitantly lesser effect in driving emissions reductions. Regarding the UK ETS, the first source of credits up to 2006, a Defra report from 2007 describes it as having provided an “over-allocation of allowances […] linked to generous baseline setting and the inclusion of non-CO2 GHGs [greenhouse gases].” This points to a serious weakness in the rigour of the CCA system so far, and underlines the fact that in all carbon trading schemes it is the level of the cap, rather than the trading mechanism, which is the key element. It also makes looking at the number of firms and sectors which have passed their Agreements targets an even less useful measure of the environmental impacts of the CCA system. (Paragraph 33)

5. It appears to us that isolating and enumerating the impacts of the Climate Change Agreements is even more complex and uncertain than accounting for the impacts of the Climate Change Levy. It is remarkable that the performance of most sectors is measured from a variety of different starting points that predate the start of the Agreements, in three cases stretching all the way back to 1990. While measuring the impact of Agreements by reference to business as usual projections avoids some of these problems, it also creates new ones of its own: as we have argued in previous reports, BAU projections intrinsically lack certainty, and depend very much on the quality of the assumptions and data used to generate them. For these reasons we

52 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

recommend that, when reporting figures for the impacts of the Agreements, the Government gives a range of uncertainty attaching to them. (Paragraph 35)

6. Although there are difficulties in arriving at a firm evaluation of the carbon savings driven by the Agreements, the anecdotal evidence suggests that the process of complying with CCAs has had a very positive effect, leading to a widespread improvement in energy management systems, greater sharing of good practice, and a general raising of energy efficiency as a boardroom priority among participating firms. (Paragraph 41)

Stringency and value for money of the CCA system

7. We are highly surprised that the Government has not tightened the Agreement targets since data from the first milestone period revealed that both the initial set of targets, and those revised in 2004, were too lax. We recommend that CCA targets should be reviewed at every milestone period. (Paragraph 47)

8. Given both that targets have been readily overachieved so far and that meeting them should have saved participating firms money, and given the overall imperative to accelerate carbon reductions, we recommend that targets are considerably toughened at the next milestone period. To help preserve a constructive relationship with industry, protect competitiveness, and accelerate emissions reductions, the Government should increase public investment in low carbon technology, as well as grants or loans to aid its procurement. (Paragraph 53)

9. The NAO has drawn attention to a significant number of businesses which have both failed to meet their CCA targets through their own actions, and failed to make up the difference to these targets through other mechanisms such as carbon trading—and yet which continue to enjoy their CCL discount. Regulations should be tightened to ensure that this cannot continue. The trading mechanism established within the CCA system should make this straightforward: any firm that does not meet its target through its own actions should be required to purchase credits to make up the difference, or lose its Levy discount. (Paragraph 56)

Recycling CCL revenue

10. The effects of implementing a cut in employers’ National Insurance Contributions alongside the introduction of the CCL should have been both to win the support of businesses for the idea of the Levy, and to help genuinely change their spending priorities. With the subsequent increase in NICs, announced in 2002, we are far from convinced that these have been the effects. Overall, as we have long recommended, the Government should be far bolder in altering the balance of taxation between ‘goods’ and ‘bads’. (Paragraph 62)

11. We note that there appears to be significant demand for the Carbon Trust’s SME loan scheme. It is reducing emissions, and it should bring about a net benefit to the UK economy through reducing overheads and increasing the growth of energy efficient products and services. For these reasons we recommend the Government provides funds to expand the scheme significantly. (Paragraph 69)

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 53

12. Despite the significant efforts already directed by the Carbon Trust to large firms, some evidence suggests there is a shortfall in provision for energy intensive sectors in terms both of very specialist advice and loans for energy efficiency investment. We recommend that the Government reviews the needs, for more assistance from the Carbon Trust, of larger and more energy intensive sectors, and assesses how best this demand can be met. (Paragraph 70)

13. Some evidence suggests a lack of awareness of the Enhanced Capital Allowances scheme. This could be linked to the restricted scope of the scheme, which excludes many technologies, such as insulation products. We recommend that the scope of the scheme be expanded, to include a wider range of energy efficiency products, including those relating to thermal efficiency of buildings, lighting efficiency, whole systems, and sector-specific products. The Government should also state an estimate of the costs to the Exchequer, and effects on the use of the scheme, of increasing the allowance from 100% in the first year to 150% and to 200%. (Paragraph 74)

14. We note the fact that the Treasury has explicitly accepted the principle of hypothecating funding in the case of the Climate Change Levy. This only makes it more important that the Government be more transparent and consistent about its use of CCL money. We recommend that the Government clarifies whether CCL revenues are offset by the 2001 cut in NICs, or whether they are available to fund low carbon programmes—since Levy receipts are too small to fund both. If the CCL is being used to fund low carbon investments, the Government should report on what it is funding each year, and how much if any revenues are left over to go into the Consolidated Fund. (Paragraph 78)

15. Whether or not the Levy receipts are treated as replacing the tax lost from the 2001 cut in NICs in terms of meeting general spending commitments, we believe that devoting only around 10-15% of the size of these funds to the work of the Carbon Trust is short-sighted. We note that the Climate Change Levy brings in around double the amount in each year that the Government’s new domestic Environmental Transformation Fund will spend over three years. We recommend funding for the Carbon Trust and the domestic Environmental Transformation Fund is increased, to match or go beyond receipts from the Climate Change Levy. (Paragraph 80)

Levy exemptions for renewable electricity and combined heat and power

16. It seems clear that the exemptions from paying the Levy on electricity from renewables and combined heat and power plants have had very limited effects on the construction of new renewables and CHP generation. Where the exemptions have had an effect in helping to increase business demand for supply contracts offering electricity generated by renewable sources, this can face the same problems widely reported as facing private consumers who switch to ‘green tariffs’ for their household supplies: power companies may simply brand as ‘green electricity’ a certain amount of their supply contracts, up to the proportion of their overall output already generated by renewable sources, without this necessarily having any real effects on the building of new renewable sources. (Paragraph 90)

54 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

17. What effects the Levy exemptions do have are reduced almost entirely in respect of companies covered by Climate Change Agreements, since they already benefit from an 80% reduction in the Levy in any case; this affects CHP particularly badly. We recommend the Government re-examines ways in which to increase the incentives to install CHP plant, or buy CHP electricity from outside sources, available for industrial firms within CCAs. (Paragraph 91)

Economic impacts and administrative complexity

18. Given the relatively limited price impact of the Levy, and the cost-savings that should accompany meeting Agreement targets, we believe that the CCL package has not been a damaging burden for UK business overall. In many cases it may have been good for the economy, given the savings in energy costs available for investment elsewhere, and the stimulus given to providers of energy efficiency products and services. (Paragraph 96)

19. A common call from business groups was that the number of different instruments be reduced, with measures such as the Climate Change Agreements and EU Emissions Trading Scheme becoming increasingly consolidated. We would urge the Government to treat these calls with caution, at least for the time being. In the future it may be possible to rely on fewer instruments to set a single carbon price to deliver all the Government’s climate change policy outcomes. Until carbon markets have matured, however, it is wise to continue to target carbon emissions with multiple policies. Furthermore, one of the lessons that the CCL and CCAs teach is that simply increasing the cost of energy (or emissions) may be a necessary component in any attempt to increase energy efficiency, but not enough in itself; in which case multiple instruments will always be necessary. (Paragraph 99)

20. Another common theme from business groups has been to argue that the criteria for inclusion in each carbon reduction scheme should be widened, so that, for instance, it was easier for businesses to qualify for a Climate Change Agreement, and easier for an Agreement to apply to the whole of a site. Given the extra progress on energy efficiency which the process of complying with Climate Change Agreements appears to have driven, we recommend that the Government look favourably on such proposals. (Paragraph 100)

21. Overall, we have sympathy for businesses, dealing with a multiplicity of policy instruments; the climate change policy landscape in the UK is messy, and is only going to become more so with the introduction of the Carbon Reduction Commitment. However, we are also aware that much of this complication has arisen from the evolving recognition that one size of instrument does not fit all, and we welcome the constructive efforts of Government to tailor its policies to the needs and drivers of different types of business. (Paragraph 101)

22. The reason given by the Government for introducing the CRC applies equally to all the SMEs too small for inclusion. The Government must set out what it is going to do instead to help drive down emissions from SMEs while addressing the particular obstacles they face. (Paragraph 102)

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 55

Further options for reform

23. We have sympathy with the Royal Society’s argument that the Climate Change Levy should have been set up as an economy wide carbon tax. Once the Government decided to implement the Levy as a downstream tax, however, the practical scope for basing it on carbon emissions rather than energy efficiency was greatly reduced. We still recommend that the Government should look into the practicalities and potential benefits of basing Levy rates on carbon content, and in particular the potential to vary rates on electricity depending on the carbon profiles of different suppliers and tariffs. However, the overall environmental value of the CCL does not depend on its being based on the carbon content of different fuels, and this should not be an overriding priority. (Paragraph 111)

24. We recommend that the Government reform the Climate Change Agreements to express all targets in the form of absolute reductions in carbon emissions. This would help to align CCAs with the EU ETS and CRC, and with national carbon budgets; and be relatively straightforward to introduce. We appreciate the concerns expressed about this idea by some business groups, but do not agree with the suggestion from the CBI that some CCA sectors should be allowed room for “efficient growth in emissions”: any sector of the economy whose emissions are allowed to rise exacerbates the problem and increases the pressure on all others to cut theirs. The Government should investigate other means of meeting the concerns of business groups, for example by ensuring that CCA targets were set with reference to the differing scope for carbon reductions in different sectors. Businesses would still be able to use the CCA trading mechanism if they exceeded their targets. (Paragraph 114)

Overall lessons for climate change policy

25. Time and again throughout our inquiry, we heard witnesses argue that there was a gap between economic theory and the actions of businesses in the real world. According to economic theory, businesses should already have been focusing far more on the rational goal of reducing their costs by increasing their energy efficiency. The theoretical basis for introducing the Levy was that it would harness this rational interest. Yet we heard repeatedly that on its own this was not enough to capture the interest and innovation of the majority of firms; they require an extra stimulus to create new organisational structures and cultures, focused on energy efficiency. This has obvious implications for climate change policy, not just covering the business sector, but all sectors of society: it says that the Government cannot rely simply on increasing the cost of carbon to achieve incremental reductions in emissions. If even large energy intensive companies require additional policy measures, then this must go even more so for small businesses, public bodies, and domestic households. We recommend the Government report on how it is applying this lesson in other policies, across the whole of the UK Climate Change Programme. (Paragraph 117)

56 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

Formal Minutes

Tuesday 19 February 2008

Members present

Mr Tim Yeo, in the Chair

Colin Challen Jo Swinson Mr David Chaytor Dr Desmond Turner Mr Nick Hurd Joan Walley Mark Lazarowicz

Reducing Carbon Emissions from UK Business: the role of the Climate Change Levy and Agreements The Committee considered this matter.

Draft Report (Reducing Carbon Emissions from UK Business: the role of the Climate Change Levy and Agreements), proposed by the Chairman, brought up and read.

Ordered, That the draft Report be read a second time, paragraph by paragraph.

Paragraphs 1 to 116 read and agreed to.

Summary agreed to.

Resolved, That the Report be the Second Report of the Committee to the House.

Ordered, That the Chairman make the Report to the House.

Ordered, That embargoed copies of the Report be made available, in accordance with the provisions of Standing Order No. 134.

Written evidence was ordered to be reported to the House for printing with the Report.

Written evidence was ordered to be reported to the House for placing in the Library and Parliamentary Archives.

[Adjourned till Tuesday 26 February 2008 at 10.00am]

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 57

Witnesses

Tuesday 16 October 2007 Page

Mr Gareth Stace, Head of Environmental Affairs, EEF, The Manufacturers Organisation, Mr Ian Rodgers, Director, UK Steel Ev 7

Mr Nick Sturgeon, Head of Climate Change and Energy, Chemical Industries Association, Mr Steve Bryan, Energy Business Manager, SABIC Europe, Mr Richard Leese, Manager of the Legislative and Regulatory Programme, British Cement Association, Mr Ray Gluckman, Chairman of Working Group I and II, UK Emissions Trading Group, and Mr Matthew Croucher, Economist, Society of Motor Manufacturers and Traders Ltd Ev 35

Tuesday 23 October 2007

Mr Andrew Warren, Director, Association for the Conservation of Energy Ev 51

Mr Ravi Baga, Director, Environment and Market Regulation, EDF Energy plc and Mr Graham Meeks, Director, Combined Heat & Power Association Ev 64

Mr Robert, Bell Managing Director and Mr John Huddleston, Principal Consultant, AEA Energy and Environment Ev 70

Tuesday 30 October 2007

Professor Michael Grubb, Chief Economist, and Mr James Wilde, Director of Insights, The Carbon Trust Ev 77

Dr Ian Bailey, Senior Lecturer in Human Geography, University of Plymouth Ev 83

Professor Paul Ekins, Head of Environment Group, Policy Studies Institute Ev 87

58 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

List of written evidence

1 Association for the Conservation of Energy Ev 49 2 British Cement Association Ev 30 3 British Energy Group plc Ev 129 4 British Glass Manufacturers’ Confederation (BGMC) and The UK Glass Manufacturing Industry Ev 104 5 British Lime Association Ev 114 6 British Plastics Federation Ev 116 7 The Carbon Trust Ev 76 8 CBI Ev 126 9 Chemical Industries Association Ev 25 10 The Combined Heat & Power Association Ev 60 11 Confederation of Paper Industries Ev 96 12 Darlington Crystal (Torrington) Ltd Ev 119 13 Department for Environment, Food and Rural Affairs (Defra) Ev 134 14 EDF Energy Ev 56 15 EEF Ev 1 16 EEF Supplementary memorandum Ev 44 17 E.ON UK Ev 19 18 Environmental Industries Commission Ev 109 19 Federation of Small Businesses Ev 132 20 Food and Drink Federation Ev 100 21 Hambleside Danelaw Ev 134 22 Imperial Tobacco Ev 93 23 John Huddlestone and Robert Bell, AEA Energy & Environment Ev 68 24 Louis Meyerowitz Ev 120 25 Manufacturers’ Climate Change Group Ev 121 26 Mineral Wool Insulation Sector Ev 124 27 National Insulation Association Ev 133 28 PricewaterhouseCoopers LLP Ev 112 29 Scotch Whisky Association Ev 99 30 The Society of Motor Manufacturers and Traders Ltd Ev 15 31 UK Emissions Trading Group Ev 18

Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements 59

List of unprinted evidence

The following memoranda have been reported to the House, but to save printing costs they have not been printed and copies have been placed in the House of Commons Library, where they may be inspected by Members. Other copies are in the Parliamentary Archives, and are available to the public for inspection. Requests for inspection should be addressed to The Parliamentary Archives, Houses of Parliament, London SW1A 0PW (tel. 020 7219 3074). Opening hours are from 9.30 am to 5.00 pm on Mondays to Fridays.

Faber Maunsell Andrew Warren

60 Reducing Carbon Emissions from UK Business: The role of the Climate Change Levy and Agreements

List of Reports from the Committee during the current Parliament

The reference number of the Government’s response to each Report is printed in brackets after the HC printing number.

Session 2007–08

First Are biofuels sustainable? HC 76

Session 2006–07

First The UN Millennium Ecosystem Assessment, HC 77, (HC 848) Second The EU Emissions Trading Scheme: Lessons for the Future, HC 70 (1072) Third Regulatory Impact Assessments and Policy Appraisal, HC 353 (HC 849) Fourth Pre-Budget 2006 and the Stern Review, HC 227 (HC 739) Fifth Trade, Development and Environment: The Role of FCO, HC 289 (HC 1046) Sixth Voluntary Carbon Offset Market HC 331 Seventh Beyond Stern: From the Climate Change Programme Review to the Draft Climate Change Bill, HC 460 (HC 1110) Eighth Emissions Trading: Government Response to the Committee’s Second Report of Session 2006–7 on the EU ETS, HC 1072 Ninth The Structure of Government and the challenge of climate change, HC 740

Session 2005–06 First Greening Government: the 2004 Sustainable Development in Government Report, HC 698 Second Sustainable Timber, HC 607 (HC 1078) Third Sustainable Procurement: the Way Forward, HC 740 Fourth Pre-Budget 2005: Tax, economic analysis, and climate change, HC 882 (HC 195) Fifth Sustainable Housing: A follow-up report, HC 779 Sixth Keeping the lights on: Nuclear, Renewables, and Climate Change, HC 584 (HC 196) Seventh Sustainable Development Reporting by Government Departments, HC 1322 (HC 1681) Eighth Proposals for a draft Marine Bill, HC 1323 (HC 1682) Ninth Reducing Carbon Emissions from Transport, HC 981 Tenth Trade, Development and Environment: The Role of DFID, HC 1014 (HC 197) Eleventh Outflanked: The World Trade Organisation, International Trade and Sustainable Development, HC 1455 (HC 354) Twelfth Transport Emissions: Government Response to the Committees Ninth Report of Session 2005–06 on Reducing Carbon Emissions from Transport, HC 1718

Processed: 03-03-2008 20:24:47 Page Layout: COENEW [SO] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 1 Oral evidence

Taken before the Environmental Audit Committee

on Tuesday 16 October 2007

Members present

Mr Tim Yeo, in the Chair

Mr Martin Caton Jo Swinson Colin Challen Dr Desmond Turner Mark Lazarowicz Joan Walley Mr Graham Stuart

Memoranda submitted by EEF

Introduction 1. EEF is the representative voice of manufacturing, engineering and technology-based businesses. We have a membership of 6,000 companies employing more than 800,000 people. Comprising 11 regional EEF associations, the Engineering Construction Industries Association and UK Steel, EEF is one of the UK’s leading providers of business services in employment relations and employment law, health, safety and environment, manufacturing performance, education, training and skills. 2. In preparing our response, we have consulted with member companies as well as our regional oYcials. It should be understood that although this is an EEF response, when discussing the steel sector Climate Change Agreement (CCA), the views are also those of UK Steel, the trade association for the steel industry in the UK. 3. UK Steel represents about 98% of the steel sector by energy use. The CCA represents, in total, 307.6PJ of primary energy, equivalent to 24 million tonnes of carbon dioxide. The sector has implemented significant saving measures and a rationalisation programme that has resulted in an absolute reduction on carbon dioxide emissions of 7.3 million tonnes between 1997 and 2006. 4. One of the key achievements of CCAs has been to move energy eYciency and awareness up the business agenda. This has brought about the implementation of significant eYciency measures within businesses with CCAs and the targets have provided companies with achievable goals. These actions all took place at a time when energy prices were appreciably lower than at present. 5. The current climate change policy mix does overlap and create confusion for businesses. The government has failed so far to take on board the recommendation of the Stern Report in calling for the greater use of environmental taxes alongside trading and regulation and is currently advocating the use of trading, rather than exploring other options. There sometimes appears to be an assumption that emissions trading is the favoured instrument. However, EEF believes the majority of businesses see emissions trading falling behind taxation and regulation as the preferred option for UK business. 6. In relation to costs associated with Climate Change Levy (CCL) and CCAs, the UK steel industry operates in a highly competitive global market in which overseas capacity, quality and penetration of the UK market are all increasing rapidly. Therefore any unilateral increase in costs will result in carbon leakage to global markets not subjected to any carbon constraint. This can actually result in an increase in global carbon emissions. 7. The UK steel industry has a turnover of ƒ10billion and employs approximately 25,000 people. Therefore it is crucial to the financial viability of the sector to have some long-term certainty in relation to the future of both the CCL and CCAs. 8. Government should consider improving incentives for energy eYciency in other business sectors by extending the right to participate in CCAs to any sector that can demonstrate a credible plan to deliver eYciency gains. 9. In parallel, looking further ahead to the end of the current CCAs, EEF supports an option to scrap CCAs for sectors that are subject to EU ETS. However, this would only work if CCL is not applied to those sectors, so that installations continue to receive the CCL 80% discount. Of course, the rebate should only apply if the installation is in compliance with EU ETS. 10. In some circumstances trading provides the mechanism for companies to achieve carbon reductions at lowest cost. In order to achieve the desired carbon reducing investment, EEF agrees that the current price of UK allowances may be too low. This could act as a barrier for some companies to implement further energy savings measures because the “pay back” time for certain projects will now be too lengthy. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 2 Environmental Audit Committee: Evidence

11. Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed? 12. There are two separate issues here—how the CCL is charged on energy use by commercial organisations and how companies with CCAs are eVectively measured against targets. 13. However, attitudes and understanding have changed significantly since 2001. Therefore understanding the carbon content of the energy a company is using could provide member companies with a real ability (and incentive) to improve their own carbon footprint by fuel or tariV switching. 14. There is no reason why a change to carbon intensity rates for CCL could not be changed as soon as reasonably possible, providing the overall burden is not increased. 15. A similar story holds true for the CCAs. Participants of CCA can opt for one of four diVerent currency matrixes for their individual agreement. Two of these currencies are carbon based and a number of facilities took this option in 2001. UK Steel believes the reason that most facilities opted for energy targets was the perception that this type of target would be administratively simple for reporting annual performance. In 2001 most companies measured their energy use in kWh, rather than carbon. Therefore, for ease of internal reporting of performance to directors and staV, energy was the most suitable communication method in order to increase energy eYciency. 16. With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy?U Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)? 17. One of the key achievements of CCAs has been to move energy eYciency and awareness up the business agenda. This has brought about the implementation of significant eYciency measures within businesses with CCAs and the targets having provided companies with achievable goals. These actions all took place at a time when energy prices were appreciably lower than at present. 18. Relative targets have enabled facilities to make changes within their processes in order to improve the carbon footprint per unit of production. The value of relative targets should not be underestimated as they provide a useful benchmark for all stakeholders to measure day to day performance. 19. If absolute caps on energy were imposed on companies then meeting targets may move away from implementing energy eYciency improvements to reducing output, without actually making the process less carbon intensive. It should also be noted that emissions and energy use are not necessarily measuring the same thing and either could be capped for certain industries or processes without particularly constraining growth, whereas for other industries it could well be a major constraint on growth. An example of this would be fuel switching to reduce carbon emissions. 20. EEF opposes unilateral absolute energy targets on UK industry, as they would serve only to disadvantage UK industry against overseas competitors. Any measure that increases costs to the UK steel sector will tend to increase imports from areas of the world where these costs are not applied. This can be clearly seen in Figure 1.

Figure 1

EUROPEAN PRICE-IMPORTS CORRELATION

Imports penetration ratio (Europe)

EU price(t) - Third Countries price(t-1) 35% 150

30% 100 50 25% 0

20% Price gap -50 Penetration ratio 15% -100

10% -150 Q4 Q3 Q2 Q4 Q3 Q2 Correlation =

2000 Q1 2003 Q1 2006 Q1 65% Source: JPC Consulting (courtesy of EUROFER) Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 3

21. Relative targets can also encourage site rationalisation that results in significant absolute carbon reductions, whereas absolute targets would discourage this abatement opportunity. 22. How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? 23. As has already been highlighted, there is some overlap between the current climate change policy mix which creates confusion for businesses. The government has still not taken on board the Stern Report recommendations, which called for greater use of environmental taxes alongside trading and regulation. 24. Although it is widely recognised that EU ETS and CCA emissions overlap, it should be acknowledged that Defra has worked hard to facilitate a workable solution that has enabled both schemes to work alongside each other. The current solution is not perfect, but does enable facilities to operate in both schemes. The majority of CCA sectors have accepted that this current system should be used at the next milestone period, but then should be examined again for milestone five. 25. UK Steel has made clear to Defra that during this review, it should engage fully with industry to develop a more workable solution. 26. EEF believes that splitting both the CCA and EU ETS targets could throw up anomalous results and confusing reporting procedures. However, in the long term (post milestone five) a mechanism for separating the coverage of CCAs, EU ETS and the forthcoming Carbon Reduction Commitment (CRC) must be sought, as EEF foresee the real possibility of a single business being subjected to CCL, CCA, EU ETS and CRC simultaneously. Therefore a company’s carbon emissions will be priced three times over. 27. The administrative burden of complying with the three schemes would be significant, in terms of diVerent targets, gases, coverage, verification, monitoring periods and compliance factors, all separately agreed for each scheme. In addition, those companies would be subjected to IPPC, with its whole site approach to monitoring and reporting—again with diVerent reporting variables. 28. Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? 29. Trading theoretically enables facilities to achieve emission reductions at lowest cost and potentially encourages industry to go beyond the agreed targets in certain years, with the understanding that this “banked” surplus can be used to oVset annual fluctuations in other years. 30. Carbon trading is most eYcient when there are as few overlapping tradable quota schemes as possible. Currently, in the energy and climate change policy area, there are a number of such schemes, each with their own curency. 31. EEF does not believe that trading needs to be controlled anymore than it is already by external verification and the UK emissions trading registry. 32. Overachievement of the UK steel industry CCA targets is largely due to significant investment rather than unchallenging targets. For example, CELSA, a steel producer (via the electric arc furnace route) in CardiV, commissioned a new meltshop that was completed at the end of 2006 at a cost of £90million. In 2005 Corus installed increased boiler and generating capacity at its integrated steel works in Port Talbot, which used gases that were previously flared to atmosphere. The cost of the two year project was £7.1million. 33. What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? 34. The steel sector has seen a significant increase in energy costs associated with the CCL—the mandatory 20% levy adds £8.2million per year to the industry after NI rebate. This significant sum would be better used to fund sector wide energy eYciency measures and technological improvements in carbon management. Overseas competitors are not subject to this tax on energy. 35. The UK steel industry operates in a highly competitive global market in which overseas capacity, product quality and penetration of UK market are all increasing rapidly, whereas the CO2 emissions are up to twice those of the EU15 average. Therefore any unilateral increase in costs will result in carbon leakage to global markets not subjected to any carbon constraint, which is likely to result in an increase in global carbon emissions. 36. The 80% CCL rebate is vital to the survival of the UK steel sector and UK Steel is becoming increasingly concerned over its future. Industrial companies with CCAs are currently uncertain about the climate change policy that will be applied to them by government at the end of current CCAs. All energy intensive industries are seeking an early start to discussions about the future of CCAs. This is necessary not only to ensure that government and energy intensive industries can start planning for target periods after milestone five, but also to ensure exemption from CRC. As discussed earlier CRC would add further complexity to industries which have parallel obligations under CCAs, IPPC and EU ETS. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 4 Environmental Audit Committee: Evidence

37. Unless the CCL is scrapped at the end of the CCAs, sectors with agreements will then be subject to pay 100% of the levy, which for the steel sector amounts to £42million, which would be a crippling burden on the profitability of the sector. UK Steel believes that there should be no delay in engaging with industry to discuss the future climate policy measure direction after March 2013, particularly bearing in mind the additional uncertainty over the future direction of allocation policy under EU ETS. 38. Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent? 39. The agreements evolved in full consultation with industry between 1999 and 2001, with the steel industry being partly instrumental is developing the idea of the CCAs. Whilst we accept that the agreements often appear to be complex, this is largely due to the diVering circumstances of sectors that have signed up to them. 40. It should be remembered that CCAs were the first emissions trading scheme developed in the UK and therefore the development of sector agreements was a learning process for both government and industry. 41. Although UK Steel would wish to see CCAs simplified, it believes that now is not the time to carry this out. We believe that a full review of the agreements would be lengthy and resource intensive. 42. However, simple measures such as reforming the 90/10 rule would greatly ease the administrative burden and increase emissions reductions by expanding the coverage within existing facilities. UK Steel would wish to see the rule changed from 90/10 to something closer to 70/30. 43. Furthermore, we believe that the government should improve incentives for energy eYciency in other business sectors by extending the right to participate in CCAs to any sector that can demonstrate a credible plan to deliver eYciency gains. We do not believe that State Aid rules represent a major barrier to extending CCAs, given the European Commission’s more pragmatic focus on major market distortions. Internal resources within Defra may be a barrier but given the success of the CCA in improving energy eYciency, resources from other programmes could be diverted to support what is a very eVective measure. 44. Defra’s assessment of existing climate change policies show that CCL and CCA have been one of the most cost eVective instruments and are projected to save significant carbon emissions.1 45. UK Steel hope that lessons can continue to be learnt from the failings of the current system, with which to feed into the process of reforming the agreements at the end of the final milestone in 2012 as discussed earlier. 46. It should be noted that the experience of the current CCA has enabled government to design the forthcoming CRC in a way that will hopefully avoid complex agreements that may be present in CCAs. 47. In terms of making the CCA targets “more stringent”, there is the 2008 review of the milestone five targets, which will again seek to amend the current agreement milestone five target to reflect “all cost eVective saving measures”. The last review took place in 2004 to review the targets for milestones 3, 4 & 5 and tightened some of the existing targets, where necessary. It should be noted that the two reviews should not be used purely for tightening targets, but as an opportunity for both parties of the agreements to take stock and review whether the agreed targets still reflect “all cost eVective saving measures”. 48. UK Steel is keen to engage now with DEFRA in order to start the milestone five target review discussions for the steel sector agreement, rather than wait for 2008. 49. Looking further ahead to the end of the current CCAs, UK Steel supports an option to scrap CCAs for sectors that are subject to EU ETS. However, this would only work if CCL is not applied to those sectors, so that installations continue to receive the CCL 80% discount. Of course the rebate should only apply if the installation is in compliance with EU ETS. 50. What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? 51. Research carried out by Enviros for EEF in 20062 suggests that there are a number of barriers that impede the take-up of measures to improve energy eYciency. In many cases, attempts to forecast the potential of energy eYciency to deliver reductions in carbon emissions have failed to take suYcient account of these barriers. It is therefore vital that policies to encourage greater energy eYciency are based on a full understanding of these barriers and how to overcome them. The research and face-to-face interviews highlighted the following barriers: — Costs. The benefits to the firm from investments that would yield significant gains in energy eYciency are often outweighed by the costs or are suYciently uncertain to prevent the investment from going ahead. This view has been strongly supported by extensive work undertaken by Enviros in a report for Defra.

1 Review by the National Audit OYce: Cost-eVectiveness analysis in the 2006 Climate Change Programme Review (January 2007) http://www.nao.org.uk/publications/nao—reports/06-07/Climate—Change—analysis.pdf 2 Increasing energy eYciency in manufacturing: barriers and opportunities. EEF, 2006. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 5

— Hidden costs. The Enviros work also identified “often (significant) additional costs, over and above financial costs, that will also influence an end-user’s decision of whether or not to invest in energy eYciency measures”. These include paying specialists in areas such as safety, the impact on energy systems and a range of auditing requirements. — Skills. Smaller firms will often lack staV with the skills required to assess the costs, including hidden ones, and benefits associated with investing in energy eYciency. This is supported by the findings in EEF’s survey that management time and information were the major reasons for not undertaking energy eYciency audits. In addition, companies in energy intensive sectors tend to require more complex solutions and technical experts are becoming increasingly rare. — Lack of R&D. The energy intensive sector is more likely to have undertaken all the easily achievable steps to implement energy eYciency measures. Further abatement potential is therefore more diYcult to achieve, and for some processes will require a step change in technology. The lack of a programme similar to that undertaken by the Energy Technology Support Unit in the early 1990s may have slowed progress in this area. Anecdotal evidence supports this point and further evaluation needs to be undertaken to assess the impact of this apparent gap. — Competition for funds within trans-national organisations. A growing number of UK manufacturers, both UK and foreign-owned, have plants outside of this country. Therefore, the UK plants will be competing for investment within organisations. Unless the company can prove a significant return on investment, compared with competing sites, it is unlikely to get the budget required to make the investment. This is likely to be a problem for firms with ageing plants, which are probably most in need of action to improve their energy eYciency. Understanding the factors that influence the strength of these barriers will help to target measures to overcome them. Our work highlights four key influences that drive or hinder a company’s response to energy eYciency: — the energy intensity of its activities and processes; — whether it is subject to compliance requirements such as EU ETS or climate change agreements (CCAs); — its size; — its participation in voluntary initiatives such as ISO14001 and the Corporate Social Responsibility (CSR) agenda, including influences through the supply chain. 52. Products which can increase energy eYciency (such as insulating glass for windows) can be energy- intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything, should be done about it? 53. The steel sector has made significant investment into lightweight automotive products.3 Key outputs of these projects include a holistically designed steel body structure that meets tough structural and crash criteria while weighing 25% less and costing no more than typical vehicles in its class. Producing lightweight, structurally sound steel automotive suspensions that achieve up to 34% mass reductions over conventional steel systems. 54. Climate change policies should not undermine the production of energy eYcient products 55. Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments? 56. The take up of Enhanced Capital Allowances (ECA) has not been as comprehensive as envisaged. The scheme is seen as complex and restrictive, with not all energy eYcient products qualifying for inclusion to the list. EEF members do not see the financial benefit to be significant enough to cancel out the increased cost of purchasing plant from the list, as these products increase in price once they qualify for inclusion. 57. ECA is only of value to businesses that are in profit. Loss makers cannot benefit. This is a major drawback and therefore take up is limited. 58. EEF would like to see the percentage of ECA increase from 100% to something closer to 200%. We hope that this would then provide a significant driver, both for manufacturers to produce plant capable for inclusion to the ECA list and then companies the incentive to purchase those products. Price competition will be greater, as more products are included on the list. 59. All EEF members have paid CCL since April 2001 and we are therefore concerned that monies raised by the Levy have not, as announced, been spent on promoting improvements in energy eYciency. When CCL was introduced the government proposed to set aside £50million per year to fund the ECA scheme. EEF would like assurances that this money will be spent in the way proposed, rather than being transferred to the consolidated fund.

3 http://www.worldautosteel.org/ Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 6 Environmental Audit Committee: Evidence

60. The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how? 61. CCL and CCAs have played a role in incentivising the growth of renewables. In response to both CCL and compliance with CCA targets, facilities have made informed decisions on how the electricity they consume is generated. 62. EEF believe however, that the primary function of CCL and CCAs is not to increase the proportion of renewables, which in our opinion is the function of the Renewables Obligation, which EEF members are paying for through electricity prices. 63. The Levy has been a greater driver of change in energy-intensive industries than in those which are less energy-intensive. What role is there for a climate change tax in less energy-intensive sectors and how will it work alongside the Carbon Reduction Commitment? 64. Although we can easily separate both energy-intensive and less energy-intensive sectors within CCAs, it can be argued that all sectors that are part of the agreements are indeed, energy-intensive. These so called “less energy-intensive sectors” with a CCA have arguably benefited more, in qualitative terms, from having a CCA than more energy-intensive sectors. 65. Pre-CCAs, energy-intensive sectors were to a large extent engaged in implementing energy savings measures, as the cost of energy as a proportion to the overall costs is high. However, sectors where energy costs were approximately 2% of overall costs may not, on the whole, see energy eYciency as a high priority. In our experience, this has changed significantly and as a result, carbon management has risen higher up the boardroom agenda. 66. It is our belief that this is as a direct result of the sector CCAs. As Monitoring, Reporting and Verification (MRV) systems are implemented into the operations of facilities, a greater understanding of energy usage, and ideas for reducing energy, within the whole organisation takes place. 67. From the perspective of the taxpayer and competitive rivals, is it right that some businesses can be given a tax discount despite failing to achieve their Agreement targets? 68. In the vast majority of sector agreements this situation would not be possible, as it would require a company giving away, free of charge, surplus allowances to its competitor. In reality what happens is that each facility in the sector agreement meets its target exactly and then this performance is collated to arrive at the sector performance. Any facility then not meeting its target though either emissions reductions, or by trading would be de-certified by the Secretary of State. 69. Should the Government conduct more analysis to assess the scale of any potential error in the total carbon savings figure generated from the results of the Agreements? 70. The government has carried out a robust verification system since the agreements were established. Random audits are carried out at a number of facilities per year. This system sends a strong signal to other facilities to ensure that data are robust and verifiable by external verifiers. As an organisation that manages the steel CCA, we also use government feedback from audits to assist facilities to improve their data and monitoring, reporting and verification systems. 71. UK Steel would be happy to see the number of audits increased, if there were concerns around the accuracy of the data. 72. Carbon trading is becoming a more important way for businesses to meet their targets under the Agreements. What will be the impact if businesses purchase carbon credits (if they continue to be traded at low prices) rather than push for greater energy eYciencies? Is the large surplus of carbon credits, which could be used in future target periods, a problem? 73. As previously discussed, trading is a reasonable way for facilities to meet their targets. Trading provides the mechanism for companies to achieve carbon reductions at lowest cost. EEF agree that the current price of UK allowances is too low and this could act as a barrier for companies to implement further energy savings measures because the “pay back” time for certain projects will now be too lengthy. 74. Facilities that have invested in measures to reduce their carbon footprint with a view to selling this surplus, may now find that the monetary reward for making those investments has been drastically reduced. 75. It should be acknowledged by all stakeholders that the current low prices of UK allowances is not as a result of the CCA targets being too easily met, but rather a design fault of the UK ETS, that led to a massive oversupply of allowances that flooded the CCA allowance market. 76. EEF would support measures that would result in an increase in the price of the UK allowance market, in order to further stimulate future energy eYciency projects within member companies. EEF accept that this has been partly addressed through the voluntary retirement of UK allowances by some of the participants of the UK ETS. However, this measure did not go far enough. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 7

77. Does it matter that econometric estimates of policy impact can vary widely due to changes in business as usual projections, even if policies are working as expected? In the case of the Agreements, what are the implications of the fact that taxpayers are receiving less value for the tax foregone? 78. The CCL is revenue neutral and designed as such through the reduction of employers National Insurance (NI) contributions. Although for most sectors with CCAs the CCL is not fiscally neutral, as their energy intensity is far greater than the number of people they employ and consequently the cost of CCL (even at the 20% rate) is higher than the reduction in employers NI contributions. 1 October 2007

Witnesses: Mr Gareth Stace, Head of Environmental AVairs, EEF, The Manufacturers Organisation and Mr Ian Rodgers, Director, UK Steel, gave evidence.

Q1 Chairman: Good morning. Welcome, Mr Stace: If we look back at formation of CCAs in everybody. Thank you very much for coming in. 2001, negotiated from 1999, they were the first of Could I kick oV by asking you just to remind us their kind in the UK. In addition to the quantitative about the kind of organisation that EEF and the results that we have seen of reducing emissions, Manufacturers’ Climate Change Group represents. which are very significant from all sectors, we really Perhaps you could also summarise your view of the see, in a way, almost the bigger benefit of a more Climate Change Levy and the Climate Change qualitative measurement, in terms of bringing Agreements first of all. energy eYciency very much up the agenda at a time Mr Rodgers: I am the Director of UK Steel, which is when perhaps it was not. It was very low down at the sectoral trade association for the iron and steel that time. Things have changed now and so I think industry in this country. Amongst other things, we it is quite diYcult to look back and see where we run the steel industry’s Climate Change Agreement were then and where we have come to now, and I which in terms of energy consumption is probably think the Climate Change Agreements have been a the largest Climate Change Agreement in the UK. big part of that. We are, since a merger about four years ago, a division of EEF, which is the voice of the Q3 Chairman: Focusing on the levy for a moment, manufacturing sector more generally, which Gareth the Cambridge Econometrics study suggested that comes from. most of the savings from the levy were the result of Mr Stace: I am Gareth Stace, Head of the “announcement eVect” and the fact that people Environmental AVairs at EEF. I manage the started thinking about it when it was introduced, Climate Change Agreement for the steel sector. In a rather than the levy itself. Is that your view as well? previous role, I have managed another Climate Mr Stace: In terms of the levy, there was an Change Agreement for a very diVerent sector I am announcement eVect. I think that has stayed with us. also the Chairman of the Manufacturers’ Climate However, the sectors that are not subject to or Change Group, which has evolved from the ad hoc cannot join the Climate Change Agreements really Energy Tax Steering Group—you can see why we now see the levy as just an added cost to energy that changed the name—which is a formalised group of is unavoidable. For our sector, in terms of the steel energy intensive sectors that was formed at the sector, we probably did not really see an beginning of the Climate Change Agreements to announcement eVect from the levy because energy Y discuss and provide a unified voice from energy e ciency was much further up the agenda at that intensive manufacturing companies and sectors. We time anyway. I think we might see it in perhaps the look at Climate Change Agreements, the Emissions less energy intensive sectors, or the smaller sectors, Trading Scheme and now the Carbon Reduction than the steel sector. At the time, the announcement V Commitment. e ect might be confused with an actual cycle of downturn in manufacturing in the UK. Also, within the steel sector we saw a reduction in production Q2 Chairman: Do you think the levy and the which led to a reduction in emissions at the time. I agreements are the right sort of instruments to tackle think there are other factors; it is not just the the problem? announcement eVect of Climate Change Levy that Mr Rodgers: We certainly think the agreements are we are seeing. I was just there focusing on CCL the right sort of instrument to tackle the problem. rather than CCA and the announcement eVect of The steel industry, back at the beginning of the CCAs. century, was urging the adoption of negotiated agreements as the way forward, negotiated energy Q4 Colin Challen: The National Audit OYce have commitment agreements but with some sort of highlighted in their report that energy prices in penalty attached for non compliance. The CCA is an general have risen considerably since 2001, whilst extension of that concept, with the penalty obviously the levy impact on energy costs has declined. They being a return to the full 100% Climate Change Levy said, “Therefore companies do not recognise the if you fail to meet your targets. We think the CCA Levy as a major decision driver.” Do you think the has been a very cost-eVective way, in terms of not levy is really driving energy eYciency damaging our competitiveness while at the same improvements? Or is it just a bit of additional cost time delivering environmental improvements. which does not impact on people’s decision making? Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 8 Environmental Audit Committee: Evidence

16 October 2007 Mr Gareth Stace and Mr Ian Rodgers

Mr Rodgers: For the steel sector, because we are global market, so it is very, very important for us to covered by a Climate Change Agreement and keep those additional unilateral costs down because we could incur additional levy costs of over compared to our competitors. 30 million per annum if we failed to meet our targets, given that there is the rolling two-year reduction in targets within the Climate Change Agreement, I Q7 Colin Challen: Does that suggest that we are think the CCL/CCA system as a whole is continuing talking here about an impact that the levy might make, aVecting very marginal decisions whether to to drive whatever additional energy improvements V can be squeezed out of the system. invest or not invest, if it is going to a ect Mr Stace: I think it is one factor that companies will competitiveness? take into account when deciding upon investment in Mr Rodgers: Again, if you draw a distinction energy eYcient plant or systems within their between energy intensive sectors, covered by companies. I think when energy prices went up, the Climate Change Agreements, and non energy cost of the Climate Change Levy diluted that to intensive companies, the NAO report shows that some extent, but that would not have gone away. In non energy intensive companies, because energy tends not to be a significant cost for them, have not terms of our members, the energy prices, yes, have really focused on improving energy eYciency and gone up, but securing the 80% rebate is the main suggests that energy prices or energy taxes would focus for our members. As I have said, the benefit is have to go to a very high level indeed before that not just securing the 80% rebate; it goes far beyond started making a diVerence. I am not sure that that into how companies have changed by being in companies in those sorts of sectors would relish the Climate Change Agreements. impact on their competitiveness vis-a`-vis their European competitors, let alone elsewhere, of such Q5 Colin Challen: Setting aside the levy for the additional tax levels. But, again, for sectors such as moment, has the rise in energy prices themselves the steel industry, we currently pay 20% of the been by far the greatest driver for change in the Climate Change Levy, that is basically wasted tax. industry towards energy eYciency? That of itself is not driving any further Mr Rodgers: Again, I think it is going to depend on environmental improvement from us because that is the energy intensity of the company involved. From driven, that is controlled, by the target setting in the the steel sector, there have always been substantial agreements, so already we have a 20% residual tax drivers towards improving energy eYciency because which is not environmentally eVective. To increase energy is such a huge part of our costs. In the years the level of that by increasing the level of CCL prior to the introduction of the Climate Change generally I think will simply impose another Levy and Climate Change Agreements, we reduced unnecessary cost burden. our specific energy consumption, the amount of energy consumed per tonne of steel, by 40% over a Q8 Colin Challen: You perhaps would not agree with 30-year period, so that has always been high on the proposition that it should keep pace with boardroom agendas. The fact that energy prices inflation on a regular basis and that would be a have been fluctuating quite a bit at quite high simpler way of addressing the question of where it levels—certainly two years ago very high levels—has should be set. Bearing in mind that the Government not been a further driver because the driver was is often criticised by environmentalists of allowing there already. the level of green taxation to fall as a proportion of taxation overall, perhaps we should have an automatic increase each year, but you seem to think Q6 Colin Challen: If the Government were to look at reforming the levy—it is currently a flat-rate that would not be welcomed. charge—perhaps if it were put more along the lines Mr Rodgers: I think it depends what you link it to. of VAT as a percentage figure, how do you think If you link it to inflation—if you link it to RPI, for that would aVect policy? Do you think that would example. deliver the Government’s intentions better or would it be a charge that is bound to increase it that you Q9 Colin Challen: Chief executive’s bonuses! would rather resist? Mr Rodgers: That would be understandable. Mr Stace: Yes, we accept that the levy has stayed the Mr Stace: But it has changed. In the last budget, the same since 2001 and is only now increasing. If it was levels of Climate Change Levy have increased for the higher, then it would clearly focus the minds of those first time since 2001, so our members within the EEF companies which are paying the levy, but, in terms of that are not subject to Climate Change Agreements sectors that are in Climate Change Agreements, they are seeing an increase in their energy costs as a result are only paying 20% of that, and so the big focus is of the CCL. getting the 80% rebate. If the levy charge was higher, Mr Rodgers: I think the problem with linking it to then that would be all the more reason to make sure energy prices, by making it a percentage rather than those energy saving targets within your agreements a flat rate is that, is that with energy prices are met, to avoid paying the full rate of the levy that fluctuating incredibly widely in this country, would expose your sectors. In the steel sector, we are certainly for intensive sectors, if you suddenly have very exposed to international competition, and whatever it is on top of that which is the levy that is paying the levy would increase the costs of our going to increase that fluctuation eVect and be quite materials and we would become uncompetitive on a destabilising for business. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 9

16 October 2007 Mr Gareth Stace and Mr Ian Rodgers

Q10 Joan Walley: You are saying that the money who cannot get Climate Change Agreements, and that is spent on the levy by your companies would be the story is very diVerent, and, in my mind, we are better spent on making carbon reductions and almost still back to that place in 1999 where you ask investing in energy eYciency and low carbon about energy eYciency and it is not really there. I technology. It would be better to have no levy at all think that is why we are really strong believers in and the levy is no longer a kind of way of Climate Change Agreements, both for the actual producing that. emissions reductions that are taking place, have Mr Rodgers: The residual 20% levy that Climate taken place and will take place but also, as I keep Change Agreements companies pay has no saying, for driving this up the agenda and helping environmental benefit, it is just simply a tax. If that those companies to explore other areas where they were recycled back to industry, in a very clear way to could go beyond what they might do in terms of stimulate further investment in energy eYcient perhaps energy price increase, going beyond their equipment, then that would be an improvement. targets and realising that they can do more. Because the targets are renegotiated—in 2004 for the last Q11 Joan Walley: What about the Climate Change three milestones and 2008 for the final milestone— Levy, as opposed to the Climate Change we are really delivering—and I am quoting Defra Agreement? here—“all cost-eVective saving measures”. That is Mr Rodgers: Companies in Climate Change what the targets are based on. Agreements have to pay 20% of the levy anyway. The only benefit we get is not paying 80% of the levy. Q15 Dr Turner: The arguments you are making on It is that residual 20% levy that I feel is good for the behalf of energy intensive industries would carry a Exchequer but is not delivering environmental great deal more conviction if it was apparent that improvements. such industries, such as steel in particular, were undertaking clearly defined R&D programmes to Q12 Joan Walley: But you are not saying that about reduce energy consumption and CO2 emissions the Climate Change Levy itself. associated with production plants. What is the Mr Rodgers: The Climate Change Levy for industry doing to demonstrate it? I think this is a companies not in CCAs has undoubtedly, as the case where the industry should put its money where NAO report says, delivered some environmental its mouth is if it is going to make an argument for improvement. relief from the Climate Change Levy. Mr Rodgers: I would agree entirely. The most Q13 Joan Walley: Do you think it would carbon intensive process within an integrated steel automatically follow that if companies were not works is in fact the blast furnace. This is a paying the levy they would automatically invest it in technology that has evolved over centuries almost. new technology with that incentive? In the blast furnace, I should explain, the coal, the Mr Rodgers: Companies not paying the levy are only coke, is used as a chemical reductant and not as an not paying it because they have a Climate Change energy product as such, and therefore there is a Agreement. The Climate Change Agreement itself theoretical minimum amount of carbon that has to sets targets that are negotiated every two years with be consumed for that chemical reaction to take Defra, which are meant to be—and in our case are— place. The technology has advanced to the state tough but deliverable targets. It is the agreement where we have virtually reached that theoretical itself that is driving the environmental improvement minimum, there is little more that we can do, and for companies that do not pay the levy. therefore the European steel industry, collaboratively, is investing many millions of euros at the moment in looking at what the next generation Q14 Joan Walley: I suppose what I am getting at is would companies of their own volition be making of technology might be. They are currently in a the investment if there were no scheme at all for them position of evaluating winners and losers, if you like, to be part of? they are evaluating possible runners, which they will Mr Stace: In terms of our members who have then go and research. They will, in a year or two, Climate Change Agreements and members who select one or two technologies to take forward for far have not, we have seen a huge shift from 1999, when more intensive research. It is a long-term project but we started to negotiate the agreements, where we the industry is aware that it has to do something to would go and ask companies for data in order to develop new technologies to meet the climate change form a base year and they would find it very diYcult challenge. to get that data—you might talk to an engineer and he might have the data in an oily book but he does Q16 Dr Turner: Would carbon capture be a feasible not see the bills, the finance departments have those. proposition in a blast furnace? We have seen a huge shift in those companies, where Mr Rodgers: That is one of the technologies that is almost every one within that company is aware of being looked at. the current eYciency of their facility, how that is Mr Stace: Quoting from the National Audit OYce improving, what they can do to improve it, with new report, between 2002–04 output in the steel sector schemes within their company to drive eYciency rose by 18%, however the energy use rose only by improvements to meet their Climate Change 9%, demonstrating an improvement in energy Agreement targets. Then we meet companies within eYciency. Just looking at the UK as a whole, CO2 the EEF membership who do not have agreements, emissions between 1997 and 2004 increased by 1.5%, Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 10 Environmental Audit Committee: Evidence

16 October 2007 Mr Gareth Stace and Mr Ian Rodgers whereas the steel sector reduced emissions by 23% Mr Rodgers: Yes. That would be very welcome, over that same period, resulting in a saving of 7.3 yes—apart from the fact that there is a European million tonnes of CO2 emissions. So the steel sector is Directive that would not allow it to be 100%. doing quite a lot, and has done historically, and will endeavour to do as much as we can to reduce costs. Q25 Mr Stuart: No, it does not allow it. Nevertheless— Q17 Joan Walley: It was not accounted for by closed Mr Rodgers: It would still be down to about 8%, I factories, was it? calculate. Mr Stace: If the aim is to reduce emissions, that is what the sector has done by closing, perhaps, Y Q26 Mr Stuart: In terms of policymaking, the ine cient factories and moving the production into central view is that, far from those with exemptions other factories to make those other factories more being let oV and therefore doing nothing, perversely, eYcient. An excellent way of reducing emissions and Y counter-intuitively, in fact they are the ones who are improving e ciency. making the biggest change because they want to avoid the penalty. So the avoidance of penalty is Q18 Colin Challen: Can I clarify that point. It is actually a bigger driver than paying the cost— based on the same level of production but you have because that is just accepted and— reduced carbon emissions within the UK. Mr Stace: Absolutely. Mr Stace: Just to explain, our output between 2002 and 2004 rose by 18% but there was an increase in energy use of 9%. Q27 Mr Stuart: Can you expand on that at all? I have already expanded it briefly, but I suppose I was aiming to get you to expand a little more on how In the other statistic you quoted you Q19 Chairman: Climate Change Agreements work in practice and were claiming a reduction of 23% at a time when UK therefore get a better understanding of how they emissions rose. could be spread to other businesses and eVect change Mr Stace: Yes. there, if you have anything to add on that. The clarification we need is whether that Chairman: Mr Stace: I am just thinking in terms of our is based on a level output or whether there was a fall experience. As I previously said, it has been very in output as well. positive in terms of Climate Change Agreements, both with the steel sector and other sectors that we Q20 Joan Walley: In the UK. have had experience in. The other sector I am Mr Stace: It is both. It is a combination of both. thinking of is a less energy intensive sector, and I think the benefits are as clear in those sectors as they Q21 Chairman: So there was a fall in output. are in the steel sector. That is why we would be Mr Rodgers: There was a fall in output over that saying that if there are other sectors that could particular— demonstrate that agreements would deliver the same environmental benefits, they should be allowed to Q22 Chairman: How much was the claimed negotiate or have discussions, at least with reduction attributable to the fall in output? government, to negotiate an agreement for their Mr Rodgers: We can come back with data for the sector. We have seen that with eligibility historically Committee if you wish.1 for Climate Change Agreements with Pollution Chairman: Certainly we would not be able to attach Prevention Control—that regime. I am sorry, I do much weight to a stat which appeared to have more not want to confuse things here, but you are eligible than one cause, and one which does not represent for a Climate Change Agreement if your sector is any achievement by the industry at all. regulated under Pollution Prevention Control from the IPPC Directive. However, we have seen, and we Q23 Mr Stuart: Coming back to the levy, where a have welcomed in recent years, another criterion of company pays 100% of the levy, eVectively they are “energy intensity” for a sector—so that has brought factoring that into their costs and it does not lead to more sectors in, so that is very welcome—and I think the cultural change which you are arguing the we would say that we would like to see more sectors agreements bring. Is that right? brought in that might not even be covered under the Mr Stace: Yes. energy intensive criteria. We could be seeing that Mr Rodgers: Broadly. taking place, with the forthcoming Carbon Reduction Commitment, but it is a very diVerent Q24 Mr Stuart: So you are saying that the nature of scheme from Climate Change Agreements in the the agreements is what triggers the change and that sense that it is not relative targets. I think for most even the 20% level is eVectively dead money. You facilities, for most companies, relative targets have would accept that the levy needs to be there in the been the big driver in reducing emissions, because background as the penalty but 100% exemption for economic growth has not been stifled, it has been companies that fulfil their agreements would be encouraged, but eYciency has been driven down. more eVective and lead to a more eVective utilisation That is what we have seen through rationalisation. of the money directly to reductions. Is that what you As I have said, if a company has 14 sites and they are arguing? close four of them because they are ineYcient and move all the production into eight of them, overall 1 Note: See Ev there is an environmental benefit. We would say that Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 11

16 October 2007 Mr Gareth Stace and Mr Ian Rodgers we see that more sectors would be covered with the 20% still not drive some improvements because Carbon Reduction Commitment, but that might not surely that is still relative to the amount of energy be the best route to reducing the emissions and they use. delivering that qualitative result that we have seen in Mr Rodgers: The agreements themselves are setting the Climate Change Agreements. challenging targets based on what Defra says is the best that the industry can do. You may not be able Q28 Mr Stuart: In the MCCG memo2 you also talk to do any better than the best. about the fact that the agreements need to buy into the workforce. Can you expand a little bit on how Q34 Jo Swinson: You did say that sometimes targets that works and give us some concrete examples? can be exceeded. If targets can be exceeded, then the Mr Stace: As I said before, I have personally seen, 20% as an absolute number surely would reduce? by visiting these companies with agreements, that we Mr Rodgers: It would, yes. have the people who would pay the bills and the engineers who would make the improvements not Q35 Jo Swinson: Why is that not a motivator at all? really discussing energy eYciency, and the people Mr Rodgers: In that situation that you postulate, it who are using the energy not being aware of how could be a motivator but I would suggest not a much energy costs or, in a way, how much they are particularly large one. using. We have seen a huge shift in that, where I have seen companies that were like that, which now— Q36 Jo Swinson: Compared to the potential threat of the much larger 80%. Q29 Mr Stuart: Do you have examples? Mr Rodgers: In a company there is a finite amount of Mr Stace: Examples of companies? capital available for investment in any given period. Boards will allocate that money on where it is going Q30 Mr Stuart: Yes. to provide the best return. The energy manager is Mr Stace: We would be more than happy to share competing with projects that are going to improve 3 some case studies with you. I do not want to betray eYciency or to improve product quality or whatever. their confidence in me really, that is more it, but— For the energy manager to be able to go to the board and say, “If I don’t get that particular project Q31 Mr Stuart: I am sure they would be delighted through, the implications are that there is going to be for us to be told how they have had a cultural change an extra million pounds worth of costs next year and have improved. because we are not going to meet our targets” that Mr Stace: We would very much welcome sharing tilts the whole economic evaluation of a project very those with you when we get agreement from them4. much in favour of that sort of investment. We have seen that these companies would now have weekly energy meetings with many parts of their V Q37 Jo Swinson: Compared to saying, “The business; on the sta notice boards would be graphs £200,000 of costs that we are currently paying might showing relative energy eYciency and what they Y be reduced to £180,000.” have been doing. If there were ine cient spikes Mr Rodgers: Exactly. within that, people understand, “Oh, yes, that was last week when such and such happened. We must In terms of the rationale for the not let that happen again because we are improving Q38 Jo Swinson: Climate Change Levy itself and turning to what its eYciency and we want to continue to do so.” It is a focus is, the Pre-Budget Report last week confirmed dramatic change. We would be more than happy to that the rationale the Government puts forward is take you to some of these companies to show the the targeting of energy eYciency, basically making dramatic change that we have seen. companies less vulnerable to energy market volatility. Do you think that is the right rationale? You do not have their agreement Q32 Joan Walley: Do you think it is true that the CCL and, to a to tell us about them now. diVerent extent, the Climate Change Agreements Mr Stace: We have not, no. make the companies less vulnerable to energy market volatility? Q33 Jo Swinson: Could I try to get some clarity on Mr Rodgers: No. issues. You make a very compelling case for why the agreements have been successful but I want to get to the nub of why you think 20% is a dead tax, which Q39 Jo Swinson: What would your view be on the has no impact whatsoever, when at the same time CCL being reformed to target carbon emissions you are accepting that the 100% levy that other rather than energy, especially given the rather companies pay has driven some improvements. I can impressive statistics about how your industry had understand how the agreements have particular been reducing carbon emissions? Do you think, motivation and also how obviously you would given the current focus generally on CO2, that that prefer to have as much exemption from that as would be a welcome change if it could be done? possible, but if it works in other industries that Mr Stace: If we look at Climate Change paying 100% drives improvement, why does that Agreements, there are options to have your target expressed as energy or carbon, both absolute or 2 See Ev 121 relative, and so there is the choice there and 3 See Ev 44 companies can change that choice as well 4 See Ev 44 throughout the agreement if they feel their focus has Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 12 Environmental Audit Committee: Evidence

16 October 2007 Mr Gareth Stace and Mr Ian Rodgers shifted. At the beginning of the agreements, people the UK. The only one with which it is possible to in 2001 or 2000 really were not thinking of carbon as make a direct comparison without some very we do now. Not a day goes by when we do not see complicated arithmetic is on electricity, where the in the newspaper an article about carbon; it was very minimum level that need to be imposed across diVerent then. I think that is why most people at the Europe is about 8% of the level of the Climate time thought about energy targets. If we were Change Levy. looking to negotiate Climate Change Agreements again now, they might not be energy targets; they might more be carbon targets. But bear in mind that Q42 Mr Caton: Can we move on to look at the carbon targets are actually just a straight Enhanced Capital Allowances scheme that was conversion from energy usage to carbon. Electricity brought in at the same time as the Climate Change forms part of your total energy return in your Levy. Its impact does not seem to have been agreement and the carbon content of that electricity, anything like as great as the Government hoped and apart from if it is renewable energy and you have a expected. Why do you think that is and what can be certificate to show that, is not factored into it, it is done about it? just a straightforward conversion from electricity to Mr Stace: I think that is very important. Our Defra’s conversion factor to carbon. Perhaps, in the industry had great hopes for the Enhanced Capital future, we might see either the individual or Allowances scheme. I think the problem is that the electricity supply company carbon intensity of very real benefit from a member company purchasing its kilowatt hour that they sell you reflected, and that equipment kit from that list, the Enhanced Capital might oVer more opportunities for our members to Allowances list, is not as great as we envisaged back decide diVerent tariVs as well as fuel switching, say in 2001. What happens is that a member will realise their boiler runs at the moment on heavy fuel oil, to that the discount they will get from 100% Enhanced running on natural gas, and therefore significantly Capital Allowances to be able to oVset that in the reducing their CO2 emissions. However, the only first tax year after they have purchased the piece of problem there might be—and I have shifted from kit, might be between 5 and 10%, or something in talking about CCAs there to the Climate Change that region, and they find that the kit that is on the Levy—that in the shift to charging the levy based on list actually is more than a 10% cost increase than the carbon intensity of that fuel you are double- items that are not on the list and, therefore, I think counting or triple-counting the cost of carbon within we find our members not going for things that are on that electricity in terms of electricity supply the list. I think it is not as well publicised as it could industries caught by the EU Emissions Trading be as well. I think a lot of our members are very Scheme. They factor into their costs the price of unaware of the Enhanced Capital Allowance carbon, so then, if that is then factored again, are we scheme. Of course, you only benefit from it if your double-counting there? That would need to be company is in profit. We would like to see something looked at. Personally, from our sector we would not to help companies that are not in profit, and see a problem with changing the focus from energy therefore perhaps have more need than companies to carbon. that are in profit, to be able to gain some benefit from purchasing energy eYciency equipment. We would Q40 Jo Swinson: Do you have anything you want to like to see the benefit increase somehow and one add to that? thought might be—and this is not firm policy here; Mr Rodgers: Not particularly, no. we would be open to a number of diVerent ideas—to increase the 100% to something like 200% Enhanced Q41 Jo Swinson: Would you be able to say Capital Allowance, just to provide that extra benefit something briefly on what happens in other EU to member companies to encourage them to go to Member States and the impact energy taxes there the list to find suitable plant which is on that list, have on their competitiveness and what your purchase those and increase their eYciency as a awareness is from your competitor companies in the result. We might be finding our members buying rest of the EU about the regimes in diVerent energy eYciency equipment that is not on the list, countries. which does not have the certificate—because you Mr Rodgers: A number of Member States do not have to apply to get on the list—because it is a bit have systems. The one we are aware of, that is not cheaper but it might be just as energy eYcient. identical to the Climate Change Agreements but has been in place for some time, is in the Netherlands. Obviously my largest member happens to have a Q43 Mr Caton: Have your members told you that if very large plant in the Netherlands and there is a tax the carrot was increased in the way you are exemption given there for the large energy intensive describing that they would be more likely to get into companies like Corus meeting energy commitments. the scheme? There are similar systems, we are told, in a number Mr Stace: Yes, but, more strongly, when I am asking of Northern European countries but the framework them if there is any routine maintenance or big that other countries are working under is of course extensions to their operations, I am always saying, the Energy Products Directive, which sets out “Have you looked at the Enhanced Capital minimum levels of energy taxation that countries Allowances list?” they say, “Yes, yes, but we don’t have to apply, and those minimum levels are see it being a real driver, a real benefit” and they considerably lower than the Climate Change Levy in discount it, which, as you say, is very unfortunate. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 13

16 October 2007 Mr Gareth Stace and Mr Ian Rodgers

Q44 Joan Walley: Could I press you a bit more target, that is based on carbon and not on carbon because I do not really understand about the list. dioxide, but your compliance with CCAs is carbon I do not understand how the list is drawn up, what dioxide. It is quite a confusing message that comes influence industry has in determining what would out from Government for our members in terms of qualify to be on the list and what incentives there where the focus really is. are to get other technologies on to the list that presumably would be of benefit. I just would like to have a bit of an idea about how that list is Q50 Mark Lazarowicz: Can you give us some idea accessed by the diVerent things on it. of what eVect that has in practical terms, as to how Mr Stace: If I was manufacturing variable speed companies behave in response to these. What are Y drives and they were very e cient and I wanted the results of that? It probably costs more in them to get on to that list, I would have to apply administration—I understand you are going to say and prove that my variable speed drive is very that—but in terms of how it aVects their behaviour, Y e cient and therefore should be on that list. what eVect does it have? Mr Stace: It does cost more in terms of Q45 Joan Walley: Who determines what goes on administration—you know, in terms of diVerent to that list? reporting periods and that sort of thing. They are Mr Stace: As far as I am aware, that is Defra. very diVerent. In who they are reporting to, the verification requirements are very diVerent. The Q46 Joan Walley: Do you have no discussions or allowances used for compliance are diVerent and Y talks with Defra o cials as to how that list is when the Carbon Reduction Commitment comes in comprised, what goes on to it? they will again be diVerent. So they will have three Mr Stace: Historically we have not. We might diVerent allowances, almost non transferable, that encourage our members who are manufacturing kit can be used for compliance for those three schemes. that could go on the list to do that. But I think our members, particularly the larger ones, are struggling along with being in both EU Q47 Joan Walley: Do you do that? Do you ETS and CCA and reporting separately for them proactively go out and do that? Would engineering but double-counting certain emissions within that. firms in my constituency, for example, have heard I said in our response that I think Defra has from you about what they would need to do to get worked quite well with us to try to overcome the their products on to that list? problems that our members face with being in both Mr Stace: We do but, discussing this now, we schemes and I think we have come up with a probably do not do that enough because it is one solution that works reasonably well—I will not say of those things where it has been there since 2001 well, actually, at all—now, for milestone 4. Possibly and, as time goes on, we almost discount it more we would need to think about something diVerent and more. Could this be an opportunity where we for milestone 5. Definitely we need to think about talk it up to members again and try to invigorate something diVerent beyond milestone 5, with the our members to get their equipment on that list and then our other members to purchase plant from announcement last week that CCAs will extend to that list? As it stands, there may not be the 2017. Defra, I hope, are very keen to work with us incentive to do so. to come up with a better solution to the issue of double-counting than we have at the moment but it is a very diYcult nut to crack really. Q48 Joan Walley: Or there may not be the awareness. Mr Stace: No. Q51 Mark Lazarowicz: Would the introduction of a Carbon Reduction Commitment be an As I think you mentioned Q49 Mark Lazarowicz: opportunity to bring about some of the in passing a few questions ago, a number of firms simplification, clarification which you clearly would will be subject both to the Climate Change Levy like to see or will it inevitably bring in its tread and Climate Change Agreements and also the EU ETS as well. In practical terms, what implications more confusion? does this have for your members companies in how Mr Stace: I think it would make it more confusing. they cope with having to comply with a number of I think our members understand Climate Change diVerent schemes? Agreements well now. That took a number of years Mr Stace: I think it is very confusing, even for large for them to bed in. I do not know if you are companies, that are subject to both Climate suggesting it, but to try to move that then over to Change Agreements and EU ETS, and then Carbon Reduction Commitment would really add possibly, in the future Carbon Reduction complexity and change the shift and focus of where Commitment and then obligations under IPPC as our members are. I think we are always calling for well. I think they are kind of forced at the moment longer-term certainty. Our members need to think to live with that. But we see there is a diVerent about investing. Lifecycles in our industry are 20/ coverage within their operations of what is covered 30 years, so if we do not have that long-term within EU ETS and what is covered by CCAs, certainty of where we are and what is expected of diVerent gases, diVerent measurements in terms of us in the future then it is going to be very diYcult Climate Change Agreements. If you have a carbon to make those investment decisions. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 14 Environmental Audit Committee: Evidence

16 October 2007 Mr Gareth Stace and Mr Ian Rodgers

Q52 Chairman: Finally, your memorandum suggests until when it came in 2001 was really an uphill that businesses are turning against emissions trading struggle and an awful lot of work educating our in favour of taxation and regulation as a way to members as to what it is going to mean for them. achieve the goals. Would you like to say a bit more That is the reason why I would say our members are about why that is? not advocating the Emissions Trading Schemes. Mr Rodgers: That came from a survey that EEF conducted of their members, so Gareth can talk to that. But, coming over here, we were speculating as Q53 Dr Turner: Do you think that in part, though, to what the reasons might be and one of the reasons your members’ attitude towards EU ETS might be is undoubtedly predictability and certainty. In the improved were it more demonstrably eVective than steel industry, if you wind the clock back a few years, it has been and were it demonstrably fairer across we were already regulated through IPPC and its UK diVerent European countries than it has been up to predecessor. Then the Climate Change Levy came now? Would that attitude be even further improved along, which could have been ruinous had we not were the ETS to be transmogrified into some sort of had Climate Change Agreements. So we get used to European carbon tax which is much more readily Climate Change Agreements, which were an understood and much more predictable? extension of what we had been asking for anyway, Mr Rodgers: That is a complex series of questions. and this then becomes overlaid by Emissions Certainly the lack of consistency across Europe has Trading Scheme. At the moment that is having little been a concern in phase one. It looks like it will be real impact, because during phase 1 it is learning by less of a concern in phase two because the doing and there is plenty of carbon in the system; that is not going to be the same in future. It is partly Commission has cut back the National Allocation that companies like what they know already—and Plans for every Member State other than the UK. we know Climate Change Agreements and we know Transmogrifying it into a carbon tax? The problem they work and they of course are a necessary is that we exist in an international market. If by counterpart of the tax, of the levy. EU ETS will or transmogrifying it into a carbon tax it means that does create that extra degree of uncertainty. It is a you can then start imposing that same tax on all cap in trade scheme. It looks like it is going to remain products, regardless of where they are a cap, a trade scheme, applied just within the manufactured, that is a way of eliminating the European Union, whereas we have competitors competitiveness impact of it—and we certainly have outside of the European Union from non carbon no policy position on this (it is not something we constrained economies. Our main non-European have debated)—you could see that that might be a competitors these days are China, Brazil and India, preferable solution to what we have and what we are all non carbon constrained economies. We can see likely to have post-2012, which is a cap and trade that if we get the situation where we are carbon scheme where the greatest incentive will probably, constrained ourselves, in the sense that we have to for compliance, be reducing output rather than buy allowances, that is going to be very costly. That improving energy eYciency. is why, instinctively, we feel that EU ETS as Mr Stace: Then, if we reduce output in the steel currently constructed, as a cap and trade scheme, is sector in the European Union, somebody else is not something that we relish. going to produce that steel and they might produce Mr Stace: I think the results come from two surveys it less eYciently and, therefore, global emissions will that we did, one on energy and energy prices and increase. So, environmentally, it is actually making another on tax in general. Unfortunately, we did not the situation worse. ask for reasons, so it was tick the box, and what came out at the top was that energy taxation is more preferable to emissions trading. This is also seen in All those objections would apply to 5 Q54 Chairman: the PWC report that we have seen. I am wondering a tax anyway. A tax is not going to be paid by if it is more, as Ian said, that these companies Chinese steel producers if it is a British or EU tax. understand tax. They have always paid tax, so Mr Rodgers: With a tax it does become easier to another tax is something they feel more comfortable impose something at the border which is WTO- with; whereas, if they have not been subject to an compliant. It is virtually impossible, I think, to Emissions Trading Scheme before, it is a whole new impose a border measure within EU ETS and keep ball game that they really do not understand at the it WTO-compliant. With a tax it does become easier. moment, and they worry that it is going to increase their costs and be more of an administrative burden than a tax would be. I am saying that if the survey Can I just press you a bit more on went to FD’s companies, that is what they might be Q55 Joan Walley: that? It is this area of competitiveness and saying. I think we should understand that Emissions Trading Schemes are not simple. That is why we are production that is taking place in countries which do probably here today, because the Climate Change not have the same targets, agreements and levies to Agreements and Climate Change Levy is not a meet. I just wonder what work you are actually simple issue. Okay, it seems quite simple now in doing at the international level which would, if you 2007, but introducing this to our members from 1999 like, start to look at how this lack of a level playing field, in terms of manufacturing processes, should be 5 A Review by the NAO on The Climate Change Levy and incorporated into the kind of international Climate Change Agreements, August 2007, p.41. agreements, and where that fits with the European Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 15

16 October 2007 Mr Gareth Stace and Mr Ian Rodgers

Emissions Trading Scheme, and where it fits with the Q56 Joan Walley: Can I ask how that started, that levy and agreements in this country. discussion, and interfaces with the international Mr Rodgers: We certainly think that the negotiations and the international framework that is globalisation of whatever scheme we have is the way going on currently looking at international forward. The International Iron and Steel Institute agreements? only last week met and agreed that all the major Mr Rodgers: Probably, at the moment, it is not players, all the major steel companies around the interfacing a huge amount because the steel industry world will start exchanging data. This is an only took this international decision last week. interesting first step towards something that could However, clearly, the next stage has to be some sort lead to an international agreement. We would of interface with the international negotiations for certainly support international sectoral agreements the post-2012 global system. as the way forward, as a way of constraining carbon Chairman: Thank you very much indeed. That has but, at the same time, not hitting competitiveness. been very helpful to us.

