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Energy and Climate Change Committee

EU Emissions Trading System

Ref Organisation Page

ETS 01 Department of Energy and Climate Change 3

ETS 02 Barclay Capital 19

ETS 03 Prospect 35

ETS 04 EUREELECTIC 38

ETS 05 Vattenfall 42

ETS 06 Mineral Produts Association 49

ETS 07 Office of the City Remembrancer 54

ETS 08 RICS 58

ETS 09 Energy Services and Technology Association 60

ETS 10 CIVITAS 63

ETS 11 UK Petroleum Industry Association 70

ETS 12 Centrica 76

ETS 13 Carbon Trade Watch 79

ETS 14 Instituto Bruno Leoni 85

ETS 15 The Bryman Partnership Ltd 96

ETS 16 National Grid 102

ETS 17 E.ON UK 105

ETS 18 International Biochar Initiative 112

ETS 19 SSE 118

ETS 20 Lichen Renewal 122

ETS 21 Shell International 129

ETS 22 CAFOD 134

ETS 23 Friends of the Earth (EWNI) 143

ETS 24 International Emissions Trading Association (IETA) 151

ETS 25 PricewaterhouseCoopers 161

Ref Organisation Page

ETS 26 Drax Power 164

ETS 27 Confederation of Paper Industries 168

ETS 28 Sandbag Climate Campaign 172

ETS 29 British Ceramic Confederation 180

ETS 30 RWE npower 183

ETS 31 EDF Energy 186

ETS 33 FERN 192

ETS 34 EEF, the Manufacturers' Organisation 206

ETS 35 Esso Petroleum Company ‐ ExxonMobil, UK 216

ETS 36 INEOS ChlorVinyls 221

ETS 37 The Carbon Capture & Storage Association 226

ETS 38 Association of Electricity Producers 232

ETS 39 Heathrow Airport Limited 236

ETS 40 Chemical Industries Association 238

ETS 41 ScottishPower 242

ETS 42 The Chamber of Shipping 248

ETS 43 UK Emissions Trading Group 250

Memorandum submitted by the Department of Energy and Climate Change (DECC) (ETS 01)

1) The Government welcomes the Select Committee’s inquiry into the EU Emissions Trading System (EU ETS) which is timely. The Government has recently published to ETS installations for scrutiny the draft National Implementation Measures setting out UK industry allocations of emissions allowances for phase III. The Government has also begun reviewing the UK Greenhouse Gas regulations, which implement the System and the amendments made to these since 2005 to examine the scope for deregulation and simplification in the UK application of the EU ETS rules.

2) The EU ETS is a central component of the UK Government’s policy for delivering emissions reductions in line with our EU targets and in line with the UK targets established in the Climate Change Act. The ETS will deliver over 50% of the UK’s CO2 emissions reductions between now and 2020. It is an important part of ensuring the correct incentives are in place for low carbon investment, and for ensuring that emissions are reduced across the EU, not just in the UK.

3) The system has been in place since 2005, and is currently in its second phase which runs between 2008 and 2012. It was the very first system of its kind anywhere in the world and has provided an example for others of how to deliver emissions reductions at least cost. Over phase II we expect the ETS to deliver EU emission savings of around 580 MtCO2e relative to 2005 levels.

4) Given both the novelty and scope of the ETS, it is not surprising that there has been an element of learning by doing in the development of the system. Over this time, we have learnt a lot about how to optimise such a system to ensure it achieves its environmental impact while maintaining the competitiveness of UK and EU industry. In 2009 the EU amended the ETS Directive to provide new rules for the third phase of the ETS (2013-20). In particular phase III will see a centralised and tighter cap which declines over the phase; much greater volumes of auctioning with free allocation according to harmonised rules to mitigate against carbon leakage; more harmonised monitoring, reporting and verification; and a centralised registry system with greater levels of security to protect against criminal activity.

5) These changes will ensure greater emissions reductions (estimated as 3,100 MtCO2e (relative to 2005 levels) over the period 2013 to 2020), a more harmonised approach to the implementation and enforcement of the scheme, which will provide a more level playing field for installations across Europe, more

efficient allocations which avoid creating windfall profits and sufficient protection for those sectors most vulnerable to carbon leakage. By addressing security in the registries we are helping to safeguard a market in emissions trading worth around £90bn1 in 2010, which is predominantly based in the UK.2.

6) Phase III will also see the inclusion of additional sectors such as Aluminium and gases such as Nitrous Oxide. From the start of 2012 we will see the biggest expansion of the system since its inception, with the inclusion of the aviation sector. This will ensure that this important and fast growing sector will also have the right incentives to reduce emissions and inclusion is expected to deliver up to 2020 approximately 94 MtCO2e emission savings relative to 2005 levels and 560 MtCO2e reductions relative to Business as Usual levels3.

7) Phase III will put the ETS on a stronger path towards emissions reduction, but looking ahead, the key challenge for the system is to make sure that it continues to provide a strong enough incentive for the investment we need to deliver a low carbon economy. The coalition Government is committed to moving to a tighter emissions reduction target at an EU level and to a tighter cap in the EU ETS as part of delivering this.

8) This memorandum will address each questions raised by the Committee in turn.

Q1: Does the EU ETS remain a viable instrument for climate change mitigation in the EU?

9) Yes. The Government continues to see the EU ETS as a central component for delivering emissions reductions within the UK and across the European Union. It is a key part of ensuring we comply with the legally binding system of five-year carbon budgets to reduce emissions by at least 35% in 2020 below 1990 levels and by 80% in 2050 as set out in the Climate Change Act. The EU ETS is also central to meeting the 20% EU emissions reduction target by 2020.

10) The EU ETS operates by setting an overall cap on emissions that cannot be

exceeded without incurring severe penalties. It allows organisations to reduce emissions where the cost of the reduction is lowest by trading in emissions allowances. Each company has a choice to invest in abatement technology or

1 $142bn (£87bn) - World Bank (2011) State and Trends of the carbon market, available at: http://siteresources.worldbank.org/INTCARBONFINANCE/Resources/State_and_Trends_Updated_June_2011.pdf 2 (since 2009, the London-based European Climate Exchange has traded over 96% of futures and options EU ETS allowances contracts). 3 [1] Forecast of aviation emissions (without a carbon price) from Bloomberg New Energy Finance, using their Global Energy and Emissions Model. All assumptions are from Bloomberg and may not be consistent with wider assumptions used for analysis across DECC. Note that this figure is an update to the estimated savings published in the Impact Assessment of “Second Stage Transposition of EU Legislation to include Aviation in the European Union Emissions Trading System”, which estimated savings relative to BAU levels of 480 MtCO2e..

http://siteresources.worldbank.org/INTCARBONFINANCE/Resources/State_and_Trends_Updated_June_2011.pdf

http://siteresources.worldbank.org/INTCARBONFINANCE/Resources/State_and_Trends_Updated_June_2011.pdf

purchase allowances from those who have made such investments, thus funding the lowest cost abatement in the System.

11) While there has been room for improvement within the system, evidence

suggests that this approach works:

• There has been a high level of compliance by companies within the scheme across Europe.

• The cap for phase II was set at a level which would deliver 6% reductions across the EU on 2005 emissions, equivalent to 580 MtCO2e

• The scheme has led to greater investment in abatement technology; 59% of EU ETS installations surveyed by Point Carbon responded that the EU ETS already caused them to reduce emissions. An additional 9% stated the EU ETS has caused reductions to be planned4.

• In the same survey, half of respondents agreed with the statement that “the EU ETS is the most cost efficient way to reduce emissions in the EU”.

• The EU ETS has established itself as a credible and liquid emissions trading market worth $120 billion in EU emissions allowance (EUA) trades in 2010 with a further $19.8bn of trading in CDM (mostly for EU ETS compliance)5. High levels of trading ensure liquidity in the market and the achievement of the cap at a minimum cost.

• Although the recession has reduced BAU emissions to a level broadly in line with the cap, we are still seeing a significant carbon price as the market can see stringency of the future cap. This carbon price has incentivised abatement – with Bloomberg New Energy Finance estimating c. 260 MtCO2e of abatement from 2008-10 driven by the carbon price.

12) To build on this and to address those areas of the ETS where improvement

could be made, we are taking steps to improve further the performance of the System. In March 2007, the EU set an overall target for 2020 of a 20% reduction in emissions on 1990 levels. In 2009, within this context, the EU ETS Directive was significantly revised to make a much greater contribution to tackling climate change.

13) The changes, which will take effect from 2013, include:

• A more ambitious EU-wide cap on emissions, set top down with harmonised rules. From 2013 the cap will reduce by 1.74% per year towards an overall

4 Point Carbon (2011), Carbon 2011 5 World Bank (see previous reference)

target of 21% reduction in emissions from ETS installations on 2005 levels by 2020. This annual reduction continues beyond 2020;

• Auctioning as the preferred means of allocation, with 100% auctioning to the power sector. This will ensure that the cost of carbon is better integrated into business decisions and will reduce windfall profits as a result of pass-through of the carbon price to consumers.

• Free allocation of allowances (based on benchmarks) to ensure adequate protection for those sectors at significant risk of carbon leakage while maintaining incentives to reduce emissions;

• Additional access to project credits from outside the EU, but in a lower proportion than in phase II to ensure actual behaviour change in the EU while maintaining international linkages.

• An improved single ETS registry with greater security to ensure the ETS is more secure against criminal activity, protecting the integrity of the valuable global market in emissions trading ;

• The development of stronger Monitoring, Reporting and Verification (MRV) regulations, applied to the same standard across the EU ETS;

14) And recognising the benefits of cap and trade, from January 2012 the aviation sector will also be included in the EU ETS. Emissions from all flights into and out of EU airports will be capped under the EU ETS. Net CO2 emissions from aviation in the EU will be under a legally-binding cap of 97% of average 2004-06 levels, with the cap tightening to 95% of average 2004-06 levels from 2013 onwards. Any emissions above these levels will only be possible by purchasing allowances from the market (i.e. allowances resulting from equal reductions in other sectors in the EU ETS). The result is that any expansion of UK and EU aviation would lead to no net increase in CO2 emissions.

15) These changes will result in many more emission reductions, more predictable

market conditions and improved certainty for industry. Reductions in the cap should lead to EU emissions savings (compared to 2005 emissions) during Phase III of around 3,100 MtCO2e.

16) Looking ahead, it is clear that the ability of the ETS to continue providing a

strong signal for innovation will be related to the stringency of the cap. A tighter cap, in the context of a move in the EU to a 30% emissions reduction target by 2020, would be consistent with the EU’s target of a long term transition to a low-carbon economy (80-95% emissions reductions by 2050) and improve the effectiveness of the EU ETS to drive investment.

Q2: Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes?

17) Yes. The EU ETS is currently working effectively, delivering emissions reductions and investment in abatement technology in the EU, although as noted above there is potential to improve the system. The ETS also provides a good demonstration of the workings and benefits of a trading system as a model to others in developing their climate change mitigation policies.

18) The EU ETS has a wide scope, covering around half of EU emissions, and covers sectors with substantial and varied emission reduction potential. This has led to the creation of a liquid market balancing demand and supply and leading to effective price discovery. Although linking to other cap-and-trade scheme could increase liquidity and improve cost-effectiveness (see Q4 for more detail), the EU ETS can continue to operate effectively even without the creation of other cap-and-trade schemes and without linking these schemes to the EU ETS. The UK’s vision though is that by 2020, we would be able to start linking with other compatible cap-and-trade schemes to create a network of linked ETSs.

19) We believe that the EU ETS provides a model for other countries to implement similar cap-and-trade schemes. Although progress in the creation of new cap-and-trade schemes has been slower than expected, there has still been some positive signs of progress, notably:

• In December 2010, California announced the creation of an ETS starting in January 2012. Following a legal challenge, commencement has since been delayed to January 2013 to allow for additional cost-benefit analysis to compare the benefits of cap-and-trade compared to other policy instruments.

• On 10 July 2011, Prime Minister Julia Gillard announced the Australian Climate Change Plan. A key feature of the plan is to implement a cap-and-trade scheme. From 1 July 2012, a carbon price of £15 (AU$23) will be adopted (higher than current EU ETS price ~£11-12), covering 60% of Australia’s emissions (electricity generation, stationary energy, some business transport, waste, industrial processes, and fugitive emissions) and rising by 2.5%/yr until 1 July 2015, at which point carbon price will turn into a cap and trade scheme. There is an explicit scope to link with other cap-and-trade schemes.

• In March 2011, the Government of China announced its 12th five-year plan, including provisions to pilot cap-and-trade schemes in key provinces.

20) In addition, DECC has been directly involved in the development of cap-and

trade systems – for more detail, see Q5.

21) In the absence of an international deal however, it is important that provision is made for sectors at significant risk of carbon leakage. We need to retain a

competitive industrial base as part of ensuring a balanced growth path for the UK. There would be no environmental benefit if industry simply relocates to avoid ambitious climate policies. The EU ETS has addressed this problem through the proportionate free allocation of allowances to sectors at significant risk of carbon leakage. We believe this is the right approach and avoids raising barriers to international trade.

22) We are also conscious that some industries may be particularly affected by the increase in electricity costs stemming from both the EU ETS and wider UK climate change policy measures. So before the end of the year we will be announcing a package of measures for those energy intensive businesses whose international competitiveness may be most affected by our energy and climate change policies.

Q3: What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad?

23) We estimate cumulative (global) GHG reductions from the EU ETS over Phase III will be : • 3,100 MtCO2e relative to 2005 levels • 3,200 MtCO2e relative to forecast Business As Usual Emissions6

Further details of these methods of estimation are given in Annex A

24) Within this, the EU is likely to import around 750 MtCO2e of international offsets

during Phase III of the EU ETS. Once these offsets have been taken into account this will mean that around 2,350 – 2,450 MtCO2e7 of reductions are likely to be within the EU.

Q4: Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved?

25) Yes, linking with other cap and trade increases efficiency gains. The Lazarowicz Report on ‘Global Carbon Trading: A framework for reducing emissions‘ (2009) suggests that global carbon trading, through linking of ETSs and use of international credits, could reduce emission reduction costs by up to 70%. This would allow reduction of global emissions by an additional 40-50% at the same costs and provide substantial financial flows to developing countries.

6 Forecast of emissions (without a carbon price) from Bloomberg New Energy Finance. 7 Depending on whether you use a baseline of 2005 emissions or business as usual emissions

26) By linking different systems, a broader range of emission reduction potential will be covered, which will promote cost effective abatement. A network of linked ETSs would also achieve greater liquidity in the market and help avoid competitive distortions.

27) However, to avoid diluting the ambition of the EU ETS, we would need to ensure

that any system that would link to the EU ETS had a comparable level of ambition and rules. Analysis based on the Lazarowicz Report suggests that four design features need to be coordinated to link cap-and-trade schemes:

i) Monitoring, reporting and verification rules as well as compliance and enforcement mechanisms should be robust and trusted by ETS authorities, so that they could confidently link in the future.

ii) The rules to use international credits (offsets) should be aligned in order to avoid undermining the cap.

iii) Banking and borrowing rules should be aligned. iv) Price interventions (e.g. price floors and ceilings) can also impact linking.

28) The UK has a vision of a network of linked trading schemes among, first,

developed countries and, later, more advanced developing countries. Norway, Iceland and Liechtenstein have already been integrated within the EU ETS, having adopted the ETS Directive. The EU is now in discussions over linking with Switzerland.

29) Currently, the EU ETS is linked to the global carbon market through international credits including the Clean Development Mechanism (CDM), which helps provide valuable financial flows to developing countries ($26.5bn of carbon finance since 20058) while also resulting in emission reductions at lower cost than those within the EU.

30) We are also advocating for the improvement and expansion of global carbon markets through:

• Reform of the CDM to promote the widespread use of standardised baselines and improve institutional arrangements (e.g. rules-based approach in the approval process applied by the CDM Executive Board to decrease administrative burden). DECC is also working closely with DFID to improve access to CDM projects in Least Development Countries (LDC - as defined by the World Bank), as post-2012, only new CDM project credits taking place in LDCs will be allowed for compliance in the EU ETS.

• Creation of new large scale market mechanisms internationally (e.g. sectoral crediting and sectoral trading). These new mechanisms will encourage developing countries to pursue their own emissions reductions, hence

8 World Bank (2011) State and Trends of the carbon market

contributing to the creation of a level-playing field for sectors exposed to international competition, and will provide a new supply of international credits for use in the EU ETS.

Q5: What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally?

31) The UK will seek an agreement in the UNFCCC negotiations for an overarching framework of rules for future international credits and trading. The UK is actively advocating for the reform of the CDM and the creation of new market mechanisms (as mentioned in Q4).

32) Regarding the implementation of domestic ETSs in other countries, it is worth noting that ETSs are one policy tool among others, and that in some specific national contexts, they might not be a suitable mitigation policy. Although the UK remains committed to market-based instruments globally as a cost-effective tool that can help increase global ambition, market-based instruments are only a mean to an end. ETSs are not a silver bullet; they will have to be implemented in combination with other policy tools (e.g. policy tools that directly impact behavioural change and promote investments in new low carbon technologies).

33) Currently, the UK is working with other governments to create compatible trading systems that could be linked in the future:

• Last January 2011, Secretary of State Chris Huhne signed a UK-China low carbon memorandum of understanding that covers three provinces (Hubei, Guandong, Chongqing) and includes a cap-and-trade component. DECC is currently working closely with the Foreign Office to define and agree detailed areas of collaboration with the Government of China. This will help accelerate the development of cap-and-trade schemes in China.

• The UK, along with other EU Member States, has pledged a £7million ($11.4m) contribution to the World Bank Partnership for Market Readiness that aims at building capacity for market-based instruments including cap-and-trade in 10-15 middle income developing countries. This will allow the UK to share its experience on the EU ETS and other market-based instruments with other countries and accelerate the expansion of carbon markets and hence mitigation activities globally. To date, eight countries (China, Indonesia, Thailand, Chile, Mexico, Colombia, Costa Rica, Turkey) are planned to receive a preparation grant of $350,000.

• DECC, in collaboration with DFID and FCO, has been helping the Government of India to design and implement their new energy efficiency trading scheme (‘PAT’ scheme – Perform Achieve and Trade), which covers around 10-15% of Indian emissions. The scheme is very similar to UK Climate Change

Agreements and is a positive step towards the creation of a domestic carbon market.

• DECC has also been working closely with the Republic of South Korea to help them draft their ETS Bill, which is now planned to start in 2015.

34) Finally, the EU set up the International Carbon Action Partnership (ICAP), this is

made up of a number of countries and regions that have implemented or are actively pursuing implementation of carbon markets through mandatory cap and trade systems. The partnership provides a forum to share experiences and knowledge. Through this knowledge sharing it is intended that ICAP will make possible future linking of trading programmes. The UK is a member along with other Member States and the EC. Other trading programmes that take part include the Western Climate Initiative (WCI) and their members, the Regional Greenhouse Gas Initiative (RGGI), the New Zealand ETS and the Tokyo Metropolitan Government. Japan, South Korea and the Ukraine also have observer status.

Q6: Could sectoral agreements form part of the future of the EU ETS?

35) Yes. The EU ETS Directive includes a provision on the use of bilateral sectoral agreements to allow the use of credits from new large scale ‘sectoral’ mechanisms such as sectoral crediting and sectoral trading. This opens up the possibility of using sectoral agreements to generate credits for compliance in the EU ETS. This would be dependent on those agreements establishing comparable rules and accounting procedures in accord with the EU ETS.

36) In practice, a sectoral crediting mechanism only issues credits for emissions reductions that are beyond a baseline which is set at a level lower than business as usual emissions. This ensures that these countries are making their own contribution to the global emissions reduction effort and over-achievement against their pledges is incentivised by the possibility of earning sectoral credits. Such credits could potentially be used in the EU ETS for compliance. Such sectoral mechanisms could greatly reduce competitive distortions by incentivising an appropriate degree of “own-action” in the host country and contribute to creating a more level-playing field for internationally competitive industries

37) The UK’s position, which is in line with the EU position, is that such sectoral agreements should be developed under an international architecture agreed through UNFCCC negotiations. However, short of an international agreement, there is a possibility for the EU to start developing such agreements bilaterally in the future.

38) The UK is a strong advocate for the creation of new market mechanisms internationally. To promote progress on the ground and demonstrate feasibility, the UK has pledged a £7million contribution to the World Bank’s Partnership for Market Readiness to ensure that capacity is built on the ground with a view to a pilot sectoral market mechanism in the future. (see Q5 for more detail on this initiative).

Q7: Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism?

39) Although the UK is actively advocating for a successor to the Kyoto Protocol to be agreed internationally, there is indeed a risk that we end up without a successor to Kyoto. In this event, the UK (and EU)’s view is that the CDM could continue – there are no legal barriers for this to happen. However, the challenge will be to secure political agreement from other countries.

40) Up to 2012, an estimated 1,100 MtCO2e of international credits are likely to be issued9, of which 900 MtCO2e are estimated to be surrendered into Phase II of the EU ETS. The EU ETS directive allows for around 1,650 MtCO2e of project credits to be used over Phases II and III combined. Thus after accounting for Phase II use, there be a demand for credits from the EU ETS over Phase III of around 750 MtCO2e. As a result, if the CDM stops existing post-2012, there is likely to be remaining demand for alternative types of credits post-2012. In the current context, we do not have such alternative sources of international credits, although the UK is strongly advocating for the creation of new sources of supply (see Q7 for UK activities to promote creation of sectoral mechanisms).

Q8:Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system?

41) The ETS is an important part of the Government’s policy framework for tackling climate change, ensuring emissions reductions across a range of industrial sectors and within the power sector, and delivers reductions across the EU. By its design, the ETS delivers these reductions at least cost and therefore where it is most efficient for them to take place. As a market based mechanism the ETS readily accommodates complimentary and additional policies as the market readily prices in any such policies by Member States,

42) While the EU ETS provides a clear carbon price, there are other market failures which justify government intervention to help reduce emissions. The current ETS alone is also insufficient to deliver the scale of emissions reductions needed to

9 UNEP Risoe CDM/JI Pipeline Analysis and Database, August 1st 2011

ensure the UK is in line with our 2020 and 2050 trajectories. In the UK we see the need for additional policy measures to complement the impacts of the EU ETS and to strengthen the signals within the UK, particularly to investors in low carbon electricity generation. For instance, as part of the Electricity Market Reform White Paper, we set out our intentions for a carbon price floor (CPF) to provide a stronger carbon price signal to encourage investment in low-carbon electricity generation in the UK. The CPF will give a clear and credible early signal to investors on the trajectory of carbon prices, avoiding lock in of high-carbon technologies, which could prove expensive as the ETS cap gets tighter. We are also pursuing ambitious policies to drive emissions reductions in the non-traded sector, such as the Green Deal, which will encourage significant energy efficiency savings within the domestic sector.

43) The UK is not alone in pursuing wider decarbonisation policies beyond the EU ETS, with most major EU countries pursuing additional policies targeted beyond the ETS.

44) Given the efficiency of reductions under the EU ETS, we do of course consider

the impact of any complementary policies on the incentives created by the ETS, and would not want to pursue a policy which actively undermined the effects of the ETS. Looking ahead we will be carefully considering the impact of the proposed Energy Efficiency Directive on the EU ETS. In many cases this directive has the potential to drive energy efficiency savings outside of the traded sector. Where there is overlap with the EU ETS, we will need to look carefully at the level of the ETS cap to ensure that the incentives of the ETS are preserved. Improved energy efficiency across the economy whether driven by the EU and/or Member State action will make achievement of an EU 30% reduction target easier and less costly. The cheapest energy is that which is not used.

Q9: How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? 45) The EU ETS is supported by a system of electronic registries to issue, transfer,

hold and cancel EU emissions allowances (EUAs). Currently each MS has a registry; all companies that participate in the ETS and all companies or persons wishing to trade EUAs and Kyoto Units (units assigned under the Kyoto Protocol) within the EU ETS must have an account in a registry which holds those EUAs and Kyoto Units. From 1st January 2012, the member state Registries functioning in relation to EUAs and will be moved to a single Union Registry, hosted by the European Commission, which will hold all EUAs and Kyoto Units.

46) The registry system has been subject to fraud to date. In September 2008 the carbon market fell victim to VAT carousel fraud in a similar way to other markets previously. The UK acted swiftly to address this, first zero rating carbon, before introducing a reverse charge mechanism, which means it is no longer possible to conduct carousel fraud in the UK carbon market. Many other member states have since taken similar steps and the UK has supported the European Commission in pressing those member states still to implement this mechanism to do so.

47) During 2010 and 2011 there were a number of cyber attacks on several Registries in various EU Member States (not including the UK). These attacks resulted in the alleged theft of approximately 4.3m carbon allowances which were transferred out of operators’ accounts into different accounts.

48) Fears about registry security and the subsequent uncertainty around ownership

of allegedly stolen allowances had an impact on trading in the carbon market. Most notably, trading in spot allowances (i.e. for immediate delivery), which accounts for around 10% of the market, almost ceased. There was less practical impact on the futures market, the majority of which is based in London. However, market participants were naturally keen to see increased security across the registry system and clarity on transfer of title given the differing legal regimes across the EU.

49) Since the attacks, work has been underway to improve the security of the

system, in which the UK has played a leading role. This included proposals to amend the existing Registries Regulations, and introduce yet tougher regulations for phase III of the ETS.

50) The EU’s Climate Change Committee voted in June to adopt a regulation to

enhance security of the EU ETS registries and therefore to promote confidence within the carbon market. UK lobbying ensured a much improved final regulation, with a better balance between security, certainty for market participants and the efficiency of the market.

51) Provisions in the new regulations, which we believe will strengthen security and

confidence in the market include:

• Improved clarity on issues of title in the registry system, which should give purchasers of EU emission allowances greater confidence;

• Greater powers for registry administrators to freeze accounts or allowances e.g. where they suspect money laundering;

• Provisions to impose a 24 hour delay to transactions, with exemptions possible in certain situations, to provide time for fraud to be detected;

• A range of provisions which will improve security, including ‘two factor authentication’; double validation of all transactions; and better ‘know your customer checks’.

52) The regulations will come into force in three stages between now and June

2012.

53) Later this year, we are also expecting Commission proposals on regulation and oversight of the carbon market. These will build on the security provisions already established in the registries regulation, as well as looking more widely at lessons which can be learnt from other markets e.g. to mitigate the risks of market abuse, protect customers and improve transparency. The UK Government supports this further work on the risks facing the market and options for addressing them in a proportionate way, balancing the integrity of the market with openness and efficiency.

Q10:How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations? 54) As discussed in the responses to questions 1 and 2, the EU ETS is already

operating well in a world without legally binding emissions reductions. Given the element of learning by doing within the development of the system, there has been room for improvement and measures are being taken as part of the move to Phase III of the ETS to strengthen the ETS further. These revisions include a more ambitious cap, auctioning being used as the preferred means of allocation, free allocation according to benchmarks for sectors at risk of carbon leakage, reduced access to project credits, greater registry security, stronger MRV standards and also from 2012 the inclusion of aviation (as mentioned in response to question 1).

55) These changes will ensure that the EU ETS can deliver a greater level of environmental ambition. However, they also mean that: a) we can ensure a more level playing field for UK installations, by ensuring a more even implementation of the EU ETS across member states; and b) we will maintain the competitiveness of EU industry alongside this increase in environmental ambition, which is critical in the absence of an international agreement.

56) Over the longer term, the Government is committed to pushing for a greater

degree of auctioning in the EU with a view to further improving the way in which allowances are allocated.

57) The Government is committed to pushing the EU to move to a 30% emissions reduction target in the EU (in 2020 relative to 1990 emissions), with a

commitment to a tightening of the EU ETS cap to deliver this. We believe that this will put the EU and the UK on the right pathway to meet our longer term climate change goals, such as those legislated in the UK’s Climate Change Act and the EU’s commitment to limit climate change to 2°C and reduce EU emissions by at least 80% by 2050. A tighter EU ETS cap will increase the incentives to invest in low-carbon technologies. Given the provisions that exist within the Directive to manage the risk of carbon leakage, we believe that such a move is in our own economic interest even in the absence of an international agreement.

August 2011

Annex A We have estimated the savings associated with the EU ETS in 2 ways Method 1 We have looked at the cap level (and thus net EU emissions) relative to 2005 levels. This is best shown by diagram 1. Diagram 1

This approach is relatively easy to estimate. While using 2005 levels may seem a somewhat arbitrary point to estimate emission reductions, such an (historical) point is justifiable in that it is not effected by when the assessment is made (see below issues with method 2) and is in line with much of the legislative structures of the EU ETS, which regularly use 2005 as a baseline.

Method 2 Another way of estimating the savings of the EU ETS is to compare the ‘business as usual’ (BAU) emissions with those of the cap.

Such a method compares the cap level with the estimated emissions under a zero carbon price. This is illustrated by Diagram 2. 10 There are however issues with this approach to estimation. These include; - The order in which policies are considered will affect the savings associated with

them. For instance, if one considers the renewable energy target before the EU ETS (as has been done for this analysis), then the savings of the EU ETS are substantially less. Alternatively if the EU ETS is considered first, no emission savings would be attributed to the renewable energy target.

- BAU will significantly change over time as fundamental drivers change; so the

estimated BAU (and therefore emission savings) are significantly lower today than they were when the EU ETS cap was set, as a result of the recession significantly lowering the estimated level of emissions. Similarly changes in fossil fuel prices will cause BAU emissions to change. This approach to estimation, with emission savings falling and rising in line with changes in external drivers ignores the fact that the main purpose of the EU ETS is to limit emissions to a pre-determined level.

Diagram 2

10 Forecast of emissions (without a carbon price) from Bloomberg New Energy Finance.

Memorandum submitted by Barclay Capital (ETS 02)

Barclays Capital welcomes the opportunity to respond to the Committee’s inquiry. As the investment banking division of

Barclays Bank plc, Barclays Capital has been at the forefront of emissions trading since the inception of the European

Union Emissions Trade Scheme (EU ETS), and has dedicated emissions trading desks in London and New York.

To date, we have traded over 6 billion tonnes of CO2 and were the first market participants to both take delivery of

physical CO2 allowances under a spot market trade (2005) and to deliver CERs into an EU registry the day the link

between the Community and the International Transaction Logs went live (2009).

In this response we address the main questions outlined in the Committee’s call for evidence. Although we have kept our

answers succinct we do include further detail in the two attached appendices.

Executive summary

The EU ETS has taken concern about climate change from the corporate social responsibility area and moved it into

the boardroom;

It has fundamentally altered the behaviour of business across Europe, making climate considerations central to all

future investment decisions;

Climate change is a global problem and the more widespread and consistent the pricing of carbon, the more

efficiently emissions reduction will be made;

The UK and EU should push for trading schemes rather than taxes, deep targets, and the absence of price-distorting

measures in ETS design;

As climate change is a global rather than local issue, any unilateral action on emissions is always going to be

somewhat frustrated by the behaviour of others;

A regulator of the carbon market that is independent of policymaking bodies should be created to address the issue

of fraudulent behaviour.

Responses to Committee’s specific questions

Does the EU ETS remain a viable instrument for climate change mitigation in the EU?

Yes. For companies with compliance obligations, the EU ETS has taken concern about climate change from the corporate

social responsibility area and moved it into the boardroom. In doing so, it has fundamentally altered the behaviour of

business across Europe, making climate considerations central to all future investment decisions. If anything, the EU ETS

coverage should be expanded to cover more of the non-traded sectors – particularly household heating and

transportation. Please see appendix 1 for the attached extract from our published research on the effectiveness of the EU

ETS.

Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and

other cap-and-trade schemes?

Yes. The operation of the EU ETS is fully independent of the UNFCCC process and policy development in third countries.

Even though policy development on climate around the world has been slow, it would be even slower without the

example provided by the EU ETS.

What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad?

The emissions reductions delivered by the EU ETS are entirely a function of the cap on emissions that is agreed. If it is

deemed that the emissions reductions are not as high as some desire, or that supplementary policy will help meet the

cap goals, that is a political failure to deepen the cap. It is not a failure of the working of the EU ETS, which has the sole

purpose of delivering emissions in line with the cap. Emission reduction funded abroad will total 1.7 Gt from 2008-2020,

which is the quantitative limit of imports of CERs and ERUs. A deeper cap would have greater import levels and would

fund more international emission reductions.

Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions

trading schemes and how can this be achieved?

In theory, yes. Climate change is a global problem and the more widespread and consistent the pricing of carbon, the

more efficiently emissions reductions will be made – as the pool of low cost abatement options to be realised widens.

The biggest practical barriers to direct linking are a lack of other emissions trading schemes around the world with which

to link, rendering this discussion academic, and the inconsistency in the emission reduction ambitions of various schemes.

If two schemes link with very different levels of ambition, the resulting price convergence and flow of allowances from

low-priced to higher-priced areas would result in a substantial welfare transfer that is unlikely to be justified by the

environmental benefit. If an ETS has effective price control measures, then linking could also lead to missing the

environmental goals of the scheme without such price control.

What actions should the UK and EU be taking to promote the development of compatible ETSs internationally?

The UK and EU should push for trading schemes rather than taxes, deep targets, and a lack of price-distorting measures

in the ETS design.

Could sectoral agreements form part of the future of the EU ETS?

If this question means ‘could the EU ETS link with a sectoral ETS in a developing country?’, the answer would be yes,

subject to the caveats expressed in the answer to the previous question. If the sectoral target is efficiency-based rather

than absolute, then equivalence of the environmental goals is harder to establish and increases the risk of over-allocation

in the market. Such risks could be managed with quantitative limits on the import. A sectoral scheme within the EU

should be unthinkable, as any attempts to further regulate carbon emissions in currently non-traded sectors should be

done through the expansion of the EU ETS.

Will the EU ETS be able to access viable alternatives to international credits without the Clean Development

Mechanism?

The Kyoto Protocol mechanisms (the CDM and JI) are important as the only internationally-recognised offset standards.

This does not mean they will be the only internationally-recognised offset standards in the future but it is clear that it is

the standard with the greatest focus on ensuring the additionality of the emissions reductions. If offsets are not

additional to what would have happened anyway, then using them under a binding cap only serves to frustrate the

environmental integrity of the compliance system. Hence, any new offsets that are made eligible under the EU ETS need

to be as stringent on the additionality criteria as that in the CDM.

Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member

States’ own policies affecting the operation of the trading system?

The EU ETS sets the EU’s goal for emission reductions in the traded sectors. Any over-achievement of emissions

reductions in the traded sector of one Member State will be able to be exported to the traded sectors of another

Member States (ie. allowing higher emissions in other states).

To the extent isolated policy is driving higher emissions reductions in the traded sectors, then this should lower the

carbon price against what it would be otherwise. The UK’s own “carbon floor price” tax, to the extent it can encourage

greater use of gas-fired generation in the UK, would soften the EUA price. In doing so, it allows higher emissions

elsewhere.

As climate change is a global rather than local issue, any unilateral action on emissions is always going to be somewhat

frustrated by the behaviour of others. This underlines the importance of the multinational framework on climate change

provided by the UNFCCC.

How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further

improvements in security and auditing required?

It has been very severe in damaging the EU ETS reputation for integrity, and has paralysed the effective operation of

some parts of the market (the spot market). In terms of EUA theft and registry security, we feel this issue has largely

been resolved although it is always possible for security breaches to occur even with very tight security protocols.

On a wider basis, we believe that the EU ETS is still open to other types of fraudulent behaviour, including money

laundering, and believe that a root cause has been the ability for anyone to open up a registry account and trade EUAs.

We have recommended to stakeholders including the EC that limits be imposed on the type of participants that have

access to this market. Please see appendix 2 which reproduces a position paper Barclays Capital released following the

discovery of the EUA theft incidents.

We also believe that a regulator of the carbon market that is independent of policymaking bodies is desirable. The model

here would be the regulator of energy markets and in no instance should such a body be able to interfere in the price

mechanism.

How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions

reduction obligations?

If we define “strengthen” as increasing the level of emission reductions delivered, then this only requires a deepening of

the cap. In conjunction, a broadening of the coverage of the EU ETS, in particular to cover transport and household fuel

use, would be desirable as this widens the pool of potential abatement opportunities.

August 2011

APPENDIX 1: THE EFFECTIVENESS OF THE EU ETS

The following is an extract from research published by Barclays Capital commodities

research team in Monthly Carbon Standard, 1 July 2011.

The EU ETS: Is it working?

Has the EU ETS been worth it? With recent commentary even questioning whether the EU ETS has fostered the

development of an effective secondary market in emissions allowances (we believe it

has), a perennial question is: has the scheme been effective in actually reducing

emissions? Certainly opponents of the ETS from both sides of the political spectrum

like to answer no, while the proponents sometimes answer in the affirmative – with

both sides often employing arguments heavy on assertion and light on evidence.

While this seems a fairly binomial proposition, the difficulty of actually quantifying the

answer does make such answers complicated. The issues have to do with the difficulty

of establishing the counter-factual (what would emissions have been without the EU

ETS) and the time frame (over what period are we looking).

Experience to date

High level evidence is murky The experience of the EU ETS in phase 2 is difficult to separate from the effect of the

financial crisis in 2008 and the subsequent recession and slow recovery. We use 2008

as a base reference because the numbers only have half a year of recession in them

and are a consistent reference point given the expansion of the scheme from 2007 to

2008.

The facts of the matter are stark, with the years 2009 and 2010 having:

Industrial emissions that averaged 15% below 2008 levels. This is against the

background of industrial output falling an average of 12% in those two years

against 2008 levels. Thus, emissions reductions did outpace the fall in industrial

output, but this is fairly simple and superficial evidence as to whether current

emissions reductions are driven by the economic climate or the EU ETS.

Power sector emissions are about 8% lower in 2008, while power sector output

was down 7% on the 2008 levels. Again, this shows emissions reductions

moderately outpacing the reduction in output, which is weak evidence that the EU

ETS has encouraged some emission reductions.

Looking beyond these high-level statistics and focussing most here on the power

sector, two key topics must be considered: long-term effects through the investment

in low carbon technology and short-term abatement through fuel switching.

Long-term effects: Investment patterns

The EU power sector has benefited from considerable investment in lower carbon

technology. From 2000 to 2010, the EU saw:

A net increase in gas-fired power stations of 118 GW, versus a net decrease in

coal-fired generation of 9.5 GW. While some new coal plants have been added

(about 16 GW), the speed of retirements has exceeded those additions. We note

that Germany is seeing a number of new coal plants come on line that will add 11

GW, but, true to trend, we expect some older coal capacity to be lost.

The EU saw additions of 75 GW of wind, 29 GW of solar (mostly PV) and 8 GW of

others (including hydro). The pattern of growth is such that the biggest additions

have been in the second half of the decade: 2005-10 saw 73% of those additions

come across all the renewable technologies, while 2009 and 2010 alone saw 36%

of the additions.

To put these numbers into context, there is about 875 GW of power generation

capacity in the EU including the renewable technologies.

Figure 1: New installed capacity per year (GW)

0 5 10 15 20 25 30 35

RenewablesThermal

RenewablesThermal

RenewablesThermal

RenewablesThermal

RenewablesThermal

RenewablesThermal

RenewablesThermal

RenewablesThermal

RenewablesThermal

RenewablesThermal

RenewablesThermal

Wind

Solar

Other renew

Gas

Coal

Source: EWEA, EPIA, Barclays Capital

CCGT – the choice of a generation

The interest in gas in the last decade was driven by a number of factors, including:

The capital cost and speed of construction advantages of combined cycle gas

turbines (CCGT) compared with coal-fired plants. New entry costs made CCGT the

choice of plant in most markets in the past decade and likely to continue into the

current decade (see Figure 3 and Figure 4); and

Expectations of future carbon liabilities. With fuel price relativities often favouring

coal, particularly in areas in which gas remained priced to oil such as Germany, the

threat of future carbon liabilities (price and volume) is essential in keeping the

choice gas.

What happened to the new coal renaissance?

In 2003, there was serious talk in Europe of a new coal renaissance driven by the

effect that increasing oil prices were having on gas prices. In 2003-05, there was a raft

of new coal projects, particularly in Germany, that were going to financing and

construction. These German plants constitute the 11 GW of coal plant scheduled to

commission by 2013. At the time, the German government was promising that new

coal plants would continue to receive high levels of free allocation of EUAs out to

2020 – a promise that the EC subsequently objected to and took the German

government to court on and won, meaning that all German power and heat

installations would be subject to 100% auctioning from 2013 onwards. The threat of

high carbon liabilities for coal has certainly changed the decision regarding what is

built.

Figure 2 shows the current status of the main German coal projects that have been

announced but have yet to go to construction.

Figure 2: Status of coal-projects not yet in construction in Germany

Project name Capacity (MW)

Status

Staudinger 1100 The most likely to proceed. Eon examining likely legal challenges.

Project involves closure of older three units at site would keep

capacity largely same but improve efficiency and emissions per

unit of output.

Brundsbuttel 1800 Project beset by withdrawals with Iberdrola, EBM, Romande Energy

and Group E all pulling out. Looking for new partners although

project originally announced in 2007.

Profen 660 No news since 2008 when project was looking for partners.

Various projects 5050 Abandoned: Dorpen (900 MW); Griefswald (1600 MW); Stade (800

MW); Hurth (450 MW); Wilhelmshaven (500 MW); Kiel (800 MW)

Herne 5 750 Indefinitely postponed: Due to 100% auctioning of EUAs and

rising equipment costs. Postponement announced in 2008.

Total 8260 Total of projects either abandoned or likely to be abandoned

Source: Platts, Barclays Capital

Little new coal in Western Europe

In Figure 2 we see that with the possible exception of Staudinger, there are no new

coal projects in advanced development that could proceed to construction. By

contrast, more than 8 GW of coal plant projects have been abandoned or appear

likely to be abandoned. Widening this to Western Europe, only 3.4 GW of coal plant

are in advanced development, and with Italy’s Porte Tolle running into further

permitting problems in June, even that looks ambitious. Comparing this with gas,

there are something like 21 GW of CCGT under construction and some 31.5 GW in

advanced development (source: Platts). So while the current new build ratio is about

60% CCGT/40% coal, we expect it to be more like 90%/10% once existing coal

projects under construction are completed.

The lessons from the evolution of the preference for new build are that the EU ETS

has:

Fundamentally altered the balance of new build in western Europe and has biased

it further towards gas. While it was not the only factor pushing the choice of gas,

the pricing of carbon has ended the brief renaissance of coal that seemed to be

emerging in the first half of the past decade.

Done this with current pricing at modest levels. The keys here are the following:

− Current prices are irrelevant for long-lived investment decisions. What is

important is the future promise of scarcity and the expectation that future

potential liabilities require action to manage them today.

− Move away from free allocation to 100% auctioning means that incentives

went from being on the margin to being on the entire level of carbon

emissions of plant.

These two factors changed the new build economics fundamentally, increased the

potential risk of building new thermal plant significantly and are a strong argument in

favour of the effectiveness of the emissions market in reducing emissions.

Figure 3: Economics of new build – no carbon (€ct/kW) Figure 4: Economics of new build – with carbon

(€ct/kW)

Source: Various industry sources, Barclays Capital Note: Carbon at 30 €/t CO2. Source: Various industry sources, Barclays

Capital

Renewables – the other choice

The other trend seen has been that the speed of the uptake of renewables has

quickened. Figure 5 shows how the uptake of renewables in Europe has accelerated

since 2007, which corresponds to the move into the second phase of the EU ETS.

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Figure 5: Pace of the uptake of renewables (MW)

0

5000

10000

15000

20000

25000

30000

2000 2002 2004 2006 2008 2010 2012 2014

Wind Solar Other renewable

Note: Actuals to 2010. 2011 onwards are forecasts. Source: EWEA, EPIA, Barclays Capital

EU ETS role in the renewable story

The speed of the uptake of renewables is often separated from the effect of the EU

ETS as the primary direct subsidisation policy is through feed-in tariffs (FiTs), which

means renewable generation does not earn the wholesale power price. With the

remuneration of renewables often being isolated from direct effects of the EU ETS,

one argument is that it has not played any role in driving the faster uptake of

renewables in the second half of the decade. Instead, the recent increased pace of

investment in renewables is explained by the increased commercialisation of the

technologies. While there is some truth to these claims, such conclusions do mask the

fundamental changes in renewables investment.

In 2000, investing in renewables was still the preserve of smaller companies, largely

dominated by boutique wind project developers. Project pipelines are now being

dominated by the big utilities with more money to spend. The developments that

have driven this are:

A growing preference for larger projects, particularly with a growing role for off-

shore wind, to dominate. The utilities tend to like the bigger capital projects, and

off-shore wind makes most sense on a bigger scale. Offshore wind farms are

growing in size, with early farms often being less than 100 MW, but most of the

project pipeline being 500 MW and above. Part of this scaling up of project size is

a tendency for bigger turbines (a technological leap), and the European utilities

have been at the forefront of working to surmount some of the technical and

logistical difficulties of these larger turbines. For instance, RWE specially

commissioned two offshore installation vessels that are to be trialled next month.

These vessels will be the first of their type to be able to transport up to four multi-

MW offshore wind turbines and erect them in water depths of more than 40

meters. The reported (offshorewind.biz) contract value for each of these platforms

is about €100mn. Such financial depth is only likely to be found in the utilities.

The big utilities now have significant future carbon liabilities, and the importance

for these companies in finding ways to manage this risk, by lowering the carbon

intensity of their fuel mix, should not be underestimated. A good case study of this

is the “Forewind” project that looks to build a 9-13 GW offshore wind farm in the

UK (Dogger bank). The Forewind consortium consists of four utilities: RWE, SSE,

Statkraft and Statoil. At a conference for investors in which RWE presented the

technical and logistical obstacles it was surmounting in developing the project,

RWE made clear its motivation for undertaking this project. The message it gave

was unequivocal – FiT, while helping with the project economics, was not the

reason for doing this investment. The reason for doing this was to reduce the

carbon intensity of its generation to manage its future liabilities under the EU ETS.

The CO2 reduced from this wind farm alone would be something like 12 Mt per

year.

Scaling up of renewable projects due largely to EU ETS

As such, one of the driving factors in the changing face of renewable project

development, and the consequent scaling up of the uptake of renewable generation in

Europe, is the EU ETS. Even a cursory look at the investment strategies of European

utilities shows the importance these participants place on managing carbon exposures

under the EU ETS in their future investment strategies.

Fuel switching

Has fuel switching happened in phase 2?

Another area in which the EU ETS was meant to encourage emissions reductions was

in promoting short-term abatement in the power sector through incentivising greater

use of gas plant at the expense of coal plant (fuel switching). The main issue with

looking at its effectiveness in encouraging abatement from fuel switching is that, given

the reduction in emissions caused by recent European economic performance, the

market does not require short-term abatement to balance. As such, the relative

movement of gas and coal prices has been largely irrelevant for carbon pricing over

the past couple of years (an average correlation of 39% over phase 2). EUAs are

largely pricing as an option on future emissions and will do so until the market gets

tighter and needs short-term abatement to balance.

Given this, and before even looking at the data, we expect the EU ETS would, to date,

have driven little short-term abatement. Figure 6 shows the cost of generating gas

against the cost of generating coal for fuel switching in the middle of the merit order

(gas plant at 50% efficiency against coal at 34%). When the line is above the x-axis, it

means gas is more expensive to generate with, while negative numbers mean coal is

more expensive.

Evidence of short-term abatement

What we found was that from January 2008 to June 2011, the number of days in

which the series excluding carbon costs was positive (gas out of merit) and the series

including carbon was negative (gas in merit) was 51%. That is, for more than half of

phase 2, the CO2 price would have been sufficient on its own to generate some short-

term abatement in the power sector – even in an environment in which the CO2 price

did not have to price itself to generate that abatement.

Figure 6: Fuel switching: Cost of gas-fired less coal-fired generation (€/MWh)

-10.0-7.5-5.0-2.50.02.55.07.5

10.0

Jan08

Apr08

Jul08

Oct08

Jan09

Apr09

Jul09

Oct09

Jan10

Apr10

Jul10

Oct10

Jan11

Apr11

Excluding CO2 Including CO2

Note: Uses 50% efficient gas, 34% efficient coal. Source: Ecowin, Barclays Capital

With regards to the absolute level of abatement this has generated, we estimate this

to be about 10 Mt of carbon per year. The reason this level of abatement is relatively

limited (power and heat emissions across the EU ETS at about 1.37 Gt) is that:

The analysis uses UK gas prices, and throughout the period in question, UK gas

has had a considerable discount to the oil-indexed prices on the continent (45%

lower in 2009 and 18% lower in 2010). Using oil-indexed prices over the period

would lead to almost no fuel-switching gains, which highlights an important but

often lost point: namely, one of the biggest barriers to emissions reductions in

European power is not the prevailing carbon price but the lack of gas price

liberalisation that keeps prices in that market related to oil. Unfortunately, with

LNG markets also pricing largely on oil index, global gas market liberalisation is

likely to be necessary to fundamentally break the link between oil and gas prices.

The fuel-switching is largely on the marginal plant as the most efficient gas plants

would still be in the money regardless of the carbon price. The number of days the

least efficient plant would be switched on just due to the carbon price is more

limited, while issues such as transmission constraints and demand levels means the

effect of fuel-switching is always constrained.

Summary

The lessons to draw from this discussion are:

The EU ETS has ushered in a fundamental change in compliance participants’

behaviour. The change in how utilities invest in generation plant has been altered

fundamentally and has ushered in a scaling up of investment in renewables that

would not have been driven by feed-in-tariffs alone. Becauase no utilities,

particularly in Western Europe, will want to build new coal plant given the

potential future liabilities in carbon this allows, the remaining investment options

are cleaner gas-fired generation and renewables.

While actual short-term abatement appears limited, this is due to factors outside

of the markets’ remit. Namely, European economic performance has been weak,

helping reduce emissions well below the cap, and the lack of spot gas markets has

meant that fuel switching gains have only happened predominantly in the UK.

So, despite the recent volatility in carbon prices that has led to much wringing of

hands in anguish, future scarcity is being driven by the 1.74% reduction factor that

implies the following reduction targets on 1990 levels: 25% by 2023; 30% by 2026;

and 37% by 2030. Without sufficient investment this decade, such targets will be

impossible to meet, and all evidence suggests that the investment decisions of the

utilities are being driven by this reality. Given this, the EU ETS has most assuredly been

working to drive future emissions levels downwards.

APPENDIX 2: REMOVING CRIMINALITY IN THE EU ETS

The following is a position paper released by Barclays Capital on 2 February 2011.

€5 BILLION AND COUNTING

Removing criminality from the carbon market

Over €5 billion of VAT fraud1;

Over €45 million of EUAs stolen from registry accounts2;

Suspension of registries and cessation of spot market trading;

Arrests of over 100 people in connection with criminal activity3;

Door left open to criminal activity including further theft, VAT fraud and money laundering;

Enhanced IT registry security will improve matters but it does not solve most of the problems;

The time has come to fix the problem. Access to the market by criminals needs to be stopped.

Confidence in the EU ETS has hit new lows at the beginning of 2011 following the latest fraud to affect

the market involving theft of EUAs. The carbon market is now in danger of seeing irreversible damage

and a slide into disorder as confidence in the regulatory framework evaporates. The headline problems of

the market, while making grim reading, are to do with implementation rather than the basic principles of

the market. Indeed, despite the large amount of criminal activity, the environmental integrity of this

market remains intact and it is the importance of this market in reducing the emissions of greenhouse

gases that makes it worth fixing.

The heart of all of the problems affecting the carbon market is that criminal elements have access

to the market. Anyone wanting to engage in criminal activity can open up an account in a registry,

take delivery of EUAs, transfer them on and receive payment. This facilitates VAT fraud, out and out

theft, and leaves the door open to problems such as money laundering.

While better IT registry security will help guard against theft, it likely will not fully stop it, and it is

not an answer to the problem of VAT fraud (that had an inconsistent solution of changing VAT

rules – to date only selected countries have changed VAT rules) or money laundering. Theft could

still occur, either by more sophisticated hacking or through inside knowledge of passwords and

security protocols. VAT fraud is still occurring in countries that have not modified VAT rules and

money laundering can still occur anywhere.

The upshot of these problems is that legitimate firms with a genuine intermediation and liquidity

provision role to play in the market are now looking at a carbon market so full of potential risk that

future participation is a real question. The risks come from unwittingly abetting criminal activity

1 Source: Interpol. http://www.europol.europa.eu/index.asp?page=news&news=pr101228.htm 2 Source: Thompson Reuters Point Carbon http://www.pointcarbon.com/news/1.1501159 3 Source: Thompson Reuters Point Carbon http://www.pointcarbon.com/1.1495037

http://www.europol.europa.eu/index.asp?page=news&news=pr101228.htm

(such as by taking possession of stolen property) and facing both monetary loss and/or legal

sanctions.

The solution to all of these problems is that criminal elements must be denied access to the market

and this can be done most practically by restricting access to the registry accounts to those

companies with installations with compliance obligations under the EU ETS, their affiliates, and

MIFID regulated firms. At the start of the EU ETS, access to registry accounts in different Member

States was characterised by ease of access. The ease of access was a policy choice that was

presumably taken on the basis that wide access to the market would facilitate deeper, more liquid

markets that would be more efficient. The issue now is that the criminal activity that this has

opened the door to is driving out the legitimate liquidity providers. As such, this unintended impact

of the policy has the ability to undermine liquidity provision as bona fide liquidity providers leave,

being deterred from participation by the criminal element.

We acknowledge that restricting access to registries to compliance entities, their affiliates and

MIFID regulated firms may mean some bona fide firms will no longer be able to participate in the

physical markets. However such participants would still be able to participate in financially settled

contracts and would still have access to the physical market through MIFID regulated

intermediaries.

Failure to restrict access will mean that participation in the market will wane and liquidity will

reduce at the real expense of the market. With over €5 billion lost already it is clear to us that the

economic cost of maintaining unfettered market access far outweighs the economic benefit. Failure

to introduce proper controls on carbon market access will lead to bad liquidity pushing out the

good.

A more over-arching solution is to bring financial regulation to bear on the spot market. Almost all

of the criminal activity to date has occurred in the spot market which is attractive to criminals as it

is unregulated, involves an immediate transaction (so minimises the chance for detection prior to

the transaction being complete) and does not involve requirements for credit and balance sheet

disclosure, which most fraudulent traders cannot provide. However bringing to bear full financial

regulation on the market is more difficult to implement, will take considerably more time, and

possibly has more unintended consequences than the restricted registry access alternative.

One final issue that will still need to be solved is the handling of stolen EUAs. Whilst physical

commodity markets are susceptible to theft (e.g. theft of oil or gold bullion), EUAs only exist in

registries and have unique identifiers in the serial numbers. Given that any stolen EUAs can then be

tracked as they move around the registries, this means that stolen EUAs will be identified. The

handling of stolen property, and who gets to keep the affected EUAs is legally unclear, creating

prohibitive risk to anyone trading physically settled EUAs. An EU wide approach of extending buyer

protection laws to transactions in EUAs could help resolve the issue.

We firmly believe that we need to see the EC begin the implementation of restricting access to the

carbon market to save its integrity. Failure to do so will continue to leave the door open for criminal

behaviour to further damage the reputation and confidence in the market. The existing registry closures

present a unique opportunity for the EC to take the problem in hand.

15

Figure 7: EU ETS events – explanation and scale of the problem

Event Discussion Scale of problem

VAT

(Carousel)

Fraud

VAT fraud is the theft of Value Added Tax (VAT) from a government by

persons exploiting the way VAT is treated where the movement of goods

between jurisdictions is VAT-free. This allows the persons to buy the good

tax free – in this case EUAs - charge VAT on the sale of goods, and then

instead of paying this over to the government's collection authority, simply

abscond, taking the VAT with them. The term "missing trader" refers to the

fact that the trader goes missing with the VAT, "carousel" refers to the way

that the fraud sees VAT and goods passed around companies and

jurisdictions, similar to how a carousel travels round.

Value of the fraud has been put by Interpol at

€5 billion in lost tax receipts (implies over 2

billion tons of carbon traded on such fraud)

and individuals were arrested in a number of

EC countries including Norway, Spain and the

UK.

Probably on-going as in 2010 VAT fraud in Italy

became apparent in large volumes.

EUA Theft The theft of EUAs in the EU ETS has been done through a combination of

hacking and phishing attacks on registries and accounts. Once the criminal

has access to an account, it can transfer EUAs from it to an account it has

set up. From there, it quickly sells the EUAs into the market and then

transfers these stolen EUAs to an unwitting buyer before the theft is

realised.

An estimated 250 k (€3 million) EUAs were

stolen out of nine accounts (out of 2000

accounts) in Germany through this fraud in

early 2010. In early 2011, over 3.6 million EUAs

taken from the registries of Austria, the Czech

Republic, Greece, and Romania.

Source: Barclays Capital.

http://en.wikipedia.org/wiki/Value_Added_Tax

Memorandum submitted by Prospect (ETS 03)

Introduction 1. Prospect is a trade union representing 120,000 scientific, technical, managerial and specialist staff in the Civil Service and related bodies and major companies. In the energy sector, we represent scientists, engineers and other professional specialist staff in the nuclear industry, the wider electricity supply industry and, increasingly, also in the gas industry. Our members are engaged in operational and technical management, research and development and the establishment and monitoring of safety standards, environmentally and in the workplace. 2. Prospect’s view is that security of supply and reduction of carbon dioxide (CO2)

emissions are key and linked priorities for future energy policy. In previous submissions on aspects of energy policy, we have recognised that in order to capture environmental externalities effectively it is essential to build the costs of carbon pollution back into the system and to incentivise current investment decisions accordingly. 3. In this light, and recognising political pressures, we have supported an emissions trading scheme (ETS) that poses a cost penalty related to the environmental consequences of emissions. We note, for example, that the UK Government remains ‘fully committed to the EU ETS, and consider(s) it the primary vehicle through which to deliver our carbon emission reduction targets’.1 However based on experience of the EU ETS to date we do remain concerned about the effectiveness of this approach and about the scope for market manipulation. We therefore argued that the Government should keep open the option of a rationalised harmonised greenhouse gas tax.

4. It is acknowledged that UK policy has developed since the previous round of consultation on the EU Emissions Trading Scheme, notably with the establishment in statute of the Committee on Climate Change and more recently with the proposed establishment of a Carbon Price Floor. In our view, this reinforces the need for a holistic view of all economic instruments to control energy use. In general terms, costs should be:

• Proportional to the amount of each greenhouse gas emitted • Proportional to the relative warming effect of each gas • Independent of where it is emitted • Independent of who emits it • Independent of the process that emits it • Paid by the emitter when the gas is emitted to the atmosphere • Applied to all emissions of greenhouse gases and credited for their

absorption • Paid for other by activities that commit the future emission or prevent the

future absorption of greenhouse gases.

1 ‘Planning our electric future: a White Paper for secure, affordable and low-carbon electricity’ – July 2011

5. Our response to specific questions raised by the Committee is set out below.


6. Inter-Governmental Panel on Climate Change (IPCC) data shows that Europe achieved a 6% cut in CO2 emissions between 1990 and 2008 which, even accounting for other causes, seems to indicate a degree of success for the EU Emissions Trading Scheme. However, there is significant cause for concern as the evidence also shows that much of the success of developed countries in reducing CO2 emissions can be attributed to ‘outsourcing’ of such emissions to developing countries from which goods are imported. Overall, we remain sceptical about the ability of the EU ETS to effectively mitigate climate change. The Government appears to share this view since the White Paper on Electricity Market Reform notes that ‘the carbon price signal resulting from this cap has not been stable, certain or high enough to encourage sufficient investment in low-carbon electricity generation in the UK’. Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes? 7. The trend towards ‘outsourcing’ emissions supports a view that the EU ETS will only operate effectively in the context of legally binding emissions reductions commitments worldwide. In Prospect’s view it is vitally important to continue to work towards achieving this goal, not least as we approach Rio+20. However, we do not underestimate the difficulties in doing so, not least in influencing major emitters such as China and the USA. From the UK’s perspective, it is also essential to effectively address ‘carbon leakage’ as it is not acceptable simply to displace industry and employment to countries with less stringent emissions requirements. What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad? 8. One of the weaknesses of the EU Emissions Trading Scheme is that it is very difficult to know in advance what reductions it will deliver in practice either within the EU or more widely. It is certainly the case that the setting of caps in the first two phases meant that very little was delivered by way of emissions reductions. Prospect has supported the more rigorous approach proposed for the EU ETS from 2013, which more appropriately values environmental cost and is necessary to influence behaviour in practice. Nonetheless the system will inevitably prove complex and could have unintended and undesirable consequences. Many of these complexities could be eliminated by an approach based instead on taxation of greenhouse gases.

] Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved? 9. We note that the proposed Carbon Price Floor in the UK will link with the EU ETS. Prospect supports the introduction of a stable floor price for carbon alongside strategic Government support to stimulate innovation and UK supply chains. We understand that the Carbon Floor Price should work with the EU ETS to deliver what the carbon market was always intended to deliver by restoring carbon prices to the level that had once been expected in the EU ETS.

10. However, it is worth noting that because there is uncertainty about the EU ETS carbon price, there will remain uncertainty about how much of the total carbon price will come from the EU ETS and how much from the UK-specific carbon price support “top-up”. It is also worth noting that the Carbon Floor Price is essentially a top up tax rather than an emissions trading scheme. Although it is not universally popular, there is no doubt that this is a more certain mechanism and likely to be more effective – though it is of course confined to the UK. What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally? 11. We supported the Commission’s proposals in 2008 to introduce a regulation for harmonised verification and accreditation, but are not sure what progress has been made. Promoting transition to greenhouse gas emissions taxes would be a significant step forward. Could sectoral agreements form part of the future of the EU ETS? 12. We remain to be convinced that sectoral agreements would provide additional benefits.

13. Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism? 13. We do not think so. Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system? 14. The EU ETS has not proved to be a constraint on unilateral action to reduce emissions in the UK, where the Climate Change Act provides a very clear and legally binding framework for UK emissions reductions. However, as indicated above, it is not yet clear how the EU ETS will interact with instruments such as the Carbon Floor Price which to date has only been set for the first year of operation from 2013/14. There is a strong argument that the UK’s mixture of incentives and mechanisms to control greenhouse gas emissions has become too complex and opaque, and the measures proposed as part of the Electricity Market Reform White Paper will exacerbate this trend. It remains to be seen how the range of policies that will take effect in the UK from 2013 will affect the operation of the trading system, but there is no doubt that this continuing uncertainty is not helpful. How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? 15. We consider that there should be a robust and forensic regulatory regime that includes powers to inspect permit users without notice in order to detect collusive and anti-competitive behaviour. However, there is an underlying concern that because emissions trading schemes award credits for emissions that have not occurred, they are fundamentally open to fraud August 2011

Union of the Electricity Industry - EURELECTRIC AISBL . Boulevard de l’Impératrice, 66 - bte 2 . B - 1000 Brussels . Belgium Tel: + 32 2 515 10 00 . Fax: + 32 2 515 10 10 . VAT: BE 0462 679 112 . www.eurelectric.org

Energy and Climate Change Committee - Response by EURELECTRIC to the Inquiry into “The EU Emissions Trading System”

July 2011 Introduction 1. EURELECTRIC is the sector association representing the common interests of the Electricity Industry at pan-European level, plus its affiliates and associates on several other continents. The European Electricity Industry recognizes the responsibility of the power sector as a major emitter of CO2 and is taking actions to mitigate its impact. That is why sixty one electricity companies' CEOs - representing well over 70% of total EU power generation - signed in March 2009 a Declaration whereby our sector clearly committed itself to carbon-neutrality by 2050. As a requisite, the declaration also draws attention to the need for a properly-functioning electricity market in Europe, the desirability of an international carbon emissions market and the role of all technologies, including nuclear, renewables and CCS, to efficiently evolve to a low carbon electricity system. 2. The EU ETS is a key element of the policy framework for achieving Europe's climate change policy objectives. EURELECTRIC is fully supportive of market-based approaches to climate and energy policy and believes that an efficiently functioning EU ETS is the most effective means of delivering cost-effective reductions in greenhouse gas emissions. The establishment of EU ETS, the mechanics of which are, in general, functioning well, is a significant achievement. It is important that there is strong EU-wide political commitment to EU ETS going forward, including delivering a robust long-term and enduring framework and regulatory stability, so that there is necessary confidence on the part of investors to deliver the low carbon infrastructure that is needed to achieve EU policy goals. Response to questions Question 1: Does the EU ETS remain a viable instrument for climate change mitigation in the EU? The EU ETS is – and remains - the only functioning and credible EU-wide instrument for delivering explicit quantitative greenhouse gas emission reductions. The alternative of an EU-wide carbon tax is unlikely to be palatable to Member States and, unlike ETS, would neither guarantee specific emission reductions to meet mandatory EU targets nor ensure that those reductions are achieved at the least possible cost to the EU economy. Question 2: Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes? The ETS will remain the most cost efficient and effective policy instrument to meet an emissions reduction objective so long as the EU retains an ambition in this regard. Linkage through an international agreement with other cap and trade schemes merely acts to improve the global cost-efficiency of meeting an internationally agreed target. Consequently, it is perfectly possible for the EU ETS to operate effectively in the absence of a globally binding greenhouse gas agreement. However, it will be important to ensure that the politically determined driver for the ETS operation, the emissions reduction trajectory, is consistent with the following principles.

• Strong sustainable economic growth within the EU is delivered • CO2 emission reductions must not be achieved by driving industrial production outside the

EU • Research and innovation is encouraged and rewarded • EU ETS must be combined with economically efficient greenhouse gas emission reduction

policy instruments across all economic sectors • A diverse range of technologies should be promoted to deliver emission reductions. The

current approach of politically determining technological solutions fundamentally undermines the cost-efficiency principle of the EU ETS and its price formulation mechanism.

Question 3: What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad? Emission reductions by the EU ETS will be those specified by the cap trajectory i.e. 79% of 2005 emission levels, offset by allowed credits from current JI and CDM projects, including credits banked from Phase II to Phase III, where the emission reductions will occur outside the EU. At present, in the absence of an international agreement, there remains the prospect of credits being generated through mechanisms that can be established as a result of bilateral agreements between the EU and other countries. Question 4: Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved? The EU ETS is primarily an economic instrument. Its environmental efficacy is determined by the emission reduction cap and trajectory set at a political level. The integrity and robustness of the cap-setting mechanism under various schemes will determine the environmental efficiency of linkage. There remains the prospect of improving the economic efficiency of the EU ETS through linkage with other schemes, but progress on developing these remains disappointingly slow. Should linkage be considered at some point, it will be important to ensure appropriate safeguards including signaling to the market well in advance, so as not to undermine the stability of the EU ETS. In particular, schemes will need to demonstrate strong environmental integrity and be sufficiently mature to have a credible track record with any initial teething problems having been satisfactorily resolved. A comparable set of rules will be essential, including comparable emissions reductions objectives; a consistent basis for setting caps; and, robust monitoring, verification and reporting procedures. Question 5: What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally? The UK Government and the EU Commission have to date acted as commendable ambassadors for the use of emissions trading as the cornerstone of EU efforts to tackle climate change. They should continue to spread the message that emissions trading works and should resist any temptation to “give up” on the principles of emissions trading in the face of competing green and emissions reduction initiatives which are undermining the ability of the ETS to meet emissions reduction targets at least cost to the economy.

Question 6: Could sectoral agreements form part of the future of the EU ETS?

“Sectoral agreements” covers a variety of potential mechanisms. At one end, we have the ETS which applies to certain sectors of the economy, but where those sectors are covered by an overall absolute cap on emissions. Similar sectoral agreements – i.e. those featuring absolute emissions caps – would significantly enhance the scope and efficiency of the EU ETS. Question 7: Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism? Demand and access to Clean Development Mechanism (CDM) (and Joint Implementation) credits in the EU ETS has been increasingly limited and the combination of quantitative and various qualitative restrictions (e.g., on gases or host countries) will limit the future use of Certified Emissions Reductions. The only “viable alternative” envisaged under the current ETS would be credits arising out of bilateral international agreements. Any credits arising from those sources would presumably need to pass similar tests to those involved in the CDM to ensure the environmental integrity and the “additionality” of the associated reductions. Given progress to date in initiating discussions on such bilateral agreements the practical answer is “no”. Question 8: Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system? The UK with its partner EU Governments have determined, in order to maximize overall cost effectiveness, that emission reductions from installations covered by the ETS should be delivered at pan-European level. Having taken this decision, then subsequently seeking to deliver notional additional reductions at a domestic level is not rational as this extra local effort will reduce cost efficiency. Any domestic reduction will be offset by a balancing increase elsewhere to deliver the cap. The option for Governments that believe additional reductions are feasible is to seek to have the overall EU cap revised downwards. In this context, the EU ETS should be a “constraint” on unilateral action by Member States to deliver emission reductions in the traded sector. The introduction of carbon price support by the UK Government in the last budget is extremely disappointing in this regard. Setting a carbon floor price in the UK will not deliver any additional emission reductions across the EU as a whole and theoretically should lower the price of allowances making compliance for installations in other Member States less expensive. Question 9: How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? We consider that the recent cases of fraudulent handling of EUAs have had no lasting effect on confidence in the EU ETS and that added security measures introduced by the EC through the revisions to the Registry Regulations will provide adequate safeguards for the future. Question 10: How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations? The future functioning of the ETS is not dependent on any international agreement. It is at base a domestic European policy instrument that relies on the long-term political commitment of the EU to greenhouse gas emission abatement targets. A credible international agreement that permits linkage of the EU ETS to other schemes can improve the overall global cost efficiency of meeting global targets.

We believe that the following three objectives are central to its long-term development: • Long-term reduction targets are needed to provide effective carbon price signals for

investments which have long pay-back periods. While the revised EU ETS Directive reflects this by imposing a linear reduction factor on the cap that applies beyond 2020 (with the option to be further revised), the extension of the cap and the desired trajectory must be supported by a clear political consensus. Such a consensus first requires holding a thorough debate – as planned under the EU 2050 low-carbon roadmap – which the EU cannot afford to delay.

• Encourage all other Parties to the UNFCCC to adopt sectoral emission trading schemes for the most developed sectors of their economies and offer linking options with the EU ETS in return for adopting rules that protect the integrity of the scheme. These can be implemented in conjunction with Copenhagen Pledges or KPII commitments.

• Develop and advertise the broader benefits of emissions trading and reduced energy consumption.

Memorandum submitted by Vattenfall (ETS 05)

Vattenfall supplies electricity, heat and gas to millions of customers across Northern Europe. It is the fifth largest generator of electricity and the largest producer of heat in Europe. It has a wide generation portfolio which includes hydro, wind, biomass, coal (including carbon capture and storage), gas and nuclear. In the UK our main activity is the development and operation of wind power, both off and onshore. We are also investing in wave power. Vattenfall considers the UK a strong growth market, in particular in offshore wind, and we have invested more than £1.5 billion in new wind farms since late 2008. Vattenfall appreciates the opportunity to present our views on the EU Emissions Trading Scheme (EU ETS). Our response is based on the set of questions contained in the inquiry launched by the UK Parliament’s Committee on Energy and Climate Change. The EU ETS is the most important instrument at the EU’s disposal to jointly achieve its international commitments and long-term climate objectives. Since its establishment in 2005-2007, the policy has improved in many respects due to a large extent as a result of the review of the EU ETS directive in 2008. When the third trading period starts in 2013 many key features such as the emissions cap, the allocation principles, etc. will take their point of departure from an EU-wide and an (almost) harmonized framework. For the business community this will likely translate to, among other things, a more level playing field and a greater degree of transparency. This development also has implications for Member states designing their own domestic climate policies. Vattenfall supports the EU’s long term decarbonization objective and is convinced of the benefits of a highly coordinated EU policy approach to our common challenges. The important role of the EU ETS during this profound transformation is a central topic in the ongoing Roadmap 2050-initiative. A natural part of those discussions is also how the CO2 price signal can be strengthened through decisions on the EU level. Our responses to the questions brought up by the inquiry can be found below. They should be viewed in conjunction with the more specific material which Vattenfall’s has previously submitted to the UK Government in connection to public consultations on the UK’s Electricity Market Reform conducted during the first half of 2011. If Vattenfall can be of any further assistance on this, or any other energy related matter, please get bin touch.

Vattenfall’s general view on the EU ETS policy

1. The EU ETS is one of the most cost efficient and reliable policies at the EU’s disposal to achieve its joint climate targets of reducing GHG emissions through international and cross-sectoral participation. The ETS policy can both create a uniform price on CO2 emissions and ensure that the overall emissions are capped on a level which is consistent with the adopted climate targets. The EU ETS retains its position as the world’s most ambitious international response to address climate change.

2. Vattenfall is convinced that the EU ETS is capable of delivering very deep cuts in CO2 emissions and considers that it should be the principal instrument to promote low-carbon measures towards the EU’s decarbonization objectives. This requires that the ambitions of reducing the CO2 emissions are reflected in the EU-wide cap of allowances and that the EU ETS is protected as the EU’s main climate policy instrument as far as the sectors covered by the ETS directive are concerned. Interventions and other policies targeted at the same very same emission sources will only re-distribute the CO2 emissions and increase the societal costs. To the extent that amendments to the EU ETS policy are deemed necessary, they should always be completely EU-wide and predictable from a regulatory point of view.

Answers to the questions specifically raised in the UK Parliament’s inquiry


3. Yes, definitely. When the EU ETS was introduced in 2005 it was referred to as the EU’s flagship climate instrument. There is no reason why this should not continue to be the case. The creation of a CO2 price which internalizes the external cost (environmental damage) for all large CO2 emission sources in the EU can be a very powerful tool, especially when it is combined with the market forces which promote cost-efficiency through the trade of CO2 allowances between the regulated operators.

4. Due to the many amendments to the EU ETS directive agreed in 2008, which are about to take effect from 2013 when the 3rd trading period begins, the functioning of the system has improved substantially in terms of, for example, increased transparency, enhanced level playing field, more reliable price signal and the notion of a long-term GHG emissions reduction trajectory settled to 2020 and beyond. Altogether, these measures have induced more stability and predictability for the benefit of the market and the operators’ abilities to contribute to the profound transition of the energy system which is necessary.

5. As a result, the EU has at its disposal a very effective tool to reach both current and future climate targets. Vattenfall appreciates and is largely engaged in the discussions about the Roadmap 2050 initiative which brings up very important aspects of the EU’s future climate policy and underlines an EU commitment to reduce carbon emissions by 80-95% by 2050. Key issues include what should be the EU objectives and milestones in terms of reduced overall emissions throughout this challenging period.

Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes?

6. It should be recognized that the EU ETS directive was introduced during a time when the outlook for a global climate agreement, including binding commitments for all developed economies in the world and flexible mechanisms developed as core vehicles by UNFCCC decisions, appeared somewhat stronger than today. Although this has implications for the (un)likelihood for a truly global CO2 market to eventually emerge at the horizon, it does not necessarily compromise with the prospects or usefulness of domestic or regional emission trading schemes. Instead, what it means is that we will probably face a more fragmented landscape ahead where linking of markets is made on basis of bilateral agreements.

7. The EU ETS will continue to be in operation after the second trading period (post-2012) on the basis of provisions in the amended ETS directive as agreed in 2008. This is independent from whether there will be a ratified binding global treaty in which the EU’s climate target is inscribed. The same goes for the emission trading schemes which are drafted in China and elsewhere which are unlikely to be directly linked to a binding commitment according to which the parties have agreed to an absolute emissions cap for the entire economy.

8. However, what above all sets the limits for how effectively the EU ETS can operate in the absence of an international agreement with binding emission reduction commitments is the potential risk of CO2 leakage. Without an international agreement with binding commitments, there is a risk that the reduction obligations will not be sufficiently comparable in terms of ambition level or the compliance regime. The implications on competitiveness and environmental integrity in such a scenario could reduce the effectiveness of both the EU climate target and the EU ETS. This conclusion is however not unique for the EU ETS, it applies to many climate policies.


9. The outcome of the EU ETS in terms of reduced GHG emissions during Phase III is entirely determined by the pre-defined amount of allowances distributed to the covered sectors. The allocation, in its turn, is directly correlated to the EU’s climate targets (i.e. every year linearly reduced in order to arrive at –21 % in 2020 relative to 2005 which is exactly the reduction burden imposed on the EU ETS sectors through co-decision). Precisely how much that will be achieved inside the EU (“domestically”) and abroad using the global mechanisms (e.g. CDM) respectively, depends on, for example, which credits the operators surrender for compliance. But there are qualitative limits on every installation which ensure that at least 50 % of the overall reduction efforts in 2008-2020 will be achieved by measures undertaken within the sectors of the EU economy.

10. It is important to underline in this context that the outcome of the EU ETS policy in terms of reduced emissions is totally independent of potential interventions introduced by individual Member states. Although additional interventions might reduce the CO2 emissions regionally, there will not be any additional effect in terms of reduced CO2 emissions in the EU or globally. As a consequence of the nature of the “cap-and-trade” policy, the resulting climate impact from sectors covered by the EU ETS (currently

responsible for approx. 45 % of the EU’s GHG emissions) can only be affected through adjusting the number of allowances made available to the market.

Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved?

11. Yes. The concept of emissions trading implies that the economic benefits increase when there are new schemes, sectors and emission sources merged together under the same “cap”. Using flexible mechanisms will minimize the societal costs as the market steers towards undertaking the most cost efficient abatement potentials among the participants. There are also many other arguments for linking such as improving the liquidity and functioning of the CO2 market as well as creating a more level-playing-field where industries in different regions will face more equal conditions.

12. Linking of emissions trading schemes probably has to be done on bilateral basis but can gradually be expanded into a more international CO2 market with global reach. There are currently a number of national or sub-national emissions trading schemes introduced or at the drawing tables around the world (e.g. South-Korea, New Zealand, California). The EU should seek to engage with them in the same it did with Norway, Iceland and Lichtenstein.

13. Keeping the ETS policy as simple and transparent as possible is likely to increase the possibilities for a linkage to be accepted by both parties. The harmonization of allocation principles and gradual transition to auctioning is expected to further facilitate in that respect. Fiddling around with the ETS though different forms of quick-fixes and interventions, on the other hand, will only give rise to uncertainty and hesitation at the other side, and therefore potentially conflict with the prospects for linking.

14. Consistent with our previous statement about the need to let the market decide on the CO2 price based on fundamental factors and the supply of allowances allocated by the authorities, focus should not be too much on the CO2 prices in the two markets. Divergent CO2 prices in the markets (before linking is accomplished) can be a result of different stringencies in commitments already agreed or differences in abatement costs. Such differences increase the benefits of flexibility. More important is to ensure that competition is not distorted through the allocation regimes applied by the linked trading schemes.

What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally?

15. It is important to signal the continued support of, and confidence in, the ETS policy as the main vehicle to reach the EU’s international commitments on climate change. The EU needs to act jointly on the subject and prove that international cooperation is the right way ahead. The EU should encourage other parties to develop market based instruments similar to the EU ETS and support them in learning from the EU’s both positive and negative experiences.


16. Yes, the option of sectoral approaches comes with many good opportunities and should be further investigated. The inclusion of international aviation in the EU ETS (in

17. The development of sectoral approaches can increase the effectiveness and international reach of the ETS policy. However, it should not be used in a way that breaks out sector by sector, eventually eroding the purpose of emission trading which very much lies in the cost-minimization achieved by exploiting the natural differences in abatement costs. The actual exposure to significant risk of carbon leakage applies to a limited number of sub-sectors and therefore should not be considered a general solution. The ambition should rather be to continuously expand the coverage with regards to both countries and sectors to reap the potential competitiveness and efficiency gains of a uniform and economy-wide CO2 price.

Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism?

18. According to the EU ETS directive, the ETS operators will, alongside with EUAs, be able to use CDM credits (CERs) in Phase III even in absence of a new international agreement, albeit to a limited extent. With regards to new projects, the credits from CDM must come from least developed countries (LDCs) or countries which has subscribed to the new agreement. It is at present impossible to say whether additional types of credits will be allowed during Phase III and beyond.

19. As one of the largest buyers of CDM credits in the world, Vattenfall has fully embraced the concept of global carbon markets. It is important that these institutions are further developed in terms of e.g. environmental integrity and the effectiveness of approval procedures in the future. Vattenfall supports the on-going work to reform the CDM.

20. Vattenfall assumes that the EU will take all necessary steps to provide the market with the greatest degree of predictability in the regulatory framework as possible, as well as be open for recognizing other credit types whenever possibilities for bilateral linking might appear, and to adjust as appropriate to the development of new and existing flexible mechanisms.

Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system?

21. The EU Member states have, as a result of the decision to adopt the EU ETS directive in 2003, and perhaps even more importantly the amendments in the directive agreed in 2008, promoted a centralized approach to setting the (EU-wide) cap on emissions. It also gives the EU ultimate influence on what should be required in terms of reduced GHG emissions from the sectors covered by the ETS directive.

22. As a direct result of the EU ETS directive’s absolute and pre-defined emissions cap, expressed by the linear reduction trajectory (which individual Member states can not

alter through domestic decisions), additional and unilateral actions targeted at the ETS sectors are inadvisable from both an environmental and cost-efficiency perspective.

23. Making interventions to reduce the emissions in the EU ETS sectors without using the formal and only rational route of adjusting the amount of allowances made available to the market would be counter-productive. The reason is that it would only reduce the CO2 price – not the CO2 emissions generated within the parameters of the EU ETS – and thereby weaken the ETS policy. A weaker price signal in the EU ETS could then pave the way for even more quick-fixes and interventions on the EU or Member state level, so the chain-reaction starts.

24. A reliable CO2 price signal is achieved by making as few political interventions as possible in the market’s price formation process. It means that the CO2 price should be determined only on basis of the availability of EU emission allowances and fundamental market factors such as fuel prices, energy demand, etc. Additional interventions in the market will weaken the EUA price and make investments in the EU energy sector more difficult. An undistorted and uniform CO2 price, on the other hand, is key to promoting a strong EU ETS based on cost-efficiency, transparency and level playing field.

How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required?

25. All forms of criminal activities that occur in the EU ETS market are bad for the confidence of the instrument. Some of the attacks have also raised particular concern because of the large values that have been stolen. However, the problems are not entirely unique to the EU ETS market. Considering the increasingly large values that are in circulation in a quickly growing market such as the EU ETS, it might have been expected early on that it could attract criminal elements. If the regulators had been more prepared, it could have mitigated some of the most negative consequences in terms of, for example, the reputation of the EU ETS and the spot market’s collapse with complete shut-down of registries and frozen transactions.

26. The need for enhanced registry security standards which emerged following these events has been seriously addressed in the work which led up to amendments in the EU registry regulation on 17 June, 2011. Further changes to the EU ETS market are then expected as a result of the on going Market oversight initiative. Vattenfall is following the development, and is confident that a secure and effective market framework will be established.

How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations?

27. The most important measure to strengthen the CO2 price signal is to ensure that long-term objectives and CO2 reduction trajectories are clearly expressed. Enhanced visibility around the future direction of the EU ETS and the EU’s climate objectives in general is vital for new investments in the energy sector. Targets beyond 2020 are more appropriate as a starting-point for the discussion than how the CO2 price level can be rapidly inflated through, for example, auction set-asides during the next years leading up to a new global climate agreement.

7

28. The on-going Roadmap 2050 initiative is the perfect context for discussing, for example, new milestones for the emission reduction pathway leading up to the long-term decarbonisation objective and the continued role of the EU ETS. Decisions introduced as a result of that work should above all seek to provide a long-term predictability and a regulatory framework which functions well with the EU energy markets. Vattenfall is committed to taking an active role in this important dialogue and contribute to the shaping of Europe’s future energy landscape.

August 2011

Memorandum submitted by the Mineral Products Association (ETS 06)

1. Introduction

1.1. The Mineral Products Association (MPA) is the trade association for the aggregates, asphalt, cement, concrete, lime, mortar and silica sand industries. With the addition of The British Precast Concrete Federation (BPCF), it has a growing membership of 418 companies and is the sectoral voice for mineral products. MPA membership is made up of the vast majority of independent SME companies throughout the UK, as well as the 9 major international and global companies. It covers 100% of GB cement production, 90% of aggregates production and 95% of asphalt and ready-mixed concrete production and 70% of precast concrete production. Each year the industry supplies in excess of £5 billion of materials to the £110 billion construction and other sectors. Industry production represents the largest materials flow in the UK economy and is also one of the largest manufacturing sectors.

1.2. MPA Cement and Lime members have been participants in the EU Emissions Trading Scheme since its inception. From 2013 around 65 additional sites within the MPA membership will join the EU ETS, principally asphalt producers. Around 90% of these new sites will be eligible for a ‘small emitter’1 opt out from the EU ETS because of their small emissions (typically 3-5,000 tCO2/year)

Specific Inquiry Questions 2. Does the EU ETS remain a viable instrument for climate change mitigation in the EU?

2.1. The EU ETS has been successful in raising the profile of carbon trading in Europe and worldwide. In the UK, manufacturing industry has been involved in emissions trading for much longer and UK manufacturing companies are well placed to comment on the effectiveness of EU ETS.

2.2. The key criterion regarding whether the EU ETS remains a viable instrument rests on the effort from non-EU countries particularly in the far-east. Even if the EU ETS achieves its target of -21% emissions reduction by 2020 from 2005 then its contribution to the emissions reduction required to halt global temperature rise to 2oC will be less than 5%2. It is therefore imperative that the EU ETS does not operate in isolation because an unequal global carbon price will lead to distortive trade patterns for the most CO2 intensive products. Cement and lime are the most CO2 intensive products in the EU ETS listed activities.

2.3. Furthermore, the EU ETS takes the greatest burden share of the EU’s -20% target by 2020 in doing so this places unequal pressure on manufacturing compared to other sectors of the EU economy. If the EU commits to a target that is more challenging than -20% it is vital that domestic and service sectors, that are not vulnerable to carbon leakage, take the burden of achieving this stricter target.

3. Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes? 3.1. The short answer is no. Based on their CO2 intensity, cement and lime production in

the EU are recognized in a Commission Decision3 as the two most vulnerable activities to be affected by the threat of carbon leakage. Both cement and lime production have high ‘process’ emissions which means that around 60% and 50-75% respectively of the CO2 emitted comes from the decarbonation of limestone with the remaining

1 Article 27 of Directive 2003/87/EC 2 Assuming that the 2013 to 2020 EU ETS cap trajectory continues to 2050 3 COMMISSION DECISION of 24 December 2009 determining, pursuant to Directive 2003/87/EC of the European Parliament and of the Council, a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage

CO2 from fuel combustion. Without comparable carbon costs, regulatory implementation and decarbonation trajectories in non-EU countries the threat of imports is very real. Specialist cement and lime products are already traded internationally and if greater proportions of CO2 would need to be purchased it is feasible that standard cement and lime products would increase from their current relatively low levels of internal trade to higher levels. Boston Consulting Group4 calculated that at a carbon cost of €24/tCO2 the whole of the UK’s cement clinker production is vulnerable to off shoring. Whereas at prices of €30/tCO2 lime production cost would increase by more than 50 percent on average, making CO2 the most significant single cost in lime production5.

3.2. Phase III of the EU ETS will impose benchmarks on cement and lime production based on the top 10% most efficient plants in Europe. Over the 7 years of Phase III the expectation of the EU ETS is that the less efficient plant will be replaced by more efficient plant. The reality is that 7 years is a short window in the life of a cement or lime plant that may operate for 30-35 years. So in the short term the EU ETS is a tax on production which will either depress production volumes and/or reduce profitability as the trajectory of transition between current operation and the benchmark levels will be too steep for some plants.

4. What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad? 4.1. If carbon leakage is encouraged by the unequal carbon price of the EU ETS, global

emissions could rise despite the best intentions of the EU. The UK cement industry CO2 emissions in 2010 were 57% lower than emissions in 1990, the baseline commonly used for GHG measurement. Carbon efficiency has also improved, 2010 emissions were 25.9% better than the per tonne emissions in 1990. These improvements have been principally delivered by significant investment in more efficient kiln technology and by investments in alternative fuel handling to replace fossil fuels. If the unequal global carbon price continues throughout Phase III then investors will be encouraged to invest outside of the EU. Diverted investment would inevitably lead to delays in achieving progress on novel technologies such as Carbon Capture and Storage in the UK manufacturing sector.

4.2. Companies in the UK cement and lime sectors have a particularly relevant insight into the international functioning of the EU ETS as many are owned by international parent companies and operate in an internally competitive market. Moreover, UK investment decisions are often made outside the UK and it is these investment decisions that will determine the emissions reduction in Phase III and beyond.

5. Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved? 5.1. Linking with other national or regional schemes is an important stepping stone to

global emissions trading, however there are some important criteria to meet before linking should take place:

5.1.1. Overall absolute emissions reduction placed in industry should be comparable

5.1.2. The effort sharing between the sectors of the economy should be similar and the reduction commitment of the traded sector should be comparable.

5.1.3. Equivalent costs should be placed on the traded sector i.e. equivalent carbon cost in both developed and developing nations

4 2008 BCG. ASSESSMENT OF THE IMPACT OF THE 2013-2020 ETS PROPOSAL ON THE EUROPEAN CEMENT INDUSTRY. Available at www.Cembureau.eu 5 2008 Radov. D et al. Potential Impacts of the EU ETS on the European Lime Industry. NERA economic Consulting

5.1.4. There should be equivalence in the reduction trajectory for the traded sector.

5.1.5. There should be a critical mass of production from the activities listed in Annex I of the current EU ETS directive so that the linked schemes are regulating the same activities.

5.1.6. The type of system to be implemented should be the same. Only absolute reductions (not relative) will be comparable with EU ETS.

6. What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally? 6.1. A successful EU ETS for both industry and the environment is the best advertisement

for international GHG trading schemes to develop. However, it is clear that the lack of support for trade exposed industry is not a good example to set. Treatment of small emitters is also an important aspect when the attractiveness of EU ETS is judged by others. In the EU ETS small emitters are being treated disproportionally compared to their emissions. In Phase III around 65 MPA member sites will join the EU ETS for the first time because of their rated thermal capacity and the Directive’s expanded combustion definition in Phase III. Many of these sites are asphalt producers and although they have equipment with a highly rated thermal capacity, this capacity is never used due to planning, permitting constraints and the periodic operational nature of the business of road surfacing. These plants typically emit 3-5,000 tCO2 but will be subject to the highly administrative and costly elements of EU ETS particularly related to monitoring, reporting and verification. The UK Government still has time to influence the European Commission to greatly simplify the rules for small emitters. The UK Government should also use its right in the Directive (Article 27) to allow installations to choose whether to stay in EU ETS or opt-out into an equivalent scheme which could be simpler for small emitters.

6.2. Importantly, the EU ETS in isolation will have little impact on the level of global emissions, and can therefore contribute little to meeting the 2oC stabilization challenge. However, the EU scheme can play a significant role in demonstrating how to operate a successful cap and trade system and therefore influence what other countries and regions do. In order to do this it must demonstrate how it can ensure the competitiveness of the industries that come within its scope.

7. Could sectoral agreements form part of the future of the EU ETS? 7.1. Academics6 and other commentators7 have looked at the cement sector as one of the

candidate sectors for a sectoral agreement. On the surface a sectoral agreement appears attractive if there is derogation from regulation but if the sectoral agreement is additional to EU ETS it becomes less attractive.

7.2. Different sectors and different Governments have different ideas as to the composition of a sectoral agreement and this is one of the barriers to their development. In this regard it is difficult to see how a voluntary sectoral agreement would be attractive to participants in non-EU countries that are not currently subject to climate change legislation.

6 2010. Wooders.P. Exploding the Myths of Sectoral Approaches (and renaming them Sectoral Approaches, Agreements and Measures). Climate Strategies 2011. 7 2009. UNEP. INDUSTRY SECTORAL APPROACHES AND CLIMATE ACTION: FROM GLOBAL TO LOCAL LEVEL IN A POST-2012 CLIMATE FRAMEWORK: A Review of Research, Debates and Positions

7.3. The Committee may wish to see the work of the World Business Council for

Sustainable Development Cement Sustainability Initiative8. The work shows that a sectoral approach involves organized action by key actors of a specific industry sector and their host governments to address the greenhouse gas emissions from their products and processes, within the UNFCCC framework but that this would involve international cooperation to develop agreed data, monitoring and verification requirements, identify best practices, and define possible crediting policies.

8. Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism? 8.1. For operators in the EU ETS it is imperative that they have access to flexible

mechanism credits so that abatement can be made at the point of lowest cost. It is important however that abatement carried out outside the EU is additional and is not double counted in global GHG accounting and that projects are viable on their own merit and not because of double subsidies (domestic and international).

9. Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system? 9.1. The EU ETS is only one of the measures affecting MPA members. A number of

companies that operate EU ETS installations also operate within Climate Change Agreements, Carbon Reduction Commitment and energy efficiency provisions in other legislation such as Industrial Emissions Directive. This, alongside other environmental taxes, creates a significant cumulative burden on UK manufacturing that is counterproductive to the Government’s agenda to rebalance the economy.

9.2. The plethora of policy measures affecting MPA members means that the measures are sometimes conflicting and often do not compliment each other. There is not an endless reserve of investment capital for companies to draw upon and therefore company actions needed to comply with EU ETS are competing with actions required for domestic legislation. Many of the MPA member companies affected by EU ETS have their head quarters outside of the UK and therefore investment decisions affecting UK jobs and UK material supply security are often taken outside of the UK. It is therefore important that the UK is seen to be a good place to manufacture and the complex and overlapping suite of UK and EU measures affects the view of the UK in that context.

10. How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? 10.1. The value of the allowances traded in the EU ETS is significant and EU ETS

security is paramount to ensure that company assets are not affected but also so that there are no consequential influences on energy prices. The Commission should tighten security to ensure the market is not affected by outside influences.

11. How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations? 11.1. In the absence of effective global emissions trading where trading partners are

subject to equivalent carbon cost and equivalent regulatory regimes then there are two principle options that remain to protect EU manufactured products being off-shored to non-EU states.

11.1.1. Free allocation for sectors that are the most CO2 intensive, and therefore the most vulnerable to carbon leakage, is the most effective way of protecting domestic manufacturers from the threat of unequal carbon pricing.

8 http://www.wbcsdcement.org/index.php?option=com_content&task=view&id=156&Itemid=171

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11.1.2. Border adjustment mechanisms (BAMs) remain an option for those products

that are easily defined, relatively harmonized in their product quality and are less likely to be manufactured into goods that would not be subject to the BAM. Cement has been studied and the conclusions are that BAMs would be a possible mechanism to protect the industry from carbon leakage. For this reason the UK Government should ensure that BAMs are part of its international negotiations.

August 2011

Memorandum from the City of London Corporation, Office of the City Remembrancer

(ETS 07 ) Introduction 1. The City is a founder member of the London Climate Change Partnership and, in 1999,

was a founder member of the UK Emissions Trading Group (UK ETG), which played an important role in laying the foundations upon which the UK, and then EU, Emission Trading Schemes were built.

2. The development of the emissions trading market is the result of a combination of the

policy requirement to reduce carbon emissions and a market opportunity. The signing of the Kyoto Protocol and the resulting EU Emissions Trading Scheme (EU ETS), have led to the development of the market in carbon allowances. London’s pool of expertise in financial and professional services has enabled it to become Europe's emissions trading ‘hub’ in a market that has seen considerable growth in recent years and a cluster of firms servicing this emerging industry has already developed.

3. The City Corporation therefore welcomes the opportunity to contribute to the Committee’s inquiry.

Does the EU ETS remain a viable instrument for climate change mitigation in the EU? 4. In establishing the EU ETS, policy makers created the demand for a commodity (an

allowance to emit carbon) which was previously considered free. To this end, in establishing the world’s only regional trading scheme, Europe has a massive potential advantage not only in the development of new financial products, but also in the financing of developments in new technologies to combat climate change. Now the price of carbon has been set, the commercial viability of abatement projects can be more readily calculated and capital or project finance sought from the private sector.

Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes? 5. Whilst emissions trading is currently a significant tool in the fight against climate

change, it is not a universal panacea and is reliant both directly and indirectly on enabling legislation which will lead society to a low carbon future. However, by harnessing the market in emissions abatement, cap and trade schemes allow specific reduction targets to be set and monitored, and the efficiency of the market will ensure that emissions reductions are met at the lowest possible cost.

What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad? 6. The overall cap in Phase III will inevitably be far more stringent than in previous

phases. Unlike in the previous phases where discretion to determine the emissions cap was left to member states, it is likely that the cap will be set at an EU wide level in Phase III. Evidence suggests that the cap will be determined by using the average total quantities of allowances issued by Member States in Phase II as a starting point, and

then reducing this by 1.74% each year. The effect of this would be that there will be far fewer allowances issued in this Phase which is likely, therefore, to lead to increased prices.


7. Carbon trading is a broad church and currently two emissions trading markets are

evolving in parallel

• Formal markets – epitomised by the EU ETS; and • Informal markets involving Verified Emissions Reductions (VERs), which are a

key market in the US. 8. Although the UK Government’s new Quality Assurance Scheme1 begins to address

this, VERs currently lack market infrastructure, such as registries and monitoring. This Voluntary market may, however, evolve into a more formal trading system – in which case carbon offsets, such as Clean Development Mechanism credits, may form a bridge to a wider market, and could provide a common ‘currency’ between schemes. The development of carbon trading schemes will increase market value by an order of magnitude and is likely to spawn a plethora of new products and secondary markets

9. The primary impetus for this may come as other nations- China, Australia, South Korea

and Japan move towards domestic carbon trading schemes, leading to a strong possibility that border carbon taxation may become the norm (with trading schemes effectively becoming a form of non-tariff trade barrier). To this end a formalised system of VERs could replace CDM as a bridge to a global market, and could provide a common currency between schemes.

10. Whilst there are arguments in favour of developing a global trading mechanism, another school of thought suggests that the future success of carbon markets does not necessarily rely on a global scheme since no other commodity has one (although no other commodities scheme has the same aims as carbon trading). It may be that establishing a global system could be overly complex and thus counter productive. Many regions are setting up their own trading schemes and it might be better to allow subsidiarity whilst allowing cross scheme fungibility.

11. Regardless of whether the future of carbon markets is in a global trading system or

greater compatibility between regional systems, London (and therefore the UK) cannot afford to be complacent and cede any of its commanding lead in this field. It must capitalise on its experience in the market so far to develop new products, protect the integrity of existing markets and influence the development of new markets with the long term aim of encouraging growth in carbon trading.


1 http://campaigns.direct.gov.uk/actonco2/home/features/offsetting.html

http://campaigns.direct.gov.uk/actonco2/home/features/offsetting.html

12. The free flow of information and expertise with countries developing domestic trading schemes, particularly China, should be encouraged in order to ensure that these nations benefit from the knowledge gained in introducing the EU ETS. In this regard, it may be appropriate for the EU and UK to enter into formal negotiations with China and other nations considering domestic or regional trading schemes, outside of the UN framework, in order to avoid the creation of non-tariff trade barrier and to agree international standards for VERS.

Could sectoral agreements form part of the future of the EU ETS? 13. Sectoral agreements on aviation and shipping are already well developed. The UK

Government has already gone further than other nations with the development of the Carbon Reduction Commitment. The scheme was originally envisaged as a trading scheme, which would have allowed the recycling of credits and the focusing of revenues on carbon reduction. To this end there was some dismay over the decision to remodel the scheme as a tax rather than on trading. In the future there may be merit in moving back toward the original trading scheme.

Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism? 14. Yes, if moves are made to create a formalised system for VER trading as discussed at

para 9 above. Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system? 15. Individual Member States remain free to create the policy frameworks which enable

their domestic industries to maximise competitive advantage within the EU ETS. The mechanism by which member states can do this is in three parts- • Legislation - the development of policy instruments to discourage negative

behaviour. • Regulation - the management of markets to encourage positive outcomes (for

example the development of industry standards and the development of transparent, long-term and clear policy frameworks)

• Education - demonstrating market opportunities to industry and ensuring a strong skills base from which growth in the low carbon sector can grow.

How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? 16. The large scale theft of allowances in January 2011 has given rise to a number of

problems one of which is resolving issues of ownership of the allowances issued under the EU ETS. This is of concern because different national legislation across Member States means organisations which hold or trade the stolen allowances may be subject to prosecution. For example in the UK companies may fall foul of the Proceeds of Crime Act. As a result, given the hazards in this market, a number of large players are now withdrawing from trading and closing their desks. There may be further implications for futures and options trading unless this issue is resolved quickly.

17. Practitioners are surprised at the decision by the Council to obscure the registration numbers of permits. It is not understood how this will aid security as it prevents the market from identifying the provenance of the allowances.

18. In the short term the issue of liability needs to be resolved. Attempts to increase security in the registries are only temporary solutions. Some have argued for a system of licencing operators is needed although it would need to be sufficiently workable so as not to preclude project operators or day traders.

How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations? 19. As set out in paragraphs 7–11, it is essential that fungibility between regional schemes

is enabled. To this end the issue of a replacement mechanism for CDM is one of pressing concern. The development of a formal mechanism for the trading of VERs is one possible solution to this issue, however it will require international agreement if it is to work.

August 2011

Memorandum submitted by the Royal Institution of Chartered Surveyors (ETS 08)

The Royal Institution of Chartered Surveyors (RICS) is pleased to respond to the EU Emissions Trading Inquiry. RICS is the leading organisation of its kind in the world for professionals in property, construction, land and related environmental issues. As an independent and chartered organisation, RICS regulates and maintains the professional standards of over 91,000 qualified members (FRICS, MRICS and AssocRICS) and over 50,000 trainee and student members. It regulates and promotes the work of these property professionals throughout 146 countries and is governed by a Royal Charter approved by Parliament which requires it to act in the public interest. RICS offer responses to the Committee’s questions as follows: Does the EU ETS remain a viable instrument for climate change mitigation in the EU? The EU ETS remains an important instrument for three main reasons;

• Because of the results in terms of emission reductions or limitations already achieved • It provides a basis for further measures such as inclusion of other emission sources in the EU

ETS • The scheme has significant value as an example for other markets and as a sign of the EU

commitment against a background of the obvious difficulties faced in relation to emission reductions more globally.

Can the EU ETS operate effectively in a world without legally‐binding emissions reduction commitments and other cap‐and‐trade schemes? It is reasonable to question the effectiveness of the EU ETS in the absence of wider commitments, and it is important to continue to consider the distortion of trade effects of having a system to require emission reductions in the EU without there being similar mechanisms elsewhere. However, to dispense with or to weaken the EU ETS would be a step in the wrong direction with damaging environmental consequences for the EU itself and would reduce the chances of wider measures being agreed.

What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad? RICS does not wish to respond to this question.

Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved? In principle, RICS believes improvements could be achieved but the extent of these would depend on the measures being considered. These could include mutual recognition of emission credits from other schemes, cooperation on markets for and registers of emission credits from other markets, common standards for verification and certification of credits or joint initiatives to promote Kyoto‐type schemes to reduce emissions in third‐party countries.

What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally? The EU, including the UK, has already played a positive role in the discussions on a Kyoto‐replacement mechanism. The value of the EU ETS as an example is already significant and possible further measures could include a more positive recognition of the existence of an ETS in another country in the context of bilateral trade and other discussions and the increased provision of advice and other services as part of international aid arrangements.

Could sectoral agreements form part of the future of the EU ETS? RICS sees this as likely, as the circumstances differ between sectors, for example aviation emissions or specific industry agreements according to the market context of these particular sectors. However,

within EU an overall framework is important and the cooperation with other countries might be better advanced on a sectoral basis.

Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism? RICS believes that in principle, the EU ETS would be able to access viable alternatives to international credits. RICS would suggest that the following factors are considered:

‐ To what extent will emission reduction initiatives dry up without CDM? ‐ Assuming that CDM‐type initiatives continue, how are they to be administered and credits issued, recorded, etc without CDM? ‐ Can and should the EU ETS be extended to provide a replacement mechanism, at least to serve the scheme’s own needs? ‐ Are there possibilities for the EU ETS to positively promote such initiatives, rather than waiting for them to happen? ‐ What form should such initiatives take? How can they be integrated in the EU ETS framework? ‐ What will other players do without CDM?

Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system? This needs to be addressed in the context of national targets. In principle, the EU ETS should provide a mechanism for recognition of and counterbalancing of unilateral action, rather than acting as a constraint, but this requires further consideration and would be a matter for international negotiation.

How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? The issue is important, but the effect on the EU ETS should not be overestimated. If organisations have their data security threatened by hacking, the EU ETS will not be immune, and fraudulent manipulation will not improve the schemes reputation. However, given the EU ETS represents a highly specialised field, there is probably less significance for the general public. Furthermore, the bodies and agencies who use the system honestly have a clear interest in doing whatever is possible and necessary to deal with any abuses.

How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations? One example would be bilateral agreements with key players to the extent that there is willingness to cooperate

RICS would be pleased to expand on any of the points made if required. Please do not hesitate to contact me if you require anything further. August 2011

Memorandum submitted by the Energy Services and Technology Association (ESTA) (ETS 09)

ESTA is the UK Industry Body representing suppliers of products, systems and services for Energy Management. The 120 members cover Energy Consultants, meter, AMR and controls manufacturers through to full Energy Services/Contract Energy Management. ESTA is engaged with UK Government policies on Energy and Climate Change, The Green Deal, Energy Performance of Building Directive, Part L Building Regulations, Display Energy Certificates, Carbon Reduction Commitment, Energy Services Directive and the roll-out of smart and advanced meters. It also provides UK input to developing international energy management standards and Chairs several BSI committees. ESTA members are key to the realisation of a low carbon, secure and affordable energy future. Our members provide equipment, systems and services for energy management to reduce energy demand at source and including renewables. Our response is a majority consensus of the members involved. Where ESTA members respond directly, they may offer differing opinions on some issues which we respect as expressing their own definitive view. Key points:-

♦ It would be helpful if the UK Emission Trading Schemes (EUETS, CCA and CRCEES) schemes were coordinated to remove duplicity of emissions reporting, used the same emission factors and if there was harmonisation of the price/cost of allowances across the different schemes.

♦ Imports into the EU of products, which are subject to EU ETS within the EU, could be made to demonstrate that they had been subject to environmental taxation or pay an appropriate import tariff.

♦ Demand side efficiency measures as well as management and reporting need to be key drivers for emissions schemes to ensure that targets are reached.

♦ The sharing of technology and management information may assist in promoting the development of ETSs internationally.

Does the EU ETS remain a viable instrument for climate change mitigation in the EU? 1.1 Yes Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes? 2.1 Yes, but see response to Q5. What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad? 3.1 It should deliver significant reductions for power generation and have some impact on industry and commerce covered by the scheme. 3.2 However it will have no impact on the largest emitters which are domestic usage and transport (aviation apart). Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved? 4.1 EUETS should be coordinated with Climate Change Agreements (CCA) and the Carbon Reduction Commitment Energy Efficiency Scheme (CRCEES).Duplicity of emissions monitoring, in particular the differing emission factors, variance in cost of Allowances and the anomaly of free and cost of Allowances across the schemes removed. We await receipt of the Government review on CCA and the simplification of CRCEES. 4.2 There needs to be a greater incentive for demand side energy management best practice. Experience of the above schemes indicates a number of problems with supply side and demand side data. Should the above coordination be adopted, there will need to be a greater emphasis on demand side monitoring. What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally? 5.1 Imports into the EU of products, which are subject to EU ETS within the EU, could be made to demonstrate that they had been subject to environmental taxation or pay an appropriate import tariff. 5.2 Placing additional costs on the production of materials abroad does bring into question competitiveness for companies, but the responsibility for both the UK and the EU to push for global commitment can only be brought about by the example of companies within our borders. 5.3 It is important that the EU ETS and other schemes remain viable and show improvements if promotion of schemes to other countries are to be furthered. Demand side efficiency measures as well as management and reporting need to be key drivers for emissions schemes to ensure that targets are reached. Trading platforms alone are not enough and the UK and the EU should consider a robust package of measures aimed at behavioural change and minimum energy management standards across the board for participants in the schemes.

5.4 The sharing of such management information and associated technology may assist in promoting the development of ETSs internationally. Could sectoral agreements form part of the future of the EU ETS? 6.1 Yes. With the adoption of Benchmarking for Phase III, and the targets set on the best 10% in that sector, to some extent, Sector targets are being set. Many of these sectors will be in CCA and harmonisation of the 3 trading schemes, as discussed in Q4.1 would be beneficial. Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism? 7.1 No answer Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system? 8.1 The EU ETS is not a constraint on any actions to reduce emissions How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? 9.1 Fraud is an issue which does undermine both the effectiveness and the reputation of the EU ETS. It is a concern however, that the new centralised Registry may not be as robust as the UK Registry administered by the EA. How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations? 10.1 See response to Q5 and Q6. August 2011

Memorandum submitted by David Merlin‐Jones, Civitas (ETS 10)

Executive Summary: At present, the EU ETS has an known operational lifespan of just 9 years; businesses are in the dark as to what will take its place after 2020. Overall, the scheme has been plagued with controversy: issues of price volatility, uncertainty and fraud (see below paragraph) have left the ETS damaged in the eyes of investors and undermines long‐term emission reductions. Additional concerns such as carbon leakage mean that the EU ETS cannot be viewed as a viable policy tool without major structural changes well beyond any envisaged thus far. We must look post‐2020 for the innovations and technologies that will allow us to make the transition to a low‐carbon economy at the lowest price, something the ETS fails to deliver. 1) Does the EU ETS remain a viable instrument for climate change mitigation in the EU?

No, for the following reasons: 1.1 Grandfathering: This approach to allowance distribution has seen the ETS subjected to two Phases of lobbying and distortion; firstly, from industry seeking to influence the national allocation plans (NAPs), and secondly from national governments pressing the EU for the most generous caps to protect their own industries’ price competitiveness. The result of this is well known, with an estimated 400 million surplus permits having been distributed in Phase II. As a consequence, it will be possible for some installations, totalling around 50% of EU emissions, to not engage in abatement until 2016.1 Even in Phase III, when NAPs are being abolished, lobbying is still likely to continue, with governments looking to secure the lion’s share of auction revenues. 1.2 Uncertainty and volatility: We have seen significant and volatile fluctuations in the price of an EUA, varying between €30 and €0.03. This is undesirable if we are to provide a consistent incentive to reduce carbon emissions. Uncertainty over the price of carbon makes it far more risky to invest the necessary resources into abatement, given that the potential payback is subject to great insecurity. Instead, many companies prefer to pay for credits and avoid abatement, running the risk of a continued carbon‐intensive technological lock‐in for another business cycle. 1.3 Short‐termism: This volatility and uncertainty has resulted to some extent from the short term nature of the scheme. With plans only running until 2020, a mere nine years away, firms looking to make significant abatement efforts are disadvantaged by being unable to tell if their investment will pay off. This short term bias is not a failure of politics or foresight, but an intrinsic requirement of climate change policies that are reliant on consistent approach running through successive governments. It would be hard to reengineer the current ETS to take the longer term into account. 1.4 Conclusion – Not viable: These issues of uncertainty, short termism, over allocation, distorting lobbying and price volatility all undermine the case of the ETS remaining a viable instrument for climate change mitigation. The myriad of problems damages investor confidence and provides the shakiest of foundations for businesses looking to put resources and investment into achieving a low carbon economy.

1 Friends of the Earth Europe, The EU Emissions Trading System: failing to deliver, October 2010, p. 3

2) Can the EU ETS operate effectively in a world without legally‐binding emissions reduction commitments and other cap‐and‐trade schemes? No, for the following reasons: 2.1 Carbon Leakage: The main issue affecting the operation of an EU only emissions trading scheme, where other countries do not impose comparable costs, is carbon leakage. This occurs as firms emigrate to countries where the cost of carbon is smaller or non‐existent, allowing them to pollute more and giving rise to a net increase in global emissions, whilst those in the EU’s are falling. While efforts have thus far been made to avoid leakage by allocating free credits, this does not mean that companies could withstand full exposure to the ETS by having to purchase all their credits: 2013 will likely see a sharp rise in the number of firms emigrating. It is important that a balance is found to create the necessary incentives, while not promoting carbon leakage; the ETS does not provide this. 2.2 Costs and existing evidence of carbon leakage: Although the costs associated with the ETS are currently small in comparison to those imposed by other environmental levies, these will jump from near zero now, to over £1.5 million in 2013 once Phase III begins and by 2020 they could be as large as £3 million.2 It is the cumulative effect of the EU ETS costs on top of those from other levies and targets which will have the real damaging effect. Carbon leakage is a real and present problem as evidenced by the Teesside Corus plant that was mothballed in December 2009 despite receiving free permits worth £250 million over three years3. 2.3 Energy intensive industries: Carbon leakage and negative impacts on competitiveness are greatest when in energy intensive industries. Critics have argued that even in these industries the free allocation of credits has developed into a surplus, proving that the ETS is not having an adverse effect. Taking the cement industry as an example, we can see that under Phase I’s underwhelming targets, over‐allocation did occur; during Phase II, although the allocation remained broadly the same, the effect of the recession meant that a surplus did build up. However, had the recession not occurred, it is likely that by 2008 the energy intensive industries’ emissions would have exceeded allocations, forcing firms to either reduce emissions or buy excess credits, thereby imposing additional costs. 2.4 Exporting and importing emissions: By pushing energy intensive firms outside the EU we are not reducing emissions; we are merely exporting them to an area which is unlikely to have the same environmental standards as our own. Many of the products of émigré companies are imported back into the EU, causing further emissions in the process and compounding the negative effect. In the UK’s case, although the production of carbon has fallen by 15% between 2005 and 2009, once carbon imports are included, carbon consumption has in fact risen by 19% over the same period.4 2.5 Solution: border tax adjustments: This would impose a tariff on goods imported from outside EU ETS‐compliant zones, to account for the cost of carbon emitted in production and transportation, and thus deliver parity of costs with products made by ETS installations. This means that firms facing financial pressures as a result of the EU ETS will not lose out to firms abroad who are otherwise effectively gaining a competitive advantage due to the EU’s environmental concern. However, such a

2 Waters Wye Associates, The Cumulative Impact of Climate Change Policies on UK Energy Intensive Industries – Update Against New Government Policy, March 2011, p. 3 3http://www.steelguru.com/sfTCPDF/getPDF/MTM0NjU0/Downsizing_deals__Corus_to_receive_GBP_250_million_in_carbon_credits.html 4 Helm, D., ‘Green growth: opportunities, challenges and costs’ in Tsoukalis, L., & Emmanouilidis, J., eds. The Delphic Oracle on Europe: Is there a Future for the European Union?, Oxford, May 2011, p. 17

tariff may be considered a protectionist measure, with potential retaliatory responses from trading partners. Nonetheless, it remains a strategy that should be seriously considered. 3) What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad?

3.1 Carry over from Phase II: The ability to carry Phase II credits over puts Phase III at the same risk of being ineffectual. It is estimated that credits worth 970 MtCO2 will be carried over, the equivalent of 40 per cent of the Phase II cap5. This problem will be self‐correcting over time, as companies will be forced to use their surpluses for compliance purposes when freely allocated credits and the cap limit decline. However, this still means emissions reductions will only really begin in 2016‐18. This is an unacceptably long period of time, especially when more efficient policies and mechanisms to reduce emissions already exist. 3.2 There will still be a Phase III surplus: While Phase III itself is the most credible part of the ETS, it still has significant shortcomings. In the third Phase, auctioning will only be introduced slowly, with a large number of permits still given free initially. Companies will be able to bank the excess allowances they receive in the less onerous first years, which guarantees that the emissions release will occur at some point. They will then be able to use them as auctioning increases. This means that during Phase III, the level of emissions might fail to fall in line with the cap, at least until the banked credits are used up. 3.3 Unacceptable solution: Historical emission cap: An oft‐mooted solution to this problem is to adjust the caps to reflect historical emissions. However the obvious and clear danger with this proposal is that it will shackle industries emissions to a historically low level. By basing the cap on a period including the recession, and its consequential lower emission levels, companies will be trapped under a ceiling that fails to reflect normal market conditions. This would present a real problem for industry to supply the increasing demand as the recovery strengthens and therefore is unsuitable. 3.4 Unacceptable solution: Set aside credits: An alternative to adjusting the cap would be to cancel unused allowances. This also seems unpalatable, with the European Parliament already rejecting a proposal for the setting aside of 1.4 billion allowances6. This is a welcomed decision given the effects it would otherwise have on investor confidence: the artificial intervention and resulting price inflation would have been counter to market expectations and would have totally undermined the premise that the free market should determine the price of carbon. Once the precedent is set, there would be no guarantee it would happen again so would entirely undermine the credibility of the scheme. 4) Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved?

4.1 International ETS trials are failures: A global or multi‐regional ETS does have attractions as it would overcome the issues of carbon leakage as there would be a global carbon price and therefore no competitive issues. However the political economy of such a scheme is fraught with difficulties. Other nations have attempted emission trading schemes but with scant enthusiasm:

5 World Bank, State and Trends of the Carbon Market 2010, May 2010, p. 57 6 Committee on the Environment, Public Health and Food Safety, On the analysis of options to move beyond 20% greenhouse gas emission reductions and assessing the risk of carbon leakage, (2011/2012(INI)), June 2011, paragraph 19

• Australia – delayed after a huge negative public reaction • China – undergoing provincial trials but it will only limit the rise in emissions, not reduce

them. • Japan – delayed due to being perceived as too costly to the Japanese economy and likely to

be abandoned • South Korea – delayed for four years and going ahead with less than 10% auctioning and

pathetic non‐compliance penalties • United States – rejected, and California’s own state ETS is delayed due to being legally

challenged 4.2 Countries do not want to burden themselves: Most of these countries rejected schemes because nowhere else (bar the EU) has subjected themselves to the crippling economic costs an ETS creates. Hence they are keen to avoid disadvantaging themselves competitively. Realistically, the EU is and will continue to be the sole ETS in the world, and this alone greatly reduces its effectiveness 4.3 Complexity of linking: China, if it goes ahead with a full scale ETS will be the largest other scheme, but given it is not actually reducing emissions, it is not compatible.

5) What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally?

5.1 None: the EU ETS is a bad advert: It could be argued that the EU should promote the development of similarly designed systems across the globe but this is a naïve wish. Any country would look at the EU ETS and all its inefficiencies, corruption and fraud, and recognise it is not a viable solution to carbon emissions problems. The international reputation of the system has been tarnished to such a degree that the already difficult task of convincing other nations to impose additional costs on industries has been made even harder, especially in this era of low growth, with intense international competition.

6) Could sectoral agreements form part of the future of the EU ETS?

They should not, for the reasons below using the example of the aviation sector 6.1 The long‐term economic cost: The planned inclusion of aviation into the ETS in 2012 has created a backlash from airline companies and governments. Standard & Poor has estimated that at a carbon price of €15 per tonne of CO2, the aviation industry will have to pay €1.125 billion in 2012 alone. Additionally Ernst & Young has suggested that the EU ETS will erode European airline profits in the long‐term, potentially by as much as €40 billion by 2022. We should not undermine successful European industry. 6.2 The short‐term consumer cost: Proponents of the inclusion argue that aviation’s viability should not be affected as they can pass on whatever costs they suffer to the consumer. However, with 85% of the permits being freely allocated until 2020, there is a chance that companies will benefit from windfall profits while also having the excuse to pass on non‐existent ‘additional’ costs to consumers. 6.3 Uncertainty: Ignorance about the timeframe for inclusion is rife and the shadow of uncertainty that plagues much of the ETS falls here as well. There has been a failure to meet the February 2010 deadline for the adoption of the legislation, with four countries including Germany yet to accept the change. However tickets for flights in 2012 are already on sale with airlines forced to guess what the

effect of extending the ETS will be. This makes investing very hard, while time and money are wasted second‐guessing what will happen. 6.4 Legal challenges: The potential saving grace of the inclusion of aviation is that it applies to all airlines operating within EU airspace, not just European carriers, creating a comparative competitive disadvantage. However, non‐EU firms are not willing to accept this and are prepared to resort to legal resistance. The Chinese Aviation Transport Association has stated that it is prepared to sue the EU and has described the measure as “only useful in Europe”. The Transport Association of America makes the point that only 9 per cent of emissions from a San Francisco to London flight are released in European airspace. The EU could launch a trade war against itself with China, Russia, the US and others all pitted against it. 6.5 Damaging knock‐on effects: The results of these legal challenges will be unwelcome either way. If they are successful and foreign airlines become exempt, then the imposition of uneven costs will have disastrous consequences for European airlines in a very competitive market. If they fail, the backlash from non‐EU airlines will mean companies refusing to pay and therefore suspending flights into Europe. The loss of revenue from airport slots as well as the impact on business and tourist trips will have a large economic cost for the wider economy. There is even the chance of carbon leakage, with passengers using airlines with extra‐EU transport hubs to avoid added fees, adding to carbon emissions. 7) Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system?

It is not a constraint for the UK, although it should be 7.1 The UK context and how the ETS nullifies extra action: Britain’s attempts at unilateral action have been numerous and varied but their effectiveness in all cases have been hampered by the existence of the ETS. Policies such as the carbon price floor, while sound in theory, have no practical purpose in reducing emissions: any carbon reduction that occurs in the UK as a result of this will allow other ETS installations to buy the saved credits and pollute more as a result. Given the nature of global warming, a ton of carbon dioxide released in France has the same effect if it were released in the UK. The ETS means unilateral action displaces carbon emissions but does not reduce them. 7.2 Unilateral action is economically damaging: Looking at just one sector, in the chemical industry ‐ highly vulnerable to energy cost rises ‐ 600,000 jobs are at risk if energy bills continue to be inflated by extra green costs. While companies can deal with individual levies, their cumulative effect is too damaging. Along with the potential social consequences of this loss, the industry has a turnover of £60 billion per annum and accounts for 15% of UK exports, almost all of which would also be lost.7 Lastly, but by no means least, the chemical industry is a vital supplier of low‐carbon products, from insulation to fuel‐efficient materials and without these, Britain’s attempts at creating a low‐carbon economy will be smothered in the cradle. 7.3 Carbon Leakage: Unilateral action of any kind, when it comes to emission reduction policies, is risky. There is a real chance of overburdening home industries with crippling costs (above those of the ETS), inadvertently making them less competitive compared to others who do not. This is more so the case within the EU, with low transport costs and a common market. Although forcing dirty polluters to go out of business may be an effective way of reducing carbon emissions in the short

7 Chain Reactions, p. 2

term it does not help us move towards the LCLC economy that we will need to establish a sustainable green future ‐ all it means is that we will import the carbon back. We must balance the emissions reductions whilst remaining economically viable. 8) Should the EU ETS allow Clean Development Mechanism (CDM) credits to be used?

No, for the following reasons 8.1 The CDM is beset by manipulation: Given the funds on offer, many extra‐EU companies are trying to muscle in and exploit the system and a service industry has emerged to help them. Some accrediting agencies are being paid according to the number of Certified Emission Reduction credits (CERs) they can deliver. A study of the top five UN‐accredited validatory bodies found that on a scale from ‘A’ (very good) to ‘F’ (very poor), none scored higher than ‘D’.8 8.2 Non‐environmentally beneficial companies are supplying credits: The Industrial Gas Credit fraud (as it should be called) based on HFC‐23 production is already well documented. It is so lucrative that the Chinese government has also been making a significant sum out of the scheme by charging a 65 per cent tax rate on HFC‐23 CDM profits. Overall, 77 per cent of EU ETS CERs come from the reduction of HFC and N2O and in Phase II, these credits amounted to €2.8 billion.9 Non‐renewable or carbon‐intensive power sources can also apply for CDM status. A 4,000MW coal plant in Gujarat, India, has received CERs because it is marginally less polluting than other coal stations. This is despite the fact it emits 26 million tonnes of CO2 per annum, will do so for at least 25 years and is India’s third largest source of emissions and the 16th largest worldwide.10 Given how tainted the CERs are, they should not be accepted. 8.3 Zero‐sum global benefit: the CDM effectively exports the EU’s carbon reduction commitments onto developing countries, an appalling shirking of responsibility. This is because while local installations might reduce their emissions by 500t/CO2e, this allows the buyer of resulting 500 CDM credits to raise theirs by the same, cancelling out the benefit. In the case of industrial gases, the outcome is entirely negative. Here, the emissions are deliberately produced and then destroyed to generate credits, which then allows EU firms to emit more CO2. In other words, without the CDM, these emissions would never be made. Overall, the scheme has no environmental benefit.

9) How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? Very serious and there is an urgent need for improvement 9.1 Fraud is rife: Security in registries is appalling, as evidenced by the January 2011 scam that stole €30 million worth of credits and led to the suspension of all trading for a week (and longer for some countries) In addition, VAT ‘carousel fraud’, has cost the EU ETS €5 billion so far, in 11 countries.11

8 Öko‐Institut, 2010 Rating of Designated Operational Entities (DOEs) accredited under the Clean Development Mechanism (CDM), May 2010, p. 4 9 Sandbag, Industrial Gas Big Spenders: HFC and N20 adipic credit usage in 2010, May 2011 10 http://www.guardian.co.uk/environment/2008/may/21/environment.carbontrading 11 http://climateandcapitalism.com/?p=4363

Indeed, the European law agency has estimated 90 per cent of all market volume in 2009 was caused by fraudulent activities.12 9.2 Fraud is the result of weak security: Registries all have differing levels of security, which means some act as a backdoor to the whole system. So long as some are inadequately protected, they are all vulnerable. 9.3 It erodes investor confidence: The black market of credits means companies are increasingly suspected that the credits they purchase are fenced, and therefore void if found to be stolen. This uncertainty undermines the credibility of the ETS. 9.4 Phase III reforms are not enough: The creation of an EU‐wide registry is good, but countries (including the UK) are opting out. Unless their security is equal to the universal registry’s, this Achilles’ Heel remains vulnerable. Passive laws are inadequate: an active watchdog is required if the ETS is going to continue. A full‐time, independent agency is required to prevent fraud. It would also be sensible to restrict access to the carbon market purely to those who need it for compliance purposes. 10) How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations?

10.1 Suggested reforms: The list of reforms that could improve the ETS in a world without legally binding targets might include:

• The ending of free allowances earlier • An EU wide price floor to reduce volatility • A clear outline of the shape and future of the ETS post‐2020 • The ending of primary participants in auctioning • Better auditing and fraud detection

10.2 The EU ETS is inherently unsuitable: However, none of these small improvements will necessarily overcome the ETS’s Achilles heel: that it doesn’t promote the long term investment necessary to reduce emissions. This is setting us back in achieving lasting targets, such as the 2050 80% carbon reduction. 10.3 Proposed solution of a carbon Tax: To this end, this report does not recommend trying to reform the EU ETS but completely replacing it with an EU‐wide carbon tax.