Submission from The Society Of Motor Manufacturers and Traders Limited

SMMT is the leading trade association for the UK automotive industry, providing expert advice and information to its members as well as to external organisations. It represents more than 500 member companies ranging from vehicle manufacturers, component and material suppliers to power train providers and design engineers. The motor industry is a crucial sector of the UK economy, generating a manufacturing turnover of £47 billion, contributing well over 10% of the UK’s total exports and supporting around 850,000 jobs.

SMMT has had a climate change agreement since 2001. Currently we have 25 sites in the CCA. They have made significant improvements against their CCA targets through hard work, investment and increasing output. Below we answer the 10 questions laid out by the Committee.

1. Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed?

The CCL and CCAs have worked well and delivered significant emissions reductions. However, SMMT has questioned the need for CCL to continue under the significant rise in energy costs. In addition, when CCL was introduced NIC were cut in lieu, but quickly raised after the introduction of the scheme. However, if the CCL is to continue then it must do so with CCAs also in place. The CCAs were designed to oVer some protection to energy intensive sectors. If the CCAs were to be removed and the CCL remains (or sites fall into the proposed CRC), then the competitiveness implications for the sector would be significant.

When the CCA was first introduced there was much concern over the design of the scheme. It now appears to be working well and SMMT would suggest little change is needed to maintain it as an eVective policy instrument. Although the targets are based on energy use, they have delivered large actual carbon savings.

SMMT has serious concerns that the CCAs are not being given due credit for the environmental benefits they have achieved, and in particular notes that the NAO report suggests that the targets “have not been as stringent as possible” (page 27). The targets in the automotive sector were generated after the government sent an independent consultant to a cross section of automotive sites to assess potential energy eYciency savings. The targets finally agreed went beyond those the independent consultant recommended. Through hard work, early action on investment decisions and also improved volumes the sector has gone beyond its eYciency targets in the previous milestone periods. In 2004 the targets were toughened in the pre-arranged target review. A similar review is due in 2008.

The CCAs also ensured better collection of energy data—and more access to the data for the trade association. The move to better monitoring of the data ensured that better management of the energy use could be undertaken. The data could also be used to compare sites and this in turn also helped speed up the process of improving energy eYciency. The data also enabled the sector to be more open and transparent in its activities. In this respect SMMT has published a sector sustainability report since 2000. The availability of the energy data also enabled the sector to input into development of other initiatives to reduce energy use, eg the EU ETS. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 16 Environmental Audit Committee: Evidence

2. With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)? SMMT still believes that the eYciency aspect is very important. Absolute caps can be useful and SMMT is exploring the impact of moving towards them in CCAs, but they could penalise growing companies or sectors. The proposed carbon reduction commitment (CRC) revolves around absolute caps, but is set to include some element of a growth factor in the league table, which will influence an organisations position in the published results and for revenue recycling. SMMT fully supports this position. Relative targets can help reward sectors which are growing and which would be penalised by absolute emission targets. A growing healthy manufacturing sector is vital in sustaining jobs and the economy. The CCAs involve an eYciency remit in both relative or absolute emissions targets (SMMT members use largely relative targets, but some have switched to absolute). SMMT is particularly keen to ensure that CCAs are not removed or adjusted to involve some element of auctioning, as with proposed CRC and the EU ETS. Such a move would aVect the competitiveness of UK businesses, with energy intensive companies then subject to not only the full levy costs, but also the cost of buying allowances. Having relative targets also helps ensure that all sites, irrespective of size, have an incentive to improve. If the targets were in absolute terms then smaller sites would not appear to be making a significant improvement. The relative targets can also make it easier for workers in the sites to relate to the improvements. Automotive manufacturing sites usually clearly label and chart details of eYciency per vehicle on the work stations.

3. How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? The CCL and CCAs are now established and run relatively smoothly. If the CCL is to stay then the CCAs must also be retained, to ensure energy intensive sectors can remain competitive. SMMT believes that the current situation of only partial site coverage of CCAs within our sector adds an unwelcome complexity and cost to the scheme. SMMT would like to see an impact assessment of moving towards full site coverage, or widening the eligibility criteria of CCAs. Full site coverage would make the scheme simpler to administer, monitor and report. It would also mean that investment opportunities throughout the site to improve eYciency could be taken, rather than a focus on CCA (or EU ETS, etc) aspects of the site. However, any changes to the current regime would also include more work. However, SMMT would not like to see CCAs move towards an element of auctioning the emissions rights—as this would impact on the competitiveness of the sector, which is highly open to international competition. SMMT is also concerned about the impact of duel regulations. It is also important that organisations which are in a CCA or the EU ETS are not covered by the Carbon Reduction Commitment (CRC) as well, as this would further increase the administrative burden without significant environmental benefit and would not generate any additional awareness of climate change issues.

4. Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements.U What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? Trading has been a very useful element on the CCAs. However, the steady fall in the value of allowances, due to oversupply from the voluntary UK ETS, has meant that it now provides little incentive to go beyond a site’s emissions targets. Without trading though several sites would find it impossible to pass their targets, so it is imperative that the trading element remains.

5. What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? Within the automotive sector the CCL has added to the cost of producing vehicles and they components in the UK. A large proportion of the industry cannot join agreements—as do not have the IPPC processes deemed necessary by government to join an agreement. For example only 25 sites have a CCA in the automotive sector, but it is estimated there is in the region of 3,000 automotive companies within the UK, most of which do not meet the eligibility criteria to join the CCAs. Those sites in CCAs have clearly faced increased costs too. The levy costs those 25 sites some £6.5 million in 2006 (approx £250,000 per site). The monitoring, reporting and verification process is relatively expensive—taking some 40 man-days per annum per company, as well as the costs of installing meters, verifiers, and so forth. The arrival of CCAs coupled with high energy costs and eVective eVorts by companies to reduce their energy use and improve their eYciency have ensured significant savings in energy use in both Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 17

relative and absolute terms in the automotive sector. This has helped UK firms remain competitive. However, the loss of MG Rover and Peugeot’s Ryton plant highlight the economic climate and competitive pressures UK automotive sites are constantly under within a global market place for automotive products.

6. Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent? SMMT would like to see the CCAs widened to whole site coverage and for the eligibility criteria to be widened to allow easier entry for sites into CCAs in the first instance. The former could be achieved by adjusting the 90/10 rule to become a 60/40 rule. None of the SMMT sites have full site coverage, which makes administration and monitor, report and verification (MRV) complex and costly. It could also lead to unbalanced investment decisions at a site level. The agreement documents themselves do appear overly complex and surrounded by legal jargon. There is already a review process for sectoral targets in place and SMMT’s targets were made more stringent at the last review. This process is acceptable, although the hard work and eVorts of firms (and sectors) should not automatically necessitate a tightening of the targets, as this does discourage the drive for greater eYciency. Where the CHP is not all in the CCA then the reporting of emissions is cumbersome, and so could be simplified.

7. What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? Resource—both financial and manpower/time is restricted. Automotive manufacturers are eYcient at making automotive products. Dealing with complex policy and legal documents is time consuming. The CCAs took a significant eVort to develop. New schemes, such as EU ETS or CRC often duplicate the eVorts. Some sites find they have to MRV their environmental performance multiple times, but sometimes to cover slightly diVerent time periods and for slightly diVerent aspects of the sites. SMMT has been working with government on Better Regulations, but the process has been slow. The arrival of the new CRC highlights this issue further. On a competitive level, the benefits of achieving greater energy eYciency in the UK are welcome and desirable. However, the automotive sector is truly global—85% of what is sold in the UK is imported and 75% of what is made here is exported—and many if not all of the sites located here are not tied to the UK, many are owned by multinationals. SMMT is therefore keen to ensure that automotive sites in the UK do not face regulations and targets which make them uncompetitive in the global market. SMMT is particularly keen to ensure that policy instruments, such as EU ETS and CRC, do not place too great a burden on companies by moving to full auctioning of allowances. Uncertainty over how the aforementioned policy instruments will change going forward also acts as a barrier to investment decisions about improving energy eYciency.

8. Products which can increase energy eYciency (such as insulating glass for windows) can be energy-intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything, should be done about it? Energy intensive abatement technology has to be implemented in many of the SMMT sites which increase energy usage. This should be considered when setting CCA targets. Stricter building regulations, which have increased insulation use, will make it easier for manufacturers of such products to meet relative targets. If there is a switch to absolute emission targets then thought should be given to how manufacturers of low carbon products are treated, as those products maybe more energy intensive to make. It is estimated that 85% of a vehicles life cycle emissions come from the in-use phase, just 10 per cent from the construction and 5% from recycling/destruction. So the eYciency of the vehicles in use phase is key to its overall emissions impact.

9. Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments? ECAs have not been extensively used in the automotive sector. However, they are useful. The most disappointing aspect of ECA is that those operators with arguably the most need for the relief—non- profitable companies—do not get it. This should be addressed to make this a more equitable incentive. Increasing the size of the ECA from 100% to 200% would help make the scheme far more attractive. Expanding the list of products that the ECA can apply to would also help increase the take up. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 18 Environmental Audit Committee: Evidence

10. The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how? The only financial saving from renewable energy is that the levy is not paid. However, the energy used still needs to be reported in the CCA. It may be useful if renewable energy would not count towards the CCA reporting, and targets could be met by installing or buying renewable energy. If only part of the energy is from renewable sources this could be apportioned to the CCA area. CCL would stimulate the market for renewable electricity, but the market for this green energy is dominated renewables obligation certificate (ROCs). The market would need to become more liquid for CCL to have an impact incentivising further the growth of renewable electricity.

Summary SMMT believes that the CCL and CCAs raised awareness and encouraged members to go beyond business as usual improvements in reducing energy use, and therefore emissions. ThisUachievement has been made possibleUby hard work, increased investment andUin terms of eYciency gains also by improvements in output. CCAs increased the importance of energy management in the boardroom and allowed for top- down commitment from directors, but also for bottom up action by people on the production line, who could see the impacts their actions were making through better monitoring and reporting processes. SMMT is concerned that there is an excess of instruments relating to climate change and this is leading to dual regulations and an administrative burden. SMMT has been working with government on better regulation and would welcome a review of the interaction between the CCL/CCAs, EU ETS and the proposed CRC. SMMT has questioned the need to the CCL to continue in its current form, but if it does then it is imperative for the CCAs to continue, as they protect the competitiveness of energy intensive industries. SMMT is concerned that if the CCAs were removed or replaced by a CRC style scheme the competitiveness of an industry which is highly open to international trade and competition would be damaged. 28 September 2007

Memorandum submitted by The UK Emissions Trading Group

Introduction This response provides written evidence to the House of Commons Environmental Audit Committee in relation to the inquiry into the roles played by the Climate Change Levy (CCL) and Climate Change Agreements (CCA) in reducing carbon emissions and energy use by the UK business sector. This inquiry follows a new study by the National Audit OYce (NAO), prepared especially for the Committee.

Background to the UK Emissions Trading Group The UK Emissions Trading Group (ETG) is a body that represents numerous companies and organisations that are involved in CO2 emissions trading schemes. The ETG has 112 members including individual companies and Trade Associations that represent relevant industry sectors. Both Defra and BERR have had regular input into ETG meetings since the organisation was founded in 1999. The ETG has provided the UK Government with an enormous amount of practical help in relation to the implementation of emissions trading. The work of the ETG has included input into 4 important CO2 trading schemes, including: 1) The UK ETS. 2) The EU ETS. 3) CCAs (Climate Change Agreements, which rely on trading for eVective operation). 4) The proposed Carbon Reduction Commitment. ETG membership includes representatives of companies that have over 94% of all UK emissions in the EU ETS and also includes Trade Associations responsible for a large proportion of the companies in CCAs. One of the ETG Working Groups (WG 1/2) concentrates on issues surrounding the interaction of CCAs with the other trading mechanism. WG 1/2 has members that have been fully involved in the development and implementation of CCAs since they were first announced by the Chancellor in 1999. This body of expertise is possibly unique, and forms a useful basis for input to the current deliberations of the Environmental Audit Committee. Approximately 40 members of WG 1/2 have debated the NAO report at a meeting on September 19th 2007. This written evidence is based on the key outputs of that discussion. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 19

General Comment on the NAO Assessment of CCA Effectiveness The general tone of the NAO report was that CCAs have failed to deliver what was originally promised. Members of the ETG strongly disagree with this view. We have had over six years of experience of CCAs and believe that they have been a policy that has had a very positive eVect on energy intensive industries in the UK. The establishment of CCAs has led to: 1) Tangible energy eYciency improvements well beyond Business-as-Usual (BAU) in many CCA industrial sectors. 2) A significantly raised awareness of energy issues at board level. In particular, there has often been a greater involvement of Finance Directors due to the tax saving implications. In many CCA sectors this improved awareness has helped lead to the development of much bigger energy eYciency investment programmes. 3) The creation of much improved data in many industrial sectors due to the CCA requirement for annual reporting of energy and production data. In 1999 only a small number of industry sectors had voluntary schemes in place for collection and interpretation of annual energy data. In most cases the datasets only represented a proportion of the whole industry sector. Under CCAs there is now at least seven years worth of annual data for almost all factories in each industry sector. This data provides a powerful platform for improved understanding of energy saving opportunities. 4) The creation of strong industry sector networks, based on the requirements for a Trade Association to manage each CCA. These networks have led to improved sharing of energy saving ideas and have formed a new platform for dissemination of new technologies eg via Carbon Trust funded Network Projects. 5) Better interaction between Government and each industry sector, through the negotiating process and the on-going reporting of Milestone data. This has provided both Government and industry with an improved understanding of the energy saving potential and has helped industry understand how Government can try to achieve GHG emission reductions. The NAO report has not done justice to these positive aspects of CCAs. The ETG recognises that there are some aspects of CCAs that have caused problems over the last few years. However, these are relatively minor administrative issues that can be attributed to teething problems of a new Government policy. The introduction of other major climate change policies such as the Direct UK ETS and Phase 1 of the EU ETS had far greater initial problems, which actually negated the environmental benefits of these schemes. This is certainly not the case for CCAs. The initial targets for some CCA sectors were found to be too easy to achieve, but this problem was addressed in the 2004 target renegotiation. With the availability of better data (see point (3) above), industry sectors could recognise that they had a greater potential to make savings than had first been thought. At the 3rd Milestone in 2006 most CCA sectors were making adequate progress against the renegotiated targets, and most parties involved in CCAs accepted that the sector level targets were challenging but achievable. On balance, most high energy intensity industry sectors feel positively about the structure of CCAs and believe that a similar structure should be adopted after the end of Milestone 5 (in 2010), which is the last Milestone of the existing CCAs. ETG members believe that a number of important changes can be made to reflect the lessons learned over the last 7 years and also the changes that have occurred in the Government’s wider climate change policies. However, without the current structure we believe it would be impossible to devise a policy that suits energy intensive industries and that delivers all the benefits described above.

Specific Comments on Items in the NAO Report

A. Page 4, Key Conclusions Box On the opening page of the Summary is a Key Conclusions box that shows the CCL itself had a very positive environmental benefit (3.5 MtC in 2010), but that the CCA mechanism did not deliver as much saving (1.9 MtC). We believe this is wholly unrepresentative of the savings achieved by energy intensive industry. The assessment of CCL savings is made via the work done by Cambridge Econometrics in 2005. The modelling is believed to be flawed as it did not take into account the impact of mild winters. Also, the “announcement eVect” of CCAs has been included in the apparent savings achieved by the announcement of the CCL. This leads to an optimistically high figure for the savings from CCL alone. Conversely, the figure for CCAs is believed to be an underestimate as it exaggerates the BAU impact and also does not fully account for factory closures and sector rationalisation. There is anecdotal evidence that the CCL by itself is not an eVective instrument. It often goes completely unnoticed in non-energy intensive businesses. It provides none of the secondary benefits of CCAs (eg better data, better networking etc.) and provides such a small price signal that it is not surprising that it has little impact in markets with a relatively inelastic response to energy prices (ie low energy intensity businesses). Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 20 Environmental Audit Committee: Evidence

There is robust evidence that illustrates the level of engagement in energy eYciency by CCA companies. Almost all eligible companies have signed up to CCAs and the vast majority have managed to achieve recertification at each of the first three milestones, including achieving the often much tougher MS3 targets that are based on the 2004 renegotiations. This could not have been achieved if the majority of companies were not making eVorts to achieve savings.

B. Page 5, 1st Bullet on CCAs This states: “It is also the case that some businesses have benefited from the tax discount despite failing to meet their targets: they have done this by relying on the overachievement of others within their sector.” This statement shows a significant lack of understanding of the way that CCAs work. The vast majority of businesses with a CCA take steps to ensure that they meet their targets, either by achieving the required energy savings or by taking part in emissions trading. Very few businesses are “relying on the overachievement of others within their sector”. The NAO have misunderstood the way that emissions trading operates within a CCA. In almost all cases, a business that overachieves against its target retains “access” to this overachievement through emissions trading (either selling the surplus or banking the surplus for future use). In these circumstances the sector does not benefit from the overachievement. It is worth noting that a very small number of sectors operate their CCAs in such a way that overachievement is shared amongst all companies in the sector. However, this is the exception not the rule and it is a mechanism originally suggested by Government, not by industry. It is also worth noting that the original 1999 design of CCAs gave more emphasis to the sector level target. During 2000 the OFT intervened to ensure that Defra allowed any overachiever to retain its overachievement, via the emissions trading process. This requirement made the sector level target much less important in most CCA sectors.

C. Page 6, 2nd Bullet This states: “Only a proportion of the reported results are actually additional savings achieved by Agreements. . . .. Of the 4.5 MtC annual savings reported to December 2006, revised business as usual projections suggest that only 1.9 MtC can be considered additional savings achieved by the Agreements.” The analysis behind this statement requires careful scrutiny. The 4.5 MtC figure is considered an underestimate as it does not fully account for site closures linked to industry rationalisation. These closures are part of the BAU improvements that are taking place in industry. To attribute only 1.9 MtC savings to CCAs is thought to be double counting much of the BAU improvement.

D. Page 6, 3rd Bullet This states: “Not all targets have been as challenging as they could be.” At the first 2 milestones, in 2002 and 2004, it was shown that some of the targets set were not as challenging as they should have been. In most cases, this was caused by the significant lack of information available for many CCA sectors during negotiations in 1999–2000. Both Government and the sectors themselves did not have a detailed understanding of energy use in each sector. The approach taken to initial target setting was, in some cases, conservative due to the lack of good data. This can be considered as an initial teething problem for CCAs. The CCAs had 2 target renegotiations built into the original 10 year timescale. The first was in 2004, at which the targets for Milestones 3, 4 and 5 were renegotiated. The second will be in 2008, at which the target for Milestone 5 will be renegotiated. The 2004 renegotiations provided Defra the opportunity to significantly tighten the targets originally set in some sectors. In all cases there was much better data available by 2004 and Defra adopted a tough negotiating policy. The new targets for Milestones 3, 4 and 5 are far more challenging than those set earlier. Hence it is unfair for the NAO report to criticise the targets without reference to the fact that the current targets are quite demanding and that a further renegotiation of targets is due in 2008. It should be noted that the lack of data available in 1999–2000 was a common problem but that a small number of sectors already had much better data available via existing voluntary reporting schemes.

E. Page 6, 4th Bullet This states: “Agreements have enabled businesses to achieve eYciency improvements, though business opinion is divided over their eVectiveness.” With over 10,000 sites taking part in CCAs it is almost self evident that business opinion is divided. However, the major companies and sector Trade Associations that are members of ETG are almost all very positive about the impacts of CCAs (the perceived benefits were already described on Page 2 of this document). CCAs are believed to be a good policy mechanism for energy intensive industrial sites. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 21

It is worth noting that CCAs give equal emphasis to creating eYciency savings for both electricity and fossil fuel (this is achieved by using a weighting factor that recognises the primary energy use involved in the generation of electricity). ETG members believe this to be very important. In many industrial sectors electricity is a significant part of the total primary energy use. “Upstream” climate change policies such as the EU ETS do not give a target to make electricity savings. An important part of the success of CCAs is the inclusion of electricity savings in the targets.

F. Page 7, Issues for Committee Scrutiny, 1st Bullet This refers to relative versus absolute targets. The ETG believes that climate change policy has moved a long way since the recommendations of the 1998 Marshall report, which recommended energy eYciency targets (ie relative targets). The EU ETS and the proposed CRC use absolute CO2 targets. The majority of ETG members accept that absolute targets may be better for CCAs in the future. However, it should be noted that developing a successful scheme with absolute targets is not totally straightforward—as illustrated by severe teething problems in both the UK ETS and the EU ETS. An absolute regime can reward ineYcient companies that are losing market share but, perversely, can penalise growing companies that are becoming more eYcient. CCAs already have an option for absolute targets, but in late 2000 the Government set special rules for these absolute targets because of fears over the impact of site closures. The “absolute targets” in CCAs are actually quasi-relative targets, as they are adjusted if the output of a factory falls by more than 10%. This problem may have been created by allowing companies to choose between relative or absolute targets. If all companies are forced to have an absolute target then the site closure problem would be less severe, although it will not disappear altogether, especially if production is being lost to overseas competition. The ETG recommend that great care is taken over the design of a future scheme in relation to the use of either relative or absolute targets, learning lessons from both CCAs and from relevant emission trading schemes.

G. Page 7, Issues for Committee Scrutiny, 2nd Bullet This refers to sectors with diVerent energy intensities. The ETG believes that the proposed CRC is only applicable to industrial or commercial sectors with very low energy intensity. CCAs are more applicable to sectors with higher energy intensity as the CCA process: a) Provides a framework for taking sector specific diVerences into account, and b) Provides a vital tax incentive that helps protect the competitive position of businesses spending a lot of money on energy. The best “change-over” threshold between CCAs and the CRC is hard to judge. Most CRC companies have an energy intensity of below 1%4 whilst most CCA companies are in the 3% to 10% range. A few CCA sectors have energy intensities above 10% and a few fall below 3%. The current “energy intensity” CCA eligibility criteria are considered to be set at too high a level, especially for businesses that are not subject to international competition.5 ETG would prefer to see slightly wider eligibility for CCAs that would be achieved by allowing any industry sector with an energy intensity above 3% to be eligible.

H. Page 7, Issues for Committee Scrutiny, 3rd Bullet This refers to overlap between CCAs and EU ETS. This is definitely an important issue requiring further consideration. About 500 out of over 10,000 CCA sites are in both a CCA and the EU ETS. Although the number of sites are small, these 500 sites represent a significant proportion of all the energy in CCAs as they are amongst the 500 largest industrial sites in the UK. For these sites participation in the EU ETS is mandatory and is likely to remain that way for at least the next five years and probably beyond the end of Phase 2 of the EU ETS. Participation in CCAs is voluntary, but the CCL discount is vital for financial reasons, hence almost all eligible sites are in both the EU ETS and a CCA.

4 http://www.worldautosteel.org/ 5 The eligibility for CCAs is either based on PPC processes or uses one of two energy intensity thresholds. Any sector with an energy intensity of over 10% is eligible. Sectors falling between 3% and 10% are only eligible if they also meet a high international competition threshold (50% of the UK market for the relevant product must be imported). Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 22 Environmental Audit Committee: Evidence

A fairly complex “double trading adjustment” has been agreed with Defra to avoid emissions trading benefits for the same emissions in both the EU ETS and the CCA trading scheme (based on the UK ETS). Many CCA companies would prefer a simpler mechanism that avoided the same energy use being in two separate schemes, as this would ease the administrative burden. However, it is of greater importance that the CCL discount is maintained.

I. Page 7, Issues for Committee Scrutiny, 4th Bullet This states: “From the perspective of the taxpayer and competitive rivals, is it right that some businesses can be given a tax discount despite failing to achieve their Agreement targets?” This is considered by ETG to be a highly “inflammatory” statement that actually undermines one of the main pillars of both UK and EU climate change policy ie emissions trading. Alternatively it shows that the NAO report authors do not understand how CCAs actually work. The statement “ . . . .some businesses can be given a tax discount despite failing to achieve their Agreement targets” is incorrect. Companies are only recertified for the discount if they meet the target in one of 3 ways: 1) Direct company level achievement of the target by saving energy within the company. 2) Indirect company level achievement of the target by use of emissions trading with a company that has over-achieved their target. 3) Indirect achievement of target via the sector target (this only applies to a very small number of CCA sector). The use of emissions trading is an intrinsic part of the CCA mechanism, aimed at ensuring that the overall emission reduction targets are met at the lowest cost to the UK economy. The option of sharing savings amongst companies within a sector is eVectively an alternative to trading that is an acceptable alternative within the current structure of CCAs although it is only adopted by a small number of sectors.

J. Page 7, Issues for Committee Scrutiny, 5th Bullet This refers to target renegotiations in 2008. The statement implies that the 2004 renegotiation was unsuccessful. The ETG strongly disagree. The 2004 renegotiation has already put most CCAs onto an achievable but challenging set of milestone targets. The 2008 renegotiation simply needs to apply fine tuning to take into account any changes in circumstances since 2004.

K. Page 7, Issues for Committee Scrutiny, 6th Bullet This refers to improved estimates of savings. We would welcome more thorough research into this issue.

L. Page 7, Issues for Committee Scrutiny, 7th Bullet This refers to CO2 trading in CCAs. As already stated, trading is a vital element of the way CCAs are structured. It is accepted by ETG that the current price of CO2 Allowances in the UK ETS is too low. This was caused by imperfections in the design of the direct UK ETS in 2001–02. Although these imperfections were partly addressed through the voluntary retirement of Allowances by some direct participants there is still an excess of supply over demand, leading to a low CO2 price. It is worth noting that “learning by doing” was a clear Government objective in the set up of the UK ETS. Teething problems were likely and we can now build on the lessons learned. Had the CCA trading mechanism existed by itself (ie without the links to the direct UK ETS) it is likely that a more realistic CO2 price would now prevail. However, in the early years of CCAs (ie at Milestone 1) there would have been no market liquidity because no CO2 would have been available for sale until after the first milestone was completed. This would have caused great problems. A future design needs to take these factors into account. It is also important to consider the impact of the time period between milestones on an emissions trading market. For CCAs the milestones are once every two years, whereas as the UK ETS (direct) and EU ETS operate on an annual cycle. From a trading perspective this is highly preferable—under CCAs the trading profile is very erratic, with almost all trades being completed in a two–three month period once every two years. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 23

M. Page 7, Issues for Committee Scrutiny, 8th Bullet

This refers to the long-term future of the Levy and Agreements. It also states: “Businesses see long term uncertainty in government policy as a barrier to improving energy eYciency”

This is a crucial issue. Business is very keen to start discussing the future of CCAs and have asked both Defra and HM Treasury to start this process during 2007. The 5th and last CCA Milestone in the current Agreements is in 2010. If a new regime of targets is to follow on directly after Milestone 5 we have relatively little time to agree new rules and new targets.

Business investment cycles are relatively slow—an early agreement of future targets is considered essential. On-going uncertainty about the future of CCAs could cause UK industrial investment decisions to be delayed or cancelled.

The ETG has written to both Defra and HM Treasury urging an early start to discussions about the future of CCAs, but we have not yet received any response indicating when such discussions will begin.

N. Page 7, Issues for Committee Scrutiny, 9th Bullet

This refers to conflicts for energy intensive products with low life cycle carbon emissions (eg insulating glass).

The ETG recognises that there could be perverse impacts via both the EU ETS and CCAs for some products of this type. We welcome further discussion of ways to avoid such impacts.

O. Page 7, Issues for Committee Scrutiny, 10th Bullet

This states: “Does it matter that econometric estimates of policy impact can vary widely due to changes in business as usual projections, even if policies are working as expected? In the case of the Agreements, what are the implications of the fact that taxpayers are receiving less value for the tax foregone?”

We do not agree that taxpayers are receiving less value for the tax foregone. CCAs were introduced to avoid competitive distortions for companies of high energy intensity. When the CCL was introduced it was made fiscally neutral through the reduction of employers NI contributions. This mechanism clearly does not work for businesses with very high energy costs and relatively low numbers of staV. The CCA tax discount was not aimed at giving a specific level of environmental cost eVectiveness—it was given to provide fiscal neutrality for energy intensive companies.

Further Comments on Items in EAC Inquiry Announcement

1. Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed?

For the future of CCAs it will be important to consider the scope of emissions. It is important to recognise that CCAs aVect a much larger number of UK sites than the EU ETS and that many sites are quite small. For eVective operation CCAs must retain administrative simplicity, which will be hard to achieve if emissions from sources other than energy are included

As stated in Comment 5 in the previous section, we believe it is very important to include indirect electricity emissions as well as direct fossil fuel emissions. This provides much better coverage of industrial emissions than would be provided by an upstream approach like the EU ETS.

Large process emissions from non-energy sources (either process CO2 or non-CO2 emissions) are well covered by the EU ETS. Trying to incorporate further non-energy emissions from CCAs with small factories could add unnecessary complexity. Non-energy emissions might be better dealt with under other instruments (eg F-Gas emissions such as HFCs are already covered by a new EU Regulation). Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 24 Environmental Audit Committee: Evidence

2. With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)? This is dealt with in Comment F in previous section

3. How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? This is dealt with in Comment H in previous section

4. Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? This is dealt with in Comment L in previous section

5. What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? This is impossible to answer without undertaking a wide-ranging study.

6. Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent? As already discussed in the previous section the ETG is a strong supporter of the CCA mechanism. We recognise that the current CCAs were a ground breaking policy when they were set up in 1999–2000 and that with hindsight it will be possible to create a better design that eliminates some administrative burden and that maximises the future environmental benefits. Examples of improvements include widening the “90/ 10 rule” to capture more energy savings and changing the rules applied to absolute targets under a mechanism referred to as CCA 16. The ETG has many CCA and emissions trading experts and can provide a useful forum to discuss the future of CCAs with Government. We welcome the early start to such discussions.

7. What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? This is another question that requires a “report sized” answer! Some historical barriers are being removed with the significant increase of realisation that climate change is such an important issue to address. A massive change of attitude in both the general public and in business leaders has been evident over the last two years. For many industry sectors this changing attitude will lead to much more investment in energy eYciency. However, it should be noted that for the most energy intensive industry sectors that energy forms such a large percentage of production costs that energy eYciency has already received massive investment over many years. Some of these processes are already reaching the thermodynamic minimum energy consumption. For processes of this type energy eYciency is no longer an eVective option—the only way of making further CO2 emission reductions in such circumstances is to use methods other than energy eYciency, eg renewable energy supply, nuclear power, CCS etc.

8. Products which can increase energy eYciency (such as insulating glass for windows) can be energy-intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything, should be done about it? This is briefly dealt with in Comment N in previous section. This requires more investigative work.

9. Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments? In the original CCL package announced in 1999 a significant sum of money was allocated to ECAs. However, it is not clear how much ECAs have actually cost HM Treasury and whether they have been widely adopted. A more direct and transparent method would be preferable. ECAs on some major systems such as CHP are believed to be helpful, but they have limited financial impact on many types of energy eYciency investment (and no impact for companies making a loss or organisations in the public sector). Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 25

10. The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how?

The ETG believe that the Renewables Obligation and the EU ETS should remain the main policy tools to encourage use of renewable energy. Heat only renewable energy is already incentivised via CCAs. Any on- site generation of renewable electricity is usually used to sell ROCs—with current ROC prices this is more financially attractive than using the electricity as a way of meeting a CCA target. 26 September 2007

Memorandum submitted by the Chemical Industries Association The Chemical Industries Association (CIA) Climate Change Agreement (CCA) covers around 300 sites in a sector which, in total, has 190,000 employees across every region of the UK. The sector is one of the UK’s most important industrial sectors, accounting for 11% of manufacturing gross value added and is the only major sector to maintain a significant positive trade balance, typically registering a surplus of £5 billion annually. The chemical industry faces global competition with UK assets predominantly owned by companies that are headquartered overseas. The industry converts both mineral and plant based raw materials into key intermediates for use by other manufacturing sectors as well as its own final products for households, ranging from paints to detergents, fragrances to pharmaceuticals. We buy our raw materials and sell our bulk products at global prices with energy representing a high proportion of the conversion cost. As well as being major consumers of both gas and electricity for heating and power, our members use gas and oil as feedstocks—for some companies energy represents 30% or more of their total costs. As we are both energy intensive and exposed to international competition, the impact of the Climate Change Levy (CCL) on our business could have been significant, had the CCA commitments not provided a means for securing relief. Under the CCAs we have a good track record for improving our performance while the use of relative targets has ensured there is no disadvantage to production growth it is on an energy eYcient basis. Unfortunately, overlaps and duplication have arisen with other instruments eg: the EU Emissions Trading Scheme (EU ETS). After the current CCAs run their course, we see a continuing role for a CCA-type instrument suited to energy intensive sites which fall below EU ETS coverage which, unlike the proposed Carbon Reduction Commitment (CRC), qualifies them for relief from the energy tax (currently the CCL) as provided for by the Energy Products Directive. While eVectively targeting continued improvements in performance, it is important that this instrument: — Minimizes competitive impacts; — Does not incentivize displacement of activity to countries which are not carbon constrained; — Avoids administrative complexity arising from overlaps or coexistence with other instruments on the same site; — Ensures that operators receive a single and predictable carbon price signal.

Overall Comments on the Contribution of the Climate Change Levy and Agreements to Efficiency Improvements

There should be greater recognition that the CCAs are a success story. In the chemical industry the CCAs have further built on our already good record for energy eYciency improvement. Over 1990–98, the sector’s voluntary energy eYciency agreement with DETR produced an 18% eYciency improvement and, since then the sector’s CCA has contributed 20%: in total this is a 34% improvement from 1990 to the 2006. We firmly believe that the CCAs that have raised awareness and generated beyond business as usual improvements both through the challenging but achievable targets that have been negotiated but also through instilling a greater ethos of measurement to manage to improve. Top level involvement has been stimulated through the requirement to implement the qualitative requirements (an energy policy and plan) and the need, in many companies, for board level sanction for emissions trading decisions. We believe that increased awareness is being sustained because: — Companies are required to maintain their CCAs and report progress: this includes continuing to meeting the qualitative requirements and an obligation to review targets every 4 years—in the 2004 review chemical sector 2010 targets were tightened by an average of 4%. — Our large companies and many of our SMEs include the price UK Emissions Trading Scheme (UKETS) allowances in their investment and other business decisions. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 26 Environmental Audit Committee: Evidence

There are a number of findings in the National Audit OYce (NAO) report on the CCL and CCAs which we would like to comment on: — Business is divided over the eVectiveness of the CCAs—this is credible in the context of many targets being imposed “top-down”. Whereas CCA targets in the most intensive sectors, like chemicals, are developed on a “bottom-up” basis according to what is challenging and achievable at site level, many of the less intensive sector’s targets have been set on a “top- down” basis in which all sites commit to an average sector improvement. Clearly, a top-down approach will be tough on some and easier for others and will therefore appear less meaningful. — DEFRA’s latest modelling suggests that CCAs have contributed less emissions reductions than originally estimated. This is on the basis that business as usual improvements have increased over original quantifications, although NAO recognises that the results of such econometric modelling are subject to a high degree of uncertainty. While there is no doubt that the more competitive global environment together with energy price rises have helped to drive increased eYciency, it would be counterproductive to vary climate change commitments with every change in business as usual as this would create administrative burdens and uncertainty. What matters is that targets are met and that any unexpected sustainable overachievements are factored into the next CCA target review, planned for 2008. It should be noted that high energy prices also have a negative impact and, at the 2006 milestone, led to lower throughput, and reduced contributions from combined heat and power—symptoms which, together with increased requirements for environmental abatement, were anticipated to act as a drag on our eYciency in the 2004 review. — The announcement of CCL resulted in businesses making energy eYciency improvements— we believe that most of the improvements have taken place in the CCAs. This is because we do not believe that CCL has been at suYcient levels to drive improvements outside the CCAs of most non-intensive organisations whereas energy costs are relatively insignificant to the cost base. The study by Cambridge Econometrics NAO cite, which attempts to quantify the CCL announcement eVect, appears to place a heavy caveat on its findings when it records that how far the observed fall in energy consumption is attributable to an announcement eVect or a rise in temperatures is a matter of “econometric judgement”. In relation to the Ineos Chlor case study cited as evidence of the CCL announcement eVect it should be noted that the intention to negotiate agreements for energy intensive sectors was also part of this announcement and that Ineos Chlor are CCA participants whose improvements have also been attributed to the chemical sector CCA. Other anecdotal evidence, including that from the Carbon Trust’s experience, CBI surveys, and the NAO’s survey, support the view that most improvements have taken place in the energy intensive sectors covered by the CCAs.

Please find below our comments on the issues set out in the EAC’s call for evidence.

1. Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed?

It is important that any future CCL changes take care to ensure that there is continuity in regulatory incentives which have driven long term investments. CCL is the foundation on which several Government incentivisation programmes are built, eg: exemptions for Combined Heat and Power Quality Assurance (CHPQA) and renewable source electricity. While we do not therefore support radical change, we believe that the eYcacy of the CCL would be enhanced if it were developed to reflect carbon emissions rather than calorific value. This would then be consistent with the need to make a transition to a low carbon economy. However, if this change is made, it is imperative that equivalent incentivisation programmes be put in place to replace those founded upon CCL. The continuation of access to CCL relief is essential to sustaining the international competitiveness of intensive businesses in the chemicals sector—for some of our most intensive sites, energy accounts for more than 30% of total costs. We therefore see a continuing role for CCAs. While CCAs already provide incentives to use low carbon fuels through their link to the UKETS, we agree it would be sensible to make a full move to carbon based targets. However, we see a continuing role for relative targets as this approach directly incentivises reductions in the carbon footprint of products—until industry elsewhere becomes carbon constrained, absolute targets at site level risk driving carbon intensive production to potentially less eYcient locations. We support the Government’s decision to let the current CCAs run their full course, ie: to the 2010 target, and that CCL continues until March 2013 as this gives time to plan their successor. However, we are concerned that formal consultation on the future of the CCAs is being delayed until 2008. Energy intensive sectors like chemicals have long asset life cycles so it is important to have certainty to inform on long term planning decisions. We would therefore welcome an early indication from Government on the future of CCL and CCAs. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 27

2. With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)? Part of the success of the CCAs has been due to their use of relative targets which ensure that improved energy eYciency is achieved without imposing a growth penalty. We see a continuing role for relative targets as this approach directly incentivises reductions in the carbon footprint of products—until industry elsewhere becomes carbon constrained, absolute targets risk displacing carbon intensive production to potentially less eYcient locations. Indeed, carbon eYciency is becoming more prominent in the Commission’s review of the ETS post-2012. EU ETS review discussions are currently signalling that benchmarks will be used to maintain free allocations and minimise competitive impacts—this interest is allied to a recognition that this approach has the added benefit of giving a performance (energy eYciency) signal.

3. How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? There are too many economic instruments and carbon price signals per company. We estimate that in combination, CCL, the Renewables Obligation and the EU ETS have added around 20% to the cost of electricity in our sector as this includes the full CO2 cost pass through of the EU ETS (this estimate is relates to the period before the fall in the price of Phase 1 EU allowances which will be shortly be reversed with the start of Phase 2). This means that electricity users are paying for the related carbon emissions more than once—this is particularly impacting our competitiveness with non-EU producing regions. The introduction of EU ETS has also added to complexities and administrative burdens as sites now have to participate in two emissions trading schemes and overlaps in scheme coverage produce the need for a double counting mechanism. To minimise overlap, Government should consider extending exemption from CCL to EU ETS participants to reduce the need to participate in both EU ETS and CCAs. Now that EU ETS is in place we believe that the pass through of full CO2 costs to electricity prices provides suYcient incentive for sites in energy intensive sectors to improve their use of this energy source. Government should resist any drive for a CCA successor to target improvements in the end-use of electricity on intensive EU ETS sites. Small emitters should be excluded from the EU ETS because their participation is not cost eVective; they would be better covered by equivalent schemes with lower administrative burdens like the CCAs.

Coverage of sites by IPPC, CCAs and EU ETS leads to multiple CO2 emissions reporting requirements and frustrations arise from each scheme using diVerent CO2 conversion factors. This needs to be rationalised as part of the review of the EU ETS and CCAs post-2012; change prior to that would bring a burden as systems are now established for the current CCAs.

4. Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? UKETS has provided significant early learning benefits and has made some contribution to CCA overachievements. We believe trading to meet CCA targets should be allowed because UKETS is integral to the scheme. Through the CCAs, UKETS is the first cross manufacturing sector emissions trading scheme in the world. CCA participants in UKETS have benefited from early learning and in coming to the EU ETS many already understood how to trade, how to use a registry, and had established relations with various brokers. Due to this early experience, chemical companies have included the price of UKETS allowances in their business decisions and this has also lead them to include the price of EU ETS allowances when the scheme started. Participation in UKETS has helped to incentivise overachievements against CCA targets although, owing to the oversupply of allowances, these incentives have been relatively weak. A third of chemical sector participants have also traded to meet compliance at each milestone: despite low allowance prices, trading costs have added to awareness eVects at top level within companies where trading decisions are sanctioned. Low prices have arisen in the context of UKETS being the original learning by doing scheme; we note there have been similar problems in Phase 1 of EU ETS—it is only from experience that these issues can be improved. By definition, emissions trading mechanisms work by trading to meet compliance. Trading provides a flexible mechanism which allows emissions across businesses to be secured at least cost while ensuring that overall environmental objectives are met. UKETS is integral to the CCAs and they were signed on the basis that there was provision for such trading. It is therefore entirely legitimate for a business to secure continued CCL relief by trading to meet CCA. Indeed, the EU Energy Products Directive provides for relief from such energy taxes to be provided to intensive businesses participating in trading schemes. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 28 Environmental Audit Committee: Evidence

5. What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? The cost impacts of CCL on our members have generally been muted as most pay after CCA relief at 80%. However, depending on the fuel and its current price, unrelieved CCL represents 10% to 20% of energy costs. Because our most intensive companies’ energy costs can exceed 30% of their total costs, the loss of relief therefore represents a significant sanction. Because of set-up costs and ongoing administrative requirements, CCA companies tend not to find CCA participation worth management time if annual CCL savings are below £10,000 p.a. The administrative requirements are therefore not insignificant and can be complex as they comprise: — CCA performance monitoring and reporting; — annual checks on PP4 eligibility form including the 90/10 rule; — maintaining claims for CCL on each account from each energy supplier with reviews at minimum on an annual frequency; — participating in UKETS including the registry, dealing with trader/brokers and trading agreements, and any third party verification of overachievements. To understand resource requirements we undertook a case study of a chemical sector SME. The CCA facility in question is a speciality chemicals company engaged in manufacture by batch process. The company estimates that it spends 16 man-days p.a. on administrative requirements for CCAs at a cost of £7,000 p.a These figures demonstrate that CCA costs are not insignificant. However, they are below the burdens imposed by the EU ETS which the SME is also subject to although its annual emissions are below 25kCO2 p.a. The company estimates that, of the 16 man-day spent on its CCA, 13 man-days are on monitoring and reporting that is also used for EU ETS. But there are an additional 9.5 man-days (cost £3,500) which are EU ETS only and relate to permitting. In addition, the fees for the permit, permit variations and verification total £1,800 p.a. It is clear that coverage by EU ETS adds significantly to administrative burdens and that, in this respect, the lighter touch of CCAs is a more appropriate instrument for small emitters in intensive sectors.

6. Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent? It would be sensible to make a full move to carbon based targets, reduce overlaps with other instruments and make CCAs and other instruments in the policy mix more consistent (see also answers to questions 1, 2 and 3). Simplifications should include the removal of requirements for third party verification to generate emissions allowances from CCA overachievements. This requirement makes individual verification of small overachievements, eg: by SMEs, uneconomic. Instead, allocations should be made based on self-certified data, though this should be backed by an increased number of sample audits. This would be consistent with the self-certification principle included in the Government’s CRC proposals. We would also favour some relaxation in the 90/10 rule as this bars a number of our sites from including all their activities under a CCA and thereby taking a holistic approach to targeting eYciency improvements. The current CCAs already include provision to review targets every four years to take account of changes in circumstances, eg: new technological developments. The review conducted in 2004 strengthened the chemical sector relative energy target for 2010 by 4% and this greatly reduced the overachievement at the 2006 milestone. The Government has confirmed that next review set in the agreements, for 2008, will go ahead as planned. With reference to the final bullet in paragraph 3.32 of the NAO report, it is clearly correct that emissions allowances built up from overachievements in previous milestones should not be factored into the review. This is because, under the principles of emissions trading, these form part of the payback for the improvement measures in question. It is also entirely correct, of course, that any unexpected, but sustainable overachievements are factored into the next CCA target review. We would support the new, independent Climate Change Committee advising Government on the review to ensure the right balance is struck between contributions from early starters in CCA sectors and other sectors of the UK economy, where there may be more cost eVective potential.

7. What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? In the chemical sector, an acceleration in energy eYciency will require significant process change/plant replacement or the development and innovation of step change technologies. This is because the sector is an early starter in improving the energy eYciency of its existing assets and much of the “low hanging fruit” has been addressed. Over 1990–98, the sector’s voluntary energy eYciency agreement with DETR produced an 18% eYciency improvement and, since then the sector’s CCA has contributed 20%: in total this is a 34% improvement from 1990 to 2006. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 29

Economic barriers therefore include availability of cost eVective energy eYciency projects, capital to fund them, and asset life cycles. Plant supporting our most energy intensive activities tends to have long life cycles (eg: ethylene crackers, where equipment can be continuously upgraded and refurbished within a framework laid down 20 or more years ago). While market based instruments like emissions trading can help to improve the payback on complete replacement, it would need an unsustainably high carbon price to provide suYcient incentive to replace plant mid-way through its life. What’s more, a multilateral approach to emissions trading is a pre-requisite for a high carbon price as, until industry elsewhere becomes carbon constrained, this would risk displacing carbon intensive production to potentially less eYcient locations.

There are also barriers to innovation. In the above context, as Nick Stern recognizes, additional sources of coordination and support are needed to work alongside carbon markets to ensure the development and innovation of the step-change technologies that will be needed to move us towards our ambitious long term climate change goals. In this respect we feel more needs to be done to support commercialisation and demonstration of step change technologies.

Finally, uncertainty about the future climate change policy mix also represents a barrier to improving energy eYciency. In the longer term it is diYcult to anticipate additional changes as a result of climate change policy. There is considerable uncertainty about the future shape of EU ETS and CCAs post-2012 and whether these systems will be part of a multilateral or unilateral framework for addressing climate change. This uncertainty is inhibiting investment decisions

8. Products which can increase energy eYciency (such as insulating glass for windows) can be energy-intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything, should be done about it?

Chemical sector products also provide some of the solutions to climate change, eg: materials for wind turbine blades, silicon for photovoltaic cells, fuel cells, insulation materials for housing, low weight materials for cars and other applications, synthetic rubber for low rolling resistance tyres and low temperature detergents.

It would be very complex to recognise the contributions of these innovations in schemes aimed at improving plant eYciency. A key thing that can be done is to avoid penalising these technologies by providing for their coverage by relative targets which are consistent with their realistic carbon intensity— until industry elsewhere becomes carbon constrained, absolute targets risk displacing such production to potentially less eYcient locations.

9. Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments?

The ECA scheme provides information benefits because it helpfully identifies energy eYcient equipment. Whether the 100% depreciation allowance in the first year is significant to an energy project depends on the extent to which it comprises eligible technologies. The Budget 2007 decision to extend equivalent financial benefits to companies that have not generated a profit will help to increase the take-up of the scheme and is very much welcomed.

10. The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how?

Renewable electricity enjoys suYcient incentives from the combination of Renewables Obligation Certificates (ROCs) and Levy Exemption Certificates awarded to relevant schemes. Indeed, the banding proposal in the Energy White paper will increase the ROCs allocated to technologies which need higher levels of support to be economic. There is also an incentive from the full pass-through of EU ETS CO2 costs to electricity prices. There is therefore no need to increase the incentive from CCL. 2 October 2007 Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 30 Environmental Audit Committee: Evidence

Memorandum submitted by the British Cement Association

Executive Summary — Early action has been taken by the cement industry to tackle climate change. Between 1990 and 2006, the BCA member companies have reduced direct CO2 by 29%, giving an annual CO2 saving of over 3.9 million tonnes — The current climate change policy mix is cumbersome and ineYcient, this will be exacerbated if cement companies become subject to the Carbon Reduction Commitment. — The policy mix should be designed around eYcient regulation that minimises overlap and duplication and should conform to Better Regulation Commission’s seven tests for climate change regulation, including keeping administrative costs to a minimum. — Overlaps between the Climate Change Agreement (CCA) and EU Emissions Trading Scheme (EUETS) should be removed at the earliest opportunity and especially prior to EU ETS Phase III in 2013. — Climate Change Agreement (CCA) have done their part but are now largely redundant for industries whose CO2 emissions are wholly in EUETS; as such the CCL should be removed for EU ETS sectors if not then the EU ETS compliance to be used for achieving the CCL rebate. — EU ETS is the cornerstone of UK policy going forward; CCA targets have a finite life of 2010. — Encourage best practice by using benchmarking, as positive measures are more likely to be accepted in a globally linked trading system — Adaptation to climate change is necessary; cement and concrete used as thermal mass in buildings will help to mitigate the climate change eVect.

The UK Cement Industry 1. The UK Cement Industry. The British Cement Association is the trade and research organisation that represents the interests of the United Kingdom’s cement industry in its relations with Her Majesty’s Government, the European Union and relevant organisations in the United Kingdom. The members of the BCA (Castle Cement, Lafarge Cement UK, CEMEX UK and Tarmac, Buxton Lime and Cement) are the major domestic manufacturers of Portland Cement producing over 90% of the cement sold in the UK. Additionally, BCA supplies services concerning climate change issues to Quinn Cement. 2. Energy represents an increasing proportion of the variable costs of cement manufacture (35% to 40%) and it is therefore a primary concern of the industry to take all cost eVective measures to improve energy eYciency and thereby reduce its emissions of carbon dioxide. 3. The cement industry believes in the principle of emissions trading and has supported UK Government through its signature of the Secretary of State’s UK Manifesto for the EU Emissions Trading Scheme (EU ETS), and its promotion within Europe. 4. Through their parent companies, Lafarge Cement UK, Castle Cement, and CEMEX are committed to carbon reductions through the World Business Council for Sustainable Development Cement Sustainability Initiative, (WBCSD CSI). In addition, Tarmac Buxton Lime and Cement has undertaken to adopt the commitments within the WBCSD CSI.

5. Specific Inquiry Questions 5.1 Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed? 5.2 The Climate Change Levy currently permits primary targets to be set in relation either to quantitative energy eYciency improvements, (“relative targets”), or carbon reduction, (“absolute targets”). In practice the majority of participants within the scheme opted for relative targets and whilst these have been in the most part met, they do not guarantee overall carbon reduction, since the level of production needs to be taken into consideration; 5.3. UK industry is over burdened with an excess of instruments relating to climate change. The UK cement industry is subject to the Climate Change Levy, (and the associated Agreements), the EU emissions trading scheme (EU ETS) and potentially the Carbon Reduction Commitment (CRC). 5.4 The Climate Change Agreements may contain relative or absolute targets and as such allow flexibility to both industry and government. There is no need for radical reform of the climate change levy or agreements given that the target periods end in 2010. In the post 2010 period the EU Emissions Trading Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 31

Scheme will be well established and should form backbone of climate change policy in the UK. The climate change levy/agreements and the CRC should be useful for those companies that fall outside the EU Emissions Trading Directive6 Annex I activities. 5.5 With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)? 5.6 The UK cement industry response to the EFRA Committee on the pre-legislative scrutiny of the Climate Change Bill7 supported long-term greenhouse gas budgets, rather than targets limited to carbon dioxide. The UK cement industry opposes absolute caps on energy because such an instrument may severely damage the operation and competitiveness of the UK cement industry. Furthermore it would restrict the range of fuels used in the cement industry because the use of alternative fuels8 generally increases electrical energy use due to additional handling and preparation. Barriers to alternative fuel use in the cement industry would seek to restrict the waste management options for the UK industrial, commercial and domestic sectors and potentially redirect wastes to landfill or incineration without energy recovery and thus increasing the UK climate change emissions. 5.7 How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? 5.8 Although the Stern Report9 advocates the use of environmental taxes alongside emissions trading and regulation, this is in the context of a coherent policy package. However, it is clear from Stern Review and the evidence presented to the Treasury Select Committee inquiry on the Stern Review that these instruments are to be used as alternatives. It is counter-productive to impose more than one instrument in order to achieve the same or very similar objectives. This is currently the case for many of the energy intensive industries, which are subject to the UK CCL and EU ETS. The matter will be further exacerbated should they additionally fall within the ambit of the proposed Carbon Reduction Commitment. Overlaps of this kind do not result in further emissions reductions and do not adhere to the seven tests for good climate change policy from the Better Regulation Executive.10 5.9 When more than one carbon-reduction instrument is applied, the industry or installation concerned is subject to the substantial additional costs associated with monitoring, auditing, and reporting to slightly diVerent criteria. In the case of parallel operation of the CCAs and EU ETS, there is the additional complexity of reconciling the target achievement in each scheme and the carbon credits purchased or sold— the so-called “double trading” issue.11 This alone highlights the incompatibility and ineYciency of the current situation. Annex I illustrates the complexity of the current situation where IPPC installations have energy eYciency conditions are also subject to CCA/CCL and EU ETS with diVering boundary conditions. 5.10 BCA believes that it is essential to remove the duplication between the UK CCL and EU ETS. Companies could then focus their eVorts on the reduction of carbon emissions rather than focusing on compliance with the diVering rules and regulations for the two schemes. 5.11 Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? 5.12 Carbon Trading is an eVective management tool within climate change policies. There have been examples in the UK cement sector where companies have needed to purchase allowances because production diYculties meant that they found it diYcult to meet their targets. Likewise, other cement companies have been able to call upon banked allowances from previous over achievement to meet a subsequent shortfall. Overall the cement sector has overachieved and there have been real carbon savings. Overachievement of the UK cement industry CCA targets is due to significant investment rather than unchallenging targets. UK cement companies have invested significantly in new kiln technology and new fuel handling capabilities that have resulted in a good CCA performance.

6 DIRECTIVE 2003/87/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC 7 Ev 146 EFRA Committee Draft Climate Change Bill Fifth Report of Session 2006–07 (5 July 2007) 8 Alternative fuels include those that are not coal and petcoke such as tyres, solvents, paper/packaging waste and biomass fuels 9 Stern Review on the economics of climate change, HM Treasury 10 Better Regulation Commission seven tests for better climate change regulation: 1. Ensure climate policy is consistent with a healthy UK economy 2. Government must develop and act consistently with a climate change strategy; avoiding piecemeal announcements 3. Test policy against a carbon price benchmark 4. Carbon policy choices must be eYcient; don’t do things twice 5. Keep administrative costs to a minimum 6. Do not use climate change as a justification for other policy goals 7. If it isn’t working, change it From: Regulating to Mitigate Climate Change; a response to the Stern Review. Better Regulation Commission 11 Defra document CCA 23, “Avoiding double counting between CCA and EU ETS”, 23 March 2006. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 32 Environmental Audit Committee: Evidence

5.13 On the other hand, in the 2006 compliance year, most trading in UK Trading Scheme by the UK Cement Companies has been purchasing or using banked credits to meet the requirements of the target adjustments resulting from the complex “double trading” arrangement. As such, the usefulness of the original CCA targets has been in some cases completely overwhelmed by these double trading arrangements.

5.14 What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? 5.15 Cement is a strategically vital and generally locally produced commodity;12 however, the manufacturing process is fundamentally energy intensive. The climate change levy is a direct taxation of fuels and would add around £25 million per year to the cement industry without the 80% discount. Consequently the CCL rebate is vitally important to the UK cement industry profitability, desirability for investment and essential to ensure that cement is manufactured in the UK near to where it is used. The UK cement industry is a small employer and as such the discount in National Insurance Contributions does little to mitigate the impact of the Levy. Although the UK emissions trading scheme can be used as mitigation for failed targets so the lowest cost of the CCL to the cement industry is £4.9 million plus admin., reporting etc per year. Energy intensive industries greatly depend on the CCL discount, but there is uncertainty over its future. Industrial companies with CCAs are currently uncertain about the climate change policy that will be applied to them by Government at the end of current CCAs. The cement industry feels strongly that an early start to discussions about the future of CCAs is essential. This is necessary not only to ensure that Government and energy intensive industries can start planning for target periods after Milestone 5, but also to ensure exemption from CRC. Entry into CRC would add yet further complexity to industries, which have parallel obligations under CCAs, IPPC and EU ETS. Whilst the CCL is set to continue beyond Milestone 5, energy intensive industries covered by CCAs are only able to claim the 80% CCL discount up to the end of the 6th certification period up to March 2013, subject to further EU State Aid approval. A conclusion on this issue is needed before the 4th CCA reconciliation period to ensure that cement, and other energy intensive industries, can plan investment and properly assess the potential business impact of CRC.

5.16 Under the EU Emissions Trading Scheme the UK Government has stated13 a desire to shift away from free allocation of allowances towards auctioning. With annual emissions of around 10Mt CO2 per year the UK cement industry is extremely exposed to auctioning in the absence of a global carbon dioxide trading system. The cost of auctioning to the UK cement industry could be 10Mt at ƒ35 is ƒ350,000,000 per year based on a recent forecast by the Deutsche Bank.14 The combination and magnitude of costs associated with the CCL plus EU ETS auctioning would signal the demise of cement manufacture in the UK and agree with recent comments that environmental taxes do not compare to the environmental impact from the activities they are directed against.15

5.17 The climate change agreements have served to promote the use of alternative fuels in the cement industry by making them exempt of the levy and carbon neutral in terms of meeting the targets. In doing so there has been a small but positive impact on the UK economy. The use of alternative fuels in the cement industry provides a cost eVective solution for industrial, commercial and domestic waste management; in 2006 the cement industry replaced 15% of its fuel with waste resulting in the saving of around 250,000 tonnes of coal equivalent. The diVerences between the CCA and EU ETS definitions for “carbon neutrality” means that the EU ETS provides less incentive to replace fossil fuel with waste alternatives. However, other benefits exist from using alternative fuels such as the lower emissions of sulphur dioxide.

5.18 Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent?

5.19 Beyond March 2012, the CCAs should cease to exist for sectors subject to EU ETS, provided that the CCL is not applied to them or the 80% discount can be applied in another way. In the interim, Government has the opportunity to revise CCA targets in 2008. Any proposal for the reduction of carbon emissions must take into consideration the potential for abatement of each of its participants. Most of the energy intensive industries have made significant reductions under the UK Climate Change Levy, the EU Emissions Trading Scheme, and other measures; see annex II. As a consequence, of around £500 million investment in the UK cement industry over recent years, the potential for further reductions is limited.

5.20 What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome?

5.21 It takes around seven years to design, build and commission a cement plant that will have a lifespan of about 30 years. At a cost of around £150 million new cement plants are the main method for step changes in plant eYciency. However, the industry has already undertaken a significant investment programme and with the current uncertainty and overlaps in the UK climate change policy the prospect of further investment

12 Around 90% of the cement consumed in the UK is manufactured in the UK, but imports are rising. 13 EU ETS Phase II Regulatory Impact Assessment—Auctioning, February 2007. 14 ENDS Europe DAILY 2368, 30/07/07—EU carbon price forecast to hit new highs. 15 The Case Against Further Green Taxes; The Tax Payers Alliance, September 2007. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 33

in manufacturing facilities is limited. The recent announcements16,17 from global cement companies confirm this. Investment has been diverted toward import facilities where UK manufacturers have recently invested in import terminals.18

5.22 Products which can increase energy eYciency (such as insulating glass for windows) can be energy- intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything, should be done about it?

5.23 All countries and all industries will need to adapt to climate change and the UK cement and concrete industries will play their parts. There is still plenty of scope for the Government to capitalise on energy saving improvements in buildings, especially in the field of thermal mass. Thermal mass is a term used to describe the ability of a material to absorb and retain heat. It can be used to good eVect in the fabric of a building by allowing it to absorb excess heat gains during the day and subsequently releasing them at night with the aid of natural or mechanical ventilation. This is particularly relevant in a warming climate. This process has the eVect of moderating the temperature swing within the building and lowering the peak temperatures experienced during the summer by approximately 3C.19

5.24 Traditional masonry built houses and larger buildings incorporating concrete elements provide a high a level of inherent thermal mass and perform particularly well, they also last for many years and thus provide a low energy solution when the whole building life cycle is considered. For example, the energy consumption of a naturally ventilated high thermal mass oYce is typically about half that associated with a modern, good practice air conditioned oYce such as Building Type Three described in Econ 1920 and the “in use” energy consumption of a house is typically 90% of its overall embodied and in use energy requirement. This is particularly important given the recent findings of research undertaken by Arup and commissioned by DTI, which highlights the key role that thermal mass is set to play in minimising overheating and helping avoid air conditioning as climate change drives up temperatures. Predicted changes in the UK climate, indicate that average annual temperatures are likely to increase by 2C to 3.5C this century.21 This will result in warmer summers and increase the demand for energy intensive air conditioning systems. To counter this, the exploitation of thermal mass in building design could make a useful contribution in preventing growth in this area. As the operation of buildings account for 50% of UK CO2 emissions, as well as a large proportion of UK energy use, even a small improvement in this sector will translate into significant savings in both CO2 emissions and energy.

5.25 The consideration of “whole life” building impacts is particularly relevant given that architects and specifiers currently use the Building Research Establishment (BRE) “Green Guide” methodology22 which narrowly focuses on embodied impacts of construction materials and not the impact of the building during its “in use” phase.

5.26 As the largest procurer of construction industry services, Government is in a privileged position to set the benchmark for sustainable construction projects for schools, hospitals, other public buildings, as well as transport infrastructure projects. Setting benchmarks in the built environment that can be exported to developing nations will signal the UK as a leader in climate change issues. These too should not be short term solutions, but look to the longer term and be based on whole life performance not just initial or lowest cost. The same principles should be extended to local government.

5.27 CCL or CCA are not the best fiscal instruments to encourage energy or carbon saving during product use. Reduced level of VAT or grant aid of some sort would be more useful.

5.28 Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments?

5.29 The use of ECA in the cement sector has had limited eVect on the climate change agreement targets. The main improvements in energy eYciency have been through the investment in new cement plants and investment in, and use of, alternative fuels.

16 Lafarge Cement UK (21 May 2004) confirmed that it is delaying the development of its new cement works at Snodland in the Medway Valley. 17 CEMEX UK Operations (14th March 2006) has announced that following the completion of a feasibility study, the company has suspended an application for planning permission for a new cement plant at Barrington, Cambridgeshire “due to uncertainty over the future of CO2 strategy in the UK”. 18 CEMEX S.A.B. de C.V. (NYSE: CX) announced today plans to construct a new grinding and blending facility for the manufacturing of blended cements in the UK, at the Port of Tilbury near London. This facility, which would have an annual capacity of 1.2 million tonnes, represents a US$49 million (£27 million) investment and could become operational during the first half of 2008. CEMEX MONTERREY, MEXICO, September 11, 2006. 19 Building Research Establishment. Information paper IP6/01. Modelling the performance of thermal mass. N Barnard, P Concannon, Denice Jaunzens. April 2001. 12 pp. 20 Energy Consumption Guide 19. Energy Use in OYces. Best Practice Programme. 2003. 21 Climate Change Scenarios for the United Kingdom. The UKCIP02 Briefing Report. April 2002. 22 The Green Guide to Specification. Building Research Establishment. http://www.bre.co.uk/greenguide Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 34 Environmental Audit Committee: Evidence

5.30 The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how? 5.31 The cement industry (via electricity prices) already pays for the renewable obligation and the investments in renewable technology and as such further taxation is not necessary. 5.32 The cement industry broadly supports renewable energy development in the UK but cement producers vie with the electricity supply industry (ESI) for combustible biomass material. The current status of the RO means that co-firing biomass is incentivised only in the electricity supply industry (ESI) and as such this distorts the supply/demand of potential co-firing fuels. 5.33 The RO therefore places a market restriction on the use of biomass fuels in the cement industry which could impede its ability to meet targets under Climate Change Agreements and EU Emissions Trading Scheme in the future. 5.34 These impacts could be far reaching because alternative fuel handling takes significant investment which could be diverted elsewhere by the multinational parent companies of the UK cement producers.

Annex I

OVERLAPS IN THE CURRENT CLIMATE CHANGE POLICY MIX AFFECTING THE UK CEMENT SECTOR

IPPC

EU ETS CCA

Process Fossil Fuel Electricity CO2 2 CO2 CO2 (Indirect)

Waste Derived Fuel CO 2

Biomass CO 2 Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 35

Annex II Climate Change Agreement Performance 1990 to 2006 (Cement Specific Energy Consumption kWh/te ) 1750

1700

1650 Target commitment is 26.6% improvement from 1600 1990 to 2010

1550

1500 Target SEC kWh/te Actual SEC kWh/te 1450

kWh/te cement 1400 Note: The mid-point has 1350 been taken for non- milestone years 1300

1250

1200 1990 2002 2003 2004 2005 2006 2007 2008 2009 2010 Year

26 September 2007

Witnesses: Mr Nick Sturgeon, Head of Climate Change and Energy, Chemical Industries Association, Mr Steve Bryan, Energy Business Manager, SABIC Europe, Mr Richard Leese, Manager of the Legislative and Regulatory Programme, British Cement Association, Mr Ray Gluckman, Chairman of Working Group I and II, UK Emissions Trading Group, and Mr Matthew Croucher, Economist, Society of Motor Manufacturers and Traders Ltd, gave evidence.

Q57 Chairman: Good morning and welcome. Can I ours. We need something like the Climate Change say at the outset, as we have got five witnesses Agreement to continue to get relief from the Climate together, it is going to need a bit of a management. Change Levy, and that simply would not be on oVer We have got about an hour or so to get through a few under the Current Reduction Commitment. That is subjects, so I would love to hear from all of you but our first point. Our second point is just to note that if you have not got anything particular to add to an we have, at the moment, considerable administrative answer on one question which has already been said complexity. Some of our sites are only partly by somebody else, do not feel obligated to respond covered; some sites are partly covered by CCAs and on every single occasion. Given that you represent partly covered by EU ETS, with some activity still quite a wide range of businesses, are there some not picked up by either scheme. I think that is a common concerns about the Climate Change Levy confusing picture. We also have overlaps in coverage that costs all your members? Would you be able to of EU ETS and CCAs on our sites. Ideally, we would identify any? want to get to a situation where we do not have any Mr Gluckman: Can I kick oV on behalf of the group? co-existence with or without overlaps of these I am Chairman of one of the working groups of the instruments on site, and simply have one instrument Emissions Trading Group, and all of us sitting here per site. In terms of any future instrument, we would are members of the Emissions Trading Group. I am want to see that continue to minimise competitive going to try to co-ordinate responses on behalf of impacts, and I have commented on the need to everybody here, but recognising that the Emissions continue to get relief from the Climate Change Levy. Trading Group represents an enormous range of At the same time, that instrument needs to be diVerent activities, including steel, which we have environmentally eVective. We want to be sure it has just heard from, and several sectors that are here and a shape which does not displace activity perhaps to others that are not here today. Nick Sturgeon, from other regions of the world which are not carbon- the chemical industries, was going to kick oV to talk constrained. Finally, I have noted already the about some of the common themes. number of schemes we have got and the number of Mr Sturgeon: We have got, I suppose, four points by carbon prices we are operating under. Ideally, we way of common themes between us. First of all, in would like to have a mix in the UK which ensures terms of the current CCAs, we believe they are a that operators, regardless of the scheme they are in, success story; we have made eVective reductions in are operating to a single, predictable carbon price, or our energy use under those agreements and we at least a harmonised carbon price, and which is support their continuation for intensive sites like predictable where we do know where the emissions Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 36 Environmental Audit Committee: Evidence

16 October 2007 Mr Nick Sturgeon, Mr Steve Bryan, Mr Richard Leese, Mr Ray Gluckman and Mr Matthew Croucher path is going, so we have some certainty in planning Mr Leese: Maybe I could add a point that concurs our investments. Many of these intensive sectors with the steel view earlier. The Climate Change Levy have long asset life-cycles, so that is important. costs the cement industry around £4.9 million per Those are our common themes. year, and that does not necessarily in itself drive energy eYciency or carbon reduction. The UK cement industry has invested £500 million over recent years, which has led to a reduction in carbon Q58 Chairman: That is a helpful summary. Thank dioxide emissions of 29%—3.9 million tonnes from you very much. The Pre-Budget Statement last week the 1990 baseline. So I do not think an increase in confirmed that the levy is going to increase in line line with inflation of the Climate Change Levy will with inflation and that the agreements will remain necessarily drive further reductions, given the fact through till 2017. What is your reaction to those that there are significant overlaps between the announcements? Climate Change Agreement and the Levy and the Mr Gluckman: Universally, the ETG is very positive EU ETS. We would seek to remove those overlaps about the announcement on the extension of CCAs. moving forward. Indeed, in the last four or five months, we have written to both Defra oYcials and Treasury oYcials requesting that they start the process of thinking of Q59 Mark Lazarowicz: On the point that Mr what is going to happen after 2010? We could not Gluckman made, I can see the attraction of a tax discount, but the fact is you have to pay the tax in believe there was going to be nothing after 2010, so the first place to have a tax discount. So the logical we welcome that announcement. We also have a conclusion, surely, is to increase the tax even more view that the NAO report gives a surprising balance so you can give bigger tax discounts which will have between an apparently successful impact through an even more powerful eVect on changing future the announcement eVect of the CCL by itself, and an behaviour. apparently slightly disappointing performance Mr Gluckman: It would if you gave the whole of the under CCAs. That is how I read the summary of the industry a Climate Change Agreement opportunity. NAO report. I think this group here, we all agree Bear in mind the Climate Change Agreements are that we feel it is the other way round; that the CCL voluntary; it is an interesting diVerence with other by itself is a small price signal. It was originally set polices like EU ETS and the proposed CRC are at around the 10–15% level back in 2001 of the mandatory schemes where, if you are covered, you energy price then and, as has been observed, when have to do it. So where CCAs are a carrot and a the energy prices went up the levy did not go up with stick, the carrot is the CCA discount and yes, you are it so it is less, as a percentage, now, and many people right, if you doubled the level of CCA but gave it have compared it to a 10 or 15% tax on cigarettes or back again you are not having a financial impact on alcohol—would that influence people’s behaviour if industry, particularly if you gave 100% back, or that was the level of tax on it? It is not a strong nearly 100% back, instead of 80%, but there is a enough price signal. All of those of us that have been message that you can give to your finance director involved with Climate Change Agreements believe that if we do not meet our targets then there is a that they have the benefit of isolating the targets payment to suVer, if you double the level, that is from the price signal. So as we have these volatile twice as bad as it currently is. So it is quite a powerful energy prices going up and down, which clearly tool if it is applied properly. change the drivers on businesses financially, but we have still got targets that we have to meet. So ETG I want to probe a little bit more strongly supports the target side of things, and in our Q60 Joan Walley: what you have just been saying about the written submission we pointed out some things eVectiveness of the levy, the eVectiveness of the which reflect what, I think, the EEF said a few Climate Change Agreements and the argument that minutes ago, that as well as the tangible target V you have been making that the Government figures improvements there are subtle secondary e ects of for the carbon impacts of both are wrong. I know CCAs. One of the ones that I believe is really you have just explained why you think that is, and important is it has brought energy to become a one of the reasons I think you related to the increase board level issue; finance directors of big companies in energy prices, but can you explain a little bit why are keen to get a tax discount in a way that, you think the Government has got that assessment surprisingly, people that are paying the tax just do wrong? Could you just dwell a little more on the not notice it in the same way. So getting that tax energy price increases that particularly heavy V discount is a subtle tool but it is a very e ective tool. industries and so on have been at the receiving end The other enormous benefit that we have had has of, in terms of the wider European impact on been the building up of networks within industry. energy prices? One of the big pluses of Climate Change Agreements Mr Gluckman: If I tackle the first bit, and then compared to other tools, like EU ETS and, possibly, perhaps ask the chemical sector to talk about the the proposed Carbon Reduction Commitment, is increase in prices. There are two examples of why I that they focus in industry groupings, and we have think the numbers are wrong. First of all, the brought those groupings together at lots of Cambridge Econometrics report is a big document meetings—hundreds of meetings—over the last ten and it would take an awful lot of work to really years, and I think those have been useful. probe into that data, but we believe that their data is Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 37

16 October 2007 Mr Nick Sturgeon, Mr Steve Bryan, Mr Richard Leese, Mr Ray Gluckman and Mr Matthew Croucher

flawed; that it misses out two possible impacts. One Levy and being focused through the CCA targets on was mentioned a few minutes ago by the steel sector actually measuring and managing to improve our about production levels (that there could have been energy eYciency. a coincidental drop in production), but there is also believed to be a weather eVect. The Cambridge Q62 Joan Walley: Can I just finally ask, in terms of Econometrics work was looking at the whole of the what you were saying just now about rationalisation energy use of business at a very high level, and a lot of plans, is there any research that you are doing? I V of business is a ected by the weather, of course. So am particularly looking at it from the point of view it is believed there were a couple of very mild winters of outsourcing as well? Are you doing any research after the announcement of the CCL and that that or looking at that? weather eVect was not properly taken into account. Mr Gluckman: Individual industry sectors with In the other direction, the NAO report potentially Climate Change Agreements have now got all this misses out on some of the savings that come out of data available, with annual figures from all the Climate Change Agreements. I am grateful that the factories. That analysis I just quoted from the Food Food and Drink Federation gave us some data and Drink Federation, based on 900 factories, is which they put to you in a written submission, and data that is at least being looked at now that, seven what they have explained is that when they analyse or eight years ago, did not exist. the published result of their CCA at milestone 3 (published by Defra earlier this year) it showed a Q63 Joan Walley: It would be a matter of major level of saving—157,000 tonnes of carbon was the concern, would it not, if our so-called carbon savings actual amount. However, that data was based on the have been brought about as a result of factories factories that were open in 2007 that were reporting closing down or factories being outsourced and to the Climate Change Agreement. The FDF did an moving away? interesting analysis where they looked back to 2001, Mr Gluckman: I am sorry. In the case of the data I which was the first milestone, and they discovered have just quoted, the production from those that there were about nearly 100 extra factories open factories actually rose 4.6% over the period of those in their sector at that time. If you looked at the factory closures. So it is not an oVshore outsourcing; reduction in energy from that baseline position to it is a rationalisation of the UK industry, which is where they were in 2007, instead of being 157,000 it one of those enormous step-changes that, I guess, if was 737,000 tonnes of CO2 reduction. The we do not see it over the 20 to 30 years, we are not throughput of the 920 factories back in 1999 was less going to meet the longer-term carbon targets. The than the throughput of the 830 factories in 2007. So scary factor is if we are kidding ourselves that there at least part of this eVect is an industry is a drop in the UK, and if there is an outsource of rationalisation eVect that, again, was mentioned in production to overseas, particularly if it is going to the previous witness statements. What we believe is an area of the world where eYciency is lower, then happening is that the food industry is slightly clearly that is disaster for the environment. We slimming down the number of factories that it has would not want to see that. open; small, older, ineYcient factories are closing Mr Leese: We, in the cement industry, have seen and output is being transferred. It is not being lost. imports from non-manufacturing companies in the The food industry is sensitive to overseas UK rise over recent years, and it has been a competition but I would say rather less so than, say, rationalisation of UK kiln technology—that is, steel. So I think that is very interesting data. There shutting down the wet, old, less-energy-eYcient could be other impacts that cause it, but it is showing processes—and investing in dry, new process that CCAs are rather better than the NAO report technologies, and those are larger kilns. Like I said implies, and we believe that the Cambridge before, that has resulted in the investment of £500 Econometrics data is showing the other impacts in million. Having said that, we have had two rather an optimistic light. companies in the UK which have announced that they will defer their decision to invest in new kiln technology (and that would equate to around £300 million worth of investment) given the uncertainty in Q61 Joan Walley: Does anyone else want to add to the climate change policy mix. that? Mr Croucher: From the automotive side, again, we Mr Sturgeon: Just to comment on energy prices. are internationally competitive; 75% of what we Thinking back to the winter of 05/06, we saw gas produce is exported, which is a figure that has prices multiply two or three times over due to the increased over the years, and about 85% of what is tight supply/demand balance in the UK. In that sold here is imported. Again, that has increased situation there was a very large price eVect, of significantly. Again, we have seen output actually course, and it certainly worked in reducing carbon increase in the UK and, also, the relative energy emissions because some of our members reduced performance has come down, and absolute energy throughput and some went to a temporary closure performance has come down. Going along to the situation for as long as three months and simply price increases, where energy prices have increased imported products. That is an example of how that has also meant that the ability of firms therefore eVective a price eVect can be. I think we are in a to invest in some of the energy-eYcient technologies better position with CCL in getting relief from the has also improved because the payback criteria were Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 38 Environmental Audit Committee: Evidence

16 October 2007 Mr Nick Sturgeon, Mr Steve Bryan, Mr Richard Leese, Mr Ray Gluckman and Mr Matthew Croucher changed slightly, so there have been some positive agreement targets that are of importance. So aspects of the price increases. It does mean that you virtually all businesses with Climate Change can actually look at what investments you can make Agreements either meet the target by saving the and they are a bit more justified. Again, it is a very energy as required or they meet the target by fine balance between the whole competitiveness purchasing CO2 allowances in the emissions trading aspect of producing cars here vis-a`-vis abroad, and I mechanism. think, like most people, every plant in the UK has Mr Leese: The use of the UK Emissions Trading the potential to go overseas, and it is a fine balance Scheme as a management tool is absolutely essential that is constantly under investigation. to comply with the Agreement. When building a new Mr Leese: We should not forget that, looking cement facility it may take many months, if not forward, the carbon price coming from the EU years, to get it up to its most eYcient output. So the Emissions Trading Scheme is being passed through ability to go to market and buy some carbon in the into electricity prices, so the additional levy on meantime is actually essential to future investment. electricity is unnecessary and burdensome. Mr Bryan: Just to add a point to reinforce the comments that Nick made earlier, I think the Q65 Jo Swinson: I do not know what magnitude of experience of the very high gas prices that we saw in amounts of money we are talking about here but if winter 2005/06 was a very informative illustration of the CCAs are voluntary agreements that the the dangers of having energy prices in one EU company has entered into thinking that it can country get out of kilter with prices elsewhere on the achieve a particular target, presumably it would not international markets. Not my own company, as it enter into it if it thought: “Well, I won’t be able to do that until ten years down the line because of the happens, but another company also located on V Teesside was the company Nick referred to that shut investment that is required”. Is that not, e ectively, down its units for some considerable period of time just a way of getting out of paying the Climate and was importing product from outside the Change Levy, assuming that the cost of the 80% European Union. That of itself is a point of discount is far higher than the cost of buying the significance that we operate in industries that have a carbon allowances to make up to its target? Does global reach and a global scale and can arbitrage that not seem a way of getting out of that? themselves on that global scale. So we must not Mr Gluckman: First of all, it is very important to think too confined in terms of the European recognise what the 80% discount was for. The boundaries when we are addressing these sorts of Climate Change Levy is supposed to be fiscal issues. neutral, and the fiscal neutrality is brought about by the reduction in National Insurance Contributions of 0.3% that came in at the time of the Levy. There Q64 Mr Caton: Your critique of the NAO were one or two other measures, including money assessment of the relative impact of Levy and that went to the Carbon Trust, to fund the enhanced Agreements is interesting. There is one fact, I think, capital allowances scheme that was talked about in their report that stands out and does raise earlier. However, if that is all you did then heavy question marks about the eVectiveness of industry would have been punished severely because Agreements, and that is the fact that 250 out of 4,200 they do not have enough employees for the National units covered by Climate Change Agreements were Insurance Contribution drop to be in any way a level able to pass their 2004 milestone and receive the 80% playing field. That was recognised by Government tax discount without having met their eYciency right at the beginning, and they announced that the targets because their umbrella group had met that CCAs were there to stop the lack of fiscal neutrality. target. That, on the face of it, does not seem fair to So the 80% discount delivers fiscal neutrality; it does the taxpayer and it does not seem fair to those robust not deliver a sort of cost-eVective amount of competitors that have actually achieved the environmental reduction. In return for the fiscal eYciency targets. Surely, the Agreements do need to neutrality you then have to make a promise, via the be more stringent. Climate Change Agreement, to make all cost- Mr Gluckman: We have some rather strong views eVective savings. That, of course, is subject to here. We think that the NAO have misunderstood negotiation with Government, and I am sure we will the way that most of the Climate Change come on to talk about the stringency of targets in a Agreements work. There are actually about 10,500 minute. It has always been one of the pillars of both sites in the UK that have got a Climate Change this scheme, but more particularly of the EU Agreement, and virtually all of those are in sectors Emissions Trading Scheme and the proposed where they sink or swim by themselves. The Carbon Reduction Commitment, that one should mechanism does allow sectors to try to co-ordinate allow the market to find the lowest cost solution to their response, and there are a couple of sectors— meeting the target through emissions trading. So, notably the paper industry, I think—that work very no, I do not think it is a way of just getting the Levy closely to make sure that as a sector they meet the discount. The Levy discount, as I say, delivers fiscal umbrella target that you are referring to. However, neutrality to energy-intensive industries. because of the rules of emissions trading, which were Mr Sturgeon: I think it is an essential management set up, actually, after the CCAs were originally tool for people to meet their targets at individual site signed, in the majority of sectors the so-called sector level. I say that speaking for a sector that is quite target is not of prime importance; it is the underlying cyclical. We tend to lead strongly into a downturn Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 39

16 October 2007 Mr Nick Sturgeon, Mr Steve Bryan, Mr Richard Leese, Mr Ray Gluckman and Mr Matthew Croucher and lead out of cover quite quickly, in advance of levies and discounts for achieving targets and then that. However not all sites within our sector move to some other introduction of emissions trading? Is the same cycle. If some sites are at the bottom of the there any experience from your business cycle, they have low throughput, and energy backgrounds which suggests there is too much eYciency suVers. While they might be on a long- confusion allowing for underachievement? term path to meet their Climate Change Agreement Mr Leese: I would say absolutely, but that is what target by 2010, in that particular milestone they will we have at the moment. In the cement sector we have struggle to meet it and emissions trading provides a the EU Emissions Trading Scheme covering all of mechanism for relying on the overachievements of the carbon dioxide emissions from the plant and we others to meet their target in the short term. have the Climate Change Agreements and the However, even with the emission trading there, Climate Change Levy covering the majority of those essentially, what you are still ensuring is that the emissions—i.e. the fossil fuel burning and the overall sector target is met. So I think it is just a electricity. So we have overlaps and confusion at the flexibility tool which is very valuable and, as Ray moment. What we would like is to separate those was saying, ensures that the least-cost reductions are two entities going forward so that we do not have to found, secured and delivered within a sector. have the complex double trading and double Mr Croucher: The arrival of the emissions trading counting arrangements that we currently have. element also ensured that you did not end up with a Mr Bryan: I think it is certainly true there is situation where a lot of people were free-riding on disappointment that the trading scheme has not the activity of others, because all of a sudden delivered a better value for carbon because, clearly, everybody was ring-fencing their over-performance companies will, in places, have invested and made and keeping that for themselves or selling it. So investments in anticipation of meeting their targets, originally there was this debate which was: “How are which in part would have relied upon some value of we going to meet the overall sector target? Will one return that they would have generated from that. company help another one out?” When ring-fencing Clearly, the fact that tradable prices of the carbon and trading came along everybody decided: “We are under the scheme have been very low indeed has not going to keep that for ourselves”. So nobody in our delivered that expectation. sector free-rides from anybody else; it is all down to the individual performance against their own Q67 Chairman: But the way, of course, that would underlying Agreement. have been achieved had very much lower caps, in Mr Gluckman: It is interesting, just to go back to the which case all you have done is ministering to the historic proposition that the Government initially European Commission. made, which was that the targets would all just be at Mr Bryan: I think there is probably a happy medium sector level. So you would have, for example, a somewhere between a reasonable level of incentive cement industry target, or a chemical industry that would have enabled companies to make target, and if the sector met its target then everybody investments with greater certainty, and I think the was okay. However, companies quickly realised: theme of uncertainty is important here. “What would happen if the sector failed to meet its target is that everybody would not be okay; they Q68 Chairman: But the truth is, it is the only way you would all lose their discount”. As the financial could get a higher sustainable price of carbon which penalty was significant and company A might lose its is incentivised by investment would be if you did not discount because company B did not actually do complain about the tax. anything, very early in the negotiations in 1999 Mr Bryan: As I say, I think there is a happy medium industry said to Government: “We are very to be achieved here between a scheme that is uncomfortable with this sector level target; we want suYciently stringent to deliver reward for companies to take our destiny in our own hands and we want to that are actually looking to pursue that and one— have company or site level targets”. What, actually, we have got is a hybrid of the two; there is a sector So you are confirming that the caps level target but, in fact, it is the underlying target that Q69 Chairman: are ridiculously high? the vast majority of sectors deal with. Mr Bryan: I think the evidence is clearly that we have seen credits at a value that suggests there is too much Q66 Colin Challen: I am glad we have cleared that slack in the system, and that, obviously, as I say, for up, Chairman, because if the National Audit OYce companies that have invested, has been detrimental. were confused, I think I have a very good excuse to be very confused myself by all of this! It seems to me Q70 Chairman: So we could pray-you-in-aid, when that what we would have is a situation where under- we are looking at future negotiations, to say industry achievers do not get a “get out of jail free” card; they wants to have a sustainable carbon price and they get a “get out of jail cheaper” card by using accept that the way to achieve that is to cut the caps emissions trading. I wonder if there is a lot of very substantially. underachievement covered by that, and perhaps Mr Bryan: I think industry, certainly, is seeking there should be a separation of these things to make greater certainty and reliability in the cost of carbon, it simpler for the industry itself to understand what it and that is a theme I would very much subscribe to. exactly has to achieve. Is there any sense in, perhaps, One of the big diYculties we have experienced separating these two concepts altogether: having through this scheme, and indeed through the EU Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 40 Environmental Audit Committee: Evidence

16 October 2007 Mr Nick Sturgeon, Mr Steve Bryan, Mr Richard Leese, Mr Ray Gluckman and Mr Matthew Croucher

Emissions Trading Scheme as well, is a fundamental another question, on the stringency of targets, the diYculty in understanding what, really, the value of original targets set in 2000, I believe, were stringent carbon is going to be in the future, and therefore the in some sectors and less stringent in others. In diYculties that that poses in terms of constructing general, the characteristic that defined that investment cases and delivering the rewards against diVerence is that a small number of sectors had a lot those cases. It is a very big issue for us. of real information that they brought to the table when they negotiated with Defra. The cement industry, for example, had a lot of historical data; Q71 Colin Challen: If we had a good, long-term they had data because there were only 15 cement signal on the price for carbon and a robust market, plants at that time. They had data for every single would that not really mean that we could do away plant that was discussed with Defra. At the other with Climate Change Levies, Agreements and all the V extreme you will have a sector such as the Food and other stu ? Would that be better, or would we have Drink Federation that had roughly 1,000 factories to, perhaps, go the other way and strengthen the and, in 1999/2000, no data, and Defra did not have Levies and Agreements and then forget trading? any good data either. So the analysis was done as These two things really ought to be sorted out. best it could at the time. In 2004 we suddenly had a Mr Bryan: Others members may wish to comment, lot of data available and we could make the targets but my personal view is that I would very much more stringent, as was done, and I believe that the welcome a simplification and, ultimately, perhaps, current targets are pretty stringent for virtually all one single common scheme that, in one fashion, had the sectors. In 2008 there will be another one single value of carbon attached to it, such that renegotiation of the target and if there are one or two V we would not see this plethora of di erent sectors where it is less stringent it can be tightened instruments and the overlap problems that they up. So there has been a good feedback mechanism generate for companies captured by more than one within CCAs. Unfortunately, with the EU ETS, we of them. So I have some sympathy with that point of are about to embark on a five-year slug, and if the view, yes. NAPs are not right we will be stuck with it, I assume, Mr Leese: The cement industry would agree with for five years, which is scary. that point. If we are talking about the allocation issue with the EU Emissions Trading Scheme, the concern from the UK industry and European Q72 Joan Walley: Just looking in a little bit more industry is because we have not got a global scheme detail at administrative burden and overlap, the Y at the moment, that is why we need targets that can National Audit O ce came in for a little bit of stick be achieved at the moment. Moving forward, earlier on today, but going back to their findings that perhaps we could look at global arrangements or the administrative burden of the Levy is small global sectoral agreements that do not impact upon because businesses just simply pay that through the the competitiveness of the UK or the EU. energy bills, obviously, similar to the AC, and then Mr Gluckman: It is quite interesting to think about looking again at the Agreements, the National Audit Y the teething problems of the three diVerent schemes: O ce, I think, says that however complicated the UK ETS, the so-called direct participant UK payment is through the Agreement, that is ETS, the EU ETS phase one and the Climate outweighed by the savings that are received. Would Y Change Agreements. The UK ETS has suVered you agree with the National Audit O ce on that? severe teething problems. The design of the way in Mr Bryan: The short answer is yes. which the auction worked at the beginning has led to a severe oversupply of allowances, which has caused Q73 Joan Walley: Okay. Earlier on (I think this was the price to be lowered. The UK ETS itself is not something that was raised by the Society of Motor being replaced so they are not going to learn by that Manufacturers), when all of you were talking, you lesson—it was just a mistake. Under the EU ETS talked about the problems with sites which were phase one, carbon is trading at zero in phase one of partially covered and partially not covered. I would the EU ETS, and the reason for that is very clear— like to know a little bit more about how that has that the various NAPs (National Allocation Plans) come about and what proposals you have, or around the EU were far too lax. We are hoping that government should have, to actually make it more for EU ETS phase two that lesson will have been simple and more straightforward. properly learnt because if it has not been properly Mr Gluckman: Can we split that into two separate learnt the price will collapse to close to zero again if things? One is overlap of coverage with EU ETS and we are not careful. So we have got to hope that the the other one is partial coverage because of the stringency is right. I think it is interesting with eligibility rules of CCAs. Richard, do you want to Climate Change Agreements; clearly, they were a talk about the overlap side of it? groundbreaking mechanism and they were not easy Mr Leese: Yes, I think our written submission to put in place back in 1999/2000. There are lots of illustrates in graphical form the overlap between the things that I would do diVerently now if I was three systems, really: IPPC had all of the cement starting with a clean sheet of paper, but they have manufacturer installations, and within those had fewer teething problems than the two emissions applications energy eYciency measures; Climate trading schemes, not least because the targets are Change Agreements cover the fossil fuel emissions renegotiable twice in the 10-year life, and we had a and the electricity, but that accounts for only 40% of renegotiation in 2004. Jumping ahead, perhaps, to the direct emissions from a cement manufacturing Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 41

16 October 2007 Mr Nick Sturgeon, Mr Steve Bryan, Mr Richard Leese, Mr Ray Gluckman and Mr Matthew Croucher facility. Sixty per cent of the carbon dioxide Mr Gluckman: Can I explain why there is only emissions come from what is called process CO2, partial coverage? It is to do with the fairly which is the calcination of limestone—burning complicated eligibility rules for who is allowed to limestone emits carbon dioxide. So because the Levy have a Climate Change Agreement. Bear in mind and Agreements are energy targeted they do not that I said earlier there is a carrot and stick cover all of the carbon dioxide emissions from the arrangement; the carrot being the Levy discount. cement facility, whereas the EU Emissions Trading That is a strong financial incentive and people would Scheme covers all of the carbon dioxide emissions like to have one. The Government then used, as was from the cement facility. So we see that the overlap described earlier, the PPC regulations part A. If you is unnecessary, and because of that overlap we have are a process defined in the PPC regulations you are to go through complex double-accounting eligible to have a Levy discount. What happens with arrangements and, in doing so, allowances from the a car factory, for example, is things like the paint- EU ETS scheme actually then tighten, in some cases, spray booths give oV solvents and so on, so they are the targets under the CCA scheme. So there is PPC-permitted, but lots of the rest of the car factory complexity. are not subject to a PPC permit. So we have this rather complex requirement to divide the factory into, notionally, two bits. What we would love to see Q74 Joan Walley: Who is actually trained up to deal is, obviously, the whole process just to cover the with all of this particular complexity? whole factory. It would make life simpler and it Mr Leese: The cement industry is a very energy- would deliver more environmental benefit, but the intensive sector anyway, and we have national Treasury would have to give more Climate Change energy managers in each of the companies. So the Levy discount for the bits that are currently not cement industry is very aware of its energy eYciency eligible for that discount. needs, but I can imagine that for less energy-eYcient Mr Croucher: Just to highlight the point, we have sectors that is quite a diYcult proposal. got 25 sites in the Climate Change Agreement, we Mr Gluckman: We have stressed the importance of have got 500 members in SMMT and there are the 80% Levy discount as an issue of fiscal neutrality something like 3,000-plus automotive companies in that aVects international competitiveness and the UK. So when we say that the automotive sector domestic competitiveness as well. The companies has a Climate Change Agreement, the coverage is have to be part of a Climate Change Agreement to actually very small and, as Ray said, the site get the Levy discount but they have to be part of the coverage is limited as well. EU Emissions Trading Scheme because they are Mr Sturgeon: In terms of diVerences in coverage, few mandated to do so. However, there is a chunk of of our sites are covered in their entirety by the EU emissions that are the same and they are in both ETS. A few of the largest petro-chemical refining schemes. We assume we are not going to aVect installations are close to that, but for the most part European legislation very easily, so for that stuV that the EU ETS covers 100 of our 300 sites in the CCA. is mandated to be in the EU ETS, if it is meeting the They are covered only for their boilers combined target that is eVectively set by the EU ETS, it would heat and power generators. So that does mean, to be nice if the Climate Change Levy discount could be the extent we have an overlap, that is it. We do not given for that chunk of energy. know how coverage will develop under EU ETS Mr Croucher: Again, within the automotive industry post-2012 but we fully support an early decision probably about 40–60% of the sites’ energy use is from the Treasury to extend CCL relief to EU ETS covered by the Climate Change Agreement. So the participation to relieve that overlap. Even if EU ETS site has to specifically monitor and report on that covers all direct emissions on a site there is still a area. So, again, that puts in place the cost of concern that we would have more than one instrument on the site because, currently, we believe additional metering and the fact that, therefore, Defra would wish to have a Carbon Reduction your investment decisions are, maybe, only partial; Commitment or Climate Change Agreement you are not looking at the whole site, you are just covering the indirect emissions from imported trying to target on just the CCA area. So it might electricity. We question whether that is necessary or mean there is some low-hanging fruit in other areas not. There is a considerable price eVect from pass- but you are targeting on the CCA area because that through from EU ETS to electricity prices. In fact, is where the Levy is that is most applicable. So you when we return to phase two of EU ETS prices we get this issue where you get people that are spending V V estimate that combined with the e ect of the a lot of time and energy trying to meter-o and focus renewables obligation on electricity prices the pass- on a small area of the plant, and it is restricting their through will be equivalent to something like 20% of impact to make energy gains in the rest of the plants. over-Levy electricity prices. So we believe that that So we have been pushing for greater coverage, if not is a full transmission of carbon price and should be full site coverage. We also found that because people incentive enough to reduce electricity use where are often very focused on targets—by being in the possible and make that more eYcient. We would target and being in the Climate Change prefer to see that electricity use covered by another Agreement—that gives them more of an incentive to instrument on the same site as EU ETS. achieve those energy eYciency targets than simply a tax. So we believe that by being in the Climate Q75 Chairman: Have any of you heard of the Change Agreements per se that would give better Climate Change Simplification Project? What can value for money and better savings. you tell us about it? Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 42 Environmental Audit Committee: Evidence

16 October 2007 Mr Nick Sturgeon, Mr Steve Bryan, Mr Richard Leese, Mr Ray Gluckman and Mr Matthew Croucher

Mr Gluckman: This is in terms of the Defra automotive, can we join it?” Then you have to regulation— explain to them all about the qualifying criteria, and they often find that they do not qualify in that respect. Q76 Chairman: We were told about it by the OYce of Climate Change. When we had various senior Mr Sturgeon: I think the Carbon Trust certainly has civil servants from Defra and the DTI giving a role to play and has some valuable programmes. evidence in the course of a previous inquiry none of As members have said, they are a bit generic in their focus. Prior to the Climate Change Agreements, we them knew anything about it at all. Y Mr Gluckman: To my knowledge there is a team at had a voluntary energy e ciency agreement with the Defra that is, under better regulation terms, trying to then DETR, and in exchange for our sector level look at the mix of policies, and in particular the two energy target we had free energy audits on site done by the predecessor to the Carbon Trust, the Energy or three policies that we have really been Y concentrating on today—CCAs, EU ETS and the E ciency Best Practice Programme. That is still a service which the Carbon Trust provides, so proposed Carbon Reduction Commitment—to look V at avoiding over-regulation and burdens. We e ectively those surveys were piloted in our sector as was the carbon management programme with large welcome the process. To our knowledge it is not very V progressed yet. I went to a seminar in June where companies that the Carbon Trust now o ers. So we feel they have a role to play, although for complex there were presentations from a couple of Defra Y economists, but that was quite in the early days of specialised sites I think it is di cult for them to the process. I have heard nothing since. provide the expertise. We do not actually access any Mr Leese: We provided some written submissions to loans from them. There are interest-free loans for that project and, again, we have heard nothing since. SMEs but because we are intensive even our smaller sites are above the thresholds to qualify for that service. Q77 Mark Lazarowicz: As you know, part of the Mr Gluckman: Just to finish oV on that, the Carbon revenue from the Climate Change Levy is recycled in Trust does have a very wide range of programmes, the form of grants and loans issued by the Carbon many of which are very eVective. They are Trust. How significant has that been and, more particularly eVective, as has been hinted, at the non- generally, how would you describe the relationship process-specific things—so boiler plants and with the Carbon Trust in your respective compressed air, refrigeration technology. I was industries, briefly? involved just last year in a big Carbon Trust so- Mr Leese: I can start. I think the Carbon Trust has called Networks project looking at refrigeration a role in raising awareness in, particularly, the less eYciency, which I think was a very useful exercise. energy-eYcient industries. As I mentioned before, The Carbon Trust is looking at ways of addressing the cement industry is an energy-intensive business the more complicated technologies with more in- and we need cement-specialist help in the cement depth reviews of them. So I think they are trying to industry and the Carbon Trust, generally, takes the find the right niche at the complex end of the view of general energy eYciency consultants. My spectrum as well, but it is diYcult. members have used the Carbon Trust but only in a limited way, because of their potential eVectiveness. The cement industry did make an application to the Q78 Dr Turner: It rather sounds as if the grant- making facilities of the Carbon Trust for R&D Carbon Trust when we started to look at carbon V capture and storage, but it does not seem to be an purposes are not very e ective for any of your area that the Carbon Trust is particularly interested industries. Is that right? in. Now the UK cement industry is involved in a Mr Bryan: Certainly for chemicals, that has been my project with the International Energy Agency to do experience. Nick has wider knowledge of chemicals some research into carbon capture and storage from than I do in the total sector. cement facilities. Mr Sturgeon: On the R&D side our access to those Mr Croucher: Likewise, we would share the opinion funds has not been great. We did look early on and that most of the advice they have given is fairly found, at the early stage, the agreements we would generic. When they have had some specialist have needed to have would have given the knowledge put in there, things like compressed air, intellectual property for the research that was being done to the Carbon Trust. I think that has now and things like that, our members have found that V sort of help useful but, generally, you are inviting a changed, but that was originally a bit of a turn-o , consultant to come on site for a number of days and and I think we need to re-engage with the you often do not get back much more than you knew programme not that has changed. already, because a lot of the people on the site know what they are doing. That is what they spend their Q79 Dr Turner: Is the fact that the Carbon Trust’s whole life doing—trying to improve energy grants are not very large, also, a disincentive to eYciency. We, also, as I mentioned before, heavy-scale industries, such as yourselves, to take sometimes have this issue where people find out them up? about energy eYciency and the fact that there is a Mr Leese: I think that is right. If there is going to be Climate change Agreement that the automotive major step-change of carbon reduction in the cement sector has got, but then when they come along and industry then we have to look towards novel ask us: “We are an SMMT member, or we are technologies such as carbon capture and storage. Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 43

16 October 2007 Mr Nick Sturgeon, Mr Steve Bryan, Mr Richard Leese, Mr Ray Gluckman and Mr Matthew Croucher

That takes significant investment, and I think both Q82 Chairman: Moving on to energy eYciency, two the Carbon Trust and government need to help of the memos you submitted suggest, as other people industries like ourselves to invest in that research. I do, that the low-hanging fruit, the easy gains, have do not think the Carbon Trust is particularly geared- now been captured. All the science, and documents up well to do that, at the moment. like the Stern report, suggests, actually, the progress we are making is wholly inadequate as a response and you need vastly greater improvements over the Would it help your industry, for Q80 Dr Turner: next 15 years compared to the last 10 years. How are instance, if government or the Carbon Trust could we going to face up to that? scale-up their involvement? Would it help you to Mr Croucher: We would start by saying that we have bring forward a demonstration plant? made significant progress thus far. We have Mr Leese: It may well do. achieved, I think, a near-20% reduction in absolute energy and nearly 40% in relative energy. We are not Q81 Chairman: Could I just touch on the issue of large energy users, compared to some other people, National Insurance Contributions? There is clearly but we have made significant progress. We publish a mismatch between how much individual that data in annual reports and we have a sector organisations pay and how much they get back. sustainability report—we have just published the Would you like to comment on that issue? eighth annual one of those. Yes, to go forward is Mr Gluckman: There is a slightly cynical concern going to be diYcult. We are looking at new about the history. In 2001, with the Climate Change technology; so, for things like the paint shops, Levy package, came a 0.3% reduction in National powder-coated paint and things like this, but they Insurance Contributions by employers. In the are, as we have discussed earlier, very expensive and Budget one year later there was a 1% increase in said very R&D-heavy to deliver. Obviously, any help we NIC. It might well have been a 1.3% increase had it can get to enhance those programmes would be not been for the 0.3% reduction, but that is not very gratefully received. We are looking at those on a transparent. There is a worry around the industry pan-European if not global basis because the that there is that lack of transparency about that. In technologies are global technologies, and we are any case, as far as heavy industry is concerned, the certainly moving towards that, but it is so expensive 0.3% was never going to oVset and deliver fiscal and so costly to do that it is slow to bring around neutrality. That was accepted by government on day those huge step-changes. one. I think it is quite useful to think, as well, of Mr Bryan: In a lot of the capital-intensive industries, maybe businesses split into three main bands, which such as the heavy end of petro-chemicals that I are the heaviest industries (so that is the cement represent, you are right to identify a very major plants, the steel industry and the heavy end of challenge for us. There is no doubt we have been chemicals, for example), a sort of mid-range, which successful—and I think we can say considerably are generally covered by Climate Change successful—in improving gradually the energy Agreements, but are much less energy-intensive than eYciency of our existing plant over the course of not the very big players (and we would probably put only the Climate Change Agreements but, indeed, SMMT in that category, the food and drink industry the period before that with the voluntary sector and the printing industry, for example), and then agreements. The sort of improvements that Stern you have a third level, which is the level that is identifies, however, are—and we have to be clear appropriate for coverage by the new Carbon about this—very substantially greater in terms of Reduction Commitment, which are the non-energy- their step-change size than the sort of things that intensive businesses, which generally are commercial immediately it is apparent that existing plant and businesses or the government estate (so it is your equipment is capable of achieving. Necessarily, we supermarkets, local authorities and so on). The have to own up to the acknowledgement that a lot Carbon Reduction Commitment is a policy that is of the response to that challenge will have to involve designed for that low end of the energy-intensity fundamentally new technologies, fundamentally spectrum, and it would not be a good tool if it was very large investments and fundamentally very new applied for the businesses at the high end of the thinking about how we actually seek to operate in energy spectrum. Of course, the diYculty with any the future environment. Just to give you a few spectrum is where do you divide it? As Matthew said examples, carbon capture has already been earlier, we would like to see the CCA boundaries mentioned as one particular technology that may widened slightly, down the energy-intensity become applicable, particularly, to larger-scale spectrum, to capture a bigger proportion of manufacturing processes, but there are very major industrial sites. There are quite a lot of industrial challenges in conventional boilers and sites (and, again, Gareth was representing them conventionally-fired heaters in actually achieving through the Engineering Employers’ Federation carbon capture. Other technologies that involve earlier this morning), let us say in the plastics fundamentally diVerent ways of combusting fuel industry, in mechanical engineering—many of the oVer, perhaps, an attractive proposition in that area, factories that are members of the SMMT—that but these things are not cheap. Another example would probably benefit from a CCA-type might well be fundamentally looking at bio-sourced mechanism, but they are not eligible under the feed-stocks for certain areas of the chemical current rules. industry, and there is some research and thinking Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 44 Environmental Audit Committee: Evidence

16 October 2007 Mr Nick Sturgeon, Mr Steve Bryan, Mr Richard Leese, Mr Ray Gluckman and Mr Matthew Croucher going on in that area as well. However, these are infrastructure, the piping structure and the storage fundamentally diVerent technologies, diVerent facilities—probably in the North Sea, or approaches; they are not, if you like, a natural somewhere similar. continuum of the process we have been discussing Mr Gluckman: My banding is relevant here. In that under the existing agreements. It is important that top band of highly energy-intensive industries— we register that, and it is important that that is steel, cement, glass, and so on—the low-hanging recognised. fruit is long gone. In the middle band that has still Mr Leese: I would echo the point. As I said before, got Climate Change Agreements there probably is, the 2006 carbon dioxide emissions in the cement still, some low-hanging fruit available, and it is industry are 29% lower than that of 1990. I think if important to try to understand the barriers that stop the UK, as a whole, made the same progress we logical, financial decisions. Companies will invest in would be a great deal closer to achieving 60% by a production measure, like a new packaging machine, usually with a longer payback period than 2050. A cement manufacturer is crucially important they will in an energy eYciency measure. That is not to the mitigation and adaptation eVects of climate logical at all; they would both deliver to the bottom change; cement and concrete can be used in line. So, yes, there is still low-hanging fruit, even in buildings to enhance the thermal-mass properties of some Climate Change Agreements. Outside of the the buildings and, therefore, negate the use of targeted arena, in businesses and the public sector— energy-intensive measures, such as air-conditioning. hospitals, and so on—there is enormous low- We should not forget about the life-cycle aspects of hanging fruit still available. products in moving forward. Again, I come back to Chairman: There are a lot of issues which we would the point I made earlier about carbon capture and probably like to pursue, but I think we are running storage. For cement facilities that would need a out of time now. Thank you all very much for massive investment, not just in terms of the coming in and we will reflect much of what you have equipment needed at cement facilities but, also, the said to us in our report. Thank you.

Supplementary memoranda evidence, submitted by EEF, The Manufacturers’ Organisation

About EEF EEF is the representative voice of manufacturing, engineering and technology-based businesses. We have a membership of 6,000 companies employing more than 800,000 people. Comprising 11 regional EEF associations, the Engineering Construction Industries Association and UK Steel, EEF is one of the UK’s leading providers of business services in employment relations and employment law, health, safety and environment, manufacturing performance, education, training and skills.

Introduction EEF provided written evidence to the EAC inquiry in to “The Role of the Climate Change Levy and Agreements”, and subsequently provided oral evidence—represented by Mr Gareth Stace (Head of Environmental AVairs) and Mr Ian Rodgers (Director, UK Steel)—at a session on Tuesday 16 October 2007. At the session on 16 October, the committee requested further information regarding qualitative changes made by companies since the Climate Change Agreements (CCAs) were introduced in 1999. EEF has sought the input of some of our member companies on this issue, in order to provide a flavour of the changes that have been made in response to CCAs being introduced. We do not suggest that this is a scientific sample of companies—rather, it provides some qualitative indications of the kind of activities and actions introduced by companies in the area of energy eYciency. The companies involved are participants in the Iron and Steel Sector CCA. The companies were asked the following six questions: 1) Since your company first heard about CCAs, has there been a change in the focus within the business, when looking at energy eYciency? 2) Has the monitoring and targeting of energy use improved and risen up the company agenda since 2000, as a result of CCAs? 3) Is energy use and abatement opportunities discussed more now at Board level as a result of CCA membership? 4) Have you experienced monetary savings as a result of any new found focus? 5) Has the risk of continued CCA membership influenced investment decisions? 6) Is the whole workforce aware of how they can influence the CCA performance of the company? Processed: 03-03-2008 20:24:47 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 45

The responses gathered from this informal exercise are collated in Table 1. As has been previously mentioned, this is only intended to provide a broad illustration of the kinds of responses companies have taken to the introduction of the CCAs. November 2007 Processed: 03-03-2008 20:24:47 Page Layout: CWMEM1 [E] PPSysB Job: 386002 Unit: PAG1

Ev 46 Environmental Audit Committee: Evidence cient use of Y courses each month and the CCA plays a large part in both of them—I have covered about 1/3rd of the work force so far, and will continue throughout 2008 cient The workforce are Y both management andworkforce. and equipment. equipment wherever possible. Table 1 ciency? of CCAs? Y meetings. very comprehensive. focused approach, by investments in plant more e manage both energyand the environment Ihave just making judgements amalgamated about the how two various review meetings intoone. be planned to avoid unnecessary waste of plants actually should energy. Q1 Since yourcompany first heardabout CCAs, has therebeen a change in the monitoringfocus targeting and within of the energy usebusiness, Q2 when Has looking theat opportunities energy improved discussed e and risen sinceFor up 2000, example, as do a savings you result asnow a have abatement result energy the of more company now agendameetings at that Board weren’t CCA membership? in existence when membershipCCAs Q3 influenced came level into as Is force. a energy result use any of and new how found they focus? can influence Q4 experienced Have monetary you investment decisions? continued CCA the CCA performance Q5 Has the risk of workforce aware of Q6 Is the whole of the company? RESPONSES FROM EEF MEMBERS ON IMPACT OF IRON & STEEL SECTOR CCA ON ENERGY USAGE & INVESTMENT INTENTIONS and sections producerbased in the energy West policyMidlands and an monitoring and energy committee thatWire recording Producer of based energyin South Yorkshire holds regularemploying There now has an been agenda a item forapproximately the 550 main board change ofpeople focus, and before are now oriented made, meetings Monitoring due and targeting to has a related more data is solutions now are there now are energy result, and the The CCA is a very “site”’ aware held, although of always issue. since the considered I rise improved on site as a Yes, both analysis on has process assisted in in energy costs and Would call it not a I usage, run but separately also both concentrated and when planning management risk more through a buildings desirable Energy and to maintain the need to make momentum! Environmental Awareness Training Hot rolled steel bar We now have an The amount of Energy matters are More savings than Energy e Processed: 03-03-2008 20:24:47 Page Layout: CWMEM1 [O] PPSysB Job: 386002 Unit: PAG1

Environmental Audit Committee: Evidence Ev 47 items of kit that V o are not in use ect on at monthly V The but the overriding dropping out of the U ciency? of CCAs? Y Replace one of our furnaces. Improve thermal insulation on another furnace Q1 Since yourcompany first heardabout CCAs, has therebeen a change in the monitoringfocus targeting and within of the energy usebusiness, Q2 when Has looking theat opportunities energy improved discussed e and risen sinceFor up 2000, example, as do a savings you result asnow a have abatement result energy the of more company now agendameetings at that Board weren’t CCA membership? in existence when membershipCCAs Q3 influenced came level into as Is force. a energy result use any of and new how found they focus? can influence Q4 experienced Have monetary you investment decisions? continued CCA the CCA performance Q5 Has the risk workforce of aware of Q6 Is the whole of the company? eld two steam boilers and and gas usage. We saving capital electricity bills have reason has been cost CCA will cost the Y based in She employingapproximately 100people fired gas burners in replace with directly target areas of energy have used this to our have process been tanks. approved same extent expenditure wastage projects reduced but not to the savings by senior management company money but it is an ongoing struggle to get people to turn in the West Midlandsemployingapproximately “energy” 60people Manufacturer ofalloy and stainlesssteel drawn bars We have undertaken many reportables—to energy saving projects We eg had Remove 20 additional sub meters fitted to completion Our at SEC board is monitor reported electricity monthly to senior improvements and have Our Shop gas Floor bills have management. Energy Board, Management membership of reduced dramatically. CCA level The CCA has management meetings The workforce has influenced the decision been aware been that forthcoming Reinforcing andmerchant barmanufacturer based We now hold meeting bi- to discuss monthly energy most Energy important use is now considered one of the All energy projects are impact now of assessed including the CCA We targets are well within indicating Definitely all investment considers CCA any are e made clear The savings under Processed: 03-03-2008 20:24:47 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG1

Ev 48 Environmental Audit Committee: Evidence

UK Steel Industry Energy Consumption: 1972-2006 35 35 32.8

30 30

25 25

20 20 19.4 GJ of energy consumed per tonne steel produced 15 15 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Iron and Steel Statistics Bureau Processed: 03-03-2008 20:26:49 Page Layout: COENEW [SO] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 49

Tuesday 23 October 2007

Members present

Mr Tim Yeo, in the Chair

Mr Martin Caton Jo Swinson Colin Challen Dr Desmond Turner Martin Horwood Joan Walley

Memorandum submitted by The Association for the Conservation of Energy

Introduction The Association for the Conservation of Energy was formed in 1982 by major companies active within the energy conservation industry, in order to encourage a positive national awareness of the needs for and benefits of energy conservation, to help establish a sensible and consistent national policy and programme, and to increase investment in all appropriate energy-saving measures. We welcome this opportunity to comment upon the role of the Climate Change Agreements and related policy measures.

Conclusion Climate Change Agreements have delivered more energy, hence carbon, savings than a non- interventionist policy would have done—albeit the absolute amountsU have been less than anticipated. It is likely these could all have been delivered at a lower cost to the public purse, had the original discounts recommended by its progenitor, the Marshall Report, remained at 50 rather than 80%.

A. Climate Change Agreements A1. The Climate Change Levy is the longest established instrument designed to aVect the business sector in order to meet binding international climate change commitments. In this context, the Climate Change Agreements (CCAs) are the first example of an integrated policy approach in this context, combining “carrots” (80% discounts), “sticks” (the threat of full payment for non-compliance) and “tambourines” (drawing management attention to energy consumption), which this Association has long described as absolute prerequisites for any successful energy eYciency scheme. A2. That the CCAs have delivered more energy savings than would have occurred in its absence is now presumed by government. The latest review, prepared for this Committee in August by the National Audit OYce, appears to accept the government’s estimate that the scheme will be delivering savings of 1.9 MtC by 2010, all of which are additional to those that could reasonably have expected to be delivered by business- as-usual. This figure is a reduction of one-third on the 2.9MtC which had been assumed would accrue by government, as recently as 2004. A3. However, the Cambridge Econometrics 2005 modelling suggests that most sectors would have surpassed their targets regardless: “A combination of technological change and relative decline in UK energy-intensive sub-sectors of manufacturing . . . implies that the energy (and therefore carbon) and energy eYciency targets would have been met without the Agreements.” A4. Bearing in mind that a)the basic yardstick used by government negotiators that all CCAs should incorporate only energy saving measures which would return all their capital within 24 months, and b) that only 60% of such identified saving measures needed to be taken up to achieve 80% reductions, such additional savings might legitimately be assumed to occur automatically. When the Levy was first mooted, this Association published a detailed study showing how such (self-evidently) cost-eVective savings were already factored in to the DTI’s oYcial energy forecasts for 2010. A5. In practice, we conclude that it was the economic modelling—both from the DTI and Cambridge Econometrics—which proved over-optimistic. A significant policy lever was required to realise much of these cost-eVective savings, for all the reasons set out so lucidly in the EAC report Energy EYciency, HC 159/I, published July 1999—and indeed in many subsequent committee reports. A6. Relying upon business-as-usual would simply have meant that the 1.9 MtC savings would not have been realised. That is even though all were so cost-eVective as to have been factored into the DTI’s original presumptions under business-as-usual. There is, admittedly post hoc, acknowledgement of this: according to the 2006 nPower survey of business opinion, 50% of major energy users acknowledged that compliance with CCAs resulted in these additional energy savings. Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 50 Environmental Audit Committee: Evidence

A7. Apart from anything else, the very existence of the Levy has refocused some attention onto fuel bills. This focus was assisted by the decision by every large energy company to make the Levy an identified item on fuel bills: this was against the express wish of Customs & Excise at the time, apparently fearful that businesses might seek to reclaim the expenditure as if it were Value Added Tax.

B. Value for money B1. In its January report on the cost-eVectiveness of the government’s 2006 climate change programme, the NAO stated that the cost in 2005–06 to the Treasury, of forgoing its anticipated full Levy revenue from the 51 industrial sectors now incorporated within the CCA, was “around £300 million”. The August NAO review cites Cambridge Econometrics as identifying the sum forgone in 2003–04 as £350 million. B2. The Treasury has never confirmed publicly the correct figure. It can be assumed that this figure would be at least £100m less, had the discount been limited to the 50% recommended in the progenitor Marshall report (1998), rather than the eventual 80%: it is improbable that the “stick” eVect would have been any less. B3. This makes it extremely diYcult to calculate what the precise cost per tonne of carbon saved from the CCA has been, in order to verify the former Chancellor (now Prime Minister)’s oft-repeated claim that this was the “jewel in the crown” of his carbon abatement programme. But on the basis of the two figures given, the “NAO” figure works out at £158 per tonne of carbon saved, the “Cambridge Econometrics” figure some £184. This should be contrasted with the cost per tonne saved to the public purse of other programmes identified in the January NAO Report on the climate change programme (eg the Energy EYciency Commitment at a negative cost of £270, or Warm Front, at a negative cost of £420 per tonne). B4. According to the NAO August review (page 24) the government considers the CCAs bring a net benefit—ie negative cost—to the UK of £90 for every tonne of carbon the policy saves: this more positive conclusion apparently reflects savings to participating businesses of future fuel bills, as well as benefits from improved air quality, set at £500 million. B5. When introduced, the Levy was estimated by HMRC to have increased total energy prices by on average around 15%: on which basis, it can be deemed to have increased prices to those enjoying CCAs by just 3%. Until this year, given rising real fuel prices, even that percentage has reduced subsequently. Collecting the Levy (from both 100% and 20% payers) costs HMRC 0.4% of revenue, and costs energy suppliers £13 million a year to administer.

C. Future of Climate Change Agreements C1. On page 35 of its August review, the NAO draws attention to the perverse eVect of the Levy being applied to manufacturers of energy saving equipment. Such manufacturers have had their costs increased in line with all others (whether like glass, mineral fibre and gypsum insulation at 20%, or like others at 100%). As theirs is precisely the equipment demand for which this public policy is designed to increase, this remains a singularly perverse outcome, which it is still not too late to reverse. C2. One of the main policy drivers behind the CCAs’ eVectiveness has been the threat that the full Levy would be imposed, if any participants were established not to be complying. A few sectors opted out early on, although subsequently more have joined (the initial requirement, of needing to be registered with the Environment Agency under Integrated Pollution Prevention & Control, being wisely removed). But it has been established that some 250 sites have failed to deliver their anticipated savings: however as each recalcitrant formed part of a sector which overall did succeed in complying, no penalty seems to have been imposed (other than possibly informally, through peer pressure). C3. Equally there has been little evidence placed in the public domain that gives confidence that all the savings claimed by the 51 participating sectors really exist: during the initial discussions around the CCAs, government undertook to be as transparent as possible in providing reassurance that the £300 million (or even £350 million) forgone to participating companies was legitimately spent. As of April 2007, just 9% of target units have been audited, with errors in approaching one in five cases. C4. New policies have been introduced since the Levy. Inevitably, practically all those manufacturers involved with the European emissions trading scheme are also CCA participants. The complexities of interaction between such policies are set out in Para 4.7 of the NAO August review, including double administrative costs; double taxation—electricity is covered by trading; the diVerence between relative targets and absolute caps; and the diVering criteria for facility inclusion. There is also a growing concern that—given the present nugatory price of carbon within the trading scheme—participants may be inclined to eschew making energy eYciency investments in favour of purchasing (very cheap) credits. C5. No announcement has been made about the future of the Agreements (or indeed the Levy) beyond this decade. It is not coincidental that the Carbon Reduction Commitment will certainly cover all those CCA participants not previously involved with the European emissions trading scheme. Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 51

D. Abolish the Levy? D1. Were the Levy to disappear altogether, the Treasury would be left with at least a £744 million annual hole in its revenue—this being the sum collected in 2005–06, the last year for which income has been reported. Because Levy rates were for the first time increased this April, it is reasonable to conclude that income will be significantly greater this year. D2. Eliminating the Levy would also reduce still further the proportion of ecological taxes, a continuing concern to the EAC. It would remove even such limited impact upon behaviour the Levy might be having upon 100% payers. However, assuming the full introduction of the CRC contiguously, it would be reasonable to oVer complete exemption from the Levy to participants—so long as the loss of revenue was at a minimum, made up from non-participants. D3. Uniquely amongst EU15 countries, the UK’s “energy tax”—the Levy—was deliberately imposed only upon the productive sector, and not upon households—who also pay the lowest permissible rate of VAT (5%) on fuel consumption. This is surely driven by awareness of the continuing failure to eliminate millions of households from fuel poverty, despite statutory obligations to do so.