August 2011

12 http://www.europol.europa.eu/content/press/further‐investigations‐vat‐fraud‐linked‐carbon‐emissions‐trading‐system‐641

Memorandum submitted by the UK Petroleum Industry Association (UKPIA) (ETS 11)

The UK Petroleum Industry Association (UKPIA) represents the oil refining and marketing interests of the nine main downstream oil companies in the UK. Our member companies operate all the major crude oil refineries, supply one‐third of primary UK energy demand and ~85% of the transport fuels and other oil related products used in the UK. As such, we have a major interest in the topic of the EU Emissions Trading System and welcome the opportunity to respond to the Committee’s consultation on this important issue. Our responses to the Committee’s Inquiry are confined mainly to those questions or areas where we have specific knowledge or expertise, namely the effect of EU ETS on UK refining and downstream oil activities. Background context UK operating refinery capacity is ~1.7million barrels of crude oil per day ( ~12% of the EU). Oil currently accounts for ~37% of all the UK‘s energy needs and UKPIA member companies supply around 85% of transport fuels used in the UK. One UK refinery closed in 2009 and currently 2 of the 8 operational refineries are for sale, with two others having been sold in the recent month. The main markets in the UK are: Retail (forecourt service stations): ~ 29 million tonnes per year of petrol and diesel Aviation: ~12 million tonnes per year jet kerosene Commercial: ~18 million tonnes per year (Commercial vehicles, Heating fuels & Marine) Speciality (Bitumen, Lubricants, LPG, Solvents and Coke etc): ~5 million tonnes per year Petrochemicals: ~2 million tonnes per year UKPIA members also:

• Invested £3bn in fixed assets over the last 5 years, much of it to meet tighter fuel and environmental standards and to enhance process safety.

• Operate 36 distribution terminals & 1500 miles of pipeline • Own 2,100 out of the 8,727 filling stations in the UK • and support the employment of ~150,000 people across the UK either directly or

indirectly. The value of refining assets in the UK is estimated at ~£50bn (Source: UKPIA) and each large refinery is estimated to inject ~£60m+ into the local economy where it is located. The downstream oil sector collected ~£34bn in duty and VAT on fuels in the last financial year.

Summary UKPIA’s views can be summarised as follows: 1. Impact of EU ETS upon UK oil refining

UKPIA and its members acknowledge and are working towards meeting the Government’s targets for greenhouse gas (GHG) reduction contained in the legislative framework. Both the EU and the UK Government’s approach has been to take an international lead on tackling climate change and reducing GHG emissions. However, the lack of binding internationally agreed targets is unhelpful and places the EU refining industry at a competitive disadvantage.

UK and EU policies aimed at reducing greenhouse gas emissions, of which EU ETS is a major part, have a significant impact upon the competitiveness of UK refining with associated additional costs not faced by competing refineries outside the EU, leading to so called ‘carbon leakage’. UKPIA has determined that UK refineries face a challenging 30.2% reduction in free allowances under Phase III of EU ETS from 2013 onwards. At the current allowance cost of €15/CO2e tonne, this represents an additional immediate extra cost to the UK refining sector of some €70M/year from 2013 onwards, rising to some €230M/year at €50/CO2e tonne.

By the very nature of the varied processes involved, producing a wide range of valuable refined products from crude oil is energy intensive. Older refineries, like those in the UK, will always remain at a disadvantage in terms of conversion capability (ie‐ proportion of low value heavy residual product) and flexibility in comparison, for example, to the large refineries recently constructed in India. However, they generally rank well globally in terms of energy efficiency. UK refineries were largely configured and constructed 40‐50 years ago to meet the needs of a fast developing petrol market. The UK road fuels market has now reached maturity, and this is partly reflected in the fact that the number of operational refineries in the UK has declined to 8 from 15 in 1975. The remaining refineries have expanded and developed, with much investment in recent years focused upon meeting tighter environmental standards for fuels, reducing emissions and improving energy efficiency.

2. Oil products will continue to be an important part of the future fuel mix.

The oil industry believes that due to their low cost, on‐going availability, and ease of use petrol and diesel will remain the dominant road transport fuels globally to 2035 and beyond. This view is shared by the International Energy Agency and others in their forecasts of future energy use. The IEA’s ‘New Policies Scenario’ indicates that in 2035 oil products will still be meeting ~80% of the EU’s transport needs. However, a range of alternative fuels, including initially first generation biofuels, will have an increasing role to play in what is likely to become a more diverse energy mix aimed at meeting carbon reduction and other environmental targets. The oil refining industry will also play an important role in facilitating the introduction of these alternatives as part of the oil industry’s investment in low carbon infrastructure to complement fossil fuels. However, some of these alternatives, especially advanced

biofuels, are likely to take time to develop fully for commercial scale production so are unlikely to make a significant contribution until at least 2020. It is important that policymakers bear in mind the importance of oil in making this transition to a lower carbon future. In some transport sectors, due to technical and other reasons, this change is not going to happen overnight. For some industrial sectors oil feedstocks may be impossible to substitute. Even under the most promising scenarios, it will take decades for alternatives to reach the affordability, reliability and scale of fossil fuels. The thrust of recent policy and indications of future direction largely ignores the important role oil will continue to play beyond 2020.

3. Climate, environment and energy security/diversity of supply should be part of overall policy, consistently applied. Meeting the UK’s future energy needs in a secure, diverse and sustainable way that also meets climate, environmental and air quality objectives, is a huge challenge. It requires policy that is closely aligned in these key areas. UKPIA believes that energy and environmental policy should continue to be based on maintaining a reliable UK energy system meeting all three pillars of sustainability ‐ economic, environmental and social – with clear targets underpinned by a framework for their achievement. Policy objectives should not be dominated by any one of these pillars, should also avoid ‘picking winners’ and be applied in the UK on a basis that is consistent with the relevant EU Directives and avoids ‘gold plating’. Sound science should also be a cornerstone of this policy to ensure goals are met cost effectively and with sufficient flexibility to take account of developments in technology/scientific knowledge so that unintended consequences are avoided.

In shaping its energy policy, the Government must recognise the crucial importance of a healthy UK refining sector and define its policies to help deliver the desired outcome. Clearly market and commercial considerations are important influences but if Government wants a strong domestic refining industry in the UK, then energy and other policies must not place it at a commercial disadvantage compared to its overseas competitors.

4. UK only policies on climate change (e.g. CRC Energy Efficiency Scheme, Carbon Floor Price etc) in addition to EU ETS that may penalise UK refining versus its EU and global competitors.

The Government has recently announced plans to simplify the CRC Energy Efficiency Scheme to exclude EU ETS installations and sites covered by a Climate Change Agreement. Without these changes, the Scheme had a potential impact of over £10M/year on the refineries. Similarly, if the proposed Carbon Floor Pricing policy is applied to refinery auto‐generation and electricity imported from the Grid, the potential impact has been estimated by UKPIA at an additional £25M in 2013, rising to over £100M in 2030, depending on the EU ETS carbon price. Such costs would severely compromise UK refining against both its EU and global competitors. The refining sector also faces a growing imbalance in petrol and diesel supply/demand. The effect of fiscal policy, increased HGV traffic and the better fuel

efficiency of diesel cars has increased diesel demand in the UK by ~38% since 1998. Petrol demand has been in steady decline since the peak reached in 1990 and the surplus is exported, much of it to the USA. The same trend is apparent in the rest of the EU. Addressing this imbalance is a growing challenge for UK refineries; solutions include substantial investment (£500 million+ per refinery) to equip refineries with upgrading units to produce more diesel or alternatively greater reliance upon imports. There are also consequences for air quality and for refinery emissions in meeting this additional diesel demand ‐ more energy intensive refining processes to upgrade heavier residues into diesel with associated increases in CO2 and other emissions.

Responses to Questions posed by the Committee:

1. Does the EU ETS remain a viable instrument for climate change mitigation in the EU?

1.1

The EU ETS principle of a market‐based approach used to control emissions of GHG by providing economic incentives for achieving reductions in emissions by setting an overall cap on emissions levels, is sound. Organisations that need to increase their emission permits must buy permits from those who require fewer permits. Thus, in theory, those who can reduce emissions most cheaply will do so, achieving the pollution reduction at the lowest cost to society as a whole

1.2 The problem of carbon leakage and competitiveness, as outlined in our introductory comments remains a major issue, so while EU ETS may remain a viable instrument within the EU, doubts remain as to its effectiveness in reducing global GHG emissions in the absence of binding global policy measures.

2. Can the EU ETS operate effectively in a world without legally‐binding emissions reduction commitments and other cap‐and‐trade schemes?

See 1.2 above

3. What reduction in emissions will the EU ETS deliver in Phase III, within the UK and abroad?

3.1 UKPIA believe the EU ETS will continue to provide an incentive for emissions reductions, although changing fuel quality requirements are likely to result in increased emissions from refineries as a consequence of the increased processing required. Despite criticism from some quarters, the EU ETS has been shown to be an effective policy instrument during Phases I and II, providing a demonstration to countries outside the EU of how emissions reduction measures can be implemented.

http://en.wikipedia.org/wiki/Economics

http://en.wikipedia.org/wiki/Incentive

4. Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved?

4.1

The EU ETS is already linked to the Clean Development Mechanism and Joint Implementation schemes (which provide CERs and ERUs) established under the Kyoto Protocol. Linkage to other proposed schemes should be supported such that emissions reductions can be achieved at least economic cost.

5. What actions should the UK and the EU be taking to promote the development of compatible ETS s internationally?

We have no comment on this question. 6. Could sectoral agreements form part of the future of EU ETS?

We have no comment on this question as it is outside UKPIA’s remit.

7. Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism?

We have no comment on this question.

8. Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system?

8.1

The EU ETS is not considered a constraint on unilateral action to reduce emissions – the refining sector has for many years taken steps to improve energy efficiency to reduce costs (energy costs are the second most significant operating cost faced by refineries after feedstock cost). This has resulted in significant reduction in refinery emissions over the last 20 or more years.

8.2

Poorly considered Member State policies have the potential to undermine the EU ETS and to result in carbon leakage; the carbon floor pricing policy is one example if this were to be applied to the refining sector.

9. How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required?

9.1 We cannot comment specifically on the impact but fraud potentially adds an additional cost risk for all participants. In general as with other markets, be they financial or commodities, there must be confidence both in the regulatory regime for overseeing the functioning of EU ETS and the security of the systems for maintaining registers.

9.2 Whilst security of register systems has been the responsibility of individual Member States, Phase III of the scheme from 2013 is likely to see at least 50% of allowances auctioned , compared to around 3% under Phase II so with increased levels of trading, confidence in the system will be paramount.

6

10. How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations?

10.1 The EU ETS has been strengthened considerably under Phase III and proposals to move to full auctioning after 2020 represent a further step. However, without a global agreement on emissions reductions, there is significant risk of carbon leakage and transfer of manufacturing industries to countries outside the EU, in particular those with no binding reduction targets.

We thank you for the opportunity to contribute to this important debate and would be pleased to elaborate on our views should the Committee so wish. August 2011

Memorandum submitted by Centrica (ETS 12)

About Centrica 1. Centrica plc (Centrica) is the parent company of British Gas, the UK’s largest

energy supplier with around 16 million customer contacts in the domestic sector and around one million in the non-domestic sector.

2. We also own upstream gas production and power generation assets to support

our supply businesses. Specifically: - We own 8 gas-fired power stations including Langage, one of Britain’s newest

and most efficient gas power stations; - We are a significant UK supplier of offshore wind and recently won the rights

to develop over 4GW of Round 3 offshore wind in the Irish sea; - Through our Joint Venture with EDF Energy we own 20% of British Energy,

the nuclear generator, and we also have the option to participate in the nuclear new build programme with EDF.

General Remarks Emissions Trading & the EU ETS 3. Centrica strongly supports the EU Emissions Trading System (EU ETS) and

emissions trading in principle, since it is the most cost-effective means of delivering a set reduction in carbon emissions and uses market forces to determine the appropriate carbon price for a given carbon target, which we believe is efficient and encourages innovation.

4. Despite inevitable early issues, the EU ETS has been a remarkable success. It is

the largest carbon reduction system in the world, it has delivered a carbon price throughout much of the EU economy, and has resulted in absolute emission savings. In 2020, EU emissions within the scheme are projected to be 21% lower than in 2005. Its effectiveness has been hampered by early design flaws, the economic downturn, and a political unwillingness at a European level to put in place the measures necessary to deliver a meaningful carbon price, such as a more ambitious target. These are surmountable and we believe politicians should focus attention on continuing to refine and improve the EU ETS so it continues to be a global exemplar. In doing so, we would hope this would encourage the introduction of more emissions trading systems that could ultimately link, once proven, with the EU ETS and deliver globally cost-effective abatement. Although additional emissions schemes would benefit the overall global GHG emission levels, and would assist with decreasing the potential for carbon leakage, we do not believe they are essential to the continuance of the EU ETS.

5. We believe strongly that the primacy of the EU ETS as a carbon abatement

mechanism can be maintained and that EU ETS remains viable. However, a greater degree of commitment across Member States (MS) to tighter targets and a longer term framework is required. Until the generality of MS achieve this, the possibility of unilateral action needs to be maintained where MS have made legally binding commitments to tougher targets.

6. A key principle of climate change policy should be certainty of carbon reductions

at least cost. Efficient emissions trading delivers this, since politicians set the objective (the cap) and the market sets the price at the marginal cost of

abatement. In a ‘carbon tax only’ system, the politicians set the price and the market delivers a certain volume of emissions reductions in response. This is potentially sub-optimal as the outcome is not guaranteed and the least cost options not necessarily taken.

7. It is imperative that confidence should be maintained within the EU ETS. The

recent fraud and hacking incidents have undermined market confidence and hence the regulatory protection that market participants rely on needs to be reinforced. It is important that the EU fulfill their obligations, strengthen the regulatory regime appropriately and so underpin market confidence for the future. Likewise, going forward, in order to maintain this confidence the EU and relevant MS should ensure they deliver robust and transparency auction platforms in a timely manner.

8. The groundbreaking Stern Review on the Economics of Climate Change argued

that the carbon price was a key pillar of tackling climate change, but went on to say that it was necessary but not sufficient. Additional policies were also needed, tackling innovation, technology development, and behavioral barriers, for example to taking up energy efficiency. Within this framework we believe the UK Government is right to provide additional climate change policies, including ones that complement the EU carbon price to ensure a UK specific investment signal.

UK Action to Underpin the Carbon Price 9. The UK currently has higher (legally binding) carbon targets than the EU (32%

vs. 20% reduction on 1990 levels). In addition, the UK’s carbon targets reach further out than the EU’s (to 2050). In order to meet the 2050 target the UK will need to largely decarbonise the power sector in the 2030s (to open the door for low carbon electric transport and heating). To meet these UK specific objectives of a higher 2020 target and a higher longer-term 2050 target (and consequent power sector decarbonisation in the 2030s), strong low carbon investment signals are needed in the UK now. The UK is in this unique situation because we have adopted a leadership position in tackling climate change both to catalyse action by others and to take advantage of our ‘early mover’ status.

10. Ideally the EU would be collectively taking action similar to the UK, resulting in an

EU ETS which had durations and targets commensurate with the UK’s needs. And in time the EU may do this. However, in the absence of EU agreement, unilateral MS interventions are necessary in order to fulfil unilateral MS targets. This need has been compounded by the recession which has depressed EU ETS carbon prices. In a way this reflects the EU ETS working effectively; lower emissions in the EU as a result of the recession mean that a less strong signal is needed to reduce emissions through the carbon price. However, while that might be appropriate for a snapshot moment in time it means there is not that long term investment signal required in the UK because the EU ETS does not – and is not intended to - look out to 2050 with a commensurately ambitious target. However, we remain hopeful that unilateral action in the UK might spur the Commission to work on tightening the EU ETS to ensure it generates stronger signals.

11. The UK’s decision to underpin the carbon price provides investors in the UK with

a stable carbon price, aiding investments in low carbon generation and helping the UK meet its targets. In the longer term, the carbon price floor might remove the need for ad-hoc support schemes and could provide the foundations for a more technology-neutral approach to decarbonising the UK economy.

12. The carbon price floor, by its longer term nature and structure which

complements the EU ETS, will give investors the longer term confidence they need. Low carbon investments have long lead times, asset lives and payback periods, and in order to stimulate the investments commensurate with that timescale, investors have to be able to assess regulatory risk over longer than usual horizons. While the carbon price support mechanism is also subject to political change, it is possible within a single MS to frame a greater degree of certainty than may otherwise be the case.

13. Some have argued that unilateral measures such as the carbon price floor

undermine the EU ETS since they reduce emissions, depressing the EU carbon price and undermining the cap. In response, we would argue that firstly the same can be said for any policy which reduces carbon such as promoting renewables or smart metering; and that we support Prof Lord Nick Stern’s view that the carbon price is necessary but not sufficient, and other policies will still be necessary to overcome other barriers or achieve other objectives. Secondly, we believe the impact of these policies on the EU wide carbon price is marginal. The UK power sector represents a modest proportion of EU emissions, and the UK carbon price floor is likely to reduce emissions by some degree, but not to remove them entirely. Thirdly, we believe that if the EU ETS had a more ambitious target with a longer trajectory, any impact would be reduced further still, and these additional policies may not be necessary. But in the absence of this, and given the latest science of climate change, Member States are right to adopt leadership positions to catalyse action.

14. Finally, it is worth bearing in mind that the carbon price floor has been designed

specifically to complement the EU ETS rather than undermine it. If the EU ETS carbon price is high, the carbon floor will lower accordingly to compensate. If the EU ETS generated price is sufficient, the carbon floor would reduce to zero. This helps minimise the impact on UK competitiveness. However, some impact will remain on certain industries. This could be offset by recycling some of the revenues from the levy into reduced business taxation elsewhere.

August 2011

Memorandum submitted by Carbon Trade Watch, Corporate Europe Observatory and The

Corner House (ETS 13)

1. Carbon Trade Watch, Corporate Europe Observatory and The Corner House welcome the Energy and Climate Change Committee’s present enquiry into the EU Emissions Trading System (EU ETS).1 We are grateful for the opportunity to comment on the following issues in the Committee’s remit:

• Does the EU ETS remain a viable instrument for climate change mitigation in the EU? • What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad? • Will the EU ETS be able to access viable alternatives to international credits without the Clean

Development Mechanism? • How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are

further improvements in security and auditing required?

• Executive Summary 2. The EU ETS is not a viable instrument for climate change mitigation and should be scrapped. In support of this conclusion, this submission argues that: 3. The EU ETS has failed to reduce emissions. Polluters have consistently received generous allocations of permits to pollute, meaning they have no obligation to cut their CO2 emissions. 4. Carbon offsets increase the “cap” on pollution within the ETS. Their inclusion within the ETS has weakened already weak emissions targets, delaying domestic action in the EU. Carbon offsets – mostly generated through the Clean Development Mechanism – have been generated by a series of socially unjust and environmentally harmful projects in the global South. 5. The ETS is a subsidy scheme for polluters. Power companies gained windfall profits estimated at €19 billion in Phase I, and look set to rake in up to €71 billion in Phase II. Subsidies to energy-intensive industry through the two Phases could amount to a further €20 billion. This has mostly resulted in higher shareholder dividends, with very little of the windfall invested in transformational energy infrastructure. 6. Phase III of the ETS will still see significant subsidies paid to industry, despite the auctioning of permits in the power sector. The benchmarking exercise set the bar so low that over three-quarters of manufacturing receiving free permits, which could result in at least €7 billion in annual windfall profits. An ongoing review of EU “state aid” rules in relation to the ETS could exacerbate this problem. In addition, the use of carbon market auction revenues for Carbon Capture and Storage (CCS) projects further delays the transition away from fossil fuels. 7. New market mechanisms (eg. sectoral or NAMA crediting, or sectoral trading) are not a solution to the problems of international offsets, but risk “scaling up” many of the failings of the Clean Development Mechanism (CDM).

8. The European Commission took a deliberately “laissez-faire” approach to regulating carbon trading at the outset. Recent fraud cases have made this position untenable, but rule changes for registries do not address the fundamental problems of attempting to trade an unstable, invented carbon commodity.

• Does the EU ETS remain a viable instrument for climate change mitigation in the EU? 9. The EU Emissions Trading System (ETS) has consistently failed as an instrument of climate change mitigation. The first phase, which ran from 2005 to 2007, saw too many permits handed out – with an overall surplus of 267 MtCO2e (Megatonnes Carbon Dioxide Equivalent, the internationally recognised measure of greenhouse gas emissions), or about 4 per cent of the total emissions covered by the scheme. In other words, the “cap” did not cap anything and the price collapsed. The European Commission claimed that the second phase, from 2008 to 2012, would usher in genuine reductions, and has stated that a lower level of recorded emissions in ETS sectors in 2008 and 2009 showed the scheme was working.2 Emissions from installations covered by the scheme fell by 11.6 per cent in 2009 (a drop of 246 MtCO2e), having fallen by around 5 per cent in 2008.3 But this needs to be set against falls in production of electricity and industrial goods of 13.85 per cent in 2009 as a result of the recession.4 Less production results in fewer emissions – which can hardly be claimed as the results of a successful policy. In fact, the allocation of ETS permits in 2009 was 159.5 MtCO2e higher than the actual level of emissions, roughly equivalent to the annual emissions of Spain. 10. Figures for 2010 show that emissions rose by over 3.5 per cent in 2010, compared to 2009 levels. The allocation of permits under the scheme was 3.2 per cent (57.4 MtCO2e) higher than the actual emissions measured from installations covered by it.5 In other words, the cap was ineffective yet again. The large surpluses of permits already circulating within the scheme make it possible for such increases to continue without significant costs to the industries covered. 11.The caps were set too generously, principally as a result of corporate lobbying. This is a systemic risk with carbon markets, with political decisions affecting the supply and demand of allowances playing a central role in price-setting.6 The problem with emissions trading is not simply one of cap setting, however. The “flexibility” offered by the ETS means that – even if it were to work as planned – the likely effect is that it would encourage quick fixes to patch up outmoded power stations and factories, “locking in” and delaying more fundamental changes.7 What is cheap in the short-term does not necessarily translate to an environmentally effective or socially just outcome over the long-term. 12. The failings of the first two phases of the ETS were compounded by an “offsets gap”. The 2004 Linking Directive allows companies covered by the ETS to hand in “offset” credits generated by “emissions-saving projects” implemented mostly in developing countries in the South. They are mainly generated through the CDM, which issues credits called Certified Emissions Reductions (CERs).8 In the second Phase of the ETS, the number of offsets allowed is higher than the reductions required.9 The precise limit varies between states, with the UK at the lower end of the spectrum (8 per cent of emissions) rising to 21 per cent in Spain and 22 per cent in Germany.10 EU rules allow any surplus from Phase II to be carried forward to Phase III - in effect, merging the limit on offsets from the two Phases.11 In total, companies will be able to use 1.6 billion in offset credits.12 A UK Environment Agency projection suggests that on the basis of existing practice over 1.2 billion of these credits could be “banked” for use in Phase III.13 This would once more reduce the obligation on companies covered by the scheme to take action to curb their own pollution at source.

13. The negative social and environmental impacts of carbon offsetting have been widely documented.14 Projects often result in land grabs, local environmental and social conflicts, as well as the repression of local communities and movements. For example, it is notable the CDM approval process for projects allows little space for the voices of Indigenous Peoples and local communities – and no project has ever been rejected on the grounds of rights violations.

• What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad?

14. The stated aim of Phase III of the ETS is to achieve a 20 per cent reduction in greenhouse gases across the 27-state bloc by 2020 compared to 1990 levels.15 This goal falls a long way short of what climate science suggests is needed to avoid dangerous climate change. By contrast, the EU's disproportionate historical and current responsibility for contributing to climate change means that it should be taking a lead in reducing emissions domestically. 15. The problem of an unambitious cap is likely to be compounded by a large surplus of “banked” permits from Phase II. The Phase III cap for industrial sectors covered by the ETS has been set at 21 per cent compared to 2005 levels, with decreases calculated at 1.74 per cent a year (around 35 MtCO2e). However, according to World Bank estimates the second Phase of the scheme could end with an overall surplus of 1,280 MtCO2e, which could be carried over (“banked”) for use from 2013 onwards.16 This would account for almost 40 per cent of the “reduction” target that the EU claims will be required of power companies and industries covered by the ETS in Phase III of the scheme. These figures are swelled by the use of offset credits. The Phase II surpluses alone could allow the scheme to continue without any domestic emissions reductions until at least 2017.17 16. Phase III will also see the continuation of polluter subsidies, despite the increased use of power sector auctioning. Energy companies successfully lobbied for an estimated €4.8 billion in subsidies for Carbon Capture and Storage (CCS), with a smaller amount for “clean” energy that includes agrofuels.18 The Commission’s review of “state aid” rules could further see the granting of direct financial subsidies to companies claiming that the ETS damages their competitiveness. 17. The allocation of permits according to performance “benchmarks” in Phase III was supposed to encourage a fairer and more efficient division of responsibility for emissions reductions in energy-intensive sectors such as cement, steel, paper and glass. But industry has been allowed to influence the benchmarking. For example, CEMBUREAU (the cement industry lobby) was instrumental in choosing what to measure (“clinker” not cement) and how to measure it. The final agreement saw the adoption of a lax standard that was significantly shaped by Cembureau. This will result in a surplus of pollution permits for the cement sector, allocated in a way that rewards the continued use of dirty and outdated production methods.19

• Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism?

18. New sectoral carbon markets are presented as a means to “move beyond” the CDM and “scale up” mitigation actions in the global South. However, increasing the size of carbon markets is not the same as reducing emissions. The evidence of the CDM to date suggests that offsetting increases rather than

reduces greenhouse gas emissions. New sectoral mechanisms risk “scaling up” these failings. 19. The introduction of new markets in the context of a declining global trade carbon throws this into sharp focus. If new mechanisms start delivering significant quantities of credits in a market with limited demand for them, the price of carbon would likely collapse. As of August 2011, benchmark CDM prices are close to an all time low of €7/tonne – reflecting a lack of demand.20 Introducing new markets in a context of unambitious climate action by industrialised (Annex I) countries is likely to undermine climate change mitigation efforts, while a reliance on them could weaken flows of climate finance. Instead of seeking alternative sources of credits, international efforts would be better expended seeking alternatives to carbon trading as the centrepiece of climate change mitigation policy.

• How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required?

20. Since the start of the Emissions Trading System (ETS), the EU has taken a lenient approach to regulation, with no specific financial regulations for how carbon was traded.21 The rationale behind this light touch was to encourage the growth of the market at all costs. With the ETS failing to achieve emissions reductions, the EU fell back on claims that it had “successfully established the free trading of emission allowances across the EU, set up the necessary infrastructure… developed into the world’s largest single carbon market.”22 21. The recent fraud cases – from VAT carousel fraud to internet phishing attacks -- have made this position increasingly untenable. VAT rule changes and a new regulation on carbon registries were intended to address this. The new rules are ambiguous and inadequate, however, with measures on the non-disclosure of allowances on serial numbers further reducing transparency. 22. Even if regulation were to contain the wilder excesses of the carbon market, they do little to solve the structural problems built faced by the trading system. It will continue to be prone to arbitrary volatility because the underlying asset is fundamentally unstable: there is no clearly identifiable commodity being traded, but merely an assemblage of incommensurable activities re-packaged to form a tradeable commodity.23 Moreover, the supply of carbon is “uniquely at the mercy of the political pen – where it was conceived”, since the act of allocating permits (or determining quantities available for auctioning) is the result of a political decision, rather than something that is indexed to a real-world product. The combination of this factor with the difficulty of identifying clear price drivers makes for arbitrary volatility.24 23. The political determinants on supply make the carbon market is particularly prone to lobbying and government influence, since lobbying effects not simply the rules governing how the market operates but also the supply of permits and credits. In the case of offsets, governments are both supplies and users of credits, contributing to significant conflicts of interest.25 24. More generally, carbon markets are particularly prone to fraud and gaming because they create a large trade in intangible and hard-to-measure assets.26 Once created, moreover, these reductions are simply paper permissions slip that can quickly change hands. In this sense, emissions trading “streamlines the fraudster’s profession” - a matted that went unconsidered when the market was set up.27 A greater willingness to regulate away speculative excess (eg. through capital limits and position limits) is badly needed, but this is no substitute for re-considering the EU's continued support for

5

carbon markets in the first place.

• Conclusion 25. Some proponents of the ETS suggest that the main flaws are rules that have been designed inadequately or have been badly applied, and could be reformed. We suggest that the failings are of a structural nature. The ETS is a market in a commodity that has been created by legislative fiat. The European Commission is both the supplier and the regulator of carbon as a commodity, a situation which has made the ETS particularly susceptible to rent-seeking behaviour. This should come as no surprise, since the history of emissions trading is littered with evidence that it helps companies and governments to pre-empt and delay making the structural changes necessary to address climate change.28 26. Emissions trading was proposed as a “flexible” system to help power producers and industry make the cheapest emissions reductions first, but short-term cost is not the same as environmental effectiveness. The cheapest allowances tend to look for loopholes, with the complexity of forging a single carbon commodity from several incommensurable process tending to provide numerous such opportunities. If the system worked as “planned” (and it is far from doing so), the price incentives offered by emissions trading would still only shift finance towards the deployment of existing technologies, “locking in” a reliance on fossil fuel based technologies rather than stimulating a transformation towards more sustainable development paths.29 In setting up a system of property rights for continued pollution, the ETS transposes environmental objectives into the kind of cost-benefit trade-offs that led to the problem of climate change in the first place. August 2011

1 For further details and publications see www.carbontradewatch.org , www.corporateeurope.org/climate-and-energy and

www.thecornerhouse.org.uk 2 See European Commission (2009) “Emissions trading: EU ETS emissions fall 3 % in 2008” 15 May,

http://europa.eu/rapid/pressReleasesAction.do?reference=IP/09/794 3 Total verified emissions in 2008 were 2,119 MtCO�e and in 2009 fell to 1,873 MtCO�e. See Environment Agency

(2010) Report on 2009 EU Emissions Trading System emissions data Bristol: Environment Agency, p16 4 Damien Morris and Bryony Worthington (2010), Cap or trap? How the EU ETS risks locking-in carbon emissions

London: Sandbag, p.24 5 European Commission (2011) “Verified Emissions for 2008-2009-2010 and allocations 2008-2009-2010”, 1 April,

http://ec.europa.eu/clima/documentation/ets/docs/verified_emissions_en.xls These calculations are based on a provisional data release, and take account of verified data from 8,833 installations (77 per cent of the total).

6 See Carbon Trade Watch and Corporate Europe Observatory (2011) “EU Emissions Trading System: failing at the third attempt”, Barcelona: CTW/CEO, http://www.carbontradewatch.org/articles/eu-emissions-trading-system-failing-at-the-third-at.html

7 See Larry Lohmann (ed.) (2006), Carbon Trading: A Critical Conversation on Climate Change, Privatisation and Power Uppsala: Dag Hammarskjöld Foundation

8 UNEP Risoe CDM/JI Pipeline Analysis and Database (2011), 1 March, http://cdmpipeline.org/ http://cdmpipeline.org/overview.htm As of March 2011, there were 2867 approved CDM projects, with over 3000 more awaiting approval. Only 956 of the projects have so far issued credits, however, and the majority of these issued credits arose from the claimed “reduction” of HFCs and N2O.

9 National Audit Office (2009) European Union Emissions Trading Scheme London: National Audit Office, p.19, http://www.nao.org.uk/idoc.ashx?docId=ba234e01-c494-4ab4-898b-812a0fe1c4f5&version=-1

http://www.carbontradewatch.org/

http://www.corporateeurope.org/climate-and-energy

http://www.thecornerhouse.org.uk/

http://europa.eu/rapid/pressReleasesAction.do?reference=IP/10/576

http://ec.europa.eu/clima/documentation/ets/docs/verified_emissions_en.xls

http://www.carbontradewatch.org/articles/eu-emissions-trading-system-failing-at-the-third-at.html

http://www.carbontradewatch.org/articles/eu-emissions-trading-system-failing-at-the-third-at.html

http://cdmpipeline.org/

http://cdmpipeline.org/overview.htm

http://cdmpipeline.org/overview.htm

http://www.nao.org.uk/idoc.ashx?docId=ba234e01-c494-4ab4-898b-812a0fe1c4f5&version=-1

6

10 IGES Registry Database (2010), 15 May update,

http://enviroscope.iges.or.jp/modules/envirolib/upload/2395/attach/iges_registry_data.zip 11 European Commission (2008) “Questions and Answers on the revised EU Emissions Trading System”, 17 December

http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/08/796&format=HTML&aged=0&language=EN&guiLanguage=en

12 House of Commons Environmental Audit Committee (2010) The role of carbon markets in preventing dangerous climate change, London: The Stationary Office, p.15

13 The Environment Agency (2010), p.11: “If the level of banking seen in 2008 (55 MtCO�) and 2009 (290.8 MtCO�) continued through the remaining years of Phase II, some 1,218.2 MtCO� (55 + (290.8 x 4)) would be banked into Phase III.” This projection should be treated with some caution, given the uncertainty surrounding economic growth forecasts.

14 For more on CDM, see Tamra Gilbertson and Oscar Reyes (2009) Carbon Trading: how it works and why it fails, Uppsala: Dag Hammarskjöld Foundation, pp.53-87

15 European Commission (2008) “20 20 by 2020 Europe's climate change opportunity” COM(2008) 30 final, 23 January, http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2008:0030:FIN:EN:PDF

16 World Bank (2011) State and Trends of the Carbon Market 2011 Washington: World Bank, p.63 17 Morris and Worthington (2010), p.21 18 Corporate Europe Observatory and Spinwatch (2010) “EU billions to keep burning fossil fuels : the battle to secure EU funding for carbon capture and storage ”. The €4.8 billion figure assumes an EUA price of €16. 19 For more information on this case, see Carbon Trade Watch and Corporate Europe Observatory (2011) 20 Gerard Wynn and Nina Chestney (2011) “Carbon Offsets Near Record Low, Worst Performing Commodity” Reuters, 8

August 21 Michel Prada et al. (2010) The Regulation of CO2 markets Paris: Republique France,

http://www2.economie.gouv.fr/services/rap10/101004prada-report.pdf p.15 22 European Commission (2008) “Proposal for a Directive of the European Parliament and of the Council of 23 January

2008 amending Directive 2003/87/EC so as to improve and extend the greenhouse gas emission allowance trading system of the Community”, 23 January, p.2

23 Larry Lohmann (2009) “When Markets are Poison: learning about climate policy from the financial crisis”, pp. 28-30 24 Emily Gallagher (2009) “The Pitfalls of Manufacturing a Market: Why Carbon Will Not Just Sit Down, Shut Up, and

Behave Like a Proper Commodity ” New Americas Foundation, p.2 25 Larry Lohmann (forthcoming) “The Endless Algebra of Climate Markets” 26 Michelle Chan (2010) “10 Ways to Game the Carbon Market” Washington: Friends of the Earth USA, http://www.foe.org/sites/default/files/10WaystoGametheCarbonMarkets_Web.pdf 27 Richard T. Ainsworth (2010) “CO2 MTIC Fraud – Technologically Exploiting the EU VAT (Again)”, Boston University

School of Law Working Paper No. 10-01, p.4 28 See Gilbertson and Reyes (2009), chapters 1 and 2 29 For an elaboration of this argument, see Lohmann (ed.) (2006), Gilbertson and Reyes (2009)

http://enviroscope.iges.or.jp/modules/envirolib/upload/2395/attach/iges_registry_data.zip



http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2008:0030:FIN:EN:PDF

http://www2.economie.gouv.fr/services/rap10/101004prada-report.pdf

http://www.foe.org/sites/default/files/10WaystoGametheCarbonMarkets_Web.pdf

Memorandum submitted by Dr. Carlo Stagnaro, Istituto Bruno Leoni (ETS 14)

1. The European Union has unilaterally decided to implement a cap & trade scheme to contain greenhouse gases (GHGs) emissions, starting on 1 January 2005. After the First Phase of the Scheme had been concluded on 31 December 2007, emissions from the sectors covered by the European Emissions Trading Scheme (ETS) had actually increased. That is not enough to tell that the scheme didn’t work: there are too little data to perform a credible assessment. The literature on the issue is not unanimous. It seems plausible, however, that some permits over‐allocation occurred in 2005, that might explain the not‐so‐exciting performance of the scheme. In fact, to some extent some over‐allocation was also acknowledged by the European Commission itself, which adopted more stringent criteria for the Second Phase of ETS (2008‐2012). Now a Third Phase (2013‐2020) is about to begin, with an emphasis over defining even more stringent criteria and a shift from a grandfathering system in the initial allocation (whereby allowances are initially given free‐of‐charge on the basis of historical track records for emissions), towards a partial auctioning system (whereby permits are initially given to the highest bidders), with a goal of a full auctioning in 2027. At the same time, safeguard measures are being considered in order to prevent “carbon leakage” (i.e. delocalization due to higher costs of energy) in the energy‐intensive economic sectors or sub‐sectors that are exposed to international competition.

2. A very strong case can be made, indeed, for “doing nothing” about climate change: a wide variety of issues, ranging from scientific and economic uncertainties to the lack of a global framework and the possible negative effect of climate policies on innovation and economic growth should not be ignored. However, since “doing nothing” is clearly not an option being considered by the European Union, this submission will focus on policies aimed at curbing CO2 emissions, particularly cap and trade schemes (such as the EU ETS) and carbon taxes.

3. The objective of the European climate policies is to “adopt the necessary domestic measures and take the lead internationally to ensure that global average temperature increases do not exceed pre‐industrial levels by more than 2°C”.

4. The deepest problem concerns policy objectives, functions, and consistence. Furthermore, it risks becoming an unrealistic objective.

5. Europe does not act in a void, but the background of its actions consists in the decisions of other nations. Although one can maintain that Europe could lead other nations on the sustainability path by example, so far that does not seem to have materialized, and the EU seems to be a leader without followers. It is therefore reasonable to assume that, at least in the short and medium terms, the other countries will mainly follow domestic logic, and thus, the consequences of European choices must be evaluated within a “business as usual” scenario for the rest of the world. According to virtually every scenario, worldwide emissions are going to increase in the long run, and most – if not all – such growth will take place in the developing world. Energy consumption in the developing countries will grow, and most of such energy need will be satisfied by fossil fuels. Since, on average, energy technologies in the developing world are below European standards, it follows that carbon emissions will grow more than proportionally, and that this is likely to offset most or all the EU efforts. Clini (2007, p.119) writes: “The advantage in terms of the reduction of CO2 emissions – that can be measured only at the global level – is marginal. The reduction of 20 % of the European emissions in 2020 corresponds to a global reduction of less than 4 %.” Almost by definition, a reduction of this size is destined not to have any effect on climate balances.

6. The chief instrument of the EU to cut its emissions is the so‐called Emissions Trading Scheme (ETS). The albeit small experience accumulated so far by ETS gives rise to perplexities about how well it is operating. Price volatility of allowances is one index of the shortcomings. Variable, unpredictable prices that often happen to be quite low (or below expectations) are quite inconsistent with the stated goal of investing in more costly “green” energy or energy conservation.

7. According to the proposed directive by the Commission, starting from 2013, all quotas for the thermoelectric sector will be allocated through auctions. This choice seems to collimate with the preferences of the majority of economists, who recognise two advantages in allocation through quota auctioning: less exposure to political whim (Joscow and Schmalensee 1998), and the ability to generate tax income. The argument about the greater neutrality of auctioning seems to have better foundations. Such concerns disappear, however, as soon as one

goes on reading the European directive on emission trading. In spite of the initial call for harmonization and predictability, the exceptions seem far more numerous than the cases to which the presumed rule is applied.

8. Cap and trade is one example of “economic instrument” to control emissions. Economic instruments “provide an explicit price signal to regulated firms and individuals” (Hepburn 2006, p.228). These instruments consist of instruments based on price and those based on quantity. Because a regulation of quantities assigns an implicit price to the goods subject to regulation – generally, a polluting substance, the emissions of which are the target of reduction – in ideal conditions the result of the two instruments would be identical. It is also possible to conceive hybrid forms, for example, regulation of quantities with a price cap, a price floor, or both. In theory, and in the abstract, there is no reason to prefer one instrument over the other (Requate 1993). This is because they are equivalent under ideal conditions. In fact there is no a priori reason to prefer either one (Downing and White 1986; Milliman and Prince 1989). Requate (1998) argues that, while both policy instruments can be preferable under different conditions, a tax system might prevent a real competition between non‐polluting technologies. On the contrary, Weitzman (1974) shows that – in a situation of uncertainty about marginal costs – a price instrument is more, or less, efficient than an instrument of quantity when the curve of marginal benefits is relatively less, or more, steep than that of marginal costs. In the case of global warming, as Hepburn (2006, p.232) observes, “suppose the marginal cost of reducing emissions increases quickly as we move from eliminating the cheap, ‘low hanging fruit’ on to more difficult sources of emissions (e.g. aviation transport). Suppose also that, because damages from climate change are a function of the stock of greenhouse gases in the atmosphere, they are only a weak function of emissions over short periods (e.g. 5 years), so that the marginal benefit from abatement is relatively flat. In such circumstances, a price instrument – a carbon tax – is the appropriate instrument to use.” These assumptions are consistent with the available evidence.

9. In fact, the marginal costs of emission abatement are clearly growing with a relatively steep curve. In the more energy‐efficient countries, such as EU member states, to cut the emissions is far more expensive than in countries that are less energy‐efficient, such as the emerging economies. Think, for example, that the efficiency of a coal‐

powered plant in Europe exceeds 40 %, while in China the average efficiency is around 20 %. If it were possible to export European technology to China for all new installations, it would be possible to obtain, at a relatively low cost, a much more substantial result of the objectives of the Kyoto protocol, assuming that they are reachable and that they are actually materializing later. According to the projections of Montgomery and Tuladhar (2006, p.4), the adoption of an American technology (less efficient than the European technology) for the new investments in the electric sector in China and in India could determine, in 2012, an emission savings more than four times greater than the domestic objectives of the European Union.

10. Conversely, the marginal benefit of emission reduction grows with a very mild curve, as the forcing of climate grows logarithmically next to the atmospheric concentration of greenhouse gases.1 Nordhaus (2007, p.126) writes: “the structure of the costs and damages in global warming gives a strong presumption to price‐type approaches. The reason is that the benefits of emissions reductions are related to the stock of greenhouse gases, while the costs of emissions reductions are related to the flow of emissions. This implies that the marginal costs of emissions reductions are highly sensitive to the level of reductions, while the marginal benefits of emissions reductions are insensitive to the current level of emissions reductions.” In these conditions, an instrument of price regulation seems preferable to one of quantity regulation.

11. To these considerations on efficiency we can add one concerning the proper operation of the policies. From the institutional point of view, the creation of a market for emission quotas such as ETS – destined to have a growing level of complexity and inclusiveness – implies a commitment, that is, a mobilization of resources for the managing and the maintenance of the necessary administrative infrastructures which is far superior to that of a carbon tax (Helm 2005).

1 Once a very low threshold is passed (about 50 ppm in volume), each doubling of the concentrations determines an equal increase of the forcing, about 3.7 watts per square meter. Thus, if we move from a CO2 concentration of 280 ppmv (that of the pre‐industrial era) to 560 ppmv – double – the forcing grows by 3.7 watts per square meter; if we go from 560 to 1,120 ppmv, the increase of forcing is still 3.7 watts per square meter (today, the concentrations are about 380 ppmv). It follows that, no matter the complexity of relation between emissions (a flux) and concentrations (a stock), each emission unit saved determines a smaller increase of the forcing less than was due to the previous unit, which instead was sent into the atmosphere.

12. By the same token, a carbon tax seems less distorting of the market than the current cap & trade, because of a smaller administrative structure and greater predictability. It is true that a tax, just like the emissions ceiling, can be reviewed at any time and increased, thus nullifying the projects of enterprise that were based on the earlier tax. In the case of ETS, however, to the possibility of more or less occasional changes in the structure of the system, we can add a certain amount of uncertainty on how the ETS will be applied, which sectors will be actually called to contribute, in what way the gratuitous quota will be allocated, etc.

13. To understand what consequences might follow from the introduction of a carbon tax, one should look at the demand elasticity for energy. Price elasticity for electricity is generally found relatively low in empirical studies, especially in the short run. Elasticity in the long run might, however, be more significant. A review of the most recent studies, performed by Lijesen (2007), shows that short run elasticity ranges from ‐0.04 (Al Faris 2002) to ‐1,113 (Woodland 1993), with an average value of ‐0,32. According to the same source, estimates for long run elasticity range from ‐0.09 (Boonekamp 2007) to ‐3,39 (Al Faris 2002), with an average value of ‐0,57. As far as the demand for motor fuels is concerned, Liu (2004) estimates a short run elasticity of ‐0.191 for gasoline, and ‐0.094 for diesel. Long run estimate are, respectively, as high as ‐0.318 and ‐0.516. A review of the most recent studies performed by Goodwin, Dargay and Hanly (2004) found an average elasticity for motorfuels of ‐0.25 in the short run (in the range between ‐0.01 and ‐0.57), and of ‐0.64 in the long run (with a range that varies from 0 to ‐1.81). Emissions would be reduced accordingly.

14. Strictly connected to these questions is the issue of the political feasibility of climate policies. There is virtual unanimity amongst the experts that, from the political point of view, a cap & trade system is easier to launch than a carbon tax, and the European story provides further evidence about that. However, the price of the lesser political resistance is a system that is both opaque and arbitrary. On the contrary, a carbon tax would be more easily implemented, more stable, more predictable, and more responsive to the actual changes in the climate. From a certain point of view, therefore, the lesser political feasibility, due to the difficulty of harvesting consensus on a tax and the need to substantially reformulate the fiscal system, is a further advantage of the carbon tax. The lesser political feasibility guarantees, in fact, not only that the measure will be taken only when a truly large

portion of the population is openly willing to pay more to obtain a certain environmental goal. For the same reason, it will be easier to abrogate the tax – a move that is politically less difficult than cancelling regulations as encrusted with lobby activities as they are obscure to most people – when and if it becomes evident that the European strategy is not sustainable, or that the global warming is a less severe problem than what is believed today.

About Istituto Bruno Leoni

Istituto Bruno Leoni (IBL), named after Italian law‐scholar Bruno Leoni, is a non‐partisan think tank based in Italy. IBL promotes free market‐oriented reforms and policies. IBL also performs research and studies on a number of issues, including (but not limited to) energy, climate, competition policy, welfare state reforms, telecoms, liberalisations and privatisations, etc. More information are available at IBL website: www.brunoleoni.it

August 2011

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Memorandum submitted by the Bryman Partnership (ETS 15)

Overview

The Bryman Partnership Ltd (TBPL) is a Business and Environmental Consultancy. It has extensive experience in the nuclear industry, energy and environmental matters and particularly in the UK Paper Sector. Within this context it has particular experience of Climate Change Agreements (CCA), the UK Emissions Trading Scheme (UKETS) and the administration of EUETS. In addition it has variously advised the Federal Government and some provincial Governments and organisations in Canada on climate change matters. As far as the UK is concerned TBPL rarely makes individual formal responses to consultations and has instead generally assisted the Confederation of Paper Industries and the Emissions Trading Group in any of their responses to consultations or in the development of detail. However this Inquiry is important since it comes at the point when many of the EUETS Phase III issues are being concluded and we have therefore decided to take the opportunity to inform the Committee directly. If the Committee decides at later time to take oral evidence we will be pleased to present our views personally.

In making this response there will be a balance between relatively high level comments and those of detail ‐ inevitably the detail is important to gain insight into the important issues.

Summary key points

1. EUETS was established in 2005 as a major UK/EU policy initiative. It followed years of development and had some roots in the now discontinued UKETS. At its inception it was recognised that EUETS, while reducing emissions, would cause long ‐ run power prices to rise to the benefit of all generators who could simply pass through costs. It was expected overall that these rises would be in the range 10‐20% while shorter term prices would rise by much more. This happened and before the event. This notwithstanding, for a while EUETS flourished and this was aided by the UK taking a major role in the development of some of the detail but also uniquely in the EU by verifying its ‘baseline’ data on which to base operation of EUETS. This was in key decision, unwelcome by some at the time, but later found to be valuable. The net result of this action was that in Phase I (2005‐7), the UK was the only member state with realistic data ‐ all others were later found to have been over‐allocated and consequently the peak price of emissions allowances which earlier had peaked at ca €30 by the end of 2005 had fallen away to virtually zero where it remained for much of Phase I. The price of emissions has never recovered. Phase I was therefore a costly development phase that yielded little positive result in terms of reduced emissions and opened questions as to the future of the scheme.

2. Because of the policy focus on the importance of climate change and the corresponding reduction of greenhouse gas emissions, Emissions Trading Schemes, such as EUETS, have attraction to some as putatively least‐cost solutions for compliance with emission reduction targets. However experience shows that the costs and complexity of EUETS have been progressively escalated through the first two Phases to the extent that EUETS is now causing real damage to industry in particular through the substantial increases in costs not only of administration in industry, but also of electricity in particular and the associated trading costs which are simply passed through to the consumer. Moreover Phase III of EUETS with

its huge and growing central control by relatively few EC officials in Brussels has the potential to be ruinously costly to industry not only here in the UK but elsewhere in the EU and is likely to cause closures due to further large increases in cost or indeed the flight of some industries to locations that have more liberal regimes.

3. In order to develop the basis for this control, the EC has taken to itself or has had considerable powers gifted to it by officials and Governments of some Member States, to the extent that principally EC officials are determining rules with very little political scrutiny. These rules in application are costly and to allow this unfettered development was a grave political mistake.

4. Since 2005 there has been considerable pressure from within the UK in particular for, eventually, all emission allowances required by industrial installations and power producers in EUETS to be fully purchased (100% auctioning). The argument for this step is claimed to be economic efficiency. Given that there are close to 2 Billion allowances required in the EU each year this implies an annual charge, where none existed before, of some €40 billion annually. It was only through considerable pressure that this disastrous level of new taxation, much of which would have been under the control of the EC, has been progressively deferred to at least 2020 for some and somewhat later for those having ‘Carbon leakage’ status where it was decided after the application of rigorous criteria that they might suffer unduly from such costs or relocate outside the EU. The fact that this taxation would have been passed on in higher prices was freely admitted in the briefing documents associated with the revision of the EC GHG Trading Directive to cover EUETS Phase III. Set in context the full purchase of allowances would have cost the 50 or so remaining Paper Mills in the UK in excess of £100 Million each year. This amount dwarfs current profitability in the industry and is a huge proportion of past profits. It is clearly unaffordable, as it would at first stultify investment in papermaking and eventually cause closures. It is a matter of record that the industry has lost half its installations in the past decade –almost all citing high‐energy costs as the reason for closure.

5. Having established ‘Carbon Leakage’ status in order to be relieved of some of the cost of purchases of allowances, Phase III of EUETS requires the free allocation of allowances to be distributed by a process of benchmarking –a system of central allocation from the EC for each individual EU installation. This involves each industry sector identifying its current products by their industrial codes and the EC then determining the level of emission allocation in the form of allowances/tonne of production across the whole of the EU. This is central control of enormous detail; pruriently delving down into the production details of individual companies and products, which, by the economic effects of benchmark allocation process, amounts to substantial interference in the free Single Market. Officials have justified this process by asserting that it could have been avoided had industry willingly accepted the costs of 100% auctioning. This demonstrates clearly little understanding of the economics of international trade. That this attitude is taken doubtless owes much to the fact that EC and MS see auction revenues as a substantial source of new taxation income.

6. In establishing rules and agreeing the amended Directive, there was a clear intention to deprive electricity generators of windfall benefits from free allocation and to prohibit any allocation for any electricity generation in Phase III. Consequently and illogically the operators of Combined Heat and Power (CHP) plants were also deprived of any allocation of allowances for electricity generated –even if they were in Carbon Leakage status

installations. This decision directly and adversely, affects the economics CHP and discourages further investment. As CHP is the most efficient form of fossil generation, and for which there are UK targets and an EU Directive for the greater deployment of CHP, because they benefit industry and country alike through the overall reduction of emissions, the decision to take this action is incomprehensible. As indeed is the later decision by the UK Coalition Government to further penalise CHP by removing the exemption from Climate Change Levy for qualifying plant as part of the plan for its Carbon Price Support mechanism. CHP forms a minor part of electricity generation and could so easily have been excluded from this blanket ban

7. Given the policy drivers and the undoubted development of EUETS and other low carbon policies, it is important to factor the cost of carbon in the decision making process within companies. However generally experience has shown that electricity generators have benefited mostly from EUETS while industry at large has been disadvantaged. This is principally because of the ability of the large generators to pass through increased costs to all consumers. Thus a decision not to allocate allowances to generators merely allows generators to grow their businesses at the cost to others. This obviously raises again the issue of cost and carbon leakage and whether allowances should be issued freely to all or just some. The debate continues on this issue

8. Undoubtedly there have been strenuous attempts to harmonise and centralise regulation of EUETS in Phase III rather that the more fragmented approach in the earlier Phases. This is a good intention as harmonisation limits the propensity for idiosyncratic or partial interpretation of regulations. Despite this undoubtedly some distortions remain – for instance concessions to Eastern European States who are dependent on coal for power generation. This overall approach has led to increased central regulation rather than reduced or better regulation. It is a matter of record that the EC has been slow in the development of measures and delivery targets for key decisions have been missed ‐ in common with performance in earlier phases. This has led to very tight and, often impracticable, deadlines for comments and hence insufficient involvement of key stakeholders in the proper development of policies and decisions. Member States and officials have appeared powerless to affect this process of poor management.

9. Chief among some of the issues was the development of benchmarks and the associated EC Decision (CIMS). This was protracted and is still hotly disputed by some sectors. Another issue was the important area of the collection of baseline data for the large spectrum of products identified in CIMS and the fall‐back allocation methodology. The UK in 2010 decided to collect these data even though decisions had not be made in the EC nor guidance on interpretation developed. Industry was subject to considerable costs by this exercise. The actual call for baseline data was made in 2011 but still with many areas undecided at EC level. In consequence a further round of baseline data was required involving even greater costs than in 2010. Other MS have only just commenced this process for the first time and all MS will fail to meet the legal deadline set in the revised Directive. This directly relates not to actions by MS because the UK was clearly trying to impress on other MS the importance of timely collection of crucial data, but to the EC processes alone. This does not auger well for the ongoing administration of Phase III. It is a matter of record that the two exercises to collect baseline data cost the small UK Paper Sector in excess of £250,000. One can

therefore only hazard a guess at the overall cost for the 1100 or so UK installations required to supply data.

10. In a final remark on EUETS, it is notable that the EU has unilaterally introduced international aviation into EUETS and has announced plans similarly to include international shipping. Regardless of the merits of including these sectors in EUETS, both are covered by international agreements, which prohibit unilateral actions. Understandably the decision on aviation, which has large cost implications, has now entered the courts and encouraged trade reprisals from affected countries, thus causing huge difficulties for trade in the supply of modern European fuel ‐ efficient aircraft to those countries. Not a particularly bright move! The decision on shipping has been rejected outright by the International Maritime Organisation (IMO)!

Summary Remarks 11. In summary Phase 1 was an introduction of a fine new concept of trading. It was

accompanied by the UK being well ‐ placed to influence its development and administration and the introduction of the Environment Agency (EA) as key player was crucial. The EA acquitted itself well. Phase II was clearly a development of Phase I but with tighter administration and closer control of National Allocation Plans (NAP): in both phases based on historical emission but capped in order to deliver the reduced emission level required and leaving industry to respond in the most cost efficient way. In contrast Phase III was completely new concept with huge changes to administration and operation and the introduction of contentious benchmark processes. It has been nightmarish for industry to follow and has been costly not only in the time required but in the provision of data. At this stage it is difficult to determine whether or not it will be fit for purpose.

Answers to Specific Questions Posed


12. The EUETS will deliver emissions reductions in the EU. But it will do at high cost. It is questionable as to whether the reductions in emissions will have any effect on climate change mitigation given the huge and growing emissions outside the EU.

Can the EU ETS operate effectively in a world without legally‐binding emissions reduction commitments and other cap‐and‐trade schemes? 13. Yes but its actions will only result in emissions reductions in the EU. The economic case for

continuing this course of action should be kept continuously under review.

What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad? 14. The amount determined by the cap and the action of the 1.74% annual tightening process

and any further tightening that is justified by international agreements outside the EU. EUETS will not have a direct effect abroad.


15. EUETS does provide a simple mechanism for interaction with other regions through the use of the Clean Development Mechanism and Joint Implementation projects. However this remains for discussion following the expiry of The Kyoto Protocol. Given the complexity of EUETS there is no obvious form of direct linking with other emissions trading schemes and without coherent linkage, monitoring and verification methods there is little point in this endeavour.


16. It can only do this through quiet diplomacy. Unilaterally bringing forward regulations to include international sectors into EUETS in despite existing international laws that rule this out simply antagonises other nations and will not help. Nor will international grandstanding at the COP meetings be helpful. Unilateral declarations of ever‐higher emission reduction targets are cards that have been played too often and are now counter‐productive – as well as being damaging to our economic interests.


17. Possibly in the EU, but unlikely in a wider free‐market context.

Will the EU ETS be able to access viable alternatives to international credits without the Clean

Development Mechanism? 18. Uncertain it depends on future COP negotiations

Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system? 19. Yes it imposes rules that in some are difficult to understand. For example EUETS in Phase III

allows smaller emitters to opt out. However not content with this simple exclusion EUETS contains conditionality rather than allowing MS simply to include such installations in its own National Implementation Measures (NIMs). Moreover the EC also has views and some executive control over the acceptability of NIMs. This should not have been agreed. Some MS policies could affect the operation of the EUETS for example an aggressive decarbonisation will yield surplus EUETS allowances that will depress the price of allowances. In these circumstances the EC might be tempted to cancel these allowances thereby interfering in the market mechanism. Moreover, the UK is itself planning to interfere with EUETS by the creation of a Carbon Price Support Mechanism. Not only is CPS misguided because in a low EUA price scenario the UK will suffer higher prices when compared to other EU member states. This will impose a further competitive blow to UK

6

industry. As CPS was intended as an indirect support to the nuclear and other low carbon generators it is useful to note that 1p on the wholesale price of electricity sold in the UK will generate £4 billion/year –enough to fund the provision of one new nuclear station every year. Placed transparently on bills (as in earlier years was the fossil fuel levy (FFL) it is hugely simpler than the CPS proposal.

How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? 20. A very serious effect and requires continuing vigilance and tightened security –at the highest

level in some member states!

How can the EU ETS be strengthened to operate effectively in a world without legally binding

emissions reduction obligations? 21. EUETS was operating effectively at Phase II; it is likely to experience difficulties at Phase III

due solely to the ‘strengthening’ carried out. The actions elsewhere in the world do not affect EUETS. The only issue that has to be kept to the fore is the competitive position of EU industry and to ensure that it can continue to operate in the EU without undue penalty of excessive prices.

August 2011

Memorandum submitted by National Grid (ETS 16) Executive Summary 1. National Grid supports the development of clear policies and legislation to tackle climate

change and reduce greenhouse gas emissions. We believe that the monetisation of environmental impacts and the use of cap-and-trade solutions for managing emissions is effective at driving behaviour as long as the costs and benefits are visible to industry and consumers

2. The EU Emissions Trading Scheme (ETS) is a leading scheme and has provided a model

for the consideration of cap-and-trade schemes around the world. Linking national and regional carbon trading schemes across the globe could help provide a global solution to global change. In the absence of binding emissions agreements outside the EU, carbon leakage is a legitimate concern. This should be addressed through how the EU ETS and related carbon pricing schemes, such as the UK carbon floor price, are delivered. The risk of carbon leakage is not, in itself sufficient justification to abandon the scheme.

3. The EU and the UK should continue to show leadership in the drive towards a low carbon

economy. This should include an increase in the EU wide emissions reduction target to 30% by 2020. We are committed to continue working with governments and regulators to help them develop and deliver more effective environmental polices and targets.

Introduction to National Grid 4. This response is provided on behalf of National Grid. National Grid owns and manages

the grids to which many different energy sources are connected. In Britain we run systems that deliver gas and electricity across the entire country. In the North East US, we provide power directly to millions of customers. We hold a vital position at the centre of the energy system. We join everything up.

5. Our purpose is to connect people to the energy they use. We all rely on having energy at

our finger tips: our society is built on it. From the warmth and light we rely on at home, and the power which keeps our factories and offices going, to the mobile communications and other infrastructure technologies that are essential parts of our modern lifestyle.

6. That puts National Grid at the heart of one of the greatest challenges facing our society;

the creation of new sustainable energy solutions for the future and the development of an energy system that can underpin our economic prosperity in the 21st century.

National Grid and the environment 7. Protecting the environment is extremely important to us and is a significant part of our

reputation as a responsible business. 8. Investing in and running safe and reliable electricity and gas infrastructure means we use

energy and raw materials, and produce waste. The effect we have on the environment and the communities we serve depends on how we, together with our supply chain, work. Our goal is to reduce any impact we may have and look for ways to improve the environment.

9. In June 2011 we joined 71 other companies and the WWF in calling on the European

Union to increase the 2020 EU emissions reduction target to 30%, in support of the UK Government’s position on this issue.1 We believe that we must lead the way in tackling climate change and supporting society in reducing the amount of greenhouse gas it releases into the environment. We will do this by helping to change the way energy

1 http://www.wwf.eu/?200650/72-leading-companies-call-for-increase-in-EU-climate-ambition-to-boost-EU-economy-and-jobs

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markets work and by helping our customers use energy responsibly and efficiently. We will make sure we are a sustainable, low carbon business.

10. How we manage the environmental impacts of our business is set out in our Environment

Policy.2 National Grid and the EU Emissions Trading Scheme 11. A diverse range of technologies and fuel sources will be needed to achieve greenhouse

gas emission reduction targets. Incentives are required to deliver the right behaviours. In general we support monetisation of environmental impacts. Marginal Abatement Cost analysis shows that carbon pricing in some form is a necessary component of reducing emissions by 80% compared to 1990 levels. We believe that a key driver towards achieving these targets is a price of carbon that is strong enough, and stable enough, to influence early investment decisions.

12. We support the use of cap-and-trade solutions. They are the best way to provide certainty

on the level of carbon reductions. The EU ETS is a leading scheme and has provided a model for the consideration of cap-and-trade schemes around the world.

13. The allocation mechanism for carbon permits needs careful consideration. Linking

national and regional carbon trading schemes around the world could help provide a global solution to global change. We recognise that in the absence of binding emissions agreements outside of the EU, carbon leakage is a legitimate concern.

14. At present, emissions caused by parties importing goods and services into the EU are

essentially invisible. Defra recently consulted on mandatory reporting of greenhouse gas emissions3. In our response we supported mandatory reporting for scope 1 and 2 emissions and we have recommended the phased introduction of scope 3 reporting. Without this, the effectiveness of UK and EU policies, including the EU ETS, on emissions reductions cannot be truly assessed.

15. The failure to date of international negotiations to introduce similar schemes in most other

areas of the world is not a reason for the EU to reduce its climate change ambition. Current global emissions trajectories do not achieve the emissions reductions required to limit global warming to within 2oC by 2050. This will likely lead to significant social, environmental and economic disruption that could be minimised or avoided by taking appropriate action. Therefore the EU and the UK need to show continued leadership in the drive towards a low carbon economy.