E. Enhanced Capital Allowances An important tax concession was introduced alongside the Levy, to encourage investment in energy saving measures. This was the Enhanced Capital Allowances, enabling those Levy payers making profits to oVset all expenditure in certain energy saving measures in the first year (rather than over three or five years as with conventional capital investments). However it is diYcult to provide absolute figures for the impact of this concession, as HMRC does not record such expenditure in any accessible way. However there is anecdotal evidence regarding the impact of these Allowances, which does enable certain conclusions to be drawn: 1) The existence of a formal list of actual branded products qualifying (held by the Carbon Trust) does provide an eVective oYcial quality endorsement for such products. 2) As such, inclusion upon the approved list can be used as an initial means of drawing positive attention to a product, even if eventually no tax claim is made. 3) Conversely, the—apparently arbitrary—categories of energy saving items which qualify has appeared to undermine entire sectors unable to receive such endorsements (eg glazing, fabric insulation). 4) Certain qualifying measures have traditionally been categorised as maintenance rather than capital investment, and thus have always been oVset against tax fully in the first year (eg pipe lagging). 17 September 2007

Witness: Mr Andrew Warren, Director, the Association for the Conservation of Energy, gave evidence.

Q83 Chairman: Good morning and welcome to the think my conclusion has to be, no, we have not; but Committee. You are familiar with this Committee we have seen a sort of soft shoe shuZe on all this. In and you are an old friend of some of us and we are other words, we are moving forward, mostly, but I delighted to see you. As a general point to start oV would not actually describe it with any very great with, knowing how closely you have been involved excitement. with the energy eYciency policy, how do you think the Government has been doing on energy eYciency Q84 Chairman: Against that background, how do generally over the period since the Climate Change you think the Climate Change Levy has helped or Levy? not helped? In particular, in light of the evidence that Mr Warren: First of all, thank you very much indeed we had last week and some of the written evidence for inviting me back to this Committee. I think this we have had, it seems quite diYcult to identify how is actually the first time I have had the privilege of much of the energy savings that have been secured appearing under your chairmanship. It is a great over the last six or seven years are actually privilege to be here. Thank you very much indeed for attributable to the Levy, and how much are your kind opening words. You ask basically how attributable to other factors. For example, the progress is going overall. I recall back in 1999 that engineers last week made great play on reduction in the EAC did a full-scale study into energy energy use and emissions; but of course then it eYciency—actually it was the last time you did transpired that part of that was due to a fall in that—and you concluded that what was necessary production. was a real step change in the whole attitude. That Mr Warren: It is always diYcult to disaggregate was a phrase that was picked up by Government in these things. I think it has been particularly diYcult the 2003 Energy White Paper and in a number of relating to the 100% Climate Change Levy payers. In other subsequent documents. I was thinking about the paper we put before you we did express some whether we have actually seen a step change, and I scepticism as to the impact that the Levy has had on Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 52 Environmental Audit Committee: Evidence

23 October 2007 Mr Andrew Warren those who have not entered into Agreements. So far making the very rational argument that there is an as the Agreements are concerned, with the 51 awful lot of cost-eVective energy saving which at the industrial sectors now involved in this, I think we present moment is foregone. can come to an altogether more positive conclusion. There are savings which have been identified. I think Q86 Colin Challen: We have heard obviously that just under two million tonnes of carbon is the latest some savings have been made anyway, and that the figure that the Government have put forward, and CCAs have provided motivation for management to Y which I think the National Audit O ce have do more. Would that be an argument, which has endorsed. I think it is fair to say that had those been made to this Committee, that CCAs should be Agreements not been undertaken it is improbable extended to those sectors currently excluded? that most of those savings would have taken place. Mr Warren: The complication with CCAs is that To that extent certainly the Agreements have to be a they are by definition voluntary Agreements. I think good thing. In theory they would have taken place what you are positing there is that there should be because, as you well know, most of the Agreements compulsory Agreements? Is that accurate? were not exactly onerous. They require people on refurbishment basically to do stuV which pays back Yes. within a couple of years or so, and by no means all Q87 Colin Challen: Mr Warren: In theory of course you could do that. of that. The fact remains that those savings are You could do that right across the entire economy apparently real. We do say in our evidence we would and essentially enter into compacts with any like to have further identification of the savings particular industry or trade. The complication has actually on the public record, and further obvious been that you have got to have, for instance for an auditing of whether or not the figures that have been Agreement to work, a trade association which can published are accurate. If we look at the figures bring all the relative companies together. If you do which we have been presented with those there do not have that then it becomes a much more complex appear to be positive benefits which have accrued matter to enter into an Agreement, unless of course from that particular policy instrument. you are suggesting that there should be Agreements with every single one of the four million registered Q85 Chairman: It is true, as you will know better companies. That might be your other way of than me, that so much of the energy eYciency attempting to do that. What has been fascinating on changes that businesses make, they make entirely in this is the fact that the NAO work does show that their own interests, quite apart from the wider there has been at least a couple of hundred or so environmental benefits. Do you think there is a companies or, more accurately sites, that have been scenario in which actually a new Government involved with this, which have not delivered. Yet the initiative with lots of bells and whistles is a good owners of those sites have not been penalised, just thing, because it reminds businesses that they ought simply because they fall within a sector which has in to be doing more almost regardless of the actual practice apparently delivered on the agreed savings. I must say, that must be fairly galling for others in detail of the incentives provided? that sector. One hopes there is at any rate some fairly Mr Warren: Obviously it is always worthwhile unoYcial pressure on those who have been laggards drawing these issues to people’s attention, but we to do something. I can see intellectually what you are have had a basic thesis for a long while, propounded driving at. I just think in practical terms trying to get in the written evidence to you, about the fact that Agreements with all four million businesses in the you need to have a three-part programme. You country, along the lines that we have set these up, is would need to have carrots and sticks, for obvious probably more trouble than it is worth. The Carbon reasons, and tambourines to draw attention to Reduction Commitments, which is not actually the things. One of the reasons why the Agreements I subject of this Inquiry but, as you may know, the believe work is because you obviously had carrots Government put forward in the last Energy White there, because you were getting the tax break; sticks Paper earlier on this year, are being extended to that if you did not do them you would not get that other areas which are at the moment outside the tax break; but also, exactly what you were referring Agreements. Those are being done on an individual to, the tambourines that there was something new on company basis, and only actually with really quite the horizon. I suspect that probably one of the large companies. My concern is that if you get down reasons why the Agreements delivered savings in the to really very small companies then entering into way in which, if you like, one would have anticipated anything as sophisticated as an Agreement, it is quite that rational man might have delivered is because diYcult to deliver. Having said that—if you go back they were quintessentially cost-eVective in the first to the Chairman’s initial question which is how are place, and just simply it is much more fun saving we doing—if you want an area where we are not money from the taxman than it is just saving money. doing well, or not doing much at all, it is with small I think it does concentrate minds if you are being and medium-sized businesses where there really have told you can save money in that way. I think we have been very few policy measures which have been seen this in the residential sector too in the way in brought to bear and have any impact. The only one which people have sought to deliver the Energy that one can really think of is probably the Climate EYciency Commitment by dint of using ostensibly Change Levy. I suspect, and I know from surveys money oV the council tax. It does concentrate minds undertaken, that most businesses have no in a way which you would not get if you were merely knowledge whatsoever of the fact that there is a Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 53

23 October 2007 Mr Andrew Warren small percentage on their bill which is going for the a major decision driver”. Is the Levy itself driving Levy. If it has had an impact it is only one that any energy eYciencies, do you think; and, if not, by econometric modellers can find. how much should it be increased? Mr Warren: The Levy itself, as far as the 100% payers are concerned, appears to have had very Q88 Colin Challen: It has been very useful, as we have heard, setting up networks, good practice and limited impact for exactly the reasons that the National Audit OYce have identified. Earlier I did so on. When those networks and good practices are make the distinction between those who are often established is there a continuing need for Agreements to maintain motivation of managers or completely unwittingly paying the Levy at 100% and those who are threatened with paying the Levy at would it simply fade away without that incentive? Mr Warren: I suspect having this tax break, for the 100% but, because they have undertaken these Agreements, have actually got a very heavy discount reasons that I alluded to before, does have a much on it. It is that discount which has led to action. I more powerful impact upon a company in terms of getting them to look at their energy bills, than mere really am very dubious as to whether the arrival of what was not a very heavily publicised Levy upon exhortation. EVectively what we are doing with this tax break is to say to companies, “Come on, if you ordinary businesses’ bills, those outwith the 51 sectors, has made more than a marginal diVerence. don’t deliver even these really not desperately demanding savings, then you will lose out”. To answer the other part of your question, yes, obviously if you start putting prices up very heavily then sooner or later it will impinge upon even the Q89 Colin Challen: Also they are doing something most purblind. The question is eVectively, how much which by then becomes quite natural to them; it is do you have to put the price up in order to do that? built into their thinking. Why should they get a tax I would suggest that in the case of a lot of those in break for it because they have made the change? You the commercial sector, where you are talking about actually really have a permanent tax break of things energy prices forming at most 2% and often below that then just come naturally. 1% of total revenue expenditure, it is going to have Mr Warren: I think the complication with trying to to go up a great deal. We have seen, and you have take a tax break away is that those who have just evidenced the fact from the National Audit received it are likely to kick up a substantial fuss OYce, that since 2001 there has been a real increase about it. One of the things which again in our written in prices which undoubtedly has led to some increase evidence we have alluded to is the fact that when the in interest in this area; but I do not think that anyone concept was first put forward under an inquiry would suggest that any more than a fraction of the headed by Colin Marshall, who was then the ostensibly cost-eVective savings which can be found President of the CBI, the suggestion was that the tax across the whole of the commercial sector are being break would not be 80% but 50%. Personally I have picked up. Manifestly, if you are going to rely on never seen any evidence whatsoever to suggest that price alone, you are going to have to hike that price we would not have got just as much in terms of up a lot. It has always been our view, as I think you savings from a 50% tax break, as the Marshall know, that merely having a stick does not work. I Inquiry proposed, as opposed to the 80% we used the metaphor earlier about the stick. You need received. carrots, and you do need the noise going on of the tambourines as well. Put that together and you can actually make a very eVective set of policies. That is Q90 Colin Challen: Perhaps we could liken it to mortgage interest relief which was introduced to why I think the Climate Change Agreement, simply encourage the home-owning democracy. That seems because it does tick all those boxes, can be described to have succeeded—the interest relief was quite legitimately as a success. withdrawn and nobody really complained. We all now just accept that you do not have the subsidy on Q92 Colin Challen: To be clear, you are not saying buying a house any more. Is that not a similar case? then that the energy increased costs since 2001 have Mr Warren: If you will forgive me, Mr Challen, I made a marked diVerence on the carbon emissions think actually to be fair one of the reasons why there of the companies that have faced those extra costs? was very little impact on that was the mortgage relief Mr Warren: Just to clarify this, are we talking about was limited to, I think, £30,000 and there was only the companies involved in the Agreements, or the the tax break on that initial amount; and as house companies outside of the Agreements? price inflation increased the £30,000, whilst obviously important, was a relatively small Put to one side the Levy, energy proportion and an ever-decreasing proportion of the Q93 Colin Challen: costs have gone up considerably but you seem to be cost that people were having to bear in buying saying that has not really in itself driven eYciencies? homes. Mr Warren: Transparently it has driven some; but the fact remains that, obviously as prices go up, then Q91 Colin Challen: The National Audit OYce the cost-eVectiveness ratio improves so that all sorts highlighted in its report that energy prices generally of energy-saving measures which were marginal then have risen since 2001, so the impact of the Climate become undoubtedly very cost-eVective. Of course Change Levy on energy costs has declined as a there is some investment going on—it would be very proportion of overall energy costs. In fact they say, foolish to pretend it was not. The fact remains in “Therefore, companies do not recognise the Levy as terms of the potential for rational savings, which an Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 54 Environmental Audit Committee: Evidence

23 October 2007 Mr Andrew Warren economist would identify, comparing that with what back up again and that has been the position ever is actually happening on the ground, we are only since. In eVect, this has been a nice little earner, and essentially getting a fraction. it has continued to be a nice little earner, and as the rates go up it will be an even better little earner. This Committee has in previous reports pointed out the Q94 Dr Turner: In 1999, when the CCL was a fact that the way in which the Treasury has tended to proposition, you argued strongly that the tax had to look at using the financial system for concentrating be accompanied by a recycling of revenue directly to Y minds on climate change has essentially been by aid energy e ciency investments otherwise it just penalising rather than providing incentives. In other becomes “a nice little earner for the Treasury”. Of words, it has been drawing the revenue in but not course we have had some. We have had some actually, if you like, extending that revenue. Whilst upfront recycling. We have had some funding of the the Climate Change Levy and Agreements have been Carbon Trusts, Enhanced Capital Allowances and V described by the former Chancellor now Prime so on. How e ective do you think this recycling of Minister as being very much the jewel in the crown the Climate Change Levy revenue into energy Y of the Climate Change programme, I suspect that e ciency improvements have been? one of the reasons why the jewel will shine so well is Mr Warren: I am very flattered that you have done because the revenues do flow in in rather large your homework to go back to what I was saying in measure to the Treasury. 1999. I had forgotten I had used the expression “nice little earner” then. I have got into trouble with people both from the Treasury and in Number 10 Q95 Dr Turner: We had a row of business witnesses subsequently for using that expression, but I do not sitting where you are last week and we asked them if resile from it. It has proved to be a nice littler earner. they could tell us anything about the impact of the The last figure that the National Audit OYce Carbon Trust’s grants and loans and they could not. produced on the revenues on this, and that was a Does your Association have any view on the actual couple of years or so ago, suggested that the total impact of the Carbon Trust’s activities in promoting 3 R&D in energy eYciency? revenues coming in were around £4 billion a year; of that a proportion, about 10%, has gone to the Mr Warren: Yes, it does, and it is actually mostly Carbon Trust who are doing excellent work, as this pretty positive. There are certain schemes that we are Committee has identified before. I am not sure really very keen on that they do. I instanced in answer to how much the Enhanced Capital Allowances are one of the Chairman’s questions about the problems actually costing the Treasury. They do have merit in finding programmes for helping small and actually as a means of attracting people’s attention; medium-sized businesses. They have a very sensible and there is a list now of about 400 or 500 products zero interest loan scheme which has been around for the Carbon Trust holds of specific named products several years, and which is available only to smaller which can qualify for the Enhanced Capital businesses; it is a very uncomplicated one and it is Allowances. I have never seen any figure from the delivering tremendous savings. If I have a criticism Treasury as to what their “losses” have been as a of the Carbon Trust on that, it is that the number of result of companies picking up on the Enhanced small businesses to whom this could be applicable Capital Allowances. One has to recognise that who know about it is actually very small; but actually the losses can only be on interest, because certainly those who have subscribed to this, and who eVectively all you are doing is saying instead of have got zero interest loans payable back at the end getting that capital back and having to amortise it of a five-year period to install energy-saving over three or five years, depending on the size of the measures, have found that actually it has been a company, you can do it just over a single year. There tremendously successful programme. I am giving is therefore, if you like, a potential loss of interest you an instance of one particular programme which there for the Treasury but not much else. It has still is being helpful; but it is no part of my function to been a useful mechanism to put an imprimatur onto sit here and defend absolutely everything the Carbon the 400 or 500 products which are covered by this. Trust does. Apart from anything else I do not know The converse of that is products that do not qualify everything the Carbon Trust does! One point that under the Enhanced Capital Allowances, which are has been made, and it is one that this Committee has predominantly those involved in the fabric of a picked up on before, we found it so when it was building, insulants, glazing and so forth, they to that originally proposed and we continue to find it extent lose out. Enhanced Capital Allowances have ludicrous that, uniquely in Europe, we choose to been quite helpful, but after that we stop. After that have two Trusts to deliver our carbon saving: we it has been a nice little earner for the Treasury. I do have a Carbon Trust and an Energy Saving Trust. know that when this was originally announced—and Frankly, we do not see why we need two ways of it was part of the Colin Marshall package that was telling the time. Those two Trusts should be originally proposed which was the progenitor of the amalgamated. Climate Change Levy and the Agreements—part of that said what we should be doing is increasing taxes Q96 Dr Turner: Can you suggest any ways in which on bad things, too much fossil fuel energy, and you would like to see the recycling of carbon levy decreasing taxes on good things, getting people into revenues beefed-up? work. For one year the National Insurance rate did Mr Warren: I have given you one obvious example go down, and it went down so as to make this actual there, which is the zero interest loan scheme for small revenue neutral, but the subsequent year it went businesses, which really has been extraordinarily Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 55

23 October 2007 Mr Andrew Warren helpful on this. There is no question at all that using Mr Warren: I suspect, as far as they are concerned, grants and loans, even for investments which are their footprint compared with the footprint which ostensibly very cost-eVective, does tend to get the their products have is relatively small. Their attention of more senior people than those who are products will help to reduce the overall level of directly involved with energy management. The carbon emissions. Manifestly, you cannot make Enhanced Capital Allowances is a wonderful wheeze anything without having some carbon impact. If you for exactly that reason—that gives those who are are deterring other companies from investing in supplying those 400 or 500 products which qualify those products—it might be the high eYciency under the Enhanced Capital Allowances a means to lighting which you refer to, or any other—if by dint be able to draw attention to their product and say, of putting up the costs on those products you are “Look, the Treasury so believes in this that they will deterring others from investing in them, then that allow you to oVset the capital cost on this in the first must be counterproductive. year”. As we have seen, actually the number of companies who actually do that are relatively few; Q99 Martin Horwood: You do not worry that but the feedback we have certainly had is that that introducing allowances in a sense for more energy- is helpful in terms of drawing the attention of more eYcient products is going to introduce a level of senior people in the company to the fact that this is complexity into what at the moment is actually an an area where they should be looking at, and it is one admirably simple system? You can imagine if we got where they should be considering investment. I onto biofuels the arguments which would result in would like to see that money, much as I seem to have exactly what the carbon impact of that product was. said in 1999, recycled directly into helping those Mr Warren: Obviously it would make it more who, if you like, are essentially bearing the burden of complicated. I am not sure that I subscribe to your the extra taxation on this. view that it is an admirably simple system. For a V Dr Turner: Perhaps we need to make sure that their start, there has to be 51 di erent sets of negotiations. accountants are more aware! Q100 Martin Horwood: I am not saying it is my view. I am just asking the question. Q97 Martin Horwood: Can I just draw you onto the Mr Warren: Manifestly it would increase the part of your memo where you echo the National complexity; it would be stupid to pretend otherwise. Audit OYce in drawing attention to what you call I have to go back to what the main object of the the perverse outcome of the manufacturers of energy exercise is; and it is to encourage those paying the eYcient products actually suVering the same Levy to invest in measures which will help to penalties as everybody else. You called this “a decrease their overall energy and, hence, carbon singularly perverse outcome, which it is still not too consumption. If the measures which they could be late to reverse”. What would you do to reverse it? installing have increased in price as a result of this Mr Warren: The answer is that what one would seek particular policy measure, then it undermines the to do is to identify obviously those products which overall viability of the scheme. That is the point that at the moment can legitimately be described as the National Audit OYce were making. It is one that providing energy eYciency services; and, having I know you were asking for specific responses on. identified those and recognising that they are paying You have my response. the Levy at the moment, find some means of removing those products from having to carry the Q101 Martin Horwood: It would be even simpler to Levy at any rate at all. I instanced in our written move to something like a carbon tax—it just paper the fact that a number of these sectors, a incentivises consumers and manufacturers to use the couple of the insulating sectors, the glazing sector, lowest carbon route in each case? currently enjoy the 20% rate, but there are others Mr Warren: Are you asking me to become Prime who are paying at the full rate of 100%. It does seem Minister! There are all sorts of things which could be to be perverse almost to be doing this because, after introduced and might be more eVective. I am not all, one of the main objects of the exercise is, sure they are on the table before us at the moment. I think what we do have before us is a scheme which strangely enough not to create a nice little earner for 3 the Treasury, but to try to concentrate the minds of at the moment is certainly raising £4 billion for the the companies who are paying the Levy on investing Exchequer each year, and it is reasonable to ask in sensible energy-saving measures. If you put up the whether that money is being wisely spent in terms of cost of those measures, then you are helping to actually recycling the funds. The trouble is, because undermine the basic objective. we have not followed the pattern of recycling the funds, I think it has undermined the whole credibility of revenue neutrality environment taxes. Q98 Martin Horwood: If we just take an example. If Essentially people have said, “Here’s the biggest we are moving towards eventually banning high con” and that has turned out to be just another way energy light bulbs, is it not still worth incentivising of the Treasury raising money. several diVerent competing manufacturers of light bulbs to reduce their energy footprint as part of the Q102 Martin Horwood: As you have already said in manufacturing process; or should they receive a answer to some earlier questions, one of the lower incentive to do that than other companies in confidence-building measures is the knowledge that other sectors? these things are actually making a diVerence. Can I Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 56 Environmental Audit Committee: Evidence

23 October 2007 Mr Andrew Warren just ask you briefly, you have a rather alarming unnecessarily generous, and that it might be just as factoid in your memo which is that only 9% of target eVective in terms of saving carbon if it had been 50%. units covered by a Climate Change Agreement have What evidence do you have to support that actually been audited to make sure they have contention? achieved the energy savings they claim to have made. Mr Warren: As I instanced before, the progenitor of Do you think that is an adequate level, or do you this entire scheme was the Colin Marshall report think we need a much more stringent auditing back in 1998 or so, and that certainly did suggest a regime? 50% reduction would deliver. A lot of the work that Mr Warren: We need a far more stringent auditing went on around that report, which was regime. That was a figure that again has emerged Y commissioned by the then Chancellor, did suggest from the work the National Audit O ce did for this that we would oVer just as much of an incentive there Committee. I think that for all of us to have to companies to look at this if the discount was 50% confidence that these quite substantial tax breaks rather than 80%. The same answer to Mr Horwood have been well earned, then we do have to know that earlier—we are talking about somewhere between the sectors, who are the only ones who produce the figures, are actually to be relied upon in doing so. To £300–350 million that we have foregone on this. By have only done less than 10% of these is really not dint of having a reduction of 80% rather than 50%, suYcient to give one complete confidence that these there is certainly about £120 million extra that has tax breaks are justifiable. The tax breaks, after all, been foregone, again because of that generosity. If are worth somewhere between £300–350 million a you were to ask me whether or not that £120 million year in total. Were all these Agreements to have been which the Treasury have not taken in could perhaps proved completely worthless, and were all the have been better spent in terms of delivering the end companies to have failed to deliver even these objective, which is improved energy eYciency and relatively modest savings then, in theory at any rate, improved carbon savings, I have to say the answer the Exchequer would be receiving somewhere would almost certainly be yes. I am dubious as to between £300–350 million more each year. It is quite whether it was strictly necessary to be as generous as legitimate to turn round and ask the question: “Are the Government turned out to be in the end. we convinced that that public money foregone has actually been foregone deservedly?” I am not sure that just 9% of the sites being looked at are suYcient. Chairman: Thank you very much indeed. It is very Q103 Dr Turner: Something else in your good to see you again. memorandum to us is the suggestion that 80% of the Mr Warren: Thank you very much indeed for Climate Change Agreements is perhaps inviting me.

Memorandum submitted by EDF Energy

Summary

EDF Energy is one of the UK’s largest energy companies with activities throughout the energy chain. Our interests include coal and gas-fired electricity generation, combined heat and power plants, electricity networks and energy supply to end users. We have over five million electricity and gas customer accounts in the UK, including both residential and business users. Climate change is the biggest challenge facing the world today. EDF Energy is fully committed to tackling climate change. We support the UK Government’s ambition to move progressively to a low carbon economy and to play a leading role in the global eVort to address climate change. In our view, the scientific evidence presented to date justifies action to mitigate climate change by reducing greenhouse gas emissions. The Climate Change Levy (CCL) and Climate Change Agreements (CCA) were the first major climate change policies to address carbon emissions from energy-intensive industries within the UK. They have played an important role in focusing the attention of energy-intensive businesses on energy eYciency. Climate change policy has evolved since their introduction, in particular, with the introduction of the EU Emissions Trading Scheme (EU ETS) and with the draft Climate Change Bill being progressed in Parliament. The underlying principles supporting a future regulatory framework should be that policies covering industrial sectors are consistent, cap emissions from these sectors and provide business with flexibility to meet the emissions cap in a cost-eVective manner. This is an opportune time to review these policy measures. We believe that CCAs should not be renegotiated after 2010 and that CCL should be significantly reformed and focused on energy supplies where there is an absence of robust carbon pricing. This will ensure that climate change policy measures are better aligned with the approach being undertaken in the draft Climate Change Bill and are streamlined to avoid overlap. Below is EDF Energy’s reform proposal. Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 57

EDF Energy Proposal Climate Change Agreements should, in our view, be concluded at the end of 2010 (milestone 5). The cessation of CCAs will result in both direct and indirect CO2 emissions from these sectors being captured under existing and proposed cap and trade schemes. Large scale direct emissions are already covered by the EU ETS and indirect emissions and small-scale direct emissions will be captured under Carbon Reduction Commitment (CRC). The provision of absolute caps for a much higher proportion of industrial emissions than are capped at present will provide greater environmental integrity.

The Climate Change Levy should also be reformed to focus on CO2 emissions to ensure that there is a single robust price of carbon integrated into energy costs, with: — CCL on electricity being set to zero, as the cost of carbon is already incorporated into wholesale electricity prices via EU ETS. While the CO2 price signal in electricity prices for tariV customers is currently somewhat weakened by a combination of retail market competition and a significant proportion of free allocation of carbon allowances to the electricity power sector, it will become much sharper once the electricity sector moves to full auctioning of allowances after 2012; and

— CCL on gas remaining based on its associated CO2 emissions until an alternative robust price signal exists. The removal of revenue recycling from CRC or the inclusion of a carbon price in wholesale gas prices, for example via EU ETS, would provide a suYcient carbon price signal to allow CCL to be set to zero for gas. Setting CCL to zero on electricity will have little impact on investment in low carbon generation. Investment decisions for new renewable electricity or CHP assets already factor in the risk that the CCL exemption mechanism may not exist in the future. The key support mechanism for renewable generation developments should continue to be the Renewables Obligation. If necessary, Government can review the need for a new more eVective support mechanism to promote the uptake of large, carbon eYcient, good quality CHP.

Answers to Inquiry Questions

1. Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed?

Climate Change Levy 1.1 CCL is eVectively a tax on the use of energy, based on the energy content of fuels consumed. We believe it should be significantly reformed to focus on CO2 emissions and be focused on energy supplies where there is an absence of robust carbon pricing. This supports Government’s primary environmental objective of CO2 emission reduction and the mitigation of climate change. 1.2 Currently business electricity users pay twice for the cost of carbon, via CCL and via the EU ETS price of carbon that is integrated into the wholesale electricity market price. Refocusing CCL to become a tax on CO2 emissions would create an opportunity to remove this duplication of the cost of carbon in electricity prices by setting the CCL rate to zero for electricity.

1.3 CCL on gas should remain based on CO2 emissions until a robust price signal is provided through either EU ETS or CRC. Large users currently pay CCL and have to surrender allowances against their direct emissions. However, energy-intensive users are provided with “business-as-usual” free allocations and are therefore not directly exposed to EU ETS carbon prices associated with their gas consumption. Direct emissions associated with smaller gas users will be captured under CRC but they will not be exposed to the price of carbon as a result of the proposed revenue recycling mechanisms. CCL on gas therefore remains a means of providing a carbon price signal to gas consumers. 1.4 The removal of revenue recycling from CRC, or the removal of free EU ETS allocations to the energy intensive sector, or the inclusion of a carbon price in wholesale gas prices could provide suYcient price signal to allow CCL for gas to be set to zero in the future.

Climate Change Agreements 1.5 We believe that CCAs should be concluded at the end of 2010 (milestone 5). This would result in both direct and indirect CO2 emissions from these sectors being captured under existing and proposed cap and trade schemes. Large scale direct emissions are already covered by the EU ETS and indirect emissions and small-scale direct emissions would be captured under Carbon Reduction Commitment (CRC) into which emissions will fall by default under the current proposal for eligibility criteria in CRC. 1.6 EU ETS is a more appropriate mechanism for managing emissions from large-scale direct emitters than any future UK-only cap-and-trade scheme, as large emission swings are better managed within a large, liquid emissions market and could be potentially damaging to other participants in a smaller UK-only market. Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 58 Environmental Audit Committee: Evidence

1.7 The introduction of the EU ETS for energy-intensive industries has created an overlap with CCAs, adding complexities for both operators and the administrators of the scheme and duplication of policies on emissions. Removing CCAs would remove this overlap and reduce the administrative burden. 1.8 EDF Energy’s proposal outlined above is consistent with Government’s desire to cap UK direct and indirect emissions and the need for all sectors of the economy to contribute to the overall UK CO2 emissions reductions. Importantly, it will also create equality with non energy-intensive organisations whose emissions will be capped by the Carbon Reduction Commitment (CRC).

2. With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)? 2.1 EDF Energy believes that all sectors of the economy should contribute to achieving the overall targeted reductions in CO2 emissions. These policies should focus on CO2 emissions, with the aim of capping absolute direct and indirect CO2 emissions from the sectors covered by the policy measure. These policies should be aligned with the carbon budget approach proposed in the draft Climate Change Bill and Government’s current approach to implementing both upstream and downstream measures. 2.2 The Climate Change Levy does not suYciently incentivise non-energy intensive large energy consumers to invest in energy eYciency (for example retail chains). Sectors without CCAs have no leverage over the CCL charge and the additional £4.30 per MWh is not considered suYciently “material” (ie costly enough) to stimulate additional eVort towards improving energy eYciency. It is worth noting that the higher energy prices seen in the last couple of years are beginning to stimulate this eVort, but the growth in energy services is not as large as might have been expected from such a substantial increase in energy costs. Government has recognised and addressed this through the proposed introduction of the Carbon Reduction Commitment. 2.3 Please also refer to our answer to question 1.

3. How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? 3.1 Please refer to the answers to questions 1 and 2. 3.2 The current CCL structure places considerable administrative expense and burden on energy suppliers. Suppliers are responsible for the integration of CCL into customer bills, and for charging customers, collecting the moneys and making payments to Government. This process places compliance responsibility and the financial risk on the supplier rather than Government. 3.3 Setting CCL to zero on electricity and in the future potentially on gas, as proposed in answer to question 1, would reduce the administrative burden on both energy suppliers and Government, without compromising UK’s desire to reduce CO2 emissions.

4. Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? 4.1 Trading allows greater flexibility for industry to meet environmental objectives in the lowest cost manner. In principle, we support the use of trading to meet environmental objectives.

5. What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? 5.1 No comment.

6. Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent? 6.1 As outlined in Question 1, we believe that CCAs should be concluded at the end of 2010 (milestone 5). This would result in both direct and indirect CO2 emissions from these sectors being captured under existing and proposed cap and trade schemes by which these emissions would be capped. Large scale direct emissions are already covered by the EU ETS and indirect emissions and small-scale direct emissions would be captured under Carbon Reduction Commitment (CRC). 6.2 If Government decided to continue with CCAs, alongside an absolute carbon emissions reduction target, there would be an opportunity to use CCAs to promote energy and production eYciency. This enables the use of carbon intensity based targets which encourage production eYciency, do not restrict production and manage fluctuations in emissions profiles related to production variations. Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 59

6.3 The Netherlands Covenant benchmarking of industrial sectors energy could assist in the development of any energy eYciency targets and simplify the process. Work has been undertaken to create world wide benchmark studies for a range of industrial sectors.

7. What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? 7.1 We believe the key barriers to accelerating energy eYciency in the business sectors is the lack of long term visibility and stability of Government policy that provide strong pricing signals for both energy eYciency and CO2 emissions reductions. The current policy timeframes do not match investment cycles and do not provide investors with suYcient certainty. 7.2 To assist in overcoming these barriers, a long term stable framework that drives investment in low carbon technologies needs to be created. A predictable and stable carbon market is required that provides certainty around the level of abatement required from the sectors to allow scarcity within the market to be forecasted, and hence a price of carbon to be determined based on fundamentals.

8.Products which can increase energy eYciency (such as insulating glass for windows) can be energy-intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything, should be done about it? 8.1 We do not believe that CCL and CCA penalise manufacturers of products that increase energy eYciency. Energy eYciency and carbon abatement benefits should be valued in the sale price of the products. With the increase in focus and requirements to reduce carbon emissions and increase energy eYciency, the demand for these products will increase. If there is a barrier to incorporating the value of the carbon saving in the product price, for example if the sector in which it is deployed is not subject to a transparent carbon price, then action should be taken in that sector to correct defective carbon pricing rather than distorting the CCL / CCA mechanism.

9. Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments? 9.1 No comment.

10. The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how? 10.1 The levy exemption for renewable and CHP electricity has had little impact on incentivising the development of new projects because: — the CCL exemption for renewables does not provide a significant financial incentive to develop new projects, and the key mechanism for this is the Renewables Obligation (RO), which provides about ten times the level of support; and — uncertainty around the longevity of the CCL and exemptions has resulted in its financial benefits not being fully integrated into investment decisions. 10.2 However, the Levy exemption mechanism has influenced the behaviour of final consumers. There is a strong and growing demand for levy exempted certificates (LEC) due to the financial benefits of the exemption and the corporate driver to be a responsible organisation. It has provided an incentive for business customers to contract for renewable and good quality fossil CHP electricity. However new certification mechanisms, for example Renewable Energy Guarantee of Origin certificates and CHP Guarantee of Origin certificates, mean that demand for energy with particular environmental characteristics could be met in future without the need for continuation of the LEC mechanism. 10.3 The RO should remain as the key driver and mechanism for investment in renewables, along with a carbon price signal from the EU ETS via wholesale electricity prices. Government should provide greater certainty around these policies and ensure that long term stable frameworks are implemented to allow financial incentives and benefits of policies to be factored fully into investment decisions. Where possible Government should encourage market mechanisms that incentivise the use of low carbon and or renewable energy, rather than potentially duplicative policies favouring specific technologies. September 2007 Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 60 Environmental Audit Committee: Evidence

Memorandum submitted by The Combined Heat & Power Association

Background to the Combined Heat &Power Association

1. The Combined Heat & Power Association (CHPA) works to promote the wider use of Combined Heat and Power (CHP) and community heating. The Association is the UK’s leading advocate for high eYciency CHP technology. 2. The CHPA has an active role in COGEN Europe to secure eVective European wide policies for CHP.

3. The CHPA has well over 60 members and represents a significant proportion of the total CHP capacity within the UK. Our members are made up of CHP developers (small and community scale, large scale industrial and utility companies), end users, suppliers, public sector bodies and professional services providers. In nearly all cases fiscal regulatory incentives, and in particular CCL, play a vital role in the economic viability of CHP. The CHPA hopes that the comments and suggestions made in the course of this response help the Committee in their research and informs future Policy in this area.

Summary of Memorandum

4. CHP or cogeneration, presents an important opportunity to realise carbon dioxide savings in a range of commercial and industrial applications. These savings are archived through the generation of heat and power on-site, or local to the power use, providing the opportunity to utilise the heat that would otherwise be wasted, whilst also avoiding significant transmission and distribution losses.

5. The Climate Change Levy (CCL) has been a significant and important incentive for the operation of CHP plant through the Levy Exemption Certificates (LEC) scheme.

6. It has had a mixed impact in encouraging the wide-scale development of new CHP plant, with the real value of the CCL often proving insuYcient to ensure the long-term commercial viability of new CHP investments in the UK’s liberal energy markets. The value of CCL does not reflect changing energy costs, In particular the diVerential between fossil fuel and electricity prices, on which the commercial viability of CHP depends. The recent introduction of indexation to RPI is a help, however RPI does not reflect relative movements in fuel and power prices that impact directly on the viability of CHP plant.

7. It has had the greatest impact in encouraging some very large industrial projects that benefit from economies of scale and positive project circumstances and in the commercial sector, which faces higher prevailing market prices for energy.

8. Climate Change Agreements (CCAs) have had a negligible impact on CHP development since installation and in some sectors did not contribute towards the meeting of sectoral targets. Likewise the requirement placed upon sectors to develop CHP where it is “cost eVective” led to varying definitions as to what “cost eVective” meant at a time when, after the introduction of NETA, CHP economics were diYcult. Additionally, where CHP plants have been installed, unrecognised potential may still exist where higher power to heat ratios are possible in addition to greater primary energy savings. CCAs have also worked to compromise benefits to CHP from CCL exemptions in providing an 80% discount on CCL liabilities for business.

9. Enhanced Capital Allowances (ECAs) have had very limited impact owing to the restrictions placed on accessing the benefit. Notably CHP plant developed and owned by utilities for the benefit of their customers are not eligible to receive ECAs. Furthermore the benefit of ECAs can only be realised in circumstances where the company owning the CHP plant is earning a profit and therefore eligible for relief from corporation tax.

10. With regards to the development of new CHP capacity, the lack of certainty over the future availability (from April 2013) and the accessible value of the CCL benefit means that in today’s market the CCL is failing to act as a meaningful driver to the CHP developer. A CHP project today is likely to receive, at best, four years of cashflow benefit from CCL; a larger project somewhat less.

11. The lack of future certainty over the CCL will also limit the scope for continued operation of the existing CHP fleet, much of which will require significant mid-life investment over the next five years. Without CCL benefit, or a benefit of enhanced value, this fleet may be decommissioned or become a dedicated, flexible power-only plant that will be able to access higher revenues from mid-merit or peak- power markets. Running in a flexible power-only mode will compensate an operator for the loss of CCL revenues but removes the GHG benefits associated with cogeneration. Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 61

12. The loss of benefits associated with Good Quality Combined Heat and Power (GQCHP) are now likely to be further undermined by forthcoming changes to the assessment criteria proposed by the Government’s CHP Quality Assurance (CHPQA) scheme to comply with the EU Cogeneration Directive (2004/8/EC)1.

Response to Specific Questions Raised

Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed? 13. Carbon emissions are increasingly becoming the common currency of climate change policy. However each policy instrument should focus on the practical changes that a consumer can make to improving energy eYciency or reduce direct emissions. Customers cannot directly influence the carbon intensity of grid electricity generation. 14. It is of central importance that future reforms or extensions to, or replacement of, CCL is done in a way that guarantees that there is continuity in regulatory incentives, those have played a key role in building CHP capacity to date. 15. Adoption of carbon as the metric would help to bring greater transparency to this instrument but will highlight the fact that carbon emissions from electricity generation are already covered by the EUETS. For participants in the EUETS it would raise questions about double counting of their own non-electricity emissions.

With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument that enforced absolute caps in energy use (or CO2 emissions)? 16. The merit of absolute caps is highly dependent upon the ability of businesses to respond to this incentive. 17. Caps imply a tradable certificate-based system that aVords businesses covered by a scheme, the flexibility to purchase allowances to meet their capped limit. Many businesses may not have the ability or inclination to actively trade in such a market, thereby restricting liquidity and any inherent benefit of the cap-and-trade model. 18. However, should the proposed Carbon Reduction Commitment be extended to cover sites currently under CCAs, this could be a possibility. Care must be taken to ensure that onsite generation, in particular, CHP is not disincentivised. The risks of disincentives can be presented by a range of circumstances, for instance allocation of free allowances for conventional “merchant” power generation or inappropriate assumptions over the carbon emissions associated with the output from CHP plant that does not qualify as CHP electricity. 19. As a rule, the calculation of emissions generated on site should be based on the fuel inputs (as with ETS) rather than as currently proposed in the CRC consultation.

How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? 20. As an energy levy, the CCL operates in a fundamentally diVerent manner to the EUETS: — With CCL, the levy rate or “price” is fixed, leaving the level of compliance to reach its equilibrium level, whereas. — With EUETS, an attempt is made to fix the extent of abatement, leaving the cost of compliance, in the form of an allowance price, to reach its own level. 21. This diVerence in operation between the mechanisms means that they have the potential to operate in a complementary manner, each addressing the limitations of the alternative. 22. By way of illustration, a carbon tax variant of the CCL could establish a floor in the market price for carbon, whilst allowing the price of carbon to float above this level. This approach would provide business with the certainty of a minimum avoided cost for carbon abatement measures, which is lacking from the current matrix of incentives for capital-intensive abatement options such as CHP.

1 As at the date of submission, the CHPQA scheme has proposed new qualifying criteria, although these remain to be ratified. The proposed criteria will apply to existing CHP schemes from the end of 2010-Jan 2011and already apply to new schemes from Jan. 2007. In addition to meeting the existing conditions embodied in the CHPQA scheme, plant will now be required to simultaneously meet 70% energy eYciency and minimum Primary Energy Saving conditions (as set out in the Cogeneration Directive 2004/8/EC). Further information regarding the changes to CHPQA to accommodate the EU Cogeneration Directive http://www.chpqa.com/html/presentations/CHPA members brief 13-sept07-r1 18Sep.pdf Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 62 Environmental Audit Committee: Evidence

23. The need to fill gaps in the coverage of existing and proposed policy instruments remains prominent. Under a recently proposed policy instrument, sites that do not come under EUETS and have less than 25% of their energy emissions covered by CCAs, in addition to having a yearly half hourly metered electricity consumption of more than 6000MWh, will be subject to the Carbon Reduction Commitment scheme to commence in 2010. Until this is introduced, there will continue to be many sites which are not in EUETS and yet have a majority of their energy emissions not covered by a CCA.

What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy?

Impact of CCL and Related Incentives on CHP 24. The Association is concerned that CHP as a relatively low-cost, high impact carbon abatement technology has not been strongly incentivised by the CCAs. 25. The following table illustrates the uptake of CHP in the CCA sectors since the introduction of the Agreements. In interpreting the data, it should be recognised that a major CHP project will typically be operationally commissioned some two to five years from project inception. Thus any impact arising from a CCA would normally only be attributable to plant entering into operation from 2004–05 onwards. 26. The data demonstrate that there has only been a small increase in CHP capacity that may be linked to the CCA framework. In 2002 industrial CHP electrical capacity stood at 4,089 MWe across 292 sites, whilst total CHP electrical capacity stood at 4,595 MWe on 1,509 sites2. Recognising the constraints of project lead times described and so disregarding the period 2002–04, the 183 MWe of capacity added in the period 2005–07 represents an increase of less than 5% in industrial CHP capacity over the 2002 figure.

Table 1

NEW ADDITIONS OF CHP CAPACITY IN SECTORS IMPACTED By CCAS

CHPQASector GQCHP Capacity (QPC), in MWe Year of entry into operation 2002 2003 2004 2005 2006 2007 Chemical industry 40.2 53.1 0.6 Commerce 0.1 0.4 0.2 1.7 Electrical and instrument engineering 0.6 Extraction, mining and agglomeration 22.4 Food, beverages and tobacco 5.5 31.4 5.2 14.5 Horticulture 11.9 3.9 Manufacturing and Retail Mechanical engineering and metal products Mineral products (eg glass, cement, bricks) Non ferrous metals 2.9 1.4 Oil refineries 740.0 58.0 Other 4.1 3.2 Other industrial branches 1.3 Paper, publishing and printing 1.4 175.6 10.7 Power generation 22.0 Textiles, clothing and footwear Timber 2.7 3.6 Transport Vehicles 3.0 0.4 2.0 Total GQCHP Capacity (MWe) 22.9 244.4 773.8 118.3 4.8 59.6 Total number of schemes 9 9 6 5 4 13 Source: CHPQA, 2007 27. The principal incentive for CHP presented by the CCL is through an exemption from the Levy for both the input fuel and that proportion of the power produced that is deemed as “Qualifying Power Output”. Qualifying Power Output is determined under the Government-sponsored CHP Quality Assurance (CHPQA) framework that identifies those CHP plant that meet minimum standards for energy eYciency and primary energy savings. 28. Initially this benefit was restricted to the power consumed on-site, thus limiting its impact and so encouraging the development of sub-scale CHP plant matched only to the power demand of a site. In many applications the heat load of a site provides the opportunity for the development of a significantly larger CHP plant, however this situation would necessitate the export from the site of any power that is surplus to the site’s requirements. In many cases, without the value derived from the CCL exemption, this scale and configuration of plant would not prove commercially viable.

2 DUKES 2007: http://stats.berr.gov.uk/energystats/dukes07 c6.pdf Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 63

29. The value of the incentive has been further eroded by the 80% discount from the Levy that is aVorded to qualifying sites under CCAs. In this situation the incentive for CHP presented by the Levy is only 20% of that for sites outside of an Agreement. In these circumstances a site in a CCA does have the facility to export the power from its CHP plant in order to realise a greater proportion of the CCL benefit, replacing the exported power with conventional grid supply. However this arrangement introduces further complexity and contractual cost. 30. In any situation the benefit of the CCL exemption for exported power is subject to leakage of value through the supply chain that is needed to take the power from the CHP plant to the final consumer. Parties along the supply chain, including the final consumer, will seek to access some of the additional value created by the CCL exemption. The extent of this leakage will relate to the transaction costs, the volumes of power involved and the relative market position of the counterparties involved. In general terms the smaller a CHP plant, the greater the impact of this leakage. 31. The residual value of the CCL exemption to a CHP project will vary on a site-by-site basis. The theoretical maximum incentive available would be £4.41 per MWh of electricity produced. Small-scale CHP plant on a site within a CCA may see this incentive reduced to approximately £0.80 per MWh once the eVect of the 80% CCA discount and a sharing of the benefit with the customer are taken into account. If the plant is required to export power to realise this benefit, then the value could be reduced further. Larger plant will tend to fare better, and such plant owned by a utility may expect to realise approximately £3.57 per MWh.

Future Risks for CHP Presented by the CCL 32. Looking forward, there is no guarantee from the Government over whether the CCL will be retained beyond 2013, or what the level of taxation will be. This situation presents major uncertainties for CHP plant, for which the benefits aVorded by the CCL represent a significant contribution to the revenues of any investment. Any investment case will only recognise the revenues from CCL exemption until the 2013 date, thus limiting the value of that investment. The lack of clarity over the future of the CCL will have an increasingly deleterious eVect on the expansion of new CHP capacity and scope for refurbishing and retaining existing capacity.

Wider Competitiveness EVects for UK Business 33. Incentives for CHP vary markedly between European Member States, bringing significant impacts for the competitiveness of those sectors exploiting CHP. Strong incentives in Belgium, for instance, are resulting in new investment in the energy infrastructure, and specifically CHP. The recent Cabinet announcement by the German Federal Government, augmenting existing feed-in tariV arrangements with additional investment incentives is expected to lead to a wave of investment in lower-cost and low-carbon energy supply infrastructure that will help support the competitive position of the industrial sites that benefit from this investment. [Reference Cabinet position]. Relatively weak levels of incentive for CHP in the UK, allied to the uncertainty over the continuing availability of the benefit will therefore tend to undermine the long-term competitive position of the UK industrial sector, as competing Member States’ industries benefit from policies that support investment in CHP capacity and related energy infrastructure.

Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent? 34. The incentivisation of CHP must be harmonised across the various sectoral Climate Change Agreements to include the installation of CHP in meeting the sectoral energy saving targets. Likewise sectoral targets should be made more stringent. 35. The entire pattern of incentives for the non-EUETS sector should be simplified, in order to provide clarity for the sectors aVected, for businesses providing low-carbon goods and services, and for Government to better understand the impact of these incentives.

What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? 36. The CHPA can only comment in respect of CHP. 37. CHPisa highercapitalcostinvestmenttomeetenergyneedscomparedtosimpleboilerplantandtaking grid electricity. Therefore this will require a player to make significant capital outlay or enter into a long-term “Energy Service” type contract. These represent a liability to both business and the developer. Business needs some measure of certainty over long-term costs and benefits to enter into such commitments. 38. By contrast the policy derived incentives for investments are short-term and uncertain in nature, as described previously: — EUETS needs a stable framework and long term targets to provide firm value beyond Spring 2013. — CCL exemption on electricity exports is due to expire in Spring 2013. Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 64 Environmental Audit Committee: Evidence

— Qualifying conditions for new Good Quality CHP developments are now much more stringent under revisions to the CHPQA schemeimposed bytransposition of theEU CogenerationDirective. For existing schemes the revisions will come into force from the beginning of 2011 and will result in a considerable, and as-yet undefined, reduction to CCL exemption benefits. 39. Consequently the conditions for expansion of CHP capacity are not favourable under the pattern of incentives and prevailing market conditions within the UK. Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments? 40. The ECAs scheme is potentially a major driver for the expansion of CHP. 41. However, its impact is only limited since access to the ECA scheme is subject to a range of restrictions. These restrictions prevent a number of potential developers of major CHP schemes from accessing the benefit and so reduce the value and viability schemes and prevent them from being taken forward. 42. Limitations include: — A requirement that the investor/developer is the end-user beneficiary of the scheme. — Access to taxable group profits, in order to realise the benefits of the accelerated capital allowance. 43. These restrictions limit the eligibility for, or benefit from, ECAs for many CHP developers. This includes utility developers who could be a major driving force in the development of UK CHP capacity. The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how? 44. The CCLis a relatively minor component of the value of a renewable energy project, with the exception of energy-from-waste schemes which are ineligible for support under the Renewables Obligation (RO). For those schemes that are eligible, the economic driver presented by the RO is approximately a greater order of magnitude and therefore has tended to eclipse that presented by CCL. 45. Furthermore, for renewable electricity schemes using mature technology that are eligible for the RO, the constraints on expansion of capacity are primarily grid access and planning. For emerging technologies, the lack of suYcient value over the long-term to drive early-stage investment in technology development and deployment is also a constraint. 46. Lookingforward,itis possiblethatthisandfutureGovernmentsmayseekto reducetherelativebenefits aVorded to the certain technologies under the RO. In the recent Department for Business, Enterprise and Regulatory Reform: Consultation response for the Reform of the Renewables Obligation, the Government has proposed that future landfill gas developments and co-firing should be liable to receive only 0.25 ROCs/ MWh of qualifying renewable generation. In these circumstances the benefits aVorded through CCL exemption are more significant. 8 October 2007

Witnesses: Mr Ravi Baga, Director, Environment and Market Regulation, EDF Energy plc and Mr Graham Meeks, Director, Combined Heat & Power Association, gave evidence.

Q104 Chairman: Good morning, and welcome. Q105 Chairman: How much does the Climate Thank you for coming. Can we begin on a general Change Levy help in all of this? point really about how you think we are doing in Mr Meeks: It is often quite diYcult to tease out the terms of renewables, in particular CHP, and how impact of one particular factor or incentive. Any they are getting on contributing towards the targets investment in the power sector at the moment is which the Government has given to you? going to be aVected by the underlying market Mr Meeks: I think slowly would best be the way to conditions, the cost of the fuels, the cost of the describe that. As the Committee are probably aware power, the competitiveness of other options and also we have a target to reach of 10Gw of combined heat the other calls on capital the companies that are able and power capacity by 2010; we are presently to invest could direct their investment towards. It 1 standing at about 52. Interestingly Defra published has to be looked at in that context. The Climate on Friday last week a study which suggested there Change Levy itself is probably only having a modest was cost-eVective potential to add not just another impact. It is a relatively small amount of value that target, say, 4Gw by 2010 but something around is being added, something as a maximum around 8Gw. The reality is that few in the industry actually £4.40/MWh of electricity generated against the believe that is a target that is going to be achieved wholesale price that is typically between £30–40. under the current set of incentive, and indeed the There is a general sentiment around the industry, incentives combined with the market conditions that and of course it does vary depending upon site and we are looking at today. Perhaps if you asked me for application, that in order to incentivise perhaps the my best estimate it would certainly be no more than sort of levels of investment the Government would an additional 1Gw by the 2010 target date. be looking for we should probably need a level of Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 65

23 October 2007 Mr Ravi Baga and Mr Graham Meeks incentive of something around £6–7/MWh. The the question: if the Climate Change Agreements are CCL provides at most £4.40, but in practice that in place, what is the incentive to comply with one value is eroded through a number of other unless you are receiving the benefit of an exemption? considerations—not least the discount of 80% that is We are reading between the lines at the moment, and provided to Climate Change Agreement we have written to the Financial Secretary to the participants. There are also other reasons why the Treasury to try and get some clarification over that value eVectively leaks as one tries to sell the power particular point. I would also echo the comments and realise the benefit. To realise the benefit one has that my colleague has made, that this lack of to sell the power to somebody else who is paying the visibility beyond 2012 is comprehensively Climate Change Levy, thus realising the exemption. undermining the value of the incentive as it presently Passing any commodity through a series of hands to stands today. reach the end customer means that people take a margin on the way through, and so we see an erosion of the value to the person who is actually making the Q107 Joan Walley: In terms of trying to get that investment as we go through the supply chain. The clarification what would your preferred practical eVect is very limited. arrangement be? Mr Baga: If we just evaluate the impact on Mr Meeks: Very much in the short to medium investment in renewables then the buy-out price for term—given that the CCL is there, it is on the table meeting the renewable obligation is £34.30 for the and it is something that people know and current year. The value of a renewable obligations understand—we would look to see a very clear certificate for the last year was £49.28 because there statement from the Chancellor that the Levy would was a shortfall of about 2.1% against the dollar.1 The stay in place over that timeframe. I would not say it way the monies get recycled means that the value of is necessarily the ideal outcome, but in terms of what renewable electricity was worth an additional could be delivered over this very short timeframe £49.28/MWh. In terms of delivery against a target of through to the Budget next year and given that we 6.7% the actual performance in the electricity sector are at a period now where people are considering was about 4.6%. If you compare the value of ROC investments, or considering new plants which would at £49.28 against the levy of £4.35, for which only become operational shortly before 2012, we are suppliers can get an 80% discount the pull from the looking for something that is deliverable in the very customer is only worth £3, therefore it is an order of near-term. magnitude less than the primary support mechanism for investing in renewables. So in that sense the Climate Change Levy is not a primary driver. In Q108 Colin Challen: I am now getting the impression addition, when we are factoring in decisions on that CCL has done very little to encourage new renewables we will often question the longevity of investment in renewables and combined heat and the CCL mechanism, and very often the value of that power, but it has encouraged take-up of existing is discounted because it is by no means certain that sources in that regard. Is that correct? Is there no we will see the value of the CCL throughout the life new investment flowing from this at all; or is it now of the project. Looking at renewables investments it something that seems very useful? is not really a great driver, and some of the prime Mr Baga: The CCAs and CCL I would describe as a obstacles that we have got on renewables are more “good start”. They were one of the first climate related to planning and cost. That is all part of what change policy instruments designed to incentivise we are here to discuss. energy eYciency. However, I think the diYculty is that they do not recognise the ultimate objective, Q106 Chairman: We are familiar with those kinds of which is a cap on CO2 emissions. So as currently diYculties certainly. Does the fact they announced structured you have a projected baseline and the two weeks ago that the regime for both the Levy and value you get is the reductions you achieve against Agreements extends to 2017 have any aVect on what that baseline without any consideration of what the you have said at all? absolute constraint is that you need to work within. Mr Baga: Partly, yes, but again because the value is In our view, it is an opportunity now to realign this so low compared to the primary driver then even at instrument so that we can meet the ultimate 2017 you are only looking at about six years of an objective of an absolute cap on CO2 emissions. In operational life and that is if you are deciding to our response we outline that we think the carbon build one today. It would not be a significant factor reduction commitment, or the CRC, which is due to in investing in renewables. come on-line in 2011, would provide an eVective Mr Meeks: If I might just add to that, Chairman. instrument, even though we recognise that you There was a statement in the PBR about the would be paying for carbon twice—first, protecting extension to 2017; it still seems somewhat the price of your energy, certainly on electricity ambiguous as to whether the Climate Change Levy [through the EU ETS], and, second, through the is itself extended to 2017. There was a statement on mechanism in the CRC. We recognise that it is the Climate Change Agreements and one would ask necessary to drive behavioural changes to achieve energy eYciency, because as it currently stands we 1 Note by Witness: For the last year the value of the do not think the pricing is strong enough. In the last Renewable Obligation Certificate was £49.28 as there was a shortfall of about 2.1% against the target, not the dollar as two or three years we have seen energy prices rise indicated during the evidence session. significantly, and that has had some impact on Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 66 Environmental Audit Committee: Evidence

23 October 2007 Mr Ravi Baga and Mr Graham Meeks energy consumption, but on its own the CCL is not on the Levy under the Climate Change Agreements costly enough to really drive energy eYciency largely cancels out the incentive of the Levy changes. exemption for renewables and CHP. How big do Mr Meeks: If I might just add a comment in direct you think this eVect has been? response to Mr Challen’s question. You can Mr Meeks: I think it has been hugely significant. probably look at the impact of a CCL and say, You go from £4.30 to 0.2% of that, so 80p if you like “What would have happened if it hadn’t been becomes the value of that incentive. As I said, in the there?” The answer is that we probably would have Government’s own modelling they have seen the seen even less investments in CHP. It has probably impact of that discount and, therefore, largely helped to incentivise those projects which were discounted the impact of the Climate Change Levy. closest to becoming economic without it, but it has Mr Baga: It really comes back to one of the reasons not had a huge impact; so one has to look at what why we are proposing some fundamental reform. If would happen if it was not there. We would see you take CHP as an example, CHP has two marginally less investment. The other danger that we products, one is electricity and one is heat. Whereas would have seen would be a plant which is already V the point on NETA is to do with electricity sales, operating actually switching o , or becoming there is no real mechanism for recognising the something diVerent; ceasing to become a combined carbon intensity of the heat that comes from the heat and power plant; changing to operate as a CHP. The risk is that if we continue to promote power-only plant; but changing how it operated so instruments which have confused objectives then that it could chase the higher power prices that are these are the sorts of results we will get. Therefore, available during peak times of the day. Of course that works commercially; but it does not deliver the we believe it is an opportunity to refocus the environmental benefits that one would imagine the instrument entirely on carbon emissions and not on Government is seeking. There is also some evidence energy use. As a company we have made a from the report which Defra published on Friday commitment to help reduce our customers’ CO2 which I referred to earlier. Even in that modelling it intensity by 15%. Therefore, having an instrument suggests that the impact of the Climate Change Levy which brings CO2 into the boardroom, such as the on their future projects is a maximum of 10% over CRC is hoping to achieve, then that would be very their baseline projections. Even with the CCL in helpful in focussing attention on carbon emissions. place it would only increase the amount of CHP that The way it would work in practice is that potentially we would see by 10%, and I think that is because of you could set the CCL rate for electricity to zero, a number of failings in the system; perhaps the fact because people are paying for the carbon in the that it is not reflecting some of the underlying electricity price that they are paying; and until such objectives and value that we should be looking to time as we have an inclusion of gas in an equivalent realise. trading scheme, or have the carbon emissions associated with heating and gas accounted for, then the CCL could provide that price signal to equalise Q109 Colin Challen: Just looking back to one of this Committee’s inquiries a few years ago, we had heard the carbon costs of heating and allow carbon-free about the impact of NETA on CHP and how that technologies or low carbon intensity technologies to had been quite a bad thing for the development of compete on a level playing field. CHP. Has the Climate Change Levy in any way counterbalanced those impacts in the past? Mr Meeks: It has gone some way to address that, but Q111 Dr Turner: Another unfortunate thing is that, certainly a CHP plant has faced increased risks by definition, the industries covered by the Climate operating under the new electricity trading Change Agreements are precisely those that use the arrangements. The arrangements themselves look to most energy. What would you like to see done to reward flexibility and predictability and a plant increase demand by these companies for electricity which is able to respond to those signals. CHP plant from renewables and CHP? will typically operate as what we call a base load; Mr Baga: I think the ultimate objective is a running for the maximum amount of time; it will be reduction of carbon emissions. Therefore, having designed to work with its heat load, be it in an urban agreements which do not place caps on carbon environment or be it in an industrial environment; emissions is unhelpful. I think EDF Energy supports and in doing that it tends to be producing the low the implementation of the carbon reduction value electricity under these market arrangements. It commitment because it will impose a cap on the is fair to say that in providing some value the CCL carbon emissions from the energy being used by has addressed something of that; but has not been large organisations. Until that happens, or if that suYcient to deal eVectively with the changes of the does happen, then that will provide a much more new electricity arrangements and, of course the robust constraint on carbon, lead to a stronger fundamentals—the fact that gas prices and other carbon signal which will then in return provide a fossil fuel prices have gone up. That is a generic much stronger signal for investment in low carbon problem. technologies or low carbon intensity technologies, both in heating as well as electricity. Our view is that Q110 Dr Turner: You have already referred to the we should have streamlined policy rather than fact that two aspects of the Climate Change Levy overlapping policy which does not really address the have tripped themselves up, in that the 80% discount fundamental issue. Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 67

23 October 2007 Mr Ravi Baga and Mr Graham Meeks

Q112 Mr Caton: Can we look briefly at Enhanced administrative complexity; and every time one Capital Allowances that came in at the same time as creates a new company you have to license it; there the Levy. What part have they played in are a whole plethora of licences and overhead costs encouraging combined heat and power and that would come with that. While you can access the microrenewables? benefit then it will again be devalued by all these Mr Meeks: If I can speak for the combined heat and additional costs that would come with it. In power part of the question. The answer is mixed, and summary, ECAs are not universally applicable and it really does depend upon which the party is that is a simplification of the Enhanced Capital Allowance looking to take the benefit of the Enhanced Capital regime to ensure that any party, irrespective of who Allowances. The Capital Allowance, you owns it and what their primary business is, if they understand, is an accelerated Capital Allowance but were able to access it then I think it would be a far it is available subject to a number of restrictions. The more eVective mechanism in driving forward CHP in first one of that is that eVectively the party that is particular. making the investment does have the tax capacity to actually exploit the benefit. If the business unit or the entity that is making the investment does not have Q113 Mr Caton: You mention the state aid rules, for the tax capacity to actually realise the benefit of the CHP to really benefit would we need to go back to Capital Allowance then it is not able to realise that get those reformed a well? benefit and it can be deferred into subsequent years, Mr Meeks: We would need to go back and revisit but the further one defers it the less the value this with the Commission certainly, correct. becomes. That is one restriction. The second Mr Baga: In our written response to the Committee restriction is really on who the party is, and one of we did not really comment on this primarily because the conditions of the state aid ruling in respect of the we see it as a distraction. Enhanced Capital Enhanced Capital Allowances is what we refer to as Allowances, depending upon how they are the “own-user test”, in that the investment has to be structured, may or may not benefit individual made (I paraphrase) to primarily meet the energy projects. I think the overarching aim is wanting to needs of the site, deliberately therefore tending to deliver a robust carbon price signal which should exclude schemes which may export a significant bring investment forward on its own right rather amount of the power that they generate. At one level than relying on sweeteners provided by the tax then that is a failing to realise the opportunity. The system. benefit of CHP comes because there is a big heat load there and one should really look to maximise the amount of electricity and heat that one can produce simultaneously; that is where you see the most Q114 Chairman: EDF have made a submission carbon savings. There is also a level of suggesting reform of the whole thing. Would you discrimination which gets introduced here, because like to explain to the Committee briefly what you what it has tended to mean is that utilities, who tend think the advantages of that are and the fact that the to be the parties most likely to invest in new power regime may be extended to 2017? generating capacity of any type, have been excluded Mr Baga: The announcement that it was being from accessing Enhanced Capital Allowances. If we extended to 2017 did take us by surprise. look at the pattern of investment in combined heat Fundamentally the question is still: do we think the and power, or the opportunity for investment by the existing mechanism is working and do we want industrial sites, many will not do it because it is a reform? In that sense our position has not changed. very large capital expenditure item. It is not core The primary reason for reform, as I said earlier, is business, and therefore they would look to another that the current mechanism does not provide a cap party to make that investment eVectively on their on CO2 emissions; that is one of the fundamental behalf and then pay for that, finance that, through objectives that needs to be realigned with the rest of the charges that they will pay for their heat and their the climate change policy instruments that are being power. That third party more than likely would be developed. Defra has published a consultation on a a utility, or it could well be a utility. By keeping the policy instrument called Carbon Reduction utilities out of the equation, if you like, through this Commitment. The carbon reduction commitment restriction what we have done is cut oV perhaps one will capture medium and large-sized businesses, and of the most straightforward ways of actually it would place a cap on the CO2 emissions both from realising the opportunity and addressing the their electricity use and from their gas use that is problems of access to capital that the industrial sites used in heat. In essence we think this is a good would themselves have. Utilities have capital which opportunity to, if you like, abandon CCAs and use they would put to work investing in power stations, the caps that will be driven through the carbon not manufacturing paper, or biscuits or whatever reduction commitment to drive energy eYciency else it might be; so that is their core business; that is behaviour. Our proposal is that from milestone five what would be the logical outcome. What we have in 2010 CCAs are not extended. The Climate Change seen is that opportunity has tended to be limited and Levy would continue for gas because we still do not the value has been restricted and cut oV from have a mechanism to price carbon in the utilities. One caveat there: you can work around it; consumption of gas for industry; but the CCL rate there is a scope to work around it but it involves for electricity would be set to zero because setting up further companies and further consumers are paying for the carbon cost of their Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 68 Environmental Audit Committee: Evidence

23 October 2007 Mr Ravi Baga and Mr Graham Meeks electricity by the prices coming from EU ETS. As the electricity and we have a single carbon price looking carbon reduction commitment develops, the initial across both of those, then CHP will compete in its phase of the proposal is that all of the revenue that own right, given the merit of its carbon intensity. would be raised from the sale of allowances in the carbon reduction commitment would be recycled Q115 Chairman: The CHP Association are more back to industry, but in the longer term if that relaxed about having the Levy operating alongside revenue was not recycled and there was a genuine in support of the ETS, is that right? price signal on the emission covered by the Mr Meeks: I think we are more near-term in our organisations involved then that would give an outlook. What we are concerned about, I suppose, is opportunity to set the CCL for gas to zero as well. In a short-term disruption to the pattern of incentives that we see in front of us. I think in the long-term the essence what that would do is force all businesses movement to a transparent, equitable, common and all types of energy to be driven by the same carbon price across the market which is the principle carbon price signal. On the other two points, on that my colleague described is probably the sensible renewables we see the renewables mechanism as way to go, and one which we will invariably move being the primary mechanism to deliver investment towards. The question is: how do we get there? I renewables. There is some reform underway to suppose the concern for my members at the moment V recognise the costs of di erent technologies. We is managing the transition and providing continuity believe that should be concluded as soon as possible in that process. As I say, my focus is perhaps so that investors can get on with the plans that they somewhat more short-term, rather than necessarily currently have in investing in renewables. For CHP “relaxed”, Chairman. I think if we can get the CRC right, so that we have Chairman: Thank you both very much for coming an eVective carbon signal on both heat and in.

Memorandum submitted by John Huddleston and Robert Bell, AEA Energy & Environment

Background AEA is a leading international energy and environmental consultancy (750 people) specialising in policy support and programme management for policy implementation. AEA have been involved in all aspects of UK sustainable energy policy since the 1970s. In the 1980s and 1990s, we ran the Government’s industrial energy eYciency programmes and have supported the Carbon Trust since its formation in 2000. We are also a major consultant to the European Commission and other international agencies. Information provided by AEA was used by Lord Marshall to form his recommendations in the report into “Economic Instruments and the Business Use of Energy” in 1998, which in part led to the Climate Change Levy and Agreement. We have been in contract with Defra since 1999 to provide technical support and auditing services for Climate Change Agreements (CCAs). AEA has provided extensive support to formulate both the structure and continuing operation of the agreements, including: — development of the details of the agreement framework; — negotiation of both individual organisation and sector targets; — target period assessments and analysis; and — auditing of sector associations and individual facilities to ensure accurate reporting. We oVer the following observations on the agreements.

Summary These were groundbreaking agreements. We believe they have achieved major savings of carbon dioxide emissions but, very importantly, they have improved industry’s knowledge of, and attitude to, the energy implications of its processes and its potential to save emissions. CCAs are reaching the end of their period of operation; a follow-on instrument can be designed to build on the strengths of the current agreements to continue the savings through the next decade.

Observations on CCA Design and Targets The following points aVected the design of the Agreements in 2000. These are given only to describe the context at the time. Agreements designed now would be diVerent to meet the current context, partly because of the experience gained and partly because of changed circumstances. We comment on this later in the submission. The current agreements have a ten year span and can be changed only by negotiation. Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 69

1. In 1999, the political and environmental climate was considerably diVerent. There was a driver for energy eYciency, but not for absolute carbon savings. The world has changed. 2. The agreements were a novel instrument in the UK and there was considerable pressure to develop a package that industry would sign up to quickly and so get a process of improvement underway. Many companies and sectors had diYculty accepting that energy savings were available with investments that would be beneficial to their bottom lines. Boardrooms were not well informed about this potential, and/or did not give such investments high priority. For instance: — Some sectors argued that all possible technological advances had been achieved in their field. Despite the fact that history suggested that breakthroughs, then unknown, would continue to occur, they found it diYcult to sign up to targets that they regarded as a leap into the unknown. Unless they could see exactly how savings would be made over the 10 years, they did not want to commit. — Some sectors found the basic concept of diVerentiating between “Cost EVective” savings, and “All Technically Possible” savings diYcult to accept. Whereas the Agreement sought to capture only the former, some sectors believed they were being asked to sign up to the latter as well. There is now much better understanding of the approach and terminology. Several risk management measures were therefore included specifically to overcome industry’s reservations, but these added to the complexity of the agreements. 3. There was no pilot phase, and there were few useful precedents. There is now considerable experience of working to energy eYciency / emissions reduction targets. We believe this has benefited CCA participants in entering the EU Emissions Trading Scheme, through reduced set up costs, enhancing British businesses ability to compete within the EU. 4. The advent of emissions trading (both the UK and EU) has increased the complexity of CCAs. 5. Establishing a transparent definition of energy intensive industry proved diYcult. The initial use of the IPPC directive to define eligibility was expedient and necessary, but produced many anomalies. The later additional definition based on the EU Energy Services Directive is an improvement. 6. Sectors had considerable concerns about the supply of commercially sensitive information to Government and the agreements were structured to accommodate these concerns. This causes problems for the analysis of the results. Since then, the Freedom of Information Act has been implemented and precedents are available, eg the EU Emissions Trading Scheme, which should make this less of an issue in future and hence allow better analysis. 7. The agreements are mainly developed on a “bottom-up” process where individual target proposals are combined into a sector target. This allows for more appropriate targets to suit individual circumstances, provided the sector target is judged demanding. This gives greater ownership of the targets by the organisations, as they are not simply imposed. However, short of a very extensive and expensive programme of industry research, the only people theoretically who really know what can be achieved are the organisations themselves. Studies such as the “GAD reports”3 and work under the Energy EYciency Best Practice programme4 were agreed to provide the best available data, but naturally had gaps in some areas. However, in 2000–01, many companies themselves did not have any idea of what they could reasonably achieve and so considered the targets suggested by AEA as crippling. Experience has shown the AEA view to be largely correct, but negotiated deals had to be achieved. Industry’s knowledge is now much better.

Outline of Ongoing CCA Structure Here we give AEA’s views of the basic outline of future agreements. Clearly there would need to be additional work to develop these basic principles. These points generally respond to question 6 of the committee’s list of specific subjects. 1. The truly energy intensive industries should continue to have the opportunity to claim a reduction in their CCL and a development of the current CCAs is the most eVective vehicle to achieve this. 2. The psychology of CCAs (in that targets must be met to claim a tax reduction), the method of target setting, and the method of operation, all stimulate board level interest and empower energy managers. Furthermore, organisations have not responded to CCAs in the rational manner predicted by economic theory. For example, in some sectors, organisations willingly share overperformance with underperformers to achieve a positive sector result. Companies in general seem to have achieved targets in their own right rather than extensively purchasing carbon allowances which would be more cost eVective. For both of these reasons, CCAs have a constructive function alongside trading systems.

3 For example—Industrial Sector Carbon Dioxide Emissions: Projections and Indicators for the UK, 1990–2020. ETSU (now AEA Energy and Environment) Reference EPSC20616001/Z/1—April 1999 4 Now the “Save Energy” aspects of the Carbon Trust Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 70 Environmental Audit Committee: Evidence

3. Targets should be absolute carbon dioxide in order to give certainty of results. It would also emphasise the value of carbon dioxide emissions in business decisions. To be consistent, the value of the levy should be based on the carbon emissions associated with the fuel. 4. There needs to be clear separation between EUETS, CCAs and the Carbon Reduction Commitment (CRC). Overlap between CCAs and CRC has been minimised by the proposed design of the CRC. Overlap between CCAs and EUETS should be eliminated by having an indirect emissions CCA for EUETS incumbents, ie they should have CCA targets for reducing electricity usage. We believe the price signal associated with the pass through of carbon costs by electricity suppliers is insuYcient to stimulate specific actions. 5. The eligibility criteria should be changed. For some IPPC sectors, the value of the energy used is small in comparison to the administrative resources required. IPPC should be reconsidered and replaced by a simplified version of the more recent CCA criterion based on 3% energy costs, but without the import penetration criterion. This would be in line with the EU’s directive on the taxation of energy products and electricity. The import constraint should be dropped to maximise the number of organisations eligible. A transition to full levy would have to be agreed for those sectors no longer eligible. 6. Targets should be negotiated on a “bottom up” methodology. This builds on the strengths of CCAs that give a more customised approach to target setting. This engenders greater ownership of targets within the organisation, as the means of achievement is real and pertinent to the managers concerned. In the current agreements, some sector targets were set “top-down” due to the lack of data on individual organisations. After over six years of CCAs, all eligible facilities should have adequate records and an understanding of their savings potential, without needing to resort to “top down” targets. 7. The current timings of biennial milestones and four yearly target reviews should be maintained. This gives reasonable certainty for business and a continued incentive, with a timescale to allow sensible planning and with the scope to adjust targets with time. 8. Involving the sector associations has generally been beneficial in the negotiations and operation of the agreements. Good sector associations can provide advice, training and can spread best practice. Some sector associations provide an excellent service—a means of improving the less eVective sector associations needs to be put in place. 9. As stated above, several risk management options were introduced in the current agreements, though some have now expired. Providing a risk management option is important for business confidence. However, the only risk management measure now needed is a link to a trading system. 10. The level of the CCL should be increased to bring it back to its level compared to energy costs as it was in 2001, or higher in order to be cost neutral to Treasury. 4 October 2007

Witnesses: Mr Robert Bell, Managing Director and Mr John Huddleston, Principal Consultant, AEA Energy and Environment, gave evidence.

Q116 Chairman: Good morning and welcome to this was new to industry, there was a lot of concern you; you have obviously heard the earlier exchanges. on industry’s part that this would take them out of Would you like to start by talking us through your business, so there were all sorts of risk management proposals for reforming the Climate Change Levy processes, built into the system, which were required and the Agreements? then and, in a nutshell, we do not now believe that Mr Bell: Yes, if I could just make an introductory those would be necessary if we were starting from remark to that and then John could take us through here because industry is so much more advanced in the five or so points. Could I just begin by saying that its thinking. That really is the overarching point in as a contractor to Defra we have worked ever since our submission, so we can go through the four or 19892 very closely with Defra on these agreements— five points. their formulation and subsequent work—so I should Mr Huddleston: First of all, we do feel that the just make it clear that these are our views and not agreements should now become absolute carbon Defra’s views in case there is any confusion. dioxide agreements; indeed, the current agreements can adopt that, there is one sector at least that has absolute CO targets so the scope is within the Q117 Chairman: Sure. 2 Mr Bell: As you will have seen from our evidence, at complexity of the current agreements to do that, but the time of the agreements we were very involved in we feel that within the current climate, the current not only advising on the targets but also the detailed need for absolute caps, it is sensible to focus on the construction of the agreements, and they became carbon emissions. It is possible to maintain Y indeed very, very complex. The reason for that was agreements which stimulate energy e ciency, but we feel that the time is right for carbon agreements and 2 Note by Witness: The contractor has worked with Defra we feel that it is important that agreements cover since 1999, not 1989 as indicated during the evidence session. energy intensive sectors. The criterion that was used Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 71

23 October 2007 Mr Robert Bell and Mr John Huddleston at the start was not ideal and we believe that a 3% The evidence is that for more recent milestones, the threshold in line with the European directive is more quality of data is much better, and there is other appropriate and would allow more people, more evidence for that in that we know that those who sectors, into agreements and that would be a good joined EU ETS—I have been told that the quality of thing to widen the scope. As Robert indicated, we the data for EU ETS for people who were in CCAs think that some of the devices that were put into is much better than for those who have come into bringing industry on board in 2000 or so are no EU ETS without being in CCAs, so there are longer necessary, people understand it, so we would encouraging signs to be seen about the audits. With suggest that there are no risk management measures respect to can we be confident that companies are other than trading, with the possible exception of doing what they are doing, generally speaking that is something along the lines of disruption of supply or true, they are improving their performance and they new regulatory constraints. It is important that there are delivering according to their requirements. There is a clear separation of scope between EU ETS, will be some who are not and there are others who between climate change agreements and the carbon are over-delivering. reduction commitment, and certainly that has been designed into the CRC and it is something that we Q119 Chairman: The National Audit OYce report should look at as we look at how CCAs will develop. said that in 2004 6% of target units claimed their levy When we started this process many sectors did not discount even though they did not meet their targets, really have a clue what their energy performances and they were able to do that because the sector they were like, they did not have good baseline data and were in passed its sectoral target. One of our so it was necessary to set the targets on a top-down witnesses last week actually disagreed with that; process so that across an industry if a sector be 10% which of those claims is right? by 2010 or whatever, that advantaged some and Mr Huddleston: The agreements were conceived as a disadvantaged others. The time is now right and the fairly collegiate type structure within a sector, so in sectors have many more years now of much better some sectors there can be a situation where the quality data and we feel it is more appropriate that sector passes so members of that sector do not pass there is a bottom-up approach in that a sector’s the agreement but are covered on the overall targets are aggregated from what individual performance of the sector. Other sector associations V members can o er. Sector associations play an that I am aware of advise their members that they important part in this process, both on an should not make any assumptions, they should administrative side and an educational side. There make sure that they are qualified in their own right, are some sector associations in our experience which and therefore everybody in the sector will pass. are excellent at this, there are some which are not so There are possible areas of confusion in that it is good. That is partly because of size, partly because possible for a sector to pass in its own right and then of time, partly because of other resources and we feel there is also a situation where although a sector fails, that there should be more assistance given to the because every member within that sector has traded sector associations in order to transfer the ethos of or whatever they all individually pass, so you get a the agreements to their members and, further, to situation where the sector appears to have failed yet Y help them with their energy e ciency or carbon every member in the sector has passed, so it is a reduction methods. My final point is that I believe, technical pass. as Andrew Warren said, there needs to be a stick and carrot approach and therefore we need to be able to It sounds a pretty relaxed regime if give a good discount oV a meaningful sized levy. Q120 Chairman: you as a company can fail to meet your target but because your chums have done better than their Q118 Chairman: Right. If we move on to auditing, targets then you can get the discount, but in other an area in which you have some experience, we have situations where the whole sector has failed you still heard that just 9% of target units covered by a get the discount. How do you manage to do so badly climate change agreement have actually been and still get the discount? audited to make sure they have achieved the energy Mr Huddleston: Sorry, how do I manage? savings that they are supposed to have made, and Martin Horwood: How can you fail? actually nearly one in five of those audits have been found to have errors in them. Can we be confident Q121 Chairman: What you have described is a that companies that have signed climate change situation where some companies are able to claim a agreements are actually doing what they are discount despite the fact that they have not achieved supposed to do? their own target but their sector has, but then you Mr Huddleston: First of all, it is 9% to date, we are also went on to say that even when a sector fails to continuing the audit programme and that achieve its target, all the companies may still get the percentage will increase with time. The significant discount. results from the audit to my mind are that the base Mr Bell: This was always constructed as a one-way year data are often not very good and where one is gate, partly for administrative simplicity and partly looking at errors in audit, it is because there are as another risk management technique. It was a one- problems in recovering the base year data or it was way gate in the sense that if a sector passed we were not clearly recorded. That harks back to the lack of not asked to look within that at who passed and experience and the lack of understanding of failed, but if a sector failed you could look then and companies of the importance of this data at the time. pass the ones that had passed and fail the ones that Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 72 Environmental Audit Committee: Evidence

23 October 2007 Mr Robert Bell and Mr John Huddleston caused a problem, so that was always very well- agreements came into place while we developed known at the beginning, so it is not necessarily true this—that we realised that they did not actually that everyone will always pass; if a sector fails then think in terms of a “business as usual” trajectory, an some may fail themselves. “all cost-eVective” trajectory and beyond that Chairman: I think this scheme was devised by the technically possible, and there was a lot of same person who devised the A-level system misunderstanding in that they thought we were whereby everybody passes with a double AA. Joan looking for targets which were aimed at all Walley. technically possible, for instance, and that gets across to, perhaps, the education that has to be done initially when a sector engages with CCAs, Q122 Joan Walley: In your opening comments, Mr Huddleston, you said there were some sectors that regardless of whether or not you give them help subsequently. Just bringing sectors up to speed with were perhaps more on the ball with this than others Y or some sectors were performing better than others. the way to think about energy e ciency, refits, I just wondered if you could give the Committee capital investment, low-hanging fruit, behaviour some idea of the sectors that you would rate highly change, that is a common education that we can take in terms of understanding and implementing this sectors through at the beginning. whole agenda and the sectors that perhaps you would not rate so highly, because obviously that has Q124 Joan Walley: I am just wondering where implications for what you just said about pass and anyone gets this awareness or education or fail rates. training from. Mr Huddleston: The sector associations that are very Mr Bell: Sectors can go to other consultancies and good in the management of their CCAs, some pay for help to help them respond to this but that is examples are the Chemical Industries Association, not our remit under the CCAs. the Paper Federation, the Aluminium Federation; Mr Huddleston: There is support on an individual they are examples of sector associations that I know basis that the Carbon Trust oVer. They oVer a survey of that have good control of the CCA process but product specifically aimed at assisting companies to also then go out to their members on a regular basis meet their CCA targets. and assist them and educate them. They are large organisations, they were the original energy- Q125 Jo Swinson: I just have two questions, going intensive sectors; the sectors that are not seeming to back to the figures. We are told by the NAO that 6% oVer such a high level of support to their members of the target units claimed the discount, despite are some of the smaller sectors—the horticultural having failed to meet their targets. How confident sector, the agricultural sectors—where there is in are you in that figure given that you have only some sense a slightly diVerent problem because they audited 9%? Is that 6% of the 9% you have audited actually have a lot more members, a lot of very small are in that circumstance—and that is extrapolated members. It is generally the sectors where there are across the whole field—or is it that that 6% is taken small groups and the sector association itself is from the industry figures and only 9% have been small, and therefore the environmental director or audited? environmental manager within the sector Mr Huddleston: They are separate sources if you association is also the guy that does the CCAs and like. We ourselves do not necessarily know who has is also having to do health and safety as well, so it is passed or not. The rules of the agreements as they pressure on their time as much as anything. were formulated were that if a sector passes then we have to satisfy ourselves that it passes but they are Q123 Joan Walley: Presumably you work with the not obliged to give us individual information about sector associations to assist them with all this, that is the performance of the members of that group. part of your consultancy remit, so what can you do to actually make them understand better that even Q126 Jo Swinson: The other thing was just to pick with their limited capacity they can actually help roll up on Tim’s point of all the diVerent ways that a out this agenda? company can still get its discount, even if it has not Mr Huddleston: We do not have the resources to hit its targets. How common or perhaps how rare is work closely to develop a training schedule or it that a company actually does not get the discount anything like that; our role is more resolving issues and has to pay the full whack? on a day to day basis and assisting them to Mr Huddleston: It is very rare; there were only about understand the process such that they can 25 to 28 companies that got decertified this time, so disseminate it. We have not got involved in recent it is quite a rare event that people do not get the years in assisting them with that dissemination; we discount. did right at the start in 2000 and 2001 but we have Mr Bell: That can be one of the arguments for our not had the resources to do that subsequently. submission that a lot of the risk management Mr Bell: What we did do originally with the sectors techniques could now be removed. There was a great is that there is quite a lot—certainly for the original deal of nervousness at the time about these sectors there is a large education job to be done in the agreements from industry and the targets were very potential for energy eYciency. The whole concept of much a negotiation, they were a deal. The starting “all cost eVective” energy savings was new to some point of our remit was all cost-eVective and, as you sectors. It was actually quite well into the process— know well, on average the agreements were there were two years before the levy and the negotiated at 60% of all cost-eVective. In addition to Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 73

23 October 2007 Mr Robert Bell and Mr John Huddleston that, industry in that negotiation managed to get a Q128 Joan Walley: With the benefit of hindsight, is whole set of risk management measures—tolerance that the way forward, do you think? bands and product mix changes, and John could list Mr Bell: Certainly, we feel very strongly that one of you about half a dozen risk management techniques the big benefits of the climate change agreement is which were all to help them increase the probability that it has forced people to think about concrete of passing. That was right at the time because these actions. You could imagine, I suppose, in many, were ground-breaking agreements, industry did not many years to come that the trading mechanisms— have good data, they were very nervous about the markets were operating so perfectly and the price looking forwards. I remember one sector well, in the of carbon was so realistic that that would be middle of negotiation, eVectively claiming that suYcient, but we are well oV that, we are still in the despite 100 years of technology advance that was all very big transition stage where the carbon price is going to stop in 2001 and nothing new would be not necessarily sensible or predictable and other invented in the next ten years. That sounds a bit ways of getting people to think about hard actions sarcastic but in other words if they could not see is a very, very good complement to a market-based something, they were not prepared to take our word approach. that all through history technology improves and Mr Huddleston: Trading does not necessarily bring something would come up in 2006/2007. They are other benefits which are improving the performance now much better informed and a lot of that could be of the company in way of its operation and looking wiped away, that insurance policy. at its processes, so CCAs have made people think much more about how they can save energy and how they can improve their general profitability because Q127 Joan Walley: Just sticking with this theme there is great pressure on them to do that. really, in your memorandum you state that Mr Bell: It also gives some help to entering into the “organisations have not responded to CCAs in the EU ETS. We have got companies which have talked rational manner predicted by economic theory”. I about one area where they have been in a CCA and hear what you say about this was a groundbreaking one where they have not and the great advantage of way forward at the time, but given that the climate the CCA history of making them think about energy change levy has been designed by economists, could and thinking about their data has made them a you just say why you think it has not delivered what better informed player in the EU ETS because it is it could have done and could you perhaps say what thinking about the realities of life. this means for the market-based approach to reducing carbon emissions that we base things on at Q129 Martin Horwood: The incentives and the moment? information side does not really seem to have Mr Bell: We had been working in the field of energy worked does it, because there is a market in tradable eYciency obviously for many years before the allowances. You seem to be painting a picture of a climate change agreements came along, and it is market that does not really work because people try certainly my firm belief and the belief of expert to hit the targets but they do not really look colleagues like John that, to echo what Andrew rationally at how they might have achieved that by Warren said, the whole game changed with climate tradable allowances; is that fair? change agreements; there was something about the Mr Huddleston: If I could comment on that, the way psychology of getting the tax back that changed. We that people have worked—the agreement set them a had been producing case studies and help for target to be achieved and so in an ideal world, and industry for many years which showed cost-eVective most companies do this, they will set about an savings were there, but it was not taken up. Okay, energy plan, they will measure what they are doing, you can argue many reasons about other calls on they will look at the methods of performing savings capital and so on, but businesses just do not always and see what needs to be done. There will be energy act rationally, they are busy people, they do not do and other eYciency benefits in doing those actions, a spreadsheet every night and decide the best way to people do not do things generally solely from an behave. That was the experience through the energy eYciency point of view, but after a period, Eighties and the Nineties—clearly in the Eighties say after a year, they will look at the results when when industry was up against it this cost-eVective they come to their milestone review period and they saving was there but they did not take it up. The will see how they performed and generally they will whole interest, the power of energy managers and fine tune their pass and fail situation by trading. So the interest of the boards changed during those two the general approach of the energy managers years and that is one bit of evidence that businesses concerned has been to see what they need to do and do not—life is too complicated, they do not always then generally, if they want to do this, the CCAs take the economically rational view. You can also have empowered energy managers. say why did not more trade their way out of the climate change agreements with a low carbon price? Q130 Martin Horwood: Have they really used the It does not work like that in practice when running trading system in practice? the business, so the bottom-up nature of climate Mr Huddleston: Only as a fine tune, that is my point. change agreements where you are forcing people to They do not start out at the start of the two-year think of concrete things they can do and in return period thinking we have got to save this much energy they get the carrot, that cuts across a lot of the at the end, what they will do is they will measure, economic theory. they will undertake actions and they will fine tune. Processed: 03-03-2008 20:26:49 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG2

Ev 74 Environmental Audit Committee: Evidence

23 October 2007 Mr Robert Bell and Mr John Huddleston

Q131 Martin Horwood: Does that mean that the Q136 Martin Horwood: Do you think this is a whole system was a bit loose and perhaps the cost of problem in forward planning for businesses, this these allowances was too low; there was not enough whole area and what looks like the increasing of an incentive there to do your utmost and then complexity of it? trade if you could not? Mr Huddleston: I would hope that the three schemes Mr Huddleston: It has surprised us more recently have very clear boundaries and that people will that more people have not traded their way out by know when they can trade on whichever scheme. I buying allowances when they were so cheap. would not have thought it that much of a problem. Mr Bell: They seem to use it not at the beginning of V the two years to say “What is the most cost-e ective Q137 Martin Horwood: Do you think every thing for my company to do, trade or invest?” they boardroom understands what the boundaries are? use trading just as an insurance policy that they get Mr Bell: I would doubt that but we are really talking out of the drawer at the end if they need it. about this transition in the next few years. At the moment, companies that are covered by both in Q132 Martin Horwood: What I am saying is do you some way still have to deal with that complexity and think that would have been diVerent if the price had there is a complex mechanism for making sure that been higher, there would have been more of an you do not get double rewards for the same carbon incentive? saving. What we are suggesting is that there will V Mr Huddleston: It would have made it worse. continue to be companies that are a ected by both Mr Bell: It would work the other way; if they had to but there is a far simpler way of dealing with that pay more to buy carbon that would be even less double counting than the present one, so it is just a incentive for them to think forward in that way. cleaning up really, it is not solving some Mr Huddleston: If the carbon price had been higher fundamental problem that you are talking about. we would have expected them to do more energy eYciency things. Q138 Mr Caton: In your memo you reminded us that at the outset of these agreements many companies did not accept that they could actually We are rather in this bizarre Q133 Martin Horwood: make significant energy savings, and then when the situation where they relate that they were able to levy came in lo and behold they were actually able trade within the UK ETS but the UK ETS has to deliver. now finished. Mr Bell: Yes. Mr Huddleston: Yes.

Q139 Mr Caton: In our evidence session last week we Q134 Martin Horwood: But CCA participants are had various industrial lobbies arguing that now for still able to trade ETS credits, is that right? How is it energy-intensive industries there is very little going to work? potential for further cuts. Are they right? Mr Huddleston: The direct part of UK ETS is Mr Bell: I do not think so, that sounds a bit of a re- finished. The bank account is still open and the run of the arguments we had with them in the year registry for UK ETS is still open and will remain 2000. For example, there will be some sectors, open certainly until 2010, I assume. It has not been because of the particular process that they have, discussed but for the duration of the current which might almost be running up against a agreement people can still trade on UK ETS. theoretical law of physics reason why they cannot do more, if it is a very narrow technical area, but more Q135 Martin Horwood: You argue in your memo generally, for instance, I mentioned that when we set that there is a clear separation between the EU ETS, out the opening negotiation it was aimed at all cost- CCAs and the carbon reduction commitment. Does eVective carbon. The model that we were running to that mean you are expecting these people to be inform our negotiating position there did not just operating simultaneously in sort of parallel stop at 2010, it ran out to 2020 and, actually, the four universes, or is the logic having these systems joined megatons of saving which the NAO quotes as being up and enabling the people with CCAs to use credits the cost-eVective saving up to 2010, even then we from the EU ETS or the CLC? were predicting that at 2020 there was another three V Mr Huddleston: It would be good, as has been megatons of carbon to get cost-e ective because the mentioned by previous speakers, to get a common model allowed for long investment cycles and things carbon price. I must admit I have not solved the that we would not do until late on. Even back then answer of how to bring all these schemes together when there was a lot of discussion at the time in the but one might note that the plans for CRC, carbon select committee about whether our targets were too reduction commitment, are that there will be a one- tough I was asked—I was reviewing the evidence way leak from EU ETS to carbon reduction over the weekend—“Will it all have been done by commitment and it may be sensible in due course to 2010?” and I categorically said “No” because with merge the UK ETS with the CCA registry3 and there the best will in the world there is long investment. In is scope for simplification there, but it is not clear addition, beyond all cost-eVective savings, you can quite what that should be at the moment. go to what was then at the day a higher level of saving which was technically possible but not cost- 3 Note by Witness: The witness meant to refer to the CRC eVective. With the changing oil price, of course, registry, not the CLA registry. some of what in those days would have been deemed Processed: 03-03-2008 20:26:49 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG2

Environmental Audit Committee: Evidence Ev 75

23 October 2007 Mr Robert Bell and Mr John Huddleston all technically possible but not cost-eVective moves there will be scope for negotiating the savings that down into the cost-eVective range, so from that high are not necessarily cost-eVective on the basis that we level modelling point of view I would say that there have got this challenge to deal with them and there are still savings and then John could quote many will be costs to individuals, but there may eventually examples on the ground of examples of technologies need to be a cost to business that is not a cost- not yet taken up—for instance, looking at it in a eVective saving? more detailed way, one common issue in industry Mr Bell: I would answer that in two ways. Firstly, I that saves a lot of energy is to install the most suppose there are all sorts of mechanisms and eYcient motors; it is a large amount of energy that is taxation that brings in a real cost of carbon and that used just in motors and it crosses all industry sectors. will be informed, if the markets work, by the amount We know there is not yet full penetration of that of carbon that we want to save by 2050; that will just technology and we could give other examples, so for change what is presently the boundary between what both the top-down look and what we see on the is possible and what is cost-eVective, so that just ground we would argue that there are still cost- means a gradual tightening of the screw so that the eVective savings to be taken in most sectors, though real cost of carbon if you are going to make 60% cuts maybe not all for the reasons I said at the beginning. by 2050 is realised; that is the economic answer. Also Mr Huddleston: We do not necessarily hear exactly then the point that John made is relevant, that there what companies do in order to meet their targets, could be a type of cost-eVective saving which is not they are not required to tell us, but my feeling is that really in the current agreements and that is not about at the start of the agreements, in 2001/2002, once “if we make this thing now how can I make that with companies knew that the game was on and it was less energy”, but, “can I make something diVerent going up to board level people found more savings, that still meets the needs of the consumer”. Over the probably much more low-hanging fruit than they coming decade my own personal view is that, as actually anticipated and that and the current John has said, that is going to be the new thinking activities have mainly been directed more at the because despite what I have said so far there is only utility side of energy use and there is scope in many so much you can do to make that more eYcient. If sectors for more energy-saving capability on the we are going to get 60% or even more, as you know process lines—heat recovery, as Robert said they are talking about by 2050, you have got to think installing more eYcient motors, but generally about why you make that in the first place and can looking at how am I making it and indeed why am you make something diVerent, and that would be a I making it rather than just looking at a new steam very interesting new set of agreements maybe in ten system or a new compressed air system. There is still years time. a lot of that basic stuV to be had but there is also Mr Huddleston: People are doing things which are another level of thinking which is yet in some areas less cost-eVective but they are doing them now, to be had, saying are we doing this processing in the partly because there might be other business reasons most eYcient way or can we schedule it diVerently or and partly because some companies are genuinely whatever. That is why I think there are more savings quite green. We know that the sector that makes to be had. insulation products, mineral wool, has done actions that are not cost-eVective and it would have been far, Q140 Jo Swinson: Just to follow up on that and just far cheaper to buy carbon but they have chosen to looking ahead to the future, obviously it makes sense take those actions because it is better for the industry to target first the savings that are cost-eVective and in the long run. that is the basis on which the CCAs have been Chairman: Gentlemen, thank you both very much negotiated in the past, but do you think in the future indeed for coming. Processed: 08-02-2008 11:32:38 Page Layout: COENEW [SE] PPSysB Job: 386002 Unit: PAG3

Ev 76 Environmental Audit Committee: Evidence

Tuesday 30 October 2007

Members present

Mr Tim Yeo, in the Chair

Martin Horwood Jo Swinson Mr Nick Hurd Dr Desmond Turner Mrs Linda Riordan Joan Walley

Memorandum submitted by the Carbon Trust As you will be aware, the Carbon Trust is an independent company primarily funded by Government and tasked with helping the UK move to a low carbon economy by working with business and the public sector to develop low carbon technologies and help organisations reduce their carbon emissions. We read with interest the NAO review which concluded that the introduction of the Climate Change Levy contributed to a significant refocusing of attention on energy use and that this has driven energy eYciencies and emissions reductions relative to business as usual in both energy intensive and less intensive industries. It however also found that the extent to which the Levy has continued to drive further energy eYciencies in more recent years harder to discern, especially with the addition of other policies and drivers since its introduction. Econometric analysis suggested that the Levy has permanently raised managerial awareness, although its impact on energy prices has been limited. The NAO’s survey conducted in early 2007 also suggests the Levy is no longer seen as a major driver of improvement in energy eYciency. On the Climate Change Agreements, the NAO concluded that the Agreements have stimulated additional energy eYciency improvements and emissions reductions. The negotiation of Agreements and the development of monitoring regimes to measure progress against Agreement targets raised awareness of the potential for energy eYciencies which were then achieved. It found that not all Agreement targets were stringent, but early overachievement against them was the result of genuine significant improvements in eYciency as much as weak targets. In 2005 the Carbon Trust carried out a detailed review looking at how policy measures impacting the business and public sectors might evolve to deliver significant carbon savings, while at the same time maintaining or enhancing the competitiveness of UK companies. This included analysis of the Climate Change Levy (CCL) and Climate Change Agreements (CCAs). The findings were summarised in the report “The UK Climate Change Programme: Potential evolution for business and the public sector” (Carbon Trust, November 2005), to which the Committee could refer for further detail and we have attached a copy for reference1. Below is a high level summary of the report findings regarding the CCL and CCA, which you will see broadly agree with the NAO conclusions. The CCL and CCAs, along with other measures such as the EU Emissions Trading Scheme (EU ETS), Building Regulations and the Energy Performance of Buildings Directive (EPBD), form powerful building blocks in the current Climate Change Programme for business and public sector. However, the Carbon Trust believes that implementation issues across all of these instruments could limit their ultimate carbon delivery. Moreover, the current package of instruments is not providing suYcient incentive for change across the less energy intensive segments, where energy costs are less material, and where in particular the current CCL does little to drive change and structural failures persist. CCAs create a good incentive to secure low-cost emissions reductions in energy-intensive industry outside EU ETS sectors. In addition CCAs oVer insurance from a policy perspective against EU ETS price uncertainties and under-delivery. Overlap between the CCAs and the EU ETS is not problematic from an economic perspective at this stage but the overlap does create administrative burdens. CCAs have been successful in that they have driven material emission reduction. However, we recognise that there are information asymmetry and administration issues in particular in terms of negotiating targets. Over time we see a strong case for building on the success of the best elements of CCAs by moving sectors covered by CCAs into either the EU ETS (mainly energy intensive sectors) or the Carbon Reduction Commitment (mainly less energy intensive sectors) as outlined below. In “The UK Climate Change Programme” report we made a strong case for the adoption of a new mandatory auction based trading scheme for large, less energy intensive organisations that fall outside the EU ETS and CCAs. The basic idea has been taken forward by government and developed into the Carbon Reduction Commitment (CRC). One of the other options investigated as a means of incentivising change in this group included increasing the CCL rate. This would increase carbon savings in some sectors but economically acceptable CCL increases would have little impact in service sector energy use, where emissions are forecast to increase significantly if action is not taken, due to the relatively low price sensitivity in this sector where energy is a very low proportion of overall costs. The report also looked at restructuring

1 Not printed. Processed: 08-02-2008 11:32:38 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG3

Environmental Audit Committee: Evidence Ev 77

the CCL to a consumption-based carbon tax which would increase carbon delivery, but only very slightly. Therefore on balance we believe that the introduction of the CRC is the best option for the large non-energy intensive organisation both from an emission reduction and competitive point of view. The Government committed to proceed with the Carbon Reduction Commitment (CRC) in the Energy White Paper in May 2007, and Defra is currently consulting on implementation of the scheme. With the introduction of the new CRC scheme, one potential option would be for CCA companies, once the CCA reaches the end of its current term, to then either enter the CRC or be covered solely by the EU ETS. If this were the case, it would be important that these companies maintain their CCL discount to maintain competitiveness and that CRC revenue should be recycled to business to accelerate progress on emission reduction. This simplification would benefit the economy in a number of ways. It would accelerate emission reduction by further aligning incentives and removing information asymmetries between the business and government objectives and it would also keep administrative burdens to a minimum, whilst not aVecting the competitiveness of current CCA companies. We believe the specific issues posed by the Committee are important ones to be considering and we look forward to giving our views on these more specifically in person. 19 October 2007

Witnesses: Professor Michael Grubb, Chief Economist, and Mr James Wilde, Director of Insights, The Carbon Trust, gave evidence.

Q142 Chairman: Good morning and welcome back sector, the public sector, also many SMEs, which to the Committee; familiar faces on both sides. In would be harder to classify—and that there there the 2005 you published a review of the measures which policy mix really was not so extensive, the main were targetting both the business and public sectors instrument was the Climate Change Levy, and in the in the Climate Change Programme, and you said course of our study we received a lot of indications that one of the reasons for your review was the fact that for the less energy-intensive parts it was not a that UK CO2 emissions were starting to creep up very eVective instrument. It was better than nothing again after having gone down for a while. Most of us but essentially the price signal of the CCL on its own recognise that the fall was mostly about the dash- for organisations which were either very, very small for-gas. Of course, that trend has not improved since SMEs or which were not energy intensive and totally 2005; it continues to creep up. Since all the scientific focused on other things was pretty modest. We came evidence that is accumulating suggests that the up with a number of suggestions relating to possible problem is more rather than less urgent than actions for the less energy-intensive parts, and that previously understood, are you now satisfied that covered things like the proposal for a downstream the Government’s policies in terms of what business cap-and-trade scheme for large companies, not big is doing are adequate for the task? intensive facilities like the ETS but for measures Professor Grubb: Maybe it would be useful if I tried relating to SMEs—information, product standards, to give a very brief summary of the main conclusions metering, and so forth. To address your question in from our study and then cross-check that against that context, how do we feel about progress in the progress in the last couple of years. The purpose of past couple of years, I think what I would say is that the study to which you referred was specifically in the Government did push through a significantly the context of the Government’s Climate Change stronger allocation ban on the European Trading Programme review, and as The Carbon Trust we Scheme than some had expected and than many were looking at the business and public sector initial proposals from European counterparts, options on policy issues and trends. Firstly, I would particularly in the electricity sector, and that was a clarify that we did not cover transport or domestic very positive move, and unquestionably has helped use, and none of my comments really would relate to to strengthen the European Trading Scheme overall. those sectors. In the areas that we covered, I would We expressed a view that allocations in the non- say our broad conclusions could be summarised as electricity sector could have potentially been follows: that for the energy-intensive sectors the stronger, they could have involved some degree of Government already had instruments in place—the cutbacks compared with the broadly “business as issue was about strength of application—those usual” allocations given under the UK Allocation instruments being primarily the European Plan, but the overall cut-back was a very significant Emissions Trading Scheme and the Climate Change thing. I think there are other notable measures. The Agreements, which is obviously the topic of this Government has moved forward and developed a inquiry, and in that area the most important single new instrument called the Carbon Reduction thing seems to be trying to ensure a reasonably Commitment, which we certainly like to think builds strong European emissions trading allocation for fairly significantly upon our ideas and that has also Phase II, and indeed clarity beyond. I will come back been, in a sense, protected so that it does include to that in a second. I think in a way the bigger finding some of the public sector. It has been focused on in our study or the more, if you like, newsy item was large organisations, which I think is probably that about half of total emissions associated with appropriate. I think it is still a little early to say business and public sector use were from non-energy exactly how strong that instrument will be applied, intensive sectors—light industry, the commercial but we are pretty happy with the progress there, to Processed: 08-02-2008 11:32:38 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG3

Ev 78 Environmental Audit Committee: Evidence

30 October 2007 Professor Michael Grubb and Mr James Wilde be honest. I think metering is another area where the mentioned the access to capital. The Government White Paper came out fairly strongly. Qualitatively are also doing things to improve the governance. In we feel that the progress on instruments is good in the comprehensive performance assessment for local the areas that we have covered. It is not complete, authorities, climate change is going to become far there are still question marks over the strength of more prevalent, but I think more can be done. I am application, and there is still uncertainty about for not sure that anything has been done about the example the European Trading Scheme post 2012, energy management capacity and also procurement. although that is obviously not purely in the UK I think we could leverage in the public sector spend Government’s hands at present. Is it strong enough? an awful lot more. Probably not. As you say, the size of the problem is becoming more concerning. We are still facing Mr Wilde, if you can just enlarge upward emissions, partly associated with the fuel Q143 Joan Walley: a little bit on what you were saying about price change in the power sector. One could always procurement and how that could really make an want more and I think we need to see more, but there impact. What would need to be done to get has been substantial progress which broadly we procurement policies such that this was something would be pretty pleased with compared with what that was really taken as an important issue? things looked like three years ago. Mr Wilde: A nice example is in the building sector. I Mr Wilde: One thing I might add is that in the think the Government procures one-third of all new building stock, building regulations and also the builds in the non-domestic sector. Central Energy Performance of Buildings Directive, and the Government have made a target that they are only building labelling associated with that, were key going to use top quartile buildings in terms of their drivers as well in the market that we highlighted in energy performance, but they are not actually our review. On building regulations, the tracking what the energy performance of their Government is showing strong ambition. In the buildings is or defining what top quartile is. Unless homes and domestic sector they have made a target you actually make that target real and you track to get to zero carbon homes by 2016, with a compliance against it, you will not have that market possibility of going a similar way in the non- transformation eVect, because if the Government domestic market. If they are going to go that way it are only going to buy or use top quartile buildings, needs to be backed up by sound reasoning and a the market will make sure that any building they are route map to make that transition smooth and cost- V going to produce is top quartile and it will help to e ective and to decide what the right definition of transform the whole market, so that is a nice zero carbon is, whether it is all on site within the example. envelope of that building. It is very important that we do have strong building regulations. but linked to that, if we do have those strong building regs, we also Q144 Joan Walley: How should it be done and who need to ensure that there is compliance in the market should be doing it if that is really going to be and enforcement of the regulations. On the labelling properly monitored and followed through? side the Government needs to implement the energy Mr Wilde: I think the energy performance performance certificates of existing and new builds certificates I was talking about before are a nice that are used every time you sell or you rent a mechanism to leverage there. If that is coming in in building. That needs to be implemented by April 2008, I think using those labels to ensure that the next year, which is not far away at all, so it is going Government are only buying or using the top to be a challenge to get that implemented well in ranking buildings will help to stimulate the market time. A couple of other quick things. Another area that way. we highlighted in our work was product standards and the importance of product standards in the SME When you talk about the targets for market in particular. I think the Government have Q145 Chairman: zero emission buildings, that is new buildings by made good steps there. It was a strategic priority in 2016, and yet the vast majority of emissions come the Energy White Paper and they have also signed a from existing buildings. Unfortunately, our voluntary agreement with the lighting industry to evidence in previous inquiries was that the phase out high energy-intensive light bulbs, so that enforcement of building regulations is scandalously is a good step in the right direction. Financial feeble. constraints in the SME market were also something Mr Wilde: Absolutely right. 60% of the buildings we highlighted and in the Climate Change which will be around in 2050 are already in existence. Programme Review which came out subsequent to Major refurbs are a big opportunity point which is our review the Government said that they would put covered by building regulations but the compliance more money into both interest-free loans for SMEs issues around those major refurbs are a concern. as well as the equivalent for public sector emissions, There is not any compliance really. Des? which are also material—about six million tonnes of Chairman: carbon per annum—so there is a big carbon prize there as well. We highlighted four main areas for Q146 Dr Turner: As a select committee, of course we improvement: improved governance; tighter do like to see the Government responding to reports procurement guidelines, leveraging in the large so we are only too happy to give you credit for public sector spend; increased capacity of energy having stimulated the Government in its proposals managers; and improved access to capital. I have for the Carbon Reduction Commitment. Could you Processed: 08-02-2008 11:32:38 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG3

Environmental Audit Committee: Evidence Ev 79

30 October 2007 Professor Michael Grubb and Mr James Wilde tell us a bit more about it? Could you tell us how the Agreements, that the Government will be too lenient scheme will work and which organisations are to in setting up the Carbon Reduction Commitment in be covered? order to get people into the scheme? They will be set Professor Grubb: The fundamental reasoning first very easy targets—in fact Defra are suggesting that was that when we looked at how these sectors people be able to determine their own emission behaved, in practice, it was extraordinarily common targets—and that there will be an introductory to get stories from energy managers who had phase to tempt people into the scheme without virtually no budgets, no interest or support from the auctioning. How many years do you think it would board and who, frankly, felt in a somewhat token be before the Carbon Reduction Commitment position in some cases, and that the boards of these actually delivered serious carbon savings if the companies were busy with other things and energy Government is going to be that lenient? was just written oV as an unavoidable cost. What we Mr Wilde: I think the first thing about the scheme is therefore proposed was a system in which companies that it is a mandatory scheme, so if your energy overall and not individual facilities would be consumption as an organisation, whether it be in the responsible for their entire UK-wide emissions, in private sector or the public sector, is outside the EU the sense that they would be required to go out and ETS and CCA Agreements, you will be in the acquire allowances to cover their required emissions scheme; it is mandatory. It is linked to half hourly and to report those in their annual reports, and that electricity metering. So that is the first thing—they thereby that would force companies to make sure do not get a choice about whether they are going to they actually measured and tracked emissions across be in the scheme. I think the introductory phase is their entire UK operations and built that into the really important because the experience from the EU financial reporting chains though which they Emissions Trading Scheme was that we are not quite basically govern company operations. That would sure exactly what the baseline emissions of the give a strong incentive for the board, which found covered sectors will be, and I think if we look at the that it had to understand its carbon emissions, to Climate Change Agreements and the Climate project its carbon emissions and then go out and buy Change Levy there is a big awareness-raising eVect allowances. We very strongly recommended that the when you introduce a scheme like this, so the fact allowances should be 100% auctioned. We that you have got that uncapped period whilst you recommended that there should be no free are getting a sense of the overall emissions within the allocation, partly because of the sheer complexity of scheme from the Government’s perspective so it can trying to negotiate and we just thought set a more realistic cap but then from participants’ administratively it would be a waste. We perspective so they can get used to the running of the recommended it should be revenue-neutral and we scheme, makes a lot of sense, and that awareness- felt the simplest way of doing that would be through raising eVect will start to drive emissions reductions rebates on the CCL. We recognised that obviously a straight away. In 2013, you can start to set a cap and scheme like this needs to be fairly careful in terms of the advantage of this scheme versus the EU ETS and its boundaries. We looked at options associated with the Climate Change Agreements potentially is that half hourly metering, but recognising there would be the cap will be set in aggregate overall so you are not various ways of drawing the boundaries around a setting a cap for individual installations. If the scheme. The way the Government have taken that coverage of the scheme is 13 million tonnes of forward in terms of some of the high-level carbon, or something along these lines, you may developments—for various reasons the option of decide overall we are going to cut that 13 million to recycling against CCL rebates was dropped but 11 million, or whatever the number may be, and that other ways have been taken forward. I think the means that the sector as a whole needs to respond principle of auctioning has been maintained. I think and those companies that can reduce their emissions the boundaries have been slightly narrowed to really do so; those that cannot. focus on around 3,000— Mr Wilde: 6,000 megawatt hours. Professor Grubb: 6,000 megawatt hours. The first Q148 Dr Turner: Can I come back to whether you V three years would be a fixed price system but the could speed up the transitions to e ectiveness, understanding is that it would then move into because if the scheme is mandatory the Government absolute caps, which in eVect is an auctioning has got lot of control, if it chooses to use it; it can system, and companies would go out and have to make it bite quicker if companies have no way of say, “We are going to need this many allowances, we evading it. Could the introduction be made sharper V need to go out and buy them and we will be and more e ective? Y transparently accountable for that or we will have to Mr Wilde: I think it is di cult at the moment and buy on the market.” A lot of the essentials we feel because of the paucity of data in the market place it were important in what we are proposing are is very hard to actually identify the 4,000 to 5,000 preserved in the Government’s design at present. As thousand companies that are going to be in the always, there is an extraordinary number of details scheme or know precisely how much they are that have had to be resolved and sorted out and it emitting. To get to the point where we are ready to has been out for two rounds of consultation. implement the scheme in 2010, the first step is identifying the participants, and so once you have Q147 Dr Turner: Do you share our concern, based identified them then you need to get a sense of on the experience of the initial phase of the exactly how much they are emitting so you have a European ETS and of the Climate Change sense of the overall emissions. Processed: 08-02-2008 11:32:38 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG3

Ev 80 Environmental Audit Committee: Evidence

30 October 2007 Professor Michael Grubb and Mr James Wilde

Q149 Dr Turner: How will you assess their emissions desirable or the way that the board might do if they anyway? Are you just going to have to go over their felt they were under a lot more public scrutiny accounts and see what their energy bills are? Is there associated with something like the CRC and the any other more eVective way of doing it? If that is all projection of emissions and the need to justify that. that is involved, that should not take long, should it? So the first answer is there do need to be diVerent Mr Wilde: In the first instance, they get identified by instruments because the failures and obstacles to the energy suppliers who tell them that they need to energy eYciency are diVerent and are much more provide the information to government about how complex than just price alone. There has been much they are consuming through their half hourly extensive debate as to whether if all that is true why meters and that will happen in 2008. That will do you need price at all, and I think that is an equally basically be the means by which you work out clear answer, that very frequently for these whether you are qualifying for the scheme or not, companies it is the combination of things which when you have to be within the scheme. Post that, force managerial change and make the board realise once the scheme actually begins, the companies will that there is a cost associated with being ineYcient be given good information by their suppliers, there which is the driver, and so I think it is the will be obligation upon suppliers to provide good combination of having price and the right design of information, and that is an important part of the those instruments that far and away drives the most scheme because transparency of energy performance eVective change in these sectors. Is it becoming too in the market was an issue, and then the companies cluttered? I think there is a very legitimate case that or organisations themselves provide that with the EU ETS, the Climate Change Levy, the information to government. So it is a light-touch Climate Change Agreement and the CRC, it is admin scheme where there is self-certification and getting quite a complicated landscape, along with self-monitoring. the building regulations and so forth. In our study, we suggested that the Government should look Q150 Dr Turner: Can you see scope for evasion in seriously at the option of not extending the Climate that because otherwise it would seem to me that the Change Agreements because we felt that was a scheme will start oV with all the knowledge that you middle sector which could move either into an need to set the baseline. expanded EU ETS or in part into the Carbon Mr Wilde: I think that is one of the things that needs Reduction Commitment, and that would be a to be taken into account. The scheme needs to be substantial simplification. I understand for various designed sensibly with not too much admin and reasons that the Government will be extending the auditing at a level of maybe 20% of all participants, CCAs. I can see an argument—and I have not or maybe slightly less, will help to ensure that there actually looked at it enough to know how strong is compliance because there are big reputational that argument is—that actually business does want risks for the companies concerned if they do not some foresight as to what the rules are going to be comply. and, let us face it, we did say in our report that only if the EU ETS looks solid enough and clear enough and the CRC equivalent has been reasonably Q151 Mr Hurd: If I can just be permitted a supplementary to Des on the Carbon Reduction robustly proven so that business really knows what it Commitment. Do you think there is a risk that the is dealing with that will these have a credible impact. policy landscape is getting increasingly over- Speaking of today, we cannot really say that either cluttered? Would it not be simpler just to send a is the case about what these things will look like post stronger price signal to these companies through a 2012. Can I add one other thing in relation to the reformed Climate Change Levy, perhaps backed up previous question. It is a very important issue and by stronger incentives for energy eYciency? the history of allocation under these schemes has Professor Grubb: Certainly one of the potential frequently been too generous in the first round. I concerns is the complexity and that is an issue that think that having the CRC starting as a fixed price businesses have frequently raised. On the other auction avoids some of those complexities of initial hand, there was equally strong reaction from allocation. You can find out through the auction and companies that simply relying on a price signal the associated auditing processes the data to which would have ultimately to be a very high price signal James referred. The thing that James did not add is to get some of the changes we are looking at, in part that some serious foresight into what the because particularly outside of the energy-intensive Government has in mind about the degree of sectors a lot of these companies just do not quite cutbacks in this sector for the CRC when we move behave in the way economic theory might predict in into the capped phase from 2013, if that is when it is terms of carefully appraising all of their costs and to be, could send a very useful signal right now. I investing optimally in energy eYciency. There are think what is very important is that these sectors do bundles of reasons for that. I alluded to one or two not get the idea that they have just got to pay for of them, and we ran through the various kinds. A these allowances in the fixed price auction phase and particularly important one for these sectors is often then they carry on paying at about the same level the problems around buildings. The fact that they and maybe they do not need to worry about it. I may not own the buildings they occupy and think if there is a clear signal that these sectors are therefore they do not control the fabric, and just the going to have to deliver substantial reductions when fact that energy managers may not be well the scheme moves into the capped phase, that will empowered in the way that would be, frankly, also be another string to the bow of driving change. Processed: 08-02-2008 11:32:38 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG3

Environmental Audit Committee: Evidence Ev 81

30 October 2007 Professor Michael Grubb and Mr James Wilde

Q152 Mr Hurd: Our inquiry is into the Climate suppliers that are oVering this high energy eYcient Change Levy and, in theory, part of the revenue equipment and oVer the loan at the same time at the from that policy instrument is recycled through the point of sale. We also cross-sell through our site work of The Carbon Trust. Specifically in relation to surveys so we give about 5,000 site surveys across the interest-free loans to the small business sector, how market per year and a lot of the opportunities we popular and eVective are those proving as a policy identify through that may well qualify for loans, so instrument in terms of emissions reductions and in we cross-sell. terms of cost eVectiveness? Mr Wilde: They are actually a very popular and very eVective mechanism. Since we introduced the Q155 Mr Hurd: And are you building data on how scheme as a pilot, the financial amount of loans much money companies are saving? committed has doubled year on year until the fourth Mr Wilde: Absolutely. Overall this scheme will have year, which was last year, and reached £18 million, a net benefit to the UK economy. When you take in which year we gave 480 loans and saved about into account the investment costs and the energy savings there is a net benefit to the economy. 50,000 tonnes of CO2. The good thing about those carbon savings is that the persistence is very high because it is associated with capital investments. The Q156 Mr Hurd: And the other instrument is persistence is around nine years so we are saving a lot enhanced capital allowances? How does that of carbon through this scheme and it is also cost measure up, because it sounds like interest-free loans V e ective. There is an overall net benefit to the is an eVective instrument which could be leveraged economy. more. How is the enhanced capital allowance side performing? Q153 Mr Hurd: Are those carbon savings audited? Mr Wilde: We promote that scheme on behalf of the Are they subject to some external scrutiny? What is Government and the associated Energy Technology the methodology for measuring that? List. That is a list that Joan and I were talking about Mr Wilde: We have implemented a very robust way last week. It lists high energy performing products of tracking our carbon and we now have limited across a wide range of categories. There are about assurance on it through accountancy. I think we are 14,000 products on that scheme and each year we are the only people out there that do actually have trying to raise the bar of what qualifies. It is typically limited assurance over the processes we use to track the top ten to 25% performing products in a given our carbon, so we take a lot of eVort to go loan-by- category. Last year, for example, we added 2,000 loan looking at exactly which bit of kit they have put products and took away 1,200. One of the big drivers in place and how much carbon is being saved and within this scheme is the eVect it has in transforming what persistence it is likely to have. Historically it the market, so a lot of manufacturers improve the has grown very rapidly. We have reached the £18 products they are bringing to market just to get on million of loans committed last year; this year we are the ETL, whether or not they think their clients are planning to have around 900 loans and £26 million going to claim ECAs or whether they are not. For committed; and next year we are looking to do about example, the public sector buys a lot of equipment £50 million, so there is a huge potential to grow the oV the ETL and they cannot claim ECAs, so a big scheme and at the moment we are constrained really driver for change is that energy technology list in its by the amount of capital we have. There is loads of own right. In terms of the ECAs, the Treasury have demand out there. estimated how much is being claimed and round about £170 million to £130 million per annum is Q154 Mr Hurd: To what degree is private sector being claimed through the scheme. Awareness in the capital leveraged? target audience is actually pretty high, it is around Mr Wilde: That is one of the things we want to do. 40%, and we promote the scheme with a wide range The first of the two options is that we get more of diVerent marketing activities. There are issues funding from the Government, and we have asked around which products can qualify for ECAs and for that through the CSR bid. The other option is that is one thing the Government are consulting on that we use Government money to pay the interest the moment, and we will feed in our thoughts on expenses and leverage in private sector capital. That that. There are three example issues around what is is something we are very keen to explore, we are excluded from qualifying for ECAs. One is that only talking to the Government about whether or not we plant and machinery can qualify. That means, if you can do that. There is a big potential future look at lighting for example, 80% of expenditure on opportunity as well in this market and we are using high eYciency lighting cannot qualify for an ECA. three principal ways to promote this interest-free The second area is that systems cannot qualify; it is loan scheme. The first is marketing direct to for individual pieces of equipment, so you can customers, so on-line radio, trade and regional unlock a bigger opportunity if you allow systems to press, direct mail, and we have a current campaign qualify. The last one is that sector-based equipment on-going. The second really important route is cannot qualify, so it needs to be equipment that is through suppliers, so we allow the suppliers to sell applicable for a broad range of sectors, it cannot be their qualifying equipment and sell at the point of specific to a single sector, so there are opportunities sale the fact they can get an interest-free loan, and to expand the qualifying types of equipment or that has a real market transformation eVect. At the systems that would allow this scheme to have a moment 70% of all our leads are coming through bigger eVect going forward. Processed: 08-02-2008 11:32:38 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG3

Ev 82 Environmental Audit Committee: Evidence

30 October 2007 Professor Michael Grubb and Mr James Wilde

Q157 Mr Hurd: Finally a broader question on the Mr Wilde: That is a really important point. We vet Climate Change Levy. It brings in about £700 the suppliers and the bits of kit that the loans can million a year in terms of revenue to the Exchequer; qualify for quite strictly, so they would have been the Carbon Trust budget is around £100 million a more expensive than the convention in the market. year—how much of the remaining £600 million is Particularly with SMEs, where there are financial recycled by the Government into improving energy constraints, they almost need that sweetener to be eYciency? Finally, does the Carbon Trust still able to buy the more expensive bit of kit. The other consider itself to be financed by the Climate thing we do is track by talking to customers. For Change Levy? example, the NAO have just audited our activities Mr Wilde: A large proportion of our funding comes and they spoke to a large number of our interest-free through the Climate Change Levy, but we do get loan customers and they found that 96% of the users funding from other sources such as DBERR and the would not have bought the equipment without the devolved administrations. In terms of how much loan. We go back and we interview clients to money is recycled from the Climate Change levy to understand whether or not there is that dead weight energy eYciency investment, the ECAs is the £170 associated with the list. million in 2005–06 I was talking about before. Beyond that I am not sure how much would be Q161 Joan Walley: I just want to ask a little bit more recycled directly back because when they introduced about the list, if I can, because that came out of our the scheme they gave the reduction in the national previous inquiry. I am really interested in what the insurance contribution and I am not sure there was interface is between The Carbon Trust and that part any other kind of direct recycle back. of design and innovation and research and the use of the extra money that there could be to stimulate that innovation, so that the addition of names and Do you think there should be a Q158 Mr Hurd: companies and processes which are more energy clearer link between a tax on energy and incentives eYcient on the list. I am not quite sure where the for energy eYciency? stimulus for that is coming from, bearing in mind Professor Grubb: I was going to add one point which that we have got other evidence to the Committee is for a period there was also, in eVect, at least some which basically says that what we really need is a payment to industry through the original UK step-change in terms of the technology if we are Emissions Trading Scheme, although now those really going to get the huge shift in terms of incentive payments have expired, and I think the reduction of energy consumption or carbon Government generally, particularly the Treasury, is reduction that we are looking for. So what is that not in favour of much hypothecation, or as little as interface between companies and their processes humanely possible. that get on to the list and the research and development and innovation that would stimulate Q159 Mr Hurd: We had noticed! it? Professor Grubb: As James said, the Carbon Trust Mr Wilde: Absolutely. At The Carbon Trust we does get funding from a number of sources and have a two-fold mission: one is to help companies to primarily it would not consider itself “funded by the reduce their emissions today and the other is to CCL”. Is more hypothecation desirable? I think develop new low carbon technologies. The ETL, in some has proved very useful. I think the concept of essence, is trying to highlight the best performing environmental taxation does not rely on pieces of kit that are available today in the market- hypothecating the revenue. The prime purpose is to place. We were talking about lighting before and make pollution more expensive and thus give an LED lighting is a nice example of that. It is the next incentive for polluters to move away from those generation of lighting and it is not available mass market at the moment. We are just reviewing that to activities to invest in cleaner things. Hypothecation see whether we should put that on the ETL list. In of a serious eco tax in that sense is useful at the our innovations business we focus on developing margins to oil the wheels, to provide the kind of new low-carbon technology, so we have an applied information and the support the Carbon Trust does. research programme where I think we have got over I would not support wholesale hypothecation. 120 low carbon technology projects going through R&D programmes, and some of these for example Q160 Jo Swinson: Just going back to something you are in LED lighting, so we help to try and stimulate said on the interest-free loans to SMEs, I was quite those early stage technologies helping them develop struck by the fact that you said that 70% of the cases the technology and its cost and its performance in you dealt with came through suppliers at the point use. We also have an incubator arm where we help of sale. Is there not a danger, if that is where so much early-stage companies get investment ready and of the loans are being sourced through, as it were, develop their business case. We also help to that there is money going to interest-free loans the demonstrate new technologies through our companies would have bought the product anyway, technology acceleration arm. so they got all the way through the suppliers at the point of sale. How do you audit that and manage it Q162 Martin Horwood: Are you saying that no LED and make sure you are targeting the money where lighting is on the ETL list at the moment? the investment would not otherwise have been Mr Wilde: Not at the moment. We are currently made? reviewing LED lighting. Processed: 08-02-2008 11:32:38 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG3

Environmental Audit Committee: Evidence Ev 83

30 October 2007 Professor Michael Grubb and Mr James Wilde

Q163 Martin Horwood: There is quite a lot out in the Q165 Mrs Riordan: You have concluded that market. You can buy it in B&Q. Plenty of companies changing the levy to target carbon rather than are substituting LED lights for halogen lights now. energy use would not have a huge eVect on carbon Mr Wilde: Yes, and that is why we are reviewing it. It emissions because the opportunities to switch to is now time to review it because it is becoming widely other energy supplies are very limited. What if the available for the types of applications we are looking levy rate on electricity was varied according to the at in the non-domestic sector, in manufacturing. carbon profile of diVerent suppliers, or tariVs? Professor Grubb: That is an interesting question. I will start by clarifying that in the studies we did we Q164 Joan Walley: Just going back to what you were looked at the average carbon content of electricity talking about in terms of research, just looking at it and we looked at the eVect of changing the weighting from a constituency point of view, representing an between electricity, gas and coal. I confess that I was area where there has always been lots of really quite surprised at the initial results which manufacturing and innovation and research, I am showed hardly any impact, because you tend to interested in what talks you are having with the assume that if you switch an energy tax to a carbon regional development agencies because often that tax you are going to save carbon but, as you say, support for fledgling businesses or fledgling because of substitution between fuels in the end uses, technologies is at the level whereby firms are either the opportunities for that were actually very limited aware or not aware of how they can maybe get so, in a sense, the whole debate about whether the matching funding from perhaps the regional CCL should really be a carbon tax is probably yes in development agency and maybe yourselves. I do not principle, but actually in practice it makes very little quite see that interface taking place. diVerence. Your suggestion of weighting CCL on the Mr Wilde: Absolutely. We have got nine regional basis of carbon content of electricity, according to managers so we have got nine people across the the supplier concerned, I can imagine that would be diVerent regions in the UK who are actually based in pretty complicated to implement, but I would think the RDA oYces who act as The Carbon Trust’s that the impact could be non-trivial, and I honestly interface there, both in terms of the innovations do not know until we have looked at it. You would business, where they are looking for those kinds of need to be pretty sure about how you were opportunities in working with the RDAs on their calculating the carbon intensity of the diVerent innovation work, but also, importantly, in the work suppliers and look at how the cost diVerential of the the RDAs do in terms of Business Links and CCL stacked up against the cost diVerential between working with companies to help them improve and the suppliers. I am sorry I cannot give you a firmer give them business advice where we work with the answer. RDAs and try and find opportunities. Joan Walley: It is just that from where I sit there Q166 Chairman: As the House is going to prorogue seems to be a huge gap between what should be this morning our whole session has to be curtailed happening and how it is actually happening on the and we are going to have to bring this one to an end ground with companies and businesses really as well. Thank you very much for coming in. As benefitting. Maybe that is an opportunity for a usual we are very grateful to you. future recommendation or discussion. Professor Grubb: Thank you very much.