Potential impact of Electricity Market Reform – Carbon leakage between EU member states 16. As part of its Electricity Market Reform programme, the UK Government will be

introducing a carbon price floor from 2013. The aim of this support mechanism should be to deliver a stable floor to the EU ETS price to give investor certainty against a crash in the price of carbon similar to that seen at the end of the first phase of the scheme. This would allow the future price of carbon to be fully accounted for as part of investment decisions. However, we are concerned that the carbon price support mechanism could create an incentive to import electricity to GB, to the extent it creates a price materially above the EU ETS price. This may lead to higher carbon emitting flexible generation plant in the UK closing earlier, whilst similar generation plant in neighbouring member states enjoys a longer operating life.

2 http://www.nationalgrid.com/NR/rdonlyres/760E6B3A-39E5-4BC8-89B8-D12AF37FEAC0/33300/Environmentpolicy20093.pdf 3 http://www.defra.gov.uk/consult/2011/05/11/ghg-emissions/

http://www.nationalgrid.com/corporate/Our+Responsibility/Managing+our+Impacts/Ourpolicies/Policies/summary_environment_policy.htm

http://www.nationalgrid.com/corporate/Our+Responsibility/Managing+our+Impacts/Ourpolicies/Policies/summary_environment_policy.htm

http://www.nationalgrid.com/NR/rdonlyres/760E6B3A-39E5-4BC8-89B8-D12AF37FEAC0/33300/Environmentpolicy20093.pdf

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http://www.defra.gov.uk/consult/2011/05/11/ghg-emissions/

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17. Such flexible generation plant is important in the short-term, for security of supply, until

lower carbon emitting generation investment can be made to replace this plant. Whilst it is desirable for investors to have the certainty which the carbon price support mechanism would provide, it should not be set substantially above the EU ETS price level in order to avoid “exporting” carbon emissions. Electricity is readily transportable and, subject to system constraints, can be traded between GB and mainland Europe on essentially an instantaneous basis based on spot market prices. This makes electricity generation even more susceptible to carbon leakage than other sectors, such as goods manufacture, which may be more restricted by difficulties associated with relocation of production.

18. Taxation rates are always subject to uncertainty and change and, as such, cross party

support for a carbon floor price support mechanism may deliver some investor certainty if delivered through the tax system. However, we feel that there should be a continued push to reform the EU ETS such that it can provide a stable, and predictable price at an appropriate level, thereby making a UK-only carbon price support mechanism redundant.

19. It is important to note that the decarbonisation of UK generation is not about the amount

of higher carbon capacity generation in existence, but about how much of it is used. As more low carbon, low marginal cost plant is built, supported by Feed in Tariffs, the resulting wholesale spot prices will reduce the utilisation of higher carbon generation plant. The optimal result is decarbonisation with security of supply, in that more low carbon plant is built but that flexible higher carbon plant stays available to generate at progressively lower levels of utilisation.

August 2011

Memorandum submitted by E.ON (ETS 17)

Summary of key points

1. As one of the world's largest investor‐owned power and gas companies E.ON is strongly committed to reducing its carbon dioxide emissions. In 2010 E.ON reduced its CO2 intensity to 0.39tCO2/MWh in Europe.

2. The EU Emissions Trading System (EU ETS) plays a key role in climate change mitigation in the EU. By placing a price on CO2 emissions in high emitting sectors it provides investment signals which will help the EU achieve its greenhouse gas (GHG) reduction goals.

3. The effectiveness of the EU ETS relies on investors’ confidence in the political will that underpins the scheme. Short‐term adjustments to the cap or policies (national or EU wide) that undermine the carbon price signal will damage confidence so should be avoided.

4. Member States which introduce policy measures to deliver sharper domestic CO2 emission reductions need to be conscious of the effect this will have on other countries within the EU where there is no comparable domestic action and where the EU ETS is the only policy driver. In these countries low carbon investments will not be incentivised as strongly, resulting in a two‐speed EU from a climate change perspective.

5. Long term signals are crucial for investors. Although the EU ETS Directive allows for a continuing linear reduction in the cap beyond 2020, without the support of legally binding, long‐term, EU wide GHG targets, investors’ confidence in the EU ETS and associated carbon price beyond 2020 will be weak which could result in lower prices and therefore reduced low carbon incentives. Without an international legally binding agreement, any EU policy aimed at reducing GHG emissions will suffer from uncertainty due to increased political risk. The EU ETS should be supported by a long term EU commitment to an overall CO2 emissions reduction target within the framework of an international agreement.

6. The EU and UK should promote the development of a global GHG trading scheme and further regional GHG trading schemes until this appears. It should seek to link the EU ETS to other regional GHG trading schemes ensuring they are compatible, have robust monitoring, reporting and verification mechanisms and ensuring disruption to the EU ETS is minimised.

7. The EU ETS can only reduce emissions in the sectors it covers. Non‐traded sectors of the EU economy also need to contribute to the EU’s GHG reduction goals.

The Committee’s specific questions are addressed below.

Q1. Does the EU ETS remain a viable instrument for climate change mitigation in the EU?

8. The EU ETS remains a key instrument in the EU by placing a price on CO2 emissions for the sectors it covers. This is crucial to provide investment signals for low‐carbon technology which will help the EU achieve its greenhouse gas (GHG) reduction goals.

9. The cap‐and‐trade elements of the EU ETS give it integrity as the cap ensures that the level of emissions reductions set will be achieved whilst the market based nature of the scheme gives incentives for investment in the lowest cost abatement methods. An EU‐wide carbon tax would not be able to guarantee any fixed future emissions limit.

10. To provide robust investment signals, investors need confidence in the carbon price which must be reasonably stable and predictable. Investments have been made based on the agreed approach for Phase III of the scheme; new EU policy interventions that directly affect the market price (such as elements of the proposed Energy Efficiency Directive and any potential set‐aside of allowances) could undermine investors’ confidence and should be avoided. National policies (such as the UK’s carbon price floor and emissions performance standard which we discuss in Q8) could interfere with the carbon price signal provided by the EU ETS

1. The damage this could do to confidence is not limited to this phase of the scheme, political interference will increase the political risk investors associate with future phases and will weaken the carbon price investment signal.

11. Member States which introduce policy measures to deliver sharper domestic CO2 emission reductions need to be conscious of the effect this will have on other countries within the EU where there is no comparable domestic action and where the EU ETS is the only policy driver. In these countries low carbon investments will not be incentivised as strongly, resulting in a two‐speed EU from a climate change perspective.

12. To remain viable the EU ETS needs to reflect long‐term GHG reduction targets. Given the long development/build times and long payback periods often associated with new low carbon generation investments, longer‐term investment signals to 2030 and preferably beyond are needed now. Although the Directive does allow for reductions in the cap beyond 2020 through the annual decrease of 1.74%, without the support of firm, legally binding EU wide GHG targets beyond 2020, investors’ confidence in the EU ETS and associated carbon price will be weak. To remain effective and robust, and to minimise political risk these targets should be supported by a global legally binding agreement on GHG emissions reductions.

13. Harmonised action across the EU is crucial to ensure emissions reductions occur at lowest cost and to minimise the impact of carbon leakage. We recognise that individual Member States such as the UK may have specific climate change targets and investment needs but domestic policies should as far as possible be consistent and compatible with the EU ETS, and should aim to not undermine the price signals it gives.

14. The EU ETS can only be a viable instrument for the sectors it covers. Emissions from the non‐traded sector still account for around 60%2 of the EU’s total CO2 emissions. In order to achieve the EU’s climate change mitigation goals, action in the non‐traded sector is crucial as these sectors do not have targets beyond 2020. Whilst expansion of the scope of EU ETS to include

1 The carbon floor price will increase carbon prices in the UK but reduce them (albeit modestly) elsewhere in the EU ETS, reducing incentives for low carbon investment in countries where it may be more economic to deliver it.

2 http://ec.europa.eu/clima/policies/ets/index_en.htm

http://ec.europa.eu/clima/policies/ets/index_en.htm

other sectors could be a viable option to achieve this, any impact on the existing scheme and the carbon price signal would need to be very carefully managed.

Q2. Can the EU ETS operate effectively in a world without legally‐binding emissions reduction commitments and other cap‐and‐trade schemes?

15. The EU ETS has in fact already been operating since 2005 in a world where large emitting countries have not ratified any legally binding international commitments and where there are few domestic cap‐and‐trade schemes and none on the multinational scale of the EU ETS.

16. Global legally binding commitments will undoubtedly increase the effectiveness of the EU ETS by reducing political risk (as investors will have more confidence in the EU’s desire to reduce emissions), reducing the impact of carbon leakage and enabling the EU to adopt a tighter reduction target without damaging the international competitiveness of its economy. However, the scope and liquidity of the EU ETS are sufficient to enable it to function efficiently without the support of a global agreement or other cap‐and‐trade schemes. It is still an effective means of meeting the EU’s own GHG reduction goals in a cost‐effective manner.

17. The absence of a global binding agreement does limit the credibility of longer term targets for the EU ETS as investors may doubt the EU’s long term political will or expect future changes to the EU’s ambition as international negotiations progress (or, perhaps more relevantly, if they do not progress). We believe longer‐term targets for the EU are crucial, even without the added certainty a global agreement would bring.

18. GHG emissions in the EU account for around 15%3 of global emissions. In order to limit global temperature rise to 2°C, a target recognised by the UNFCCC COP16 in Cancun4, the EU ETS can be a useful role model for a multi‐national carbon market but ultimately global action is necessary to achieve the 2°C goal.

Q3. What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad?

19. The EU ETS cap and linear reduction factor as proposed will result in a 21% reduction in GHG emissions for the traded sector by 2020 (compared to 2005). This is consistent with the EU’s overall 20% GHG reduction target for 2020 (vs. 1990 levels). The EU ETS Directive allows for review and potential amendment of the scheme, including the cap, following the approval by the Community of an international agreement on climate change which would increase the EU’s overall GHG reduction ambition to 30% by 2020 (vs. to 1990).

20. The Directive allows for the use of international project credits (through the CDM for example) for up to 50% of the total reduction below 2005 levels for current EU ETS sectors between 2008 and 2020. This implies a potential of up to 1.6billion tCO2eabatement abroad over the period 2008‐20205.

3 http://unfccc.int/ghg_data/ghg_data_unfccc/items/4146.php

4 http://unfccc.int/resource/docs/2010/cop16/eng/07a01.pdf#page=2

5 http://ec.europa.eu/clima/faq/ets/index_en.htm

http://unfccc.int/ghg_data/ghg_data_unfccc/items/4146.php

http://unfccc.int/resource/docs/2010/cop16/eng/07a01.pdf#page=2

http://ec.europa.eu/clima/faq/ets/index_en.htm

21. It is in the nature of a cap‐and‐trade scheme that it will deliver to the cap. Emissions reductions beyond those implied by the cap are unlikely.

22. A robust carbon price in Phase III may encourage investment in new technology and new processes. This could reduce the cost of future abatement by driving early investment in low carbon technology and future economies of scale which could result in additional emissions reductions beyond Phase III.

23. As discussed in Q4 below, linkage to other schemes internationally could encourage least cost abatement through a wider scope of industries and locations. Internationally, the EU ETS should be a role model for future cap‐and‐trade schemes, reducing the time needed for design and implementation phases of new schemes. These benefits will help to achieve maximum emissions reductions at lowest cost to society globally.

Q4. Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved?

24. In the absence of a global trading scheme supported by legally binding global emissions reduction targets, encouraging the development of other cap‐and‐trade schemes could increase emissions reductions globally. Linking such schemes with the EU ETS would increase liquidity and offer a greater opportunity for emissions reductions at lowest cost. This would ensure the EU ETS itself is more efficient and effective, with more certainty for investors as the carbon price becomes more robust. Linkage could also reduce the impact of carbon leakage as carbon prices could equalise between the linked schemes.

25. The current use of international offsets in the EU ETS represents an indirect form of linking which has encouraged lower cost abatement for companies in the EU ETS. In the absence of a global binding agreement, these bilateral agreements could gradually be expanded, creating a more international carbon market without harming the overall integrity of the EU ETS.

26. Linkage to other schemes could result in compromises to ensure compatibility. It is important that the integrity and stability of the EU ETS are not impacted by such a compromise. Any linkage to other schemes would need to be managed very carefully to avoid disruption of the existing market and investment signals. The EU ETS should only link to schemes with robust and comparable monitoring, reporting and verification systems, and comparable levels of ambition in terms of CO2 reduction to ensure confidence and price stability in all linked schemes.

Q5. What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally?

27. The EU should clearly demonstrate the benefits that the EU ETS has brought to the EU, both in terms of emissions reductions and development of new technologies and new industries. Progress towards targets should be published clearly and simply so international observers can clearly see the impacts. Policy makers need to signal the continued support of, and confidence in the EU ETS as the main vehicle to achieve emissions reductions in the EU.

28. It is important to recognise honestly the pitfalls and lessons learnt. The EU ETS should not be cited as a perfect example of how a carbon market should operate. Instead, it should be promoted as a role model with many insights learned from successes and failures in earlier phases. These insights can help to reduce the development and implementation time for new schemes.

29. Progress is already being made on linking with Californian, Chinese and South Korean schemes6. Encouraging the development of other compatible schemes (such as Australia’s scheme which includes a cap‐and‐trade element from 2015) and linking to them should continue to be an aim for the EU in the absence of a global binding agreement and associated global carbon market.

30. Monitoring, reporting and verification are crucial elements of any compatible scheme. The EU and UK should focus on promoting these elements of international schemes.

Q6. Could sectoral agreements form part of the future of the EU ETS?

31. Sectoral agreements and sectoral crediting mechanisms could be important to the EU ETS in future by widening the scope of the scheme (which increases liquidity, creating a more efficient market and a more robust carbon price signal) and by reducing the impact of international carbon leakage on EU ETS sectors.

32. There needs to be clarity over how sectoral agreements could be defined in relation to, and be consistent with a global binding agreement. We believe sectoral approaches which encourage emissions reductions across different sectors and countries as part of a global carbon market should be explored.

33. Any sectoral agreement or sectoral crediting mechanism linked to the EU ETS must be compatible and must have robust monitoring, reporting and verification mechanisms.

34. As we have seen in the aviation and maritime transport sectors, negotiating sectoral agreements at a global level can be extremely challenging. Any sectoral agreement resulting in exemptions for EU ETS sectors must have comparable emissions reduction ambitions.

Q7. Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism?

35. The CDM has been a very effective and fair method of reducing GHG emissions globally so should be supported and strengthened. The scope of the CDM should be extended to include cost‐effective and efficient emissions reduction measures such as carbon capture and storage, technology restrictions should be removed. Rules on additionality need to be redefined and project approval and credit issuance processes need to be redesigned to become more streamlined while maintaining integrity. The EU’s approach to EU ETS crediting for the CDM or any replacement mechanism should be long‐term and stable, giving investors in projects that qualify for such credits more certainty.

6 http://www.argusmedia.com/pages/NewsBody.aspx?id=760626&menu=yes

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36. The CDM provides an important source of supply of credits in the EU ETS and encourages least cost emissions reductions at a global level so its principles should be maintained. In the absence of the CDM the EU could pursue bilateral agreements with developing countries to ensure these benefits are not lost.

37. The success of any alternative bilateral agreement or new mechanism relies on robust monitoring, reporting and verification of emissions. Any international credit should only be given in return for a genuine and appropriate reduction in emissions. This is most easily managed at a global level and will be a key challenge if the EU pursues alternatives in the absence of a global agreement.

38. International crediting does rely on the success of global negotiations. If the CDM does not exist after 2012 any alternative would rely on a global commitment to reduce emissions in some form.

Q8. Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system?

39. E.ON supports a harmonised EU approach to delivering climate change objectives, consistent with the operation of the EU internal energy market, and national interventions should be avoided wherever possible. However, as outlined above, we recognise that intervention by individual Member States may be necessary where Member States have specific investment needs (such as the UK). Where this is the case, national policies should aim to be consistent with EU policies, particularly the EU ETS.

40. Any potential unilateral action should complement and be designed to work alongside the EU ETS and should not undermine it.

41. The UK’s carbon price floor and proposed emissions performance standard (depending on the level at which it is set) will distort the operation of the EU ETS and trade between Member States. Given that total EU ETS emissions are capped, reductions from UK generating plants covered by the EU ETS as a result of these policies will be offset by higher emissions elsewhere in the EU. The principle of least cost abatement that the EU ETS encourages within the EU will be damaged.

Q9. How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required?

42. The incidents of fraud over recent years have affected the confidence of operators and other market participants in the EU ETS. Although these experiences harmed the reputation of the EU ETS, we do not anticipate any long term impact on confidence.

43. The experiences demonstrated the need for improvements which the Commission is pursuing. Member States and the EU Commission need to remain vigilant and pro active in preventing fraud.

Q10. How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations?

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44. The key risk to the EU ETS is investors’ confidence in the political will that drives it. Global legally binding emissions reduction obligations are crucial in improving this so should continue to be a priority for the EU and for the UK.

45. The EU’s long term vision for GHG emissions reductions needs to be defined further and reflected in longer term targets for the EU ETS. Although this is challenging in the absence of a global agreement, it is vital for long term confidence in the scheme.

46. Certainty and stability of the scheme are vital. Short term measures that interfere with the emissions cap already agreed (such as a potential set aside of allowances) must be avoided as these will increase concerns about the risk of political intervention which could undermine confidence and damage long‐term investment.

47. Benefits of the EU ETS should be clearly demonstrated, including those in addition to emissions reductions. The EU needs to demonstrate that decarbonisation can occur without damaging the EU economy.

48. Encouraging bilateral or sectoral agreements that can be linked to the EU ETS will help strengthen it. This will be challenging without global consensus.

August 2011

Memorandum submitted by the International Biochar Initiative (ETS 18)

1. This submission is made on behalf of the International Biochar Initiative (IBI). The aim of the IBI is to promote knowledge and understanding of the potential role biochar technology might play in reducing the increase in atmospheric greenhouse gas (GHG) concentrations. The IBI operates internationally but is registered as a charity in the State of Virginia.

2. We believe we can most usefully contribute to the second part of the work of the Enquiry. This submission is to draw the possibilities of biochar to the attention of the Committee and to indicate how an expanded scope for the EU Trading Scheme can reduce net emissions of GHG.

3. The Appendix contains an extended summary of the way in which the natural growth of plants can be employed to reduce atmospheric carbon dioxide concentrations. In brief, growing plants withdraw carbon dioxide from the atmosphere by the process of photosynthesis. The quantity of carbon dioxide so removed each year is presently about 7.5 times greater than the net annual emissions from human activity. Nearly all the plant material formed is degraded by animals, microbes and funghi, with the return of the carbon dioxide to the atmosphere, so that this natural carbon cycle presently absorbs only a small part of human emissions. However, the balance of the natural cycle can be tilted slightly to increase the permanent fixation of carbon dioxide, by intervening in the processes that oxidise some of the dead plant material.

This intervention (chemical transformation of some plant material by the action of heat, called pyrolysis) could be applied to the agricultural residues (eg rice husks, nut and coconut shells, some cereal straw, sugarcane bagasse, corn stover) that are presently not used, or used inefficiently. Even if confined to this subset of plant materials, the process could increase net withdrawal of atmospheric carbon dioxide by plant growth, by about 3.7 billion (3,700,000,000) tonnes annually, this representing about 1/8 th of current anthropogenic emissions1.

4. We stress that our proposal is restricted to the process of transforming existing agricultural by-products (such as rice husks) by pyrolysis to produce a char that is resistant to biological oxidation.

5. Forestation and re-aforestation are complementary ways of using natural processes to withdraw carbon dioxide from the atmosphere but are not discussed in this submission.

6. Pyrolysis of agricultural wastes can be seen as a method of post-emission carbon capture and storage. The unit ‘product’ would take the form of a tonne of carbon, incorporated into stable char, that represented the

1 Woolf and Amonette, 2010

withdrawal and permanent2 fixation of a quantity of carbon dioxide from the atmosphere. Since the important issue in climate forcing is the balance between the rate of emission of carbon dioxide from all sources, and the rate of removal to all sinks, natural or engineered, it is valid to regard this technology as a form of carbon capture and storage and to link it notionally to emissions from fossil fuel combustion. We shall describe this product as a ‘char-carbon-capture-and-sequestration’ unit (char-CCS).

7. In this submission we argue that a revised EU Emissions Trading Scheme should recognise char-CCS units as tradable entities that could be bought freely by businesses that needed to acquire carbon credits. We recognise that the EU-ETS has hitherto been concerned principally with carbon dioxide emissions. However, char-CCS units representing the capture and storage of 1 tonne of carbon in stable solid form are easily linked to units representing carbon dioxide gas. One tonne of elemental carbon is the equivalent of 3.67 tonnes of carbon dioxide simply by virtue of the ratio of molecular weights.

8. There is no case to restrict the international trade in char-CCS units. The greatest benefit in net emission reductions will be realised if agricultural producers anywhere in the world are free to sell their char-CCS units to any willing buyer wherever the need arises. As such, we believe char-CCS units may also have a place in sectoral mitigation strategies, within the agricultural sector.

9. These char-CCS units could meet the needs of those businesses that are required to acquire additional carbon credits in consequence of cap-and trade regulations imposed by any authority to which they are subject.

10. The char-CCS units cannot be dismissed as a license to continue ‘business-as-usual’. A company that emits an excess of carbon dioxide, and that consequently bought char-CCS units, both entirely nullifies its excess emissions and incurs a cost that provides an incentive to minimise its emissions.

11. Regulators might choose to force emitters to nullify all their emissions, or some specified proportion, by purchasing char-CCS units (or equivalents that might be generated by appropriately-managed forests or other storage schemes). We can consider aviation as an example. The aviation industry has made, and may continue to make, reductions in its emissions of carbon dioxide per passenger-mile. A limit to such reductions will be reached quite quickly, though, so that total emissions will continue to grow unless the cap is so tight as to halt further development of the aviation industry. That might be economically undesirable and politically unachievable. Alternatively, regulators might stipulate that the industry should become rigorously carbon-neutral by demanding that any sale of aviation fuel be exactly matched by the purchase of equivalent post-

2 True biochar has a mean residence time in soils of hundreds to thousands of years; it is a stable, carbon-rich product that is resistant to degradation, but which confers beneficial properties and impacts on soils.

emission capture and storage units, such as the proposed char-CCS units. These units should represent carbon captured and stored prior to the sale of the fuel, or to be captured within a short period of the sale.

12. The estimated scale of the potential for char-CCS units is comparable to total current usage of fossil hydrocarbons as liquid transport fuels.

13. It would take a little while to complete research on the methods of production, stability and usage of char-CCS units and of the competing technologies that would create a competitive market. Nevertheless we anticipate that gaining access to formal markets would stimulate development of the industry. At present char-CCS units are sold in small numbers into the voluntary carbon market, where they attract attention because they can be seen as a premium product within the markets for carbon offsets.

14. In the short term, admission of char-CCS units to official markets would be likely to generate a net flow of part of the proceeds from rich countries (with high-carbon-intensity industries and dense transport networks, but relatively small land areas) to the major developing countries whose agricultural producers farm large areas, often on a small-scale basis, with the benefit of abundant sunshine. The char so produced can be used to ameliorate soil properties in these countries, boosting agricultural productivity. This is outlined in the appendix. Farmers in all countries should be free to enter the market.

Appendix: The carbon cycle and the rationale for char technology

15. Figures presented in the reports of the IPCCC show the broad features of the flow of carbon between the atmosphere, land, vegetation and seas. These figures are presented in terms of the mass of carbon (rather than carbon dioxide) in the flows. (A molecule of carbon dioxide has a mass 3.67 times that of the single atom of carbon that it contains). The atmosphere contains some 750 Gt. (giga-tonnes, or billion tonnes; 1 Gt.= 1,000,000,000 tonnes). Human activities currently add about 8 Gt. annually. Photosynthetic plants withdraw 60 Gt. of carbon from the atmosphere each year, but about 59 Gt. returns to the atmosphere each year. The plant structures built by photosynthesis are degraded and metabolised by organisms that consume plant materials and respire carbon dioxide.

16. It follows that a small shift in the balance between photosynthetic withdrawal (60Gt.) and re-oxidation (59Gt.) would have a significant impact on the much smaller flows (8 Gt) from human activities, including agriculture and fossil fuel combustion.

17. A high proportion of the oxidation of plant materials is performed by micro-organisms (bacteria and funghi) that degrade dead and dying plant residues. These organisms employ enzymes that have evolved over

millions of years to metabolise the major structural polymers of plants, including cellulose, hemi-cellulose and lignin.

18. If plant remains are subjected to pyrolysis – a family of processes in which the material is heated, typically into the range 400 to 800°C, in the absence of air – the chemical structures are altered so as to render the pyrolysed plant remains highly resistant to degradation by micro-organisms.

19. Charcoal is a familiar example of pyrolysed plant material. It is prepared by heating wood without air, or with very little air. Charcoal is generally prepared for subsequent use as a fuel, by procedures that are often environmentally damaging, and is not what we have in mind for a biochar technology.

20. Rather, we foresee the development of activities at various scales to pyrolyse low-value feedstocks to produce char, with electricity and heat as possible co-products. In principle well-designed equipment could release around 50% of the energy content of the plant material while converting 50% of the carbon atoms into a char that would be highly resistant to biotic and abiotic oxidation for 500 years or more.

21. Many agricultures activities produce residues that are either not used completely or efficiently, or not used at all, being burnt for disposal or simply left to be degraded by rotting organisms. These include the husks of rice and other cereals; cereal crop straw; sugar cane bagasse; corn stover; forest and vineyard trimmings and residues. In estimating the total potential resource it is important to allow for existing uses that may be important in e.g. animal husbandry (straw for cattle) or that preserve beneficial properties in soils (mulches, composts, manures). After making these allowances, it is estimated that the remaining unused or underused agricultural residues would suffice to make of the order of 1 Gt. of char annually.

Char can also be made from sewage sludge and the organic fractions of municipal and construction waste.

22. The chars so produced therefore represent a method of withdrawing carbon from the atmosphere by plant photosynthesis, then extracting some of the stored energy while transforming the residue into stable high-carbon char and so delaying or eliminating the return of the carbon to the atmosphere. The term biochar was coined to denote those chars whose purity and properties make them suitable for incorporation into agricultural soils (elaborated below). Chars made from sorted municipal wastes may also be suitable provided careful testing for recalcitrant contaminants (e.g. heavy metals from the odd dry-cell battery) shows them to be sufficiently pure. Otherwise such chars could be stored in disused mines, or in landfill, or perhaps incorporated into construction materials.

23. In summary therefore a fully-develped char industry could remove and store permanently and safely, of the order of 1 Gt. of carbon from the

atmosphere each year, thereby neutralising about 1/8th of current human emissions of greenhouse gases.

24. Biochar can be incorporated into arable land with beneficial effects on soil structure and on the ability of the soils to retain water and nutrients. These effects are particularly marked in the poor soils of the tropical and sub-tropical soils of the major continents – Africa, India, South America and China. Over large areas the soils are very low in clay minerals (a consequence of high elution by rainfall) and of humic substances, because the prevailing high temperatures may promote oxidation of soil organic matter before it has time to undergo the complex sequence of reactions that form humus. Clay and humus in soils confer their ability to retain nutrients.

Very significant improvements in agricultural yields have been obtained in trials in tropical and arid soils amended with biochar. We anticipate that as understanding of how to make a biochar suited to a particular soil improves, so the potential for agricultural benefits will be realised.

25. An ability to sell a char-CCS unit into carbon markets will provide a useful addition to the business case for char production enterprises. The char produced for such units would need to be checked for its carbon content and tested to establish that an identifiable fraction (maybe 90%) would persist for 500 years or more. Only the resistant carbon content of the char could be counted towards the char-CCS. Secure storage or incorporation into agricultural soils would need to be verified. These techniques will be incorporated into formal protocols, one of which is currently under development for the Alberta Trading System.

26. Biochar units can be produced wherever there is growing vegetation. We stress that the IBI will not support the accreditation of any scheme that cut down existing forests solely for the purpose of making biochar. A biochar industry would pose far less risk to native forests than does the existing uncontrolled production of charcoal in some countries, partly because the value of the biochar units would be relatively low.

27. Some critics have argued that allowing biochar units to be traded in any market opens the way to an industry, dominated in their anxieties by large companies, that would buy up or otherwise expropriate large areas of agricultural or underdeveloped land in developing countries in order to establish plantations to produce biomass for charring, so as to profit from the sale of biochar units.

Historic, present and foreseeable prices for carbon dioxide in the exchanges render these arguments untenable. It will not be economically viable to produce biochar from purpose-grown crops purely for the value that might be realised from the sale of the char-CCS units. The feedstock for char production will have to be essentially free (e.g. rice husks flowing from the grain preparation mill) or be of ‘negative value’, such as waste streams whose originators have to pay someone to dispose of them. The manufacturing cost, of transforming biomass into char, ensures that prices

for the biomass feedstock that were remotely comparable to the value of agriculture for food production, could not be supported by the value of the char-CCS units alone.

August 2011

Memorandum submitted by SSE (ETS 19)

0.1. SSE welcomes the opportunity to respond to the Committee’s inquiry into the EU Emissions Trading Scheme and provides comments on the Committee’s questions below.

0.2. It is crucial that Europe’s early lead in using market based instruments to tackle the complex challenges of climate change is maximised through a renewed commitment to update the trading scheme to reflect current emission levels and achieve consistency with related policy programmes for energy efficiency and renewable energy.

0.3. A strong EU ETS puts European businesses on a pathway to a more energy efficient future and secures competitive advantage in new low carbon technologies. EU member states should ensure the scheme remains a leading policy instrument to reduce GHG emissions by modest scheme reforms. There remains merit and integrity in acting unilaterally. However, beyond these factors, the EU ETS will be enhanced by efforts to link to new emissions trading schemes, and to projects under the CDM or its successor. It makes an important contribution to building confidence and securing international agreement on specific concrete actions and commitments to address the challenges of climate change.

0.4. As the Committee will be aware, SSE is the largest generator of renewable energy in the UK and is committed to a low carbon economy. It has committed to reducing by 50% the carbon dioxide intensity of electricity produced at power stations in which it has an ownership or contractual interest, over the period from 2005/06, the first full year after acquiring coal-fired power stations, to 2020.

0.5. SSE is in favour of a more ambitious binding European target having recently published a joint statement alongside 5 other European utilities calling for a 25% rather than 20% reduction in GHG emissions by 2020.1 SSE has supported going beyond 25% by signing The Climate Group’s joint declaration which calls for a 30% target.2 There needs to be a clear long term goal, and a high enough carbon price, to drive investment in low carbon electricity generation as this sector is key to achieving long term emissions reduction targets to 2050 and beyond.


1.1. SSE believes that the EU ETS is a vital policy instrument for carbon mitigation and facilitates the most appropriate framework to address a truly international issue such as climate change. A market based approach is the most cost effective way of ensuring a volume reduction in carbon emissions, rather than a simple tax on carbon.

1.2. As the Committee is aware, there have been some serious issues during phases I and II, including over allocation of permits and fraud. However, it must be conceded that it is unsurprising that such an innovative scheme has encountered challenges in the early phases of its implementation. Providing these issues can be overcome there is no reason the EU ETS cannot be successful in providing a clear carbon price signal and delivering real reductions in carbon emissions across Europe and beyond.

2. Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes?

2.1. The EU ETS operates as an autonomous scheme independent of quantified legally binding targets derived from the UN’s Framework Convention on Climate Change (UNFCCC). The Convention (and subsequent agreements reached by the states bound by the Framework) contains obligations of a more general nature to reduce emissions and the EU ETS is evidence of the EU member states taking action to 1 SSE (2011) European Energy Industry CEOs call on EU to adopt a 25% greenhouse gas emissions reduction target by 2020 http://www.sse.com/uploadedFiles/Controls/Lists/News_And_Press_Releases/Press_releases/2011/JointDeclarationOnEU_EmissionsTarget.pdf 2 The Climate Group (2011) EU 30% initiative http://www.theclimategroup.org/EU-30-per-cent-initiative

http://www.sse.com/uploadedFiles/Controls/Lists/News_And_Press_Releases/Press_releases/2011/JointDeclarationOnEU_EmissionsTarget.pdf

http://www.sse.com/uploadedFiles/Controls/Lists/News_And_Press_Releases/Press_releases/2011/JointDeclarationOnEU_EmissionsTarget.pdf

http://www.theclimategroup.org/EU-30-per-cent-initiative

meet these obligations. By pursuing meaningful emissions abatement, the EU member states demonstrate leadership and effort which underpins confidence in the diplomatic effort to reach the next international agreement to curb emissions.

2.2. Within the EU ETS there exist legally binding domestic emission reduction obligations among participants, which highlights that there is no inconsistency between domestic obligations and participation in a multinational trading scheme.

3. What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad?

3.1. The reduction in emissions in Phase III of the EU ETS will depend on a large number of factors, not least the performance of the EU economy; as such it is not possible to say what reduction will be achieved with any certainty. Although Phase III is likely to reduce emissions substantially, the reduction may well be less than initially envisaged as a consequence of the recession that occurred during Phase II.

3.2. To deliver the reductions that are required and to use the scheme most effectively, the EU ETS needs to be strengthened and issues resolved before phase III starts in 2013. The EU ETS can deliver meaningful abatement and the cap should be tightened to achieve this.

4. Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved?

4.1. The key to economic and environmentally efficiency is the robustness of the schemes to which the EU ETS may link. These difficulties should not be used as an excuse to undermine efforts to link schemes. International cooperation of this nature is indispensable to develop effective responses to the challenges of decarbonisation.

4.2. The EU ETS is designed to link to other schemes once those emerge and SSE is supportive of efforts to link the EU ETS with other schemes across the world but realistically it will be difficult to achieve given the differing levels of maturity and scope of other schemes. The pace of policy development varies from time to time, but there is notable effort to develop schemes at the national and sub-national level in various states. Once robust schemes are launched, abatement costs are expected to reduce for market participants and technology transfer will be stimulated.

4.3. A major challenge to linking systems will be in managing different prices of carbon around the world, and different levels of ambition. This is unlikely to be easily achieved where countries are at different stages of economic development or economies are locked in to high carbon technologies. This reinforces the need for clear long term signals to industry and investors, and also suggests that carbon intensive industries may require international sector wide standards.

5. What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally?

5.1. The UK Government’s commitment to be “the greenest government” should lead the Government to take a forefront position in EU discussions and in its international activities to encourage greater ambition in greenhouse gas emission reductions including through the EU ETS development.

5.2. Both the UK government and the EU should aim to achieve meaningful progress at the next meeting under the UN Framework Convention in Durban later this year. Solidarity of purpose and ambition among EU member states and commitment to optimising Phase III of the EU ETS are important factors in maintaining effort among states to move towards quantified legally binding reduction commitments.

5.3. Assisting other nations and regions to develop emission trading schemes to improve carbon price signals through ETS development would have significant benefits to addressing international climate change, reducing abatement costs and enabling technology diffusion. In addition, there has been important progress in relating policy areas such as deforestation/afforestation which should continue to be supported and may form an important part of the global carbon markets.

6. Could sectoral agreements form part of the future of the EU ETS?

6.1. Appropriately structured sectoral agreements could form a useful element of the EU ETS and address claims of carbon leakage in certain industries, and development of such agreements should be encouraged. The potential contribution of such agreements was researched as part of the Lazarowicz report which also usefully explores the transition of sectors through sectoral crediting.3

7. Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism?

7.1. It seems likely viable alternatives will emerge and/or agreement will be reached on some form of transition for the CDM at the end of the first period under the Kyoto Protocol. A transition for the CDM would preserve the institutional learning gained to date, underpin confidence in the voluntary carbon markets and reduce uncertainty among several streams of project development. The vital issues in either case relate to project quality, compliance, accounting, additionality and so forth which have been well examined in the context of the CDM.

8. Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system?

8.1. No, the EU ETS is not a constraint on a member state creating its own complementary policy programme which is evident to SSE from operating within the comprehensive climate change programme established at the UK and Scottish levels.

8.2. The introduction of different carbon price regimes by member states in the EU ETS, such as the UK’s Carbon Price Support mechanism will have an impact on the operation of the EU ETS, but it is unclear as to the scale of price differentials (and a range of other factors will trigger change in EU ETS carbon prices) and the arbitrage opportunities which may occur. At worst, emissions may be transferred to other member states netting off reductions in UK emissions.

8.3. The EU ETS should remain the primary driver in emissions reduction. However it is likely that countries may want to impose schemes to underpin the EU ETS for example taxation, subsidies and regulation to support the research, development and deployment of new technologies. Individual states should use the policy tools that are most appropriate for their own specific circumstances, as noted in Mark Lazarowicz MP’s report into the EU ETS.3

9. How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required?

9.1. Relative to the size of the market, the recent fraud has been small scale and has therefore not fundamentally damaged the market, but it must be noted that it has undermined confidence in the short term. Improvements to security and auditing are important, especially where fraud has been a result of poor IT security. If the EU ETS is to provide a clear and credible carbon price signal and remain a dominant global driver for emissions reduction then it requires commitment by member states to an ongoing programme of monitoring and improvements to protect against fraud.

10. How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations?

10.1. As mentioned above, the EU ETS can exist as an autonomous mechanism scheme independent of quantified legally binding reduction targets. The trading scheme will be enhanced by efforts to link to new trading schemes elsewhere, to new sectoral schemes, and to projects under the CDM or its successor. However, to strengthen the EU ETS, the EU should give an early indication of willingness to reduce the

3 Mark Lazarowicz MP (2009) ‘Global Carbon Trading: A framework for reducing emissions’

number of allowances in Phase III and reconcile the scheme with energy efficiency policy. While this decision should be leveraged in return for robust action in other developed and developing nations, if necessary, the EU should press ahead unilaterally for the reasons of diplomatic effort, competitive advantage and long term investment cycles. The EU ETS can deliver meaningful carbon abatement and the cap should be tightened to achieve this.

August 2011

Memorandum submitted by Lichen Renewal (ETS 20)

1. Executive summary

Report positioning statement:

In response to the Commons DECC Select Committee consultation, Lichen Renewal here provides its insight into the function of the EU ETS and its potential for significant improvements. The focus of this paper is to illustrate how enhancements to the EU ETS are to be seen both in its operation and ability to deliver deeper GHG reductions while encouraging climate change mitigation projects in the UK, with wider social and economic benefits.

Former uncapped landfill sites which took society’s biodegradable waste continue today, and will for several more decades, generate and release methane gas unabated to the atmosphere i.e. as that waste continues to rot. These sites are in effect unregulated with little (if any) economic incentive to be dealt with. Using a “bottom up” approach we have modelled that 500 former landfill sites, if dealt with as described below could result in 11,000,000 to 13,000,000 tonnes of carbon dioxide equivalent savings.

Without government incentives or appropriate carbon market mechanisms, these sites will continue as environmental liabilities. It is estimated that 60% of which are owned by Local Government. An expanded and more flexible EU ETS can be that incentive. Alternatively article 24a of the Revised ETS Directive may be of use to the UK.

Our submission sets out how the Government, by leveraging existing policy combined with innovative clean technology solutions, has the opportunity to establish a long term roadmap for the UK that will deliver maximum benefit from its continuing participation in the EU ETS. We advocate the deployment of a domestic market via Article 24a, combined with adopting sectoral crediting approaches and facilitating linkages to emerging international regional schemes. We have detailed the full spectrum of the outcomes of these solutions in Section 7 of this submission, however in summary they include:

• UK energy security

• Encouraging UK investment

• UK meeting its carbon reduction targets

• Reduced government spending

• UK clean technology and 'green job' development

• Benefits to UK businesses

We therefore urge the Committee to consider the issues raised and the holistic solution proposed in this submission.

2. Lichen Renewal Limited (the author)

2.1 Lichen Renewal landfill management

Lichen Renewal is an independent UK company operating as an innovative leader in landfill site recovery and restoration. Lichen Renewal has developed a unique approach to capture GHG emissions released from former landfill sites by capping them with pulverised fuel ash (PFA) from coal‐fired power plants. Lichen is examining and researching strategies where the coal dependent electricity generating sector may in future be in a position to offset some of its own carbon footprint when using its own waste stream (PFA) to mitigate/cap gassing landfill sites. By capturing methane and remediating landfill sites, Lichen Renewal is able to create climate change mitigation projects in the UK, with wider social and economic benefits.

There are in the order of 22,000 former landfill sites in England and Wales that leach pollutants into the groundwater and emit millions of tonnes of potent GHGs. Of these, 1500 are emitting significant enough levels of emissions to worry the Environment Agency. Lichen Renewal understands that waste disposal to landfill sites is the single largest source of UK methane emissions, accounting for approximately 42 per cent of methane emissions in the UK, yet there is no current policy for driving a reduction of landfill related emissions in the UK and EU for former landfill sites. This is a serious issue because of the global warming potential of methane, and since this gas makes up approximately 8% of the UK’s GHG emissions.

Using new environmental proprietary technology Lichen Renewal can deliver:

• The return of environmentally damaged land (i.e. former landfill sites) to productive social and economic use

• The prevention of: o pollution from landfill gases (carbon capture); o water pollution from landfill sites

• Production of low carbon renewable energy (electricity and heat) from landfill gas (methane) and green waste

• Reduced costs of waste management and ‘green jobs’

• Numerous other social and economic benefits of redeveloping UK’s former landfill sites


3.1 EU ETS Limitations

As DECC understands the EU ETS covers approximately 45% of the EU’s CO2 emissions (CO2e) and 40% of GHG emissions. However, some 60% (3 billion tCO2e) of EU emissions are therefore not subject to capped limits under the EU ETS. The majority of emissions that fall outside the EU ETS are subject to various other national and EU‐level policies and measures. We must draw attention, however, to a highly significant volume of emissions for which there is no current policy for driving a reduction of emissions in the UK and EU. Waste disposal to landfill sites is the single largest source of UK methane emissions, accounting for

approximately 42 per cent of methane emissions in the UK, yet there is no current policy for driving a reduction of emissions in the UK and EU for former landfill sites. This is a serious issue because of the global warming potential of methane and since this gas makes up approximately 8% of the UK’s GHG emissions. Whilst assessing the viability of the EU ETS for climate change mitigation in the EU it is worthwhile to understand this failing and look at how the system can be improved.

As discussed above, there are 22,000 former landfill sites in the England and Wales. Lichen Renewal calculates that if they cap only 500 sites, this will mitigate 11‐13 million t/yrCO2e. This comes from preliminary modelling from three sites which were found to produce 22,000 to 26,000 t/yrCO2e. Lichen Renewal calculate that if the 500 sites were left in their current state, over 40 years (taking into account decline in emissions over time), 158 million tonnes of CO2 equivalents will be released to the atmosphere unabated. In the UK, there is currently no framework to directly tackle the large volume of emissions from former landfill sites.

The Carbon Reduction Commitment Energy Efficiency Scheme is predominantly designed to reduce energy use in buildings, while the EU Landfill Directive (1999/31/EC of 26 April 1999) is designed to reduce the volume of materials being sent to landfill. Neither of these specifically tackle the emissions that are emitted as a consequence of waste degradation occurring within former landfill sites, which are in effect unregulated.

Whilst the volume of methane emissions from landfill sites are included under the UK’s emissions within the Kyoto Protocol and, according to the IPCC Guidance, must be reported in the national GHG inventory, the waste sector is not included in market‐based GHG regulations such as the EU ETS and so the reporting is not relevant to these schemes. Further more, the capping of landfill sites and the utilisation of GHGs is a valuable source of carbon credits through the Clean Development Mechanism (CDM) and Joint Implementation (JI) schemes. However, the UK is unable to directly benefit and to reduce emissions in the UK through this mechanism as it does not approve JI projects hosted in the UK.

4. Revised ETS Directive in place to reward investment in UK landfill management projects

4.1 Article 24a of the Revised ETS Directive (2009/29/EC)

i. Paragraph 1 of Article 24a states that “measures for issuing allowances or credits in respect of projects administered by Member States that reduce GHG emissions not covered by the Community scheme [the EU ETS] may be adopted”. Explicit reference is also made to the offsetting mechanism of Article 24a under the Effort Sharing Decision (ESD) of the European Parliament and the Council, which introduced emissions targets for Member States in a range of areas not covered by the EU ETS (e.g. transport, buildings, agriculture, waste). Under the ESD, Member States are permitted to trade up to 5% of their annual emission allocation between themselves, and can also use limited volumes of CERs and ERUs to meet their targets. Importantly, the Directive states they would be allowed to use credits resulting from Article 24a projects without any limitations.

ii. As described above, the majority of GHG emissions within the EU (c. 60%) lie outside the scope of the EU ETS. A new offsetting mechanism could therefore potentially extend the economic incentive provided by the carbon market to domestic emissions reductions outside of the scheme, many of which, such as landfill gas projects, are likely to represent highly cost‐effective abatement projects. Introducing such offsets into the EU ETS could reduce the costs of achieving the targets, thereby potentially allowing for an increasing tightening of the scheme’s overall cap. An extension of the offsetting mechanism in Europe could also potentially address some of the problems associated with JI.

iii. As we have discussed, emissions from landfills sites not captured under the EU ETS scheme or by any UK support scheme to encourage a reduction in emissions is preventing an opportunity for the UK to reduce its national emissions and benefit from the economic environmental and social advantages of improving these sites. We note that Article 24a of the Revised ETS Directive (2009/29/EC) provides the legislative basis for establishing a domestic offsetting scheme and ultimately allowing the UK to benefit from the carbon reduction projects in the UK without the issues that prevents the UK allowing projects under the JI mechanism.

5. Linking the UK’s domestic carbon scheme to other International ETS’s

5.1 Australian example

In Australia, the New South Wales GHG Reduction Scheme (GGAS) has been operational since 2003. It is a trading scheme focused on reducing the carbon intensity of electricity suppliers and makes use of domestic project offsets. The GGAS recognises offsets that “destroy landfill methane that would otherwise have been vented to the atmosphere”.

Beyond this the Australian Government has structured a comprehensive climate action plan which addresses its domestic emissions reductions targets and has been designed to complement existing international carbon market mechanisms. The Clean Energy Future legislation encompasses three main areas:

i. National Carbon Offset Standard (NCOS)

In effect from 1st July 2010: Companies in Australia claiming carbon neutrality can only do so if they are compliant with NCOS

NCOS recognises a clearly defined list of eligible offset types • Australian Carbon Credit Units (ACCUs); • Certified Emissions Reductions (CERs) • Emission Reduction Units (ERUs) • Removal Units (RMUs) • Verified Emissions Reductions (VERs) ‐ Gold Standard • Verified Carbon Units (VCUs) ‐ Verified Carbon Standard

ii. Carbon Farming Initiative (CFI)

Successfully passed the House of Representatives in June 2011 and likely to pass the Senate later in 2011: Mechanism for domestic farmers and landholders to benefit from carbon markets via GHG reduction projects including: • Legislation to establish a carbon crediting mechanism • Fast‐tracked development of methodologies for offset projects

CFI credits will be both Kyoto and non‐Kyoto compliant There is potential linkage/trading of the non‐Kyoto CFI credits in other regional/national trading schemes, such as California.

iii. Carbon Price

Currently proposed and likely to be approved by the House of Representatives in 2011 prior to passage through the Senate: Initially in the form of a fixed price tax, set at A$23 per tCO2e and commencing 1st July 2012

Transitioning to a floating price, cap and trade mechanism from 1st July 2015 Expected to have a cap of 280‐315 million tCO2e by 2020 Expected to be linked to international carbon markets, such as the Kyoto market for CERs, from the start of the floating price period

Anticipated that Australian Cap and Trade scheme will have demand for up to 100 million CERs by 2020

Up to 50% of participants’ liability can be sourced from international credits Australian originators will be able to sell their Kyoto and Non Kyoto credits to the international market

Ability for regulated Australian entities to offset 5% of their emissions liability during the fixed price period and 100% of their liability under the floating price period using Kyoto‐compliant CFI ACCUs

This comprehensive legislation represents a multifaceted approach to addressing the combination of domestic reduction objectives and broader international carbon market participation. Essentially it offers Australian industry and Government the opportunity to derive domestic benefits across a spectrum of criteria including economic, carbon mitigation, attracting domestic investment, catalysing innovation, promoting clean technology development (adoption and export) and providing a more sustainable model by which Government can manage its GHG emissions. The approach underpins the ability for Australia to export carbon assets rather than liabilities, thus generating revenues and broader economic benefits.

The UK has the opportunity to achieve such benefits by harnessing the existing policy and provisions facilitated by the EU ETS to implement a complementary domestic market, which has interoperability with other international schemes. This approach reinforces the UK and EU’s long term objective of achieving an international carbon market, and through establishing interoperability, building confidence in the market and attracting investment. This investment will stimulate UK innovation in clean technology, economic activity across sectors and contribute to effective GHG reductions against their targets.

‐ 6 ‐


Sectoral agreements could contribute to a post‐2012 EU ETS market benefiting the relevant signatory countries. The flexibility of sectoral agreements could allow the UK government to tailor its choice of commitment type to particular UK sectors (potentially at risk of rising carbon prices) such as the energy generation or automotive sectors. By assisting in diffusing competitiveness concerns and channelling the technology and financial focus towards specific sectors, this allows the UK government to concentrate on areas of the environment (and the economy) which need it most.

August 2011

‐ 7 ‐

7. Expanding the EU ETS ‐ our Solutions and Outcomes

UK energy securityEncouraging UK investment

UK meeting its carbon reduction targets

Reduced government spending

Benefits to UK businessesUK clean technology and 'green job' development

Landfill capping (Lichen Renewal solution)

UK solution to deliver landfill site restoration, carbon capture and

energy generation

Production of low carbon renewable energy (electricity and heat) from landfill gas (methane)

and green waste

Through investment in UK projects ‐ the return of environmentally

damaged land (i.e. landfill sites) to productive social and economic use

Reduced carbon emitting energy source (electricity and thermal)

Land available for biomass energy generating facilities

Direct carbon capture equating to absolute emission reductions

Alleviates the burden of local authorities managing landfill sites

Improves landfill capacity management (reduced quantities of PFA and "green bin" landfill waste)

Regeneration of land for local social and economic benefits (at reduced

cost to local authorities)

Reduced electricity costs, costs of carbon, waste management costs and improved corporate responsibility

The creation of long standing job opportunities through investment into UK based clean technology projects and infrastructure

UK based carbon initiativeArticle 24a

Provides the legislative basis for establishing a domestic offsetting scheme and ultimately allowing the UK to benefit from carbon reduction

projects in the UK

Improved profitability (and in effect stability) of the UK's energy producing companies through their investment in UK based renewable energy sources and direct reductions in carbon

Encouraging UK businesses and international funds to invest in UK

based carbon mitigating projects and technology

Incentivise UK businesses to take the lead on carbon reduction

An accelerated route to meet the UK's carbon reduction targets

Utilising a carbon trading market to reduce direct government incentive

schemes

Incentivise UK businesses to take the lead on carbon reduction (reducing the UK governments carbon related

spend)

Project led developments (infrastructure, earth works,

maintenance etc)

Allowing companies to reduce their carbon burden (and passed‐on effects of carbon cost savings to consumers

and small businesses)

Creating a new and sustainable domestic industry within the low

carbon economy

Knowledge building for UK labour force

Sectoral crediting approach

Based on a clear target agreed on emission reductions at a sectoral level within a non‐Annex 1 country

Improved international competitiveness and profitability

Improving the attractiveness for energy intensive industries to be UK based due to comparable carbon costs

with international markets

Drives carbon credits back to UK and leverages UK innovation overseas

(exporting assets)

Improve UK industry competitiveness

Reduce the necessity for direct UK government support/investment

Reduced carbon leakage

Knowledge sharing

Reduced costs of carbon, waste management costs (less additional burden on top of energy costs)

Export of UK developed clean technology and intellectual property

Underpinning UK based jobs and incomes

Emerging regional emissions schemes

Supports opportunity for UK to export carbon assets rather than liabilities, thus generate revenues

and economic benefits.(e.g. the Australian model where interoperability is paramount)

Incentivises investment into low carbon renewable energy

(electricity and heat)

UK energy generators to have a broader and more flexible mechanism for sustainably

managing their carbon burden and its financial implications

Underpins the UK's domestic carbon trading market, and therefore entices investment into UK based carbon

generating projects

Encouraging UK businesses and international funds to invest in UK

based carbon mitigating activities and technology

An accelerated route to meet the UK's carbon reduction targets through a combination of both domestic and international carbon credit schemes

Underpins the UK's domestic carbon trading market

Supports opportunity for UK to export carbon assets rather than liabilities,

thus generating revenues and economic benefits for the UK

Increased investment, competitiveness, UK based

innovation and the ability for UK businesses to export carbon assets

and knowhow

Knowledge sharing with international community

Policy to underpin the value of UK generated carbon assets

Reinforces UK as key cleantech and carbon market hub

OutcomesSo

lution

sEffectiveness of the EU ETS to assist the

UK in meeting its carbon reduction targets and the positive impact of the

inclusion of landfill management solutions

Internationa

lDom

estic

1

1 Section 7, word count:653

Memorandum submitted by Shell (ETS 21) Summary • Shell believes cap and trade schemes such as the EU Emission Trading System are the most effective

mechanism to deliver quantified reductions in greenhouse gas (GHG) emissions. The existence of a cap on emissions is designed to deliver absolute reductions while trading ensures that these reductions can be achieved at least cost to the economy.

• But we are concerned this critical policy instrument will not deliver the desired pathway to a low emissions future.

• The policy framework that the EU constructs and the goals that it sets must remain robust throughout macro‐economic shocks. Unforeseen circumstances such as the recession in 2009, together with the overlaying of additional non‐complementary reduction measures to drive emissions reduction are undermining its effect by lowering the carbon price.

• The EU should therefore consider a tightening of the EU ETS Phase III cap, and the most appropriate means to do so is to recalibrate Phase III (2013‐2020) by setting aside allowances from the auctions during this period.

• After 2020, an auction reserve price should be implemented in Phase IV, in order to give a longer‐term carbon price signal. The auction reserve price would set a carbon price floor for the primary market thereby enabling investment in low carbon technologies and provide investor certainty. This should be done well in advance and ideally as soon as possible.

Introduction

1. Shell welcomes the opportunity to respond to the Committee’s inquiry and believes that it is timely to investigate the functioning of the EU Emissions Trading Scheme (ETS). Urgent action is required to ensure that the EU ETS can deliver the desired environmental outcomes.

2. The ETS is not a short‐term policy structure, but one that should be looked at in the context of a forty year trajectory during which time the energy system and industry across Europe are fundamentally and permanently changed. The ETS and the carbon price that it delivers are key to the investment decisions that will be made by companies over the coming years.

3. It is clear that the original environmental objective of the EU ETS, to reduce greenhouse gas (GHG) emission to a pre‐determined level, will be met. However, it is not assured that the intended pathway ‐ which includes increasing energy efficiency in manufacturing, changing the investment profile of the power sector, and pushing technologies such as carbon capture and storage (CCS) and wind power generation ‐ will be delivered.

4. Shell believes that to prepare the energy and industrial system for future changes and enable Europe to decarbonise, it is vital that the EU ETS must be able to operate as a robust and effective policy instrument. This will not be the case with the current carbon price.

5. This submission to the Committee’s Inquiry will thus focus on the current threats to the EU ETS, and mechanisms to ensure that this critical policy tool will deliver a robust carbon price and a step‐change in investment to progress Europe on the pathway to a low emission future. We would be pleased to participate in one of the Committee’s oral evidence sessions in the course of the Inquiry to explore these issues and proposals further if the Committee would find that useful.

Current threats to the EU Emission Trading Scheme

6. In recent months, we have seen a pattern of uncertainty developing which appears to threaten the EU ETS. The effectiveness and credibility of the EU ETS has come under question, as a result of the severe recession in 2009 which has resulted in lower industrial output, a reduction in GHG emissions, and an economy with lower emissions intensity.

7. This has created a surplus of EUAs that has depressed the carbon price. Moreover, it is possible that this surplus may be transferred to future phases through the banking of allowances so that the carbon price in phase III of the ETS is also dampened.

8. We are concerned that the current EU ETS will not deliver the step‐change in investment required to set the EU on the pathway to a low emission future. The EU ETS set out to increase energy efficiency in manufacturing, change the investment profile of the power sector and push technologies such as carbon capture and storage (CCS) and wind. However, these environmental goals have not been achieved.

9. Through the introduction of the Carbon Price Floor, the UK has taken national action to address this issue and to drive low carbon transition in the domestic power sector. However, taking action on a unilateral basis will decrease demand for EUAs from UK EU ETS participants and could lower the prevailing carbon price and further threaten the EU ETS. This action leads to the specific cross border effect of carbon leakage with impacts on the competitiveness of local business, and does not necessarily result in a reduction in emissions at an EU level. Dealing with competitiveness concerns through a carbon tax is difficult to regulate and administer.

10. More widely, the EU ETS market is being stifled through the overlaying of additional policies such as the obligation to promote renewable electricity, other specific technology deployment incentives and emission performance standards. These can all lead to a decrease in emissions from the power sector, but make the EU’s progress to a low emissions future less economically efficient. The fundamental efficiency of a cap and trade scheme is that, in theory, those that can reduce emissions most efficiently will, and therefore emissions reductions are achieved at the lowest possible cost. If policies are implemented which decrease or remove the range of options to reduce emissions under the scheme then this lower efficiency will cost more to both business and the consumer.

Phase III recalibration: tightening the cap

11. As the first three phases of the ETS were developed, the designers catered for an EU growth scenario that was steadily increasing in a linear manner. This baseline on which the EU ETS cap was determined has changed as the global financial crisis imposed an economic shock on the system which left the economy looking very different to that originally envisaged.

12. The reduction in GHG emissions from the global financial crisis has resulted in a lower than expected carbon price in the EU ETS. This carbon price signal needs to be strengthened to provide investors with an incentive to invest in low‐carbon technologies. We believe that the most appropriate method to achieve a robust carbon price is to recalibrate Phase III by setting aside allowances from the auctions during this period. The removal of allowances from Phase III will deliver a robust carbon price by tightening the cap.

13. In its Roadmap for moving to a competitive low carbon economy in 2050, and the impact assessment in the proposal for a Directive on energy efficiency, the European Commission has already recognized the need to monitor the impact of new measures on the ETS. The Commission notes, “that appropriate measures need to be considered, including recalibrating the ETS by

setting aside a corresponding number of allowances from the part to be auctioned during the period 2013 to 2020 should a corresponding political decision be taken.”

14. Given the scale and complexity of the EU energy and industrial system, it is not possible to know exactly how the baseline for forward emissions levels has changed. However, it is currently estimated that the downturn has resulted in a surplus of between half a billion to one and a half billion allowances. We strongly recommend that the Commission works with EU ETS experts to determine the surplus as a necessary precursor to agreeing action to deal with it.

The EU’s 2020 Emissions Reduction Target

15. When the EU’s 2020 GHG emissions reduction target was established in 2008, it acted as the foundation for a broad policy framework. History has shown that modern economies remain cyclical and that such cycles include both recession and periods of strong growth, and that is likely to remain the case for the future. The policy framework that the EU constructs and the goals that it sets must remain robust throughout such inevitable cycles.

16. One of the main issues that has been debated in the EU since development of the climate and energy package is whether the EU’s 2020 GHG emissions reduction target should be adjusted to 30% from the current 20%, against 1990 levels.

17. Formally, the shift to a 30% target is linked to the existence of an international agreement on climate change. For example, had Copenhagen delivered a new framework within which real and meaningful reduction targets were agreed, there would have been a swift political mandate on the part of the EU to change the reduction target to 30%.

18. The EU’s 2020 reduction target is for the economy as a whole, with the sectors covered by the EU ETS (traded sectors) having a 21% reduction target versus 2005, and the balance of the target taken by non‐traded sectors with a 10% reduction target versus 2005. While Shell agrees that EU ETS cap for the traded sector should be recalibrated, we do not believe a case has been made altering the reduction target for the EU as a whole. Mandates and standards applied to the non‐traded sector have not been affected by recession. Renewable obligations and standards on power, transport and heat, vehicle emissions and building efficiency standards reduce the intensity of emissions related to the amount of the product used, such as fuel consumed in car. As standards are throughput based they will not change as consumption rises or falls, so they are independent of macroeconomic developments.

19. Shell believes that the key issue for consideration now is the Phase III cap on emissions in the EU ETS and how a tightening of the cap will create the carbon price signal to ensure that progress on the pathway to a low emissions economy is started. A successful Phase III and a clear carbon price floor signal for Phase IV will establish the EU along the right pathway and result in further substantial reductions by 2030.

Phase IV: post 2020

20. Post 2020 onwards, a longer term solution is to implement an auction reserve price in Phase IV. The auction reserve price should be announced well in advance, and ideally as soon as possible and its existence would allow long‐term support for the carbon price, thereby enabling the investment environment that was the original intention of the system.

21. Implementing an auction reserve price for Phase IV and beyond would give new value to existing allowances, and any excess of allowances could be banked forward into future phases and benefit from the known auction reserve price.

22. Furthermore, it is not too early to start discussions on the annual reduction factors and the overall cap for Phase IV, as this will provide industry with a view on future market conditions which can allow for deployment of low carbon technologies now being developed and demonstrated. Action

should be taken now because most large‐scale investments being considered today will factor in a Phase IV carbon price in terms of operating costs, given the timeline for investment decisions and implementation.

International linkage of Emission Trading Schemes

23. The cost effectiveness of reducing greenhouse gas (GHG) emissions through a carbon market is primarily determined by the range of abatement options available to the market. International linkages offer increased global coverage and the ability to capture more cost‐effective abatement options because reductions in emissions from projects outside the ETS region can be used to meet the compliance obligation, ie the cap.

24. Linkages between ETSs need to be limited to provide a balance between domestic and international low‐carbon investments. This will ensure investment to decarbonise the economy will occur in all regions that are linked, setting all regions on a pathway to a low emission future. The offset portfolio should thus be aligned with the portfolio of the related ETS, i.e. the reductions should come from the same sectors, for examples power and industry, and the same section of the abatement curve.

25. A good example is the way in which EU ETS participants may use Certified Emission Reductions (CERs) from the Clean Development Mechanism (CDM) from some, but not all, projects for compliance. For example, CERs from afforestation, reforestation and nuclear projects cannot be used. In order to maintain the integrity of the EU ETS, only CERs and regulated offsets verified against a robust set of standards through the Clean Development Mechanism (CDM) should be used as an offset. The objective of reducing GHG emissions through trading schemes should not be compromised by allowing less credible carbon credits to enter the system. In the absence of a global framework deal, linking can be achieved by bilateral arrangements between the EU and those jurisdictions with ETS or emerging schemes, such as New Zealand, Australia, Japan, California and South Korea. However, any linking should only be done after careful review of the methodologies for monitoring, reporting, and verification (MRV) of emissions and implementation of strict international standards in this area. These should be similar to those set by the EU ETS, the largest compliance‐based emissions trading scheme with international linking.

Emission trading systems versus carbon taxes

26. There is a continuing debate over the merits of carbon taxes over cap and trade schemes for delivery emissions reductions. Shell believes an ETS approach is preferable to a carbon tax because an ETS is designed to deliver an environmental objective, whereby the absolute cap on emissions must be met through quantified emissions reductions. This certainty is critical for the environment.

27. Whilst a carbon tax delivers some level of fiscal certainty, it does not necessarily deliver any particular environmental outcome. Emissions could fall, but equally they may continue to rise. It may take some years for policy makers to establish the level of tax necessary to deliver a given emissions reduction pathway.