Witness: Dr Ian Bailey, Senior Lecturer in Human Geography, University of Plymouth, gave evidence.

Q167 Chairman: Dr Bailey, this is the first time you incentives with which they are faced and, if you like, have given evidence to this Committee and we are the geographical and market complexities of grateful to you for coming in. We are in an unusual translating environmental economic theory into situation this morning in that we will not be allowed practical policy. I have been doing that for round to sit once the House prorogues so whereas normally about ten years, firstly in the field of waste we can let things run on a bit, we have to be a little management and since about 2000 in the area of bit tighter on our timing and more disciplined, which climate policy, looking primarily at the United is usually something my colleagues on the Kingdom, Germany, the European Union, and also Committee struggle to achieve! As it is your first more recently Australian experiences with time, would you like to introduce yourself and say a negotiated agreements. bit about your background. Dr Bailey: Yes of course, and thank you very much for the opportunity to be here today. My Q168 Chairman: Okay. With the benefit of that background is one of being a political/economic/ experience, would you like to tell us what you think environmental geographer. I am not a trained about the eVectiveness of the Climate Change Levy economist but my research over the last ten years has and the Climate Change Agreements? focused on issues of environmental policy Dr Bailey: I think they were all very useful starting- implementation, in particular the impact of things point instruments because the package as was put like negotiated agreements and market-based together in 2001 did provide an avenue to make a instruments on industry behaviour and how fairly fundamental change in the way business thinks basically business managers respond to the price about energy eYciency and make it more palatable Processed: 08-02-2008 11:32:38 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG3

Ev 84 Environmental Audit Committee: Evidence

30 October 2007 Dr Ian Bailey to ease businesses towards this form of regulation. I forward. I am not saying that the relationships do also think, however, that the initial impact of those not exist between price incentives and corporate instruments in terms of raising business awareness of responses, but one has to take into account energy eYciency had a fairly limited shelf level in so diVerences in sectoral make-up, ownership, and so far as, as I understand it, there was a pretty low on and so forth, geographical diVerences obviously starting base point, and the initial impetus gained between diVerent countries, and the regulatory will gradually be lost unless, for example, the price frameworks within which they operate, and a whole incentive of the Climate Change Levy is host of other factors, which means that this idea of substantially increased—and some of the diYculties economic rationality in terms of response is one of that have already been broached this morning which is very diYcult to observe empirically when and, if you like, the low-hanging fruit get rapidly one is speaking to these people. Just to add to that exhausted by business leaders and that begins to of course because I spend all my time speaking to pose diYculties, so I would expect to see a process, if business leaders—and one could level the charge at policy is not changed, of diminishing returns. I have me that I have been captured by industry interests— limited confidence in the EU Emissions Trading I would like to think that I am reasonably discerning Scheme to fundamentally reverse that situation, for in terms of how I unpick what we might call the reasons which perhaps I might have the opportunity smokescreen-type arguments from the real diYcult to come on and explain. I have spoken to an awful structural issues that many energy-intensive lot of business leaders over the course of the last ten industries are facing. years. The first of the two key issues that I would like to highlight from the outset is, as Joan alluded to in the last session, the step changes in investments Q172 Dr Turner: The situation is summed up in needed by, particularly, energy-intensive industries some evidence that we have had, and I quote: to make a fundamental diVerence to their emissions “Organisations have not responded to Climate profile. That raises all sorts of issues about capital Change Agreements in the rational manner availability, capital aVordability, and persuading predicted by economic theory.” Given that the entire chief executives to accept those quite significant package of policies aimed at businesses in the UK investments. Allied to that of course, there is a lot of Climate Change Programme is designed by vintage capital we are talking about in energy- economists, that is quite a serious statement. Do you intensive industries, ones which have very long pay- recognise that and what do you think it implies for back periods, and that only increases the obstacle as the Climate Change Levy package and other far as I can tell to the step-change sorts of market-based approaches? investments. Another complicating factor which is Dr Bailey: Is that a quote from myself? coming out quite strongly at the moment is the variability of base energy prices, particularly when Q173 Dr Turner: No, it is from AEA Energy & we look at the base oil prices over the course of the Environment. last three or four years or so, and how that interacts Dr Bailey: I have a lot of sympathy with the with a market-based instrument and how that statement, yes, I think there is a lot to be said for creates long-term security as far as energy-intensive that. The implications it has are principally that industries are concerned for planning these major over-reliance on the price mechanism and markets, investments. howsoever constituted, whether through a tax-based mechanism or a trading-based mechanism, maybe Q169 Dr Turner: You have written academic papers addresses part of the problem by making sure that that have some fairly critical things to say about the polluters pay for their emissions, however, it does way economists design and evaluate policies such as not address some of those more structural the Climate Change Levy. Could you expand on that constraints facing decision-makers within industry, a bit? Is this a criticism of fellow economists in and particularly their capability to eVect the sort of designing fiscal instruments? large-scale investments that are necessary. I think as Dr Bailey: I would not like to think that I am too an overall summary of the implications, it says critical of economists. I suppose as a geographer, I things like the Draft Climate Change Bill have put am naturally interested in— forward ambitious emissions targets for the United Kingdom. Whether the current package of instruments stands any chance of coming close to Q170 Dr Turner: You are not an economist? Dr Bailey: I am not an economist. that, I have to say I have strong reservations.

Q171 Joan Walley: He made that quite clear! Q174 Dr Turner: You obviously know about the Dr Bailey: As a geographer, I am interested in the forthcoming Carbon Reduction Commitment. complexities of the real world, as it were, and policy What are your views on the design and likely implementation. Environmental economic theory is eVectiveness of that? based on a number of assumptions about market Dr Bailey: I have not studied it in detail because I behaviour and competition, and my task in my have been focusing predominantly on the EU ETS, research is to explore how well these actually pan out so I have been listening very interestedly to the in the real world. What I have observed from the preceding session. However, I think it does many of research that I have done is an awful lot of factors the same things as emissions trading and I think it which complicate the relationships which are put possibly addresses the same issues and fails to Processed: 08-02-2008 11:32:38 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG3

Environmental Audit Committee: Evidence Ev 85

30 October 2007 Dr Ian Bailey address the same issues, and the issue in particular is about in the preceding session that would meet the this idea of capabilities and bringing about step requirements of the task. I could possibly see greater changes in investment. potential from fuller auctioning of EU ETS permits but, to be honest, I do not have a figure. Q175 Martin Horwood: It is becoming a bit of a theme of this inquiry that companies are refusing to But you think it is a question of behave in the rational way that economists want Q179 Jo Swinson: money; it is not a question that the technology is not them to. You in your academic papers seem to be out there yet? You think the technology is there, it is arguing, I think the phrase was, for more interventionist strategies. We are inquiring into just a question of investment? market-based mechanisms, but are you saying that Dr Bailey: The best thing I can do is to report the the market-based mechanisms are a bit of a red findings of the various people that I have spoken to. herring? The issue of the actual existence of technology seems Dr Bailey: I was re-reading the abstract of the paper to be a lesser issue for most of the energy incentive where it had the word “interventionist” and I was sectors that I have spoken to. The greater issue is the V reminded that I had great diYculty finding the a ordability of that technology and the various correct word, and I am still not sure that I found the either internal company financing requirements or correct word. the need to go out on to open capital markets and persuade other investment organisations to invest in things which have got a very long pay back lead- Q176 Martin Horwood: I was going to ask you what do you mean by more interventionist strategies? Do time. you mean getting away from market-based mechanisms altogether and going into regulation Q180 Jo Swinson: You have mentioned that you and subsidies? would be quite in favour of the hypothecation of the Dr Bailey: No, I am generally supportive of the CCL money going back into energy eYciency package of instruments that has been developed in investments. We heard from UK Steel a couple of terms of the CCL, CCAs and EU ETS. However, I weeks ago that they felt the 20% levy that they were V think I di er from Professor Grubb in terms of my paying was a blanket tax, that it was not necessarily degree of supportiveness of the idea of recycling Y incentivising them at all. They were suggesting that monies directly back to reward energy e ciency if they had that money they could spend it on the investments. I think reliance on the market and the energy eYciency improvements themselves. Given price mechanism component of the market to your wish for hypothecation, do you think that achieve that may well get nowhere near where we would be a more eYcient way of doing it, or do you need to be on all this, and when I say interventionist not agree? I am talking basically about hypothecation. Dr Bailey: I have heard that particular issue addressed in a number of diVerent ways. My Q177 Martin Horwood: So you would support instinctive response is to say that is probably quite a hypothecation from this? sensible position for UK Steel where energy Dr Bailey: I would support the continued use of the consumption is such a large proportion of operating Climate Change Levy and the EU ETS, but I would costs and therefore they have a very strong normal be thinking in terms of how can we create a more market incentive as an internationally competitive direct link between the revenue that is raised from Y things like the Climate Change Levy, or potentially industry to make energy e ciency one of their top- through greater auctioning of EU ETS allowances, most priorities. Other slightly smaller companies and creating financial incentives for businesses to that I have spoken to, still in the energy-intensive invest by getting a positive financial incentive, if you sector, say that the 20% is extremely useful to them like, to invest in energy eYciency. That might be because it provides something that the accountants quite a naive view from an economist’s point of view, will look at where they will see that 20% charge and but it is where my investigations have tended to say that creates an impetus. It raises the profile and lead me. of course the follow-on argument from that is if we do not meet the CCA targets then we are going to be encountering 100% climate change levy. There may Q178 Jo Swinson: Going back to one of the barriers that you cited for why there have not been further be a few very high profile companies where the idea V cuts in emissions, which is the lack of the capital of a 20% CCL is e ectively not creating any required for these step-change investments in additional incentive, but for the vast majority I think technology, in your view what is the scale of it does create some sort of profile. Having said that, investment that is required and how should that be the one virtually unanimous thing that I have heard funded? from talking to industry groups over the years is they Dr Bailey: To be honest, I do not have any view. I deny any direct link between the levying of a carbon do not have enough knowledge to be able to make or energy tax—this is not just the United Kingdom, a sensible comment on the levels of figures. We are this is other countries as well—and increased talking about very substantial funds and I would not investment in energy eYciency, and a lot of them foresee that if all the revenue that was gained from also say that we would understand the rationale of the Climate Change Levy were recycled back the tax much more clearly, there would be much less through the sort of schemes we have been talking obfuscation of it, if you like, if the money was not Processed: 08-02-2008 11:32:38 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG3

Ev 86 Environmental Audit Committee: Evidence

30 October 2007 Dr Ian Bailey recycled via national insurance contributions but it questioning as this particular Committee takes was recycled back in terms of rewarding energy evidence of some degree of unease aboutthe ability of eYciency. market-based instruments in their current form to deliver large-scale emissions cuts. I think it is Q181 Mrs Riordan: Companies involved in Climate probably a view shared by industry, yes. Change Agreementshave generally sought to achieve their own targets rather than rely on purchasing carbon allowances, though that would have been Q184 Dr Turner: Therefore, I have to ask you what more cost-eVective, and that tends to reinforce it in you would do about it, both in terms of raising the industrial firms’ view as a compliance regime Government consciousness and designing rather than a trading scheme. Would you agree with instruments or methods of regulation that would that and what does that mean for the future achieve the result? development of the Trading Scheme? Dr Bailey: I am afraid I do not actually have the Dr Bailey: We are talking about the European Union complete solution to the problem, otherwise I would Emissions Trading scheme here? have come to the House rather earlier. Dr Turner: Aw shucks! Q182 Mrs Riordan: Yes. Dr Bailey: Yes, that certainly has strong resonances Q185 Joan Walley: What about parts of the solution? with the feedback I have had so far. We have been Dr Bailey: One of thethings that the industry sector is conducting some interviews very recently on the EU certainly talking about very strongly is the need to ETS, and certainly amongst the industrial sector we tackle those emissions which they have little control have quite strong risk averse behavioural over, what they call the “over-the-fence emissions” in characteristics whereby organisations are waiting terms of electricity provision. I think I would make until they get some sort of certainty about what their that oneof thecoreprioritiesof theclimatestrategy to position will be in relation to their emissions cap and bolster renewable energies and to move to lower then only entering the emissions market if they carbon fossil fuels at a much more rapid pace. The absolutely have to. They are not particularly part of the solution that I have already suggested to interested in the concept of emissions trading in the theCommitteeisthroughcontinuationoftheexisting way conceived by environmental economics. As you mechanisms. The Climate Change Levy now being say, they are using it as a compliance instrument as linked to inflation obviously addresses something opposed to according to the theoretical principles of which was quite problematic for the Climate Change emissions trading. However, the EU Emissions Levy—in eVect it was stagnating when other prices Tradingsystem issegmentingquite significantly.You were increasing so it was having a diminishing eVect. also have what is being referred to as the compliance The move to link to inflation addressed that to an players, mainly the utilities, who are looking into the long-termbuyingfutureallowances; theyareshorton extent, and continues to provide some amount of financial incentive for businesses to take energy allowances so they are looking to acquire allowances Y and so they are trading into the future; they are e ciency seriously. However to my mind what hedging forthefuture basically.Theyaretryingto get happens with the revenue from the Climate Change emissions allowances out of the industrial sector, Levy could be as important as the price incentive which are risk-averse and will only tend to release itself. Similarly, with the EU Emissions Trading EUAs onto the market when their position is Scheme we know what percentages of EUAs were actually known.1 issued free-of-charge in Phase I and Phase II. I know there are proposals from the German Government for full auctioning beyond2012. One can see that that Q183 Dr Turner: What everybody is really aiming for is to stabilise the atmospheric concentration of would potentiallybearevenuegenerator whichcould greenhouse gases. You have made it quite clear that be used to tackle some of those issues either through you have little confidence in the ability of the current over-the-fence electricity or recycling back to portfolio of economic instruments to produce that industry to promote energy eYciency. If we are eVect. Do you think that is a view which is shared by looking for what I feel is part of the solution that Government and by business? would be it. I cannot claim for one moment I can Dr Bailey: I do not think it is shared by Government, quantify what percentages of the solution that might without actually being privy to Government’s view be. on this specifically. I think there is increasing Theproblems donot reallylie on the 1 Note by Witness: This means that diVerent segments of the Q186 Chairman: market are operating to diVerent time horizons and nature of the instruments being used, but their speculatingtodiVerent degreesand indiVerentways.Utilities application. A cap and trade scheme which had a are, basically, much more speculative and long term than the tight cap and involved 100% options would be quite industrials, and only time will tell whether market forces will eVective. Similarly, you could use the price signal translate this into a credible abatement incentive. Additionally, when one creates a market, the incentive for through the tax system. We froze the fuel duty market players is to maximise returns or minimise costs. escalator some years ago and the Climate Change These outcomes may be achieved through investment in Levy itselfhas notbeen raised inline with inflation, so abatement but there are also plenty of other ways that markets can achieve these ends, not all of which are in a sense it is not the fault of the instruments but necessarily compatible with the environmental objectives of rather the way in which they actually have been emissions trading. implemented that has made them so ineVective? Processed: 08-02-2008 11:32:38 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG3

Environmental Audit Committee: Evidence Ev 87

30 October 2007 Dr Ian Bailey

Dr Bailey: In what regard? markedly. If that avenue is to be pursued seriously I think there would need to be further research on that Q187 Chairman: Since we are not on target to reduce to confirm that on a wider basis. I would not want the emissions by as much as we need, we all are groping Government to go forth and implement that on the around saying, “Why is that? What shall we do?” basis of what I have said today. What I am saying is that emissions trading is Chairman: Nevertheless, what you have said today is potentially a perfectly eVective way of achieving that quite encouraging on that point. goal, except that we have not actually tried it. We introduced Phase I with limits that were so high no- Q189 Jo Swinson: Your research has focussed on the one had to make any cuts; we gave away the alliances diVerent approachestakentotackling climatechange so the only benefits were received by the biggest in diVerent countries. How does the UK compare to polluters; and there was no carbon price which drove other countries you have looked at; what might we be investment in low carbon energy; but that is not able to learn from what they are doing better than us? becauseemissions tradingis per sea flawed concept— Dr Bailey: As I say, my research has mainly taken actually it is quite a good concept if it is properly place in Germany, the United Kingdom and applied? Australia. Probably the best direct comparison is Dr Bailey: I would agree with that wholeheartedly, with Germany. I have to say I think the British and that has been the point I have been trying to put Government has handled the whole process of across when I have been asked: do I see the current transition to this type of market-based regulation in a portfolio of instruments as eVective or ineVective? much more skilful manner than has the German Your point is exactly correct, yes. What I am saying Government, where eVectively the Federal really is that the scale of the problem is such that one Government took on the role of the negotiated needs to fight it in every possible way, and that would agreements, the self-commitments, and they became be through tighter emissions caps and allowing the thoroughly embedded in theindustry psyche as a way European market to do what it can, but also through that industry should be dealing with climate change the auctioning and the use of the revenue from issues. The Red-Green Coalition in 1999 decided to auctioning to create an additional spur. I have not move towards a taxation-based regime and thought through all the complexities of how that encountered enormous resistance. In a way similar would operate. phenomena have been observed within Australia, where wehadtheGreenhouseChallenge,followedup Q188 Chairman: One of the diYculties I think about by the Greenhouse Challenge Plus in 2005. It is the revenue is the scepticism of business and embedded within industry—there is a certain way consumers about what actually happens. We have that things should be done in relation to industrial seen it with the Climate Change Levy; a tiny little cut emissions. Making the further transition to market- in NICsandthen a year ortwolatera bighike in NICs based instruments howsoever applied has I think to pay for the Health Service. That makes encountered much stronger resistance and led to people a bit cynical, I think. We heard last week from quite significant delays. The British Government, by the Minister in a debate we had in Westminster Hall parcelling the whole lot up together eVectively, that the Government was absolutely against providing what was at the time a reasonably clear set hypothecation of revenues. Doyou share theconcern of signals as to the long-term intent of Government that if that was the case it is going to be quite hard to policy and providing flexibility avenues through get business to support, for example, auctioning a Climate Change Agreements, through the EU much greater percentage of allowances in the EU Emissions Trading Scheme and so on and so forth, Scheme, becausethey will thinkthegovernments that did actually manage to ease that transition. Of course run the EU Scheme will swipe the money? that is a story about the past. I return to the comment Dr Bailey: All the evidence I have from my research I made at the beginning of this about having suggests if there was a very clear and transparent potentially a limited shelf-life in its current form and system where it could be demonstrated to industry the question is: how should one reform it? Generally groups that the monies were not being swiped by speaking I have been quite impressed by the way the Government but were being genuinely used to British Government handled what was quite a promote and reward initiatives in energy eYciency, diYcult transition. then the acceptability of what initially appears to be Chairman: Thank youvery much, that is very helpful. an unpopular approach would increase quite We much appreciate you coming to give evidence.

Witness: Professor Paul Ekins: Head of Environment Group, Policy Studies Institute, gave evidence.

Q190 Chairman: Welcome back to the Committee. technique which on the basis of theory, economic As one of the authors of the Cambridge theory in this case, seeks to arrive at statistical Econometrics study of the Climate Change Levy, relationships between diVerent variables, in this case would you just like to tell us about how that study particularly the price of energy, including taxes, and arrived at its conclusions? the demand for energy from which you can get Professor Ekins: Good morning. It is always a carbon emissions if you know the carbon emission privilege to be invited to give evidence to you. As you factors involved. The way one normally models the are probably aware, econometrics is a statistical imposition of something like the Climate Change Processed: 08-02-2008 11:32:38 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG3

Ev 88 Environmental Audit Committee: Evidence

30 October 2007 Professor Paul Ekins

Levy would be ex ante, in other words you have your goods, such as reduced emissions, is not normally statistical relationships between the various part of mainstream business strategy. It is something variables in the model; it is a large-scale economic that businesses sometimes do when they feel that model; it has 50 diVerent industry sectors; it has there are reputational benefits to be gained; when households; it has the government sector; it has they feel that they need to make impressions on taxes—obviously; it has relations with the outside either policymakers or consumers; but it is certainly world. It is intended to include many of the statistics not normally part of mainstream business produced by the OYce for National Statistics and to behaviour. From looking at both the negotiation represent the kinds of dynamic eVects that take place process for the Climate Change Agreements and the in the world on the basis of estimated statistical very long lead-time that went into the actual relationships that have applied in the past. You implementation of the Climate Change Levy—a full arrive at your estimation of the various relationships two years between the report of the Marshall involved; you then impose the tax; and in theoretical Commission and when the tax was actually levied terms you have estimated that if you increase the (during which time the CBI waged an absolutely price of something you are likely to reduce the relentless campaign against the Climate Change quantity and that then will show you the likely eVect Levy, which I remember very well)—there was an of that tax as it rolls out into the future. The study enormous information eVect. This meant that this that was done in 2005 obviously was done some issue of energy prices, which before had been very, years after the tax had been implemented so, instead very close to the bottom of most mainstream of looking forward and doing it in the way I have businesses’ business agendas, because energy prices described, what we did was to take what we call “the had been cheap, and accounted for a very low base case”, which was the economy as it had proportion of most companies’ costs and was not developed using the statistics from the then DTI something that occupied the time of any board DUKES, Digest of UK Energy Statistics, and the member—during that process of implementation, OYce for National Statistics and external factors both with regard to the Levy itself and the such as the oil price, over which the UK Agreements, we found boards taking an interest in Government does not have any influence. They are this issue for practically the first time in their lives. It all in the model, so we had the base case which was was no surprise to me to find that, in the event, they how the economy had developed, including the discovered they could actually save quite a lot of Climate Change Levy, and then we removed the energy in a cost-eVective way, and they then went Climate Change Levy from that base case and saw about and did it. the extent to which that made a diVerence to the energy use and the carbon emissions. That, in a nutshell, is how it was done for the Climate Change Q192 Chairman: I think what you have just said Levy. For the Climate Change Agreements, which actually rather weakens the initial part of the are much more complicated, we had to combine that answer. If you say that businesses operate primarily kind of technique with much more detailed analysis in the interests of maximising the return to of industrial sectors, because obviously the Climate shareholders—if indeed, as you are quite right, a lot Change Agreements are concluded with particular of the measures that were taken as a result you say of the Climate Change Levy relate to energy industrial sectors, industrial associations; they do Y not map very closely onto the industrial sectors in e ciency—that of course is directly in the interests the model; and so there were quite a lot of of shareholders. It may be that businesses needed a assumptions and manipulations necessary to get the stimulus to think about the potential for greater energy eYciency, but undoubtedly investment in Climate Change Agreements and the energy Y reductions which they were thought likely to deliver energy e ciency is one of those areas where the on the basis of the technologies to map onto the environmental and economic advantages precisely industrial sectors. coincide? Professor Ekins: Indeed. One of the curious things which economists and others have spent quite a lot Q191 Chairman: The econometrics obviously of time trying to work out is why there is such analyses the stats which have taken place and the compelling evidence that, with regard to energy changes, but people behave in diVerent ways for eYciency in particular, people do not make cost- diVerent reasons. It has been suggested by some of eVective investments oV their own bat. I think there the other witnesses we have had that actually a lot of are very diVerent reasons why that happens in these savings would have been achieved by those business and in households; but there is compelling businesses regardless of whether there had been any evidence in both those sectors that that is in fact the Climate Change Levy or any Climate Change case. What I think the evidence suggests is that Agreements. In other words, it was pushing at an businesses are more driven by price signals than open door; and that businesses were interested in households, because that particularly is what they moving in this direction anyway? are interested in; but that energy is not something Professor Ekins: I would certainly not be of that that has traditionally occupied core managerial view. I think that businesses have an absolutely time. When it starts to occupy core managerial time explicit obligation, which they frequently remind us then they become very interested in the fact that they of, to maximise the returns to their shareholders; can very often save money, which they had not and to invest in technologies which are not cost- realised before—that the board members were much eVective in order to achieve public goals, public too busy before that dealing with what they regarded Processed: 08-02-2008 11:32:38 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG3

Environmental Audit Committee: Evidence Ev 89

30 October 2007 Professor Paul Ekins as strategic business issues of market development sectors had achieved their targets for 2010 in 2002. and sales etc and were not focussing in that You would be unlikely to do that unless these particular area. I think one of the major impacts— achievements were being done in a cost-eVective way both the Climate Change Levy through what we call for good business reasons. Therefore, I would the “announcement eVect” in our work for conclude that they were good for the competitive Treasury, and in subsequent academic work that I position of those companies because it reduced their did on the Climate Change Agreements, what I call expenditures on energy. the “awareness eVect” of the negotiations that were carried out—was that business people who normally Q194 Joan Walley: Does that mean then that we can are very interested in reducing costs (that, after all, conclude the Agreements have outlived their is what a very large portion of a MBA is all about) purpose? Now everybody is focussed on energy had suddenly discovered there was a whole area of eYciency savings, good practice, cost-eVectiveness potential cost reduction which they had not been they have served their purpose and there is no need paying attention to, and they started to take for them anymore because everyone is aware; good advantage of that. managers now know what savings can be made? Professor Ekins: Something where I slightly disagree Q193 Joan Walley: Recently you have been the joint with one of the points made in the previous evidence author of a paper which argues that sectors subject is I think technology develops; low-hanging fruit to Climate Change Agreements have gained an once picked is inclined to grow again, especially if advantage in respect of international there are price incentives to encourage it. The 80% competitiveness. It would be helpful if you could rebate on the Climate Change Levy is a very perhaps summarise the findings and conclusions of significant incentive for an energy-intensive that report for us? company. For as long as that rebate exists then it is Professor Ekins: It was a very interesting piece of likely that managers, especially once they have work for me because the whole area challenges a lot started focussing on the issue, are going to be V of the assumptions that economists tend to make looking for further opportunities for cost-e ective about the way businesses work. You will remember energy savings. While I think a new generation of that the Climate Change Agreements targets were Agreements could perhaps involve rather tighter set on the basis of calculations by the then AEA targets—because there is no evidence to me that the Technology of all cost-eVective possibilities for targets in the original Agreements were really part of energy saving. The Agreements were never entered what drove the business response—I think that kind into in the thought that they would cost companies of incentive is likely to be useful to keep managers on money, because they were calculated on the basis of the ball and to keep them focussing on the new what AEA Technology thought were all cost- technologies that come down the track. Obviously eVective energy savings. Then of course there was you have got an 80% rebate; you have got much negotiation between the Government and the higher oil prices now than when the Climate Change businesses concerned. Not surprisingly many Levy was introduced; you have got other incentives businesses thought that AEA’s Technology’s working in the same direction. All that suggests to assessment of all cost-eVective savings was rather me that we will be more likely to move closer to the greater than their own. The outcome was that the real economic optimum of managers investing actual targets represented some compromise where they can save money than if these instruments between the initial assessments of all cost-eVective not in place. savings and then the companies’ assessment of that. That was the basis of the targets. If indeed it is true Q195 Joan Walley: I am just moving to the that all the energy that was saved by those international competitiveness which your report companies was through the implementation of cost- singled out was giving people an advantage. I am not eVective measures, and that was the explicit basis on sure all the evidence we have had from industrial which those Agreements were set up, then what you lobby groups actually would agree with that. Do you would have obviously is that companies would feel that lobby groups or large industrial sectors are reduce their energy consumption in a cost-eVective lobbying against all of this; or do you think they manner, this would reduce their cost base in a cost- actually appreciate the gains that are being made? eVective manner and that would be likely to increase Professor Ekins: I think industrial lobby groups their competitiveness. Those were the kinds of have a great incentive to argue against taxes of all calculations that we did. Then of course there were kinds. I would be extremely surprised to find an the ex ante calculations carried out before the industrial lobby group that said anything good had Agreements were introduced. Now we have had not ever come out of a tax that had ever been imposed one but three target periods reported on; and, on them or their sector! I have to say that I am indeed, the companies are reporting that they are inclined to discount to a very large degree those managing to achieve energy savings in excess of the kinds of statements. We have just finished with six targets which they were set and it is very unlikely that European institutes a research project funded by the they would be doing that if in fact it was not cost- European Commission, which has quite an extensive eVective for them to do so, because they will get their website, called the COMETR Project, which looked 80% rebate on the Climate Change Levy by just in great detail at the six environmental tax reforms meeting the targets; in some work I did on the 2002 that had been carried out by European nations, target period it transpired that 15 of the then 44 including the UK with its Climate Change Levy and Processed: 08-02-2008 11:32:38 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG3

Ev 90 Environmental Audit Committee: Evidence

30 October 2007 Professor Paul Ekins its Landfill Tax, and we did some very detailed Professor Ekins: What I was arguing was on the sectoral study of some of the most energy-intensive basis of the Climate Change Agreements there is sectors (indeed some of the ones who had been evidence that practically all those sectors exceeded complaining most vociferously about potential their targets on the basis of targets that had been set competitiveness eVects from these measures in all in an explicitly cost-eVective fashion. To the extent countries—UK lobby groups obviously are no that they did that, I conclude that they are more exception to the general rule in this area) and we competitive now than they were before the Climate could find absolutely no evidence across a range of Change Agreements. I have not got the numbers for indicators of competitiveness that there had been the aluminium sector in the UK oV the top of my any sectoral disadvantage from these instruments at head. all. I have to say I give that kind of detailed work we were privileged to be able to carry out through funding from the European Commission rather Q198 Martin Horwood: Were they included? more weight than I do lobby groups’ assertions to Professor Ekins: They were included in the Climate the contrary. Change Agreements; they did have targets; they did meet those targets; and these were presumably cost- eVective energy reductions that they made. To that Q196 Martin Horwood: You have half answered the extent they would have improved their question I was about to ask, which was really about competitiveness. whether or not the impact on competitiveness depended crucially on what kind of company you were running. It is fine for a marketing agency, Q199 Joan Walley: Have you done any cross- accountancy firm or something like that to be able to research with other companies in other countries cost-eVectively reduce their bills and, therefore, gain that are not subject to the same levies or the same some competitive advantage; but it is very diVerent restraints? I am thinking in particular of the with a classic example such as aluminium which is a ceramics industry. very, very energy-intensive industry but quite Professor Ekins: Across Europe we all have climate mobile, so you are subject to very easy competition change policies and obligations. from places like the USA which might not have a price for carbon in the same way. You are confident Q200 Joan Walley: No, I am talking about with from the detailed work you have done that even other countries where there is outsourcing. If you do energy-intensive mobile industrial sectors like not manufacture in the UK or in Europe but you aluminium would gain some competitive advantage shift manufacturing production, say, to Indonesia or from this kind of regime, are you? wherever it might be, where does the competitiveness Professor Ekins: There are always exceptions from issue then come into it? any rule or experience that one cares to look at. Y Professor Ekins: Clearly there can be Aluminium is a particularly di cult sector, in the competitiveness eVects under those circumstances. sense that it is very energy-intensive; it does put a lot The only thing I would say on all the pollution haven of eVort into managing its energy use already; and, V hypothesis literature which I know about, which is as you say, countries have very di erent energy not something I have studied very recently, certainly prices in an attempt to woo those sectors. I think it up until about five years ago all the studies that is going to be increasingly improbable in a world sought to show that there was a so-called “pollution that is carbon-constrained that those countries that haven eVect”, that sought to show that companies have commitments to reduce their emissions will be did move to places with low environmental wooing aluminium, unless they have very low standards and regulations in order to get carbon sources of energy; and of course we can see competitive advantage, the data do not show that. that in some instances the aluminium industry The reason is quite simple: that environmental already operates from countries that have low regulations tend to be a very small part of most carbon sources of energy. One has to recognise that industries’ cost base, even when they are relatively part of the aim of these instruments is to reduce energy-intensive; other things like labour markets carbon emissions; is to make aluminium more are much more important; proximity to markets; expensive, because aluminium is a very energy- proximity to raw materials; skills bases; these things intensive, if convenient, product; and is to encourage are really what drive location. That is not to say people to find lower carbon ways of meeting the there will not be some exceptions—of course there same needs. will, because companies are interested in reducing costs; that is part of what they are all about. If they Q197 Martin Horwood: That is a slightly diVerent look at all the issues that decide their location, and argument, is it not? That argues for a more environmental regulations are a big part of that, comprehensive international agreement so that there are huge energy taxes where they currently are actually an aluminium company could not relocate and they can find somewhere that satisfies their because there would not be anywhere that was priorities in other areas and will greatly reduce their oVering the price advantage. That is a diVerent one energy tax bill, one would be surprised if they did not from arguing, as you seemed to be doing a minute move. It is precisely the same argument I was ago, that almost everybody can gain a competitive making earlier that prices matter. When prices go up advantage from being in a more rigid carbon- managers, once they have been alerted to that fact, focussed regime? tend to pay attention. Processed: 08-02-2008 11:32:38 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG3

Environmental Audit Committee: Evidence Ev 91

30 October 2007 Professor Paul Ekins

Q201 Dr Turner: The Climate Change Levy is based the capability of fuel-switching, are now subject to on energy rather than carbon. The Trade and the Emissions Trading Scheme very greatly weakens Industry Committee back in 1999 concluded that that argument; whereas I think there is certainly an this was basically because the Government was incentive to keep a tax on the electricity use of trying to protect the coal industry, but of course electricity consumers; because I think energy since then coal has got cheaper than gas, and our eYciency, however we generate our electricity, is to CO2 emissions are going up. Do you think that be desired; and I think it is a good thing for slightly regressive situation could have been changed businesses to have an incentive to save electricity, if the Levy had been targeting carbon instead of whatever the electricity source because they all have energy? environmental implications associated with them. Professor Ekins: In my view, from what I remember there were two reasons why the decision was taken Q203 Mr Hurd: Do you agree with the Chairman’s to go the energy rather than the carbon route. The assessment in the previous session that the problem second one was a desire to protect households, is not so much the mechanics of the various policy because had the electricity sector been included, the instruments that are available to Government, the power generation sector been included directly in the problem is in the application and the political Climate Change Levy as it is in the EU Emissions process? Do you think the Government should be Trading Scheme that would have had an upward more explicit in linking policy instruments to impulse on electricity prices which would have fed absolute reductions in emissions and less tolerant of through into the household sector as well. I think creeping language around (and the CBI used the that was another important argument I remember expression) “eYcient growth” in emissions? being rehearsed at the time. Of course Lord Professor Ekins: It is quite clear to me that we are Marshall in his report recommended a carbon tax; not on a trajectory of a 20% carbon reduction by that was his first recommendation which the 2010 nor, and I have not seen the latest proposals in Government then moved away from. Because you the Climate Change bill, the window that has been will have gathered that I think prices matter, I think proposed a 26–32% reduction by 2020, so much were the price of this energy to be related to its more will have to be done. I think it is worth carbon content so that more carbon-intensive users remembering in the context of the UK that the UK paid more, there would definitely be an incentive to is unique in that it has taxed business use of energy switch. Of course if the incentive is on the firm, the much more heavily than it taxes the household use firm does not have a great many opportunities to of energy. Undoubtedly in my view there is scope for switch as I think you were hearing in previous greater use of the price mechanism in households in evidence. The incentive needs to be on the generator, order to seek to get energy eYciency gains from that because it is the generator that has the capacity to V source. I think it is going to be important for switch between di erent kinds of fuels. Certainly at business to continue to contribute carbon savings. I the time, the information base as to the carbon- think that increasing the Climate Change Levy, as intensity of individual generators, that information we have had at least for inflation for the first time this base was not available. Through various carbon year, is an important move in that direction. I rather disclosure directives there is a much greater hope that it will continue to increase on an escalator requirement now for generators to disclose the basis in order to keep managers on their toes and information about what their energy sources are, ensure that they do continue to realise the kind of and indeed that information will soon have to be cost-eVective energy eYciency improvements that made available on customers’ bills. Conceivably you V the Climate Change Agreements I think have shown would be able to di erentiate an electricity tax based are available. on the carbon intensity of that electricity, but it would not be simple and it would certainly greatly “complexify” what at the moment is a relatively Q204 Dr Turner: Andrew Warren told us last week administratively easy instrument. Given that power that Climate Change Agreements might have had generators are now included in the EU Emissions the same eVect, the same impact, on carbon Trading Scheme and once that has a reasonable emissions if, instead of giving away an 80% discount, price involved with the allowances (which of course it was only 50% as apparently was originally it does not have at the moment but might have from proposed and this could have saved the taxpayer at next year) the generators will get an incentive to least £100 million. What do you think of that switch fuels from that source, and then the Climate statement? Change Levy perhaps can continue in its present Professor Ekins: It is an interesting hypothesis. I am fashion. not sure how I would devise a means of establishing whether it was likely, because I think that the key to the success of the Climate Change Agreements was Q202 Dr Turner: Do you think the Climate Change to catch the attention of managers. People like me Levy should be reformed to target carbon and, if so, and the IEA have been telling businesses for many how would you do it? years that there were extensive cost-eVective Professor Ekins: As I say, I would certainly have potential improvements in their energy use. been in favour of its introduction as a carbon tax Especially the energy-intensive sectors would always back in 1999, or when it was implemented in 2001, come back and say, “No, we don’t believe that. but I think the world has moved on. I think the fact We’re very eYcient at managing our energy. We that power generators, who are the people who have have a good incentive to manage our energy Processed: 08-02-2008 11:32:38 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG3

Ev 92 Environmental Audit Committee: Evidence

30 October 2007 Professor Paul Ekins properly and so we don’t think this is the case”. very, very small proportion of expenditure to simply What the Climate Change Agreements did was to a very small proportion of expenditure whether that really put feet to the fire on that issue, because the would have made a diVerence on the great majority Government produced an independent assessment of sectors: but there could easily have been some of the potential and then said, “We’re going to give exceptions to that statement and you can be sure you a financial incentive to reach these targets”, and that the industrial lobby groups, if those exceptions the financial incentive was big: it was an 80% exist, will find them and will present them as a reduction. A 50% reduction is also quite big, but general rule. clearly it is less than an 80% reduction. Would it have caught the attention of managers to the same Q206 Mr Hurd: Do you support the introduction of extent as an 80% reduction? Perhaps it would, and the Carbon Reduction Commitment, or do you perhaps Andrew in that sense is quite right. On the think we would be better served by keeping the other hand, had it been only a 20% reduction then I policy landscape simple and sending a stronger price do not think he would have been right to the same signal through the Climate Change Levy? extent because people would have said, “Not worth Professor Ekins: That is an interesting question. I us giving time on this. This is small beer”; but an 80% suppose if I am to be honest and if I look at the reduction really did catch the imagination and did 26–32% carbon reductions that the Climate Change cause people to put real managerial eVort into this bill suggests that we need by 2020 I would say we issue, which is what was required. would probably need both. The advantage of all these trading schemes has meant that carbon, which Q205 Dr Turner: If it had been 50%, what eVect do is a notoriously abstract quantity, becomes visible. It you think that would have had on the becomes visible in terms that business people in competitiveness of the energy-intensive industries, particular understand. It is something they can like Joan’s ceramics? trade; they can buy and sell it; it has a price; they Professor Ekins: Again, they do pay 20% and we did cannot see it but they can warm to that. I think look at some of the sectors that pay 20% and we introducing a trade scheme for that sector is could not find any kind of eVect. Even the tax they probably a good thing, because the one thing we were paying was a very small part of their energy bill; know about that sector is that its energy use is and their energy bill was a relatively small part of currently very invisible to it. You get landlord/ their total costs. Had that tax been two and a half tenant problems and all these kinds of issues in times the size, which is obviously what it would have commercial property such that people do not really been if it had been 50%, obviously there would have know what their energy use and carbon emissions been a greater impact. They would have been are. If the Carbon Reduction Commitment can contributing more to the public purse; and the impact that situation then I think it would be very National Insurance reductions would not have cost useful. Obviously if you have that allied with a the Treasury money—which they ended up doing proper price signal—and we do not know what price because Government gave back more to business signal the Carbon Reduction Commitment is going through the National Insurance reductions than it to generate because we do not know the details of had raised from the Climate Change Levy and that how many permits are going to be given and what would not have been the case if it had been 50%, the trajectory is going to be downward of those because that is what the original calculations were permits—it seems to me what the evidence of the based on; and that would mean obviously that taxes CCL and the CCAs have shown is that if you could have been lower in other sectors for the same combine a price signal with an awareness of the level of public expenditure and the same public fiscal issue, and obviously the increased public awareness stance. To work out the detailed economic is also important as well, then we might start seeing implications of that is obviously beyond me at this some real action. session, but I think it would have been very small. I Chairman: Thank you very much indeed. We have would have been very surprised if you changed a come in on time for once! Processed: 03-03-2008 20:35:04 Page Layout: COENEW [SO] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 93 Written evidence

Submission from Imperial Tobacco

Executive Summary a) Imperial Tobacco welcomes the opportunity to respond to the Environmental Audit Select Committee’s call for evidence as part of its inquiry into Reducing Carbon Emissions from UK businesses: The role of the Climate Change Levy and Agreements and to oVer its views on the carbon reductions within industry. b) Imperial Tobacco has been proving its commitment to tackle its contribution to climate change by reducing its global scope 1 and 2 emissions by 20 % since 2001, and more significantly, its UK scope 1 and 2 emissions by 49% over the same period. In comparison, the Government’s Energy White Paper commits to it to a reduction in CO2 emissions by 60% on 1990 levels by 2050; and, in the draft UK Climate Change Bill it sets out to achieve “real progress” by 2020, equating to reductions between 26 % and 32 %. We are currently well on track to exceed these targets. Our eVorts were recognized by a short list nomination by the Financial Times / Citi Private Bank Environmental Awards on 19 September 2007. c) We have achieved these savings in a regulatory framework that oVers us a considerably smaller financial incentive in comparison to other UK business through our inability—due to a technicality—to join a Climate Change Agreement (CCA). Imperial Tobacco is currently unable to gain access to a tobacco sector CCA because we are the only remaining UK-based manufacturer. We have thus far been unable to gain membership of another industry agreement. d) As a result, we are not exempt from paying the Climate Change Levy (CCL), which currently constitutes £125,000 a year. Despite this, we have achieved far more reductions than a lot of companies that participate within a CCA. We have reduced scope 2 emissions in our UK facilities by 100%, by purchasing only green electricity. Our reduction in scope 12 emissions from on-site fuel combustion in the UK amounts to 24% since 2001—a time when production increased by 8%. e) Since 2003, Imperial has purchased all of its electricity for its UK facilities from renewable sources. However, the increased demand for renewable electricity generation without an expansion of supply has resulted in a cost increase which could soon become prohibitive. In such a circumstance we would be forced to revert to purchasing electricity from non-renewable sources, resulting in an increased CCL payment of £370,000. f) There is more we could do to reduce our carbon footprint, but it is up to the government to provide a clear framework. It should be straightforward and non-discriminatory, and should replace the current multitude of constantly changing schemes such as CCA, CCL and the inclusion of low scale emitters in the EU Emissions Trading Scheme. It should also provide long term certainty for business so that the price of carbon can be integrated in longer term business planning cycles. g) If the government does not want to abandon CCA, then it should consider a system which allows companies otherwise unable to join their own sectoral CCA to access one, and thus to access the exemptions to paying the CCL. Our inability to access such routes of exemption from the CCL has led to it becoming little more than an extraneous and regressive business tax. Should the current system remain, we would be unfairly taxed a second time through the Carbon Reduction Commitment.

1. Company profile

1.1 Imperial Tobacco Group manufactures, markets and sells a comprehensive range of cigarettes, tobaccos, rolling papers and tubes. Since listing in 1996 we have expanded from being a predominantly UK business into the world’s fourth largest international tobacco company, with sales in over 130 countries worldwide. The composition of our revenues has changed significantly as we have invested in the sustainable growth of our business. 1.2 Throughout this transformation, we have remained committed to building a sustainable and profitable business while behaving as a good corporate citizen in all our operations. Our strategy is to embed the principles of corporate responsibility into the Group executive management practices and processes across all aspects of our business. Within this framework, climate change is one of five priority areas for our attention. The aim of our climate change strategy is to reduce our direct impacts by improving energy eYciency and to reduce our indirect impacts by influencing our partners in the supply chain. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 94 Environmental Audit Committee: Evidence

2. Carbon reduction strategy within Imperial Tobacco

2.1 Since 2001, we have made great strides in gathering environmental data as robust as our financial data. As a first step, we have rolled out environmental management systems certified to the ISO 14001 standard to all of our large and medium sized factories. This ensures the measurement and constant monitoring of quality data at site level. In 2006, we rolled out a web based reporting tool for reporting non- financial performance indicators. Every year our non-financial performance data are independently verified for inclusion in our Corporate Responsibility Review.

2.2 Such robust data has enabled the development of sound business cases in many of our factories for consumption and emission reductions. This has contributed to an estimated reduction of 11% in energy consumption and 20% in CO2 emissions in our portfolio of factories across the world since 2001. Another significant contributing factor has been the restructuring of production capacity.

2.3 In the UK alone, Imperial’s energy consumption went down by 13% while emissions (scope 1 and 2) went down by 42%. We achieved these reductions by purchasing 100% green electricity for all UK sites (scope 2) at the same time as reducing our emissions from fuel combustion by 24% (scope 1). These reductions took place against a background of an increase of 8% in production volumes in the UK, showing genuine energy eYciency improvements.

FY 00/01 FY 05/06

Total Energy consumption—GWh 176 154 "13% Total Energy consumption per mn cig equivalents —kh/mce 4,426 3,713 "16% Scope 1 CO2 Emissions—Tonnes 23,120 17,668 "24% Scope 2 CO2 Emissions—Tonnes 10,271 0 "100% Scope 1!2 CO2 Emissions—Tonnes 35,579 18,064 "49% Scope 1!2 CO2 Emissions per mn cig equivalents—Tonnes/mce 0.89 0.43 "51% Production Volumes (millions of cigarette equivalents—mce) 37,683 40,771 8%

2.4 All of our large and medium sized factories and oYces have been audited by an independent energy expert to identify and prioritize energy saving opportunities. In the UK, this applies to our factories in Nottingham and Bristol and to our Head OYce in Bristol. Savings opportunities identified in these reports have contributed to our suite of energy reduction projects.

2.5 Managing climate change is not only about monitoring CO2 emissions from energy consumption. The supply chain is an important source of scope 3 emissions and waste is an important contributor through releases of greenhouse gases. We have applied the same approach to waste management as to controlling emissions, resulting in a global reduction in 3% of total waste, and a very significant reduction of 32% in waste to landfill since 2004. 2.6. As the table below shows, in the UK alone, we reduced total waste by 17% between 2004 and 2006 and sent 44% less waste to landfill over the same period—significantly more than our global average reductions.

FY 03/04 FY 05/06

Waste sent to landfill—Tonnes 3,751 2,098 "44% Waste sent to landfill per mn. cig. Equivalents—Tonnes/mce 0.06 0.04 "33% Total waste—Tonnes 8,285 6,854 "17% Total waste per mn. cig. Equivalents—Tonnes /mce 0.15 0.14 "5%

We are also working with the Carbon Trust on a Carbon Management Scoping Study. This will investigate how we can embed carbon reduction even further as a metric in business decisions.

2.7 The tobacco sector generates less direct greenhouse gas (GHG) emissions than most other industrial sectors. However, indirect greenhouse gas emissions from tobacco leaf curing and distribution may be significant. As are most businesses, we are at the beginning of measuring and monitoring GHG emissions in our supply chain. We are currently taking part in the CDP (Carbon Disclosure Project) and the Supply Chain Leadership Collaboration Project (SCLC) alongside other major players in the retail and FMCG sector. These are intended to start the process of mapping our scope 3 GHG emissions.

2.8 On 19 September 2007, Imperial Tobacco was shortlisted for a Financial Times/Citi Private Bank Environmental Award for “The Greatest Improvement in Carbon EYciency Achieved by a Large Enterprise—Europe, Africa and Middle East”. This award was based on our global improvement in carbon eYciency in manufacturing by 21% since 2001. In the UK alone, our carbon eYciency improved by 51% over the same period. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 95

3. Climate change levy and climate change agreements 3.1 Imperial Tobacco is not part of a Climate Change Agreement, although this is not for the want of trying. CCAs are associated with industrial sectors. Since Imperial Tobacco is the only tobacco manufacturer remaining in the UK, there is no scope for a tobacco sector agreement. We have, of course, attempted to find a way around this problem, although other manufacturing sectors have not been willing to include us so far. As things stand, we have a Climate Change Levy cost burden of approximately £125,000 per year. This sum would increase under the CRC. The CCL is a tax on energy consumption, and not on carbon emissions. In the absence of energy reduction opportunities for ITG on the gas it currently consumes, there is no alternative for ITG to oVset its carbon footprint. The £125,000 charge therefore becomes little more than an extraneous and regressive business tax. 3.2 We disagree with the committee’s statement that the CCL appears to have had little impact so far. It may not be the eVect intended at the creation of the CCL, but there has been an increased demand for renewable energy without an increase on the supply side. As part of its voluntary CR strategy, Imperial Tobacco has been buying 100% electricity from renewables in the UKUsince 2003. Since then, the price has risen so significantly that renewal will become so prohibitive that we will be forced back to buying non- renewable electricity or payingUa premium ofUover £260,000 for green electricity. 3.3 Imperial Tobacco is currently exempt to pay CCL for its electricity consumption, but this may change, if we are forced back to use non-green electricity. This would result in an additional CCL charge of £245,000. 3.4 If the government wants to increase the oVer on renewable electricity, it should therefore not just implement policies that create demand but also put frameworks in place to make it a secureUand rewarding marketplace for private companies to invest in. One way of achieving this would be by removing existing barriers to investment in renewable energy in the planning system. It should also consider providing framework regulation to incentivise the generation of renewable energy by industry at large, by creating mechanisms that allow excess electricity from combined heat and power plants (CHP), solar panels, wind turbines etc to be fed back to the grid at a price equal to the purchase price at that moment in time. Imperial Tobacco is a signatory of the Cooperative Insurance Wind Energy Wish List. This can be viewed at http:// www.cis.co.uk/images/pdf/Wind Energy Wish List.pdf 3.5 We have an old CHP in Nottingham which we have ceased to operate as the price of gas has risen significantly. Therefore there is no more price diVerential between gas and electricity that made CHP a financially attractive proposition in the first place, nor is the business case there to upgrade the installation to “Good CHP” quality standards. 3.6 Government policies on the issue of incentives for renewable energy are forever changing. The schemes put in place by the Government have too often proved to be short-term measures which are replaced on expiry by new schemes. Government needs to recognise that business is willing to invest in carbon reduction and that by setting clear regulatory frameworks that would remain in place in the medium to long term, it would be able to adopt these frameworks into its long term planning cycles. For electricity providers to invest massively into renewable energy, investors need consistent policies over much longer periods. 3.7 This applies as well to the government’s enhanced capital allowances scheme. It allows the write oV of capital investments in energy eYciency projects in the first year. The scheme is a good start, but is generally known only to finance experts and would gain from receiving wider exposure. 3.8 Any real change in investment decisions can only come when renewable energy and renewable energy projects becomes exempt of VAT. The current combination of mechanisms such as CCL, CCA and EU ETS are now seen within Imperial Tobacco as overhead taxes and additional administrative burdens. They no longer provide eVective means by which a focus on carbon reduction can be achieved.

4. Carbon reduction commitment 4.1 Organisations with more than 25% of emissions in a Climate Change Agreement (CCA) would be exempt from the proposed CRC. The problem for Imperial is that CCA’s apply to specific industrial sectors. Since Imperial Tobacco is the only tobacco manufacturer remaining in the UK, there is no scope for a tobacco sector agreement. It is discriminatory that, under the CRC, other manufacturing industries could again be exempt from having to take any further action while Imperial Tobacco is not exempted solely because it is the only manufacturer in its sector. Having already incurred more of a burden than others, at the same time as having done so much to reduce our emissions voluntarily, Imperial Tobacco will be negatively aVected a second time due to this arrangement. 4.2 An absolute cap on CO2 would be useful as a mechanism only if introduced as a replacement for all existing schemes, including CCL, CCA and, possibly EU ETS for low and medium sized emitters. The existing policies, which also include EU ETS already come with an excessive burden of administration resulting in very little real carbon reductions. A better approach would be to introduce a single policy that covers all aspects of carbon reduction along with one set of reporting requirements, one set of targets and the need for a single annual verification event. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 96 Environmental Audit Committee: Evidence

4.3 Under the current proposal, the reference year is known to participants in advance. Participants will have the opportunity to inflate their consumption to obtain a larger cap because it is only based on a short period (one year). There is again a high risk of over-allocation of emissions as is the case in EU ETS—for this system participants were not even given prior notice of the reference year. Ultimately this could create another paper mountain that generates no real emission reductions. It would be preferable to base this on past consumption (as for EU ETS) or over a larger reference period that would prevent the short-term inflation of consumption. 4.4 Also, under the current proposals, there are fines for over or under reporting. If we are forced to employ third party services to verify emissions, we believe that any fine levied should be used to make these third party experts accountable for the quality of the data they verify. If there is no accountability for the third party suppliers to enforce them to guarantee the accuracy of our emissions, it is not clear what benefit they add to the process. 4.5 We will continue to seek opportunities to organise our business, integrate acquisitions and invest in ways that help the group to remain a low cost manufacturer, and see emitting less CO2 as an integral part of our core business values. 10 January 2007

Submission from the Confederation of Paper Industries

1.0 Executive Summary

1.1 CPI strongly believes that the implementation of CCAs has been a success for energy-intensive industry. Despite energy costs comprising a significant portion of a paper mill’s operating costs, and the associated incentives to reduce consumption, we believe that participation in the CCA has driven energy eYciency activities to achieve more than would otherwise have been the case. 1.2 Our sector’s participation in a CCA has focussed our activities to improve energy eYciency both at a collective and individual site level. The CCA has raised the profile of energy eYciency in the workplace both at board level and amongst mill personnel and the understanding of why it is an important and necessary objective is significantly greater now than it was 2000–01. By 2010, our sector’s specific energy consumption will be 40% lower than in 1990 if, as expected, we continue on our target path. 1.3 We now have a detailed and coherent energy consumption dataset for each of our mills (comprising monthly data from 2000) and this has given us, as a Trade Association, opportunities to analyse and separately to compare mill performances and to recommend improvements in monitoring and reporting. Our understanding of mill energy use is now excellent and this is a direct result of participation in the CCA process. This increase in understanding and increased ability to analyse energy data is, we are sure, common to other sectors. This, coupled with the collegiate approach of our sector to achieving the agreed CCA targets represents significant achievement for the sector on one hand and Defra on the other. The Defra achievement though, must be seen in its wider and more substantial context when recognising that originally 44 sectors were brought into CCA. 1.4 The NAO identified a concern that some businesses had benefited from the tax discount despite failing to meet their targets by relying on the over-achievement of others within their sector. We feel strongly that this is a false criticism. CCAs were originally set up and negotiated as sectoral agreements (unlike EU ETS which has individual targets for all installations) and it is precisely this model—where, provided the agreed target is met by the sector, a small number of installations can fail and yet still retain eligibility for the discount—that encouraged participation from every single paper mill in the country in our sector CCA. This model encourages participation whilst keeping individual performances confidential—which we feel is of critical importance in the competitive markets in which we operate. We ensure all mills do their best in meeting their individual targets by continually monitoring their performance and forecasting future outcomes; we will not tolerate mills that are not pulling their weight. On this basis, if the sector meets the agreed target then the Government’s objectives have been achieved and it is of secondary importance that some individual mills may, perhaps through no fault of their own, have encountered situations which have meant they have contributed less than others to the sector achievement. 1.5 We feel that a way of maintaining eligibility to the discount to the CCL by demonstrating continued energy or carbon eYciency improvements is necessary once the last CCA Milestone period has passed (September 2010). As it is not possible to base the discount for the CCL on EU ETS performance, we feel it is appropriate that the current CCA arrangements are reviewed and modified to allow continuation of a similar scheme post 2010. For planning purposes and good order it is essential that discussions on this subject should commence as soon as possible. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 97

1.6 If a CCA replacement must run in parallel with EU ETS then it is logical to continue with relative rather than absolute targets for CCAs. Almost all of our mills are in EU ETS and therefore already have absolute CO2 targets which they must meet. Targeting a CCA on a relative basis—ie having an eYciency- based target—will allow us more flexibility in how the industry meets the Government’s carbon reduction targets. 1.7 The increasing evidence supporting the need to reduce GHG emissions may indicate that a move to a relative target for carbon eYciency may be more appropriate than a relative target for energy eYciency. However this will require detailed examination as part of the post 2010 review. 1.8 In this review it should be recognised that the paper manufacturing industry, as others, suVers unnecessary administrative burdens resulting from its participation in both CCAs and EU ETS. Furthermore, the requirement to report energy consumption and carbon emissions as part of the PPC regime should be abolished.

2.0 The Confederation of Paper Industries 2.1 The Confederation of Paper Industries Ltd (CPI) works on behalf of the UK’s paper industries. It was launched in January 2000 and brought together four long-established industry trade associations—the Association of Makers of Soft Tissue Papers (AMSTP), the British Recovered Paper Association (BRPA), the Corrugated Packaging Association (CPA) and the Paper Federation of Great Britain. 2.2 CPI represents the whole of the paper chain starting with the recovery of used paper, papermaking, conversion into finished products and distribution. The paper-making sector, which includes the manufacture of pulp, paper, board and tissue, is the most energy-intensive of all the activities in our industry. 2.3 CPI, through the Paper Sector Climate Change Management Company Ltd, manages the papermaking sector’s Climate Change Agreement with Defra. There are 61 paper mills in the CCA at present, and our total primary energy consumption is of the order of 24 TWh per annum. 2.4 CPI’s website may be found at www.paper.org.uk

3.0 Response to Specific Questions Raised in the Call for Evidence

3.1 Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly?U If so, how should they be changed? 3.1.1 With the world-wide focus on GHG emissions there is a case for the CCL and CCAs to be changed to target (fossil) carbon emissions directly. However, we believe it is still appropriate for CCAs to be predicated on eYciency improvements rather than absolute caps (see 4.2 below) and therefore a CCA based upon tonnes of fossil CO2 emitted or energy used per tonne of production is still appropriate.

3.2 With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)? 3.2.1 EU ETS already introduces an absolute cap on emissions and this should not be repeated or duplicated by CCA. Furthermore, basing CCAs on an absolute CO2 emissions cap is unnecessary for the paper sector as almost all of our direct emissions are covered by EU ETS. It seems sensible, given that our industry is subject to several parallel climate change policy instruments, to allow one of them to be based upon eYciency improvements to give the widest possible flexibility in achieving the Government’s emissions reduction targets. 3.2.2 The focus on energy eYciency has worked very well over the six years that CCAs have been in operation. This focus allows industry to grow whilst at the same time improving its energy eYciency. In fact, growing industries are more likely to invest in the best and latest energy eYcient technologies than declining ones. A relative approach provides incentives for reducing product carbon footprints.

3.3 How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? 3.3.1 The CCA fits well with CCL as the means of incentivising energy reduction and improvement in eYciency. However, the paper manufacturing industry suVers unnecessary administrative burdens resulting from its participation in both CCAs and EU ETS. It is therefore important to minimise the burden of individual participation in both. This is best done by simplifying some of the administrative burden of CCA while also removing small emitters from EU ETS (but obviously retaining them in CCAs). 3.3.2 An example of the administrative burden of CCA is the complex “double counting” adjustment is being insisted on by Defra for sites in both CCAs and EU ETS predicated on the unproven theory that a site should not be allowed to benefit twice (or be penalised twice) from its performance in both schemes. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 98 Environmental Audit Committee: Evidence

This is a tenuous theory—especially for the paper industry where one scheme is based upon relative energy targets and the other on absolute emissions targets. This requirement will create a huge administrative burden for our sector for doubtful benefit and the need for such an adjustment should be reviewed. 3.3.3 The Environment Agencies require further energy reporting as part of the PPC permitting procedures which is yet another duplication—this requirement should be firmly excluded from the scope of PPC permits.

3.4 Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? 3.4.1 Trading is essential to ensure targets are met—provided there is a limited supply of allowances at an appropriate price this results in real energy or carbon savings. Trading mechanisms are eYcient and eVective because of this provision which allows required eYciency improvements or emissions reductions to be achieved at least cost. 3.4.2 Recent history shows the poor implementation of UKETS resulted in an oversupply of allowances causing the price to decline to a level that is now too low to drive significant energy eYciency improvements. Since the end of the direct participants scheme no new UKETS allowances can be generated by this route (allowances can now only be generated by CCA sites passing their targets and ring-fencing the surplus in the form of UKETS allowances) so the value of allowances may increase slightly. Clearly, lessons have been learned (from UKETS and from Phase I of EU ETS) and Phase II of EU ETS and any similar trading scheme must be designed in such a way that oversupply of allowances is prevented.

3.5 What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? 3.5.1 CCAs have delivered real savings to paper industry. We believe that participation in the agreements has focussed our drive for increased energy eYciency within the sector—the saving of 80% on a tax levied is a powerful driver to comply. The eVect of the CCL on those parts of our sector not covered by CCAs is diYcult to estimate but is unlikely to have driven significant energy eYciency improvements. The eVect of the CCL on the paper industry is certainly not revenue neutral—the rebate in the form of reduced NICs is worth little to a sector that does not employ many people. The cost of the administration and reporting in CCA on a sectoral basis is not insignificant, nonetheless it is cost eVective. 3.5.2 We cannot comment on the eVect on the wider economy other than to say that organisations that employ large numbers but have relatively low energy bills (eg large supermarkets) will tend to benefit from the NICs rebate as this may exceed their levy payments. This represents an unnecessary transfer of revenue from industry to the retail sector. Any review of the CCL should examine this area.

3.6 Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent? 3.6.1 See our comments in sections 4.1 to 4.3 above. 3.6.2 The targets for the CCA were subjected to rigorous examination by Defra prior to initial approval and subsequently at the first review when tighter targets were imposed for the remaining three target periods. Thus there is built into the CCA a process of continuous revision that we recognised as appropriate when negotiating the structure of the CCA. 3.6.3 It is clear that the easy wins have been achieved and the paper sector’s energy eYciency, whilst still improving, is improving more slowly as we move forward. There is a limit to what can be done in every industry—you cannot make paper and not use any energy to do so. Any revision of the CCAs should be a negotiated process with industry to ensure that targets are realistic and achievable but are still challenging.

3.7 What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? 3.7.1 In the paper manufacturing sector, energy costs have always been a significant part of our total operating costs and energy eYciency projects have always been implemented. Nevertheless, any investment in energy eYciency will always depend on the payback required. Participation in CCAs has increased the payback from energy eYciency projects, as did the high energy prices pertaining over the 2005–06 period. 3.7.2 One way in which the paper industry is improving its (fossil) energy eYciency and reducing its carbon intensity is by using biomass for heat and electricity production. This strategy should continue to be recognised and allowed in any revision of the CCAs. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 99

3.8 Products which can increase energy eYciency (such as insulating glass for windows) can be energy- intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything, should be done about it? 3.8.1 It seems sensible to consider allowing energy eYcient products to receive some form of tax discount—but this should be outside the CCA/CCL scheme. Perhaps this could be accomplished within the VAT regime.

3.9 Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments? 3.9.1 We have no evidence that ECAs have helped much as they only contribute a small benefit to overall project economics—and then only to businesses in profit. The paper sector’s operating profit was negative in 2005 and 2006.

3.10 The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how? 3.10.1 The Renewables Obligation is the appropriate policy instrument to incentivise generation from renewables and recently-proposed modifications to the numbers of ROCs received by diVerent technologies should improve its eVect. It is right that the CCL is not payable on renewable electricity but further incentives should not be granted through CCLs or CCAs.

4.0 Recommendations 4.1 CPI recommends that the Government takes urgent action to begin policy discussions on a scheme to replace CCAs when the final milestone period expires in 2010. Government should involve industry and existing CCA participants in such discussions. Given the wider policy issue that CCA address (namely CCL) it essential in our view that they continue. CCA have the prospect of giving an extra emphasis to energy/ carbon eYciency and complementing EU ETS therefore their continuation would entirely be in line with the Government intent to consider every avenue to contribute to reduction of CO2 emissions. 28 September 2007

Memorandum submitted by The Scotch Whisky Association

1. Introduction 1.1 The Scotch Whisky Association (SWA) is the trade body which represents the interests of the industry at home and abroad. Its main objective is to promote and protect the Scotch Whisky industry. 1.2 Scotch Whisky is important to the economy of Scotland and the UK as a whole. With exports contributing £2.5 billion to the balance of trade, Scotch Whisky represents 25% of all UK food and drink exports and supports 65,000 jobs. 1.3 Scotch Whisky production is closely linked to its natural environment, from distillery location to raw material supply. Protecting that environment is fundamental to ensuring future industry sustainability. Energy-eYciency is therefore a key area of industry activity, with SWA members investing in a range of improvements and energy-eYciency technology. As a result, the industry continues to successfully meet its Climate Change Agreement targets. 1.4 The SWA welcomes the Committee’s inquiry, and the opportunity to provide evidence on the Scotch Whisky industry’s experience of the Climate Change Levy and Agreements.