28. A tax does not offer long‐term fiscal certainty, in that it may have to be varied substantially over time to meet the desired emissions pathway. But it will deliver price certainty in the short term. However, price certainty can also be achieved in the ETS by establishing a price floor through establishing an auction reserve price. An ETS will deliver its environmental objective at lowest cost to the economy. By combining trading with a price for emitting CO2, the approach seeks out the most attractive reduction projects within the market, delivering a lowest cost reduced emissions outcome.

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29. Carbon taxes also are not an effective means to address cross border/competitiveness issues. Since taxes are largely national instruments for redistributing or repricing assets, they are not fit for purpose to deal with global issues like climate change.

Fraud

30. Finally, it is clear that the current issues regarding fraud in the ETS have deeply affected confidence in the market. The Commission is taking action to resolve the problem by implementing the Registries Regulation, which has recently gained support from the EU Climate Change Committee and is expected to come into force in October 2011. Shell believes the EU Commission and Member States should agree a common approach and compensate those who bought carbon allowances in good faith by replacing them with allowances that have not yet been issued. This could be done using allowances not yet allocated for 2012, or allowances left over in the New Entrant Reserve, or by issuing ‘entitlement notes’ to swap Phase II for Phase III allowances, when Phase III allowances become available.

August 2011

Memorandum submitted by CAFOD (ETS 22) A global and equitable mechanism for carbon pricing of international maritime transport is a key building block to an effective EU climate policy.

Executive Summary

1. This submission focuses on international maritime transport and aviation (sectoral agreements). Unless the rapidly-growing emissions from these global sectors are addressed, the goals and effectiveness of EU climate policy will be seriously undermined.

2. Global carbon pricing of international shipping emissions is needed to achieve this mitigation objective. Technical measures recently adopted by the International Maritime Organization (IMO) would achieve an emissions reduction of just 1% below BAU by 2020. Carbon pricing would expand the market-based approach pioneered by the EU ETS. It could also contribute $10-15 billion per year to finance climate action in developing countries.

3. Ensuring no net incidence (NNI) or costs on developing countries is crucial to reconcile a global maritime scheme with the UNFCCC principle of “common but differentiated responsibilities and respective capabilities” (CBDRRC). The UK and the EU should also be supportive of compensating poorer countries that would be most affected by carbon pricing of shipping emissions. CBDRRC and any impacts on poor countries could be addressed through a Rebate Mechanism (RM), such as is currently under consideration at the IMO. The RM would ensure NNI on developing countries and would also provide flexibility for wealthier developing countries to forego their rebates voluntarily, in whole or part.

4. Raising long-term climate finance from pricing shipping emissions is fair, affordable and necessary. Fair, as all developed countries would pay, with the EU and UK contributing 28.5% and 4% of the total revenues respectively. Affordable, given the minimal potential increase it would entail on prices of imported goods (under 0.2% on average). Necessary, as mobilizing the predictable, stable, new and additional sources of climate finance required under the Cancun Agreements, with developed countries meeting their goal of providing $100bn annually by 2020, requires a range of sources of new financing.

5. Establishing a global maritime carbon price could constitute a helpful precedent for action in the aviation sector. Concerns raised by developing countries about current EU plans to include international aviation in the ETS are that they do not address concerns about CBDRRC and there is no proposal to channel revenues towards financing action on climate change.

6. Conclusion: A global and equitable mechanism for carbon pricing of

international maritime transport is feasible. Agreement on such a mechanism should be pursued actively by the UK and the EU. Such a mechanism would significantly reduce emissions from this sector, while ensuring no net incidence on developing countries. It could also raise substantial finance to help poorer countries adapt to climate change and build low carbon development. As such, it would constitute real progress towards a functioning global climate regime. The UK should champion such an approach through coordinated action with its EU partners and at the G20, with the aim of reaching agreement at the UNFCCC Summit in Durban, in December 2011.

1. Introduction: Focus on international maritime transport and aviation

1..1. CAFOD welcomes the opportunity to submit the following evidence to the UK

House of Commons Energy and Climate Change Committee Inquiry on the EU Emission Trading System.

1..2. CAFOD is the official relief and development agency of the Catholic Church in England and Wales. We work with partners in more than 40 countries across the world supporting poor communities. CAFOD prioritises partnerships with local church organisations but works with people of all faiths or none.

1..3. CAFOD has been campaigning for several years for a fair, ambitious and global deal to cut carbon emissions and for sufficient resources to be mobilized to support countries suffering climate change impacts. Our partners are working with vulnerable communities at the frontline of climate change, for instance in Kenya and Bangladesh.

1..4. From August to December 2011, we are calling for the UK government to commit to providing its fair share of long-term climate finance and, working with its EU partners, to proactively seek agreement on the mobilization of new sources of climate finance and on establishment of the new Green Climate Fund at the next UNFCCC Summit in Durban (see: http://www.cafod.org.uk/dontdroptheball).

1..5. We commend the EU’s pioneering work in developing the ETS, while acknowledging that its current emissions reduction targets are weak and need strengthening.

1..6. However, it is CAFOD’s view that without global coverage of the rapidly growing emissions from international maritime transport and aviation (i.e. coverage extending well beyond the current EU ETS), the goals and effectiveness of EU climate policy will be seriously undermined. The greenhouse gas emissions from these two inherently international sectors are significant and growing and therefore require coordinated global approaches. This has been widely recognized, including by the UK House of Commons Environmental Audit Committee.1

1 In 2009, the Committee, in its report Reducing CO2 and other emissions from shipping (fourth report of Session 2008-09), concluded: “The emission of greenhouse gases from shipping is a serious problem for international climate change policy [.…] The Kyoto Protocol handed developed economies the responsibility of working to curb emissions from shipping through the International Maritime Organization (IMO). Very little progress has been made [….] The Government’s position on the use of emissions trading to tackle GHG emissions from ships lacks coherence. Ministers support the use of revenue from a trading scheme to fund climate change adaptation in developing countries but oppose the hypothecation of revenues for that purpose [.…] The Government admits that the current calculation of the UK’s share of international shipping emissions is an underestimate[.…] Emissions from shipping cannot be allowed to grow uncontrolled. It will take several years before technical changes start to make a significant change.” See: http://www.publications.parliament.uk/pa/cm200809/cmselect/cmenvaud/528/528.pdf

http://www.cafod.org.uk/dontdroptheball

http://www.publications.parliament.uk/pa/cm200809/cmselect/cmenvaud/528/528.pdf

1..7. Carbon pricing, also referred to as a market-based measure (MBM), would

achieve this objective and would complement any technical and operational measures aimed at reducing emissions from these sectors. The latter alone are insufficient to achieve the desired objective. Any MBM should ensure that there is no net incidence (NNI) or costs incurred by developing countries, in line with the UNFCCC principle of “common but differentiated responsibilities and respective capabilities” (CBDRRC).

1..8. A significant portion of the revenues generated by such an MBM could be used for climate financing, contributing to the promise by developed countries, including the UK, to raise $100 billion annually to support developing countries by 2020. The proposed approach addresses these two issues at the same time.

2. Global carbon pricing on international shipping to reduce emissions

2..1. Carbon dioxide emissions from international shipping can be reduced through

technical measures, operational measures and market-based measures (MBMs).

2..2. After several years of negotiations on measures to address carbon dioxide emissions from international shipping, in July 2011 the International Maritime Organization (IMO) adopted a technical measure applicable to new ships, in the form of the Energy Efficiency Design Index (EEDI). The IMO also adopted operational measures applicable to all ships in the form of Ship Energy Efficiency Management Plan (SEEMP).

2..3. The negotiations leading to the adoption of these regulations demonstrated that it is possible to reach global agreements on reducing emissions from international shipping but only when the special circumstances of developing countries are taken into account (in this case, through promotion of technical co-operation and transfer of technology relating to the improvement of energy efficiency of ships and a waiver for a phased implementation)

2..4. The adoption of the EEDI and SEEMP are very welcome but insufficient steps. The EEDI, for instance, will deliver emissions reductions of just 1% below business as usual (BAU) levels by 2020.2 These technical and operational

2 The 1% emission reduction can be estimated through the following simple calculations. Annual emissions from new ships entering service are 5% (based on an annual scrapping rate of 3% and an annual increase in overall emissions of 2.2%, i.e. the average emission growth scenario). Thus when the regulation applies to all ships, without any waiver, with EEDI improvements of 10%, the regulation will deliver reductions of 0.5% annually (5% of 10%). To calculate total improvements by 2020, the improvements from the individual periods are added together. New ships subject to the improved EEDI would be entering the service from around mid-2017, for ships not applying for a waiver, and from mid 2019 for ships applying for a waiver. Given that 75% of ships are registered in developing countries that could issue a waiver, and assuming that 2/3 of new ships

measures will also not deliver any finance, but will rather require funding

2..5. Thus a revenue-raising MBM is needed, both to deliver real cuts in emissions

and to raise finance. Essentially, a MBM would put a price on emissions from international shipping, either through a levy or an ETS. The carbon price would incentivize implementation of cost-efficient, in-sector emissions reductions and could also pay for the most cost efficient out-of sector emissions reductions (i.e. in other sectors, including forestry), adaptation to climate change in developing countries and also be used for technical co-operation and, potentially, R&D for clean shipping.

2..6. Whether the carbon price for shipping would be established through a levy or ETS is a secondary issue. Well-designed proposals for each option are under consideration at the IMO, even if the majority of countries, as well as industry stakeholders, would prefer a levy, mostly for practical reasons.3

2..7. The key outstanding issue is to how reconcile the principles of the UNFCCC relating to CBDRRC with the requirements of the IMO regime, where measures must be applicable to all ships, irrespective of flag and nationality, in order to deliver a scheme that is both universal and equitable. A proposal that could achieve this, a Rebate Mechanism, is also under consideration at the IMO and will be discussed in more detailed in the next section.

2..8. Assuming that revenue generated from shipping activities by developed countries is used for climate change action, carbon pricing could raise circa $10 – 15 billion per year in climate finance for the new Green Climate Fund (GCF), which was agreed at Cancun in 2010.4 Thus a global carbon price on shipping emissions would expand the market-based approach championed by

registered in developing countries would apply for the waiver, the percentage of all new ships with improved EEDI would halve in the period when the waiver applies (=0.25 + 0.75 x 1/3). Thus the estimate of emissions reduced in 2020 is the sum of improvements from new ships delivered from mid-2017 to 2020 and equals 1.25% (= (0.25 + 0.5 + 0.75 + 1) x 0.5%). This needs to be somewhat discounted for three reasons: some of the technical improvements or slowing down of new ships would happen with or without the EEDI; the EEDI does not yet apply to all ships; and the EEDI improvement rate is less than 10% for some ships. Thus the improvements from EEDI in 2020 are estimated at circa 1% from BAU level. 3 See, for instance, the position stated by the International Chamber of Shipping (ICS) in its press release of 6 July 2011: “MBMs are expected to provide a means whereby shipping can make a significant financial contribution to environmental projects in developing countries - satisfying the UNFCCC principle of ‘Common But Differentiated Responsibility’, something which is important to developing countries. ICS has recently announced that if Market Based Measures to reduce CO2 emissions are developed by governments then the international industry has a definite preference for a mechanism that is fuel levy/compensation fund-based rather than any emissions trading scheme” [emphasis added]. See: http://www.marisec.org/pressreleases.htm 4 This figure is calculated on the basis of the 60% of total shipping activities attributable to developed countries, a carbon price of $25/tCO2 and emissions of 1,000 MtCO2, and assumes that a major share of the revenue raised would be used for climate action in developing countries.

http://www.marisec.org/pressreleases.htm

the EU ETS globally to another large sector with emissions comparable to the emissions of Germany. On the other hand, including the EU/regional share of international shipping in the EU ETS would only apply to emissions in the EU sphere.

2..9. In the European Commission’s ongoing consultations, a regional approach to

MBM for shipping emissions is opposed by nearly all stakeholders, both on grounds of impracticality and low efficiency. Such an approach, assuming that all the practical challenges relating to this inherently global and complex sector could be resolved, would have limited effect since the EU’s share of international shipping emissions is estimated at circa 30% (based on the EU share of international seaborne trade).

3. Ensuring no net incidence (NNI) or costs on developing countries 3..1 The Rebate Mechanism (RM) proposal currently under consideration by the

IMO aims to reconcile the principles of the UNFCCC with the application of global carbon pricing for shipping by rebating the cost burden incurred by a developing country. It would thus ensure no net incidence on developing countries from the introduction of a carbon price. We believe that this proposal, along with use of the revenue generated from developed countries for climate action in developing countries (see next section), is the key to breaking the current deadlock in negotiations in the complex area of emission reductions and innovative financing from international transport.

3..2 The RM proposal – and, more generally the concept of NNI or cost burden – has generated considerable interest from a number of developed and developing States and observer organizations at both the IMO and the UNFCCC.5 These concepts have been endorsed in the 2010 report of the UN High Level Advisory Group on Climate Finance (AGF)6 and are likely to be discussed further in the forthcoming World Bank/IMF report on sources of climate finance requested by the G20 Finance Ministers meeting in October 2011.

3..3 The RM was designed to apply to any revenue-generating market-based mechanism for shipping (maritime MBM) – be it a levy or an ETS. It can also apply to aviation. Through the RM, developing countries could be rebated the potential cost or incidence of any maritime MBM. The RM also provides flexibility for wealthier countries or regions, such as Singapore and Hong Kong, to forego their rebates, in whole or part.7

5 See for instance, the following submissions to the IMO by the World Wildlife Fund, Germany, and France, respectively: MEPC 62/5/14, MEPC 62/5/15, and MEPC 62/5/34 6 See: http://www.un.org/wcm/webdav/site/climatechange/shared/Documents/AGF_reports/AGF%20Report.pdf 7 See, for instance, the RM proposal described in MEPC 60/4/15 and MEPC 61/5/33 submitted by the International Union for Conservation of Nature (IUCN), or the report of the IMO’s MBM Expert Group contained in document MEPC 61/INF.2.

http://www.un.org/wcm/webdav/site/climatechange/shared/Documents/AGF_reports/AGF%20Report.pdf

3..4 The mechanism calculates the rebate country-by-country, using global maritime MBM costs and a trade-based key, namely a country’s share of seaborne imports.8 Each developing country receives its attributed rebate, unless it chooses to forego it. A developing country that chose to forego its rebate, or part of it, would receive international recognition for its action and the revenues could potentially contribute to South-South cooperation, including climate change action.

3..5 Developed countries would not be entitled to rebates but would be automatically credited for their share of financing raised through the MBM, based on the same attribution key. Consequently, the net revenue raised, after rebates, would come from customers in developed countries only, thereby complying with the principles and provisions of the UNFCCC in relation to CBDRRC, while simultaneously ensuring a universal approach to reducing shipping emissions.

3..6 The rebate key could be adjusted yearly, in line with changes in trade patterns. The optimal rebate keys for 150+ developing countries and attribution keys for developed countries are calculated based on 2007 trade by sea and air.9 As an example, assuming that the total maritime MBM costs $10 billion, Ethiopia’s annual rebate would be $6 million (i.e. 0.06% of $10bn).

3..7 Thus to make further progress on the global carbon pricing of shipping emissions, the EU and especially the UK, given that the IMO is headquartered in London, should support compensating poorer countries that would be most affected by such approach, as proposed in a Rebate Mechanism.

4. Long-term climate financing from pricing shipping emissions: fair, affordable and necessary

4..1. The second condition in order for global pricing of shipping emissions to be consistent with the principles and aims of the UNFCCC is for the net revenue generated, or a significant share of it, to be channelled towards climate financing. This would help to mobilize the $100bn that developed countries agreed to provide annually by 2020 to support climate action in developing countries (as agreed in Copenhagen Accords in 2009 and confirmed in the Cancun Agreements in 2010).

8 Detailed analysis is available in the study on the Optimal Rebate Key, available at: www.imers.org/docs/rebateKey.pdf. 9 See: http://www.imers.org/docs/RM_outline_and_keys.pdf

http://www.imers.org/docs/rebateKey.pdf

4..2. Raising climate finance from pricing shipping emissions is fair, affordable and necessary, providing there is no net incidence on developing countries, especially the poorest, as described in the previous section.

4..3. It would be fair because everyone would pay for the shipping emissions globally, but the revenue raised from developed countries would go to finance climate action in developing countries. As an example, assuming the total revenue raised is $10 billion, the EU would be credited with $2.85 billion in climate finance, including $400 million credited to the UK, assuming that all the revenues raised are used for climate finance (reflecting the attribution keys of 28.5% and 4% for the EU and UK respectively).

4..4. This would also be easily affordable, owing to the high-energy efficiency of seaborne transport. The potential increase in prices of imported goods is low, under 0.2% on average (equivalent to 2 pence in every 10 pounds).10

4..5. Finally, it is necessary to mobilize predictable, stable, new and additional sources of climate finance, including to meet the goal of providing $100bn in climate finance annually from developed countries by 2020, from a mix of different sources. This is highlighted by the UN High Level Advisory Group on Climate Change Financing (AGF). This consideration is particularly pertinent given the significant budgetary challenges currently faced by some developed countries.

5. Progress on a maritime carbon price could be helpful to negotiations on aviation

5..1. Concerns about equity issues and the lack of earmarking of revenue for climate finance have also been raised in relation to the proposed inclusion of aviation in the EU ETS. In fact, the EU is facing concerted challenges to its unilateral approach to tackle emissions from aviation – court challenges from US airlines, opposition from the USA and Russia and threats of retaliation or disputes from China and India. Similar tensions can also be expected from the pursuit of a unilateral approach to shipping by the EU.

10 The average cost impact is calculated as 0.16% for 2020, by dividing the total cost of $26.3 billion by estimated seaborne trade of $16.6 trillion (both figures for 2020). The total cost is calculated by multiplying the forecast emissions of 1,050 MtCO2 by an assumed carbon price of $25/tCO2. In reality, the average cost impact is likely to be even lower: the current calculation ignores fuel savings arising from behavioural change and any efficiency improvements, while the carbon costs are counted at the assumed carbon price applied to all shipping carbon emissions. Similar average results are obtained when using bottom-up incidence calculations for individual countries, although impacts on different product categories vary, with low value-to-weight products impacted most.

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5..2. Thus the best approach to the inherently global sectors of international transport is a concomitantly global one, with equity concerns addressed through the inclusion of a rebate mechanism and earmarking of revenues for climate finance. We believe that there is currently an opportunity to move forward with such an approach. China, Brazil, India and South Africa have all signalled – in the IMO or on the side-lines of the UNFCCC – a new willingness to consider a global approach to tackling emissions from shipping, provided such a global scheme would entail “no net incidence” on developing countries.

5..3. The EU is unlikely to change their current policy on reducing emissions from aviation until a suitable global approach is agreed, given the difficulties faced in negotiations on agreeing a global solution to date. Nevertheless, both the UK and the EU can and should reiterate their preference for reaching a global agreement on international transport emissions and champion a fair approach to carbon pricing of shipping, with no net incidence on developing countries and with revenues being used for financing climate change action. Such a position in relation to shipping could have the additional advantage of reinvigorating discussions in the International Civil Aviation Organization (ICAO) on pricing of aviation emissions.

6. Conclusion

6..1. A global and equitable mechanism for carbon pricing of international maritime transport is feasible and agreement on such a mechanism should be pursued actively by the UK and the EU. It would significantly reduce emissions from this sector,11 and is likely to be acceptable to developing countries if it ensures no net incidence on them. It could raise substantial finance to help poorer countries adapt to climate change and build low carbon development. As such, it would constitute real progress towards a functioning global climate regime. The UK should champion such an approach through coordinated action with its EU partners and at the G20, with the aim of reaching agreement at the UNFCCC Summit in Durban, in December 2011.

August 2011

11 As confirmed by the comprehensive report of the IMO’s MBM Expert Group contained in document MEPC 61/INF.2, available at: http://www.imo.org/OurWork/Environment/PollutionPrevention/AirPollution/Documents/INF-2.pdf.

Memorandum submitted by Friends of the Earth (EWNI) (ETS 23)

1. Friends of the Earth EWNI welcomes the Energy and Climate Change Committee's current enquiry and is grateful for the opportunity to comment on a number of the issues that it has chosen to examine. Executive Summary 2. The UK government should not support the continuation of the EU ETS and immediately shift its resources and attention to the better alternatives already being pursued. The EU ETS has not and will not deliver the genuine emissions reductions necessary to meet the UK’s obligations in averting catastrophic climate change. The first two phases have failed to cut emissions, while Phase III looks set to start with a surplus of permits so large that it would require no domestic reductions until 2018. 3. The EU ETS has handed over huge sums of taxpayers’ money to the power sector and industrial polluters at a time of great austerity, with little obvious benefit: subsidies could amount to almost £100 billion by the end of phase II. This is the combined effect of “passing through” to consumers the costs of permits received for free, plus the resale value of surplus permits. A windfall tax should be considered to re-capture these surpluses, with the income spent on domestic energy efficiency work. 4. While the UK government should not support the continuation of the EU ETS, the very least it can do is address extensive loopholes throughout the scheme. These include measures to exclude all international offsets, putting a stop to the practice of freely allocating permits to polluters, imposing a much tighter cap, and preventing the use of banked permits from earlier phases of the ETS scheme. Measures to expand the ETS by linking with schemes outside of the EU, or promoting “new market mechanisms” (such as sectoral crediting or trading) with developing countries should be stopped. These recommendations do not obviate the need to reconsider support for the ETS altogether. 5. A stop should be put to the dangerous obsession with the ETS. Instead, much greater priority should be given to other policy options, including but not limited to regulations such as energy efficiency standards, renewable energy incentives such as feed-in tariffs, and financial incentives for cleaner investment such as a financial transaction tax or redirected EU structural funds. 6. Friends of the Earth has published a number of reports analysing carbon trading, which include:

A Dangerous Obsession: The evidence against carbon trading and for real solutions to avoid a climate crunch, http://www.foe.co.uk/resource/reports/dangerous_obsession.pdf

Clearing the Air: Moving on from Carbon Trading to Real Solutions http://www.foe.co.uk/resource/reports/clearing_air.pdf

The EU Emissions Trading System: failing to deliver http://www.foeeurope.org/climate/download/FoEE_ETS_Oct2010.pdf

http://www.foe.co.uk/resource/reports/dangerous_obsession.pdf

http://www.foe.co.uk/resource/briefing_notes/dangerous_distraction.pdf

http://www.foeeurope.org/climate/download/FoEE_ETS_Oct2010.pdf

Does the EU ETS remain a viable instrument for climate change mitigation in the EU? 7. The EU ETS has failed to significantly reduce carbon emissions across Europe. The first “pilot” phase (2005-2007) saw too many permits handed out, with an overall surplus of 267 Mt CO2e (Megatonnes Carbon Dioxide Equivalent), more than the annual emissions of the UK1. The permit price collapsed when markets saw that the scheme was over-allocated. 8. Phase II of the ETS, from 2008 to 2012, is also misfiring badly. The Commission has claimed some successes – for example, emissions from installations covered by the scheme fell by 11.6 per cent in 2009. However, this needs to be set against falls in production of electricity and industrial goods of 13.85 per cent in 2009 as a result of the recession2. This comparison indicates that emissions reductions were the result of less production (in the context of an economic downturn) rather than the ETS itself.

9. The combined effect of the economic downturn and generous provisions for the purchase of international offsets is an oversupply of permits. All credible predictions for phase II expect there to be a significant surplus by 2012. Permit prices have not collapsed to zero (as in Phase I), but this is only because it is possible to “bank” them for use in Phase III (2013-2020). However, this same possibility undermines environmental integrity. More than three-quarters of installations have surplus permits, which means they can delay taking action to reduce their greenhouse gas emissions at source3. These surplus permits should be cancelled. 10. By the end of Phase II, the EU ETS could well have awarded polluters close to £100 billion in subsidies. This includes an estimated €19 (£16.7) billion to power companies in Phase I, and up to €71 (£62.5) billion in Phase II; and up to €20 (£17.6) billion to heavy industry4. These perverse incentives result from the “pass through” of costs to consumers, plus the estimated worth or freely allocated surplus permits. 11. Phase III will still see further significant subsidies paid to industry. The free permits being enjoyed by three-quarters of manufacturing has resulted from lobbying by heavy industry, and could yield at least €7 (£6.2) billion in windfall revenues annually.5 In addition, the Commission is currently undertaking a review of “state aid” rules which could see the granting of direct financial subsidies for “indirect” losses – in effect, subsidising cost pass through. The University of Groningen Centre of Energy Law has pointed out that this “artificially reduces the operating costs of high carbon-content generation capacity lower in the merit order (from hydro and nuclear to coal, combined fuel and gas) leading to the building of more coal-fired power plant.”6 Such a measure is counter-productive, in other words. The DECC submission to the Commission's state aid rule consultation also notes that the number of sectors exposed to carbon leakage risks is small.7 The UK should therefore seek to address at the earliest opportunity the over-generous allocation of free permits to heavy industry, 12. In the process of passing the revised ETS Directive, energy companies successfully lobbied for an estimated €4.5 (£4) billion in subsidies for Carbon Capture and Storage (CCS), with a smaller amount for “clean” energy that includes biofuels.8 Such investments could be an impediment - CCS delays the transition to renewable energy; while biofuels cause significant environmental and social harm9. These measures are counter-productive: auction revenues should not be used to subsidise fossil fuel infrastructure, CCS, or other impediments to a low carbon transition.

13. The use of international offsets is a further, endemic problem. Carbon offsetting is, at best, a zero-sum exercise: it moves the obligation to reduce emissions away from the EU, and counts reductions from “emissions-savings” projects as equivalent to domestic reductions. In reality, between one-third and three-quarters of these projects do not represent reductions by any reckoning. The net effect of the scheme is therefore to increase emissions. 14. To date, the CDM has mostly substituted a reduction to reduce CO2 emissions with spurious industrial gas offsets (from HFC and N2O). Even though these credits are banned from phase III, the “banking” of permits means that they can continue to be “cashed in” until 2012, displacing permits and so reducing obligations in the longer term. The emissions reductions claims of the other most numerous project types (including hydro-power and wind) are also highly questionable – the volatility of offset prices, combined with the mix of other incentives, makes it highly likely that such projects would have happened anyway (they are “non-additional” in the emissions trading jargon). Research by Friends of the Earth EWNI has further shown that offsetting does not ensure positive sustainable development and is profoundly unjust10. Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes?

15. The ETS should exclude offset credits, and a broader reconsideration of policy should be undertaken. The scheme is increasingly isolated internationally. Proposed emissions trading schemes in the USA, Japan and Canada have stalled indefinitely; new markets in Australia and South Korea face significant delays; and a court action in California has also delayed the start of a planned scheme there. According to the latest World Bank figures, the EU ETS drives up to 97 per cent of the global trade in carbon.11 The assumptions that the ETS would lead to the emergence of a global carbon trading system are not being borne out. This has led to a situation in which the availability of permits and credits already exceeds demand. New carbon market mechanisms (e.g. sectoral), the expansion of the CDM into new areas (e.g. agriculture) or longer-term moves towards offsets from REDD, would significantly worsen this situation (see below). What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad? 16. If current policies remain unchanged, there are significant reasons to doubt that the EU ETS will deliver domestic emissions reductions in Phase III. Current estimates suggest that the second phase of the scheme could end with an overall surplus of 1,280 Mt CO2e, which could be carried over (“banked”) for use from 2013 onwards12. These figures are swelled by the use of offset credits. The phase II surpluses alone could allow the scheme to continue without any domestic emissions reductions until 201813. 17. Beyond these loopholes, the EU ETS is fundamentally incapable of meeting the necessary ambition to tackle the planetary emergency and keep temperatures below 2 degrees or the 1.5 degrees now being called for by over 100 developing countries and Christiana Figueres, Executive Secretary of the UNFCCC. The stated aim of the phase III cap is to achieve a 20 per cent reduction in greenhouse gases across the 27-state bloc by 2020 compared to 1990 levels. This falls a long way short of what climate science suggests is needed to avoid dangerous climate change. By comparison, Friends of the Earth has shown that an immediate target to reduce greenhouse gas emissions within the UK and EU by 40 per

cent or more by 2020 without offsets and the use of carbon markets is both achievable and desirable14;15.

Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved? 18. In theory, the linking of emissions trading schemes underneath a global cap would make the scheme run more smoothly: reducing competition distortions, and doing away with the need for offsets. However, such as scheme would be unlikely to respect the requirement of “common but differentiated responsibility” within the international system; and it would still (if it worked as planned) incentivise short-term reductions over longer-term transformative changes. 19. In practice, there is no credible possibility that a global cap-and-trade scheme will be introduced. Linking emissions trading schemes is far more likely to result in a patchwork of rules, and trigger a race to the bottom. At present, the EU ETS excludes credits from Land Use, Land Use Change and Forestry (LULUCF) and from hydro-power projects that do not comply with World Commission on Dams guidelines. It will also exclude HFC and N2O offset credits from April 2013. Such measures would be impossible to police if the scheme were linked with others that did not share these exemptions, since it would be impossible to tell if trading units entering the EU ETS had been freed up by their displacement (within a linked scheme) by others that the EU would not accept for compliance. Put simply, if the EU bans LULUCF credits, but an Australian scheme accepts them, Australian installations might buy LULUCF credits for compliance purposes and sell their own permits into the EU ETS scheme. This form of “arbitrage” is not so much an abuse of the system as a symptom of a flawed design. 20. The claim that carbon markets are “economically efficient” also needs to be examined more critically – again, with an eye to looking how the practice has diverged from the theory. In theory, emissions trading incentivises companies to trade permits in a way that allows for the cheapest reductions to happen first. This is the basis of the claim that it is “efficient.” In practice, cheap permits circulate because of structural surpluses awarded to heavy industry within the EU, and because offsets are allowed in the scheme. These are cheap because these are mostly paper “reductions” that do not require changes in industrial or power sector practice. 21. Emissions trading has not incentivised significant technological changes. At best, it has had localised and temporary effects in incentivising power generation switches from coal to gas. But this should be set against some of the scheme's perverse incentives – most notably, the generous award of free certificates to hard lignite plants in Germany (through the “new entrants reserve”) has contributed to a “dash for coal” in German power production.16 Such generosity is not an anomaly, but is the result of industry lobbying (and protectionism). 22. Temporary power production switches from coal to gas can also be seen to illustrate the limitations of the EU ETS. They do nothing to encourage the transition to clean technology. Indeed, the “flexibility” of permit trading tends to trigger a “lock in” of outdated forms of power and industrial production, by offering a means to delay this transition. Such delays can end up costing more in the long-term, however.


23. Rather than spending money and effort on trying to export the failed carbon trading model, the UK should spend those resources promoting measures that directly catalyse cleaner development. For example, the UK has pledged £7 million of its fast-start funding to the World Bank's Partnership for Market Readiness, which promotes cap-and-trade in middle income countries; as well as putting resources into ICAP (International Carbon Action Partnership). 24. There are multiple actions that the UK and the EU could take to promote and support more effective action on climate change. These include market mechanisms, such as feed-in tariffs, which are estimated to be responsible for almost 90 percent of the growth that has occurred in Europe’s wind energy sector since 1995.17 Could sectoral agreements form part of the future of the EU ETS? 25. Climate Change Agreements, which agree a significant discount from the Climate Change Levy in exchange for an agreed sectoral target, are hampered by significant information asymmetries between government and industry. They have so far proven ineffective, offering a financial transfer from taxpayer to business in exchange for what amounts to little more than “business as usual.” This model would not address the problems of the EU ETS. Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism? 26. The UK should be actively trying to exclude alternative international credits in lieu of the CDM. International offsets offer an escape hatch for the avoidance of emissions reductions commitments, and shift the burden of climate mitigation to developing countries – contributing to breaches of the global carbon budget.18 As we have shown above, the inclusion of international credits is a considerable “hole” in the scheme's cap, which should be closed. 27. Closing the door to CDM credits would require a swift cut in their supply, if it is to be meaningful. This is in contrast to the implementation of the ban on HFC and adipic acid credits, which was delayed to April 2013 despite Commissioner Hedegaard's recognition that such projects exhibit a “total lack of environmental integrity.”19 Delaying the closure of this loophole is likely to see the over-surrender of the banned credits in the short term, with surplus allowances banked. 28. New market mechanisms, such as “sectoral crediting”, do not offer a viable alternative to international crediting. In fact, EU efforts to pursue these new mechanisms in the context of a declining global trade in carbon are likely to further undermine the scheme by generating surplus credits that would collapse the carbon price. Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system? 29. The EU ETS does not constrain unilateral actions, but it does have the capacity to undermine them at a time when we should be aggressively pursuing effective alternatives. For example, the Integrated

Pollution Prevention and Control (IPPC) Directive was modified to explicitly exclude CO2 emission limits for installations which are covered by the EU ETS, amid fears that efficiency requirements under the IPPC could damage carbon prices.20 Leaked documents (from 2007) suggested that the UK government sought to weaken energy efficiency measures and renewable energy targets on the grounds that these could collapse the carbon price. Such fears are not arbitrary – a recent European Commission Impact Assessment on the proposed inclusion of industrial sectors in EU energy efficiency regulations suggested a scenario in which the carbon price could collapse to zero.21 30. Carbon floor prices have been suggested as a means to address this risk, and the UK has taken a lead in implementing such measures. However, as reports by both Credit Suisse and IPPR have pointed out, the most notable effect of the UK's policy is likely to be a rise in consumer energy prices, exacerbating fuel poverty, and windfall profits for existing energy generators of around £1 billion per year – while doing nothing to reduce emissions.22 Its environmental effectiveness may, arguably, be increased if a floor price were European-wide – but appending such a measure to the ETS would remain considerably more cumbersome (and less cost-effective) than other forms of taxation, such as financial transactions taxes or carbon taxes. However, this should not stop the UK introducing a windfall tax to capture the surpluses unduly gained by energy companies which, along with income from the carbon floor price, should be spent on domestic energy efficiency work. 31. The underlying point is that the EU ETS contradicts more effective policies, and that making it the central climate change mitigation policy is counter-productive. Member States and the Commission should be encouraged to develop a suite of climate-related policies, including binding energy efficiency targets; and national climate laws to tackle industry or industry sector emissions. How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? 32. The fraud cases have further damaged confidence, but the recent changes to registry rules have not addressed many of the risks associated with trading carbon. It is certainly the case that new registry rules include basic improvements (e.g. know-your-customer checks). But the new rules also include some steps in the wrong direction – for example, a provision for “non-disclosure of the serial number of allowances” (except for law enforcement agencies) reduces transparency in an already opaque system, and could actually make it more difficult for civil society groups and the media to draw attention to fraud cases.23

33. Changes to registry rules do not fully address the problems faced when trading carbon, however. Regulations should consider environmental effectiveness criteria, such as those proposed in Senator Kerry's American Power Act (the latest version of the leading climate bill in the U.S. Senate).24 These include mandatory exchange trading and clearing of carbon, and also measures to orient trading so that it is mainly restricted to compliance traders, rather than speculators. At present, the majority of trades are for speculation, resulting in a carbon price that is highly volatile. This means that it sends a poor signal to investors seeking to make longer-term decisions on infrastructure investments. Position limits and capital and margin requirements on traders could also help to rein in some of this speculation.

34. There is a limit to what such regulations might achieve, however. Currently, carbon traders are lobbying for exemptions from derivatives and commodity regulations being developed in the wake of

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the financial crisis.25 A key problem with regulating carbon markets is that there is no clarity on the underlying asset (e.g. it is not agreed whether carbon is a “financial instrument”). The relative complexity and size of this market in an intangible commodity leaves it susceptible to gaming or full-blown fraud. These problems are better addressed at the level of fundamental market structure, rather than simply through derivatives legislation or market abuse rules designed to contain their excesses. Simplifying the market structure by excluding offsets or credits from “new market mechanisms”, and limiting the sectoral scope of the ETS, would be steps in the right direction. However, this does not obviate the need to reconsider support for carbon markets altogether.

August 2011

1 Ellerman, D. et al. 2010. Pricing Carbon: The European Union Emissions Trading Scheme Cambridge: Cambridge University Press, p.48

2 Morris, D. and B. Worthington, 2010. Cap or Trap?How the EU ETS risks locking-in carbon emissions p .18 3 European Commission DG Clima. 2011. Verified Emissions for 2008-2009-2010 and allocations 2008-2009-2010, 15

April http://ec.europa.eu/clima/documentation/ets/docs/registries/verified_emissions_en.xls 4 Ellerman et al., p.326; Point Carbon, WWF. 2008 EU ETS Phase II – The potential and scale of windfall profits in the

power sector. The figure for industry combines an estimates of “pass through” costs (€14 billion) with an estimate for the value of surplus permits (€6.5 billion). See De Bruyn, S. et al. 2010. Does the energy intensive industry obtain windfall profits through the EU ETS? Delft: CE Delft; Morris and Worthington, p.26

5 Ralf Martin, Mirabelle Muûls and Ulrich J. Wagner. 2010. “Still time to reclaim the European Union Emissions Trading System for the European tax payer”, Policy Brief, Centre for Economic Performance, London School of Economics

6 State Aid Group of the Groningen Centre of Energy Law. 2011. “Comments on the Commission's Consultation paper dealing with: 'New State aid Guidelines in the context of the amended EU Emissions Trading Scheme'”

7 UK Government. 2011.“UK response to The European Commission consultation on New State aid Guidelines in the context of the amended EU Emissions Trading Scheme”, http://ec.europa.eu/competition/consultations/2011_questionnaire_emissions_trading/uk_en.pdf

8 This figure corresponds to the auction revenues from 300 million permits in the New Entrants’ Reserve, and assumes a €15 carbon price.

9 Bowyer, D. 2011. Anticipated Indirect Land Use Change Associated with Expanded Use of Biofuels and Bioliquids in the EU – An Analysis of the National Renewable Energy Action Plans. London: Institute for European Environmental Policy

10 Friends of the Earth EWNI, 2009. A Dangerous Distraction: Why offsetting is failing the clime and people 11 World Bank 2011. State and Trends of the Carbon Market 2011 Washington: World Bank Group, p.9 12 World Bank 2011, p.63 13 Morris, D. 2011. Buckle Up! Tighten the cap and avoid the carbon crash London: Sandbag, p.16 14 Friends of the Earth Europe and the Stockholm Environment Institute. 2009. The 40% Study: Mobilising Europe to

achieve Climate Justice. Brussels: FOEE 15 Friends of the Earth. 2009. Cutting Carbon Locally – and how to pay for it. London: Friends of the Earth 16 Pahle M. et al. 2011. “How emission certificate allocations distort fossil investments: The German example.” Energy

Policy, doi:10.1016/j.enpol.2011.01.027, p.12 17 AtKisson, A. 2009. Global Green New Deal for Climate, Energy, and Development, UN-DESA, p11 18 Friends of the Earth EWNI, 2010. Reckless gamblers : How politicians’ inaction is ramping up the risk of dangerous

climate change 19 Carrington, D. 2010. “EU plans to clamp down on carbon trading scam” The Guardian, 26 October 20 Gilbertson, T. and Reyes, O. 2009. Carbon Trading: how it works and why it fails Uppsala: Dag Hammarskjöld

Foundation, p.21 21 European Commission DG Energy. 2011. “Impact Assessment Accompanying the document Directive of the European

Parliament and of the Council on energy efficiency” SEC(2011) 779 final, 22 June, p.30 22 Maxwell, D. 2011. Hot Air: The carbon price floor in the UK London: IPPR; McCabe, J. 2011. “£7bn windfall for UK

utilities from carbon price floor” Environmental Finance, 28 June

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23 European Commission DG Clima. 2011. Questions & Answers on Emissions Trading: new registry rules, 8 July 24 Friends of the Earth USA, 2010. Comments to Commodity Futures Trading Commission on Oversight of existing and

prospective carbon markets, 17 December 25 IETA, 2011. Response to MiFID Consultation, 2 February

Memorandum submitted by the International Emissions Trading Association (ETS 24)

Please find below the response by the International Emissions Trading Association to the inquiry by the UK’s Energy and Climate Change Committee into the EU’s Emissions Trading Scheme. 1 1. General Remarks

1.1 IETA is the leading voice of the international business community on the subject of

emissions trading since 2000. Our 155 member companies include some of the world’s largest industrial and financial corporations—including global leaders in oil & gas, electricity, cement, aluminum, chemical, paper, and banking; as well as leading firms in the data verification and certification, brokering and trading, offset project development, legal, and consulting industries. A full list of our members is available on our website at www.ieta.org.

1.2 An emissions cap and trade scheme (ETS) ensures certainty in reaching an environmental target. It does this by setting an overall emissions cap, allocating that cap amongst the entities and allowing them to trade these allowances amongst themselves. Covered entities have to surrender one allowance for each tonne of carbon emitted. Trading allows the market to discover a price for emission abatement. This price corresponds to the costs if this tonne is abated rather than emitted and provides an incentive to cut emissions. An ETS thus ensures that emission reductions occur at a certain pace and at least costs allowing companies to evolve their own tactics, strategies and investments.

1.3 IETA’s members support emissions trading as a cost‐efficient and reliable way of achieving emission reductions. The European Union’s Emissions Trading Scheme (EU ETS) has succeeded in both, creating an EU‐wide price on carbon emissions and ensuring that approximately 45% of the EU’s GHG emissions are capped at a level consistent with adopted climate targets. This would not have been possible through other means, such as carbon taxes, which set a price but no emission limit. The EU ETS retains its position as the world’s most ambitious and comprehensive international response to addressing climate change.

1.4 Carbon leakage is a concern that looms over the effectiveness of an ETS if other nations do not introduce comparable efforts. The EU ETS already partially addresses this problem by ensuring that sectors exposed to significant risks of carbon leakage and accounting for over 70% of non‐power emissions in the ETS continue to receive a large but declining share of free allocation throughout phase 3 of the EU ETS as compensation ‐ though distribution between installations will vary with the application of stringent efficiency benchmarks.

1.5 Additional national policy measures targeting abatement for ETS‐covered sectors may lead merely to a re‐shifting of emissions between countries; additional EU measures may just shift demand between sectors. Unless the cap is altered, total EU emissions are likely to remain the same. While the ability to use such mechanism is not disputed, the breadth of IETA’s membership encompasses a disparity of views on unilateral measures. Many members are concerned about efforts to include additional provisions for emissions abatement in the ETS sectors such as the UK’s carbon price floor or the proposed Energy Efficiency Directive; others acknowledge the desire to drive achievement of more demanding national targets.

1 http://www.parliament.uk/business/committees/committees‐a‐z/commons‐select/energy‐and‐climate‐change‐committee/inquiries/eu‐emissions‐trading‐system/

http://www.ieta.org/

http://www.parliament.uk/business/committees/committees-a-z/commons-select/energy-and-climate-change-committee/inquiries/eu-emissions-trading-system/

http://www.parliament.uk/business/committees/committees-a-z/commons-select/energy-and-climate-change-committee/inquiries/eu-emissions-trading-system/

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1.6 While the EU only accounts for about 10% of worldwide emissions and will not, on its own, be in a position to significantly affect climate change, it needs to sustain a clear, irrevocable and ambitious agenda on climate change. It is on this basis that companies are undertaking better management of GHG emissions, investments in energy efficiency, clean technologies and switching from coal use to gas or renewables thereby also enhancing our energy security and removing sources of local pollution.

1.7 The absence of a legally binding international emissions reduction commitment does not have a bearing on the continuation of the EU ETS, but does, in the absence of a comparably effective suite of voluntary national actions, slow down the pace of global climate mitigation. The ETS Directive2 is an EU‐internal legislation to fight climate change and provide enhanced energy security with no sunset clause. An internationally binding agreement seems out of reach anytime soon, but what matters now is that Member States reach a political agreement on the EU’s 2050 Roadmap to give clarity to industry on the post‐2020 abatement trajectory in the EU. This will prevent a lock‐in of emissions through today’s investments and make the transition to a low‐carbon economy least costly.

1.8 The EU’s leadership on emissions trading is having effects around the world, even if the deployment and scale of new schemes has not been as ambitious as we had hoped for. Currently at least 20 nations world‐wide contemplate the introduction of cap and trade system of some kind, including South Korea, Australia, Japan, Taiwan, Brazil, India, United States and China (the two latter at sub‐national level). The EU is being consulted on all steps of implementation from monitoring, reporting and verification to the trading framework needed to have a liquid but well regulated market.

1.9 IETA strongly supports linking of emissions trading schemes as this can enhance cost‐effectiveness and, by adding liquidity, also strengthens price discovery ‐ thereby contributing to a more efficient outcome. Linking will require some strong efforts of design harmonization and should only involve thoroughly tried and tested schemes. The accounting framework will be of key importance, i.e. certainty that a tonne of carbon emitted and abated is the same across different schemes and that the verification process is transparent.

1.10 Regulators should base market supply on transparent, well‐understood and predictable processes and criteria. An ETS can only function when scarcity is ensured. While IETA is still developing its position on the idea of setting aside allowances to ensure scarcity following adoption of additional measures including energy efficiency obligations, it is important to note that without a revision of the ETS Directive before 2020, the allowances withdrawn would have to be put back to the market.3

2. Specific points on questions raised

2.1 Does the EU ETS remain a viable instrument for climate change mitigation in the EU? The EU ETS is the cornerstone of the EU’s climate policy and continues to be a viable instrument for climate change mitigation. It is also a learning process, which builds on experience from past trading phases to continuously improve the functioning of the scheme. Carbon emissions in the EU ETS have fallen by 13.79% between 2007 and 2009. According to

2 2003/87/EC (consolidated version, following amendment 2008/101/EC). 3 According to article 10 of the EU ETS Directive, “[f]rom 2013 onwards, Member States shall auction all allowances which are not allocated free of charge [… ]“

3

e EU ETS.

data published by the Commission, average annual emissions per installation are now 8.3% below 2005 level.4 According to a 2011 survey by Point Carbon5, about 70% of respondents answered that they have already or are planning emission reductions in their company as a consequence of the EU ETS. And this share has remained almost stable for the past five years. For the pilot phase, from 2005‐7, Ellerman et al6 have demonstrated that emissions decreased by 2 to 5 per cent per year as a result of th

Figure 1: Tracking Progress Towards Kyoto Targets (EEA, 2010)

An ETS gives policy makers full certainty as to reaching the environmental target, as the cap reduction factor sets out the emission reduction path that will in any case be met (see figure 1). The EU ETS is a pan‐European policy instrument setting a unique carbon price signal across the EU and beyond, thereby creating the best conditions for a level playing field within the EU – a result unreachable through other means, in particular tax‐based ones. But it also provides flexibility through the price mechanism, allowing abatement where it is cheapest and that across all industries covered by the scheme. Its institutions, trading infrastructure and measurement/verification methodologies are robust and at the forefront of what has been done elsewhere. Finally, it is providing a significant source of revenue for greening the economy as, according to the ETS Directive, at least 50% of auction revenue should be recycled for this purpose.

The introduction of the ETS resulted in carbon intensive projects being cancelled across the EU. With an absolute declining cap on carbon emissions, the case for unabated coal‐fired power plants has become very difficult. Not all emission abatement opportunities under the EU‐ETS coverage have been exhausted yet, and with new sectors and gases included from 2012, additional emission‐reduction potential will be made available. Looking

4 ec.europa.eu/clima/publications/docs/factsheet_ets_emissions_en.pdf 5 Carbon Market Survey 2011, Point Carbon: http://www.pointcarbon.com/research/promo/research/1.1509325 6 Ellerman et al (2010) Pricing Carbon: The European Union Emissions’ Trading Scheme, Cambridge University Press.

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forward, the change in design for phase III – with the combination of a longer trading period and full auctions for the power sector – is expected to reintroduce elements of long term marginal costs in the pricing of carbon. This is relevant as payback periods for low‐carbon investments can extend over decades. To the extent that amendments to the EU ETS policy are deemed necessary, they should apply EU‐wide and be predictable from a regulatory point of view. To provide robust investment signals, the level of emissions reduction ambition and the carbon price path must be reasonably predictable to give long‐term confidence to investors.

In sum, IETA believes that the EU ETS is a viable instrument for emission reductions provided that: • Policy makers provide a framework for investment decisions that signals long term

viability and longevity. Recent signals have raised doubts about the role that policy makers see for the EU ETS and have led to a reduction in market confidence.

• Ad‐hoc policy changes are avoided and, where more ambitious emission targets are desired, these should be reflected in the trajectory of the ETS phase cap or based on transparent and predictable policy rules in the existing regulation.

• The ETS price signal is not diluted by other policies and measures. Interventions and other policies targeted at the very same emission sources covered by the EU ETS would be expected to have mainly re‐distributed carbon emissions, undermining confidence in the market mechanism, and increasing the societal costs of emission abatement.

2.2 Can the EU ETS operate effectively in a world without legally‐binding emissions reduction

commitments and other cap‐and‐trade schemes?�

It should be recognized that the EU ETS Directive was introduced during a time when there was expectation of a global climate agreement, including binding commitments for all developed economies. The absence of a post‐Kyoto agreement has implications for the pace of moving towards a truly global carbon market. It does not have a bearing on the EU ETS, which is a reflection of the EU’s domestic policy ambition on climate and energy and not dependent on the Kyoto Protocol. As a market, the scope, depth and liquidity of the EU ETS are sufficient so it can function as a stand‐alone instrument in an efficient manner. So, as long as climate change mitigation remains a priority, the EU ETS may serve as a proven cost efficient tool to reach a politically set reduction target.

The EU ETS will continue to be in operation also after the third trading period (post‐2020). The amended ETS directive agreed by the Commission, European Parliament and EU Member States in 2008 has no sunset clause or mechanism. This makes it independent from whether there will be a ratified binding global treaty in which the EU’s climate target is inscribed. The same goes for the emission trading schemes, which are currently drafted in California, Australia, South Korea, China and elsewhere. These nascent schemes are unlikely to be directly linked to a binding commitment according to which the parties have agreed to an absolute emissions cap for the entire economy. We have hence moved away from a top down climate negotiation process to a bottom up one where national policies are implemented even in the absence of agreed international climate targets.

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Without an international agreement with binding commitments, there is however a risk that the reduction obligations will not be sufficiently comparable in terms of ambition level or the compliance regime. The implications on competitiveness and environmental integrity in such a scenario could reduce the effectiveness of both the EU climate target and the EU ETS unless sufficient measures are developed to cope with such a negative impact. This conclusion is however not unique for the EU ETS, it applies to many climate policies.

So, in short, the ETS can operate effectively without an international climate agreement but it will be most effective if the EU (a) makes a clear political choice of the mid‐to long‐term target for emissions reductions, without attempting to choose, in the place of the market, the way it is achieved; (b) remembers that no pricing system can operate effectively without adequate scarcity; and (c) continues to support existing (i.e. CDM) and new offset mechanisms.

2.3 What reduction in emissions will the EU ETS deliver in Phase III, within the EU/abroad?�

The cap trajectory is set in advance and reflected in the number of allowances allocated to the installations subject to the EU ETS each year throughout the phase. This will lead to an average emission reduction in the ETS installations of 21% compared to 2005 levels by 2020. International offsets can contribute to this goal up to 50% but it could be less in practice, depending on how much market participants will make use of this cost‐efficient option. It is important to note that additional measures in individual countries will have no effect on the overall outcome of the EU ETS. Regional acceleration of carbon reductions simply lowers the overall demand for allowances, thereby reducing the EU‐wide carbon price (while increasing local costs) and slowing the pace of abatement elsewhere.

2.4 Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved?�

More generally, linking to other schemes would enhance economic efficiency by levelling the playing field, extending options for low cost abatement and scaling up liquidity. But this is not necessarily a one‐way equation. Environmental integrity could also suffer if the other scheme does not use the same accounting basis and if double counting occurs. Transparency and solid monitoring, reporting and verification would be a key condition for an environmental and economically efficient linking. The use of offsets in the major trading schemes around the world represents an indirect form of linking to other trading schemes using the same classes of offset, which has resulted in significant cost savings for companies in the EU ETS. Given that we do not ‐ and will not for some time ‐ have an international climate agreement, linking will take the form of bilateral agreements and can then be gradually expanded towards a more international carbon market. In sum, linking is challenging but will allow in time progressive delivery of a global solution: • There are no other large and credible schemes with which to link at present. New Zealand

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has the only national operational scheme but it is much smaller and includes forestry credits, which the EU ETS does not.

• Linking introduces significant complications in the form of banking and offset eligibility. Any scheme that the EU ETS proposes to link to must share the EU ETS rules on banking and eligibility. Linked schemes must also take particular care concerning potential over‐allocation of allowances, which then flood into the EU ETS or vice versa.

• From a longer‐term perspective however, the EU ETS is in a good position to work now with each new scheme that is in operation or developing (eg ETS at State level in New Zealand, Australia, South Korea or at regional level in California or Chinese provinces). The more schemes that link under EU ETS compatible rules, the more standard these rules will become for any new schemes.

2.5 What actions should the UK and the EU be taking to promote the development of

compatible ETSs internationally? On the basis of lessons learned from the EU ETS, policy makers should promote achievements in international fora and with trading partners. Policy makers also are expected to signal the continued support of ‐ and confidence in ‐ the ETS as the main vehicle to reach emission reductions in the EU. Joint action on this front is required. Too often, we hear doubts about the existence of ETS beyond phase 2. This leads to delays in investment decisions, which can add costs for companies and slow down a transition towards a low carbon economy. The EU and Member States should actively encourage and provide capacity building to other countries to develop market based instruments and make available the expertise in technical domains from monitoring, reporting and verification to allocation through benchmarks or auctions and trading infrastructure. Offering linking could be another form of encouragement for countries to further proceed in their own ambition and to diffuse local resistance. Here are some of the key messages, IETA has been communicating to an international audience:

• Emissions trading does what it says on the tin. • Prices reflect the supply‐demand equilibrium. • Set up the parameters right and a substantial market will appear. • Scarcity is needed – banking helps. • Strong central allocation control is necessary. • It is not a substitute for investment targets, should those be thought necessary. • Competitiveness is a potent political issue even without evidence. • Coherence with other overlapping policies is not easy to achieve.

2.6 Could sectoral agreements form part of the future of the EU ETS?� Sectoral mechanisms are one of many potential new market mechanisms, discussed under the UNFCCC. However, this is just one option, and one that has not been yet clearly outlined in any proposal, especially as to how the private sector will participate.

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If sectoral mechanisms were defined as a binding emission cap applied to a given sector in an economy, then yes, they could form a critical part of a future EU ETS. The EU ETS is itself a multi‐sector scheme covering installations, which operate stationary sources and shortly, aviation. Other countries (not just Annex 1 countries) could also implement multi‐ or single‐sector ETS and link with the EU ETS. For example, the power sector or the cement and steel sectors or international aviation sector in a given economy could enter into a binding ETS and link with the EU ETS. Sectoral mechanisms should enable extension to other sectors of the economy, as in the end the cost‐effectiveness of emissions trading resides in exploiting the natural difference in abatement costs within and across different sectors. By the same token, carbon leakage is not a problem in all sectors of the economy. A sector agreement could be seen as a first step towards a broader cap and trade scheme. During the seven years of existence of the CDM, we have developed valuable insight and experience with regards to establishing a credible and robust international standard for carbon offsets, appropriate governance structure and market oversight. Although there are still improvements to be made to the CDM, replicating this kind of infrastructure is likely to take at least two to three years. Ultimately, environmental integrity could suffer if the sectoral mechanism would not use the same accounting basis and if double counting occurs. Transparency and solid monitoring, reporting and verification would be a key condition. Sectoral mechanisms have in the past met great skepticism on the side of developing economies, because they tend to operate directly counter to the UN principle of Common but Differentiated Responsibilities, which requires action from developed countries first. The benefits of sectoral mechanisms (and other new market mechanisms) for the host country thus need to be elaborated and communicated much more clearly and vocally. Otherwise they will not take off. The advantages include: • Transfer and deployment of state of the art technology. • Investment from new sources of capital, backed by a newly created carbon currency. • Savings to the host country economy through lower subsidies on energy use / freed up

energy for sale on the international market. • Enhancing energy security. • Free access to low carbon markets (if the EU were one day to deploy border adjustments

on carbon intensive products).

2.7 Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism?

New mechanisms are desirable to expand the carbon price incentives to other parts of the world and to unleash a far greater abatement potential than the project‐based approach could possibly achieve.

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Developing such mechanisms is a challenge and will require full political support by the UK and other EU governments. But it has the potential to become a viable compliance instrument, like CDM credits.

IETA has been deeply involved in this debate for a number of years and is contributing to concrete proposals for such mechanisms. Yet such mechanisms can only emerge if there is a demand and investors’ interest. The EU ETS will be a key demand factor.

Until such new mechanisms are operational, the CDM remains the only workable market‐based tool to incentivize low carbon investments in developing countries. As such it constitutes a crucial bridging element. It is hence important to offer clear prospects for CDM credits as compliance units in the EU ETS and to support whole‐heartedly the current reforms at UNFCCC level.

The CDM has created a robust standard for carbon offsets which safeguards environmental integrity. To establish an alternative benchmark to this in order to source alternative credits with all the necessary checks and balances will take at least 3 – 5 years.

According to the ETS Directive, operators will still be able to surrender CDM credits alongside EU allowances in phase 3, albeit to a limited extent ‐ up to their use limit and not for all types of credits. This applies even in the absence of an international agreement. The EU should demonstrate flexibility in the use of offsets in the future and incentivize the development of new market mechanisms by granting access for solidly verified credits to the EU ETS. There have been some concerns that failure to agree targets under a second UN Kyoto Commitment Period will lead to the CDM Executive Board (EB) and other CDM machinery coming to a halt. The legal position does not seem to be entirely clear; but the majority view among practitioners and countries is that it is very unlikely the UNFCCC Parties will allow the system to stop.

2.8 Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system?�

The EU ETS has been legislated for by the EU Member States and the European Parliament, on the basis of a proposal by the EU Commission. The ETS Directive had to be transposed into national legislation, some countries are still in the process of adopting the 2008 amendments. In the 2008 revision, Member States agreed to substantially reinforce central aspects of the scheme. From 2013‐20, the EU‐wide cap will decrease each year by 1.74%. While other policies might be needed to deal with wider energy policy questions, the ETS should be the main policy instrument to abate emissions from installations under its remit. While IETA recognizes that some Member State have a more ambitious climate agenda, unilateral efforts by individual Member States to accelerate abatement in industries covered

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by the ETS7, lead to a re‐shifting of demand from one country (where additional efforts are undertaken) to the other countries, without any additional effect on aggregated emissions in the EU.

2.9 How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required?

The accumulation of fraudulent events over recent years has not affected confidence in the EU ETS as such but has significantly shaken confidence and trust of operators and other market participants in its administration. Moreover, it also damaged external perceptions of EU policy and emissions trading as a policy tool. While the fraud cases experienced in the EU ETS (online theft and VAT fraud) are not unique to the carbon market, the perceived lack of action from the side of the regulators has done great damage. Considering the increasingly large sums that are in circulation in a quickly growing market such as the EU ETS, it should have been expected early that it could attract criminal elements. If the regulators had been more prepared, they could have mitigated some of the most negative consequences in terms of e.g. the reputation of the EU ETS and the spot market’s collapse with complete shut‐down of registries and frozen transactions. Member States and the EU Commission need to remain vigilant and pro active in preventing fraud. For now, the registry security has been overhauled and if this will succeed in making the system more robust, we can be content. Further work on market oversight is expected, which should further enhance supervision of the market and prevention of other abuse cases that we have so far not experienced, including insider trading and market manipulation – known from the financial markets.

2.10 How can the EU ETS be strengthened to operate effectively in a world without legally

binding emissions reduction obligations? Member States, including the UK, should focus on supporting the development of the EU ETS as the most efficient way of providing carbon price investment signals. The case must be made that the EU can decarbonise without damaging the industrial basis of its economy. For this, certainty and stability of the scheme is vital. Global agreement and action should remain a priority, as the EU cannot solve the problem of climate change on its own. We believe that the following four objectives are central to its long‐term development: • Long‐term reduction targets are needed to provide effective carbon price signals for

investments, which have long payback periods. While the revised EU ETS Directive reflects this (no sunset clause on the emission reduction trajectory), the extension of the cap and the desired trajectory should be supported by a clear political consensus in which the ETS

7 Additional unilateral emission reductions may not be detrimental to the EU‐ETS if undertaken outside the scope of the EU‐ETS with no indirect impact on emissions within the EU‐ETS. Diffuse emissions (agriculture…) could thus be decreased without negative impact on the EU‐ETS.

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is accorded a central role. Such a consensus first requires holding a thorough debate – as planned under the EU 2050 low‐carbon roadmap – which the EU cannot afford to delay.

• Encourage all other Parties to the UNFCCC to adopt sectoral emission trading schemes for the most developed sectors of their economies and offer linking options with the EU ETS in return for adopting EU ETS values and rules. These can be implemented in conjunction with Copenhagen Pledges or KPII commitments.

• Develop and advertise the broader benefits of emissions trading and reduced energy consumption.

• Continue the internal co‐operation between EU and EEA competent authorities, to strive for harmonization of application and internal consistency of implementation ‐ particularly on National Implementation Measures, Accreditation & Verification, Monitoring & Reporting ‐ and to continually improve security measures against fraud.

August 2011

Memorandum submitted by PricewaterhouseCoopers (ETS 25)

Introduction PricewaterhouseCoopers LLP (PwC) welcomes this opportunity to respond to the Energy and Climate Change Committee Inquiry into the EU Emissions Trading System. PwC is a leader in climate change and carbon markets services, with over 200 experts worldwide. We have a deep understanding of policy developments and market trends, having been involved in the carbon markets for over 9 years. We have a high profile in climate change issues on the back of strong relationships with the UNFCCC, governments, and think tanks as well as our role as financial adviser on some of the biggest transactions in the carbon markets and a track record of diverse thought leadership pieces. PwC is an active member of the International Emissions Trading Association (IETA), the Carbon Markets and Investors Association (CMIA), and the Carbon Capture and Storage Association (CCSA). These industry associations are all responding the EEC’s inquiry and we broadly support the majority of the points made in their submissions. Our response is therefore limited to those areas where, we believe, further input or clarification is valuable. Responses to specific questions Does the EU ETS remain a viable instrument for climate change mitigation in the EU? 1. The debate about the viability and efficacy of the EU ETS, and cap-and-trade programmes more

broadly, is confused by differing views on what the objectives of an emissions trading scheme should be.

2. For some, the EU ETS should simply limit the total GHG emissions from a given group of

emitters and allow them the flexibility in determining how to meet their compliance obligation. This should be economically efficient and therefore lower the overall cost of achieving the emissions cap. Others suggest that, in addition to the above, the EU ETS should send a price signal which is sufficient to stimulate significant capital investment in low carbon technology such as renewable power generation, combined heat and power, and carbon capture and storage.

3. There is good evidence that the emissions of the installations included within the EU ETS are

within the overall cap, i.e. the EU ETS is achieving the environmental objective. The cases of non-compliance with the EU ETS are extremely rare. However, there is less evidence that the EU ETS is promoting capital investment at the scale necessary to achieve the long term emissions reduction targets envisaged by the UK and EU.

4. The EU ETS has encouraged companies to identify and implement operational efficiencies and,

at specific price points (of coal, gas and carbon), it does incentivise electricity generators to switch, for instance, from coal to natural gas and lower emissions. So the EU ETS has been effective in encouraging the companies regulated to take the low cost actions in reducing emissions. Whether the EU ETS can support more substantial capital investment in low carbon technology, such as carbon capture and storage, depends in part on first, the carbon price and secondly, the long term stability of the cap and trade regulation. In essence, the carbon price is determined by the supply of (the overall cap on emissions), and the demand for (the level of industrial activity), carbon allowances. The carbon market is still relatively young, so regulatory stability is important if companies are to rely on the carbon price to support capital investments. Investment requires both the expectation of stability of the regulatory regime over the life of the

investment, and an expectation that the carbon price will, on average, remain above the level that makes the investment economically viable. So the EU ETS needs to both maintain the certainty of regulation (long, loud) and the carbon price, either through market intervention as is seen in currency markets, or by setting a reserve price as noted in paragraph 12.

The carbon price 5. The overall cap on emissions is set a long time in advance of the compliance period. This helps

to send a long term signal to major emitters. Some are already considering what the cap for phase 4 of the EU ETS (starting in 2021) should be. However, the level of demand in the future also depends on the level of economic activity. As witnessed recently, with reduced output during the recession came lower demand for carbon credits and consequently lower carbon prices. As it is very difficult to predict the state of the economy, simply setting a target is not sufficient to send a long term signal to business. The increase in length of the compliance period (from 5 years in phase 2, to 8 years in phase 3) is also a positive development as it can stabilise the price signal, by limiting sharp fluctuations that might otherwise be caused by seasonal or other variations (such as a very cold winter).

6. In the 2011 IETA annual survey of carbon markets participants, undertaken by PwC, we found

that the average price expected for a 2020 EUA was approximately 20 euros. Not only was this down from the year before, but it was significantly below the carbon price (of approximately 50 euros) that respondents believed is necessary to achieve the 80% reductions by 2050.

http://www.pwc.co.uk/eng/publications/ieta-sixth-market-sentiment-survey.html

Regulatory stability and price volatility 7. A number of commentators suggest that carbon price volatility is a barrier to low carbon

investment. Although the carbon price has recently made headlines by hitting a 30-month low, it has been relatively stable when compared with coal, oil and natural gas prices. Investment depends in part on the stability of the carbon regulation (and consequently the price); regulatory signals therefore need to be long and loud. The EU ETS is only 6 years old, so there uncertainty about its form in 2020. The carbon market would change fundamentally if for example, revisions to the regulation are made which link the EU ETS to another cap and trade programme (in California or Australia for example), or which give forestry credits equivalence to EUA’s. The potential for these types of changes results in uncertainty or lack of confidence in the market and hinders large scale capital investment in low carbon technology.

8. Similarly, the EU and UK should consider what the impact on the carbon market will be when

implementing “complementary” or overlapping policies in the traded sector (e.g. renewable electricity goals or energy efficiency standards). These policies certainly have an important role to play, but may have the effect of lowering demand for, and consequently prices, of EU Allowances. What will then occur is ‘leakage’ between policies. So if the UK vigorously pursues renewable electricity goals (and is successful), demand for EUA’s would fall in the UK, the price would fall and so higher emissions elsewhere in the EU would result – because the overall EU-wide cap remains the same.

9. Two options could be considered which would address some of these issues: 10. When overlapping policies are considered and implemented in the EU, the cap on the total

number of allowances should also be re-evaluated. To avoid arbitrary tinkering with the market (which would be just as harmful), a central institution, with clear terms of reference and objectives, could play the role of maintaining stability in the carbon market. This would be similar to the role played by the European Central Bank on Eurobonds, and the Monetary Policy Committee on inflation. Provided that the terms of reference for such an institution were made

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clear (in terms of emissions and price goals), this body could play an important role in maintaining confidence and stability in the market in response to changes in economic or regulatory circumstances.

11. An alternative is to agree an EU-wide carbon price floor which would escalate over time. This

could be achieved by setting a reserve price in auctions. This would have the result of limiting the total number of allowances in circulation if a recession was prolonged or if an energy efficiency policy was particularly successful. Having a reserve price in auctions (in a system where over 50% of allowances are auctioned), would achieve a carbon floor price without forcing governments to buy back carbon allowances when the market price dropped to a certain point. The floor price would send a clearer, long term signal to investors about the price of carbon and should support more low carbon investment. It should be noted, however, while a carbon price floor in the UK may encourage low carbon investment in the UK, a reserve price for EU allowances would have to be set EU-wide.

Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved? 12. Overall, linking the EU ETS with other emissions trading schemes could bring numerous

benefits. With more participants and more emissions covered by the linked schemes, there would be greater liquidity in the market, and less vulnerability to price shocks. It would also increase the number of potential low cost opportunities for carbon reductions and therefore be more economically efficient. IETA and others have highlighted the potential benefits of linking the EU ETS with other schemes.

13. There would need to be equivalence of ambition between different trading schemes, or in other words the linked schemes would need to be managed with consistent policy objectives, price ambitions and approaches to auctioning (e.g. if a reserve price is implemented). If there is free allocation of allowances or less ambition in one market, the result will be that the flow of credits will generally only be one way. Linking market A with a carbon price of 20, to market B with a carbon price of 10 will mean that compliance players in market A will buy from those in market B until the price settles at a new point. This is in effect a transfer of funds from one country or region to another. This concern could be addressed if there is full auctioning for all participants in the linked market.

14. A second concern with linking is that it has the potential to muddle policies objectives. At

Cancun, governments agreed to develop a mechanism to tackle deforestation (and land degradation), known as REDD+. Tackling deforestation is critical for many reasons. Such a mechanism could provide carbon credits to support policies or projects which limit or reduce deforestation. However, if forest carbon credits are much lower cost than current prices in the EU ETS, allowing unrestricted use of them for compliance in the EU ETS would result in a drop in EUA prices. This would dampen the motivation to tackle industrial emissions growth and potentially disrupt low carbon investment in the EU. If the REDD+ mechanism is linked with the EU ETS, the volume of REDD+ credits should be carefully controlled (as is the case with CERs). These credits could be introduced in a way to act as a safety valve on prices.

15. Finally, there is a risk that the potential for, or actual, linking of different emissions trading

schemes is disruptive to the market, as it will alter the supply/demand balance, and raise concerns about the long term stability of the carbon price. If the EU ETS links with REDD+ or another national scheme, it could fundamentally alter the market. Unless these issues are carefully considered, the potential for disruption may limit long term investment in projects (such as renewable electricity generation) which are supported by a strong carbon price.

August 2011

Memorandum submitted by Drax Power (ETS 26)

Drax Power Limited (Drax) is the operating subsidiary of Drax Group plc, and the owner and operator of Drax Power Station in North Yorkshire and owner of Haven Power Limited, an electricity supply company established specifically to serve the energy needs of business customers. Drax Power Station is the largest, cleanest and most efficient coal-fired power station in the UK. At current output levels its coal, biomass and alternative fuel burn approaches some 10 million tonnes per annum, and its six 660MW generating units supply some 7% of the UK’s electricity needs. All six of the power station’s units are fitted with flue gas desulphurisation (FGD) technology, which removes, on average, at least 90% of the sulphur dioxide (SO2) from the flue gases. All units have been retrofitted with low NOX (nitrogen oxides) burners, and emissions of NOX have been further reduced through retrofitting boosted over fire air (BOFA) technology making the power station fully compliant with the 2008 Large Combustion Plant Directive (LCPD) emissions limits, although large investments will be required to ensure that the plant is compliant with future EU environmental legislation. Over the last eight years, Drax has developed the capability to co-fire, that is, blend and burn, renewable biomass materials with coal. In June 2010, the largest biomass co-firing facility in the world was commissioned at Drax Power Station. The facility provides Drax with the capability to produce up to 12.5% of its output from sustainable biomass and reduce emissions of carbon dioxide (CO2) by over two and a half million tonnes a year. In addition, Drax is nearing the completion of its £100 million turbine upgrade project, which will improve the efficiency of the power station by 5% with a consequent CO2 saving of one million tonnes a year. Together these two initiatives will reduce CO2 emissions from the power station by 17.5% compared to 2006 levels. Over the last year, through burning sustainable biomass Drax has produced more renewable electricity than any other UK facility. Drax stands ready to transform into a predominantly renewable generator, provided an appropriate level of support is available under the Renewables Obligation.

Drax Power Limited (Drax) is pleased to have the opportunity to submit written evidence to the Committee’s inquiry into the EU Emissions Trading System (EU ETS). Drax’s view of EU ETS can be found in the Executive Summary below, which is followed by answers to the specific questions raised.

EXECUTIVE SUMMARY

• Drax supports the principle of a price for carbon. Given where we are, we believe the EU ETS is the right mechanism and this should be supported and developed further.

• Drax does not support the unilateral introduction in the UK of the proposed Carbon Price

Support (CPS) mechanism and an Emissions Performance Standard (EPS). Both would start to undermine the effectiveness of the EU ETS. The implementation of the CPS, like any Member State carbon reduction policy, would not result in any real cut in emissions at an aggregate EU-level. This is because the EU-wide cap is fixed and any reduction in UK emissions are likely to result in increased emissions elsewhere.

• The proposed CPS is flawed because it: • would increase power prices to UK consumers; • does not place an effective floor on carbon prices; • would undermine liquidity in the UK wholesale market; and • would introduce distortions between domestic and imported coals.

• The EPS is unnecessary, given the terms of the EU ETS.

• Addressing carbon emissions is a societal issue, but so far the power sector has taken the

burden of the reductions. If further significant progress is to be made the scheme must be widened to include other sectors not currently within the EU ETS, and hence Drax welcomes the inclusion of the Aviation sector from 2012.

Question 1: Does the EU ETS remain a viable instrument for climate change mitigation in the EU?

1. There is no single policy instrument which can be applied for climate change mitigation in the EU. However, the EU ETS is one of the most important policy instruments. It functions in a manner which least distorts competitive trading by the major CO2 emitters within Member States, and puts all Member States on an equal footing.

2. It is essential that the wide range of other tools which are used by Member States to reduce

their national emissions are designed and implemented in such a way that the principles of complementarity and subsidiarity are maintained. We note the potentially negative effects of the proposed Energy Efficiency Directive and the proposed UK CPS mechanism. The former could significantly reduce the effectiveness of the EU ETS by introducing unexpected market length. The latter will introduce significant distortions between the UK and other Member States with no overall emissions reduction benefit, as explained further below.

Question 2: Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes?

3. The EU ETS is enshrined in EU law, requiring an average 1.74% cut in allowable emissions from scheme participants each year. There is no requirement for a successor to the Kyoto Protocol in order that the EU ETS remains in place. There will be a review of the EU ETS from 2020 with a decision due by 2025 to determine its future. Unless a 27-state consensus on an alternative mechanism is found, the formal position is that it will continue to operate in perpetuity. This is irrespective of future linking with comparable schemes.

4. However, in reality the long term future of the EU ETS is entirely dependent on the desire of

Governments globally to significantly reduce carbon emissions. Whilst the intention of the EU to unilaterally introduce a carbon reduction programme is laudable, there are risks of ‘carbon leakage’ and the export of manufacturing industry to countries with less robust regulations. With the proposed introduction of the CPS this is true in the UK now more than ever. Therefore, any regime which reduces industrial competitiveness over the long term will require careful and ongoing scrutiny.

Question 3: What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad?

5. No Comment.

Question 4: Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved?

6. Economic efficiency would be improved via linking to other trading schemes. If compliance credits are fungible then this would result in a much more liquid market offering more efficient price discovery. Linking is best achieved by designing the respective schemes to be compatible, and initiating a linking process at a political level.

7. However, this potential improvement relies on other countries agreeing binding and robust

targets as was the intention of the Kyoto Protocol. As yet there are no suitable emission trading schemes to link to the EU ETS.

Question 5: What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally?

8. The most significant action would be the development of a successor to the Kyoto Protocol, with binding emission reduction targets.

9. The EU ETS has set the template for carbon emissions trading systems. It has been drawn

upon by several countries which have introduced their own ETS, most recently by New Zealand. China and India may follow. Compatibility of schemes is most likely to be achieved through influencing at a political level and knowledge sharing. However, the wrong signal could be sent out through domestic policies such as the EPS. This could be interpreted as a lack of faith in the effectiveness of the EU ETS.

Question 6: Could sectoral agreements form part of the future of the EU ETS?

10. Yes, addressing carbon emissions is a societal issue and the power sector has so far taken the burden of the UK and EU reductions. For both these reasons, if further significant progress to be made, it is appropriate to extend the scope of the EU ETS into other sectors not presently included. To that end we welcome the inclusion of aviation from 2012.

Question 7: Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism?

11. At present there are no viable alternatives. Offsets offer EU ETS participants access to carbon abatement at a typically lower cost than available within the EU. This reduces a participant’s cost of compliance. Hence it is desirable that there is a credible and robust international offset mechanism over the longer term. This could require that the EU assume the CDM approvals role of the UNFCCC.

Question 8: Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system?

12. The EU ETS is a constraint on unilateral action to reduce emissions, but it does not formally prevent individual Member States from introducing supplemental measures. However, if such measures are introduced they should be implemented in a manner which adds value to the EU ETS, and European Commission energy policy as a whole. The danger is that well-intentioned national policies end up undermining the basis of the EU ETS, which is a

fundamental pillar of EU energy market integration work. Drax is concerned that this is true of the proposed CPS

13. Individual Member States' own policies to accelerate abatement will not result in any net

additional EU carbon reduction. This is because any reduction in that Member State will be offset elsewhere in the EU-27 as UK carbon emission cuts result in a higher availability of EUA carbon credits.

14. The UK’s proposed CPS mechanism is a prime example of a measure which has been poorly

thought through, and would have the following undesirable effects: (a) It would simply increase power prices to UK consumers, while placing a new financial

and administrative burden on UK fossil power generators. At the same time a significant (£bns) and unnecessary windfall would be granted to existing nuclear and renewable generators.

(b) It would not place an effective floor on carbon prices. While the supplemental support rate may be fixed, the underlying market carbon price remains volatile. This would not provide investment certainty for UK low carbon power project developers.

(c) It would undermine liquidity in the UK wholesale market, because it is designed to be set annually for the period two years ahead. Generators would thereby be inhibited from selling forward power with confidence beyond the two years for which they have visibility on this support rate.

(d) It would introduce distortions between domestic and imported coals, because it does not use the same basis as the EU ETS. The EU ETS is levied on actual verified CO2 emissions, whereas the proposed CPS is to be charged on the weight of fuel used for generation. This effectively which could easily be rectified by simply adopting the existing processes for EU ETS compliance.

Question 9: How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required?

15. This was a serious issue and one which has undermined the markets confidence in the EU’s ability to deliver a robust trading mechanism. Remedies and solutions have been dealt with under a specific consultation and Drax does not feel the need to add any additional comments.

Question 10: How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations?

16. The EU ETS was designed to deliver the Kyoto Protocol targets. An alternative question would be: “Is the EU ETS a suitable vehicle to deliver the EU climate objectives within a world with no successor to the Kyoto Protocol and no internationally binding targets”. Perhaps there should be a greater focus on delivering bankable certainty to the EU investments into GHG abatement and renewable generation

17. The EU-27 should work towards evolving the ambitions of the EU ETS and avoid any

unilateral measures such as the proposed CPS and EPS. A global emissions agreement is not a pre-requisite for the continuation of this mechanism. Although well-intentioned, the UK’s proposed CPS mechanism will start to undermine the effectiveness of the EU ETS and inevitably contribute towards ever-rising energy costs for UK consumers.

August 2011

Memorandum submitted by the Confederation of Paper Industries (ETS 27)

1. The Confederation of Paper Industries (CPI) is the trade association for the paper industry in the UK and has within its membership paper manufacturers, corrugated packaging manufacturers and mill-owned and independent recovered paper merchants and exporters. The sector continues to be a major manufacturer and employer, producing slightly under 5,000,000 tonnes of paper each year in the UK, manufactured by more than fifty paper mills, with around 20,000 people directly employed by the sector. 2. Forty nine sector installations (including associated CHP) meet the criteria for inclusion in the EU ETS scheme are so are subject to regulation (at August 2011.) 2.32 million tonnes of carbon dioxide were reported by these installations for the 2010 compliance year. 3. The number of UK paper mills has declined by around half since the first UK climate change instrument – the Climate Change Levy - was instigated 10 years ago, epitomising the operational pressures faced by paper mills. Indeed a key reason for closures has been high energy prices and less than half the paper used in the UK is now manufactured in the UK. The manufacture of paper is energy intensive and uncompetitive energy prices in the UK will ultimately cause the closure of more paper mills. Closures on this scale clearly indicate the sector is generally unprofitable with a very low return on capital reported by members. The sector simply does not enjoy the levels of profitability required to absorb additional costs resulting from the cumulative impact of increased energy taxation. 4. The indicative allowances for the UK pulp and paper sector in EU ETS Phase III already show the sector short of the required number of allowances by around 700,000 or one third of the annual requirement. Assuming a conservative value of £12 per allowance, this means a cost to the sector in the region of £8.4m each year. Should the sector be required to purchase all its allowances the total cost would be in the region of £27m each year. Of course if the cost of allowances increases to £25 the cost would be much higher and in the region of £17.5m and £56m each year respectively, plus the increased costs passed on by suppliers, notably in the increased price of imported electricity. Of course these costs are a direct tax on energy used by industry and with such low profitability can only be covered by increases in the cost of product passed through to customers. Indeed this concept of passing increased costs through to customers is a fundamental concept of the scheme. It is only when this is not possible that carbon leakage status is granted. Any threat to carbon leakage status would pose a serious additional threat to the long term future of the sector in its present form. 5. We note the increasing amount of taxation revenue being raised through EU ETS and other energy taxes. Clearly Government has identified this as an area to target for revenue. Together with colleagues in other sectors, the Energy Intensive Users Group has published a report itemising the unsustainable cumulative cost of these policies on UK industry and we urge policy makers to pay attention to this critical issue. 6. The is a strong case that some of this revenue should be utilised to support the deployment of low carbon manufacturing to protect the long term future of UK industry and consequently the long term tax revenue – closed sites mean no tax at all.

7. No further strengthening of EU ETS is required – existing costs, plus the continued escalation in the cost of energy are already acting as sufficient drivers for energy efficiency.

• Does the EU ETS remain a viable instrument for climate change mitigation in the EU?

8. The basic principles of EU ETS remain unchanged from the instigation of the scheme; therefore any fundamental flaws have been present from the start. The reason for using a market based trading instrument to drive emissions reduction are still valid; namely to drive reduction in the most cost effective manner using the market to achieve the minimum overall cost.

9. The critical issue is that the targets should be reached at the lowest possible cost to the economy – therefore if targets are being met at a low overall cost (reflecting low prices in the EU ETS market) this should be seen as a positive result – not leading to criticism that the cost to industry is too low. Criticism that allowance price is too low to support investment in low carbon generation is irrelevant; firstly this should not be the role for this scheme and secondly the inherent fluctuations in the cost of carbon mean this aspiration can never be achieved anyway - the danger of price falls in the market mean that the price support arising from the cost of carbon imposed by EU ETS cannot be ‘banked.’

10. In summary if targets are being met, then the necessary investment in carbon reduction is being made within the EU ETS regulated sector to meet the targets and there should be no political interference with the operation of the market.

• Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes?

11. No. Clearly the scheme will act to reduce regulated emissions within the European Union, but will have no impact emissions outside Europe – indeed the displacement of production to areas where carbon is unconstrained may increase emissions outside Europe and so increase global emissions.

12. Costs imposed on installations operating within the European Union simply serve as an additional cost on European manufacturing not imposed on competitors outside Europe. Energy intensive industry tends to be capital intensive, meaning once an installation is built it can normally expect a long operational period as the initial investment is recovered. Accordingly installations have no option but to ride out short term fluctuations that affect operations, including factors such as EU ETS pushing up input prices to higher levels than those experienced elsewhere in the world. However in the long term higher European costs do have an impact and act as a disincentive to investment in the European Union. In particular and over the long term, European sites face the risk of losing the necessary investments that keep plant modern, up to date, efficient and competitive – the long term result is likely to be closure of some sites that would otherwise not have happened. Certainly in the pulp and paper sector there are investment opportunities in many counties meaning uncompetitive areas will lose out.

• What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad?

13. Within Europe the scheme will deliver the emissions savings as set by the targets – the design of the scheme ensures this will happen.

14. As already discussed above, there is a real danger that (in the long term) if productions costs within Europe are higher than costs elsewhere, then production will be moved out of the European Union, with imported finished product being substituted for domestic

manufacture. If such carbon leakage happens, then emissions will increase outside the carbon regulated area with no net impact on total emissions.

15. Such an occurrence would make a nonsense of the scheme, and yet with no account being taken of embedded carbon in imported product this is already happening. The seeming fall in overall UK direct emissions (and quoted as evidence that UK climate change policies are working) is more than offset when imported carbon contained in imported goods for consumption is factored into calculations. Indeed when this issue is included in calculations emissions in the UK continue to increase.

• Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved?

16. Clearly yes, this must be achieved if the aspiration of reducing global emissions is to be achieved. How this is achieved is not a matter for industry.

• What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally?

17. The intention of the UK Government to be seen as a global leader on climate change issues is incompatible with the aspiration of retaining domestic manufacturing by energy intensive industries, if the leadership is shown by the imposition of unsustainable carbon costs not being imposed on competitors outside the regulated area. The result of such policies is the inevitable loss of jobs in the UK.

• Could sectoral agreements form part of the future of the EU ETS?

18. In principle yes, but in reality there is little likelihood that equitable targets could be agreed.

• Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism?

19. This issue is in the hands of politicians. The concept of cost effective reduction does still apply and with a global issue, where this actually happens is irrelevant. Access to some sort of safety valve to prevent a major increase in EU ETS costs remains important.

• Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system?

20. Clearly not, as the UK continues to operate the Climate Change Agreements (CCA) and Carbon Reduction Commitment and has recently announced the Carbon Price Support (CPS) scheme. Certainly in the case of CPS, we would argue the UK Government should be more constrained by the provisions of EU ETS, because CPS will guarantee higher carbon costs for UK industry even compared to competitors elsewhere in Europe, let alone competitors elsewhere in the world.

21. Indeed we would draw to the attention of the Committee merits of the CCA scheme where (in our sector) targets are set for improvements in the efficiency of production rather than an absolute cap on emissions. The merit of this approach is an opportunity to increase UK manufacturing in an energy efficient manner, thus displacing imported product. Under

present carbon accounting, increases in UK manufacturing result in a seeming increase in emissions – there is clearly a clash between two different Government policies.

22. More generally CPI members have real concerns of the cumulative cost of these schemes. Each policy seems to be set individually and the cost of individual schemes is considered in isolation. In isolation, the additional costs may be sustainable – cumulatively and together with increased supply chain costs clearly they are not.

• How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required?

23. At operational level, CPI members are concerned with compliance rather than trading and so the historic problems have not had a serious impact on confidence as any trading has mostly been around March/April, (for compliance) while the major problems have been at other times of the year.

• How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations?

24. The scheme is already over regulated, with incredibly complex scheme rules and requirements to provide data verified by independent assessors at the expense of installations. As in many areas of regulation there is a perception that the UK follows the rules in more detail that other Member States, well exemplified by the UK alone requiring verification of Phase III baseline data before the final scheme rules were agreed. This early call for data resulted in the requirement for a second phase of verification, thus doubling the sector cost to in the region of £250,000. Clearly no further strengthening of scheme rules are required.

25. We would question if the scheme can have any meaningful impact on global emissions when only installations inside the European Union are covered and even more so when the UK Government imposes even higher costs on UK sites alone. Accordingly we urge that efforts are focused on agreeing a global agreement with a fair sharing of targets. The present policy of imposing costs on European industry will only lead to the loss of European production and jobs. When European production is substituted for imported product with embedded carbon, then emissions are simply generated elsewhere with no impact of global emissions.

August 2011

Memorandum submitted by the Sandbag Climate Campaign (ETS 28)

Summary

‐ In principle the EU ETS is an effective instrument to deliver low‐cost abatement and provide maximum flexibility for the sectors it covers, but in practice the ETS carbon budgets have been consistently set too high. Policymakers need to revise the caps downward.

‐ For the instrument to fulfil its potential and align with Europe’s longer term goals, Sandbag recommends that 1.7Gt be set aside from the permits auctioned in the Phase 3 budget and the trajectory be amended to a 2.4% annual decline at the earliest opportunity. 1

‐ Despite being oversupplied to date the EU ETS price signal is estimated to have driven some 330Mt of CO2 to date. Phase 3 will ensure 2.7 billion tonnes of CO2 are saved against current business‐as‐usual projections for 2013‐2020.2

‐ While the future of the Kyoto Protocol is uncertain, domestic and regional cap‐and‐trade schemes are multiplying, with several comparable schemes in place already (New Zealand, Switzerland, Eastern States of the USA) and still more due to be operational between 2012‐2016 (California, Australia, South Korea, Ukraine and even China).

‐ The barriers that inadequate international climate action present to more ambitious European climate policy, or that inadequate European action present to UK climate policy, have been exaggerated by competitively‐exposed and energy intensive industries. These industries are offered extensive protections by the Emissions Trading Directive in Phase 3 and are currently profiting from the scheme in Phase 2.

1. Sandbag is a UK‐based climate change NGO focussing on environmental reform of the EU ETS. Through producing rigorous but accessible analysis, we aim to make emissions trading more transparent and understandable to a wider audience than those directly involved in the carbon market. Our view is that if emissions trading can be implemented correctly it has the potential to help deliver the deep cuts in carbon emission the world so badly needs to prevent the worst impacts of climate change.

The politics of the EU ETS

2. The EU ETS was able to attract a broad political base to support its implementation because it combined the flexibility of a liberal market mechanism with the hard political regulation of a cap. Since its adoption, though, public comment on the system has been hijacked by market‐sceptics on the left and climate‐sceptics on the right, who both aggressively call for the EU ETS to be dismantled.

3. This excessive politicization of the European trading system has become a distorting lens through which its imperfections have been perceived, turning each technical or environmental challenge it faces into a call for its termination. These challenges should instead be perceived as opportunities

1 Sandbag, Buckle Up! The 2011 Environmental Outlook for the EU ETS (July 2011) http://www.sandbag.org.uk/site_media/pdfs/reports/Sandbag_2011‐07_buckleup.pdf 2 p.15 of Buckle Up! drawing upon Pricing Carbon (Ellerman, 2010) and Hard to Credit (Deutsche Bank, 2010)

http://www.sandbag.org.uk/site_media/pdfs/reports/Sandbag_2011-07_buckleup.pdf

for constructive engagement and reform with what is, fundamentally, a powerful policy whose major fault is that it currently lacks sufficient ambition.3

4. Those agencies who have taken an engagement approach have had considerable success in repairing the very weaknesses that the scheme’s most vociferous critics have used to damn it: from 2013 offset credits from the most controversial industrial gas offset projects will be ineligible, new CDM offsets must come from projects in Least Developed Countries, electricity sector windfalls from passed‐through opportunity costs will end, industrial sectors should no longer be able to accrue surplus permits, and new security features will reduce the opportunities for fraud.

5. There are long lead times before these changes can be implemented, but this highlights the need for early and far‐sighted intervention from policymakers seeking ETS reform.

The viability of the EU ETS in delivering European abatement

6. The EU ETS remains a viable instrument for limiting EU emissions, with the traded sector expected to deliver roughly 2/3rds of Europe’s 2020 emissions reductions under all scenarios currently tabled.

Table 1: 2020 GHG reduction scenarios accompanying the May 2010 Communiqué

2020 scenario Summary EU

%below 1990 EU

%below 2005 ETS

%below 2005 Non‐ETS

%below 2005

2009 Baseline Enacted policies as of Spring 2009

14% 7% 11% 3.5%

Reference Full implementation of 20:20:20 package

20% 14% 19% 9.5%

30% Flexible 25% internal, 5% state offsets

25% 19% 26% 13%

30% Domestic 30% internal 30% 24% 34% 16%

Source: Compiled from different tables in SEC (2010) 650

7. At present, however, the domestic emissions reductions in the EU ETS have predominantly been delivered by the recession, with a disproportionate share of active abatement being outsourced to foreign countries through offset credits. This is money that could be better spent on new energy infrastructure within Europe, protecting the region from volatile fossil prices and demonstrating clean development to emerging economies. As we discuss below , complementary policies in the EU climate package are also likely to eclipse the Phase 3 cap.

Emissions reductions delivered by the EU ETS at home and abroad

8. Over 2008‐2020 the EU ETS cap ensures emissions will be reduced by 2.7Gt against business‐as‐usual levels on current economic trends. This consists of 1.6Gt of offsets and 1.1Gt of domestic abatement.

3 See p.13‐14 of Buckle Up! www.sandbag.org.uk/site_media/pdfs/reports/Sandbag_2011‐07_buckleup.pdf


Figure 1: When does the ETS constrain BAU emissions? (Phase 2 scope)

‐

500

1,000

1,500

2,000

2,500

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

MtCO2e

Net surplus

Year 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2008‐2020 Total

BAU emissions 2,137 1,913 1,988 2,030 2,083 2,191 2,213 2,224 2,235 2,246 2,258 2,269 2,280 28,067

Max emissions (using offsets) 2,137 1,913 1,988 2,030 2,083 2,191 2,213 2,224 2,235 2,246 2,161 1,765 1,729 26,915 Max emissions (no offsets) 2,137 1,913 1,988 2,030 2,083 2,191 2,054 1,911 1,874 1,838 1,802 1,765 1,729 25,315 • BAU estimates from Deutsche Bank. Phase 2 allocations from CITL and EU website. Scope controlled Phase 3 allocations and carryover from

author’s calculations.

9. However, over this period the European Commission projects that the complementary policies from the Renewable Energy Supply Directive and the Energy Efficiency Directive will combine with the effects of the recession and the ETS to drive emissions lower than the cap by roughly 1Gt before any recourse to offsetting, as we see in the diagram below.

Figure 2: Net Surpluses accrued in the Commission’s reference scenario 2008‐2020 (Phase 2 scope)

Year 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020Cap 2,001 2,038 2,080 2,054 2,292 1,984 1,947 1,911 1,874 1,838 1,802 1,765 1,729 Emissions 2,118 1,876 1,926 1,950 1,978 2,042 2,008 1,938 1,875 1,757 1,697 1,615 1,527 Surplus ‐117 161 154 104 314 ‐58 ‐61 ‐27 ‐1 81 105 150 202

Phase 2 surplus 617 Phase 3 surplus 391

10. This means we can expect the full climate package to deliver 4Gt of domestic emissions reductions over 2008‐2020 against business‐as‐usual levels. Despite domestic emissions falling

Offset/substitute carryover

EUA carryover

Emissions

Cap (projected forward)

BAU emissions

1.1Gt1.6Gt0.3Gt

‐

500

1,000

1,500

2,000

2,500

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Millions

Potential carryover into Phase 3 ‐ Commission model

Net surplus

Phase 3 emissions

Cap (projected forward)

391Mt

617Mt

below the cap, we can also expect the 1.6Gt offsetting allowance available for this period to be fully exhausted, reducing Europe’s total emissions 5.6Gt below business‐as‐usual levels.

11. These reductions fly well ahead of the ETS cap and will effectively store up 2.1Gt of domestic emissions rights for use beyond 2020 (1Gt of domestic savings plus 1.6Gt in substituted offsets minus 0.5Gt absorbed by aviation). This is equivalent to more than a year’s worth of emissions from the traded sector.

12. In short the ETS is not currently complementary with the other policies in the climate package and instead threatens to store up the emissions saved through external circumstances and policies for use beyond 2020. The ETS cap needs to be revised in order to capture these reductions.

The effectiveness of the EU ETS independent of a global regime

13. The EU ETS can function independently of the Kyoto regime or other cap‐and‐trade systems, but it is currently a remote possibility that it will need to, with similar systems due to be established between 2012 and 2016 in California, Australia, South Korea, Ukraine, and China.

Figure 3: Existing, scheduled and planned cap‐and‐trade schemes

14. While the EU ETS can work to uncover lowest cost abatement opportunities within Europe, these opportunities will be more numerous if the scope of the scheme is expanded, either to new sectors of the European economy or to compatible cap‐and‐trade systems elsewhere in the world.

15. With the EU ETS currently the largest buyer of offsets within Kyoto Flexible Mechanisms (CDM and JI), Europe is well placed to control the terms on which it continues to accept these credits. Europe has already begun to dictate its own quality requirements for CDM entering the EU ETS from 2013, prohibiting the use of HFC‐23 or adipic acid N2O industrial gas credits and refusing credits from all but Least Developed Countries for projects registered after 2012. There remains scope for further quality restrictions to be implemented. Again, because of the concentration of demand for offsets in the EU ETS, Europe is well placed to establish alternative offsetting mechanisms if Kyoto Flexible Mechanisms are discontinued at UN level.

Promoting compatible cap‐and‐trade schemes and sectoral agreements elsewhere

16. Sandbag has prepared several papers making recommendations for new regions exploring emissions trading based on our experience of the EU ETS.4

17. We generally recommend that new regions considering cap‐and‐trade exclude competitively‐exposed sectors and begin with the electricity sector. Competitively‐exposed industries risk weakening the scheme both through demands for generous free allocations and through lobbying for weaker overall caps. While energy intensive industries are still likely to resist or weaken electricity sector caps, we suspect this lobbying will be less intense, and the concessions to these industries will be smaller and simpler than if they are direct participants in the scheme.

18. Europe would face reduced carbon leakage threats if its main competitors in exposed sectors adopted similar cap‐and‐trade policies. In this regard it is promising that neighbouring countries such as Turkey and Ukraine5 are considering cap‐and‐trade schemes. In addition, the Californian and Australian emissions trading schemes cover exposed industries and China is currently considering cap‐and‐trade schemes for its cement and steel sectors.6

19. Europe can accelerate the adoption of cap‐and‐trade systems firstly by exploring the potential to link compatible schemes and secondly by reducing the eligibility of offset credits generated in projects from competing industries in emerging economies, which potentially disincentivize domestic target‐setting.

20. If Europe genuinely experiences a net competitive disadvantage in applying a carbon price on its industrial emissions, it could consider amending the scheme so that imports of products from countries are required to pay a carbon price at Europe’s borders. The proposed Californian trading system includes a provision for a carbon price to be applied to imports of electricity from neighbouring states; the EU should consider the introduction of similar provisions. This is particularly important for Eastern Member States who share borders with uncapped countries

21. As Europe explores new sectoral crediting mechanisms to expand or replace its current offsetting provisions, it should avoid providing disincentives to developed or emerging economies to adopt domestic carbon regulations. It should also ensure that the offsets purchased do not subsidize Europe’s industrial competitors and exacerbate the risk of European operations shifting abroad. New sectoral agreements could avoid this by purchasing credits from competitively‐insulated sectors such as electricity, land transport and heating and by targeting least developed countries.

The relationship between the EU ETS and unilateral action by Europe and its Member States

22. Just as inertia in global climate ambition should not be used as an excuse to hold back ambition in Europe, inertia in European ambition should not be used as an excuse to delay ambition in the UK or other Member States. Climate initiative needs to begin somewhere.

4 See for example www.sandbag.org.uk/site_media/pdfs/reports/Lessons_from_ETS.pdf We have also made submissions to the Californian government, the Australian government and met with Chinese state officials on this issue. 5 http://www.elaw.org/node/3743 6 http://af.reuters.com/article/metalsNews/idAFL3E7J407J20110804

http://www.sandbag.org.uk/site_media/pdfs/reports/Lessons_from_ETS.pdf

http://www.elaw.org/node/3743

http://af.reuters.com/article/metalsNews/idAFL3E7J407J20110804

23. The harmonisation of the EU ETS cap does mean, however, that additional action in the traded sector by individual Member States (be it through more stringent domestic carbon budgets, price floors or energy policies) will not affect the total supply of carbon in the cap and will instead weaken the obligation to decarbonise elsewhere in Europe. But rather than being seen as an excuse for inaction, additional ambitions at Member State level should be used to leverage greater ambition at European level, and within the EU ETS in particular.

24. The UK’s ambitious 4th carbon budget covering the period 2023‐27 includes a review clause in 2014. This is explicitly to take into account the progress, or lack thereof that Europe has made towards tightening caps in the ETS. In effect this creates a deadline for the EU to act – if it fails to, then the ETS will be guilty of holding back British climate ambition rather than stimulating it.

25. The loudest voices opposing unilateral action at both national and European level are competitively‐exposed industries and energy intensive industries. It is important to highlight that competitively‐exposed industries policed by the EU ETS have enjoyed some of the largest surplus free allocations throughout Phase 2 as a consequence of their intense lobbying of Member States during the setting of the National Allocation Plans followed by the drop in emissions resulting from the recession. Far from punishing these industries, the sale of surplus carbon allowances has been a source of immediate revenue to them, or presents a buffer of extra permits to cushion them against their benchmarked free allocations in Phase 3.7

26. It is also worth noting that the Emissions Trading Directive offers both competitively‐exposed industries and energy intensive industries extensive protections in Phase 3. Competitively‐exposed industries receive 100% free allocations as benchmarked against the most carbon‐efficient installations in their sector and State Aid rules allow Member States to protect compensate energy intensive industries for the effects of the carbon price on their electricity costs.

27. For sectors in both categories it seems to us particularly perverse that the companies who have weakened the ETS caps by resisting responsibilities to abate within it, are now obstructing increased action in the power sector.

28. We must also question the sincerity of some company’s appeals for Britain and Europe to wait for multilateral action before embarking on ambitious unilateral policies. Research by CAN‐Europe in their report “Think Globally, Sabotage Locally”8 has found suggestive evidence that multinational companies that currently advocate Europe wait for more ambitious global commitments are simultaneously bankrolling efforts to scupper climate change measures in the US.

29. Vested interests have used similar arguments to weaken the Energy Efficiency Directive or renege on the Renewable Energy Supply Directive, but again, the ETS should not be used as a barrier to these policies, but should be made complimentary with them by adjusting down the cap to reflect any overlap between the instruments. The EU ETS is designed to uncover and exploit low‐hanging fruit, but the RES Directive will drive innovation and bring new technologies to market, while the EE Directive will unlock negative cost abatement that the ETS cannot access.

7 See p.20‐24 of Buckle Up! www.sandbag.org.uk/site_media/pdfs/reports/Sandbag_2011‐07_buckleup.pdf and our latest Carbon Fatcats report at www.carbonfatcats.eu 8 http://climnet.org/index.php?option=com_docman&task=doc_download&gid=1788


http://www.carbonfatcats.eu/

http://climnet.org/index.php?option=com_docman&task=doc_download&gid=1788

Figure 4: Relevance of different policies across the Marginal Abatement Cost curve

(Source: Öko institute)

Strengthening the EU ETS to operate effectively

30. As we have seen above, going forward from 2020 the environmental effectiveness of the EU ETS cap can expect to be weakened by some 2.1Gt of permits carried forward as a result of external policies and recession over 2008‐2020. It is unacceptable that these two trading periods serve mainly to retard the progress of the scheme going forward.

31. As a minimum, Sandbag recommends that a quantity of permits be set aside from auctions to reflect the impacts of the Energy Efficiency Directive on Phase 3. Estimates within the Commission’s own impact assessment find the 2020 carbon price dropping to €14 or even €0 (down from forecasts of €25) if no such adjustment is made.9

32. Our preferred recommendation would be that the Phase 3 caps are adjusted by 1.7Gt to correct for the direct and indirect effects of oversupplying permits to industrial sectors in Phase 2:

• Direct effects: Industrial sectors stand to receive some 855Mt of superfluous permits over Phase 2. While demand from the power sector absorbed some 183Mt of this over 2008 and 2009, the remaining 672Mt can carry forward to weaken Phase 3. We contend that this 672Mt be set aside from the Phase 3

• Indirect effects: As Phase 3 caps are defined in relation to average Phase 2 caps they are inflated by the excess permits that were awarded to the industrial sectors. If we adjust the Phase 3 caps and instead calculate them in reference to industrial emissions since 2005, this removes 1Gt from the Phase 3 cap.

33. A 1.7Gt set‐aside to adjust for industrial oversupply, would largely protect the scheme from the overlaps with the Energy Efficiency Directive and Renewable Energy Supply Directive as a co‐benefit. We are not proposing that the set‐aside should be removed from competitive industry free allocations but rather that the sum should be held back from

9www.sandbag.org.uk/site_media/uploads/20110505_Impact_Assessment_Energy_Efficiency_Directive.pdf

http://www.sandbag.org.uk/site_media/uploads/20110505_Impact_Assessment_Energy_Efficiency_Directive.pdf

allowances made available at auction – effectively removing them from the power sector who will continue to be the scheme’s biggest buyers.10

34. We recommend that the Emissions Trading Directive be re‐opened at the earliest political opportunity, in order to permanently cancel this set‐aside and prevent these permits from re‐entering the market at a later date. We contend that the Emissions Trading Directive be reopened no later than 2015, immediately following the publication of the 5th IPCC report, but European policymakers should ideally move to take action prior to 2014 to prevent triggering the aforementioned review of Britain’s 4th carbon budget.

35. Upon reopening the Directive, it is also pivotal that the rate of contraction in the cap be accelerated from an annual increment of 1.74% to at least 2.4% in order to align with Europe’s 2050 goals for the traded sector. Were this 2.4% increment applied from 2016 some 553Mt of any set‐aside would effectively be absorbed by 2020 (a 1.7Gt set aside would be absorbed by 2027). Without intervention, no revision to this 1.74% decline is scheduled to be implemented until 2025.11

36. Finally, as part of a review of the Emissions Trading Directive, we would like to prevent installations with surplus EUAs from surrendering offset credits for compliance. Currently some 57% of the offsets surrendered into the EU ETS have been from installations with free carbon permits to spare. This suggests that offsets are being used as an arbitrage opportunity to profit from the scheme while driving low carbon investment outside of Europe. We would also like to see restrictions placed on any carbon offsets which risk exacerbating leakage of industrial operations outside of Europe.

August 2011

10 See p.39‐41of Buckle Up! www.sandbag.org.uk/site_media/pdfs/reports/Sandbag_2011‐07_buckleup.pdf 11 See p.44‐45of Buckle Up! www.sandbag.org.uk/site_media/pdfs/reports/Sandbag_2011‐07_buckleup.pdf



Memorandum submitted by the British Ceramic Confederation (ETS 29)

Executive Summary

The EU ETS will always introduce internal and external EU competitive distortion if it exists in isolation without international binding agreements; however an initial step to improving its effectiveness might be sectoral agreements on an international level. These would, however, require careful consideration to ensure that they did not introduce their own unintended effects.

If international agreements or linking with other emissions trading schemes were to be successful, measures would have to be taken to ensure a “level playing field”.

The only emissions reductions that the EU ETS can currently guarantee are perceived emissions, or the emissions arising directly from European manufacturing. There is a danger of reducing manufacturing and importing products and emissions.

The EU ETS currently introduces competitive distortion both internally within Europe, and externally.

Externally, the cost of complying with the EU ETS puts European manufacturers at a competitive disadvantage to non-EU manufacturers; this has a secondary effect of disincentivising investment in European companies, which damages the economy and reduces available capital to fund efficiency improvements.

Internally, potential inconsistency between member states' transposition, and treatment of process emissions and small emitters introduces regional distortion; Different products with similar end uses may be placed at an unfair disadvantage subject to their 'carbon leakage' status.

The uncertainty of the UK policy landscape, including EU ETS transposition, is further disincentivising investment in UK PLC.

Brief Introduction to the British Ceramic Confederation

1. The British Ceramic Confederation (BCC) is the trade association for the UK Ceramic Manufacturing Industry, representing the common and collective interests of all sectors of the Industry. Its 100 member companies cover the full spectrum of products and materials in the supply chain and comprise over 90% of the Industry’s manufacturing capacity.

2. Membership of the Confederation includes manufacturers from the following industry sectors:-

Bricks Clay Roof Tiles Clay Pipes

Refractories Floor and Wall Tiles Sanitaryware

Gift and Tableware Industrial Ceramics Material Suppliers

3. The industry is energy-intensive (but not energy inefficient): energy bills / taxes can be up to 30-35% of total production costs. 85% of the energy used is natural gas. We support cost-effective action to reduce global greenhouse gas emissions.

Factual information

Does the EU ETS remain a viable instrument for climate change mitigation in the EU? 4. A full answer to this question can only be given with knowledge of what other climate change policies

are being developed in and outside Europe. In the absence of international climate change agreements, the EU ETS will only ever affect direct CO2 production in the EU, not CO2 consumption in the EU. The more stringent the EU ETS or national schemes get, the more likely CO2 will be imported in cheaper products sourced from elsewhere. Therefore it may only be viable for perceived, rather than actual climate change mitigation in the EU.

Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes?

5. Benchmarks are based on only the average of the 10% lowest emitters in the EU and the free allocation is reduced from this level. Products that have any competition from non-EU manufactured products, in the absence of an international agreement, will generally be at a disadvantage. This is particularly the case for sectors not given ‘carbon leakage’ status. Even with ‘carbon leakage' status, products made in factories with emissions higher than the average of these 10% will be at a disadvantage compared with non-EU competitors. Therefore, it is likely that 95% of the EU installations even in sectors with carbon leakage status will be at a disadvantage. In ceramics some state of the art energy efficient installations do not receive all the allowances they need because of factors not currently addressed sufficiently by the EU ETS.

o certain more durable variants with a longer lifespan and lower lifecycle carbon footprint require more energy to produce;

o process emissions from carbonate in clay are unavoidable and unabatable now or in the future, and depend on the type of local clay. National methodologies differ wildly for the measurement of process emissions, with some member states much less rigorous than the UK. These factors all cause competitive distortion both within and outside Europe.

What reduction in emissions will the EU ETS deliver in Phase III, within the EU and abroad? 6. Energy intensive industries have every incentive already to become energy efficient without excessive

taxation or cap and trade measures. Energy efficiency is one means of reducing significant costs and gaining a competitive advantage (or just staying in business).

7. In phase III, there is a danger that the EU ETS will only reduce perceived emissions within the EU, when in reality it will simply cause carbon leakage (i.e. production will decrease in the EU and move elsewhere, where energy costs are lower, and environmental legislation is less stringent).


8. The definition of “other” trading schemes needs to be clarified, as it is unclear if this question refers solely to EU instruments, or international schemes such as those in California in the USA and the scheme that may be developed in the Pacific basin with Australia / Japan etc.

9. Some tax systems may offer very significant rebates to energy intensive industries (e.g. Australia), therefore the linking of schemes would require measures to ensure a “level playing field”.

10. Schemes that have a relative target rather than absolute target might struggle to succeed in reducing total emissions.


Could sectoral agreements form part of the future of the EU ETS? 11. This is an extremely broad question and could be applied globally or within the EU. 12. Global sectoral agreements could offer a sensible means of achieving a more level playing field. Such

agreements would reduce or eliminate the competitive disadvantage experienced by European manufacturers competing with overseas companies that are not subject to the EU ETS or a similar scheme. Such agreements would be a crucial step towards genuine reductions in total global emissions, and would improve both its environmental and economic efficiency. If it succeeded, it would effectively allow the EU ETS to operate efficiently in a global market in the absence of other cap-and-trade schemes. It would however be a challenge to facilitate and ultimately enforce global sectoral agreements.

13. Within the EU, sectoral agreements could have a different function, providing a helpful alternative to the very restrictive definition of “installation” within EU ETS, whereby companies or sectors could choose to invest selectively to attain definitive (absolute) reductions in emissions without the currently proposed penalties of applying to the New Entrants Reserve or having targets or caps readjusted by capacity changes. More discussion would be needed to help simplify the current rules, which are prone to disincentivising investment in the EU.

Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism? Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system?

14. The cumulative effect of all climate change policies on energy bills and energy taxes in the UK including EU ETS and its UK transposition shows that many ceramic manufactures in the UK are unclear as to whether they will have a profitable business in future, compared with those in other EU and non-EU countries. Large policy swings affect manufacturing strategy and fuel choice, e.g. Fossil Fuel Levy / Renewable Heat Incentive → Carbon Price Floor (see Environmental Audit Select Committee oral evidence1).

How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations?

15. Continue with free allocations. The reduction of free allocations and the tightening of targets would only reduce emissions if the EU ETS operated globally, as this would then reduce its competitive distortion effects to different product types with the same or similar applications, rather than identical products produced in different regions.

16. In the absence of binding international agreements applied consistently, the more ambitious the EU ETS targets, the less effective the EU ETS will be as energy efficient EU manufacturers will not be able to remain profitable i the face of international competition.

Recommendations

17. We need the Government to continue to push for a legally binding international agreement with a level playing field.

18. The UK and EU need to move to measuring consumption emissions and not just initial “produced” emissions, to avoid carbon leakage.

19. We need clarity and a fair treatment compared with other states for ceramics in the UK, for o Equivalent national schemes for small emitters o Treatment of process emissions, for instance mitigation due to these being fixed and

impossible to reduce. Please feel free to contact us if you require any more information or would like oral evidence.

August 2011

1 http://www.parliament.uk/business/committees/committees-a-z/commons-select/environmental-audit-

committee/inquiries/carbon-budgets/

Memorandum submitted by RWE UK (ETS 30)

Introduction 1. RWE welcomes the opportunity to submit its views on the EU Emissions Trading System (EUETS) to

this inquiry. This is a joint submission on behalf of RWE npower and RWE Supply & Trading. RWE npower owns and operates one of the largest and most diverse portfolios of power generating plant in the UK with over 9,000 megawatts (MW) of large gas, coal and oil-fired power stations and cogeneration plant. Our retail arm, npower, is one of the UK’s leading suppliers of electricity and gas with around six million customers. RWE Supply & Trading is one of the leading companies in European energy trading and is responsible for all of RWE’s activities on the international procurement and wholesale markets for energy and carbon.

2. The EUETS is a key element of the policy framework for achieving the UK's and Europe's climate

change policy objectives. RWE is fully supportive of market-based approaches to climate and energy policy and believes that an efficiently functioning EUETS is the most effective means of delivering cost-effective reductions in greenhouse gas emissions. The establishment of EUETS, the mechanics of which are generally functioning well, is a significant achievement. It is important that there is strong EU-wide political commitment to EUETS going forward, including delivering a robust long-term and enduring framework so that there is necessary confidence on the part of investors to deliver the low carbon infrastructure that is needed to achieve EU policy goals.

Response to questions Question 1: Does the EU ETS remain a viable instrument for climate change mitigation in the EU? 3. The EUETS is – and remains - the only credible EU-wide instrument for delivering explicit

quantitative greenhouse gas emission reductions. The alternative of an EU-wide carbon tax is unlikely to be palatable to Member States and, unlike EUETS, would neither guarantee specific emission reductions to meet mandatory EU targets nor ensure that those reductions are achieved at the least possible cost to the EU economy.

Question 2: Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap-and-trade schemes? 4. It is perfectly possible for the EUETS to operate effectively in the absence of a globally binding

greenhouse gas agreement. However, it will be important to ensure that the emissions reduction trajectory is consistent with the following principles:

• Delivering strong economic growth within the EU • CO2 emission reductions must not be achieved by driving industrial production outside the EU • EUETS must be combined with economically efficient greenhouse gas emission reduction

policies across all economic sectors • A diverse range of technologies should be promoted to deliver emission reductions.

Supporting particular technologies through separate mechanisms effectively undermines the cost efficiency principle of EUETS and its price formation mechanism.

Question 3: What reduction in emissions will the EUETS deliver in Phase III, within the EU and abroad? 5. Emission reductions by the EUETS will be those specified by the cap trajectory, offset by credits from

current JI and CDM projects, including credits banked from phase 2 to phase 3, where the emission reductions will occur outside the EU. In the absence of an international agreement, there remains the prospect of offset credits being generated further to bilateral agreements between the EU and other countries. However, the European Commission seems to be extremely reluctant to pursue

such bilateral agreements, an approach which will increase the cost of emission reductions within the EU.

Question 4: Could the environmental and economic efficiency of the EUETS be improved by linking with other emissions trading schemes and how can this be achieved? 6. Linking the EUETS to other emissions trading schemes offers the potential to improve the

environmental and economic efficiency of the EUETS. Although progress on developing effective schemes outside of the EU has been disappointingly slow, should linkage be considered at some point, it will be important to ensure appropriate safeguards are in place to avoid undermining the stability and efficacy of the EUETS. Specifically, any linkage should be signalled to the market well in advance and candidate schemes will need to demonstrate strong environmental integrity and have sufficient credibility and maturity for any initial teething problems to have been satisfactorily resolved. A comparable set of rules will be essential, including comparable emissions reductions objectives; a consistent basis for setting caps; and, robust monitoring, verification and reporting procedures.

Question 5: What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally? 7. The UK Government and the EU Commission have to date acted as commendable ambassadors for

the use of emissions trading as the cornerstone of EU efforts to tackle climate change. They should continue to spread the message that emissions trading works and should resist any temptation to “give up” on the principles of emissions trading in the face of competing green and emissions reduction initiatives which threaten to undermine both the primacy of the EUETS and its ability to deliver emissions reductions at least cost.

Question 6: Could sectoral agreements form part of the future of the EU ETS? 8. “Sectoral agreements” covers a variety of potential mechanisms. At one end, we have the ETS which

applies to certain sectors of the economy, but where those sectors are covered by an absolute cap on emissions. Similar sectoral agreements – ie, those featuring absolute emissions caps – would significantly enhance the scope and efficiency of the EU ETS.

In contrast to absolute sectoral caps, we do not see intensity-based sectoral agreements as having a part to play in the future and extension of the EU ETS. Credits generated from reducing emissions against a sectoral benchmark of emissions intensity are just not the same product as an absolute tonne of CO2 abatement and the admission of these credits into the ETS would significantly dilute the “supply” of credits. The credits generated in one sector (eg, cement) would not be fungible with those from other sectors (eg, steel) and no absolute signal would be sent to consumers on the need to reallocate resources towards less emissions intensive products. The introduction of such intensity-based sectoral agreements, will be a significant source of delay, distortion and distraction from the real objective of agreeing genuine, and absolute, emissions reduction targets.

Question 7: Will the EUETS be able to access viable alternatives to international credits without the Clean Development Mechanism? 9. The EUETS has increasingly limited demand and access to Clean Development Mechanism (CDM)

(and Joint Implementation) credits and the combination of quantitative and various qualitative restrictions (eg, on gases or host countries) will limit the future use of Certified Emissions Reductions. The only “viable alternative” envisaged under the current ETS is credits arising out of bilateral international agreements. These credits might be absolute tonnes, eg, in the event that we couple cap-and-trade schemes or presumably arise from offset projects which are similar in many respects to those projects developed under the CDM. Any credits arising from those sources would presumably need to pass similar tests to those involved in the CDM to ensure the environmental integrity and the “additionality” of the associated reductions. We would question whether there is

sufficient appetite or need to reinvent the wheel in this respect and, as noted above, any form of transitional intensity based scheme is more likely to delay and deflect attention from emissions reduction than otherwise.

Question 8: Is the EUETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system? 10. The EUETS should be a constraint on unilateral action by Member States to deliver emission

reductions in the traded sector. The introduction of carbon price support by the UK Government in the last budget is extremely disappointing in this regard. Setting a carbon floor price in the UK will not deliver any additional emission reductions across the EU as a whole and could lower the price of allowances for other Member States. It also has the potential to be damaging to the competitiveness of UK industry at a time when energy intensive sectors have a vital role to play in promoting economic recovery and supporting the delivery of the significant levels of new infrastructure needed to deliver UK energy and climate goals. Furthermore, given the high level and early date for introduction, it is clear that this is simply a revenue raising mechanism for Treasury rather than one primarily designed to stimulate low carbon investment in the electricity sector. It also provides a significant windfall to existing nuclear power stations. Carbon price support will not drive low carbon investment as it is not bankable politically. Furthermore, the benefit of any pass through to electricity prices in remunerating such investment will diminish over time as the carbon intensity of the UK electricity system reduces.

Question 9: How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? 11. The recent cases of fraud and allowance theft have undoubtedly undermined confidence in the

EUETS to some extent. However, it needs to be stressed that neither needed to happen and that neither is in any way inherent to emissions trading itself (rather than economic activity more widely). Registry security was clearly inadequate and tax fraud arose from the peculiarities of the VAT charging arrangements rather than as a result of anything to do with emissions trading per se. Both problems have now been largely addressed and the changes to registry security are likely to be sufficient.

Question 10: How can the EUETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations? 12. The EUETS can operate perfectly well with binding EU emissions reduction obligations in the

absence of similar obligations outside of the EU. The best way to “strengthen” the EUETS is to demonstrate strong EU-wide political commitment to its role as the primary tool within the EU to achieve EU emissions reductions. The key strength of the EUETS is its economic efficiency, achieved by avoiding “picking winners” in terms of specific technologies, industries or geographies for achieving the required CO2 reductions. We need to stay true to this goal and continue efforts to extend the EUETS internationally, while avoiding the “second guessing” of the instrument at home with national subsidies for different technologies, carbon taxes, obligations and the like. The danger is that such national or EU-level interventions will substantially increase the cost of delivering the desired emission reductions. The EU and member states cannot hope to sell the ETS to the world, if it doesn’t trust it to achieve the required reductions at home.

August 2011

Memorandum submitted by EDF Energy (ETS 31) Executive Summary

• EDF Energy supports the EU ETS as an essential measure to meet the EU’s emissions reduction objectives. We recognise that the scheme has had problems in its implementation since inception but we believe that, if these shortcomings can be addressed, it still has a key role in the decarbonisation efforts of both the UK and EU.

• It is commonly accepted that the current EU ETS price is not providing the

long-term signal to make the relevant investments in low carbon generation. The introduction of the carbon price floor in the UK helps restore the long-term price signal that the EU ETS was expected to achieve. However, this does not obviate the need for reform of the EU ETS at the European level but in fact reinforces the importance of achieving a well-functioning scheme.

• EDF Energy welcomes a number of the changes that will be introduced in

Phase III of the EU ETS. We also support other initiatives that would help remedy some of the defects of the EU ETS at the European-wide level. These include moving beyond the 20% greenhouse gas reductions target in 2020, as well as setting an ambitious target for the fourth trading period beyond this date. We would encourage the Government to pursue these further with its EU partners.

About EDF Energy

1. EDF Energy is one of the UK’s largest energy companies with activities

throughout the energy chain. Our interests include nuclear, renewables, coal and gas-fired electricity generation, combined heat and power, 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.

Role of carbon trading 2. It is widely agreed that carbon pricing is a key element of climate change

mitigation policy, as it ensures that the environmental and social cost of greenhouse gas emissions are internalised and reflected in the price of goods and services. EDF Energy believes that greater certainty in the future long-term price of carbon will form an important and significant part of the electricity market framework required to increase investment in low carbon generation.

3. There are two main options for putting a price on greenhouse gas emissions

– carbon taxes and carbon trading. Theoretically, under conditions of certainty, both options produce the same outcome. However, a number of perceived advantages have led to a preference for carbon trading in a real-world context. The Committee on Climate Change1 has articulated these advantages, namely 1) that carbon markets can be based on clearly defined limits to total carbon dioxide emissions, with caps reducing over time 2) they provide a price incentive for firms to invest in low carbon technologies and 3)

1 Committee on Climate Change, (2008). Building A Low Carbon Economy, p147

they help minimise the cost of meeting any given emissions reduction target. The free trading of carbon allowances, by recognising that the cost of abatement differs between sectors and/or countries, ensures that mitigation occurs at least cost and in a flexible manner. In the long run, it is also perceived that carbon markets are more conducive to the eventual global harmonisation of carbon prices through their potential linkage with other schemes. This is likely to be easier to achieve than through the co-ordination of tax policies across different sovereign states.

4. It is for these reasons that EDF Energy supports the principles of a carbon

trading scheme as the primary means to meet the EU’s emissions reduction objectives. We recognise that the EU ETS has had problems in its implementation since inception but we believe that it still has a key role in the UK’s decarbonisation efforts.

Performance of the EU ETS

5. Over its six years of operations, the EU ETS has had to deal with the effects of – to name just a few – flawed initial data, insufficiently robust infrastructure and extreme economic volatility. However, despite these challenges the instrument has been successful in crystallising the concept of carbon pricing and has facilitated the commercial framework for reducing emissions. Furthermore, we believe that the changes to be introduced in the third trading period (as we will discuss in paragraph 13) will yield further improvements.

6. The EU ETS has successfully set an EU-wide carbon price and encouraged

lower carbon operations across Europe. When the scheme was initially proposed in 2002, it seemed to be the only workable way to deliver EU climate change policy objectives in a cost-effective manner. We do not believe that an alternative policy tool currently exists that could be readily deployed at the EU level to meet these objectives. The EU ETS has provided a credible platform on which international credits arising from the flexibility mechanisms of the Kyoto Protocol can be traded. Although the overall reduction in greenhouse gas emissions is not at the scale that was originally anticipated, its significance should not be underestimated. Despite the excessive allocation of allowance in Phase I, the Massachusetts Institute of Technology (MIT) has estimated that the EU ETS has cut European emissions by 120-300m MtCO2

2, primarily by encouraging fuel switching from coal to gas. The European Commissioner for Climate Action has also recently stated that the average annual emissions per installation in 2010 were around 8% lower than when the ETS was launched in 2005, and not of all this can be attributed to reduced demand as a result of the global recession3.

7. However, the EU ETS has not yet succeeded in creating a material and

sufficient incentive for low carbon investments with payback periods extending over decades. The EU ETS has not been able to put such a reliable long term price on carbon dioxide emissions for a number of reasons. At the moment prices are largely driven by the cost of switching from coal to gas rather than reflecting the marginal abatement costs of the technologies required to deliver the deep cuts in emissions required to meet our climate change objectives. The memory of the over-allocation of allowances in Phase

2 Climate Strategies (2009), Climate Policy and Industrial Competitiveness: Ten Insights from Europe on the EU Emissions Trading System 3 http://europa.eu/rapid/pressReleasesAction.do?reference=SPEECH/11/527 Last accessed: 10/08/11

I (2005-2007) and the global economic recession during the current Phase II (2008-2012) have both served to undermine the carbon price. The latter, in particular, highlights the fact that the EU ETS has limited supply side measures to deal with large external shocks, and policy interactions (as we will discuss in paragraph 18) only serve to exacerbate the situation. At the moment there is also still uncertainty over the final emissions cap in 2020 and the conditions under which the aviation sector is added to the scheme. It is still not clear which types of carbon credits from other mechanisms such the Clean Development Mechanism (one of the ‘flexibility mechanisms’ adopted in the Kyoto Protocol) will be eligible for EU ETS compliance in the future.

8. Although the EU ETS does not currently have a sunset clause and so

technically extends beyond 2020, it was only the cap up to 2020 that was the subject of the EU political agreement reached under the 2008 Climate and Energy Package. However, it is the period after 2020 that is of most concern to prospective investors in low carbon generation (including nuclear and CCS) in terms of recovering their investment. Understanding the value of carbon in this period will therefore be critical for investment decisions, even though we do not have a clearly agreed target for 2020. We welcome the longer timeframe set for Phase III (2013-2020) and the focus now should be on developing the EU ETS beyond this date to at least 2030, and ideally 2050, so that companies have sufficient confidence to make the investment in such low carbon generation that is required to meet our emissions reduction obligations.

9. It must be stressed that the prevailing energy policy landscape differs

between Member States and that the EU ETS cannot be expected to meet concurrently specific energy policy and climate change objectives in individual Member States. It is commonly accepted4 that the current EU ETS price is not providing the long-term signal to make the relevant investments in low carbon generation. With a quarter of the UK’s generating capacity due to close over the course of the decade5 as a result of the general deteriorating economics of ageing plant and the impact of environmental legislation such as the Low Combustion Plant Directive (LCPD) and Industrial Emissions Directive (IED), the reality is that the UK needs to move faster to renew its infrastructure than other Member States.