2. General Impact of Climate Change Levy and Agreements 2.1 The SWA is a member of the UK Emissions Trading Group (UK ETG) which represents a wide range of organisations involved in emissions trading schemes. We are aware that the UK ETG has made a comprehensive submission to the Committee’s inquiry and the SWA wishes to note its support for the position outlined. 2.2 Rather than repeat the contents of the UK ETG submission, we would therefore like to take the opportunity to focus our comments on one area of specific concern to the Scotch Whisky industry. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 100 Environmental Audit Committee: Evidence

3. Industry-specific Impact of Climate Change Levy and Agreements 3.1 Over 60 Scotch Whisky distilleries currently participate in the Climate Change Agreement (CCA) of the Spirits Energy EYciency Company (SEEC)—a joint venture between the SWA and The Gin & Vodka Association. Under this Agreement, at the last milestone, the industry has achieved a specific energy consumption (SEC) of 6.66 kWh/lpa against a final adjusted target of 6.75 kWh/lpa. SEEC participants have improved energy eYciency significantly with energy use per litre of alcohol produced some 13.5% below the 1999 baseline level. 3.2 There are a number of key stages in Scotch Whisky production, a process defined and protected in law under The Scotch Whisky Act 1988 and Order 1990. After distillation, the spirit (not yet called Scotch Whisky) is required, by law, to be matured for a minimum of three years in oak casks in Scotland. Upon maturation, the whisky may be blended with other whiskies and then bottled. 3.3 Production often—for reasons of history, geography and economics—does not take place on a single site. Many distilleries are, for example, located in rural locations, whilst blending and bottling operations take place at separate, central facilities. Despite this “separation”, the various stages flow from one to another through to the final bottling and dispatch of the product and, in that sense, the process is just as integrated as the manufacture of other food and drink products. 3.4 Unfortunately, however, packaging processes which are not co-located with distilling processes are excluded under the CCA eligibility criteria because it is deemed there is a physical break in the production process. This anomaly has resulted in a long-standing concern about the operation of the arrangements and faced Scotch Whisky producers with a competitive disadvantage. 3.5 A practical illustration might better illustrate the implications. One may imagine five bottles on the shelf of the local supermarket: one of ketchup, one of beer, one of spirits from an integrated distillery/ bottling plant, one of a fizzy soft drink and one of Scotch whisky from a distillery with no integrated bottling. It is inequitable that of all of these, only the last example would not qualify for Climate Change Levy relief on its bottling process. The Scottish AVairs Committee has previously called for the scheme to be reviewed to remove this anomaly (“The Drinks Industry in Scotland”, HC324, November 2001). 3.6 The Government and indeed the Trade & Industry Committee (eg “Impact on Industry of the Climate Change Levy”, HC678, 1998–99) have remarked on a number of occasions that the scheme should seek to minimise damage to international competitiveness. The CCA discount arrangements were specifically supposed to protect sectors exposed to international competition. We believe this is especially true in relation to the Scotch Whisky industry, given that 90% of its sales are overseas. 3.7 The industry’s bottling/packaging plants are well-defined, and specifically approved and controlled, as trade facility warehouses for spirits, under existing excise legislation. We therefore believe that it should be possible to describe them, for eligibility purposes, in such a way that would meet the requisite criteria for inclusion. 3.8 If such sites were eligible and able to benefit from the discount arrangements, it is estimated the cost of the Climate Change Levy to the industry could fall by around £0.5 million per annum, an industry saving of £3.5 million since the scheme’s introduction in 2001. 3.9 The Association continues to believe that the CCA eligibility rules should be reviewed to allow the range of similar industry facilities to benefit from the discount arrangements. To remove a competitive disadvantage faced by distillers, eligibility should therefore be extended to include all stand alone bottling and blending sites in the spirits sector. 28 September 2007

Memorandum submitted by the Food and Drink Federation

1. Introduction This response provides written evidence to the House of Commons Environmental Audit Committee in relation to the inquiry into the roles played by the Climate Change Levy (CCL) and Climate Change Agreements (CCA) in reducing carbon emissions and energy use by the UK business sector. This inquiry follows a new study by the National Audit OYce (NAO), prepared especially for the Committee.

2. Food and Drink Federation The Food and Drink Federation is the voice of the UK food and drink industry, the largest manufacturing sector in the country. FDF’s membership comprises manufacturers of all sizes as well as trade associations and groups dealing with specific sectors of the industry. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 101

We help our members operate in an appropriately regulated marketplace to maximise their competitiveness. We communicate our industry’s values and concerns to Government, regulators, consumers and the media. We also work in partnership with key players in the food chain to ensure our food is safe and that consumers can have trust in it.

A successful food and drink sector is a vital component of a healthy UK economy. For instance: our industry directly employs 500,000 people, and as many as 1.2 million in ancillary services; it accounts for 15% of the UK’s total manufacturing sector by value; and it is an invaluable partner to British agriculture buying two-thirds of what farmers produce.

3. FDF Climate Change Agreement

The FDF Climate Change Agreement has around 950 participating manufacturing sites that between them produce 36.5 million tonnes of food and drink products. This is a highly diverse industry and the following sub sectors are represented in the CCA: alcoholic drinks, baking and cereals, ambient foods, confectionary, frozen and chilled produce, glucose and starch, milling, oils and fats, pet foods, meat and fish, soft drinks and sugar. Energy is used for a very wide range of applications including, handling, conveyance, steam raising, frying, boiling, sterilizing, baking, chilling, freezing and packing. Further details of the energy eYciency and emissions reduction performance of the FDF CCA are given below.

4. FDF Comments on the NAO Report and Response to Inquiry Questions

We have structured our response by addressing the key conclusions reached in the NAO report (pages 5–6) making reference, where appropriate, to other section in the report. We then oVer comments on a number of the specific questions raised in the announcement of the Inquiry.

We also oVer full endorsement of the views and observations contained in the submission of the UK Emissions Trading Group of which FDF is an active member.

4.1 Climate Change Levy and Climate Change Agreements—General Comments

We are concerned about the overall tone and impression gained from the NAO report that overall the CCL has had a more positive benefit than the CCAs. This is a view we disagree with. Yes there was an announcement eVect based on the introduction of the CCL and yes there will be a price impact leading to greater focus on energy eYciency. However, we believe that over time these eVects will become diminished particularly given the volatility seen in energy prices seen since the introduction of the CCL.

The impact of the CCAs is a wholly diVerent matter. In our view the CCAs have introduced a very well balanced “carrot and stick” approach to improving energy eYciency and delivering carbon emissions reductions that the CCL “stick” alone would not have delivered. CCAs require companies to meet robust energy saving targets in return for receiving the 80% CCL discount. The eVect of this has been to; make participants focus on energy and emissions reductions at senior management levels; provide a framework to think about, develop and then deliver energy savings programmes; provide robust and ongoing energy and emissions data to allow progress to be assessed and monitored, and; created much greater awareness of support mechanisms that help then to achieve their targets and deliver emissions reductions. Very importantly CCAs have also reinforced business and competitive benefits through lower energy bills.

It is also worth noting the very high take up and support for CCAs within the food and drink manufacturing sector indicating the value placed on them by industry. Analysis conducted by The Carbon Trust indicates that 90% of the energy use in the sector is covered by the 12 CCAs in the sector (covering around 4800 sites). The FDF CCA is the largest covering around 950 sites and 53% of the sectors energy use. Of the remaining 10%, 8% is energy use at sites with Good Quality Combined Heat and Power who are CCL exempt and therefore would not benefit from a CCA. The last 2% is accounted for by ineligible sectors (such as bottled water) and SMEs whos energy consumption does not warrent participation.

CCAs have also stimulated activity within the industry through the development and delivery of emissions savings programmes designed to help participating businesses meet their targets. A good example of this are the two Carbon Trust funded projects managed by FDF looking at energy eYciency in refrigeration systems and heat recovery in canning factories. Between them energy eYciency savings delivering over 50 kTeCO2 emissions savings have been identified. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 102 Environmental Audit Committee: Evidence

Comments on NAO Summary

4.2 Most Agreements are designed to promote energy eYciency rather than absolute reductions in carbon emissions The overall FDF CCA targets are expressed as relative energy targets though individual target units within the agreement have the option to choose between relative or absolute energy or carbon targets. This flexibility was introduced to allow participants to address and improve energy eYciency without compromising competitivity and the future economic growth of the sector. This approach is not incompatible with delivering absolute reductions in carbon emissions provided that the rate that energy savings are achieved exceeds the growth within sector—as is the case for the FDF CCA. Some facts will illustrate this point. At the 3rd Milestone in 2006 the 839 target units (comprising 950 sites—some target units are comprised of more than one site) in the FDF CCA reported an improvement in relative energy eYciency of 14.0% against a target of 13.0%. Compared to the baseline for these target units an absolute reduction in emissions of 157 kTeCO2 was reported. Similar improvements in relative energy eYciency coupled to absolute emissions savings were reported at Milestones 1 and 2 and are expected for Milestones 4 and 5 in 2008 and 2010 respectively. However, the way that CCA data is collated and reported does not give the whole picture. This is because CCA reporting at a particular milestone only looks at the current sites in the CCA and how they have performed against their baseline but does not account for emissions savings achieves as a result of site closure and rationalisation. This very point is highlighted in the NAO report (page 18, Box 19, last point). We believe that the impact of the FDF CCA is therefore underestimated because of this. As we stated above, the 839 target units in the FDF CCA reported an absolute reduction of 157 kTeCO2 at Milestone 3 in 2006 compared to their baseline. The total amount of CO2 emissions reported at Milestone 3 was 5,867 kTeCO2. If we look back to Milestone 1 in 2002, and in particular to the baseline for Milestone 1, which informs us about the number of target units and their emissions in 1999, we see there were 919 target units emitting 6,604 kTeCO2. Thus if we compare the 1999 baseline with the position in 2006 the number of target units has fallen by 80 and absolute emissions by 737 kTeCO2. This is a considerably greater absolute emissions reduction than the reported headline CCA figures and supports the NAO observation of the underestimation of the impact of CCAs and the validity of site rationalisation as a means of improving overall energy eYciency and delivering emissions reductions. It is also interesting to note that over the period 1999 to 2006 the throughput of the sites rose 4.6% from 34.9 MTe to 36.5 MTe so the emissions savings do not appear, at first sight, to be at the expense of falling capacity or high levels of import substitution though further analysis would be need to fully investigate this. Clearly, this is an area for further and more detailed consideration to ensure that the full environmental benefits of CCAs are accounted for. Finally in this section, the last sentence alludes to the fact that some businesses have benefited from the CCL discount despite failing to meet their targets by relying on the overachievement of others within the sector. This is not the case in the FDF CCA. We operate our CCA in such a way that places the responsibility for meeting targets firmly with participating business—either by achieving energy savings or if needed using emissions trading. Conversely, those who overachieve against their targets are encouraged to retain their “overachievement” for their own benefit as opposed to donating it to the sector for the potential benefit of other.

4.3 The agreements are now forecast to achieve fewer savings than was originally planned, and Results reported to end 2006 suggest Agreements are making progress towards their forecast 2010 impact Based on the comments to the previous point and continued focus of energy eYciency within the sector we fully expect the FDF CCA to remain on target and deliver the expected results. We accept that in addition to the impact of CCAs, rising energy prices will influence and drive energy eYciency. Though if you conclude that rising energy prices will lower the expected benefits from CCAs—as in 2005 where prices doubled—you must also accept that CCA delivery would rise in importance in periods of falling energy prices—as during 2006 when prices fell back to early 2005 levels. The evidence suggests that CCAs continue to deliver consistent energy eYciency improvements despite widely fluctuating energy prices.

4.4 Not all targets have been as challenging as they could be The initial targets for the FDF were set based on extensive negotiation between Government and their advisors and FDF. It is true to say that determining tough, but achievable cost eVective targets was in many cases quite a diYcult task due to lack of solid information or a full understanding of energy use within a sector upon which to base a target. This was understood at the time so the 2004 and 2008 target reviews were built into the CCA process. At the 2004 review both FDF and Defra had a full set of energy performance data for the sector and a better understanding of energy use in the sector (Note that in the absence of the CCA we would not have has this information!). In practice the FDF CCA targets are first set at 11 diVerent sub-sector levels to take into account the huge diversity of manufacturing operations within the sector. At Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 103

the 2004 review the opportunity was taken to tighten the targets of the sub-sectors seen to be over performing resulting in an overall tightening of the FDF target from 12.5% to 15.1%. We continue to believe the targets remain challenging but achievable.

5. FDF Comments on Questions Posed by the EAC

3. How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? Around 60 sites within the FDF CCA are also covered by the EU Emissions Trading Scheme due to the fact they meet the inclusion criteria of having over 20MWth installed combustion plant. This has resulted in double regulation for a significant proportion of the emissions from these sites leading to additional administrative, data collection and reporting requirements as well as the need to develop and apply procedures to avoid double counting of emissions. Future development of policy should seek to address this overlap to simplify the regulation regime faced by these businesses. Sites are included in the EUETS due to regulation however if they wish to receive the CCL discount they need to participate in a CCA. This issue has been discussed extensively with Government and FDF would support changes to the regulations to allow EUETS participants to receive the CCL discount by fully discharging their obligations under the EUETS rather than having to participate in CCA as well.

4. Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? Access to an emissions trading regime was built into the operation of the CCAs from their inception as it provides a means for business to achieve energy savings and emissions reductions in the most cost eVective manner. Those who overachieve their CCA targets can either bank their overachievement against future Milestones or, after verification, sell their allowances in the market place to sites who cannot achieve their targets in a cost eVective manner. In essence fully linking the CCAs to an emissions trading regime allows CCA targets to met by business in the most cost eVective manner. This link with emissions trading should be fully maintained in any future CCA regime. At Milestone 3 in 2006 in the FDF CCA those target units who beat their targets “ring-fenced” allowances equivalent to 646 kTeCO2 whilst those who failed bought 324 kTeCO2 worth of allowances so the balance within the CCA is firmly towards overachievement and the generation of surplus allowances rather than overall reliance on the purchase of allowances to meet targets. (Note for clarification—ring-fencing refers to allowances held by overachieving sites that must have independent verification before they can be sold)

5. What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? Within the context discussed above that CCAs have focused business attention on energy eYciency we can note that the FDF CCA has delivered, at Milestone 3, a 14% improvement in energy eYciency. The financial value of this saved energy compared to the baseline is around £90 million per annum—clearly a large and valuable cost saving that benefits the profitability and competitivity of the UK food and drink manufacturing industry.

6. Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent? This question can be answered at two levels: FDF fully supports the CCA process and has found, in general, that the administration and management of the scheme both at a central and participant level has, by and large, been manageable. However, after operating the scheme for seven years experience points to a number of areas where the scheme could be simplified—such as the 90/10 rule, CCA16 reporting and the already mentioned overlap with the EUETS. More importantly the issue of the future of CCAs post Milestone 5 in 2010 now needs to be addressed by Government with some urgency. Clearly this is a major task encompassing as it will the need to build on the clear benefits and emissions reductions the CCAs have delivered to date, how they will interact (and not overlap) with policies such as the EUETS and the planned Carbon Reduction Commitment, how future targets will be set etc. FDF is most willing to be an active participant in this debate. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 104 Environmental Audit Committee: Evidence

7. What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome?

Discussion of this issue has been a major focus of the Defra sponsored Food Industry Sustainability Strategy which was published in 2006 and followed up by work within a series of Champions Group one of which focused on Energy and barriers to improving energy eYciency. The Energy Group report was published in May this year and has recently been out for public consultation. The full report can be accessed at: http://www.defra.gov.uk/farm/policy/sustain/fiss/energyclimate.htm FDF was a full and active participant in the development of this report and supports its conclusions. FDF recommends it to the Inquiry as providing a valuable contribution to this question. 28 September 2007

Memorandum submitted by British Glass Manufacturers’ Confederation (BGMC) and The UK Glass Manufacturing Industry The first part of this document provides a response to issue suggested by the committee and the second part comments on the NAO reports “issues for further scrutiny”. BGMC representative attended the ETG meeting of 19 September 2007 and BG generally agrees with the response, however this document refers to more specific issues within the sector.

1. Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed?

a) In the UK glass industry, due to a relatively stable fuel mix and with no process emissions currently taken into account, there is a clear correspondence between energy use and carbon emissions. The benefits of a move to carbon eYciency targets rather than energy eYcient targets could promote a move to fuels with a lower carbon intensivity, although the capacity for such moves in the glass industry is very limited. b) Use of carbon rather than energy would align more clearly with the European approach. Any potential inclusion of process emissions should take into consideration sector specific limitations relating to the manufacturing of process and national infrastructure eg mineral transformation, recycling.

2. With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)?

a) An absolute cap for a local area is not desirable in the context of a global market. The manufacture of glass products is driven by demand, and following significant improvements in furnace eYciency in recent decades, theoretical maximum eYciencies are being approached, the result being that emissions become closely coupled with production output. By capping energy or emissions of UK glass manufacturers, a limit is eVectively imposed on the amount of goods which can be produced without the purchase of carbon allowances. If it is not cost eVective to purchase said allowances, any excess demand for these products would then need to be met by import; decreasing UK caps could over time act to export UK manufacturing capacity to countries where costs are less. This is likely to involve manufacture in countries with less stringent environmental regulations, and import to the UK would also incur additional carbon emissions associated with the products’ journey to the UK. The net eVect is increased emissions on a global scale. b) The loss of key manufacturing sectors in the UK bodes ill for UK recycling capability. Currently manufacturing of glass places a major role in the UK infrastructure, price stabilisation and adding value to the diverted waste stream. The economic stability of the system would be significantly altered were manufacturing to decrease. c) In addition to this factor, glass manufacture is more energy eYcient when furnace output is maximised giving economies of scale. Any cap on emissions which requires a reduction in output in order to be met, would decrease furnace eYciency and therefore increase CO2 / tonne glass. d) It has been suggested that a facilitating policy to help struggling operators invest in energy eYcient technology be implemented, as well as, or in place of highly bureaucratic and penalising instruments. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 105

3. How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? a) The CCAs and the EUETS do not fit well with each other. This results in significant regulatory burden and duplication which make poor environmental sense (CCA23 double counting rules). The reporting years do not match and diVerent and overlapping emissions sources are included under each scheme. Targets are often relative in the CCA but only absolute in the EUETS, diVerentially encouraging eYciency through maximised throughput and capped production respectively. There are also diVerent rules within the schemes for how to deal with small amounts of fuel (eg de minimus limits) and exactly what activities are included, as well as other M&R guidelines discrepancies (eg use of metered versus billed energy consumption). b) The CCAs could be redesigned for EU ETS participants, so that only electricity and emission sources outside the EUETS were used as a measure of performance under the CCAs; however as things stand there is an issue concerning small amounts of fossil fuel which would not be caught under the EUETS and which it would be illogical, diYcult and costly to sub-meter. The 80% rebate would need to be maintained for all fuels used at the facility, be they under CCA or EUETS regimes, in order to protect UK industry, and promote energy eYciency / saving measures; this requires a Commission decision. Facilities not covered by the EUETS would need to be able to continue under the existing CCA regime, although the issue of mismatched reporting periods would need to be resolved. c) In order to ease the administrative burden for operators, post 2010, it may be advantageous to align CCA reporting times with EU ETS, thus enabling operators to justify that all fuels in the given time period are covered by one scheme or another. This would require review of reporting deadlines to Government. d) The criteria for CCA eligibility should be further expanded. It has now been recognised that the original definitions of “energy intensive” using the IPPC criteria, biases inclusion on the most polluting rather than necessarily most energy intensive operators. The criteria were expanded recently with additional EI sectors; however the number of facilities which can be included there under is radically limited when “international trade competition” rules are applied. This restriction eVectively means that many energy intensive installations remain ineligible, with limited incentive to reduce emissions. British Glass strongly agrees with the ETG position that energy intensivity be used as eligibility criteria. e) The Government’s proposed CRC must be carefully designed to ensure that it does not overlap with the CCA or EUETS regime coverages, or facilities already in those schemes. This is very important to prevent further regulatory conflicts between schemes for overlapping areas, such as those already seen between the CCAs and EUETS. f) Careful consideration must be given now in order that the CRC, which is explicitly not designed to encompass energy intensive industries, does not become a catchall if and when CCAs terminate. g) It should also be born in mind that electricity generated from fossil fuel is already covered by EU ETS and the costs are passed onto consumers in the form of higher electricity costs. This in its own right creates an increased incentive on users to reduce usage. h) Operators would prefer that instruments are simple and well thought out. It may be considered a better use of resources to divert the associated costs of implementing such complicated economic instruments to fiscally supporting development of energy saving technologies.

4. Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? a) Companies have ensured compliance through trading (purchasing allowances), as well as benefiting from their good performance (selling generated allowances). Whilst trading exists it should continue in this way, because it allows an overall reduction in emissions across a sector which can be made wherever is most cost eVective to do so; in accordance with market principles. b) The market should be suYciently robust to prevent a situation where the cost of carbon allowances decreases to the point where it is environmentally unrepresentative of the cost to stakeholders. A low price (such as that currently seen in the UKETS) provides little incentive to achieve actual emissions reductions as it oVers a cheap alternative to investing in new, more eYcient technologies. c) A reduction in the overall number of diVerent carbon markets would be welcomed.

5. What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? a) Whilst the CCL package was planned to be revenue neutral across industry and commerce, the glass industry felt an additional burden of some £2–3 Mpa. High energy costs are often cited as a reason for many of the recent closures in the glass industry and a further tax on energy adds to this strain. For multinational companies currently rationalising operations, the UK is seen as an unfavourable location to manufacture for several reasons, one of which is increasing legislation and severity of application of said legislation compared to other parts of the Europe and the wider World. ie there is not a level playing field. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 106 Environmental Audit Committee: Evidence

b) In addition to a tax burden, industry felt a personnel strain as key members of their staV struggled to understand the complexities of the CCA system. These are now well understood, but any new policies should not repeat this mistake. c) The impact of removal of basic manufacturing in the UK should not be analysed merely in terms of gross value added, but also within the framework of the stakeholder, transport, recycling and waste disposal chain.

6. Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent? a) The glass industry is in favour of splitting CCA targets as in 3b above. Additionally, regulatory complications such as the “90/10 rule” which do nothing to improve the environmental integrity of the scheme should be eliminated wherever reasonable. b) The drive to “reduce emissions” should not be simply translated into a tightening in sector targets without taking into account the technical possibilities and environmental benefits of products being manufactured. There is a real need for joined up thinking across all Government departments to prevent conflicts in the UK Climate Change Policy eg with building regulations, production of energy saving products and maintenance of sustainable practices. c) The glass sector CCA secures a saving of over £12 million pa for the glass manufacturing industry. Without the CCAs there would be further closures (20 of the original 52 facilities in the glass sector have closed since 2001 whereas only six facilities have joined the CCAs. This includes company rationalisation and facilities joining under the new Glass Manipulators EI sector). d) Without the CCL and CCA, it is likely that eYciency would continue to improve as high energy prices are maintained, however there would be no formal recording system to document the achievements made. e) The sector could not sustain entrance into the CRC as currently proposed. f) The sector would welcome fiscal incentive schemes to further encourage investment at a faster rate if possible.

7. What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? a) Glass melting requires a certain amount of furnace “holding” energy, even under the most eYcient operating conditions. Furnace eYciency decreases with furnace age as refractories wear; however, these will not be replaced with the latest technology during the 10–15 year life of a furnace. This is due to high capital investment and sound environmental principles (refractory production is itself energy intensive and so extension of material life is optimised. Sector targets should reflect a drive towards optimum plant eYciency, but not beyond, and allowance must be made for furnace aging and rebuild. Energy saving technologies such as VSDs etc. are already widespread in the industry, but do little to oVset the energy consumption in the furnace, the major energy centre. b) There is a serious lack of capital available to operators to invest in energy saving technology due to high energy costs and competition from low cost countries. Many operators would welcome the savings associated with improved equipment, but are unable to make an investment. EVorts to control energy prices should continue and increase and fiscal incentives could be oVered to encourage investment in new technology. Preceding the introduction of any such incentive scheme, there should be an open dialogue with each sector so that needs are understood and met. c) The container glass industry currently suVers from a shortage of good quality cullet (recycled glass). The melting of good quality, colour sorted cullet decreases the energy consumed in glass manufacture. This also reduces carbon emissions as carbon locked inside the raw material has already been removed in its initial manufacture. Whilst the weight of container glass collected for reuse has increased in recent years, proportionally less cullet has been sorted by colour and contamination has increased with a move to less costly collection methods by local authorities. It is therefore of little use to the container industry. This was a result of local authority waste targets which measure weight removed from landfill only and do not consider the requirements of the optimum recycler. Whilst other products, such as aggregates, have partially absorbed this waste stream and are thriving, it has taken away a valuable source of emissions reductions capability from the sector. This is an example of conflicting policies and highlights the unintended consequences of legislation and market forces. d) The manufacture of “green” products such as low emissivity architectural glass requires the additional coating of glass panes, which in itself requires additional energy consumption during manufacture. DEFRA are resistant to accommodating this additional energy in eased CCA targets, even though the life cycle carbon savings of the product far outweigh the additional energy involved in manufacture. That is, the addition of this technology by facilities has not been allowed for in the CCA eYciency targets. This is an example of non—joined up thinking in government policy where subtleties within specific areas can be lost under a “one rule fits all” approach. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 107

e) When considering “eYciency” in the glass industry we consider energy used per tonne of glass made. Many manufacturers of container glass are moving towards light weighting bottles in order to reduce raw materials wastage and energy consumption. The same number of bottles could then appear as less weight and a worse “eYciency”. In actuality, CO2 per bottle is reduced. Consideration should be given to taking into account relative carbon savings that do not fit comfortably under the CCA banner. These matters are of great concern to NGOs such as WRAP. f) A further complicating matter in the container industry is that marketing professionals are often uncompromising regarding the appearance of their product. Valuable work being carried out within the industry such as light weighting of bottles and investigation into increased recycled glass content (which can eVect colour purity) often meets strong opposition from brand owners who are adamant that a specific and consistent colour and a certain shape are necessary. Government product policy and incentives may be required to overcome such marketing inertia.

8. Products which can increase energy eYciency (such as insulating glass for windows) can be energy-intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything should be done about it?

a) As mentioned in 7c, the additional energy associated with making green products is an issue for the production eYciency of the flat glass sector. Fibre glass is another example, as it can be used both in building and vehicle insulation as well as in manufacture of wind turbines, lighter car bodies etc. Extra energy is often used at the manufacturing stage but consideration has not been made in CCA targets. A proper investigation into this issue should be conducted and government policy in all areas should address the findings in an integrated fashion. An easement of targets should be allowed in some instances, to recognise carbon benefits of certain products across their life cycles. Hypothecation of carbon benefits should be investigated. b) An alternative might be to oVer a further reduced rate of VAT on these products to encourage their use, although this would not counteract a move towards increased import. A further reduction in CCL rates for these products could also be considered.

9. Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments?

a) Currently this is of little use to the glass industry. This is because the list of eligible technology is very prescriptive and the majority of manufacturers had already implemented the appropriate equipment from the list prior to the introduction of the scheme. The current list may be more use to CRC participants who have historically been less likely to invest for cost reasons. b) If an operator is already paying little in tax due to poor profit margins, it would be diYcult to take advantage of such a scheme.

c) There should be more support for research and development and the feasibility testing of new technologies. d) It should also be recognised that if competition becomes more severe experience shows that the opportunity for joint action within a sector becomes less likely and more diYcult for a trade association to achieve.

10. The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how?

a) It is believed that there has been little impact so far because of limited renewable electricity supply in the UK. That generated is currently principally to meet the requirements of the generator’s ROC, and under current rules cannot also be discounted from energy consumption under the CCAs. In this context, there ought to be additional incentives for using renewable electricity, but more importantly for producing it, and this should be aimed directly at the power generators. b) Reducing the levy on energy to make products used in equipment for renewable projects would add incentive to growth in renewables from eg wind farms. 28 September 2007 Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 108 Environmental Audit Committee: Evidence

THE FOLLOWING SECTION ADDRESSES THE NAO REPORT ON ASSESSMENT OF CCA EFFECTIVENESS PAGE 7: ISSUES FOR COMMITTEE SCRUTINY i. Both the Levy and Agreements were designed to promote energy eYciency rather than absolute reductions in carbon emissions; this reflected government priorities following the 1998 Marshall report. In light of the Stern Review and draft Climate Change Bill, where do policies which focus on energy eYciency fit with those that target absolute carbon reductions directly? See 2. above. ii. The Levy has been a greater driver of change in energy-intensive industries than in those which are less energy-intensive. What role is there for a climate change tax in less energy-intensive sectors and how will it work alongside the Carbon Reduction Commitment? All UK businesses do pay the levy; obviously the greater the relative cost (and ability to pass on costs) the greater the impact. Eligibility in the existing and proposed schemes whether voluntary or mandatory, does not align with absolute carbon burden. There are inconsistencies, eg CCL rebates of 0%, 50%, 80%. Government has introduced complexity of initiatives which indirectly address the key issue but lack commonality. The usefulness of the CCL as a “stick” has been estimated time and again. Specific and relativistic targets linked to trading schemes, and the safety valve that they provide, have however proved their worth. Therefore the role of the levy for CRC organisations is highly questionable unless some form of discount is available. Thematic approaches in the EU also work towards this end. It is important that overlap between the CRCs and CCA be avoided. iii. Businesses have reported diYculties in reconciling the Levy and Agreements with the EU Emissions Trading Scheme. Can the policy mix impacting on businesses be simplified whilst still providing the required incentives? See Qs 3 & 6 above. iv. From the perspective of the taxpayer and competitive rivals, is it right that some businesses can be given a tax discount despite failing to achieve their Agreement targets? CCA are first and foremost sectoral agreements, to achieve overall targets set at sector level. As such if these targets are met, then the performance of individual target units is irrelevant. That is, the agreements are still achieving the planned eYciency improvements. However, where the sector fails its targets and an individual target unit which fails its target outright meets its obligations via risk management options (which reflect operating conditions on the ground) or through carbon trading, this represents a legitimate using of trading markets and other mechanisms which adjust targets to reflect the realities which companies deal with on the ground. It would be self contradictory to exclude the use of the market when it depends on demand. v. The Government has the opportunity to revise Agreements targets in 2008. What, if anything, should be done to tighten the targets for participating companies and industry sectors? How can government overcome the limitations in the way targets have been negotiated so far? See Q6. Essentially, targets should remain feasible. They should be split to accommodate interaction with the EUETS for relevant companies. Above all, Government should take into account the greater requirement for UK sustainability. vi. Should the Government conduct more analysis to assess the scale of any potential error in the total carbon savings figure generated from the results of the Agreements? The CCAs are a self verifying scheme. However, in an energy intensive industry such as glass a high degree of faith can be placed in the figures from the industry, as energy represents a very significant operating cost and as such this matter attracts significant scrutiny.

Recognising climate change as a global issue, it may be useful to compare the CO2 costs and benefits of various imports (manufacturing and transporting from abroad) against manufacturing in this country. Also, the energy consumed in the manufacture of energy saving products should be balanced against the life cycle emissions savings of these products. The outcome of both areas of study could give better context for the setting of targets under any climate change initiative and the penetration these products in the UK. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 109

vii. Carbon trading is becoming a more important way for businesses to meet their targets under the Agreements. What will be the impact if businesses purchase carbon credits (if they continue to be traded at low prices) rather than push for greater energy eYciencies? Is the large surplus of carbon credits, which could be used in future target periods, a problem? See Q4 above. viii. Businesses see long term uncertainty in government policy as a barrier to improving energy eYciency. Does carbon budgeting, as proposed in the draft Climate Change Bill, represent an opportunity to reduce uncertainty regarding the long term future of particular policy packages? What will be the long-term future of the Levy and Agreements? Long term uncertainty in government policy represents a barrier to improving energy eYciency as it does not support investment decisions, which play a key part in achieving emissions reductions. Carbon budgeting may help reduce uncertainty, but must take into account the global nature of climate change, and in this context, seek to maintain a well regulated but not penalised UK manufacturing industry base. ix. Products which when in use promote energy eYciency (such as insulating glass for windows) can be energy intensive to manufacture. Policies such as the Levy, Agreements and Emissions Trading Schemes can penalise manufacturers for making these products. Does the Government need to give greater consideration to this apparent conflict? See Qs 7 & 8 above. Government climate change policy needs to be integrated through the supply chain when making such targeting decisions, and not consider elements of that chain in isolation. Hypothecation of carbon savings back to would do much to ensure the continued production of these goods at highly eYcient installations close to the consumer base. Both relatively new blue sky and existing technologies and their manufacture must be supported by the government. x. Does it matter that econometric estimates of policy impact can vary widely due to changes in business as usual projections, even if policies are working as expected? In the case of the Agreements, what are the implications of the fact that taxpayers are receiving less value for the tax foregone? It must be recognised that estimates are exactly that. However, Government must seriously listen to and be advised by industry and commerce when making such estimates. Also, recognising the inherent uncertainty in such estimates, Government should take a realistic view when using these estimates to set carbon budgets and should not assume that the most extreme budget is necessarily achievable. In the context of the glass agreement, the tax payer receives excellent value against tax foregone, as all sector targets to date have been met. This is little consolation to the hundreds of people who have lost their jobs in the glass sector in the last few years.

Memorandum submitted by the Environmental Industries Commission (EIC) EIC was launched in 1995 to give the UK’s environmental technology and services industry a strong and eVective voice with Government. With over 330 Member companies EIC has grown to be the largest trade association in Europe for the environmental technology and services (ETS) industry. It enjoys the support of leading politicians from all three major parties, as well as industrialists, trade union leaders, environmentalists and academics. EIC’s Energy EYciency Working Group represents over 80 companies involved in providing advice and technology in the field of energy eYciency.

Introduction EIC believe that tackling the climate change impact of businesses is crucial if the Government is to fulfil its commitment to reduce UK carbon emissions by 60% by 2050. Furthermore, EIC believe that the Government has a crucial role in providing businesses with stable long- term incentives to invest in energy eYciency and carbon reduction. A coalition of thirty-six cross-party MPs and leading business and environmental organisations—led by EIC—recently launched a Joint Statement on Energy EYciency outlining 11 clear and achievable measures to help people and companies waste less energy. I enclose a copy of the Joint Statement for your information with a full list of signatories. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 110 Environmental Audit Committee: Evidence

Climate Change Levy The Climate Change Levy was established to encourage the business and public sectors to improve energy eYciency and reduce emissions of greenhouse gases through a price based signal on energy usage. The Levy is a tax on businesses’ use of energy, designed to promote energy eYciency and thus generate reductions in carbon emissions relative to business activity. It was not designed to promote absolute carbon reductions. Nor was it supposed to act as an incentive to make primary energy generation less carbon intensive—it taxes energy consumers rather than suppliers. The National Audit OYce report “The Climate Change Levy and Climate Change Agreements: A Review by the National Audit OYce” recently concluded that the Climate Change Levy is expected to achieve annual carbon savings of 3.5 million tonnes by 2010—this is up from the Government’s original estimation for two million tonnes of savings. EIC believe that the Climate Change Levy is an important tool to improve energy eYciency in the commercial sector, however Members believe that the Levy should be reformed to improve its eVectiveness.

A Carbon Levy The Levy was designed to promote energy eYciency rather than absolute reductions in carbon emissions. This does not provide incentives for businesses to switch to low carbon sources of energy. EIC believe, therefore, that a Carbon Levy that is more closely linked to carbon emissions should replace the Climate Change Levy. EIC believe that this will provide the right incentives for investment in low-carbon technologies.

Levy Escalator As part of this year’s Budget the Chancellor announced that from 1 April 2008 and until at least 2010–11, the standard rate of landfill tax would increase by £8 per tonne each year. EIC believe that next year’s Budget should include a similar forward look at the price of the Climate Change Levy with a commitment to increase the cost of the Levy year-or-year for a minimum period. EIC also believe that the proposed Climate Change Committee, which would be established under the Climate Change Bill, should be consulted on the appropriate cost of the Levy.

Supplier Obligations The Climate Change Levy does not place any obligations on suppliers of energy to business—it taxes energy consumers rather than suppliers. Therefore, it does not act as an incentive to make primary energy generation less carbon intensive. One of the Government’s key measures for reducing carbon emissions in the residential sector is the Energy EYciency Commitment (EEC). Under the scheme electricity and gas suppliers are required to achieve targets for the promotion of improvements in domestic energy eYciency. EIC believe that a similar scheme should be established for the commercial sector. The Government has proposed reforming the Energy EYciency Commitment into a new Carbon Emission Reduction Target, which will reflect a new focus on reducing carbon emissions. EIC believe that a suppliers’ obligation in the commercial sector should use a similar framework.

Climate Change Agreements Climate Change Agreements allow energy intensive business users to receive an 80% discount from the Climate Change Levy, in return for meeting energy eYciency or carbon saving targets. Defra recently published the report “Climate Change Agreements: Results of the Third Target Period Assessment” which concluded that the industries covered by the Agreements reduced their carbon dioxide emissions by 16.4 million tonnes in 20060–7 million tonnes of these savings were in addition to those savings projected under a business-as-usual scenario. The aforementioned National Audit OYce report states that Climate Change Agreements are expected to achieve fewer additional savings than was originally estimated. The latest projections suggest that additional savings by 2010 will only be 1.9 million tonnes of carbon, this is despite the original estimation being annual savings of at least 2.5 million tonnes of carbon. Furthermore, the report concludes that many of the targets under Climate Change Agreements were too weak. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 111

EIC’s Members, who have great experience advising business on energy eYciency, have regularly informed Ministers since the introduction of the Agreements that the potential for savings in the sectors covered is much greater than reflected in the Agreements. We, therefore, fully, agreed with this conclusion.

Targets EIC believe that it is crucial to ensure that the commercial sector makes a proportionate contribution to meeting the UK’s target to reduce carbon dioxide emissions by 60% by 2050. Therefore, the targets set by Climate Change Agreements must be, at the very least, aligned with the UK’s emission reduction targets in the proposed Climate Change Bill. In order to achieve this, EIC believe that the proposed Climate Change Committee, which would be established under the Climate Change Bill, should be consulted on appropriate targets in Climate Change Agreements. Furthermore, the Committee should have the power to propose amendments to tighten the targets as new evidence on the eVects of climate change and the levels of reductions required become available.

Enhanced Capital Allowances EIC believe that it is crucial to ensure that tighter targets under the Climate Change Agreements are backed up with appropriate measures to help businesses improve their energy eYciency. EIC believe that this should include 150% Enhanced Capital Allowances (ECA) for innovative new energy saving technologies.

Additional Measures for the Commercial Sector EIC would like to take this opportunity to briefly cover some of the other measures our Members believe are crucial for reduction the climate change impact of the commercial sector.

Carbon Reduction Commitment EIC believe that the Carbon Reduction Commitment (CRC)—a mandatory cap and trade scheme to reduce carbon emissions from large non-energy intensive organisations such as supermarkets and banks— has the potential to be an eVective mechanism to tackle carbon emissions from the large non-energy intensive sector. However, the CRC will only achieve 1.2 million tonnes of carbon emission reductions from large non- energy intensive organisations per year by 2020—equivalent to only a 6% reduction on total emissions from the sector. This is despite the recent European Commission Action Plan for Energy EYciency concluding that there is technical and economic potential for saving 30% of energy in commercial buildings. Furthermore, the CRC will only target emissions from energy use by organisations whose mandatory half hourly-metered electricity consumption is greater than 6000 MWh per year. This is despite the original proposal recommending that organisations with electricity use ( 3,000 MWhr / year should be covered by the CRC.

Energy Performance Certificates The Government recently published the Energy Performance of Buildings Regulations, which implements Article 7 of the Directive, which requires Energy Performance Certificates to be displayed in buildings over 1,000m2 occupied by public authorities and by institutions providing publicly funded services to large numbers of persons. Furthermore, the Regulations state that Energy Performance Certificates will be required for the sale or rent of buildings other than dwellings with a floor area over 500m2 and on construction for all non-dwellings. However, they are not required to be displayed in these particular buildings. EIC believe that the Energy Performance of Buildings Regulations should be expanded to require all major commercial buildings to display an Energy Performance Certificate.

Code for Sustainable Buildings The Code for Sustainable Homes is intended as a single national standard to guide industry in the design and construction of sustainable homes. The Code was originally intended to cover all buildings, however it was watered down during the consultation process to only apply to new homes. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 112 Environmental Audit Committee: Evidence

EIC believe that the Code should be extended to all new buildings at the earliest opportunity with a mandatory requirement for buildings to be rated against the Code. September 2007

Memorandum submitted by PricewaterhouseCoopers LLP In response to the Committees invitation to comment on reducing carbon emissions, the climate change levy, and its associated negotiated agreements, we thought it useful to refer the Committee to two pieces of work undertaken by PricewaterhouseCoopers LLP (PwC) in the past year. They do not address all of the more specific issues raised by the inquiry, but may be considered helpful commentaries on the mix of economic instruments available for government to tackle the environmental agenda, to give some insight as to the perceptions of business on climate change as a business issue, and how on it is impacting business strategy.

1) The world in 2050: implications of global growth for carbon emissions and climate change policy 1.1 Last year PwC published this report which showed that emissions might more than double by 2050 on certain baseline assumptions. To protect the climate we estimated that global emissions would need to reduce significantly and addressed a number of scenarios (seethe report attached). There is also a comparison to be made with the findings of the Stern report which suggests that ultimately stabilisation, at whatever level, requires that annual emissions need to be brought down significantly at a global level by 2050, with the major developed economies (in particular the US and the EU) taking the lead in this process. 1.2 Our report indicates that a viable strategy to achieve the reductions required involves three broad strands: — a greener fuel mix with more focus on natural gas, nuclear and renewables; — energy eYciency and conservation particularly for vehicles and buildings; and — investment in carbon capture and storage. 1.3 We recognise that the principal economic instruments available to assist such a strategy are: — carbon taxes (and hybrids such as the climate change levy, a tax on energy)—designed to impose tax on the source of pollution at a level which represents the cost to society of the pollution (the externality); — carbon emission trading—setting a cap for the overall quantity of what is perceived to be an acceptable level for emissions, and allows the market to set the price; and — induced technological change, including the implementation of a wide mix of policies to assist with investment, and encouraging private investment, promoting research and development and the sharing of technology. 1.4 Initial conclusions with regard to these instruments are essentially that; the EU Emissions Trading Scheme (EU ETS) has been helpful in establishing a market for carbon and therefore a market price, but that to make the scheme eVective there will have to be further reductions in the number of free allowances available (as is now anticipated in phase 2 of the scheme); also that carbon taxes or hybrids such at the climate change levy, continue to face practical and political diYculties that are perceived to blunt their eVectiveness. Further detailed research in the UK, to evaluate the relative merits and experience of taxes when compared with market based trading schemes such as the EU ETS, would be useful.

2) Saving the planet—can tax and regulation help? 2.1 As mentioned in the National Audit OYce (NAO) report, the climate change levy and agreements were the first major climate change policy package aimed at UK business. However, over the last few years a number of additions and changes have been made to the environmental tax and regulatory system including a number of new taxes, the use of some existing taxes (which would probably not have been labelled “environmental taxes” when they were first introduced), the development of specific incentives within the fiscal system (such as enhanced capital allowances and reduced VAT rates) and finally substantial new regulation such as the EU ETS and obligations under other European directives dealing with waste packaging and waste electrical and electronic equipment (WEEE). 2.2 In light of the increasing presence and impact of such environmental taxes and regulation, PwC published the results of an independent survey in July 2007 (copy attached) which was aimed at exploring and understanding the perspective of UK business on the existing regime that it has to comply with. The survey involved 151 telephone interviews with key decision-makers from UK business (undertaken between 10 April and 23 May 2007) plus 10 in-depth interviews with a cross section of businesses. The views expressed are therefore those of the businesses that responded to the survey and do not necessarily reflect those of PwC. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 113

2.3 The survey shows that the growing environmental tax and regulatory regime has forced businesses to address environmental issues. They have a requirement to understand and comply with the rules and regulations that have been implemented. 97% of respondents indicated that they believe climate change and environmental issues need to be addressed by business. Some further particularly relevant parts of the report are as follows: 2.4 With regard to the question of whether it is better to have an instrument which enforced absolute caps in energy use (or CO2 emissions): Complying with legislation and regulation is seen by most of the respondents to our survey as the primary driver in encouraging them to address environmental issues. There is an appetite for business to address these issues and the report identified five main ways in which government policy can impact a company’s environmental behaviour: regulation, tax charges, tax incentives, market trading schemes and facilitating voluntary agreements. When asked what preference there was for these instruments in terms of how eVective such tools are in changing corporate behaviour, tax based tools such as the climate change levy were considered to be more eVective by business than market trading based mechanisms, where an absolute cap is enforced. We can speculate as to the reasons for this apparent preference: — It is perhaps that business believes tax based tools provide more certainty for their commercial operations than the trading schemes currently in operation, bearing in mind recent experience with the EU ETS and the volatile carbon price that was a feature of phase I of the scheme. Taxation and incentives potentially oVer the certainty that business is looking for here. The findings suggest less support for market trading schemes. Only 9% of the full sample said these are very eVective, 38% said they are fairly eVective and 14% of all respondents said that they did not know enough about market trading schemes to answer the question. — Lack of awareness and the perceived complexity of the EU ETS may be further reasons for the poor perception currently held of trading schemes. That said, it should be noted that the minority of companies surveyed who are already participating in the scheme, all support it.

2.5 The inquiry asks how well enhanced capital allowances are working in terms of the objective to encourage firms to make energy saving investments. How well do they it fit with other existing or proposed climate change instruments? UK business believes that tax incentives can be an important tool in encouraging changes in behaviour, but feels that the current environmental incentives on oVer are unclear, complex and fail to motivate behavioural change. The survey indicates that 94% of respondents agree that government needs to oVer more incentives to encourage companies to invest in environmentally beneficial practices. Of the seven incentive schemes mentioned in the survey, the one most used was enhanced capital allowances. 40% of respondents indicated that they had taken advantage of these allowances. In a separate survey of privately owned companies undertaken by PwC last year (which included a range of companies down to the very small), the take up was much lower at 10%, and interestingly only 23% of those indicating they had used the allowance stated that it had influenced their business decisions. In an update to this survey, due to be released on 2 October, the percentage using the relief has reduced to 8%, but those stating it had influenced their business decisions has increased to 35%. If government is serious about the environmental objectives and the targets that have been set, then it will be important for green initiatives to be properly incentivised. A good example which is currently being addressed by government and industry are the projects to help facilitate carbon capture and storage, potentially using depleted North Sea oil and gas fields for such storage. The economics of these projects are still challenging, and it is clear that it will be necessary to modify the existing tax system to ensure that the necessary research, development and investment takes place. This will include the need to ensure capital allowances currently granted under the North Sea tax regime are not unnecessarily re-captured where there is a change of use of assets previously used to exploit and produce oil and gas reserves, and also that enhanced allowances for research and development are clearly available for the research and development that needs to be pursued.

2.6 A Final point Although not a question specifically raised by the inquiry, a relevant and important point worth mentioning concerns the trust that business needs to have in the direction of government policy. The PwC survey identified that 51% of respondents are not confident in making long-term business and investment decisions in light of the current UK environmental framework, suggesting that any new taxes or changes made to existing taxes need to be implemented in such a way that business confidence in making long-term investment decisions is secured. In order for business to fully engage and commit to an environmental strategy implemented by government, they need certainty and long-term consistency in policy decisions that stretch beyond the term of a parliament or indeed of a particular government. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 114 Environmental Audit Committee: Evidence

The findings of the survey clearly point to support for taxation as an instrument to assist government policy in dealing with climate change, provided that it is clearly targeted and the revenues are used to incentivise green behaviour. While the results of our survey show that UK industry believes that economic instruments can be used to achieve environmental objectives and in a way that does not hinder competitiveness, 75% of respondents view it as very important and a further 18% as fairly important that monies raised from environmental tax and regulation should be directed into green initiatives, or in other words, that they are ring fenced in some way. One third (34%) of respondents are not at all confident and a further 51% not very confident that monies are currently being directed to green initiatives, suggesting that there is a degree of trust and confidence which still needs to be fostered with business. Business needs to buy into government policy, to believe that it is seriously trying to change behaviour and that its policies are not just designed to raise more revenue or, if they are, that they are assisting the achievement of environmental goals by funding bespoke government environmental objectives and projects. In 2001, the UK’s climate change levy was introduced and this funded a 0.3% reduction in employers national insurance contributions and £150 million of additional support for energy eYciency measures. The aggregates levy was introduced in 2002 with part of the revenue raised used to fund the new sustainability fund and the remainder again being used to reduce employers national insurance contributions. Taxes that tackle specific market failures, such as landfill tax and climate change levy, are viewed by business as eVective in helping to change corporate behaviour. Revenues raised from such taxes can be used to reduce taxation on the “good” activities such as labour, but neutrality can also be facilitated by directing revenues raised from environmental taxes towards green expenditure. The perception of business is that there needs to be more eVective measures in place to ensure that taxes and what they are spent on are targeted correctly, ie to ensure that the polluter pays and that “good” behaviour is encouraged. 28 September 2007

Memorandum submitted by British Lime Association (BLA)

British Lime Association The BLA is a constituent body of the Quarry Products Association Ltd., the trade association for the aggregates, asphalt and ready-mix concrete industries. The BLA represents the interests of six member companies, responsible for producing more than 95% of the lime sold in the UK. The BLA members are Tarmac Buxton Lime & Cement, Hanson, Steetley Dolomite, Lhoist UK, Singleton Birch and Totternhoe Lime and Stone Co. Ltd. The BLA is also a member of the European Lime Association (EuLA) and represents the interest of Corus, British Sugar and Specialty Minerals on issues relating to Emissions Trading and Climate Change Levy Agreements.

General Comments — For many years, the BLA has recognised the importance of its role in addressing climate change, and the responsibilities assumed by energy-intensive industry to identify carbon abatement opportunities within their sectors. Early action has already been demonstrated by the UK Lime Industry, and many other energy-intensive sectors, following significant investment made in the 1990s. Additional savings continue to be made from meeting the challenging targets set in Climate Change Agreements and EU Emissions Trading Scheme. We support the continued use of CCL and CCA’s to reduce energy consumption, drive eYciency improvements and increase competitiveness. The BLA believes that there needs to be a greater recognition that the CCA’s have been a genuine success. — As an energy-intensive industry, the 80% CCL rebate that the CCA’s aVord to the lime industry is extremely important in maintaining competitiveness. Consequently, the removal of this provision for rebate would have major impacts for BLA members. — The report questions whether future reductions in energy use driven by CCA’s will be as significant. In the lime sector the CCA’s will continue to be a key driver in the reduction in energy use and the move towards the use of renewable energy (alternative fuels). — UK industry is over burdened with an excess of instruments relating to climate change. BLA members are subject to the Climate Change Levy, (and the associated Agreements), the EU Emissions Trading Scheme (EUETS) and potentially the Carbon Reduction Commitment (CRC). The CCA’s have increased complexity to the sector and ways to simplify them should be explored. — The overall tone of the document understates the importance attached to CCA’s/CCL by the lime sector. They have led to new energy eYciency initiatives, better energy consumption awareness within companies and sector/government networking and initiatives. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 115

Specific Comments

1. Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed?

It is important that any future CCL changes take care to ensure that there is continuity in regulatory incentives which have driven long term investments. While we do not therefore support radical change, we believe that the eYcacy of the CCL would be enhanced if it were developed to reflect carbon emissions rather than calorific value. This would then be consistent with the need to make a transition to a low carbon economy. However, CCL is the UK response to the Taxation of Energy Products Directive. Therefore changing the focus from energy use to carbon may prove diYcult, as the Directive doesn’t have any direct relationship with carbon.

The BLA has serious concerns that the CCAs are not being given due credit for the environmental benefits they have achieved. The NAO report suggests that the targets were too easy. However, all CCA targets are agreed on the basis that they reflect “all cost eVective saving measures”.

We support the government’s decision to let the current CCAs run their full course to 2013 as this gives time to plan their successor. However, we are concerned that formal consultation on the future of the CCAs is being delayed until 2008. Lime companies have very long asset life cycles so it is important to have certainty to inform on long term planning decisions. The BLA would welcome an early indication from Government on the future of CCL and CCAs.

2. With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)?

Part of the success of the CCAs has been due to their use of relative targets which ensure that energy eYciencies are achieved without imposing a growth penalty. A growing healthy manufacturing sector is vital to sustaining jobs and the economy and relative targets also help to ensure that all sites, irrespective of size, have an incentive to improve. If the targets were in absolute terms then smaller sites would not appear to be making a significant improvement. The BLA would favour the continuation of relative targets instead of absolute.

3. How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap?

There are too many economic instruments. It is counter-productive to impose more than one instrument in order to achieve the same or very similar objectives. This is currently the case for many of the energy intensive industries, which are subject to the UK CCL and EU ETS. The matter will be further exacerbated should they additionally fall within the ambit of the proposed Carbon Reduction Commitment. It is important that organisations which are in a CCA or the EU ETS are not covered by CRC as well.

The overlap between CCA’s and EU ETS places significant burden on lime producers and results in complex calculations to resolve issues of double counting. This overlap should be removed. Energy intensive industries covered by EU ETS should automatically qualify for the 80% CCL rebate.

4. Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled?

Trading has been a very useful element on the CCAs. Without trading many facilities would find it impossible to meet targets, so it is imperative that the trading element remains.

By definition, emissions trading mechanisms work by trading to meet compliance. Trading provides a flexible mechanism which allows emissions across businesses to be secured at least cost while ensuring that overall environmental objectives are met. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 116 Environmental Audit Committee: Evidence

5. What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? We are not able to provide exact data at this stage, but the impact of a removal of the 80% rebate would have a serious impact on the competitive position of lime companies.

6. Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent?

It would be sensible to make a full move to carbon based targets, reduce overlaps with other instruments and make CCAs and other instruments in the policy mix more consistent. The current CCAs already include provision to review targets every four years to take account of changes in circumstances, such as new technological developments. The 2008 review will give both industry and government a further chance to ensure that the last target reflects changes within those sectors and understanding of achievements to date. The BLA would support the new, independent Climate Change Committee advising government on the review to ensure the right balance is struck between contributions from early starters in CCA sectors and other sectors of the UK economy, where there may be more cost eVective potential.

7. What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome?

Uncertainty about the future climate change policy mix also represents a barrier to improving energy eYciency. In the longer term it is diYcult to anticipate additional changes as a result of climate change policy. There is considerable uncertainty about the future shape of EU ETS and CCAs post-2012 and whether these systems will be part of a multilateral or unilateral framework for addressing climate change. This uncertainty is inhibiting investment decisions.

8. Products which can increase energy eYciency (such as insulating glass for windows) can be energy-intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything, should be done about it?

BLA members produce products that provide some of the solutions to climate change (eg Flue gas desulphurisation and the re-absorption of CO2 by lime in many applications). Consideration must be given to the whole life-cycle analysis of products with environmentally beneficial uses.

9. Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments?

The take up of Enhanced Capital Allowances (ECA) has not been as comprehensive as envisaged. The scheme is seen as complex and restrictive, with not all energy eYcient products qualifying for inclusion to the list. 30 September 2007

Memorandum submitted by the British Plastics Federation

1. Who We Are

The British Plastics Federation was founded in 1933 and is the World’s oldest plastics association. Our 300 plus member companies are drawn from: polymer and additive producers; processors; distributors; machinery and equipment and recyclers. The BPF represents 80% of the £17bn UK sales turnover and the 170,000 employees in the UK plastics industry. The Plastics industry’s main markets are: packaging; building and construction; transport; electrical and electronic. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 117

The Plastics industry has in total 5,000 companies, most of them very small. The vast majority are not energy intensive or a pollution risk. There are a number of diVerent plastic processing methods.

2. Energy Efficiency in Plastic Products and the Plastics Industry The plastics industry only consumes 4% of the world’s oil production as feedstock. The rest is used for energy and transport. The production of most plastic products is not energy intensive compared to metals, glass and paper. Plastic products play a major role in saving and conserving energy and power safety. — 22% of an Airbus, A380 double-decker aircraft is built with lightweight carbon fibre reinforced plastics, saving fuel and lowering operating costs by 15% — 105kg of plastics, rather than traditional materials in a car weighing 1,000kg, makes possible a fuel saving of 750 litres over a lifespan of 90,000 miles. This reduces oil consumption by 12 million tonnes and, consequently, CO2 emissions by 30 million tonnes, in the European Union. — BMW in its 6 series Coupe uses a rear boot lid made of composites and thermoplastic front wings. This has saved 100 kilos in weight. — Without plastics, packaging weights could increase by as much as 400%, production and energy costs could double and material wastage increase by 150% — Renewable energies rely on plastics (pipes, solar panels, wind turbines, rotors) — PVC-U double glazed windows and doors are essential for an energy eYcient home. They have a 35 years life and are easily maintained. — Expanded Polystyrene (EPS) Insulation has a key role to play with the heating and cooling of buildings accounting for half of Europe’s total energy consumption. — Plastics do not conduct electricity so PVC is widely used to insulate wiring, while thermosets are used for switches, light fittings and handles — A plastic carrier bag weighs six times less than alternative materials — Use of plastic bottles rather than alternatives leads to savings of up to 40% on distribution fuel costs, and saves on transport pollution. — Sainsbury’s new 75cl PET wine bottle weighs 50g compared to 300g for a glass bottle Energy use by the UK Plastics Industry has fallen substantially since 1990 but simultaneously that used for transport, households and services has risen by 15%. On average most plastic companies are not energy intensive and hover around 3% of production costs being energy. They are also not IPPC sites. 3% is the minimum level at which a company can be eligible to be in a Climate Change Agreement (CCA) but must also meet additional criteria such as involvement in a market with 50% import penetration.

3. The BPF’s View On Climate Change Levy (CCL) Our member companies view this as an unfair and unpopular tax which discriminates against the plastics industry and harms our competitiveness at home and abroad. Unlike other materials such as metals, paper and glass, the vast majority of our companies do not qualify for a Climate Change Agreement with an 80% discount on the CCL. Some examples of CCL’s impact: — A major British owned packaging firm, with factories overseas, pays almost £1million a year in CCL. — A producer of plastic pipes is paying £150,000 pa in CCL. — An Expanded Polystyrene packaging producer is paying £80k pa in CCL. — A small injection moulder is paying £70k pa in CCL. — Plastics recycling companies are hit hard by CCL and pleas to exempt them have been ignored. Over many years the BPF has called for CCL to be scrapped and replaced with voluntary agreements with industrial sectors to achieve annual energy saving targets.

4. The Adverse Impact of CCL On the UK Plastics Industry’s Competitiveness Lord Marshall who produced a report on taxing business use of energy in 1998 for the Treasury, which led to the introduction of CCL, stated, “any measures must be subject to careful design in order to protect the competitiveness of British industry”. Unfortunately HM Treasury did not make Competitiveness one of its four tests for CCL. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 118 Environmental Audit Committee: Evidence

France rejected bringing in an industrial energy tax. Many other EU countries do not have such a tax. The increase in CCL in April came on top of the UK having the highest energy prices in Western Europe, worsening our competitiveness. Plastics have a competitive disadvantage against other materials such as glass paper and metals who all, via their CCAs, get an 80% discount on CCL. In UK Plastic Industry companies feel strongly that CCL harms their competitiveness overseas and within the UK against other materials.

5. The Plastics Industry and a Climate Change Agreement

The current criteria to be eligible for a CCA are: not less than 3% energy intensity (looking back over the average for four years); and an import penetration ratio of 50%. Over 12% energy intensity and the import criteria is not required. Only the plastics films part of our industry has secured a CCA due to much of home market being lost to SE Asia competition. The majority of plastic processors hover around the 3% of energy intensity but have been successful in not losing 50% of the home market, and therefore are ineligible for a CCA. Our members feel strongly that the misguided criteria for a CCA appears to reward energy intensity; pollution risk; and loss of the home market with an 80% CCL discount. We have for some time been in discussion with DEFRA and HMRC to see if a Climate Change Agreement is possible for at least some sectors of the plastics industry.

6. A Further Possible Burden for Large Plastics Companies: the Proposed Carbon Reduction Commitment

The BPF is currently consulting with its aVected member companies on the Government’s proposed “Carbon Reduction Commitment” which will apply to companies not in a CCA or EU ETS, but typically spending £500k pa on energy. Our initial view is that this is a complex mandatory auction based cap and trade scheme. We are concerned at the extra cost and bureaucracy for aVected companies and are surprised that a discount on CCL was not oVered as an incentive. The CRC will apparently be a “first” in Europe. We think there are risks to our competitiveness with such an untried, complex scheme. The proposed CRC, the EU ETS and controversy over CCL and CCAs means Climate Change Levy is probably close to the end of its useful life in our opinion. The CCL levy rates should no longer be increased and it should be withdrawn as soon as possible.

The Committee’s Questions

1. We need more detail on how carbon emissions could be targeted. 2. As stated above CCL and CCA are unfair and ineYcient and options for their replacement needs to be considered. 3. See above. 4. N/A most of the plastics industry is not in a CCA. 5. CCL has severe eVects on plastics industry competitiveness (see para 4 above) 6. Scrap CCAs or at the very minimum scrap the 50% import penetration ratio. 7. OVer advice, encouragement, incentives, and the best practice. 8. A very big issue as our submission demonstrates. All the plastics manufacturers of energy saving products listed in 2 (with the exception of plastic bags) are not in a CCA and therefore paying the full CCL. 20 September 2007 Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 119

Memorandum submitted by Darlington Crystal

1. Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed? It would be much better to target the direct producers of carbon—particularly the energy suppliers—who have a great opportunity to invest in plant that is much more eYcient and has a smaller carbon footprint than present plant.

2. With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)? The CCA and CCL have had a negligible eVect on our eYciency. Any change towards energy usage reduction, or more eYcient plant has been as a result of moving production abroad (because of expensive energy and labour) or of the normal, end of life replacement of compressors, motors and lighting.

3. Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? We have consistently failed to meet targets and so have bought carbon. The purchase of carbon has meant that the CCA has a neutral eVect for us, financially. If we were out of the scheme, we would save in manpower on the site administration and the time to complete quarterly returns.

4. What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? Before we went through a huge downsizing exercise, our CCA was probably worth being a part of. More recently, it has been a lot of “hoop jumping” for little gain.

5. What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? With the main benefits gained over a number of years (we did all the quick fix options years ago!) it is diYcult to justify spending large amounts on new, more eYcient plant when the old is working fine.

6. Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments? We have not used it and I don’t know anyone that has.

7. The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how? There should be incentives for utilising roof space for wind generation of electricity, and for buying electricity from a “green” supplier. Car parks could be used to collect heat, via a heat pump system, with financial incentives. 14 September 2007

Memorandum submitted by E.ON UK E.ON UK is the UK’s second largest retailer of electricity and gas, selling to residential and small business customers as Powergen and to larger industrial and commercial customers as E.ON Energy. We are also one of the U.K’s largest electricity generators by output and operate Central Networks, the distribution business covering the East and West Midlands. We are also a leading developer of renewable plant, including biomass generation. We welcome the opportunity to comment on the role of the climate change levy and agreements. The threat of climate change requires equitable emission reductions to be achieved across the economy. We believe that a range of mechanisms are required to deliver this action in both a sustainable and eYcient manner. We concur with government that the EU ETS must be the flagship scheme for the reduction of CO2, but recognise that additional policy options must be maintained and developed to ensure suYcient coverage of those sectors outside of this scheme. To achieve this, mandatory measures are likely to be required alongside fiscal incentives such as the CCL as well as market based approaches such as the EU ETS and the Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 120 Environmental Audit Committee: Evidence

proposed Carbon Reduction Commitment (CRC). To date the CCL has provided a useful incentive which has undoubtedly contributed to energy eYciency improvements from energy intensive industries in the UK. We continue to believe that the CCL has a role to play as part of the broad range of measures to assist with the challenge of climate change and would in particular support the development of a scheme which; — Avoids policy overlap — Encourages energy eYciency in a simple and cost eVective manner — Is revenue neutral across industry as a whole In general, the UK should be moving towards a simpler, inclusive and flexible approach to incentivising reduced carbon emissions which permits exemption from the CCL where carbon reductions can be achieved in a more eYcient manner by alternative mechanisms. Unnecessary policy overlap must be avoided. We are pleased to see that such an approach has been adopted to avoid the potential overlap between emissions covered by CCAs and the recently proposed CRC and would expect future policy developments to adopt this pragmatic approach.

Incentivising the Growth of Renewable Electricity We do not agree with the suggestion that levy exemption aVorded to renewables has resulted in “little impact”. In fact our experience in the business to business retail market indicates a positive impact on renewable products. Historically, renewable products in this market have only been defined by their CCL exemption. The eVect of this demand is likely to have supported the price of Levy Exemption Certificates (LECs) which in turn rewards renewable investment. Furthermore, our modelling suggests that CCL exemption is likely to play an increasingly important role in the future should the recycled element of the Renewables Obligation (RO) fall. We therefore believe that, in the absence of other further measures to support renewable investment, CCL exemption should continue to contribute to the achievement of the UK’s renewable targets and the EU target of delivering 20% of energy consumption from renewable energy sources by 2020.

The Effect of the CCL on CHP Schemes E.ON UK CHP owns and operates the combined heat and power interests of the Company. We have invested over £480 million in larger scale CHP schemes in the UK and continue to be a leader in this part of the market. We currently provide our customers with more than 577MW of electricity and 948 MW of heat. In common with the perceived impact on the renewable market we believe that the eVect of CCL exemption for CHP has provided a positive incentive, particularly to encourage full utilisation of existing plants. However, this benefit has not been suYcient to facilitate the longer term development of new CHP capacity. In terms of Enhanced Capital Allowances (ECAs) we are of the opinion that these have had a limited impact upon the development of new CHP installations. As vertically integrated energy companies who own and operate CHP plants do not receive the value of this financial benefit. ECAs have the potential to drive significant investment in energy saving measures. We would favour a review of eligibility criteria. Finally we would note that exemption from a tax such as the climate change levy will only act as a driver for long term capital investment to the extent that there is certainty over the longevity of both the tax and the exemption. 28 September 2007

Memorandum submitted by Louis Meyerowitz

What are the barriers to accelerating energy eYciency in the business sector and how can these be overcome? (Question 7) We are an injection moulding business consuming a significant amount of power. Investment/ depreciation is normally done on a 10 year basis and indeed the typical average life of machines is nearer to 15 years. These machines can be replaced, with latest technology and deliver spectacular percentage energy savings but in itself the actual value of saving does not warrant quick replacement of capital equipment as the payback is poor relative to the cost of new technology. If investment/tax incentives were available then providing they were viable accelerating energy eYciency could be achieved. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 121

Alongside the CCL, the Government included the enhanced capital allowances to further encourage firms to make energy saving investment. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments? (Question 9) Given comments above, as the UK’s largest manufacturer of injection moulded plastic caps (closures), not only are we ignorant of the enhanced capital allowance scheme but also the supplier of the machines to our group have no knowledge of this scheme. The scheme is therefore not known or understood and at the point of writing this email I don’t know if it is applicable or not—but I will be finding out! 14 September 2007

Memorandum submitted by the Manufacturers’ Climate Change Group

Introduction The formalised Manufacturers’ Climate Change Group (MCCG) evolved from the Ad-Hoc Energy Tax Steering Group (AHETSG) which has been successfully operating since the early days of Climate Change legislation in the UK, when it was established make a coordinated input to Climate Change Agreement (CCA) discussions. It represents a group of key UK manufacturing sectors aVected by the EU Emissions Trading Scheme and other Climate Change instruments, comprising aluminium, cement, ceramics, chemicals, glass, lime, paper, gypsum, metal forming, food and drink, mineral wool, quarry products, motor manufacturers and steel. Membership is open to any manufacturing organisation. Given the timescales and the issues; a list of members currently supporting this position is annexed. Firstly, MCCG members believe that there should be greater recognition that the Climate Change Agreements (CCAs) are a success story. CCAs have raised awareness and generated beyond business as usual improvements, both through the challenging but achievable targets that have been negotiated, but also through instilling a greater understanding of monitoring and reporting and workforce “buy in”. It should be acknowledged that the success of the agreements has not only come from the quantitative targets and the resulting reduction in energy usage, but also the qualitative requirements, that required business to develop energy management systems. CCAs have managed to push energy management near the top of the Boardroom agenda, at a time when energy prices were significantly lower than they are now. MCCG strongly believe that UK industry is over burdened with an excess of instruments relating to climate change. MCCG members are subject to the Climate Change Levy, (and the associated Agreements), the EU emissions trading scheme (EU ETS) and potentially the Carbon Reduction Commitment (CRC). MCCG wish to see a continuing role for relative targets as this approach directly incentivises reductions in the carbon footprint of products—until industry elsewhere becomes carbon constrained, absolute targets risk displacing carbon intensive production to potentially less eYcient locations. MCCG would support the new, independent Climate Change Committee advising government on the review to ensure the right balance is struck between contributions from early starters in CCA sectors and other sectors of the UK economy, where there may be more cost eVective potential.

1. Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed? It is important that any future CCL changes take care to ensure that there is continuity in regulatory incentives which have driven long term investments. While we do not therefore support radical change, we believe that the eYcacy of the CCL would be enhanced if it were developed to reflect carbon emissions rather than calorific value. This would then be consistent with the need to make a transition to a low carbon economy. However, CCL is the UK response to the Taxation of Energy Products Directive. Therefore changing the focus from energy use to carbon may prove diYcult, as the Directive doesn’t have any direct relationship with carbon. Furthermore, if a change to a carbon basis is made, it is imperative that equivalent incentivisation programmes be put in place to replace those founded upon CCL, eg: exemptions for Combined Heat and Power Quality Assurance (CHPQA) and renewable source electricity. UK industry is over burdened with an excess of instruments relating to climate change. MCCG members are subject to the Climate Change Levy, (and the associated Agreements), the EU emissions trading scheme (EU ETS) and potentially the Carbon Reduction Commitment (CRC). Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 122 Environmental Audit Committee: Evidence

The continuation of access to CCL relief is essential to sustaining the international competitiveness of intensive sectors within MCCG membership. We therefore see a continuing role for CCAs. MCCG has serious concerns that the CCAs are not being given due credit for the environmental benefits they have achieved. The NAO report suggests that the targets were too easy. However, all CCA targets are agreed on the basis that they reflect “all cost eVective saving measures”. We support the government’s decision to let the current CCAs run their full course to 2013 as this gives time to plan their successor. However, we are concerned that formal consultation on the future of the CCAs is being delayed until 2008. UK Manufactures have long asset life cycles so it is important to have certainty to inform on long term planning decisions. MCCG would welcome an early indication from Government on the future of CCL and CCAs.

2. With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)? Part of the success of the CCAs has been due to their use of relative targets which ensure that energy eYciencies are achieved without imposing a growth penalty. A growing healthy manufacturing sector is vital sustaining jobs and the economy. Relative targets also helps ensure that all sites, irrespective of size, have an incentive to improve. If the targets were in absolute terms then smaller sites would not appear to be making a significant improvement. The relative targets can also make it easier for workers in the sites to relate to the improvements. MCCG wish to see a continuing role for relative targets as this approach directly incentivises reductions in the carbon footprint of products—until industry elsewhere becomes carbon constrained, absolute targets risk displacing carbon intensive production to potentially less eYcient locations. Indeed, carbon eYciency is becoming more prominent in the Commission’s review of the EU Emissions Trading Scheme (EU ETS) post-2012. EU ETS review discussions are currently signalling that benchmarks will be used to maintain free allocations and minimise competitive impacts—this interest is allied to a recognition that this approach has the added benefit of giving a performance (energy eYciency) signal.

3. How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? There are too many economic instruments and carbon price signals per company. It is counter-productive to impose more than one instrument in order to achieve the same or very similar objectives. This is currently the case for many of the energy intensive industries, which are subject to the UK CCL and EU ETS. The matter will be further exacerbated should they additionally fall within the ambit of the proposed Carbon Reduction Commitment. It is important that organisations which are in a CCA or the EU ETS are not covered by CRC as well.

Coverage of sites by IPPC, CCAs and EU ETS leads to multiple CO2 emissions reporting requirements and frustrations arise from each scheme using diVerent CO2 conversion factors. This needs to be rationalised when the EU ETS and CCA schemes are renewed; change prior to that would bring a burden as systems are now established for the current CCAs.

4. Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled? Trading has been a very useful element on the CCAs. However, MCCG has concerns relating to the steady fall in the value of allowances, due to oversupply from the voluntary UK ETS, which has meant that it now provides little incentive to go beyond emissions targets. Without trading many facilities would find it impossible to meet targets, so it is imperative that the trading element remains. By definition, emissions trading mechanisms work by trading to meet compliance. Trading provides a flexible mechanism which allows emissions across businesses to be secured at least cost while ensuring that overall environmental objectives are met. Indeed, the EU Energy Products Directive provides for relief from such energy taxes to be provided to intensive businesses participating in trading schemes.

5. What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy? Our members will comment in their individual responses. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 123

6. Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent?

It would be sensible to make a full move to carbon based targets, reduce overlaps with other instruments and make CCAs and other instruments in the policy mix more consistent (see also answers to questions 1, 2 and 3). The current CCAs already include provision to review targets every four years to take account of changes in circumstances, eg: new technological developments. The review conducted across all MCCG sector in 2004 strengthened the robustness and accuracy of the targets. The 2008 review will give both industry and government a further chance to improve the last target to reflect changes within those sectors and understanding of achievements to date. MCCG would like to see CCAs widened to whole site coverage and for there to be easier entry for sites into CCAs in the first instance. The former could be achieved by adjusting the 90/10 rule to become a 70/ 30 rule, for example. MCCG would support the new, independent Climate Change Committee advising government on the review to ensure the right balance is struck between contributions from early starters in CCA sectors and other sectors of the UK economy, where there may be more cost eVective potential.

7. What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome?

There are a number of barriers that impede the take-up of measures to improve energy eYciency. In many cases, attempts to forecast the potential of energy eYciency to deliver reductions in carbon emissions have failed to take suYcient account of these barriers. It is therefore vital that policies to encourage greater energy eYciency are based on a full understanding of these barriers and how to overcome them. Uncertainty about the future climate change policy mix also represents a barrier to improving energy eYciency. In the longer term it is diYcult to anticipate additional changes as a result of climate change policy. There is considerable uncertainty about the future shape of EU ETS and CCAs post-2012 and whether these systems will be part of a multilateral or unilateral framework for addressing climate change. This uncertainty is inhibiting investment decisions.

8. Products which can increase energy eYciency (such as insulating glass for windows) can be energy-intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything, should be done about it?

MCCG sector members produce products that provide some of the solutions to climate change, eg: materials for wind turbine blades, silicon for photovoltaic cells, insulation materials for housing, low weight materials for cars and other applications. These products are produced within almost all MCCG sectors, such as glass, steel, chemicals, ceramics, cement etc. It would be very complex to recognise the contributions of these innovations in schemes aimed at improving plant eYciency. If there is a switch to absolute emission targets then thought should be given to how manufacturers of low carbon products are treated, as those products maybe more energy intensive to make.

9. Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments?

The take up of Enhanced Capital Allowances (ECA) has not been as comprehensive as envisaged. The scheme is seen as complex and restrictive, with not all energy eYcient products qualifying for inclusion to the list. Many MCCG sector members do not see the financial benefit to be significant enough to cancel out the increased cost of purchasing plant from the list, as these products increase in price once they qualify for inclusion. ECA is only of value to businesses that are in profit. Loss makers cannot benefit. This is a major drawback and therefore take up is limited. The Budget 2007 decision to extend equivalent financial benefits to companies that have not generated a profit is therefore welcome and we look forward to its implementation. MCCG would like to see the percentage of ECA increase 100% to something like 200%. We hope that this would then provide a significant driver, both for manufactures to produce plant capable for inclusion to the ECA list and then companies the incentive to purchase those products. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 124 Environmental Audit Committee: Evidence

10. The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how? Renewable electricity enjoys suYcient incentives from the combination of ROCs and LECs awarded to relevant schemes. Indeed, the banding proposal in the Energy White paper will increase the ROCs allocated to technologies which need higher levels of support to be economic. There is therefore no need to increase the incentive from CCL. MCCG (via electricity prices) already pays for the renewable obligation and the investments in renewable technology and as such further taxation is not necessary. September 2007

Annex 1 Given the timescales and the issues; a list of members currently supporting this position is provided below: British Cement Association British Ceramic Confederation British Glass Manufacturers’ Confederation British Lime Association Chemical Industries Assoication Confederation of British Metal Forming Confederation of Paper Industries EEF, including UK Steel Food and Drink Federation Gypsum Products Development Association Society of Motor Manufacturers and Traders Minesco—The Mineral Wool Sector 2 October 2007

Memorandum submitted by The Mineral Wool Insulation Sector (Minesco) We are pleased to submit the following comments from Minesco in response to the above call for evidence. Minesco is a trade body that represents all four UK Mineral Wool Insulation producers for Climate Change and EU Emissions Trading Scheme purposes. By way of background Insulation is central to delivery of many Government Climate Change Programmes, with for example an estimated 82% of the savings that will be delivered by the Energy EYciency Commitment 2005–08 being attributable to retrofit insulation measures. Manufacture of Mineral Wool insulation involves significant investment and long lead times. However, as a result of signals provided by Government CCP initiatives the sector has made or announced significant capacity investments amounting to an estimated £200 million, and output is now anticipated to be roughly double 2002 levels by 2010. Production is however captured under a number of diVerent Environmental initiatives, including IPPC, CCA’s and the EUETS, although saves many times more carbon in use than it takes to manufacture. The sector is therefore perhaps uniquely placed to be able to comment on the role of Business in reducing carbon emissions, being both regulated as a major energy user and strategically important in terms of delivery of Government Climate Change Policy. We can therefore submit the following comments:

1. Climate Change Agreements 1.1 We believe that the Climate Change Agreements have been demonstrably successful in focusing senior management attention and in reducing energy demand so have delivered significant, real, savings. 1.2 However, because the UK ETS was the first scheme of its type, from the outset there was considerable uncertainty over the evolution of carbon prices. As a consequence, many companies chose to meet target by investing in abatement rather than leaving themselves exposed to uncertain carbon prices. In the case of our own sector significant energy saving investments have been made, and, whilst partly driven by Corporate Social Responsibility considerations, compliance could have been achieved at far lower cost through trading. 1.3 As the awareness and sophistication of participants increases, and internal abatement options and costs are better understood, we believe that compliance based on the classic abatement cost curve model will become the default under any successor scheme to the CCA’s. This may mean that the CCA structure will become less eVective at driving actual investment in for the energy intensive sector. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 125

1.4 Manufacture of Mineral Wool insulation is a capital intensive process, with investment costs of the order of £1,000 per tonne of annual output. Historically returns on capital have been poor, and continued access to CCL rebate is essential to ensure a level playing field against both international and non energy intensive products and ensure continued access to investment. 1.5 However, as has been mentioned, industries such as Mineral Wool manufacture not only participate in the CCA’s but are captured by the EUETS as well as being regulated under IPPC. Therefore recognising the burden that the CCL represents on energy intensive businesses and noting that the CCL rebate is likely to contribute less to emissions reductions in future that other programmes, we believe that there is a clear case for not only continuing to provide CCL relief for energy intensive industries but to reduce the burden. 1.6 We believe that as the CCL is the UK transposition of the Energy Products Directive it will endure, and note that the EPD includes specific provisions for a rebate to be applied in the case of energy intensive industries where these are covered by undertakings to reduce emissions. The size of the rebate allowed is up to 100%, which compares with the 80% currently applied under the CCA’s, and we would hope that Government would try and ensure that UK industry remains competitive by adopting the higher rate. 1.7 The question is therefore one of what eligibility criteria could be applied, and what compliance mechanisms will exist. Broadly we suspect that the options include: 1.7.1 A replacement CCA structure broadly as current but with compliance using EU ETS or proposed EPC allowances. 1.7.2 Eligibility via participation in the EU ETS. The main problem with this option is that indirect emissions, ie electricity, are not constrained other than via cost pass through in electricity prices and it is not clear whether this would meet the EPD requirements. 1.7.3 A combination of EUETS coverage of Direct emissions coupled with CCA or EPC structures to cover indirect emissions and emissions from associated activities currently captured under the “90/10” rule. 1.8 Due to the complex interactions between the EUETS and CCA’s, and the associated mechanism to avoid “double trading”, there is an urgent need for early certainty on future access to CCL rebates. 1.9 Our understanding is that the issue of a replacement CCL rebate structure may be considered later this year. Our feeling is that eligibility via EU ETS participation w 100% for direct and indirect emissions (excluding 90/10) would represent an equitable and extremely welcome regulatory simplification. 1.10 However, such an approach would involve a shift from the current relative (ie energy use per tonne of production) CCA targets to the absolute caps applied under the EUETS. In the context of a rapidly expanding sector such as Mineral Wool insulation, this does raise important questions regarding how the necessary emissions headroom to cover growth can be accommodated.

2. Internalising the Cost of Carbon 2.1 This leads us to perhaps the most challenging point raised by the enquiry, how the contribution of energy saving products can be reflected in the regulatory framework. As is noted in the Committees call for evidence, the operation of existing and introduction of new initiatives can have unwanted implications for the manufacture of energy saving products. 2.2 It is entirely appropriate that all manufacturing processes, regardless of the end use of the output, should be subject to rigorous environmental constraints, and be encouraged to operate to best practice levels. 2.3 However, whereas the current regulations eVectively internalize the cost of carbon emissions, in, for example, electricity or manufactured goods, no analogous framework exists to internalize the value of carbon savings arising from these products in use. 2.4 The UKETS, EUETS and EEC frameworks have created valuable new property rights through commoditising Carbon. Historically the value of an energy saving product could be said to be underwritten by the value of energy saved over its lifetime. The introduction of new frameworks based on carbon eVectively means that a new value vector has been created, and the worth of an energy saving product in use should logically now reflect the sum of energy cost savings and avoided carbon emissions. 2.5 Currently, the very considerable value of the carbon savings generated from the installation of energy saving products accrues to the Government via, for example, the energy supplier Carbon Emission Reduction Targets (CERT) framework, but is not internalized into the value of the product. 2.6 We believe that if the value of carbon is truly to be used to drive behavior it must be fully reflected in product cost and there needs to be a symmetry; whereby both manufacturing emissions and savings in use are both considered. The EUETS could potentially be a part of such a framework through project mechanisms, although Tradable White Certificates or Personal Carbon Allowances might also represent alternatives. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 126 Environmental Audit Committee: Evidence

3. Climate Change Levy 3.1 In contrast to the success of the CCA’s, we are far less convinced that the Climate Change Levy itself has been successful in delivering eYciencies in other business sectors. A range of reasons have been suggested for the apparent lack of impact from the CCL, including cost pass through where this represents just a small proportion of costs, and issues such as the eYciency with which energy eYciency is priced into commercial property rents. 3.2 Whilst complementary regulations have been developed aimed at specific sectors, such as the proposed Carbon Reduction Commitment, we believe that there is a clear policy gap in respect of approximately 4–5 million Small and Medium Enterprises. This sector is notoriously diYcult to reach eVectively, and as a consequence there is an argument for specifically focusing the CCL to encourage action in this sector. 3.3 Whilst recognising that it is reducing carbon in the atmosphere that is key, and therefore it is appropriate for major programmes to focus on Carbon, there are unnecessary complications associated with establishing emissions from small sites, such as fuel carbon intensities and the inability to switch. We therefore suspect that a continued focus on a simple energy “tax” approach is simpler to understand and monitor and will provide greater certainty. 3.4 This also avoids introducing yet a further “flavour” of carbon over and above the UK, EU Kyoto project and CRC allowances already in existence, and can only aid the emergence of a clear, single price signal for carbon.

4. Revenue Hypothecation 4.1 Currently our understanding is that CCL revenues are hypothecated through NI rebates and Enhanced Capital Allowances for energy savings investments. 4.2 We are not aware of any evidence to suggest that the latter has made any significant contribution to reducing emissions, and uptake is constrained by issues of diVerentiating capital investments from renewals and refurbishment that can anyway be written oV in the year of expenditure. 4.3 Consequently we believe that there is a strong case for reviewing the use to which CCL revenues are put. Taking into account our earlier comments regarding shifting the focus of the CCL towards the SME policy gap, we feel that in addition to “sticks” there is a need to educate, inform and signpost smaller users to the type of energy saving technologies that are available—many of which are existing measures with proven savings. 4.4 There are a variety of ways that this might be achieved, but the Carbon trust, and/or Energy Saving Trust have the proven ability to manage this type of educational program. September 2007

Memorandum submitted by CBI 1. The CBI welcomes the chance to respond to the Committee’s inquiry. Business believes climate change is a crucial issue, and supports the Government’s approach in setting clear medium and long term targets through the forthcoming Climate Change Bill. 2. The CBI recognises that the Government will need to use a range of policy tools to create a framework to deliver the very challenging targets in the Bill. But it is important that these measures have minimal overlap, are environmentally eVective and also take into account competitiveness issues. 3. The response follows the questions set down in the Committee’s call for evidence.

Is it right for the levy and agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed? 4. The CCL was set up as a proxy for a carbon tax (according to HM Treasury) and to some degree achieves this—with the exemption of renewable electricity from the CCL and the diVerent rates of levy applied to eg gas and electricity. 5. However, it is an imperfect proxy for a carbon tax with electricity from nuclear and coal generation being levied at the same rate. The CBI has consistently lobbied on this issue, calling for the CCL to be reformed so that it better reflects the carbon content of the energy source provided (ie zero rating electricity generated from nuclear sources and reflecting the carbon content of gas vs coal generated electricity). 6. But while we would support reform of the CCL along these lines, there is a broader concern about the fact that making the CCL a purer carbon tax would still leave an overlap between the CCL and emissions trading (EUETS, plus the new Carbon Reduction Commitment). Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 127

With the advent of UK-wide carbon budgets from 2008, how valuable is the focus of the CCL and CCAs on the eYciency with which businesses consume energy? Would it be better to have an instrument which enforces absolute caps in energy use (or CO2 emissions)? 7. The type of targets—absolute or relative—varies between sectors, and there is a trend towards sectors adopting absolute targets (a requirement to exhibit comparability with EU ETS targets, where firms have opted out of the scheme in Phase I). 8. It should be recognised that beyond CCAs, instruments which enforce absolute caps are being increasingly put in place through EUETS and the forthcoming Carbon Reduction Commitment (CRC). 9. The principle underpinning the CCAs is that they are based on technical potential to reduce energy consumption/emissions (although in practice this has not necessarily been the case eg the setting of targets beyond the first period largely abandoned this, with the Government requiring sectors to tighten their targets regardless of their ability). 10. Absolute emissions trends for CCA sectors must be taken into account in assessing the most cost- eVective way for the economy as a whole to comply with the new carbon budgets. It is possible however that the availability of no-cost or low-cost absolute abatement measures in other sectors may mean that a degree of eYcient growth in emissions from CCA sectors is manageable and justified on competitiveness grounds (given the inability of many of these sectors to pass carbon costs through to their customers). We would expect the new Climate Change Committee to explore this in detail.

How well do the levy and CCAs fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap? 11. The CCAs in particular have been an eVective means of delivering carbon abatement in the industrial sector, and have been strongly supported by business. Indeed, compared to the blunt impact of the Levy, feedback from CBI members suggests that, notwithstanding the emphasis put on the announcement eVect of the CCL by the Cambridge Econometrics work, it has been the CCAs which have done most to raise boardroom awareness of energy issues and driven the uptake of data collection and measurement systems being put in place. 12. The Government’s announcement in the 2007 Pre Budget Report makes clear that CCAs will continue until 2017. However, the design and structure of CCAs in the future, and of related policy measures such as the EU ETS and the proposed Carbon Reduction Commitment must recognise that there are increasing overlaps between measures targeted at the same emissions. 13. For example, with the introduction of the EU ETS, organisations covered by CCAs are required to operate and report within both schemes (although diVerent emissions are covered) in order to retain the CCL discount, resulting in higher administrative burden. Companies with majority of emissions in the EU ETS should be eligible for the CCL discount without having to report into the CCA scheme. 14. The CRC aims to minimise the further overlaps it will create by allowing organisations with 25% or more of their emissions covered by a CCA to be exempt from the CRC. The same has not been applied to EU ETS (although EU ETS emissions are excluded, organisations are still included in the CRC) and some sectors have raised concerns that the overlaps will increase over time—if the CCAs come to an end and they are then covered by the CRC and the EU ETS.

Businesses are able to use carbon trading to meet their targets under the CCAs. What have been the impacts of trading so far? Should trading be allowed in this way? 15. We believe that reductions should be made where most cost-eVective to do so and, therefore, trading is a legitimate part of the CCA approach.

What have been the economic impacts of the CCL and CCAs on the organisations subject to them, and the wider UK economy? 16. We undertook a survey with the EEF a year after the introduction of the CCL. That survey revealed that the impact of the CCL varied between sectors: — manufacturing hardest hit by CCL; — mining and utilities also negatively aVected; and — service sector made a net gain from the levy (as a whole), although there are individual cases where companies have faced increases in net costs. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 128 Environmental Audit Committee: Evidence

17. The survey also asked companies views of the impact that the CCL had had an impact on their UK and international competitiveness—54% of companies surveyed stated ability to compete in UK markets had worsened (versus 3% who said it had improved UK prospects) and 47% said it had made their international competitive position worse. This varied between sectors, with 57% of manufacturers reporting worsening of UK position. 18. We have not carried out any other analysis of the wider economic impact of the CCL, but a reminder that the impact of higher energy prices on competitiveness is not a purely theoretical one came with the very sharp increase in energy (especially gas) prices in winter 2005–06, which casued significant job loses in energy intensive sectors such as glass manufacture.

Should the CCAs be reformed in any way? 19. There is a need to remove competitive distortions resulting from the too-narrow eligibility criteria (eg substitutable products where one type of product gets a CCL discount and the other doesn’t resulting in a distortion in the balance of business between the competing products. Examples would be laundered textiles (no discount) vs paper products (discount), plastic packaging (no discount) vs paper or metal packaging (discount)). These should be removed, through widening the eligibility criteria if necessary. 20. Previously the CBI had also called for a much broader eligibility criteria for CCAs so that anyone who is prepared to take on a target can enter into the scheme. These calls have always been rejected by the Government. We will need to reassess the this proposal in the light of the forthcoming introduction of the CRC. 21. In regard to the Committee’s particular interest in whether the sectoral targets should be made more stringent, we would point out that there is already a mechanism in place for this and they are reviewed and tightened every reporting period. Going forward, we would expect that this would take place within the context of the carbon budgets and advice from the Committee on Climate Change.

Alongside the CCL, the govt introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit in with other existing or proposed climate change instruments? 22. We have not had a lot of feedback on the ECA’s from members, but we do see them as complementary to other climate change instruments. However, the technology list setting out what is eligible for ECAs in eVect also acts as an “endorsement” of those products and needs to be broadened. In particular investment in improving the energy eYciency of the fabric of buildings needs to be included.

What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? 23. There needs to be a distinction between energy-intensives (typically covered by CCAs) and other businesses (covered by CCL) where traditionally much more diYcult to bring about energy eYciency improvements for range of well-rehearsed reasons eg energy relatively low proportion of overall input costs, high upfront capital costs for energy eYciency investments, with relative long pay back periods (in business terms), split incentives in property (ie landlord/tenant issues). 24. For the energy intensive sectors, great progress has already been made in increasing energy eYciency, and for some sectors, diminishing returns are setting in now that “low hanging fruit” opportunities have been taken. Asset life cycles are also a factor.

Products which can increase energy eYciency (such as insulating glass for windows) can be energy-intensive to manufacture. Policies such as the CCL and CCAs can penalise manufacturers for making such products. How big an issue is this and what, if anything, should be done about it? 25. We agree that this is an anomaly which is decidedly unhelpful in terms of the overall UK low carbon agenda. Reduced VAT rates on the sale of such products may be one option, but it would also be worth looking at the scope for some form of adjustment to the treatment of the manufacture of such products under EUETS/CCL. The levy exempts renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how? 26. No. We have consistently supported a move towards measures which value low or zero carbon technologies, rather than picking specific renewable technologies. A tax which better recognises the carbon content of diVerent electricity sources, rather than directly incentivises renewables (already incentivised through the RO), is preferable. 10 October 2007 Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 129

Memorandum submitted by British Energy Group plc

(I) Background British Energy welcomes the opportunity to contribute its views to the Environmental Audit Committee’s Inquiry Reducing carbon emissions from UK business: The role of the Climate Change Levy and Agreements, both of which have been important economic instruments for addressing the UK’s climate change objectives. British Energy is the UK’s largest electricity generator. We own and operate the country’s eight most modern nuclear power stations, one coal-fired power station, four small gas plants and we also hope to develop two large wind generation projects. Our fleet of nuclear stations make the largest single contribution to tackling climate change in the UK. Carbon emissions from our coal plant are subject to the constraints of the EU Emissions Trading scheme. We provide electricity to the large Industrial and Commercial electricity market, most of whom will be included with the CRC, through British Energy Direct. We have engaged fully in the climate change and energy policy debate over the years and have responded to many significant consultations and Inquiries. All our recent Submissions can be found on our website (www.british-energy.com).

(II) Summary Comments — The Climate Change Levy (CCL) and Agreements (CCAs) provided an important first step in climate change mitigation in the UK. — Other instruments have emerged over the last few years which are perhaps more cost—eVective and provide greater transparency of action. — Despite much concern about their ongoing benefits, Government has recently signalled its commitment to the CCL and CCAs by extending them to 2017. It is not clear why it has decided on this course. — If the CCL is to continue, it should be reformed to become a Carbon Levy which better reflects the carbon content of the fuel; nuclear which has life-cycle emissions the same as those for wind should be exempt from the Levy. — Failing full exemption from the CCL, the generation from life extension of nuclear plant should be exempt, incentivising investment in an activity which is important for the UK’s climate change programme. — The CCL should play no further role in incentivising renewables production beyond the current arrangements which exempt these technologies.

(III) Response to Specific Questions

Question 1—Is it right for the Levy and Agreements to target energy use, or should they be reformed to target carbon emissions directly? If so, how should they be changed? 1. The stated main objective of the Climate Change Levy (CCL) and Climate Change Agreements (CCAs) is to incentivise the reduction of carbon emissions of one group of stakeholders in the UK economy. It is fair to say that, as the first major climate change policies, they have achieved much, not least to signal the importance of carbon reductions going forward, and the need to bring the carbon “issue” into boardrooms. 2. The eVectiveness or otherwise of the CCL/CCAs is discussed in some detail by the NAO Review (Climate Change Levy and Climate Change Agreements, NAO, August 2007). But in one area at least the CCL has been a poor instrument because it does not reflect the carbon content of the fuels, deflecting and diluting eVorts to concentrate on this important pollutant; rather, the consumer is asked to pay the same rate for electricity derived from coal which has a carbon emission factor of about 900 gCO2/kWh as from nuclear which has life-cycle emissions of about 5 gCO2/kWh. The latter is about the same level as the life cycle emissions for wind power, and since renewables are exempt from the CCL, we believe nuclear power should similarly be exempt. 3. The Government set up the Levy to be revenue neutral (although according to the NAO Review this is not the case with the revenues less than the outgoings thus far). If the CCL is eVectively converted to a Carbon Levy to better reflect the carbon content of fuels, then the rates charged will have to be increased with coal approximately two times greater than for gas, and oil somewhere in between. 4. If switching the focus from energy eYciency to carbon proves diYcult to aVect, there is still an opportunity for Government to incentivise important action such as the life extension of low carbon electricity generation since this helps the UK meets it climate commitments. In particular, we believe there should be CCL exemption for electricity produced during life extension of the UK’s nuclear stations (having Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 130 Environmental Audit Committee: Evidence

been approved by the prevailing regulatory regime). This would encourage the extension of valuable assets, and since this would form a relatively small part of the CCL income, would not disturb the smooth running of the instrument. 5. Energy eYciency and carbon emissions are interchangeable through well establish emission factors for the various fuels. As such it would be a relatively straight forward exercise to change energy eYciency improvement targets to carbon reduction targets. This will also have the eVect of harmonising most of the policy instruments onto the same metric—carbon reductions. 6. There is little doubt that an increasing part of the economy is being covered as new climate change policy instruments, such as the EU Emission Trading Scheme (ETS) and the Carbon Reduction Commitment have emerged. But there is also increasing overlap between, for example, CCL/CCAs and these later instruments. Further the NAO Report suggests that the CCL, (and by association the CCAs) is no longer seen by companies as a major driver for new energy eYciencies, at least in the way it is currently constituted.

Question 2—With the advent of UK-wide carbon budgets from 2008 (proposed under the draft Climate Change Bill), how valuable is the focus of the CCL and CCA on the eYciency with which business consumes energy? Would it be better to have an instrument which enforced absolute caps in energy use (or CO2 emissions)?

7. As indicated above, it makes sense to focus on carbon reductions since this is the metric being adopted in UK and sector targets, and increasingly with policy instruments that have emerged since the CCL/CCAs. Improvements in energy eYciency can make an important contribution to carbon reductions, but it is not the only one. It is important that all options for carbon reductions are encouraged, not only to ensure targets are met, but that they are met at least cost. Of course, carbon reductions are easier in some sectors than others, and competitiveness issues must be taken into account. All this suggests harmonisation of climate change policy instruments towards a single metric in carbon reductions not only makes sense but is an important ongoing activity for Government.

Question 3—How well do the Levy and Agreements fit together with other existing and proposed climate change policies, and what can be done to ensure maximum impact from complementary policies with minimum administrative burden and overlap?

8. It is natural that as new carbon reduction policy initiatives emerge to address diVerent parts of the economy, as has happened in the UK over the past decade or so, that overlaps, double counting, and other interactions will occur. This is made even more likely when the energy system contains the consumption of primary and secondary fuels, products and services, all having carbon footprints. This suggests Government needs to take action to minimise the impacts of these interactions, whether by modifying the relevant economic instruments or even abandoning them when they become redundant. It is open for discussion whether the CCL/CCAs are already largely redundant or will become so in the not too distant future, at which point it makes sense to remove them altogether.

Question 4—Businesses are able to use carbon trading to meet their targets under the Climate Change Agreements. What have been the impacts of trading so far? Should trading be allowed in this way, or how should it be controlled?

9. It is widely recognised that trading oVers the most cost eVective approach to delivering carbon reductions, and it makes sense then to oVer this opportunity for those with CCAs to meet their obligations. However, a focus on carbon reductions rather than energy eYciency would be a better approach, providing greater transparency of action and harmonisation with trading.

Question 5—What have been the economic impacts of the CCL and CCA on the organisations subject to them, and the wider UK economy?

10. It is clear that the CCL has been internalised by organisations in the same way as VAT and other taxes; the rebates associated with CCAs have minimised these costs for many organisations. The crucial issue is whether they have led to energy eYciency improvements, and thus carbon reductions, in the most cost-eVective manner. Estimates presented by the NAO Review suggest there have been carbon reductions, although these have been largely caused by an “announcement eVect” rather than a “price eVect”. Unless Government opts to increase the CCL significantly which could harm competitiveness for some sectors, then the CCL and CCAs should be removed in favour of more eVective instruments such as the EU ETS. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 131

Question 6—Should the Climate Change Agreements be reformed in any way? For instance, should the Agreements be simplified, or the sectoral targets made more stringent? 11. The rebate aVorded by the CCAs provide some organisations an opportunity to reduce their CCL burden and as such advantages these organisations over others—although it is also true that some of the carbon reductions made by those organisations advantaged in this way may not have been forthcoming. Going forward, if the benefits associated with the CCL/CCAs as they are currently constituted have largely been had, it may be appropriate to either remove the CCAs entirely, or make the sectoral targets more stringent for incumbents and open them up to new entrants that can make further reductions, but possibly lack the financial incentives to do so.

Question 7—What are the main barriers to accelerating energy eYciency in the business sector? How can these be overcome? 12. There are a number of barriers to accelerating energy eYciency in the business sector including inertia in the system, costs and payback times associated with potential solutions, and the capacity and culture of organisations. The natural time constant associated with many physical systems mitigates against energy eYciency improvements on a quick timescale, particularly if the incentive is not suYciently large. In particular, organisations are reluctant to aVect costly change if the payback period is too long. 13. Another important barrier is the lack of the requisite capacity in the organisations involved, or those providing new products and services. The culture of an organisation can be an important barrier, although there is much evidence to suggest that organisations are increasingly taking responsibility for their carbon emissions. Nonetheless, aVecting culture change in an organisation is a long-term activity, often beyond the attention span associated with a particular policy initiative. 14. Also, the fact that the same policy instrument is being applied to a large number of organisations, in many diVerent sectors, with diVering starting positions means any benefits from a policy initiative can take a long time to become apparent.

Question 8—Products which can increase energy eYciency (such as insulating glass for windows) can be energy-intensive to manufacture. Policies such as the CCL and CCA can penalise manufacturers for making such products. How big an issue is this, and what, if anything should be done about it? 15. The scale of the issue will clearly depend on the nature of the product but the NAO Review indicates that in the case of electricity, probably the most ubiquitous of the “fuels” for organisations aVected by the CCL, the additional cost involved has fallen to about 7% of fuel prices, and has not thus far been greater than about 12%. Of course some organisations use more than one fuel source so that the total cost would be higher in these cases. 16. In a world in which fossil fuel prices are set to remain high, the contribution of the CCL to the fuel prices may well remain at these relatively low levels, even with a CCL that is indexed linked. However, what is perhaps more important is not whether this is a small or large fraction of fuel costs but whether it is the most cost-eVective way of delivering carbon reductions by participating organisations.

Questions 9—Alongside the CCL, the Government introduced the Enhanced Capital Allowances, to further encourage firms to make energy saving investments. How well is this scheme working? How well does it fit with other existing or proposed climate change instruments? 17. The Enhanced Capital Allowances (ECA) scheme is complementary to the other climate change measures, and can potentially provide an important incentive for companies to improve the carbon intensity of their operations, particularly as it addresses two key barriers to the adoption of energy eYciency equipment: up-front cost and payback time. The Government should broaden eligibility for the ECA as far as possible.

Question 10—The Levy exempts electricity from renewables, though so far this appears to have had little impact. Should it play a greater role in incentivising the growth of renewable electricity, and, if so, how? 18. We do no believe the CCL should play a greater role in incentivising renewables growth. The Renewables Obligation (RO) is the instrument that is being used to incentivise the development of this sector. The subsidy awarded by the RO is significant, making this abatement option already costly in relation to other low carbon options. Moreover, the Government has only recently consulted on changing the RO to provide greater incentives for those renewables not in the mainstream. 19. The average ROC price in the auctions since 2001 is £45.5/MWh, which is an order of magnitude higher than the Levy exemption benefit and shows why the latter has had little impact on renewables growth. It would be necessary to increase the Levy to much higher levels (with all the competitive issues for other Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 132 Environmental Audit Committee: Evidence

sectors) for there to be a discernable diVerence. Alternatively, it could also be argued that removing the Levy exemption from renewables would have little impact and consequently it may be more logical to switch this benefit elsewhere, where it can make a diVerence. 15 October 2007

Memorandum submitted by the Federation of Small Businesses

Introduction The Federation of Small Businesses is the UK’s leading non-party political lobbying group for UK small businesses existing to promote and protect the interests of all who own and/or manage their own businesses. With over 210,000 members, the FSB is also the largest organisation representing small and medium sized businesses in the UK. The FSB welcomes the opportunity to respond to the Committee’s inquiry into reducing carbon emissions from UK businesses. The following points are general in nature and a copy of the research document commissioned by the FSB back in 2002 on the levy is appended for your information.

The Climate Change Levy The FSB is supportive of measures to protect the environment and human health and encourage resource eYciency; however environmental legislation to date has continued to apply a “one-size fits all” approach which presents many barriers for small businesses in their eVorts to seek eVective environmental solutions. The FSB has for some time argued that Environmental taxation burdens small businesses disproportionately and cite the Climate Change Levy (CCL) as a clear example of this. Although the levy was intended to be revenue neutral the FSB’s most in-depth research into the issue, “The Climate Change Levy—Another Cost for Small Business” (2002), demonstrated that most small businesses are net losers, some substantially so. The study highlighted that 88% of SMEs who pay the CCL have payments greater than their savings on employers’ NICS. Few small businesses were even aware of the recycling of the levy through the reduction of NICS. Lack of awareness of the tax and the objectives for applying the levy is a significant problem area and the report went on to conclude that the levy did little to improve energy eYciency among small businesses. Further FSB research in 20041 demonstrated that the priority and the uptake of energy eYciency measures in response to the levy have been negligible.

General Points In the past, energy was low on the list of priorities for many small businesses but with energy prices’ escalating this is changing. Rising costs are having an impact on profitability and competitiveness with a recent business energy index citing 77% of SMEs reporting lower profits and 30%2 reporting reduced competitiveness. The FSB has for some time campaigned for recognition of the special position of small businesses in the energy market who behave in a similar way to domestic energy users, in terms of lack of expertise and levels of energy consumption.

Energy Efficiency Lack of resources and awareness remains a barrier to small businesses exploring ways to mitigate rising energy costs. They know they have to do something but are unclear about the next steps. The FSB has found that lack of clear advice and information together with the constraints faced by SMEs has prevented most small businesses from taking steps to improve energy eYciency. 60% of SMEs have taken some steps to increase energy eYciency (eg changes to heating and lighting) but notably 40% have taken no action.3 For small companies, technical problems and the cost of changing production processes are barriers to increasing eYciency but so too is a lack of quality information and advice.

1 “Lifting the Barriers to Growth in UK Small Businesses 2004” (The FSB’s Biennial Membership Survey). 2 npower Business Energy Index 2006. 3 npower Business Energy Index 2006. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 133

Conclusion The Government must mount a comprehensive and targeted campaign to promote energy eYciency measures that SMEs can easily apply to their businesses. This should be developed in tandem with practical support and clear examples of how small businesses can maintain and improve profitability through energy savings. Action must be taken to reduce the cost of green energy which would provide a clear incentive to switch tariVs. Finally, more Government investment in technical innovation and in financial incentives on energy eYciency for small businesses would go a long way to improving emissions reduction among small businesses. 15 October 2007

Memorandum submitted by the National Insulation Association 1. This submission is from the insulation industry and has been produced by the National Insulation Association (NIA). The NIA represents the manufacturers and installers of insulation products including cavity wall insulation, loft insulation and other innovative products. 2. Since the Climate Change Levy was introduced to increase energy eYciency through the Climate Change Agreements it has had little impact on smaller users who view it as an energy tax. This is due to the fact that the financial penalty is not high enough to aVect change in smaller businesses as this is such a small percentage of their overall costs. This is particularly acute where a company subleases the property as there is not a driver for action from either the tenant or the landlord. 3. Smaller businesses premises share many of the physical attributes of the residential sector and therefore proven cost eVective insulation measures exist which would improve their extremely poor levels of insulation. A policy lever to raise such standards in a systematic way must be investigated as a matter of urgency. 4. The potential within this market is huge as is highlighted from the following information published by the Federation of Small Businesses: — there are 4.3 million small businesses in the UK (up from 4 million in 2003); — 97% of firms employ less than 20 people; — 95% employ less than 5 people; — 12 million people work in small firms; and — small firms contribute more than 50% of the UK turnover—about £1,200 billion.

5. According to information published by Defra around 8MtC or 15% of total CO2 used by the business and public sectors are used by micro or small firms. Around 70% of this energy consumption is associated with building services such as space heating which demonstrates that there is enormous potential for carbon savings which must be explored. 6. However, there are similar barriers to the uptake of energy saving measures in this sector as in the residential sector such as a lack of understanding as to the benefits of insulation, payback periods and the like. Compared to the many pressing problems facing smaller businesses, climate change is not the top priority for management action. We believe this area has been ignored to date by the present Government and this is clearly untenable moving forward and in direct opposition to European edicts. The Energy End- Use EYciency and Energy Services Directive applies to all energy users including this market and therefore Government has a responsibility to ensure that policy measures are initiated to cover this sector which will drive action. 7. The Government is currently consulting on the Carbon Reduction Commitment which will capture emissions from energy use of any organisation whose energy use has a mandatory half hour metered electricity consumption of more than 6,000 MWh/year. This will generally capture those organisations with an annual energy bill of over £500,000. 8. But this omits smaller businesses where there is a need to encourage action to reduce carbon emissions. Therefore we believe that the monies raised through the levy must be focussed on programmes which will directly incentivise this sector to carry out appropriate measures. 9. This should be in the form of specific advice or grants which focus and overcome the barriers directly experienced by this sector. Whilst the Carbon Trust has demonstrated great expertise in incentivising and encouraging action amongst larger energy users they have not demonstrated the same expertise in relation to smaller businesses. This is due to the fact that such businesses have far more in common with the domestic retrofit market which is currently engaged in energy eYciency matters by the Energy Saving Trust. Therefore, if such an initiative were implemented then it would be essential that the expertise of the Energy Saving Trust was utilised. 10. In technological terms this should encourage the uptake of proven technologies such as insulation measures where the life time carbon savings are the greatest and the payback periods the shortest. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 134 Environmental Audit Committee: Evidence

11. At the moment such smaller businesses are paying towards the Levy but not receiving the benefits which would lead to a reduction in their carbon emissions. It is vital that if energy use is to be reduced then this market is incentivised and the current arrangements do not do so and represent a real policy gap in the Government’s carbon agenda. 12. The most robust option to ensure that carbon emissions are reduced within the smaller business sector would be to draw on the vast success and very cost eVective carbon savings which have been achieved in retrofit domestic properties via the Energy EYciency Commitment. A similarly structured scheme ring- fenced for the smaller business sector would prove to be very cost-eVective as was demonstrated under the Energy EYciency Standards of Performance scheme when this not only covered the domestic market but also small businesses.

Memorandum submitted by Hambelside Danelaw It is been drawn to my attention that the EAC’s current inquiry has invited comment on how well Enhanced Capital Allowances scheme is working in terms of business saving energy. As an environmental award-winning building products manufacturer that is carbon negative, Hambleside Danelaw ensures that where machinery is replaced or plant introduced, it seeks to purchase the most energy eYcient equipment approved by the Carbon Trust. Naturally therefore we are supporter of the ECA scheme and applaud the activities of the Trust in its eVorts to encourage energy eYciency in British businesses. However, energy eYcient plant is only part of the story as we have made clear to the select committee before and to Stern who used our observations on technological failure in the building industry in his final report. A major contribution which business can make in fighting climate change is by operating from energy eYcient commercial buildings, but despite the sustainable development provisions in the Building Regulations, very few companies are doing this. To encourage the building of more sustainable commercial and public buildings, we believe that the ECA scheme should be extended beyond plant to other energy-eYcient materials which do not necessarily incorporate moving parts. This would recognise the fact that technological advances in high-performing insulated materials can make a significant diVerence in cutting emissions, whilst reducing heating, lighting and air-conditioning costs for the building occupier. Of course, these cost benefits are of little interest to the construction company who walks away from building after completion of the project. The market failure is compounded by the builder’s common practice of sourcing the cheapest materials (often from the Far East and Eastern Europe) which have a limited service life and poor insulating values. Extending the ECA scheme would encourage businesses that are commissioning the building of new premises, moving to new premises or refurbishing existing facilities to consider more seriously the greener options and we would urge the select committee to challenge the Government and the Carbon Trust on this. As you know, financial incentives have been introduced to encourage the construction of zero-carbon homes. Hambleside Danelaw feels that Stern was right and that the time is right to look more seriously at incentives in respect of public and commercial buildings. The ECA scheme provides a ready-made vehicle for taking this forward. 26 October 2007

Memorandum submitted by the Department for Environment, Food and Rural AVairs (Defra)

Introduction 1. HM Treasury is the lead department with regard to the Climate Change Levy (CCL) and Enhanced Capital Allowances, while Defra is lead department for policy regarding Climate Change Agreements (CCAs). This memorandum, therefore, focuses on CCAs. 2. Following the introduction of legally binding targets for reducing greenhouse gases under the Kyoto protocol in 1997, the Chancellor of the Exchequer asked Lord Marshall to examine the role that economic instruments could play to help to improve the industrial and commercial use of energy. Lord Marshall supported the introduction of an international emissions trading scheme as provided for in the Kyoto Protocol, and recommended a UK pilot scheme drawn up in collaboration with UK industry. However, recognising that an international emissions trading scheme would not cover all of business and commerce, Lord Marshall proposed that less intensive users in the industrial and commercial sectors should still make a contribution to meeting the UK’s emissions targets. He proposed an energy tax to send clear signals of the Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 135

long term direction of policy, with special consideration to be given to energy intensive industries through a system of rebates targeting relief at plant level. This was implemented through the CCL and CCAs in April 2001, aimed at improving energy eYciency in non-domestic energy uses. 3. As suggested in the Stern Review,4 the Government policy framework requires three essential elements to eVectively tackle climate change: pricing carbon externalities; support for innovation research, development and deployment of low carbon technologies; and actions to encourage behaviour change and energy eYciency in the move to a low carbon economy. Energy eYciency will remain the most cost eVective way of cutting emissions, as well as aiding productivity and security of supply. Energy eYciency measures have already made significant contributions to our energy and climate change goals. Existing energy saving policies and measures in the Energy EYciency Action Plan and the UK’s Climate Change Programme will together reduce carbon emissions by up to 10 MtC, accounting for 40% of total UK carbon savings by 2010. 4. The Government has committed to providing a clear, flexible and stable policy framework within which business can make cost eVective long term planning and investment decisions. In March 2007, the Government published its draft Climate Change Bill which will put into legislation binding targets on CO2 emission reductions and introduce five year carbon budgets, starting from 2008–12. It will set up the Committee on Climate Change to advise government on the pathways to the 2050 target. Given the nature of the requirements in the draft Bill, any future policy instruments aimed at energy intensive industry will need to fit a framework where the overall UK economy’s emissions are constrained by carbon budgets, and are therefore likely to focus on absolute reductions in energy use for this sector. 5. Government is committed to ensuring that emission reductions are delivered in the most cost eVective manner possible with minimum administrative burden. Defra has undertaken a review of the interaction of diVerent climate change policy instruments, particularly for the energy intensive sector, with a view to removing overlaps and reducing burdens wherever possible. The report, “Climate Change Instruments: Areas of Overlap and Options For Simplification”, will be published shortly and supplied to the Committee. 6. Current CCAs end in March 2013, the date until which eligible businesses can benefit from the reduced Levy,5 although the obligation to meet energy eYciency targets ends in 2010. However, the Chancellor announced in PBR that CCAs will continue until 2017, subject to EU state aid approval. This will require new agreements to be put in place and Defra will consult on the terms of those agreements in 2008.

Climate Change Levy and Climate Change Agreements

General 7. The CCL was introduced in 2001 to encourage businesses to reduce energy demand. Subsequently the EU introduced a requirement for all member states to tax the business use of energy. The CCL was accompanied by a 0.3 percentage point cut in employer national insurance contributions (NICs) resulting in a net reduction in tax liability for business. The levy, and parallel taxes in other EU countries, provide an important complement to the EU Emissions Trading Scheme (EUETS) by incentivising firms to improve energy eYciency and so keep emissions below the ceiling (cap) set by the EU ETS. The 2006 Budget announced increases in the CCL rate from 1 April 2007 in line with inflation, after six years at its original level. Budget 2007 also pre-announced increased rates from 1 April 2008. As stated in the 2006 Pre-Budget Report, the Government will continue to consider the case for reforms to the CCL within the context of the development of EU ETS Phase III after 2012. 8. CCAs are voluntary, but legally binding, agreements between the parties. They are open to energy intensive industries carrying out processes specified by Regulations. They operate on a sector basis (see paragraphs 20 to 22 below) and confer a right to an 80% reduction in the CCL if sectors and operators meet targets to improve their energy eYciency or reduce carbon emissions. Their terms of operation are fixed, including provisions within the agreements for review of targets, and procedures for other limited variations to be made. The scope for radical changes to the current regime is therefore limited, unless there is agreement to change between all parties. 9. Currently, CCAs cover 51 sectors,6 and over 4,300 “target units” (sites or groups of sites covered by a single target). Energy eYciency or carbon reduction targets are set until 2010, with intermediate targets every other year (known as target periods). The 2010 target and remaining intermediate targets (2006 and 2008) were reviewed and revised in 2004. A further review of the 2010 target will take place in 2008. 10. CCAs are complex instruments. This, in part, reflects the complexity of the issues, but it also reflects the government’s wish to respond to industry concerns at they time they were set up. We have learnt from experience and believe there is considerable scope for simplification. Benefits to industry

4 Stern Review: The Economics of Climate Change, published 30 October 2006, to assess the economics of moving to a low- carbon global economy, the potential of diVerent approaches for adaptation and specific lessons for the UK. 5 Subject to a further state aid approval—the current state aid approval ends in March 2011. 6 The sectors covered are wide ranging including, for example, aluminium, cement, chemicals, dairy, food and drink, industrial gases, motor manufacturers, paper, red meat processing, steel, textiles and wall coverings. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 136 Environmental Audit Committee: Evidence

11. As CCAs are voluntary agreements, it can be assumed that the benefits of the tax reduction outweigh the cost of compliance for those deciding to participate. CCAs have encouraged those firms that have entered agreements to increase the energy eYciency of their production, and therefore realise significant energy savings. Total energy cost savings from baselines are estimated at around £500 million in 2002, £780 million in 2004 and £1,500 million in 2006, excluding savings from the 80% CCL reduction, though not all of this will be attributable to the CCAs. 12. In August 2007, the National Audit OYce (NAO) produced a report on the CCL and CCAs.7 The AEA analysis cited in the NAO’s report attributes a net benefit to the UK of £90/t carbon saved, derived largely from the energy savings made by business. The report implies that this benefit might now be lower, because total carbon savings from the scheme are lower because Business As Usual (BAU) projections have now been adjusted to allow for rising energy prices. However, it is not necessarily the case that lower total emissions savings lead to lower benefits per tonne saved. In fact, since the total savings are lower because of higher energy prices, the benefit per tonne may well have increased. 13. In terms of the economy-wide impacts of CCAs, we can draw upon evidence from studies by Cambridge Econometrics published in March 20058 and Barker, Ekins and Foxon in July 2007.9 Cambridge Econometrics estimate that CCL will reduce overall energy demand by 2.9% by 2010 (and energy demand in the commercial and public sector will decline by around 15% over the same period), and that the reduction in energy costs together with the NIC reduction will reduce overall unit costs for business by 0.13%. Barker et al estimated that energy use in the CCA sectors has reduced by 2.6%, with negligible eVects on inflation and a slight increase in economic growth through improved international competitiveness. Overall conclusions are that the CCL/CCA package has been beneficial to the economy.

Target Setting and Achievements 14. With regard to achievements of the Levy, independent analysis by Cambridge Econometrics estimated that it delivered cumulative savings of 16.5 MtC to 2005. By 2010, the levy will be saving around 3.5 MtC a year, well above initial estimates. It will have reduced energy demand in the commercial and public sector by nearly 15% a year compared with the situation had the levy package not been in place. 15. The original CCA 2010 targets were derived through negotiation with each participating sector. For the 10 largest energy consuming sectors the negotiations were based on independent reports compiled for government by AEA Energy & Environment10 that assessed the potential for industrial energy savings and whose scope accounted for about 85% of the energy covered by CCAs. The reports considered projections of energy consumption on the basis of BAU and adoption of All Cost EVective (ACE) energy saving measures, with no limitation on the availability of capital or management time. For the remaining 34 smaller sectors, negotiations were based on data provided by the sectors, supported where necessary by site audits. 16. AEA/ETSU estimated11 that if ACE measures were adopted for all 44 sectors, 4MtC per year could be saved by 2010 in comparison to BAU. The targets actually negotiated were forecast to achieve carbon savings of 2.5MtC a year, or 60% of the savings theoretically available with no limit on the availability of capital or management time. Following the 2004 target review, and with the addition of another 12 small sectors, the forecast savings were raised to 2.9MtC in 2006. However, BAU has now been revised to account for changes in energy prices and the current targets for 2010 are now forecast to achieve 1.9MtC a year against this revised (and lower) BAU projection.12 17. At the first target period, virtually all sectors exceeded their targets and more than a third had achieved their 2010 targets. This suggests that the potential for energy savings were largely underestimated by both industry and analysts. Discussion with industry suggests that, not surprisingly, once an energy eYciency programme has been identified it is implemented quickly, rather than with regard to intermediate targets. 18. This performance at the first target period therefore could have been the result of early action, with little additional savings available over the remaining course of the agreements. However, in the 2004 target review, Defra concluded that there was scope for further and continued eVorts to implement energy saving measures over the remaining life of the agreements. Defra therefore proposed default targets based on the extent of over-performance at the first target period, or, for those sectors close to missing their targets, at

7 “The Climate Change Levy and Climate Change Agreements: A Review by the National Audit OYce”, which is available at http://www.nao.org.uk/publications/nao–reports/06-07/climate–change–review.pdf. 8 Published at Budget 2005 available at HMRC website. 9 Barker, T, Ekins, P & Foxon, T “Macroeconomic eVects of eYciency policies for energy-intensive industries: the case of the UK Climate Change Agreements, 2000–2010” in the Special Issue of The Energy Journal on “Modelling of Industrial Energy Consumption”, July 2007. 10 Then known as Energy Technology Support Unit (ETSU). 11 See report “Climate Change Agreements—Sectoral Energy EYciency Targets” prepared by ETSU, which can be found at http://defraweb/environment/climatechange/uk/business/ccl/pdf/etsu-analysis.pdf 12 It is, however, worth noting that had energy prices been lower than expected, the agreements would have been likely to deliver greater savings than projected—this was in the nature of the implicit risk allocation between parties when the agreements were entered into. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [O] PPSysB Job: 386002 Unit: PAG4

Environmental Audit Committee: Evidence Ev 137

least a 5% improvement (the average of over-performance across sectors). On this basis, the over- achievement at the first target period would have been largely discounted at the start of the third period. Negotiations actually achieved an overall target tightening of 3.5%.

19. In 2006, the tightened targets resulting from the 2004 target review were more diYcult to reach for some of the participants. Within this third target period, there was a significant increase in the purchase of carbon allowances under the UK Emissions Trading Scheme (UK ETS)13 (see paragraphs 23 to 26 below) to help secure delivery of the target, with 2.6 million allowances used compared to 0.9 in 2002 and 0.57 in 2002. Nevertheless, 25 sectors still met their revised 2010 targets after trading is taken into account. This suggests that targets can be further tightened in the 2008 target review, in which it will be Defra’s intention to ensure that industry maximises its potential eYciency savings whilst retaining its global competitive position.

Sector Based Approach

20. CCAs are structured around sector associations, which brings substantial advantages. Industry sector associations take a collective responsibility for their industry performance and reputation. They provide advice and guidance to their participants, leading to sharing of energy eYciency best practice within sectors and therefore more rapid energy eYciency savings. Sector associations play a large part in negotiating, managing and administering the agreements, making the process more eYcient. 21. Defra agrees sector level targets with the sector associations, who allocate the sector level target to participants on either a top down (the sectoral percentage improvement is applied equally to all participants) or bottom up (the targets are tailored to individual participants’ circumstances) approach. Most sector associations representing large energy users allocate on a bottom up approach. Sectors with large numbers of participants tend to use a top down approach.

22. Only if the sector as a whole does not meet its sector level target does Defra examine the performance of individual participants. If the sector as a whole meets its target, this delivers an environmental outcome at least equivalent to all individual participants achieving their own targets.

Emissions Trading

23. Participants in CCAs can buy allowances in the UK ETS if they under achieve in relation to their targets. This provides an important mechanism for energy intensive industries, for whom a small shortfall in meeting targets would lead to the loss of the full 80% CCL discount for two years. This can be a very large sum for large energy users, with the potential to jeopardise a company’s competitiveness. This approach also conforms with the general principles of emissions trading, allowing emissions reductions to take place at the lowest cost.

24. To date, use of trading to meet targets has been low (see paragraph 19), despite very low allowance prices (currently £1.50 to £2.00/tonne CO2) due to the substantial over achievement in abatement of non CO2 greenhouse gasses by the direct participants in the UK ETS. There is therefore no evidence that large numbers of operators used the trading mechanism as an alternative to implementing their own energy eYciency measures. Most sectors report that operators prefer to meet the targets by energy eYciency measures if possible and tend to regard trading as an option of last resort.

25. Participants that over-achieve against targets may sell allowances (after verification) through UK ETS or “ring-fence” them to “bank” against the possibility of future need to meet later targets. Only a small proportion of total over-achievement was verified for sale (0.6 Mt CO2 in the first two target periods and 0.4 Mt CO2 in the third) while the amounts ring-fenced have been 3.2, 5.4 and 3.5 Mt CO2 in the first, second and third target periods respectively. The low price of allowances was undoubtedly a strong reason for this lack of participation in the market.

26. The UK ETS market will continue to operate for the remainder of the life of the current agreements, when it will close. Removing the potential to use UK ETS allowances in advance of this would arguably amount to a unilateral change in the terms of the UK ETS and the CCAs. The government believes trading is an important part of climate change policies.

13 The UK ETS market comprises of emissions trading by CCA companies and the 31 direct participants who voluntarily entered into commitments to reductions in greenhouse gases in exchange for incentive payments. The introduction of the scheme in 2002 was intended as a pilot exercise for more general emissions trading schemes and provided valuable lessons for the introduction of EU ETS. The direct participants part of the scheme ended in December 2006. The UK ETS market is self-contained. There is no link to the EU ETS market. Processed: 03-03-2008 20:35:04 Page Layout: COENEW [E] PPSysB Job: 386002 Unit: PAG4

Ev 138 Environmental Audit Committee: Evidence

Relationship to Other Climate Change Instruments 27. The UK’s Climate Change Programme and the Energy White Paper, set out policies across all sectors of the economy, including business and the public sector. Some of our existing and proposed policies include: — the EU Emissions Trading Scheme, aimed primarily at larger industrial emitters, was introduced across the EU in 2005; — the new Carbon Reduction Commitment (CRC), to start in 2010, focusing on large non-energy intensive organisations in the UK; and — Building Regulations, which make a substantial contribution to the emissions reductions from the business sector. 28. There are currently overlaps in coverage between the CCAs and EU ETS. Direct emissions covered by EU ETS are also covered by CCAs for around 500 EU ETS installations, although in Phase I of EU ETS, 330 of these are opted out of the European scheme. As part of the consultation on the introduction of EU ETS in 2003, Government proposed to remove this overlap by taking EU ETS energy use out of the CCA targets. However, CCA participants requested that the CCA targets remained intact, on the grounds that it would be diYcult to split the CCA targets and would remove flexibility in how targets were met. Government agreed but, to ensure that no facility could benefit in both schemes from the same emissions reductions or be penalised twice under both schemes, a mechanism was introduced to oV set the EU ETS performance from the CCA performance. This mechanism was first used for the relevant 170 installations that did not opt out of EU ETS in Phase I, in the reconciliation for the third CCA target period in early 2007. Although it had been criticised by some sectors for complexity, in general sectors and operators applied the mechanism without too much diYculty. Government is consulting with industry on whether to continue its use for the fourth and fifth target periods or whether sectors would prefer to re-consider the removal of energy use covered by the EU ETS from CCA targets. 29. The CRC, to be introduced in 2010, will also potentially interact with both CCAs and EU ETS. CRC was designed to fill a policy gap identified by the Carbon Trust in its report “The Potential Evolution for Business and the Public Sector” for the Review of the UK’s Climate Change Programme in 2005. The Trust found that the existing package is not providing suYcient incentive for change across the less energy intensive segments of the economy where energy costs are less material. CRC is therefore aimed at emissions outside CCAs and not covered directly by EUETS. CRC focuses on large organisations, for which energy eYciency benefits should outweigh administrative costs. 30. CRC will cover both direct energy use emissions and electricity. To reduce administrative burdens as much as possible, there will be no emissions overlap between CRC and CCAs, and CRC will not target any direct EU ETS emissions. Organisations with some of their emissions in EU ETS will be covered by CRC for the remainder of their energy use, to ensure this significant cost-eVective abatement opportunity is targeted. Government is working with European partners to remove small emitters from the scope of the EU ETS, so as to ensure that the administrative burden of the scheme is proportional to the potential for emissions reductions from individual operators. Furthermore, organisations with over 25% of their energy use emissions covered by CCAs will be entirely exempt from CRC. 31. Climate change is a complex and long term problem and Government will need to employ the range of policy levers to tackle it eVectively, continuing to develop the eVectiveness of the framework in a way that enables business to remain competitive. However, the costs of doing nothing would be higher than those of putting the right policies in place now. In developing the policy framework we will ensure that it reflects current good regulatory practice, including the seven tests for climate change regulation as set out in the Better Regulation Commission’s report “Regulating to mitigate climate change—a response to the Stern Review”. The Government has committed to applying these tests to future policy development and when reviewing existing policy. October 2007

Printed in the United Kingdom by The Stationery OYce Limited 3/2008 386002 19585