10. It is in this context that EDF Energy welcomes the Government’s introduction

of a carbon price floor through the Finance Act 2011. Greater certainty in the future long-term price of carbon will form an important and significant part of the electricity market framework required to increase investment in cost effective low carbon generation in the UK. The carbon price floor will also act to reduce the emissions from the existing plant mix by ensuring that a stronger price signal is factored into day to day operational decisions. It will have a positive impact on investment in existing low carbon plant, including life extensions of the UK’s existing nuclear fleet. It will also support investment in energy efficiency upgrades and increased biomass co-firing in existing coal-fired plant.

11. The introduction of the carbon price floor helps restore the long-term price signal that the EU ETS was expected to achieve. This will provide much

4 For example: Committee on Climate Change, (2009). Meeting Carbon Budgets – the need for a step change 5 DECC, (2011). Planning our electric future: a White Paper for secure, affordable and low-carbon electricity, p5

needed price stability for UK investors in low carbon generation. However, it should be recognised that the carbon price floor is only a complement, and not a reform, to the existing scheme. It does not obviate the need for reform of the EU ETS at the European level but in fact reinforces the importance of achieving a well-functioning scheme.

12. In summary, EDF Energy believes that the EU ETS remains a key driver for

decarbonisation across both the UK and the EU, provided that the current shortcomings can be suitably addressed.

Reform of the EU ETS

13. The EC has recognised some of the weaknesses that have been highlighted above and we support a number of the initiatives that will be introduced in Phase III. These include a move to a centrally determined cap at the European level instead of allowances being allocated per Member State through National Allocation Plans (NAPs), which have been deemed to have been over-inflated. The Phase III cap will reduce annually by 1.74% and will deliver an overall reduction of 21% below 2005 emissions by 2020. We also support the move to further limit the use of international project credits to 50% of the proposed reductions. As the Committee on Climate Change (CCC) has noted, “a policy of relying too much on purchased credits in the initial years could make a stretching 2050 domestic target unachievable and could cost the UK dearly by mid-century given the likely high and rising costs of purchased credits”6, and we support the EU’s pledge to focus on domestic reductions. EDF Energy also welcomes the move to the full auctioning for the power sector in the UK and across most of the EU, as long as the necessary administrative arrangements are firmly in place well in advance in order to enable an efficient and transparent auctioning process.

14. That being said, we believe international crediting mechanisms still have an

important role to play and support efforts to develop workable mechanisms that will extend the scope of the current carbon price incentive available through the Clean Development Mechanism (CDM). This will help developing countries in their transition towards lower carbon development paths. We believe that the CDM is the only instrument available to play a bridging role in any transition to a new international crediting mechanism. On the assumption that the EU ETS retains an important role in driving international emission reductions, it is important to: (i) maintain CDM credits as compliance instruments in the EU ETS, thereby preserving (part of) the experience, expertise and structures of the existing carbon finance industry which has essentially developed around the CDM; (ii) keep open the possibility of using alternative credits; and (iii) strengthen initiatives to develop workable crediting mechanisms. We recommend that the EC should expand its current focus to explore crediting mechanisms based on avoided deforestation activities (‘REDD credits’). This is a very promising area in terms of both its climate change mitigation potential and prospects for political agreement at the international level.

15. Despite the welcome reforms outlined above, we still have a number of

concerns. It is generally agreed that the recession has led to an over-allocation of allowances that has caused the carbon price to fall. However, there has not been a commensurate reduction in the cap for Phase III, which

6 Committee on Climate Change (2008). Building a Low-carbon economy, p160

is based on the average Phase II allocations. This means that oversupply in Phase II has led to the unintended consequence of being carried forward into Phase III, which covers a longer time period (8 years) than Phase II7. We believe that it is imperative to develop a mechanism by which the emissions cap can be adjusted in a transparent and timely manner to appropriately account for supply side shocks such as the global recession. The linear reduction in the cap of 1.74% per annum must be reviewed to ensure that a political consensus is formed over the long-term emissions trajectory in the EU ETS and that this cap fully aligns with the EU’s long-term aspiration to deliver a 60%-80% reduction in greenhouse gas emissions by 2050.

16. EDF Energy would therefore support initiatives that would help remedy some

of the defects of the EU ETS at the European-wide level, and would encourage the Government to pursue these. For example, we agree with the Government that the UK should work with its EU partners to arrive at a robust agreement for domestic carbon dioxide reductions across the EU, including a more ambitious reduction target for 2020 relative to 1990 levels, as advocated by the Secretary of State for Energy and Climate Change and a number of other EU Environment Ministers8. As the supply side of the EU ETS is totally inelastic, we believe a supply response mechanism, based on transparent and objective criteria, and resulting in a minimum level of scarcity, would help UK industry avoid any unnecessary differential competitive impacts and help address carbon leakage concerns.

17. EDF Energy welcomes the Government’s recent announcement to adopt the

recommendations of the Committee on Climate Change (CCC) on the Fourth Carbon Budget. The UK has taken a clear leadership position in setting the framework for reducing greenhouse gas emissions, and the challenge now is to ensure that we maintain the momentum needed to make the transition to a low carbon economy. We understand that the Government will carry out a review in 2014 to ensure that our carbon targets are in line with the EU’s. However, we believe that, instead of reducing its ambitions, the UK Government should continue to engage with other Member States to use its example to broaden theirs. However, should the Government find reason to make any changes during this review, it is important to note that even a slower path to decarbonise the economy will still require the UK to largely decarbonise the electricity sector by the early 2030s. As such any review must not undermine the development of a policy framework to decarbonise the electricity sector.

18. It is important that targets and reforms at the EU level are considered

holistically and do not have any unintended consequences. For example, EDF Energy fully supports the proposed Energy Efficiency Directive as a means to reduce the demand for energy by stimulating consumer demand for energy efficiency measures. However, we are concerned that a failure to adjust the EU ETS cap for such policy interactions may lead to a less robust carbon price. This is reflected in the Impact Assessment of the Energy Efficiency Directive9. This states that the EU has run two different models, where one model projects a drop to zero of the carbon price in 2020, while the other projects a reduction from €16.5/MtCO2 to €14.2/MtCO2 in 2020. We believe that such uncertainty may undermine the case for investment in low

7 Sandbag (2011). Buckle Up! Tighten the cap and avoid the carbon crash 8 http://www.decc.gov.uk/en/content/cms/news/chrish_eulett/chrish_eulett.aspx Last accessed 10/08/11 9 European Commission, (2011). Impact Assessment of the Energy Efficiency Directive, June 2011

6

carbon generation and believe that this needs to be addressed in greater detail. We would welcome suggestions by the EC that a number of allowances could be set aside as means of tightening the overall cap10. Such recourse is important given that the only mechanism within the EU ETS to prevent low carbon prices from occurring is the ability for participants to bank allowances between phases.

19. We believe that the EU ETS should be expanded into the heat and transport

sectors, under an appropriate approach that accommodates the challenges of these decentralised sectors. Analysis has shown that low carbon electricity generation can be a key driver in the decarbonisation of the residential heat and surface transport sectors. Bringing these sectors into the EU ETS will ensure that the cost of decarbonisation is applied equally across the economy (and not just the electricity sector) in line with the polluter pays principle.

EU ETS in the current international context

20. EDF Energy supports, in principle, the long-term goal of linking the EU ETS to other similar international trading schemes, subject to consistency in rules and regulations, so that the integrity and credibility of the EU ETS is not undermined. Nonetheless it is vital that a lack of progress elsewhere (e.g. in the USA) should not undermine or impede the urgency of reforms required in the EU ETS as highlighted above.

21. We believe that the EU ETS could facilitate common international action and

would encourage both the UK and EU to continue to engage with other countries on the issues. However, if this is not fruitful, then we believe that the EU ETS is able to operate perfectly well in a world where only the EU is pursuing ambitious emission reduction objectives (or where the international climate change policy framework is based on a pledge and review approach, as opposed to binding commitments). If there is a lack of progress outside Europe, then it will become important to have a strong and wide political consensus to support (i) the EU’s climate change mitigation objectives (and especially the target emissions trajectory to 2050), and (ii) the role of the EU ETS in delivering that objective. We believe that such support will need to come from the highest level of the Member States in the EU Council, the EU Parliament, and the relevant Directorate Generals of the EC (including Climate Action, Energy, Enterprise and Industry, Competition, Internal Market and Services).

22. The key challenge in obtaining such support is the concern that the EU

economy will be put at a disadvantage if it acts unilaterally. The question of Border Adjustment Measures will need to be looked at carefully, including a detailed and objective assessment of its merits, drawbacks and impacts.

23. The urgently needed debate on the EU low carbon roadmap to 2050 will be

critical to moving forward on the above. August 2011

10 European Commission, (2011). A Roadmap for moving to a competitive low carbon economy in 2050

Memorandum submitted by FERN (ETS 33)

Executive Summary

I. Fundamental flaws in the design of the EU ETS have been exposed by (a) a series of fraud and cybercrime incidents; (b) the excessive use of carbon offsets by companies hoarding higher-value EU ETS permits received free of charge; and (c) the lack of a functioning regulatory possibility to adjust the supply of EU ETS emission permits to a sharp economic downturn, and the resulting drop in emissions far below projected levels that were used to calculate permit allocation. It appears unlikely that amending the regulatory framework of the scheme with the aim of addressing these shortcomings will succeed when the challenge is not to remedy minor design flaws or to 'iron out the teething problems' but where the failures have exposed structural flaws of the design itself. Attempts at scaling up project-based offsets to sectoral offset trading schemes and expanding carbon trading schemes to additional sectors, such as the forest and land use sector (where error margins are even bigger and risk of reversal of carbon savings is significant), or linking trading schemes that operate in jurisdictions where enforcement capacity differs significantly, will provide the ground for trading in ‘subprime’ carbon derivatives. This is likely in particular because much of the trading activity in carbon offsets is carried out 'over-the-counter' and where the spot trading of carbon permits remains largely unregulated.

II. Regulatory arbitrage and use of loopholes by fraudsters is already an issue even within the relatively uniform regulatory framework of the EU ETS. For example, in November 2010, a surge in “suspicious” trading activity on the Italian GME exchange (where volumes on the spot market exceeded those on the futures market, and carbon traded at a discount for weeks) seemed to be the result of carbon market fraudsters switching their activities from Denmark, then Spain to Italy, one of the few countries that at the time had not yet implemented ‘reverse-charge’ for VAT. At least one EU Member State – Estonia - has still not introduced reverse VAT charges for carbon trades and has indicated it will only do so once another incident of fraud provides evidence for the need to introduce reverse charging.

Co-ordination among the EU Member States has also shown to be a challenge in relation to an earlier VAT scandal, with the Danish EU ETS register at the heart of the fraud; reportedly France and Germany refused to give Danish

authorities, who were pursuing VAT carbon fraud, access to trading accounts on grounds of data protection. The handling of the incident of theft of EU ETS permits straight out of account holder registries in early 2011 further exposed the vulnerability of the EU ETS design and the consequences of its splintered responsibility between European Commission and Member States. Due to differences in Member States' legal systems the legal wrangling over who holds ownership over the stolen permits is expected to continue for several years.

The risk of regulatory arbitrage and fraud, difficulties of co-ordination across jurisdictional boundaries and legal conflicts will increase significantly with the linking of separate regional carbon trading schemes to the EU ETS. The stringency of the caps in the different regional schemes will vary, as will the rules on which types of carbon offsets can be used in the scheme, or how many offsets are permitted. All these differences will provide significant potential for regulatory arbitrage, malpractise and fraud which would further reduce the likelihood of carbon trading schemes contributing to climate change mitigation.

IIIIII. UN-backed carbon offsets are an integral part of the EU ETS, their entry into the scheme is regulated through the Linking Directive and subsequent regulation. ‘Offset’ credit creation however, is based on conceptual incoherence, is characterized by measurement and accounting problems that are unsolvable and is giving rise to significant property rights conflicts. Yet, all existing and planned carbon trading schemes include the option to use carbon offsets. Were the EU ETS to link with offset trading schemes based on projected business-as-usual sectoral baselines, the flaws of CDM-type project-based offsets would merely be scaled up to the sectoral level. The impossibility to verify 'additionality' and the likelihood for non-additional sectoral offset credits entering the trading scheme would remain just as with project-based offsets – only on a larger scale.

IVIV. Continuation of the EU ETS beyond 2020 may thus not only fail to contribute to the EU achieving its objective to limit global warming to an average of 2 degrees C but also continue to undermine tried and tested direct regulatory approaches such as feed-in tariffs, benchmarking, aggressive energy efficiency programmes coupled with strategic investments in 'smart grids' and investments in initiatives to reduce the EU's carbon footprint outside the EU.

Introduction

FERN welcomes the Environmental Audit Committee’s new inquiry into the EU Emissions Trading System. We are grateful for the opportunity to comment on the issues in the inquiry's remit.

1. FERN is a European non-governmental organization. We work to achieve greater environmental and social justice in the policies and practises of the European Union, with a focus of FERN’s work on forests and forest peoples’ rights.

2. FERN has pursued research into climate policies and carbon trading for over ten years1. Our research and advocacy has been carried out in close collaboration with organisations in the Global South and NGO networks. FERN has provided submissions and discussion papers, including to previous Environmental Audit Committee inquiries into carbon markets and the EU Emissions Trading Scheme. Most recently, FERN provided submissions to the CFTC on financial markets regulation as it relates to fraud and malpractise in carbon markets and to the UNFCCC on 'New Market Based Mechanisms'.

1 For a summary of the analysis and extensive case study references, see 'Trading Carbon. How it works and why it's controversial. www.fern.org/tradingcarbon

Specific comments on the issues in the inquiry's remit


3. It is worth recalling that it is only the cap in carbon 'cap-and-trade' schemes that determines the climate effectiveness of the scheme; the trade only functions as a cost-management tool. In the case of the EU ETS, the cap is so oversized as to render the scheme's contribution to climate change mitigation negligible23. Due to the significant overallocation of free allowances to most covered installations in Phases 1 and 2 of the EU ETS, it is questionable whether the scheme can be considered to have contributed to any significant climate mitigation by 20204. Phase 2 of the scheme further allows the carry-over of unused permits into Phase 3. This banking of unused permits, combined with the lack of a mechanism to revise the baseline in light of the sharply reduced emissions due to the economic downturn has led to a significant collective surplus of permits held by covered entities that may increase to 1.9 billion tonnes through to 2020 - the equivalent of a year's worth of carbon permits.5 6

4. Proponents of the EU ETS argue that the scheme has led to emissions reductions in the facilities covered7. These reductions – where they are not merely the result of the post 2008-economic downturn – appear to have been the result of 'low-hanging-fruit' efficiency improvements rather than transformational investments – investments that would contribute to transforming the EU economy into a low-carbon economy which by 2050 will

2 'Buckle Up' Sandbag. July 2011 http://www.sandbag.org.uk/reports ; Carbon Fat Cats 2011. Sandbag. http://www.sandbag.org.uk/reports/

3 The EU Emission Trading Scheme: designed by committee. Arnold Mulder. http://www.europeanenergyreview.eu/site/pagina.php?id_mailing=172&toegang=1ff8a7b5dc7a7d1f0ed65aaa29c04b1e&id=2914

4 EU ETS emissions up 3% in 2010: analysts. Carbon Market Daily. Point Carbon. 25 February 2011. www.ppointcarbon.com

5 http://www.corporateeurope.org/climate‐and‐energy/content/2011/04/eu‐ets‐failing‐third‐attempt

6 Under Pressure'. Robin Lancaster in: Trading Carbon. July / August 2011. www.pointcarbon.com

7 Carbon Pricing for Low Carbon Investment. Climate Policy Initiative. 2011 http://www.climatepolicyinitiative.org/files/attachments/88.pdf

produce 80-90% fewer emissions than today without just increasing its carbon footprint outside the EU.

5. Often, the increase in trading volume is cited as evidence that the EU ETS is working. Where trading is dominated by entities not covered by emissions targets however, an increase in the volume of traded carbon permits and credits does not contribute to climate mitigation: The permits and carbon offsets get traded in secondary markets but this does not lead to additional emission reductions, nor does this form of trading in the secondary markets make significantly more capital available for implementation of emission mitigation activities. Just like profits made in the used automobile market do not result in more profits for car manufacturers, it must not be assumed that profits from trading in a multi-billion dollar carbon market will be invested in climate mitigation. For example, the reality in the carbon market is that the primary CDM market comprises only a small proportion, about 1.5 per cent of the total value of the global carbon market. Thus, only a tiny percentage of the carbon market revenue goes to climate mitigation activity that supposedly resulted in additional greenhouse gas reductions in developing countries8.

6. Architects of the EU ETS appear to have underestimated the consequences of the two groups of actors in the scheme having diametrically opposed objectives regarding price development: While entities covered by the EU ETS look to the trading scheme to deliver a predictable carbon price which allows the entities to hedge their exposure and base long-term energy infrastructure investment decisions on the carbon price, the primary objective of most non-compliance actors is the generation of price volatility9. These actors not covered by emissions targets prefer price volatility over price predictability because their profit is dependent on volatility. An increasing price volatility from speculation however may well render carbon trading increasingly unsuitable as a cost-management tool for companies with emission reduction obligations. Thus, increased involvement of speculative actors whose primary interest is not the cost-effective implementation of greenhouse gas emission reduction targets may undermine the carbon market achieving its original objective. Participants whose trading is motivated by speculation will use their trading power to generate, exploit and profit from price volatility, as unpredictable price movements is how speculators profit.

8 World Bank Carbon Finance Unit (2010): State and Trends of the Carbon Market 2010.

http://siteresources.worldbank.org/INTCARBONFINANCE/Resources/State_and_Trends_of_the_Carbon_Market_2010_low_res.pdf

9 EU ETS needs regulator to provide liquidity: Barclays. Carbon Market Daily. 25 June 2010 www.pointcarbon.com


7. Due to the build-up of a substantial surplus of carbon permits in the EU ETS, the prolonged economic downturn resulting in lower emissions and generous access to carbon offset credits, the high-emitting industry sectors covered by the EU ETS do - in net terms - not need to take domestic action to reduce their emissions before 2017, 12 years after the start of the EU ETS10.

8. The 1.6 billion tonnes worth of carbon offset credits the companies covered by the scheme are allowed to use in particular call into question whether the EU ETS can be considered to deliver emission reductions. Many companies covered by the EUETS have made extensive use of the ability to use carbon offsets even when they are in possession of large amounts of unused carbon permits. By hoarding higher-value EU ETS permits received free of charge and using cheaper offset credits to cover their emissions, companies have been able to generate windfall profits where the costs of compliance with the EU ETS were calculated using the market value of EU ETS permits and to increase the asset value on their balance sheets by retaining the higher-value permits – assets received free of charge at the time of creation of the EU ETS – on the balance sheet for longer. This substitution of permits with offsets is even more troubling considering that “[c]arbon offsets by definition do not exist in any tangible form. An offset can neither be measured directly nor observed in reality, because it represents the absence of a certain quantity of emissions that would have been emitted under a counterfactual 'without-project' or baseline scenario.”11

In addition, so far during the second phase of the scheme, over three-quarters of these have come from a few industrial gas projects, which are widely considered to lack environmental integrity and exemplify how carbon offsets are far from a cost-effective mechanism for reducing ghg emissions.12,13,14

10 See among others, Buckle Up. Sandbag. June 2011. http://www.sandbag.org.uk/reports

11 Constructing carbon offsets: The obstacles to quantfying emission reductions. A. Millard‐Ball & L. ortolano. Energy Policy 38 (2010): 533 ‐ 546

12 HFC‐23 OFFSETS. IN THE CONTEXT OF THE EUEMISSIONS TRADING SCHEME. Policy Briefing EIA & CDM Watch. JULY 2010

13 Chinese firms cashing in on EU carbon trade. Carbon Market Daily. 16 July 2010. www.pointcarbon.com

14 CDM fails to cut HFC‐23 emissions. Carbon Market Daily. 20 April 2010. www.pointcarbon.com

9. With regards to emission reductions delivered abroad, it is important to recall that (1) each supposedly additional emission reduction abroad is neutralised by an additional emission reduction within the EU ETS that allows the company using the offset credit to release emissions over and above the cap set by the EU ETS. There thus is at best no increase in emissions but never a net emission reduction as a result of an offset 'reduction'; (2) it is impossible to know with certainty whether any given offset credit claimed is additional because 'additionality' is based on projections of emissions that would have occurred in the absence of the offset project – calculations which are necessarily hypothetical. As a result, use of carbon offset credits by companies subject to binding emissions limits may in fact increase, not reduce global emission reductions if the offset credits are not generated through a genuinely additional emissions reduction that would not have occurred in the absence of the offset project.15

Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved

10. It is very unlikely that the efficiency of the EU ETS could be improved by linking with other carbon emissions trading schemes, not least because of the complexity of the regulatory regimes required for these trading schemes16. Establishing and implementing the EU ETS for example requires a vast array of regulation: The 2008 revision of the EU ETS will require 14 comitology17 procedures, seven legal proposals and many other points to review and monitor before the directive is fully in force. “It is so vast that it is overwhelming,” according to one official.18 Negotiating and writing these regulations, rules and guidelines is also extremely time-consuming – the

15 CDM Auditors Flunking Additionality. Patrick McCully. International Rivers. 2009.

http://www.internationalrivers.org/en/node/4412

16 "If training or technical assistance is required to comprehend a new market mechanism, it is probably too complex to achieve its intended goals." Frank Ackerman in: The Economics of Collapsing Markets real‐world economics review, issue no. 48, 2008

17 The term comitology refers to the institutional process by which the European Commission and EU Member States negotiate implementing legislation once a law has been passed which requires further specification for implementation.

18 J. Rankin (2009): A winding path to lower emissions. http://www.europeanvoice.com/article/imported/a‐winding‐path‐to‐lower‐emissions‐/63930.aspx

European Commission's internal timetable on the EU ETS comitology shows a to-do list that extends out to the 2020 work programme.19 Further regulation will now be required to fill the gaps in regulatory detail which have been revealed by the recent incidents of theft of EU ETS permits straight out of permit-holders’ accounts:20 Legal wrangling is expected to take years before it can be established who holds the rights to the stolen permits - those who had them stolen despite 'storing' them in accordance with the rules of the scheme or those who bought them in good faith, having followed appropriate due diligence'?21 The stolen permits had in many cases been traded on several times traded between traders in different jurisdictions before trading was halted.

11. In jurisdictions where monitoring and enforcement capacity is far less developed than in the EU, establishing and maintaining such capacity will require substantial resources. It is unlikely that costs to build up and maintain such monitoring and enforcement capacity would be born by market participants. Where the host country of the linked scheme also does not have or provide the resources to establish and maintain such functioning monitoring and enforcement structure, the risk from lax enforcement will affect all schemes that are linked.

12. Regulatory arbitrage is already a problem even in the relatively uniform regulatory framework and enforcement environment of the EU ETS. For example, in November 2010, a surge in “suspicious” trading activity on the Italian GME exchange (where volumes on the spot market exceeded those on the futures market, and carbon traded at a discount for weeks) seemed to be the result of fraudsters switching their activities from Denmark, then Spain to Italy, one of the few countries that at the time had not yet implemented ‘reverse-charge’ for VAT. At least one EU Member State – Estonia - has still not introduced reverse VAT charges for carbon trades and has indicated it will only do so once another incident of fraud provides evidence for the need to introduce reverse charging22.

13. Linking may further reduce the already questionable effectiveness of the EU ETS because it will also increase complexity even further and raise the

19 Ibid.

20 Point Carbon (2011): EU spot carbon market re‐opens, buyers wary. 04 February 2011. www.pointcarbon.com

21 Lawyers prepare suits over stolen EUAs. Carbon Market Europe. 15 April 2011. www.pointcarbon.com

22 Estonia snubs EU on carbon VAT fraud push. Carbon Market Daily. Point carbon 29 July 2011. www.pointcarbon.com

risk of ‘regulatory arbitrage’23 and fraudulent trading. The particular design of the schemes the EU ETS might link to would almost certainly have to cater to national priorities and particularities, just like the EU ETS does and did in the initial allocation of free permits. Such accommodation of national particularities would almost inevitably create the possibility for regulatory arbitrage when different national or regional trading schemes are linked24.

14. Carbon trading schemes that are open to non-compliance actors and which allow trading across different jurisdictions will provide loopholes that will be easy to exploit and difficult, if not impossible to effectively regulate. Architects of the EU ETS underestimated the attraction that such open trading schemes will pose to fraudsters and organized crime. They further failed to foresee that in order to prevent fraud, rigorous design and due diligence before actors are allowed to open trading accounts, is essential. The EU ETS has already seen a number of incidents of fraudulent trading, in three cases causing spot trading bourses to close trading activity for day(s)25. These incidents suggest that the architects of the EU ETS appear to have underestimated the importance of the design on the functioning of the trading scheme – and that in fact subsequent amendments will not be able to remedy the flaws of poor design. Linked trading schemes spanning countries with significantly different potential and cultures to regulate and monitor linked carbon trading schemes will increase such risk for fraud and malpractise exponentially.

15.Linking of carbon trading schemes will most likely also increase the predominance of speculative trading in the carbon market, thus further calling into question the usefulness of carbon trading as a cost-management tool: “We’ll have a financial crisis in emissions at some point. There'll be derivatives and all these unemployed investment bankers will then go work

23 When regional carbon markets are linked, the carbon allowances from the different markets will be considered equivalent and fungible. If the stringency of the targets is not comparable or enforcement and monitoring capacity and scrutiny vary, different prices will develop in different parts of the market for the same product – a carbon allowance. Traders will then be able to use these regulatory differences to generate profit by buying where the permits are cheap and selling for a profit but below the price level in the linked carbon market where regulation and scrutiny are more stringent. The result would be a market scheme dominated by the lowest common denominator.

24 A Changed Emissions Landscape Affects Planned Role for Cap‐and‐Trade. Legislative Analyst's Office. 29 June 2011. Presented to the California Senate Select Committee on the Environment, the Economy, and Climate Change.

25 Carbon Market Europe (2011): Registries remain closed as traders nurse legal headaches. Point Carbon 11 February 2011. www.poiuntcarbon.com; Point Carbon: Italian trader takes EC to court over stolen EUAs. 14 Feb 2011

www.pointcarbon.com

on carbon trading and come up with products which will lead to a crisis. … You’ll find few economists who disagree.”26


16. Scaling up the CDM’s project-based approach to a sectoral or programmatic offset approach will not remedy the fundamental flaw at the heart of offset mechanisms: the reliance on hypothetical baselines for the calculation of offset credit volumes. In the words of the US Government Accountability Office, “Because additionality is based on projections of what would have occurred in the absence of the CDM, which are necessarily hypothetical, it is impossible to know with certainty whether any given project is additional.”27 The same will be true for sectoral and programmatic offset schemes that equally rely on hypothetical baselines for the calculation of offset credit volumes. In fact, the danger of significant overestimation of volumes of offset credits that will be considered additional will increase when the use of hypothetical baselines is extended from the project to the level of whole programmes or sectors.

17. The land use and forest sector are particularly ill-suited for a trading-based market mechanism. In addition to this submission’s view that sectoral offset trading schemes will not remedy the flaws of project-based offsets, any offset trading mechanism would be particularly ill-suited to attempting to reduce emissions in the land use and forest sector. Error margins in quantification make Monitoring, Reporting and Verifying (MRV) of carbon fluxes ‘with sufficient accuracy’ impossible to achieve in forests and agriculture for the time being and possibly for the expected duration of the carbon market28.

26 Kenneth Rogoff, Harvard, former IMF Chief Economist, cited in: Rebecca Weisser: Tax carbon rather than trade in

it. http://www.theaustralian.com.au/news/opinion/tax‐carbon‐rather‐than‐trade‐in‐it/story‐e6frg6zo‐1225787724278 17 October 2009

27 Testimony of John Stephenson, Director of Natural Resources & Environment, Government Accountability Office, before the Subcommittee on Energy and Environment, Committee on Energy and Commerce, House of Representatives, March 5, 2009 at http://www.gao.gov/new.items/d09456t.pdf

28 REDD and Forest Carbon. Market‐Based Critique and Recommendations. The Munden Project. March 2011. www.mundenproject.com

Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism?

18. In the context of binding emissions limits, offsets do not contribute to emissions reduction because the claimed reduction in one place allows emissions in excess of a binding cap in another location outside the capped sector. The best-case scenario is thus no net increase in emissions, but never a reduction. From a climate mitigation perspective, and given the drastic cuts in emissions that need to be achieved if runaway climate change is to be averted, discontinuing the use of offsets in the carbon compliance market would thus be a positive and desirable contribution to climate mitigation: “ The CDM is not a real reduction, it is an offset of an emission and so we will need to move away from the CDM that’s clear.”29

How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required?

19. The string of fraud incidents and the way these have been handled by the regulatory authorities of the EU ETS have shaken the confidence in the EU ETS30 31 32 33 34. The combination of these incidents of fraud, remaining regulatory uncertainty over liabilities and the collapse in carbon prices due to overallocation have led to an exodus of carbon traders and financials from the carbon market.

29 Robert Dornau, SGS quoted in: Which way to turn? Robin Lancaster. Trading Carbon Vol 03 Issue 02 March 2009 Special Report ‘Clean Development Mechanism’.

30 Draining confidence in ETS helps send carbon into freefall. Carbon Market Europe. 24 June 2011. www.pointcarbon.com

31 Under pressure. Is the European Commission up to the task of running the EU emissions trading scheme. Trading Carbon. July / August 2011. www.pointcarbon.com

32 EUR 5 billion and counting. Barclays capital guest article in Trading Carbon March 2011. www.pointcarbon.com

33 ICE maintains zero collateral value for carbon units. 15 June 2011. Carbon Market Daily. www.pointcarbon.com

34 One more crisis will destroy EU carbon market: Barcap. Carbon Market News. 02 March 2011. www.pointcarbon.com

20. Even if security measures had been on par with e.g. online banking industry practice, the EU’s decision to create a carbon market in which virtually anyone can open a trading account, creates regulatory challenges which the EU ETS regulator may be unable to resolve35 36. Many participants trading emissions permits and offset credits used in the EU ETS are not covered by financial markets regulation and operate outside the oversight of financial standards authorities. Proposed revisions of financial markets regulation currently underway in the EU include the option to exempt certain activities from the new rules37. Should carbon trading or carbon market participants be exempted from the new regulations, the sector will continue to operate largely unregulated. Yet, even if carbon trading and all carbon market participants will have to comply with new financial markets and derivatives regulation it is questionable if such regulation will be able to remedy the flaws of poor design of the trading scheme.

21. The risks associated with a trading regime as open as the EU ETS are exacerbated further by the elusive, virtual nature of the asset(s)38 being traded. In the world of finance for example, even collateralized mortgage debt obligations (CDOs) were ultimately based on real, specifiable mortgages on actual houses, even if the underlying asset has been sliced, diced, and re-packaged in ways that made it virtually untraceable and unassessable. There ultimately was an end-user who tested the validity of the asset's valuation. A carbon market that includes carbon offsets by contrast lacks such a possibility for testing of the product by the end-user because the commodity is being created on the basis of a hypothetical story – the story of how many emissions would have been emitted had it not been for the offset project. The actual emission levels of the project are then compared with the levels assumed in the hypothetical baseline. The difference between these two emissions figures is the number of offset credits the project can sell as additional emissions savings. The verifiability of these 'additionality' claims

35 Ten ways to game the carbon market. Friends of the Earth. 2009 http://www.foe.org/10‐ways‐game‐carbon‐markets

36 Carbon trading a front for money‐laundering: experts. http://www.hindustantimes.com/Carbon‐trading‐a‐front‐for‐money‐laundering‐experts/Article1‐573537.aspx

37 Market seeks ‘tailor‐made’ spot trading rules. Carbon Market Daily. 04 May 2011. www.pointcarbon.com

38 While carbon permits and offset credits are considered fungible and both units can be used for compliance with Kyoto Protocol and EU ETS targets; yet they differ significantly with regard to their creation and the resulting ability to verify. For detail, see Trading Carbon. How it works and why it is controversial. www.fern.org/tradingcarbon

has long been questioned39, and many carbon market proponents today agree that 'there is no one right answer to the question of additionality'40. The consequence of this is that many carbon offsets used in the EU ETS are not really backed by genuine additional emission reductions. The only reason why a market that trades fictional offset credits alongside credits based on actual emissions reductions does not collapse is that approval by the UN's CDM Executive Board turns those fictional offset credits into a commodity that is accepted for use in the carbon market that was created by the Kyoto Protocol, and to which the EU ETS is linked via the 'Linking Directive'. No provisions exist in the CDM rulebook for withdrawing or cancelling offset credits that have been issued even if it subsequently became apparent that the savings claimed were not additional. In a step that will further erode the soundness of the asset and increase the risk of fraud and malpractise, CDM Executive Board members have recently stated that they have been “subtly signaling to investors a significant relaxation of that [additionality] rule, specifically for projects in sub-Saharan Africa and other least developed areas"41 in order to increase the number of offset projects in Least Developed Countries. With this move, the CDM Executive Board has discarded the most fundamental requirement for offset credits that allow additional emissions over and above a legally binding limit to actually be backed by additional reductions. Whether one can effectively regulate and build up confidence in a market based on assets of such dubious nature is doubtful.

22. Ultimately, without an international agreement to keep substantial amounts of the remaining fossil fuel deposits unexploited, preventing temperature increases well beyond 2°C will not be possible. Furthermore, as long as the international focus remains on regulating end use rather than input of fossil fuels at source, the absence of ambitious and binding emission reduction commitments will result in a lack of demand for offset credits from scaled-up trading mechanisms. Finally, multiple cost-effective alternatives to trading approaches abound, both market-and non-market based. Therefore,

39 See among others, Carbon Trading. A critical conversation about climate change, privatisation and power. L. Lohmann (ed). 2008 www.thecornerhouse.org.uk

40 See among others 'Assessing the additionality of CDM projects: practical experiences and lessons learned.' L. Schneider. Climate Policy 9 (2009): 242‐252; Constructing carbon offsets: The obstacles to quantifying emission reductions. A. Millard‐Balls & L. Ortolano. Energy policy 38 (2010): 533‐546

41 U.N. body relaxes rules to spread clean development credits around. Nathanial Gronewold, E&E reporter. 25 July 2011. http://www.eenews.net/search?keyword=CDM&commit=go%21

this submission concludes that terminating the EU ETS by 2020 and replacing it with a combination of tried and tested direct regulatory approaches and non-trading market instruments would provide much higher probability of enable the emission reductions needed to avoid runaway climate change than extending the EU ETS beyond 2020 and / or linking it carbon trading schemes in other jurisdictions. Incidents of fraud and malpractise as recently experienced in relation to trading with EU ETS permits can be expected to continue and grow were the EU ETS to link to carbon trading schemes in other jurisdictions or include additional sectoral offset schemes.

August 2011

Memorandum submitted by EEF (ETS 34) About EEF EEF, the manufacturers’ organisation is the representative voice of UK manufacturing, with offices in London, Brussels, every English region and Wales. We are a not for profit organisation with a growing membership of almost 6,000 companies of all sizes, employing some 900,000 people from every sector of the engineering, manufacturing and technology based industries. UK Steel, a division of EEF, is the trade association for the UK steel industry. It represents all the country’s steelmakers and a large number of downstream steel processers. Summary

• The EU Emissions Trading Scheme (EU ETS) is an overly complex instrument to achieve emissions reductions, and risks reducing the international competitiveness of EU manufacturing. EEF/UK Steel believe that isolated emissions reduction schemes do not work for globally traded goods to achieve a worldwide reduction in emissions.

• EEF/UK Steel do not believe that the EU ETS is an ideal model for other nations and regions to adopt and has almost no credibility outside the EU. A global level playing field is the key to reducing global emissions, not regional isolated caps. In the longer term this could be achieved by a global sectoral agreement on emissions reductions, where responsibility would have to be borne by all steel manufacturers equally. This will only happen with the full support of governments around the world.

• 90% of the carbon dioxide emissions from steel making are the result of chemical

processes and as such, the sector is approaching the limit of emissions reductions. This significantly restricts the abatement potential of the steel sector. The sector has invested heavily in research into ultra-low carbon steelmaking; however it is unlikely that these processes will be available before 2030.

• The UK Government must exercise the option, provided within EU ETS Directive, of

providing compensation to at-risk industries to safeguard the international competitiveness of electro-intensive manufacturing in the UK.

• We would therefore welcome a dialogue with Government on an alternative to the current

EU ETS to incentivise carbon abatement and efficiency in our sector. Introduction The EU Emissions Trading Scheme (EU ETS) is Europe’s flagship “cap and trade” scheme designed as a tool to reduce industrial greenhouse gases cost efficiently. The key aim of ETS is to achieve a predetermined cap or limit on GHG emissions at the lowest cost. The UK manufacturing sector and the UK steel industry are considered amongst the most carbon and energy efficient globally yet have an increasingly complex array of carbon costs imposed upon it by the EU and UK Government that similar sectors outside the EU do not bear. This works against the huge potential for the UK and the EU to win business and play a leading role in driving down global emissions levels.

A robust, global means of pricing carbon would be of significant benefit; however the EU ETS is in our view no longer fit for purpose. This is particularly true for internationally traded sectors, such as steel. The EU ETS, in isolation, restricts growth in carbon efficient countries, inversely incentivising production in countries with no carbon standards and hence has little or no impact on global emissions. We would therefore welcome a dialogue with Government on an alternative to ETS as the means to incentivise carbon abatement and efficiency in our sectors. The steel sector is an intensely competitive, internationally traded sector. A regionalised malfunctioning scheme, such as the EU ETS, is doing more than harm than good. It risks the displacement of relatively efficient manufacturing within Europe in favour of imported materials, often with significantly higher levels of embedded carbon. Thus investment and jobs here in the UK are put at risk with no benefit for global climate change achieved. The isolation of the EU ETS as the only multi-country cap and trade scheme increases pressure on European manufacturers and exposes them to a competitive disadvantage compared with businesses operating outside a cap and trade scheme. A recent Policy Exchange1 report highlighted how, despite the EU’s ambition of “leading by example” to achieve an effective global agreement, it had been largely unsuccessful in influencing major global players, like China and the US. The EU ETS is being increasingly regarded as a complex mechanism for reducing emissions and is unlikely to be the leading choice for other regions globally. It is increasingly recognised that global reduction commitments may be unrealistic, with many nations moving towards pledge and review. The EU ETS could find itself out of step with other carbon abatement schemes. Carbon in steel making There are two main steelmaking processes. In the UK, the majority of crude steel is produced via the Blast Furnace – Basic Oxygen Furnace primary process route (BF-BOF), where iron ore is reduced through a chemical process. The remainder is produced via the Electric Arc Furnace route (EAF), where electricity is used to melt scrap steel. 90% of the carbon dioxide emissions from BF-BOF steel making are the result of a chemical reaction rather than combustion for energy. The result of this is that there is a scientific limit to reducing carbon dioxide emissions in traditional steel making. The UK steel sector has significantly reduced its emissions over the last 60 years and is reaching the limit of reduction. The result is a flattening improvement curve (see Chart 1).

1 Boaz Moselle, Climate Change Policy - Time for Plan B, Policy Exchange, June 2011

Chart 1 – Carbon Dioxide emissions per tonne of steel produced 1950 – 2000 (Thyssen-Krupp, May 2005)

This means, regardless of the policy measures introduced by governments, the contribution of the steel sector is governed by this scientific limit. Currently significant reductions in emissions can only be achieved through reducing production. To go further, a step-change in technology is required. Research into these new technologies (see ‘ULCOS’ below), including carbon capture and storage (CCS), is currently at a very early stage, but might be able to deliver a significant contribution by 2030. This is supported by the Committee on Climate Change’s report on the fourth carbon budget2 which concludes that it is unlikely that these technologies will be available until the 2030s. The energy efficiency of primary processes in the EU is ahead of the global steel industry average, with a significantly lower potential for mitigation (See Chart 2). Although there are still some marginal potential improvements to be made through broader adoption of best practice and best available techniques3. The industry expects that these improvements will contribute to meeting existing emission reduction targets through to 2020, but that they have only limited potential to move beyond this point. 2 The Fourth Carbon Budget - Reducing emissions through the 2020s, Committee on Climate Change, December 2010 3 Assessing the Technical Abatement potential in the UK Steel Sector – report for the Energy Intensive Industries Strategy Board, 2011(awaiting publication)

Chart 2 – Regional steel sector Carbon Dioxide reduction potential – (IEA/OECD) Ultra-low CO2 Steelmaking (ULCOS) The European steel sector is investing heavily in research to achieve significant reductions in carbon dioxide from steel making. Through the Ultra-low CO2 Steelmaking (ULCOS) initiative the sector has selected four process concepts that could lead to a reduction of carbon dioxide emissions by more than half compared to current best practice. The four potential breakthrough technologies identified are Top Gas Recycling Blast Furnace with CCS, HIsarna4 with CCS, ULCORED5 with CCS, and Electrolysis. If successful, Ultra-low carbon dioxide steelmaking will provide the sector with the opportunity to significantly reduce emissions from steel making; however this will not be line with the timeframe of proposed emissions reductions in the current EU ETS. The steel sector will require significant investment to realise these technologies and the predicted cost of the Phase 3 of EU ETS will limit the sector’s ability to invest in the project.

4 HIsarna is a technology based on bath-smelting. It combines coal preheating and partial pyrolysis in a reactor, a melting cyclone for ore melting and a smelter vessel for final ore reduction and iron production. It requires significantly less coal usage and thus reduces the amount of carbon dioxide emissions. Furthermore, it is a flexible process that allows partial substitution of coal by biomass, natural gas or even hydrogen. 5 ULCORED is a low carbon steelmaking process involving direct-reduced iron. Direct-reduced iron (DRI) is produced from direct reduction of iron ore (in form of lumps or pellets) by a reducing gas produced from natural gas. The reduced iron is in solid state and for melting the iron, electric energy is required. This is carried out in an Electric Arc Furnace (EAF)

Recycling Steel Steel is the most recycled material in the world. More steel is recovered in the UK and recycled than all other materials combined. The main process for recycling steel is the Electric Arc Furnace (EAF), although additionally for every tonne of steel produced through the BF-BOF route 20% will be made up of scrap. Although increased use of the EAF process route to recycle steel could theoretically help towards emissions reductions in the sector, in reality this is limited by the finite supply of scrap. As global production continues to rise, the availability of scrap (which depends on the volume of steel consumed in preceding decades) becomes more limited as a proportion of the world’s total needs for ferrous inputs.

Chart 3 – comparison between global steel production and availability of scrap steel Additionally, increased electrification of a sector as an abatement option also relies on significant decarbonisation of the grid. Furthermore, the fact that electricity prices for intensive users are higher in the UK relative to major European competitors is also a consideration.

Steel making and EU ETS As previously noted, global demand for steel is rising by around 6% per annum. While the big increases in demand (i.e. countries showing double-digit growth) are focused in developing countries (other than China), the EU ETS means that EU producers are badly-placed to take advantage.

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Chart 4 – World consumption of steel 2000 – 2011 (forecast) Source: worldsteel

Increasing output while under the restraints of a reducing carbon cap via the EU ETS means that the costs of carbon legislation will need to be internalised either by passing the costs on to our customers or by absorbing the cost. Both represent significant challenges to the sector. Steel making is highly capital intensive, globally competitive, low margin, with long investment cycles. Purchasing of allowances could, by the end of Phase 3, be adding 10% to marginal production costs6 for BF-BOS companies. This is well in excess of current profit margins. Absorbing the costs of carbon legislation on unavoidable process emissions is thus impossible. The only option will be to reduce output, which would in turn restrict the sector’s ability to reinvest in longer term improvements. As a capital intensive industry, reducing output in any single installation causes it to lose money as economies of scale are not obtained. As set out above, the sector has already invested heavily in research into low carbon steel making; however transition to these technologies will require significant investment from steelmakers over the medium to long term. The UK manufactures a wide range of specialised, high quality steel products. However, the large bulk of our output, as with other developed nations, is of qualities available from non-EU competitors. Steel is a globally produced and traded product and the global market is highly price sensitive. The principal sources of import competition are Russia, Ukraine, China, Turkey, 6 Based on a carbon price of €30 per tonne of CO2

Republic of Korea, Serbia, Switzerland, India, Brazil and Belarus7, none of which have internalised costs of carbon. It would therefore be impossible to pass on the costs of carbon to our EU customers, who could very simply switch to imported sources. The steel sector is frequently referred to as a developed sector often located in developing countries pointing to the fact that steel manufactured in developing countries, such as China, can be produced very competitively, at new and often efficient plants. This puts increased pressure on developed markets such as the UK and the rest of Europe. EU ETS Phase 2 allocation An outstanding issue with the EU ETS, as a cap and trade scheme based on an absolute cap with fixed allocations for companies, is that the scheme and the carbon market become highly sensitive to changes in output. Since 2007 EEF/UK Steel have argued that ETS allowances for internationally traded sectors should be allocated ex post – i.e. the actual volume of allowances issued should relate both to carbon efficiency benchmarks and to actual output levels. The sensitivity to output has resulted in a number of anomalies. In the run up to Phase 2 we estimated that the allowances allocated to UK industry were just adequate to meet business as usual requirements, but would act as a brake on growth for companies seeking to take advantage of booming world markets. The recession of course changed the picture. The impact on manufacturing and steel was enormous. At the depth of the recession, UK steel output was 50% down on normal levels. Around 7,000 employees lost their jobs (25% of the workforce), and thousands more were put on short time working. Some NGOs have criticised industry for benefiting from the recession by having allowances that were higher than their needs. Companies were of course able to sell some of their allowances. This was an inevitable result of having an absolute cap – it was a design feature of the system. It helped them in small measure survive the worst part of the recession; and as we slowly emerge from the recession it should mean that companies are able to start re-investing earlier than might otherwise have been the case. The key point is that if EEF’s proposal for a system based on ex post adjustment were adopted, the scheme would respond better to market changes and would neither restrict future growth nor generate “excess” allowances during a recession. Carbon leakage The steel sector in Europe has been recognised as an industry at risk from carbon leakage8. As a result, steel manufacturers will receive a free allocation for most of their emissions; however the EU ETS benchmark system for allocation, mentioned below, will mean that many EU steel manufactures’ allocations will fall short of their expected emissions, notwithstanding potential production growth.

7 Top ten importing countries into the EU in descending order of importance 8 Carbon leakage occurs when carbon legislation in one region affects the global competitiveness of a product by adding a significant cost to manufacture of a product such that it becomes more advantageous for customers to import the product from outside the region and/or makes exports uncompetitive. The result is that production moves from a regulated carbon market to an unregulated market, resulting in the loss of control over the carbon emissions associated.

Benchmarks in EU ETS Phase 3 The EU ETS Directive states that the top 10% most efficient installations in Europe should, through the benchmark, receive the full allocation of allowances they need; however this will not be the case for the steel sector. UK Steel, as part of a joint EU group, put forward a workable solution to steel benchmarks based on actual production and emissions data. This was rejected by the European Commission, which has established a methodology for benchmarking which is based on estimates, from literature reviews. This does not represent the reality of the make-up of steel sites nor their operation, with the result that that not one single EU steel plant is able to meet or even get close to the benchmark values. EUROFER (European Confederation of Iron and Steel Industries) estimates that this effect alone will lead to an annual deficit of ca 33 million tonnes per year for the EU ETS manufacturing industry cap for the steel sector. At a cost of €30 a tonne by 2020, this would be expected to cost the sector just under €1 billon. Electricity price pressure The emissions cap underpinning the EU ETS will tighten significantly during Phase 3, along with a significant increase in auctioning, particularly for the electricity generation sector. The reason the electricity sector will be subject to full auctioning is because, as stated in the Directive they are not subject to international competition and therefore are able to pass any additional costs associated with buying allowances on to their customers. Unfortunately their customers do not have the same luxury. This is expected to have a knock-on effect on electricity prices, which could put the international competitiveness of electro-intensive manufacturing industries, including steel, at risk. The EU ETS Directive includes a provision that allows Member States to compensate at-risk industries. The design and scope of the compensation mechanism is currently being considered by the European Commission. Failure by the UK Government to exercise this option would not only be a missed opportunity to help safeguard the international competitiveness of electro-intensive manufacturing in the UK, it would put UK companies at a disadvantage to their European competitors receiving compensation. We look forward to confirmation that this will be part of the Government’s Energy Intensive Industry (EII) package to be announced towards the end of 2011. Options for a robust global solution Although talks are on-going, binding international agreements on emissions reductions have been limited to the Kyoto Protocol which will come to an end in 2012. A follow-on agreement is likely to take considerable time to negotiate. Without a global agreement, the EU ETS will not have an impact on global emissions, limiting efficient production in the EU pushing steel making into production bases with lower-cost (or no) carbon abatement policies. As already noted, most steel imports into the EU come from such countries, which also have higher average emissions (chart 2). For the steel sector, any global agreement would have to provide a fair, level playing field for steel manufactures in both developed and developing countries. The agreement would have to recognise the fact that as a developed sector in both developing and developed countries the responsibility for emissions reductions would have to be borne by all steel manufacturers equally.

Currently, the EU-27 is the only major producer of steel that operates a full cap and trade system (see chart 4). This means that only 12% of global steel production is subject to a cap and trade mechanism9.

Chart 5 – Total steel production (million tonnes) in 2010 (ISSB) A global agreement The members of the World Steel Association (worldsteel) have produced a framework to support their common endeavour to reduce the carbon footprint associated with the manufacture and use of steel. The framework consists of four building blocks covering the development of new steels, the development of breakthrough steelmaking technologies, sharing of best practice, and common measurement of carbon emissions for steel plants globally. The aim of the framework is to improve the energy efficiency of steel-using products in society and reduce the emissions associated with steel production and use. This is a significant programme relying on cooperation of many steel companies around the world. It is essential that governments work in partnership with the steel sector. The global sector has called on governments to work actively with the industry and its customers in maximising the collection and recycling of end-of-life steel products and to use a life cycle approach if they create regulations and standards for energy efficiency products and services. Finally there is a role for governments to make significant financial contributions to long term research and development of new technologies which will radically reduce the emissions from steel production and use.

9 Key Statistics, UK Steel, 2011

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The sector requires an active and on-going dialogue between governments and industry. As a sector that is fiercely competitive internationally and significantly carbon intense, it is essential that policies create a level playing field to ensure that steel companies in one region are not put at a competitive disadvantage. August 2011

Memorandum submitted by Esso Petroleum Company (ETS 35) Summary 1. This submission by Esso Petroleum Company, Limited, along with other entities in the

ExxonMobil group (ExxonMobil), focuses principally on the first question presented by the Committee: whether the EU ETS remains a viable instrument for climate change mitigation in the EU. The argument presented is that ETS mechanisms have proven only partially effective in encouraging reductions in greenhouse gas (GHG) emissions. This is due to the unpredictability and volatility they inherently create in the price of carbon, which discourages the significant, long-term investments in energy efficiency and low carbon technologies required to materially impact GHG emissions levels. This lack of effectiveness has led to the development of multiple, overlapping measures to reduce GHG emissions, such as existing or proposed EU Directives on Renewables, Biofuels, Energy Efficiency and Fuels Quality – as well as a range of carbon reduction programmes in the United Kingdom.1

2. ExxonMobil believes that a well-designed, revenue-neutral carbon tax mechanism would be

a more cost-effective alternative for reducing GHG emissions: when combined with further advances in energy efficiency and new technologies spurred by market innovation, we are confident that a carbon tax could play a significant role in addressing the challenge of GHG emissions. ExxonMobil encourages Her Majesty’s Government and other key opinion formers, most notably Parliament, to engage with fellow Member States and institutions of the EU to consider a path leading to the eventual replacement of the EU ETS with a carbon tax – perhaps following the expiry of Phase 3 in 2020.

Background 3. ExxonMobil shares the view of Her Majesty’s Government and many others that despite

climate change remaining extraordinarily complex, scientific evidence increasingly points to the fact that rising GHG emissions present risks to society and ecosystems – and that these risks warrant action by governments, companies and citizens.

4. A range of strategies are available to policymakers to reduce GHG emissions. These include promoting energy efficiency (in energy supply and end-use) and ensuring wider deployment of proven emissions-reducing technologies through carbon pricing mechanisms. Additional strategies include supporting research and development of new technologies to dramatically lower emissions while ensuring energy availability and maintaining support for climate research, to inform policy and the pace of response.

5. Assessing the appropriate mix of these strategies requires policymakers to consider carefully their likely effectiveness, interaction, scale and cost – alongside other important priorities such as employment creation and economic development, international competitiveness,

1 See for example, research published by the Think Tank, the Policy Exchange, including “Climate Change Policy – Time for Plan B” (June 2011), “2020 Hindsight: Does the Renewable Energy Target Help the UK De-carbonise?” (May 2011) and “Greener, Cheaper” (July 2010) – all located at www.policyexchange.org.uk/research_areas/environment_and_energy.cgi

http://www.policyexchange.org.uk/research_areas/environment_and_energy.cgi

poverty alleviation and public health. The challenge for policymakers is selecting those strategies that reduce emissions most efficiently and at the lowest cost while not inhibiting the pursuit of these additional policy priorities.

6. Addressing the risks of climate change will require sustained effort over many decades and will entail great expense. Consideration of the most appropriate mix of emissions-reduction strategies will therefore be a complex, ongoing and long-term debate. Policymakers will naturally adjust to experience gained implementing existing policies, to advances in scientific knowledge and technology and to changes in the global economy. A balance must be struck however between evolving policy approaches in pursuit of the most cost-effective emissions-reduction strategies and short-term interventions that disrupt the framework within which companies and other actors operate, potentially undermining the fundamental objective of a significant reduction in GHG emissions. In short, strategies must be adopted for reducing emissions that are stable, sustainable, simple and transparent – and which encourage the greatest reduction in emissions at the least possible cost to society.

ExxonMobil’s Position

7. ExxonMobil is of the view that the most effective emission-reduction strategies are those that:

• Ensure that any cost of carbon is uniform across the economy and is predictable (as uniformity ensures economic efficiency in achieving the greatest reduction in emissions at the lowest cost, while predictability facilitates investment in technologies needed to reduce emissions);

• Let market prices drive the selection of solutions and aid rapid adoption of successful initiatives;

• Promote global participation and consider the priorities of the developing world; • Minimize complexity and administrative costs; • Maximize transparency to companies and consumers; and • Provide flexibility to adjust to ongoing understanding of the economic impact and

evolving climate science.

8. Given the need for selected emissions-reduction strategies to be inherently stable and predictable to encourage the investments in energy efficiency and low carbon technology and the behavioural changes required, these principles have led ExxonMobil to believe that a well-designed, revenue-neutral carbon tax is a more cost-effective mechanism for reducing GHG emissions than other alternatives – including ETS schemes. When combined with further advances in energy efficiency and new technologies spurred by market innovation, ExxonMobil believes a carbon tax could play a significant role in addressing the challenge of rising GHG emissions.

9. This policy proposition is based on ExxonMobil’s recognition of two issues: particular flaws in the implementation of the EU ETS undermine its effectiveness as a mechanism to encourage the deep reductions in GHG emissions required in the EU and elsewhere; and the inherent strengths of carbon taxes at reducing emissions compared to emissions trading schemes in general.

Problems with the EU ETS.

10. The effectiveness of the EU ETS in emissions-reduction is undermined by several inter-linked factors:

• Firstly, the EU ETS carbon price, the cost of traded emissions allowances, is generally

regarded as insufficient to encourage the level of investment in energy efficiency and low-carbon technologies required to materially reduce GHG emissions.

• This price problem reflects the inability of multiple EU governments to accurately predict

the supply of allowances years in advance to meet a ‘satisfactory’ carbon price. This supply ‘rationing’ has led at various points to unpredictable ‘tightness’ or ‘looseness’ in the market. If the goal is driving investment, a sufficient, predictable carbon price set through a tax mechanism is a more effective way to do it.

• Investor confidence is undermined by volatility and fluctuation in the cost of traded allowances. The ETS is not operating as a market system. Regulatory uncertainty disrupts the efficient working of the market. For example, as tighter EU emissions targets, intervention in future allowance auctions, or overlapping policy measures (at country and EU level) are considered, future carbon prices are impacted and long-term price stability for investors is undermined.

• Finally, an important objective in the establishment of the EU ETS – creating a model emissions-reduction strategy that other regions would want to replicate and therefore enable the creation of a global emissions market across regions – has not materialised and is unlikely to do so in the next decade. Even countries which are considering cap-and-trade systems are likely to be wary of creating linked markets given the example of an EU system with such flaws, and with no effective global market governance mechanism.2

11. The centrality of the need to send a predictable signal on investment has been partly

recognized by the Government in considering the introduction of a Carbon Floor Price in the United Kingdom. It has acknowledged that the EU ETS has resulted in carbon prices being neither stable nor high enough to encourage sufficient investment in low-carbon electricity generation in the UK. In seeking to encourage low-carbon generation (which has higher upfront capital and construction costs than fossil fuel generation), the Government intends to introduce a mechanism to artificially ‘support’ the carbon price, which it is hoped will provide the greater stability and certainty in the carbon price required for long-term investment planning in low-carbon generation. Indeed, without price support, the Government believes that the persisting high levels of uncertainty will deter investment or direct capital to less risky and potentially more carbon-intensive forms of generation. A price floor is inferior in this regard to a carbon tax since it is likely to send a lower price signal to investors.

2 In the case of Australia, an ‘interim’ price ceiling on carbon has been established, which makes it impossible to link to EU ETS. Although policymakers propose that this ceiling will be lifted in future, this is by no means guaranteed, since it could result in significant increases in the cost of domestic allowances.

A Carbon Tax as an Alternative

12. While not specifying an annual quantitative reduction in GHG emissions to be achieved, a tax on emissions, either directly or through taxing the carbon content of fuels, is supported by most economists as the most efficient means of reducing GHG emissions. A notable study is that conducted by the United States Congressional Budget Office (CBO)3 that examined the efficiency of a carbon tax in comparison to an ETS. The paper concludes that a tax would be a more economically efficient policy for reducing CO2 emissions than an ETS with an inflexible cap (meaning a cap, such as the one in the ETS whose level was not affected by the price of emission allowances). A range of empirical studies support the CBO conclusions.4 The CBO study concluded that the net benefits of a tax-based system could be roughly five times those of an inflexible cap – assuming both policies were designed to balance expected costs and benefits. Viewed another way, any long-term emission-reduction target could be met by a tax at a fraction of the cost of an inflexible ETS cap-and-trade programme. These cost savings stem from the fact that a tax avoids the economic inefficiencies created by the cost fluctuations of an ETS. With an ETS, organisations are incentivized to forego lower cost opportunities to reduce emissions when the market prices are relatively low and to take higher cost steps to reduce emissions when the market prices are higher. A tax trajectory gives a steady, predictable incentive to take the lowest cost reduction steps at all times. Additionally, a tax trajectory can be adjusted over the long-term to enable the achievement of a long-term emission target.

The Challenge of International Competitiveness

13. The international reality post-Copenhagen is that a unified international emissions-reduction strategy is unlikely for two reasons: the inherent difficulties of governance and enforcement across regions; and the fact that regions are at different stages of their national development and therefore approach emissions-reduction with a different balance of priorities. Post-Copenhagen, a ‘mosaic’ of national and regional approaches is emerging.

14. The implication of this reality is that countries with significant carbon prices on domestic

emissions risk exporting jobs, investment and carbon emissions to those without such costs.5 Trade exposed, energy intensive businesses are especially vulnerable. As part of the development and review of the ETS, a fundamental consideration is whether the current basis of assessing progress based on emissions produced in the country is appropriate or whether a system based on carbon consumption (i.e. reflecting the net carbon content of goods consumed in the country) would be more appropriate. We do not underestimate the difficulty or complexity of such a change in approach, but we see it as imperative in a world

3 “A CBO Study: Policy Options for Reducing CO2 Emissions”, Congress of the United States Congressional Budget Office (February 2008). 4 See, for example, William A. Pizer, “Combining Price and Quantity Controls to Mitigate Global Climate Change,” Journal of Public Economics, vol. 85 (2002), pp. 409–434; Michael Hoel and Larry Karp, “Taxes and Quotas for a Stock Pollutant with Multiplicative Uncertainty,” Journal of Public Economics, vol. 82 (2001), pp. 91–114; and Richard G. Newell and William A. Pizer, “Regulating Stock Externalities Under Uncertainty,” Journal of Environmental Economics and Management, vol. 45 (2002), pp. 416–432. 5 See for example, “Greener, Cheaper”, Policy Exchange (July 2010).

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where different regions and countries are proceeding at different paces to address the risk of GHG emissions.

15. Global participation in a consumption-based approach will remain critical: it will require a

WTO-compliant system that does not damage the open markets and free trade needed to facilitate technology transfer.

Way Forward 16. To date, the British Government has been one of the strongest advocates of the ETS. We

believe given the obvious problems the ETS has encountered – which go well beyond ‘growing pains’ – it is time for the Government to ensure other approaches, including a carbon tax and the consumption-based approach, are fully considered as the EU reflects on the development of its GHG reduction policy. August 2011

Memorandum submitted by INEOS ChlorVinyls (ETS 36)

Executive Summary

1. While the ETS may function to reduce emissions within the EU there is the very real threat that higher carbon prices will force energy-intensive industries to relocate resulting in an increase in global emissions as production moves to less-regulated and less-technologically-advanced jurisdictions.

2. Energy is the main production cost for energy-intensive companies like INEOS. In the

face of global competition INEOS cannot pass on higher energy costs. As a consequence the company cannot operate competitively in jurisdictions where energy prices are significantly higher than elsewhere.

3. Imposing higher production costs on energy-intensive industries through the ETS further

risks undermining the industry’s ability to invest in low-carbon technologies and efficiency improvements, which are vital to achieve the goals of the ETS.

4. The chemicals industry is not a ‘sunset industry’ standing in the way of environmental

improvements, but a key ally in delivering the innovation and products required to realise the vision of a low-carbon future. It is estimated that on average for every tonne of CO2 used in the chemicals industry, two are saved downstream.

5. The introduction of a unilateral carbon floor price in the UK in coincidence with the start

of Phase III of EU ETS poses a severe threat to INEOS ChlorVinyls’ operations in the UK and undermines the intention of the ETS to establish a level-playing field for carbon trading across the EU.

6. Energy-intensive industries must be protected from the effect of the ETS and a UK

carbon price floor to avoid carbon leakage and to afford them the opportunity to continue investing in low-carbon solutions and efficiency improvements. Such protection should not be seen to compromise or water down the environmental goals of ETS, but to ensure their practical realisation.

INEOS ChlorVinyls

7. INEOS ChlorVinyls is a manufacturer of chlorine and caustic soda and the European market leader in PVC manufacture. We operate in the UK, Norway, Germany and Sweden. The electrolytic processes we operate are by their nature highly energy intensive. Electricity is our most significant raw material, representing approximately 60% of our production costs.

8. INEOS ChlorVinyls is committed to improving energy efficiency and reducing emissions.

At our site in Runcorn we have reduced CO2 emissions by over 33% since 1998 through replacing mercury cell rooms with the most up-to-date modern membrane technology. We have plans to reduce direct emissions by a further 75% and indirect emissions by 10%. We are currently completing the construction of a £400 million Energy from Waste CHP plant at Runcorn. When fully operational this will produce around 20% of our total energy needs from renewable sources.

9. The chemicals industry in the UK, of which INEOS is the largest company, is at the

forefront of introducing energy efficiency measures and reducing CO2 emissions. Our

products contribute to the manufacture of a range of environmentally beneficial products including catalysts, insulation, CFC substitutes and wind turbines. As a company we invest in developing new low-carbon technology. A unique biorefinery process we have developed and proved at pilot plant level can turn any carbon-based waste into renewable fuel and energy and as such could play a vital role in meeting the challenges of climate change, energy security, and waste management in the UK.

10. INEOS ChlorVinyls employs around 2000 people in the UK at sites in Runcorn and

Newton Aycliffe. Our operations support tens of thousands of jobs in allied and associated industries. The chlorine produced at Runcorn purifies the UK’s water, and our plastic and chemicals are used across industry in a vast array of applications including construction materials, medical equipment, paint, detergents, telephones and computers.

Does the EU remain a viable instrument for climate change mitigation in the EU?

11. A cap and trade system that commoditises the right to emit carbon is an established mechanism for controlling emissions through economic incentives. Phase III of the ETS will introduce a more ambitious EU-wide cap on emissions and greater auctioning of allowances, as well as impose restrictions on the use of credits. This should function to lower emissions in the EU. This, however, is not to say that EU ETS alone is a sufficient mechanism for reducing emissions in the EU, nor that it is beyond reproach. In addition to harnessing market forces, it is important to support technological innovation with public investment, and ensure that the ETS does not overburden European industry with additional production costs and thereby inhibit them from remaining in the EU and investing in the low-carbon solutions and efficiency improvements that are required. It is also vital, of course, not to neglect encouraging energy efficiency and the uptake of lower-carbon options in sectors not covered by ETS, such as households, small businesses and transport.

Can the EU ETS operate effectively in a world without legally-binding emissions reduction commitments and other cap and trade schemes?

12. Although the ETS may reduce emissions in the EU, this does not mean that it is an effective means of climate change mitigation, which is to say it may not reduce emissions overall. In the absence of equivalent trading schemes elsewhere, there is the very real danger that industries will relocate and emissions will simply increase outside of the EU, undermining the aims of the policy at great economic cost. Global emissions could in fact very well substantially increase if production moves to less-regulated and less-technologically-advanced jurisdictions, and if products have to be transported further as a consequence. In the case of PVC—one of INEOS’ main products—the carbon emissions from production in China are six times higher than in the UK. This process of carbon leakage is already starting to occur.

13. Energy-intensive companies like INEOS ChlorVinyls that operate in global markets are

acutely affected by the absence of an international level-playing field when it comes to the cost of emitting CO2. Energy represents the majority of our production costs, and in the face of global competition we cannot pass on costs to our customers. As a consequence it may not be possible to operate competitively in certain jurisdictions where energy is more expensive. This is a particular concern in the UK where Phase III of the ETS will coincide with the introduction of Carbon Price Support rates in 2013.

14. Through carbon price support rates and the ETS the UK Government intends to establish a carbon price of £30/te in 2020. This would increase our annual site costs at Runcorn by £30m—1.5 times our average earnings before interest, taxes, depreciation and amortisation. Without substantial mitigation our UK operations would go into decline as investment became focused elsewhere. INEOS welcomes the Government’s commitment to bringing forward mitigation from the carbon price floor for energy-intensive industries this autumn, and is keen to work closely with DECC and BIS to ensure that they understand the gravity of the threat to UK industry and develop appropriate measures. We welcome the Secretary of State’s commitment to do so. The mitigation announced in the 2011 Budget, such as extensions to Climate Change Agreements will have almost no impact on our business, and further measures will have to be of a very different order if they are to succeed in their purpose.

15. If energy-intensive industries were priced out of the EU, or indeed the UK, as a result of

uncompetitive energy - and real end-use energy prices will be uncompetitive, then we would not only cause carbon leakage—we would also lose the expertise, products and investment that are so vital to securing the transition to the low-carbon economy. The chemicals industry’s products contribute to the manufacture of a range of environmentally beneficial products including catalysts, insulation, CFC substitutes and wind turbines. It has been estimated that on average for every tonne of CO2 used in the chemicals industry, two are saved downstream. This ratio should be improved through supporting industry and ensuring that they have the time and financial opportunity to invest in low-carbon technology and efficiency improvements. The danger of the ETS is that imposing high production costs on energy-intensive industries will divert funds from such investment and undermine the environmental goals of the scheme. For this reason, it is again vital that energy-intensive industries are protected from the effect of the ETS and carbon price support in the UK.

What reduction in emissions will the EU ETS deliver in Phase III within the EU and abroad?

16. While INEOS is not best placed to speculate on the precise amount that emissions will fall under Phase III, we think it important to note that an ongoing lack of clarity regarding the operation of Phase III will likely have a detrimental effect on its success. Uncertainty concerning the free allocation of allowances and the validity of international credits has delayed the investment required for emissions reductions here and outside the EU. In addition it is likely that high compliance costs during the early stage of Phase III will direct funding away from investment in carbon reduction technologies and efficiency measures.


17. Securing an international agreement on reducing emissions seems a prerequisite to operating a successful global cap and trade system. A handful of ETSs without full global coverage would still encourage carbon leakage. The difficulty of securing comprehensive global coverage is compounded by the need for agreement on the level at which to cap emissions and how to allocate allowances. Without such harmonisation between ETSs there would still not be a level-playing field. Insofar as such agreement is by no means on the horizon currently, the EU should consider how to avoid carbon leakage and ensure that the ETS does not undermine industry’s ability to deliver technological improvements.

18. Member States are implementing measures over and above the EU ETS, which undermines the intention of the scheme to establish a level-playing field for carbon trading across Europe. The introduction of a unilateral carbon price floor in the UK from 2013 is a case in point, and will set the chemicals industry in the UK at a severe disadvantage with respect to other European producers. INEOS is currently liaising with DECC to clarify the scale of the UK’s competitive disadvantage in this respect with a view to bringing forward mitigation to prevent carbon leakage. This is vital not only to protect the loss of jobs and investment in the UK, but also to ensure that carbon leakage does not occur within the EU or indeed without, which would undermine the operation of the scheme.

19. Inconsistent implementation of Phase III Harmonised Allocation Rules between Member

States is introducing a risk of carbon leakage within the EU.

20. The cost of establishing, administering and complying with multiple systems is an inefficient use of Government and industry funds, which places an unnecessary strain on resources. The complexity of overlapping carbon pricing policies (such as EU ETS, the UK carbon price floor, CCA compliance, and CRC Phase 1) can also lead to confusion and difficulties in presenting costs and opportunities to the Board.

How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are Further Improvements in security and auditing required?

Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading?

21. The credibility of the trading mechanism has been severely undermined by the recent issues relating to phishing, the security of registry accounts, VAT fraud and the subsequent actions taken to deal with this. The Commission’s actions following the EUA theft in January 2011 have had significant knock on effects—the largest spot trading exchange remains closed 8 months on, and measures implemented on smaller exchanges have considerably reduced the number of participants meaning that liquidity on spot markets is extremely low. Counterparty confidence has been shaken with contract revisions requiring ‘guaranteed virgin’ allowances or other buyer protection measures. This is likely to continue as all Registries are closed in December just prior to a key Contract delivery period, and into 2012 as the new Registry Regulation is fully implemented. To make security and auditing improvements, the scheme would do well to look to established securities markets for examples of best practice.

How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations?

22. Reducing emissions in the EU cannot be an end in itself—we must not lose sight of the international context, and the real goal: tackling climate change. If the EU ETS is to function as best it can in the current international context it is vital to protect vulnerable sectors (as the EU recognises) to prevent carbon leakage. Such protection should not be seen to compromise or water down the environmental goals of ETS, but to ensure their practical realisation. It is imperative that the UK government represents the interests of energy-intensive industries in the UK to ensure that the EU makes provision for suitably substantial relief measures, and that the opportunity to provide relief is taken up fully in the UK. If the UK does not protect vulnerable industries to the same extent as other EU countries, a level-playing field will not even exist within the EU. This would

make the economic environment particularly inhospitable in the UK, where industry will already have to contend with a unilateral carbon price floor.

23. In addition to preventing carbon leakage it is vital to the success of ETS to ensure that

European industry can deliver the innovation required to reduce emissions and improve efficiency. Again this a matter of providing appropriate relief to afford energy intensive industry the financial latitude and time to continue to invest in low-carbon technological development and improve the efficiency of production methods. Energy-intensive industries are not ‘sunset industries’ standing in the way of low-carbon goals, but crucial allies in delivering the necessary technology to make this a reality. Overburdening energy-intensive industries with higher production costs will only serve to push them abroad or divert funding away from investment in the low-carbon future.

24. The introduction of benchmarking in Phase III of the ETS will increase EU sites’

production costs significantly, and UK producers will also have to contend with the introduction of the carbon price floor. This severe threat to the competitiveness of the industry in the EU and in particular the UK necessitates substantial relief measures to ensure the environmental goals of the ETS are realised. In addition to encouraging the Government to take up relief from the ETS, INEOS is liaising with DECC and BIS to discuss bringing forward mitigation measures to protect energy-intensive industries in the UK from the effect of the carbon price floor.

25. As part of this process INEOS is advocating two approaches to mitigation in the UK that

we believe would appropriately protect energy-intensive industries from the effect of the ETS and carbon price floor. One approach, which already operates successfully in France, is for the Government to facilitate an industry deal that would see low-carbon energy producers supply energy-intensive industries at a competitive fixed price. Low-carbon producers of electricity will receive a large windfall as a consequence of carbon price policies so it seems fair that they should enter into such an arrangement that would ensure the transition to a low-carbon economy, which is the intention of the policies. This is not only a green solution, but also one that would avoid funding issues with the Treasury.

26. Although an industry solution would be ideal, it is almost certain that such an

arrangement would not be up and running in time for the introduction of Carbon Price Support in 2013. For this reason INEOS is also proposing a scheme wherein energy-intensive users could claim back the carbon price support rates paid on their electricity, modelled on the Levy Exemption Certificates used for Combined Heat and Power stations. This relief could be limited to companies signed up to rigorous environmental commitments, which would ensure that mitigation helps deliver the aims of carbon price policy.

August 2011

Memorandum submitted by the Carbon Capture & Storage Association (ETS 37)

The Carbon Capture & Storage Association (CCSA) welcomes this opportunity to respond to the Energy and Climate Change Committee Inquiry into the EU Emissions Trading System.

The CCSA brings together a wide range of specialist companies across the spectrum of CCS technology, as well as a variety of support services to the energy sector. The Association exists to represent the interests of its members in promoting the business of Carbon Capture and Storage (CCS) and to assist policy developments in the UK, EU and internationally towards a long term regulatory framework for CCS, as a means of abating carbon dioxide emissions and combating climate change.

At the time the EU Emissions Trading System (EU ETS) was created, a widely held belief existed, that global carbon trading would eventually take place. However, this has not been the case, and there is therefore a need to consider how the EU ETS may be made more effective in this context and whether it can lead to a process to create a global market.

The CCSA response below firstly sets out our views on the effectiveness of the EU ETS and then gives two options for improvement; strengthening the EU ETS itself or putting in place supplementary measures to achieve emissions reductions. At this point in time, we do not have a preference for either option.

General comments on the EU ETS 1. The CCSA strongly supports the commitment to the EU ETS as the primary long-

term mechanism for delivering cuts in emissions across the EU and incentivising low-carbon technologies such as CCS.

2. Action on climate change is welcomed and the EU should be applauded for setting up the world’s most comprehensive trading market for CO2 emissions. The purpose of the EU ETS – to set a declining cap for all large industrial point sources of CO2 - in principle provides an effective and transparent target and timetable for emissions reductions across the EU and enables the market to develop the most efficient mix of technologies to reach this target. This approach is more desirable than the introduction of a large number of targeted mechanisms to incentivise or regulate certain activities which risks creating a disparate, complicated and economically inefficient strategy for reducing CO2 emissions.

3. The EU ETS provides a significant growth opportunity for low-carbon technologies but only if the market is sufficiently robust to underpin investment. However, due to a variety of reasons set out below, the EU ETS does not currently incentivise investment in low carbon generation such as CCS.

4. Regulatory volatility has created weak market prices, which are unable to support the necessary investment in low-carbon generation such as CCS.

5. Although the details of Phase 3 and the path to the 2020 cap are relatively clear, there is considerable uncertainty regarding the cap and price signal beyond 2020 (as no phase 4 has yet been agreed), and this creates a large investment risk for companies making investments based on carbon prices beyond 2020. The life-cycle of some industrial or power projects can extend up to 60 years into the future.

6. Regulatory volatility combined with uncertainty over the future of the EU ETS has created an unpredictable system which has resulted in a massive price risk. This price risk is out of the hands of industry as it depends entirely on future emissions trading policy and for the CCS industry in particular, this may have significant impacts on the economic viability of projects.

7. The EU ETS needs to be able to adapt to significant changes in the economic outlook for the EU and continue to drive the necessary investment that will provide sustained emission reductions for the longer-term. The recent recession has created large, sudden price fluctuations, making the market unbankable as support for large, capital-intensive low-carbon technologies such as CCS.

8. Finally, consideration needs to be given to the potential negative interactions between the EU ETS and other EU policies to promote specific technologies such as energy efficiency and renewables.

9. Reflecting on the above issues, there is therefore a need to consider two broad categories of options that could be used to deliver the required emissions reductions (both in the UK and in Europe):

Changes to the EU ETS 10. The first and probably most significant measure that could be introduced to

improve the EU ETS would be to set a tighter cap for Phase III (2013-2020) and beyond. In addition, certainty over Phase IV and the EU path to 2030 should be provided at the earliest opportunity. This establishes a strong regulatory signal, not just in terms of an emissions cap (for both Phase III and IV), but also in setting the long-term price of allowances.

11. A political agreement to move from the 20% target to a 30% target would underpin a policy move to tighten the market. As such a policy move would also cover sectors not currently included in the EU ETS (such as transport and heating), this would achieve additional emissions reductions across Europe. However such a policy move must be seen in the wider international context if impacts on EU competitiveness are to be avoided.

12. Another option to improve the EU ETS would be to set a reserve price on the auction of allowances in Phase IV. This is essentially similar to a carbon price floor (as proposed in the UK – see below) and would provide price certainty to the power sector (in the first instance) since this sector is required to purchase 100% of its allowances at auction from the start of Phase III. Setting a reserve price on auctioning would therefore provide long-term certainty to drive investment in low-carbon generation.

13. Strengthening the EU ETS could also be achieved by removing an amount of allowances consistent with the recent economic downturn – thereby reducing the number of total allowances available in the market and increasing the price. This could either be carried out as a one-off mechanism – removing excess allowances from Phase II before the start of Phase III, or could be incorporated as a more permanent feature, to be used when needed.

14. Similarly, the current ability to bank or ‘roll-over’ unused emissions into future years creates a perverse outcome whereby lower emissions in one year does not lead to the acceleration of total emissions reductions, but rather the ability to maintain higher emissions levels in future years. The removal of this banking or ‘roll-over’ ability would tighten the market, leading again to fewer allowances and increased carbon prices. However, the EU ETS will become much less cost-effective if there is no possibility for rolling-over unused emissions. A well

designed cap should be sufficient to avoid having to set a time-limit for the use of allowances.

Specific targeted and supplementary mechanisms (UK) 15. The auctioning of EU ETS allowances creates a massive revenue stream for

Member States. In addition in the UK the Carbon Price Floor (CPF) that was recently announced in the Electricity Market Reform White Paper also represents an additional source of revenues for the UK Government. Although not a supplementary mechanism, we would recommend that these revenue streams should be used to support the commercialisation and introduction of capital intensive low-carbon technologies, particularly CCS - for which the introduction phase is particularly capital intensive.

16. The UK has adopted a highly ambitious target to reduce CO2 emissions by 80% by 2050, with interim targets in the decades leading up to this. The UK has also signalled a goal to reach a near-decarbonisation of the power sector by 2030. Both the 2050 target and the 2030 decarbonisation goal go beyond the end of phase III of the EU ETS (2020) and puts the UK on a tighter path to carbon reduction than the EU ETS by 2020. This results from a UK desire to be a global leader and create a home-grown market in low carbon technology development for export. However, since the EU ETS cap determines the total number of allowances issued in the EU, the UK domestic policy is likely to have no effect on net emissions across the EU unless it is matched elsewhere in the EU and reflected in the total cap. It may be necessary for the UK to reflect on the path to 2030 and 2050 at a later stage (probably close to 2020), to ensure the UKs path to emissions reductions is compatible with the EU ETS. Conversely, consideration must also be given to ensuring that the EU ETS delivers a decarbonised power sector (by 2030 if that is agreed across Europe) and certainty over Phase IV at the earliest opportunity will go some way to achieving this.

17. Leading up to the decarbonisation of the power sector, the UK is implementing a long term overhaul of the entire UK electricity market (the EMR), which is a process that aims to provide specific mechanisms to incentivise the development of low-carbon technologies amongst other things. This process is a targeted domestic measure, supplementary and complementary to the EU ETS, and is strongly welcomed by the CCSA. The parallel development of a long term EU ETS process (beyond Phase III) needs to be created to complement this and incentivise other countries and regions to investigate and develop their power market strategies.

18. The UK is introducing an Emissions Performance Standard (EPS) of 450g/Kwh as part of the UK EMR. The CCSA does not support a domestic EPS policy at this time, although we support the need to decarbonise the UK power sector by 2030, and the role of an EPS would be to define fossil power plant as effectively decarbonised. Although an EPS may achieve lower emissions in the UK, it must be stated that in the context of the EU ETS, a domestic EPS policy will not achieve any net reductions in EU emissions (therefore no net environmental benefit), as lower emissions in the UK will only be offset by higher emissions elsewhere in the EU due to the EU ETS cap (this can also be said of any other domestic emissions reductions policies in other European countries). In addition, reducing emissions in the UK to such a level would mean that the UK would be

burdened with a larger share of the EU’s emission reductions, thereby increasing cost to UK consumers in the short-term (whilst not necessarily leading to reductions in overall EU emissions).

19. Under the EMR, the UK is also introducing a Carbon Price Floor (CPF) (in combination with other EMR incentives) to provide support for the EU ETS price. As well as providing another large revenue stream for the UK for the early development of low carbon technologies such as CCS, the CPF policy does provide some confidence in the carbon price up to 2030, thereby avoiding the price fluctuations that have so far undermined the EU ETS. However, as with an EPS policy, setting a domestic CPF will again place a disproportionate burden on the UK power and industrial sector (particularly if the UK is alone in introducing such a policy). In addition, a CPF policy must be carefully designed, particularly when considering the impact on the industrial sector, to avoid significant cost increases to this sector (and therefore potential carbon leakage under the EU ETS). The Government is working with the industry to ensure such effects are avoided where possible. It also worth noting that the CPF as proposed may cause substantial variation from the EU ETS market, which would likely be unsustainable (due to UK commercial power companies becoming uncompetitive compared with power companies in other European countries) and would therefore re-introduce investment uncertainty.

International competition 20. The majority of the EU ETS market is made up of fossil fuelled power stations.

However, there are a large number of energy intensive industries which also fall under the EU ETS and unlike the power sector, these industries are unable to pass through costs to the end consumer. Energy intensive industries typically have a combination of power and direct energy use which become costs embodied in their products. Compared with emissions reductions policies in other countries, the EU ETS has the highest prices for emissions and auctioned allowances, and together with the UK CPF and other EMR measures, this imposes real costs for these industries. As these industries are exposed to international competition, these industries therefore face higher costs than producers elsewhere and this impacts on the UK’s ability to maintain international competitiveness in these important industries. UK producers paying high emissions prices for embodied emissions are faced with competition from imported products which will be cheaper as the cost of embodied emissions are not effectively incorporated. In addition, UK exporters are less competitive abroad having had to pay for their embodied emissions in the EU.

21. This introduces the issue of carbon leakage, which is the possible relocation of production in the EU to regions elsewhere with less strict emissions reductions policies. Carbon leakage is a difficult subject and needs further clarity and it should not be assumed that movement of industries from one country to another is solely due to domestic emissions policies, as many other factors influence location of production. However, the EU ETS does not effectively incorporate the costs of embodied emissions in the products from energy intensive industries nor does it cover imported products. In the UK in particular, the reported decline in national emissions since 1990 is completely offset by increased embodied

emissions from products imported from countries outside the EU, so our carbon footprint has increased despite the EU ETS1.

22. For the UK to maintain its international competitiveness, it is therefore extremely important that the ETS does not create any financial burdens that (in addition to UK emissions reductions policies) result in the displacement of value added production to outside the EU. The ETS must ensure that cost-effective emissions reductions in the energy intensive sectors can take place in the UK and the deployment of CCS will be particularly important in this case, as these industries have very limited alternatives for full decarbonisation aside from CCS.

23. There are several options that could be considered to ensure that the EU ETS addresses the costs of embodied emissions in the products from energy intensive industries – thereby ensuring UK and EU competitiveness. However, these options must be carefully considered as they would likely require a considerable change to the structure of the EU ETS beyond the current scope.

Comments on EU ETS and the international market

24. The CCSA understands that there are serious questions over the continuation of the Clean Development Mechanism due to the uncertainty over the nature of the international response to climate change. This raises an issue over whether the EU will be able to access sufficient international credits post-2012. It certainly makes global sense to reduce emissions wherever the abatement cost is least and this would often be in developing economies. The economic logic of CDM is clear as a global effect but its limited interaction with an, as yet, regional emissions market needs to be understood.

25. If the CDM survives in some form under a new climate agreement then there is a need to fundamentally reform the mechanism. The CDM process is widely considered to be overly bureaucratic and time-consuming which is coupled with a somewhat arbitrary and opaque decision making process. There is a concern as to whether the CDM market can be scaled up to meet future demand for credits and where these credits would come from.

26. In the absence of a global trading system post-2012 as a catalyst for global emissions reductions (when the Kyoto Protocol first commitment period ends), sectoral agreements are sometimes considered as an alternative emission reductions mechanism. If sectoral agreements are not comprehensive they may create barriers to investment and possible carbon leakage to developing countries (especially for industrial sectors) a market-based approach, such as the EU ETS, is a much more economically effective method of setting emissions reductions across multiple sectors – allowing the market to determine the best mix of technologies and investment timetable. Considering the current status of the international negotiations, it is unlikely that the UNFCCC process will deliver sectoral agreements in the near future, and there is therefore considerable uncertainty over the global use of such agreements.

27. Another option that is being considered in countries that are outside of the Kyoto Protocol process, or do not intend to commit to a second commitment period under the Kyoto Protocol, are bilateral agreements with developing countries to develop emission reduction projects and generate credits that can be used to meet domestic and/or regional emission reduction targets. If some of the larger developed countries were to establish such bilateral agreements it is probable

1 Baiocchi, G. and J. C. Minx (2010). "Understanding Changes in the UK's CO2 Emissions: A Global Perspective." Environmental Science & Technology 44(4): 1177-1184

that the size of these markets could exceed the size of a future CDM. It is worth noting that the EU ETS does contain provisions which allow the EU to set up bilateral agreements between the EU and other markets should the CDM fail.

August 2011

The views expressed in this paper cannot be taken to represent the views of all members of the CCSA. However, they do reflect a general consensus within the Association.

Memorandum submitted by the Association of Electricity Producers (ETS 38) Summary The key points we would like to make are as follows:

• AEP considers that the establishment of an EU Emissions Trading Scheme (EUETS), the mechanics of which are generally functioning well, is a significant achievement and that the EUETS can deliver long-term, cost-effective greenhouse gas emission reductions, given the right framework conditions.

• De-carbonisation of the electricity generation sector is key to achieving long-term emission reduction targets, particularly the goals for 2050, as highlighted by the Committee on Climate Change, and the EUETS must be designed to support this.

• The focus now must be on developing the EUETS to provide sufficient long-term clarity of the carbon constraints beyond 2020 through to 2030 so that companies have sufficient confidence to invest in the low-carbon technologies that are required to achieve the target emission reductions.

• 100% auctioning for the electricity sector after 2012 is a major change from the current operation of the Scheme and the necessary information and administrative arrangements must be in place early enough to deliver a timely and effective auction process as early as possible. Ongoing slippage in arrangements for auctioning will undermine the credibility of the EUETS.

• AEP supports the goal of a global carbon market and the linking of the EUETS to similar emissions trading schemes outside the EU as a means to deliver this, but premature linking of regional schemes could undermine delivery of UK and EU objectives.

About AEP 1. The Association of Electricity Producers (AEP) represents large, medium

and small companies accounting for more than 95 per cent of the UK generating capacity, together with a number of businesses that provide equipment and services to the generating industry. Between them, the members embrace all of the generating technologies used commercially in the UK, from coal, gas and nuclear power, to a wide range of renewable energies. Members operate in a competitive electricity market and they have a keen interest in its success – not only in delivering power at the best possible price, but also in meeting environmental requirements.

Background 2. The power generation sector recognises the challenge of climate change

and is fully committed to mitigating the effects of greenhouse gas emissions through reducing the carbon intensity of the generation fleet. However, it is important that all sectors (including those not covered by emissions trading, such as industry, transport and households) are fully engaged in emissions reduction and take the necessary steps to improve

energy efficiency where it is cost-effective to do so. Reducing the carbon intensity of power generation in the UK will require very significant amounts of investment. The Government1 estimates that the UK electricity generation sector will have to invest over £110 billion in new infrastructure by 2020 to ensure the country’s future security of supply and that current climate change and renewable energy targets are met.

3. To create the necessary level of confidence among potential investors, we

called for a clear trajectory for CO2 reductions at the EU-level out at least as far as 2020. We therefore welcomed the adoption in 2009 of Directive 2009/29/EC, which amended the EUETS to set a target reduction level of 21% below 2005 emissions by 2020 for participating installations. Policy-makers must now focus on setting longer term targets and avoid short-term interventions that could undermine investor confidence.

Operation of the EUETS 4. The AEP generally favours the use of market-based instruments in

regulation to allow the market to find the most cost-effective solutions to meeting environmental goals. We consider that the establishment of the EUETS, the mechanics of which are generally functioning well, is a significant achievement and that it can deliver long-term, cost-effective greenhouse gas emission reductions, given the right framework conditions. However, it is important to recognise that its effectiveness is governed primarily by the political will to reduce emissions. The political challenges are currently illustrated by the failure of the EU-27 States to agree on increasing the EU greenhouse gas emissions reduction target from 20% to 30% by 2020 and the wider failure of the international community to agree on an emissions reduction framework to succeed the Kyoto Protocol.

5. De-carbonisation of the electricity generation sector is key to achieving

long-term emission reduction targets, particularly the goals for 2050, as highlighted by the Committee on Climate Change, and the EUETS must be designed to support this. Other sectors, including those outside the EUETS, also still have an important part to play. The longer timeframes set for Phase III and the clearer trajectory for emission reductions are a step forward, but the focus now must be on developing the EUETS to provide sufficient long-term clarity of the carbon constraints beyond 2020 through to 2030 so that companies have sufficient confidence to invest in the low-carbon technologies such as renewables, nuclear and CCS that are required to achieve the target emission reductions.

6. Although operators in the power sector take into account the carbon price signal in both operating and investment decisions, the loss of momentum caused by the political failures at EU and international level mentioned above, together with the relatively low market price for CO2 resulting from the fall in industrial output since 2008, has caused the Government to introduce an alternative unilateral mechanism in the form of a Carbon Price

1 Department of Energy & Climate Change, “Planning our electric future: a White Paper for secure, affordable and low-carbon electricity”, July 2009.

Floor in 20132. This, coupled with the introduction, via its programme of Electricity Market Reform, of feed-in tariffs designed to support revenues for low-carbon generators, will add to the complexity of the regulatory framework for the power sector. Further unilateral action by the UK or other EU Member States may risk undermining the credibility of the EUETS.

Impacts of economic recession on the workings of the EUETS 7. The European Commission (EC) recently reported3 that installations

covered by the EUETS cut their emissions by 8.3% on average between 2005 and 2010. Commentators have pointed out that severe recession, mainly in 2009, was by far the largest contributor to the reductions. As the allocation of allowances in Phase II was based on projected growth and only the power sector was awarded significantly fewer allowances than it was projected to require, it is not surprising that the fall in industrial output after 2008 resulted in many industrial operators choosing to sell their surplus allowances, thus causing the market price of CO2 to fall.

8. Although most industrial operators will have spare allowances to sell, the

UK power sector is expected to remain a net purchaser of allowances because it is about 40% short in Phase II.

9. 100% auctioning for the electricity sector after 2012 is a major change from

the current operation of the EUETS and we are strongly of the opinion that the necessary information and administrative arrangements must be in place early enough to deliver a timely and effective auction process as early as possible. Ongoing slippage in arrangements for auctioning will undermine the credibility of the EUETS. It is essential that the carbon market functions in a manner which supports the efficient operation of the electricity market. Delays in auctioning or in delivering an appropriate auction process are not acceptable either for the smooth running of the electricity market or in the context that auctions are an essential part of a legal compliance regime. The timeliness of implementation must not become a major risk issue for the electricity industry.

10. Proper supervision and control of the release of market sensitive data

becomes more urgent in the context of the greater use of the auctioning of allowances as it has potentially much greater financial consequences. Provisions should be made (with appropriate penalties) to govern the release of such information by authorities and the EC.

11. We consider that the recent cases of fraudulent handling of EU

Allowances have had no lasting effect on confidence in the EUETS and that added security measures introduced by the EC through the revisions to the Registry Regulations will provide adequate safeguards for the future.

2 HM Treasury, “Carbon price floor consultation – the Government response”, March 2011. http://www.hm-treasury.gov.uk/d/carbon_price_floor_consultation_govt_response.pdf 3 European Commission factsheet “The EUETS is delivering emission cuts”, July 2011. http://ec.europa.eu/clima/publications/docs/factsheet_ets_emissions_en.pdf

http://www.hm-treasury.gov.uk/d/carbon_price_floor_consultation_govt_response.pdf

http://ec.europa.eu/clima/publications/docs/factsheet_ets_emissions_en.pdf

4

EUETS in the global context 12. Policies are now required that can underpin cost-effective emission

reductions across all economic sectors. The extended trajectory for the EUETS must be linked to a pathway that encourages strong economic growth in the EU. It is important that legislation does not result in the movement of industry to regions outside the EU where emission regulations are more lax, thus causing a possible increase in global carbon emissions. It will also be important to maintain a diverse technological approach to emissions reduction.

13. AEP supports the goal of a global carbon market and the linking of the EUETS to similar emissions trading schemes outside the EU as a means to deliver this, but premature linking of regional schemes could undermine delivery of UK and EU objectives. While full international agreement on reduction targets post-2012 is likely to take a long time to secure, a number of other trading schemes may emerge as a step towards a global market in carbon. It will be important to ensure that there are appropriate safeguards in the linkage with these schemes, to ensure that the stability of the EUETS is maintained. These include strong environmental integrity and a comparable set of rules, including long term emissions reduction objectives, a consistent basis for setting absolute caps, appropriate monitoring, reporting and verification requirements, sufficient market transparency to prevent price shocks and a sufficient level of maturity/proven track record. Any planned linkage with another scheme must be signalled to the market well in advance.

August 2011

Memorandum submitted by Heathrow Airport Limited (ETS 39) Heathrow Airport Limited welcomes the opportunity to respond to this consultation. Heathrow Airport is a wholly owned subsidiary of BAA Ltd, which owns and operates six UK airports including, within west London, Heathrow Airport. Heathrow Airport is currently the busiest international airport in the world, with 90 airlines flying nearly 70 million people to 180 global destinations. As the UK’s only hub airport, Heathrow’s route network provides London and the UK with fast and direct access to cities all over the world, and is able to offer a variety of destinations and frequency of flights unrivalled by other UK airports. Heathrow serves nearly 80% of all passengers on UK scheduled long-haul flights, and with direct connections to 28 of the top 30 world cities ranked by GDP, it caters for around 40% of all UK business travellers, and some 63% of those using London’s five main airports. In terms of aviation and climate change, aviation’s climate change emissions are small presently accounting for approximately 2% of global emissions and 6% of UK emissions although are expected to grow in the shorter term. In the longer term Sustainable Aviation (a coalition of leading UK aviation stakeholders) have forecast that future technological and operational improvements, as well as take up of sustainable biofuel can reduce UK aviation’s CO2 emissions to those in 2000 by 2050. Similarly IATA are committed to 1.5% annual efficiency improvements, carbon neutral growth from 2020 and 50% reduction in aviation's net emissions by 2050 compared to 2005. Finally, the Committee on Climate Change have concluded that growth of up to 60% in UK air passengers is possible by 2050 without compromising the UK’s long term 80% CO2 reduction climate target. BAA have long standing policy positions on climate change and aviation (dating as far back as 2006) including the lobbying for aviation’s inclusion in the EU ETS. We are therefore pleased to offer our response relating specifically to the following two questions detailed in your consultation:

1. What actions should the UK and the EU be taking to promote the development of compatible ETSs internationally?


We regard emissions trading as an important policy tool in managing aviation’s CO2 impacts and view the inclusion of emissions from flights in the European Union Emission Trading System (EU ETS) as the first important step towards a global deal. The European Council adopted regulations in 2008 requiring aviation's inclusion (covering all arriving and departing flights from the EU) in the EU ETS from 1st January 2012, with a cap of 97% of the average of 2004-2006 emissions in 2012 and 95% from 2013-2020. Free allowances have been set at 85% with a review of the cap and free allowances scheduled for 2014. Longer term BAA’s view is that aviation, which is international in nature, should be managed as a global sector. Not only would this help resolve many of the sovereignty issues that are evident today (for example legal challenges to the inclusion of international emissions in the EU ETS), a global approach has received widespread support from the industry through its trade bodies IATA, ACI, ICCAIA and CANSO as well as the industry’s international regulator ICAO. In practice this would mean treating aviation’s emissions as a separate “country” in future negotiations to set appropriate reduction targets.

As founding members of the Aviation Global Deal Group (An industry coalition including BAA, leading airlines and NGO The Climate Group) we have develop a detailed policy framework for managing aviation's global emissions, and which include:

• The international aviation sector is integrated within overall post-2012 global climate change agreement. All international airlines on all international routes are covered

• Informed by recommendations from ICAO, an emission reduction target is set by the UNFCCC for the sector in line with wider, global emission reduction targets

• Aviation emission allowances are auctioned and also allocated to individual airlines by a central, independent authority (to be established)

• Airlines are required to surrender allowances based on carbon content of fuels uplifted

• Aviation allowances are fully fungible with other UN-backed allowances eg EUAs, CERs, ERUs etc, allowing for emissions trading to take place

• Revenue from aviation allowance auctioning is used to support climate change initiatives in developing countries

August 2011

Memorandum submitted by the Chemical Industries Association (ETS 40)

1. The Chemical Industries Association (CIA) is the organisation that represents chemical businesses throughout the UK. The chemical sector is both energy intensive and exposed to international competition in terms of both trade in our products and attracting investment. At the same time, the UK chemical sector has an excellent track record for reducing our own emissions, and we are also enablers of climate change solutions: globally, the greenhouse gas emissions saved by our products and technologies are twice the level of our own production emissions. For further information, see the annex to this submission.

Key comments: Effective operation of EU ETS 2. We recognise that EU ETS is the prime driver for EU emissions reductions up to 2020.

Clearly its potential effectiveness can only be maximised when there is a fully inclusive international agreement which uses emissions trading as the prime instrument for driving global emissions reductions. However, in the absence of the prospect of an early conclusion to UN negotiations, it seems as though a mosaic of national and regional approaches is emerging.

3. For EU ETS to meet its effectiveness potential, the operational conditions also need to be right. In any scenario, the scheme needs have a stable framework to allow businesses to plan with confidence. The climate change and energy policy mix that surrounds EU ETS also needs to be complimentary. Finally, in the absence of an international agreement, it’s also important that EU ETS addresses the risk of carbon leakage from energy intensive sectors like chemicals that form a key part of the supply chain for low carbon solutions. Otherwise, EU ETS will not contribute to global emissions reductions and energy intensive industries will not contribute to the greening of the economy.

4. A further factor to recognise when evaluating the effectiveness of EU ETS is that it is

designed only to deliver cost effective emissions reductions according to an emissions cap: EU ETS cannot deliver a set carbon price or investment in specific technologies (no single instrument is capable of this). Even then, EU ETS can only be judged to have achieved this aim if the cap has been met without the scheme itself contributing to carbon leakage. We have yet to see whether provisions for Phase 3 will be fully implemented or succeed in preventing carbon leakage. That said, if viewed from the perspective of emissions associated with consumption rather than production, it’s clear that EU emissions have risen due to increased imports from non-regulated economies. This can partly be attributed to the lack of competitiveness of the EU as a production base.

Addressing carbon leakage risks 5. In the interests of addressing the risk of carbon leakage in Phase 3, we support provisions

in the amended EU ETS directive to make free allocations of emissions allowances to exposed sectors in relation to their direct emissions. It should be noted that, even under these provisions, industry will still face significantly increased carbon costs. This is

because exposed sectors’ free allocations will be based on benchmarks which reflect top 10% best in practice. In addition, the Phase 3 cap will reduce by 1.74% p.a so these allocations will be further reduced as the phase progresses. Indeed, based on current performance, its estimated that unrelieved costs relative to EU chemical sector product benchmarks could be equivalent to 40% of the total emissions.

6. The EU ETS financial compensation measure to address the pass through of carbon costs

to electricity prices paid by exposed electrically intensive activities is also an essential provision. It is important that member states implement this measure to the full letter of the Commission’s state aid guidance to ensure a level playing field both within and without the EU. In the interests of business certainty, the Commission should provide this guidance as soon as possible.

The need for a stable framework 7. For EU ETS to meet its effectiveness potential it needs to provide a stable framework so

businesses can plan with certainty. The emissions cap and EU ETS market conditions up to 2020 were clearly defined in 2008 in the EU’s climate change and energy package. Any attempt to change these settings would undermine investor confidence and affect companies’ EU investment planning.

8. It is therefore important to resist interventions whether to tighten the cap prior to an international agreement, or by the set-aside of allowances. While the recession temporarily reduced emissions, Phase 3 covers a long period over which many events will play out, including the implications of Fukushima. In the absence of an international agreement, interventions such as those above could contribute to carbon leakage rather than encourage low carbon investment.

The need for a complimentary policy mix 9. The effectiveness potential of EU ETS also depends on the climate change and energy

policy mix that surrounds it being complementary. Even when there is an international agreement, not all the development and implementation of technologies that are judged to be strategically important can be driven by a flat carbon price alone as initial costs may be very high.

10. To ensure the measures to drive these technologies are cost effective and do not undermine the functioning of the EU ETS they should be employed in as targeted and harmonised a way as possible. While examples of targeted measures include support for R&D and feed-in-tariffs, the UK’s Carbon Price Support (CPS) mechanism does not meet these criteria. By creating higher carbon costs in the UK, CPS not only incentivises additional UK investments in much needed low carbon baseload power generation, but also reduces EU ETS compliance costs and carbon abatement in other member states. If the policy mix is to be effective, this type of skewed approach needs to be avoided.

11. We welcome DECC’s recent assessment of the cumulative impact of current and

announced climate change and energy policies on the UK electricity prices paid by energy intensive sectors. Although this is a provisional assessment, it’s clear that the current and expected impacts on electricity prices from EU ETS and national measures like CPS and the Electricity Market Reforms will be substantial (as generators will seeks

to fully pass on costs). The government has committed to announce solutions to mitigate these policies this autumn.

12. It is vital that UK cost mitigation solutions meet the challenge of matching Germany’s

treatment of its energy intensive industries. In Germany, final electricity prices have already been doubled by policy costs raised through energy taxes, but energy intensive industry is largely exempt from these taxes. Unless the UK can match this approach we will be unable to compete with Germany let alone France (where abundant low carbon electricity supplies mean policy costs are low), or the US (where there are no policy costs and base electricity prices are only half of those in the UK).

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Annex

More about the chemical industry 1. With an annual turnover of £60 billion, chemical businesses in the UK are a key

contributor to the economy. Every working day, our sector adds £30 million to our country’s balance of trade. The jobs of 600,000 workers in the UK depend on chemical businesses. Workers in chemical businesses earn on average 40% more than other parts of manufacturing.

2. The UK chemical industry is exposed to the risk of carbon leakage. We are highly energy

intensive, accounting for 22% of total UK industrial consumption. We are also highly exposed to international competition in terms of both trade in our products and attracting investment. This is because our businesses compete in global markets and pricing of basic chemicals is very similar across Asia, North America and Europe. In addition, about 70% of sites are headquartered outside the UK (and 2/3rds of these outside the EU).

3. The UK chemical industry already has a excellent track record for reducing our own

emissions, having improved our energy efficiency by 35% since 1990, and will continue to make improvements. But we are also enablers of climate change solutions in a wide range of applications across sectors of the economy including: households, transport, energy and agriculture. Examples of solutions include: building insulation, PVC and soda ash for double glazing, fertilisers and crop protection (to reduce land use), lightweight components for cars and planes, low temperature detergents, biofuels and materials for wind turbines. An independent study has confirmed that the global chemical sector currently delivers 2 tonnes of greenhouse gas savings for every tonne we emit in our production processes and that, with the right policy framework, this could rise to more than 4 tonnes by 2030. These results are summarised in CIA’s low carbon brochure which also includes case studies to demonstrate that many of these solutions are already produced in the UK.

http://www.cia.org.uk/Low_carbon_brochure_final2LR.pdf

Memorandum submitted by ScottishPower (ETS 41) Introduction 1. This evidence is provided on behalf of Scottish Power Limited (a major UK energy supply, networks and generation business), and ScottishPower Renewable Energy Limited (a leading renewable developer in the UK). Both companies are wholly owned subsidiaries of Iberdrola S.A. and references to “ScottishPower” and “we” are to either or both companies as the context requires. 2. Scottish Power Limited is an energy business that provides electricity transmission and distribution services to more than 3 million customers, supplies some 5 million electricity and gas services to homes and businesses across Great Britain (GB), and operates electricity generation, gas storage facilities and associated energy management activities in the UK. 3. ScottishPower Renewable Energy Limited is part of Iberdrola Renovables, which is the largest developer of renewables globally. Among our projects is the Whitelee wind farm; at 322MW, it is the largest onshore wind farm in Europe. 4. ScottishPower is a member of a consortium proposing to build and operate a commercial scale post combustion CCS plant at our Longannet Power Station under the Government’s CCS competition. 5. Iberdrola is also a major producer of nuclear power in Spain and is partnering with GDF Suez and SSE with a view to undertaking new nuclear build in the UK, including a proposed power station of up to 3.6GW on land adjacent to the existing nuclear complex at Sellafield. Does the EU ETS remain a viable instrument for climate change mitigation in the EU? 6. EU ETS has played an important role in the EU’s climate change mitigation programme, but it has not proved to be a driver for investment in low carbon technologies. This is largely because the carbon price has not been sufficiently visible in advance, even if the cap is known, because the demand for carbon emissions is unknown and dependent on EU-wide economic growth. The result of this is that, under the ETS as currently constituted, the relative economics of investment in low carbon technologies such as nuclear power (as opposed to higher carbon alternatives) depends on projections of overall economic growth in Europe. 7. The UK Government has responded to this issue through the Electricity Market Reform (EMR) package which supplements EU ETS with specific measures (including in particular feed in tariffs) to encourage investment in low carbon technologies such as renewables as well as arrangements to support the effective carbon price for generators through taxation. 8. It is likely that the continued development of low carbon generation elsewhere in Europe will require similar arrangements at least as regards support for specific technologies. Indeed, we think that it would be preferable for any mechanism to stabilise the price of carbon to be applied at an EU level rather than in the UK alone. This is because a UK-only scheme remains susceptible to arbitrage and carbon leakage effects with adjoining Member States, and is therefore not bankable.

9. Subject to the above caveats (that the EU ETS cannot be the whole solution, and some sort of greater stability and visibility of the carbon price could enhance the investment signals it provides), it remains the case that EU ETS is the most ambitious and innovative policy scheme so far for reducing greenhouse gas (GHG) emissions across multiple nations. The scheme is, in large, understood by participants and functions well to provide a liquid trading market. As a market based instrument, it has the potential to minimise the cost of achieving set emission reduction targets. 10. The consolidated Directive (2009/29/EC) has already made a number of improvements to the scheme, commencing in phase III. These include a single EU wide cap on the number of allowances and harmonised allocation rules. However, it is vital that the scheme is strengthened and developed further to ensure it remains a viable instrument which can play a key role in the delivery of longer-term climate change mitigation measures, as proposed in the Commission’s roadmap for moving to a low carbon economy by 2050. 11. The EU ETS also represents a strong foundation on which to build in order to link with other cap and trade schemes as they may be developed across the globe. Can the EU ETS operate effectively in a world without legally binding emission reduction commitments and other cap and trade schemes? 12. In the absence of an international framework for emissions reductions, it is important that the EU continues to lead by example in the development of efficient policy frameworks, such as the EU ETS (the largest GHG reduction scheme in the world). This actively demonstrates that emission reductions can be met at an acceptable cost. 13. The ETS operates an effective and flexible regime, enabling Member States and ETS sectors to meet their caps in the most efficient manner. However, as discussed above, it needs to be further developed and/or supplemented in order to provide greater longer-term investment certainty for business going forward. 14. Clearly, there needs to be recognition of the international competitiveness of EU participants. European steps towards a low carbon economy need to be pursued within a wider global context. In this respect, it is important to make progress towards a long term legally binding agreement. What reduction in emissions will the EU ETS deliver in phase III, within the EU and abroad? 15. With regards to the EU, the consolidated Directive (2009/29/EC) published in June 2009 stipulates that caps set at 2013 will be reduced annually by a linear factor of 1.74%. The Directive specifies a maximum level of allowances that can be sourced from outside the EU. We are working on the assumption that these will be taken up. Could the environmental and economic efficiency of the EU ETS be improved by linking with other emissions trading schemes and how can this be achieved? 16. The long-term aim should be for the ETS to gradually link with compatible systems around the world. Facilitating trade flows across different market boundaries presents greater opportunities for efficient abatement costs and achievement of emission reduction objectives on a global scale. It also provides for potential to reduce

competitiveness distortions arising from different carbon constraints/price levels in different global markets (i.e. carbon leakage). 17. The success of the EU ETS has already inspired other countries and regions to consider and develop cap and trade schemes of their own, for example, domestic cap-and-trade systems have been being implemented or discussed in the US, Japan, Australia, South Korea, New Zealand and Switzerland. However, linking with other such trading schemes could be problematic if the underlying systems and climate change policies are too different. For example, in order for linking to be successful wider schemes will need to have robust mandatory caps on emissions, comparable monitoring, reporting and verification requirements and comparable compliance and enforcement regulations. Linking will likely take the form of bi-lateral markets prior to expanding towards regional and international markets. 18. The best way to achieve an efficient global solution to linking with other emissions trading schemes would be to:

• Facilitate global trading across major emitting sectors (i.e. sectoral trading - assuming that all the major emitting sectors would be included in other schemes);

• Develop new sector crediting mechanisms (to support actions in developing countries, which will in turn result in real global emission reductions);

• Enabling the ETS to utilise credits from potential new mechanisms that can finance new low carbon infrastructure, especially abroad; and,

• Link to other carbon offset opportunities – eg REDD+ What actions should the UK and the EU be taking to promote the development of compatible ETS’s internationally? 19. The EU ETS already presents a strong foundation on which to develop a global carbon market. The UK and the EU must therefore continue to support the ETS to further demonstrate its effectiveness as a trading scheme that can meet emission reduction targets in the most efficient way. 20. We have already seen some improvements in the revised Directive (2009/29/EC), which will provide for further future alignment with other emission trading schemes such as through the introduction of other sectors (aviation) and green house gases. However, these efforts need to be complemented by further progress in meeting robust emission reduction targets in developed countries across the globe. Progress on these commitments in turn will be helped by efforts being made on long-term emissions reductions in some developing countries. 21. The EU must therefore continue to push for further commitments from developed countries, including through policies such as sectoral commitments or sustainable development policies and measures, whilst also leading efforts to secure progress on emissions reductions across the world. Could sectoral agreements form part of the future of the EU ETS? 22. Sectoral agreements could have a strong role to play in future emissions reduction initiatives. It is possible to envisage a process that leads to the creation of credits arising from efficiency improvements to CO2 benchmark or BAT standards for industrial plant. These credits could then be released into an international trading scheme.

23. There would need to be associated safeguards put in place to avoid unwelcome distortions (e.g. subsidies for certain industries) or the gaming of such a system (e.g. artificially low baselines for calculating additionality). Such a system would also need to consider the nature of trade flows and the binding nature of such agreements. Initially, it might be possible to develop bi/multi lateral arrangements between participating States. Demand for sectoral credits will not only come from the EU, but other from other developed and developing nations. Will the EU ETS be able to access viable alternatives to international credits without the Clean Development Mechanism? 24. The Clean Development Mechanism (“CDM”) (and JI) has proved to be a cost effective way to reduce emissions and increase investment in low carbon technologies across the globe. The environmental integrity of the CDM has not always been as strong as it might have been and it has also been subject to some other limitations. 25. We believe that the CDM should still play a constructive role in international markets - but it needs to be much simpler, more material in nature and be applied to a wider range of accepted technologies. 26. There is also likely to be a variety of mechanisms designed in the future that can enable investment in low carbon initiatives abroad. For example, we support examining the extension of credits arising from sectoral agreements (as above), the potential development of green bonds to stimulate widespread deployment of low carbon investment and the development of a market in other offset schemes such as REDD. 27. Whatever mechanisms are chosen in the future, it is important that the UK Government (and the EU) ensure that the highest quality governance is in place for the development of these markets. Such mechanisms must have the best available assurance in order that consumers, industry and taxpayers are protected. Is the EU ETS a constraint on unilateral action to reduce emissions and, on the other hand, how are Member States’ own policies affecting the operation of the trading system? 28. The EU ETS has the potential to act as a discouragement to domestic action within the traded sector since reductions achieved could be balanced by increases in other ETS countries. In practice, the effect has not been observed as EU Member States have pursued renewables and energy efficiency policies regardless of this effect. 29. One reason why domestic action has been pursued in the traded sector is a belief that CO2 limits will continue to fall and that a high carbon economy is likely to become extremely expensive. Against that background, it is rational for Member States to pursue domestic action in order that their economies are ready for a time when carbon prices are much higher. 30. A side effect of the continuing of domestic actions by Member States will be to depress the price of carbon in EU ETS. However, developments in the European economy have been the more significant reason for a reduction in emissions and to generally lower than expected CO2 prices. 31. In the UK, it is clear that there will be interaction between the carbon floor price and the EU ETS depending upon the level of variance from carbon prices under the EU

ETS. However, the need to avoid the competitiveness disadvantage associated with this unilateral action mean that any such variance is likely to remain limited over the long-term. Indeed, this underlies the need for effective action at a European level. If, however, the variance becomes large between the carbon price floor and the ETS price it is likely that the impact will be a redistribution of CO2 emissions across the EU and an increase in the overall cost of CO2 abatement. Effectively, the UK would subsidise higher fossil fuel emissions elsewhere in Europe.

32. We believe that it is preferable to avoid double (or triple) regulation of large combustion plant to achieve CO2 reductions. Member States’ regulatory policy design should concentrate on the non traded sector activities.

How serious an impact have the recent cases of fraud had on confidence in the EU ETS? Are further improvements in security and auditing required? 33. Recent security incidents within the EU ETS underline the importance of robust and effective anti-fraud arrangements. While the recent events have obviously caused short term concerns, we do not think that (if fully and properly addressed) they will have had a lasting impact on participants’ confidence in the EU ETS. It is essential that improvements in transparency and oversight in the ETS are brought into play as soon as possible. The risk of receiving stolen EUAs remains present in the system. 34. We strongly support the need for further Registry security and consistency across the EU. In particular, we support the establishment of a Union Registry and we agree with the need for an annual security audit. As part of the reform process, the legal status of allowances needs to be clarified as does the title of transfer. How can the EU ETS be strengthened to operate effectively in a world without legally binding emissions reduction obligations? 35. The EU ETS was designed to provide a stable framework to reduce emissions across the EU, in the most cost efficient way. Technically, the EU ETS does not rely upon a global legally binding system. The original rationale was based upon the Kyoto agreement, but its continuation is not contingent upon a successor arrangement. 36. The principal issue which may arise if the EU continues to reduce emissions but other countries do not follow – namely the risk of carbon leakage and damage to competitiveness – does not depend on the nature of the instrument being used. Indeed, to the extent that EU ETS enables the market to seek out the most cost effective measures, it will help to mitigate that risk. 37. Longer term certainty for the ETS can be sought in the design of the 2050 roadmap for greenhouse gas reductions. At an EU level, there is a need for reductions to meet a target of between 80 and 95% by 2050. It is presently understood that the EU ETS is an effective element of the actions needed to meet this objective. The associated “Energy Road Map” that will, amongst other things, set out the EU emissions reductions parameters for large combustion plant is due to be published in Autumn 2011. 38. Some improvements have already taken place such as introducing aviation and including other gases – however more needs to be done to strengthen the system; for example:

• Changes to the eligibility of CDMs/JIs – there is a need for more certainty on this • Promoting opportunities for sectoral agreements

6

• Stronger regulation around registry security (revised Registry regulations will help this)

39. The system also has to develop flexibly to accommodate fledgling initiatives globally, but in a manner that retains EU competitiveness. Links to green bonds and REDD present new opportunities for the ETS. These international steps can be best pursued, however, within a UNFCCC context and in exchange for obligations from other nations. August 2011

Memorandum submitted by UK Chamber of Shipping (ETS 42)

As the Committee will be aware, shipping was not included in the EU ETS at its inception due to the complexities of incorporating such a truly global industry without causing market distortion and potentially placing European shipping companies at a competitive disadvantage. Whilst shipping still remains outside the EU ETS, the EU Transport White Paper published in 2011 states that:

In maritime, the need for a global level-playing field is equally pronounced. The

EU should strive – in cooperation with IMO and other international organisations –

for the universal application and enforcement of high standards of safety, security,

environmental protection and working conditions, and for eliminating piracy. The

environmental record of shipping can and must be improved by both technology

and better fuels and operations: overall, the EU CO2 emissions from maritime

transport should be cut by 40% (if feasible 50%) by 2050 compared to 2005 levels.

It is the view of the Chamber of Shipping that a global solution for addressing carbon emissions from shipping is required (ie through the UN’s International Maritime Organisation (IMO)) rather than a regional solution. Progress within the IMO, however, has been slow. Developing countries have argued that measures should only be mandated in developed countries and left voluntary in developing countries. Such an approach would, of course, lead to a large market distortion.

However, in July 2011, some progress was achieved. Energy efficiency measures for ships were agreed, making mandatory the Energy Efficiency Design Index (EEDI) for new ships and the Ship Energy Efficiency Management Plan (SEEMP) for all ships. The EEDI is a non-prescriptive, performance based mechanism that leaves the choice of technologies to use in a specific ship to the industry. As long as the required energy efficiency level is achieved, ship designers and builders would be free to use the most cost efficient solutions. The SEEMP establishes a mechanism for operators to improve the energy efficiency of ships.

The Chamber has welcomed the advances made by the International Maritime Organization to promote the reduction of shipping’s carbon emissions through technical efficiencies but believes that it will prove necessary for the industry to go further – through the adoption of economic (or ‘market-based’) measures to meet governments’ expectations and targets. Though EEDI and SEEMP may deliver the 40% reduction by 2050 as desired by the EU, that does not take into account the expected growth of the shipping industry over the same period that will, in effect,

drive down the overall reduction. There is no certainty therefore that the EU will accept that the measures agreed in the IMO will be sufficient and may therefore choose to impose a regional solution. This is currently under discussion within the EU and the Commission is holding a series of meetings with industry representatives to ascertain what, if any, regional solution should be imposed on shipping. They are also commissioning a study to investigate the merits, impacts and desirability of the various market based approaches. The Chamber has recently published papers on how both an ETS and a Contribution Fund (Levy) might work for shipping and hopes that these will inform this debate.

Any regional scheme begs many questions with respect to its implementation. For example, should allocations per ship be based on distance, or route, or the distance the cargo has travelled? Is the bill of lading reliable? What if a ship has a single or multiple bills of lading between EU and non-EU ports? Should ballast voyages be regulated? Questions also arise such as which ship operators and routes will be affected by the EU ETS? Will it cover all ship-operators, EU or non-EU based? Engaged in domestic and/or intra EU trade? What about addressing emissions from all incoming routes and/or outgoing routes? Will all ship-operators thus be treated equally? What about the geographic scope of the ETS? Apart from the size limit (400GT) should any other particularities be taken into consideration before applying for exemptions? There are also concerns with respect to carbon evasion, leakage and, of course, fraud.

It is the strongly held view of the Chamber that an international solution is required for such a truly international trade and one on which the UK is so dependent. Rather than trying to develop and implement a regional solution the EU should, therefore, exert all its efforts and influence on trying to push for an international solution within the IMO.

August 2011

Notes

• The Chamber of Shipping is the trade association for the UK shipping industry, working to promote and protect the interests of its members both nationally and internationally. With 137 members and associate members, the Chamber represents over 917 ships of about 27 million gross tonnes and is recognised as the voice of the UK shipping industry.

• UK shipping has a turnover of over £11bn. With indirect effects, UK shipping’s contribution to UK GDP is £13bn.

• The Chamber is a member of Maritime UK, which brings together the major associations representing the UK’s the shipping, ports and maritime business services sectors.

• The Chamber is a lead partner in Sea Vision, the nationwide campaign working to raise awareness of the sea and the maritime sector, particularly amongst young people aged between 13 and 22 years old.

For more information on British Shipping, please go to: http://www.british-shipping.org

Memorandum submitted by the Emissions Trading Group (ETS 43)

DISCLAIMER– This submission has been shared with ETG members and, as such, is intended to represent a broad consensus of the membership. This does not imply that each individual member (or the companies by whom they are employed) subscribes to every element of the text.

Background

The Emissions Trading Group (ETG) provides an important forum for discussion between business and the UK Government and its relevant agencies – it is not a lobby organisation. Our members’ considerable combined practical experience allows us to exchange data, information and ideas with the UK Government on the formation, impacts and practical application of emissions trading policy and regulation. For over 10 years, the ETG has proved to be a highly effective organisation, helping not only to establish the first emissions trading scheme in the UK, but also to guide the UK’s implementation of the EU’s Emission Trading Scheme (EU ETS).

Since our inception we have attracted a widely‐based multi‐disciplinary membership of organisations involved in the emission trading arena including not only industrial companies and trade associations in the traded sector but also service providers ‐ lawyers, traders, accredited verifiers, and consultants.

Our members represent the vast majority of UK emissions in the EU ETS (including operators with installations in other EU member states), the principal Sector Associations signed up to UK Climate Change Agreements and many organisations subject to the UK CRC Energy Efficiency Scheme (CRC).

The nature of our organisation means we rarely make formal Submissions in response to the many UK Consultations over the years; rather it has been our practice to help Government in its deliberations through a series of Expert Papers, presented to officials on a range of issues, and published on our website at www.etg.uk.com. However this Inquiry comes at a very important time in the development of the EU ETS and we would like to put on record some key points for consideration by the Committee.

Summary key points

On Emissions Trading

1. Climate Change is a global phenomenon requiring all countries to address their greenhouse gas emissions. The creation of an international common and fungible currency in carbon through Emissions Trading, albeit at the regional EU level, provides an important first step in a wider concerted and transparent effort to address climate change.

2. The Emissions Trading initiative has been highly effective in raising awareness of the need to include the cost of carbon in the decision making process within companies over the last decade. Emissions Trading is a more complex economic instrument than a carbon tax but it is fair to say that, in the main, industry prefers the market based solution associated with the former.

http://www.etg.uk.com/

3. There has been substantial progress in developing this instrument in the 6 years of its operation,

first through its pilot Phase 1 and then the current Phase 2, with considerable learning by all stakeholders. There have been teething problems ‐ for example in Phase 1 over allocation, delays in setting up some national registries and lack of attention to the release of market sensitivity of emissions information by the European Commission (EC). More recently there have been issues with cyber‐theft from some registry accounts, and evidence of VAT carousel fraud, but a belated tightening of Member State registry security and registration process, and harmonisation of VAT treatment will largely negate these issues. In addition the common EU ETS system monitoring reporting and verification of emissions is seen as robust and a huge improvement on previously available emission data. Thus overall we believe the market is now well set to deliver the objectives set for the Phase 3 period 2013‐2020.

4. Many ETG members are active trading participants in the EU single market, while some

members are also part of EU cross border enterprises. Members have approached the EU ETS in terms of ensuring a level playing‐field through centralisation of legislation and the requisite scrutiny and harmonisation of practice by the European Commission.

5. The principles involved in the EU ETS are simple ‐ Governments collectively set the emission caps

and let industry meet the cap in the most optimal and least cost way. From a purely emissions reduction perspective, the EUETS demands a response from those carbon emitting operations as the overall emissions cap (and thus installation emissions) is fixed; in contrast, the carbon tax approach solicits a response from these operations but with no explicit guarantee of delivering emission reductions. Thus in Phase 3, the EU ETS will ensure that emissions from Europe’s power generation and other large emitting installations are reduced 21% below 2005 levels by 2020.

6. The EU’s Emissions Trading scheme provides a vehicle for interactions between regions. For

example:

a. It allows developing countries to engage in greenhouse gas emissions reduction actions though allowing some credits derived from the Kyoto Protocol’s Clean Development Mechanism and Joint Implementation projects to be fungible with EU allowances for EU ETS compliance, rather than just available for use by other Kyoto Parties

b. In time it is possible that trading schemes in other regions could interact with the EU

ETS, in much the same way as Patent Organisations have emerged from national to regional entities, with clear ‘rules of engagement’ between such organisations.

7. The EU ETS Directive specifies that the cap on emissions will decline at 1.74% each year from 2010. Note that there is no sunset clause in the EUETS Directive meaning it is very likely that this mechanism will continue beyond 2020 in further eight year phases to drive emissions reductions in the EU industrial and aviation sectors. However, when it comes to emission reductions, it is important the EU keeps in step with developments in other economic areas.

3

On the carbon price 8. Much has been made of the recent relatively low market price for carbon i.e. the EU ETS

allowance price (EUA). It is true that the prevailing carbon price is less than had been projected when Phase 2 was being developed. This price is due principally to the unforeseen global economic downturn and the subsequent reduction in EU energy demand and the associated emissions that has coincided with Phase 2. However the EU ETS cap assures and ensures that the emissions reduction target will still be met ‐ regardless of EUA price.

On the UK’s carbon price floor initiative 9. The UK Government has played a prominent role in the development initially of the UK ETS and

then the EU ETS. Most recently it has decided to introduce a UK Carbon Price Floor to deliver a more predictable but, based on the European Commission’s analysis1, a higher carbon price to 2020 and potentially beyond, than would otherwise be the case through the EU ETS.

10. However, it should be noted that the Government has only targeted the electricity generation sector and its customers with this measure (some 65.2% of EU ETS UK 2009 emissions2). Nonetheless, there are major concerns amongst ETG members on the creation of the Carbon Price Floor, and on the level at which it is set – that it has the potential for some sectors in the UK economy to be put at a disadvantage on increased electricity prices compared principally to its European but also global competitors. Of particular concern is the potential flight of new industrial capital to other EU countries or to countries outside of the EU ‐ a process commonly referred to as ‘carbon leakage’.

August 2011

1 A Communication by the European Commission on the 26th May 2010 presented the longer term implications of the economic downturn. In this analysis, it suggested a carbon price of €16 (2008 prices) in 2020 compared to about €32 projected in the Impact Assessment, carried out before the downturn. The Communication suggested that the overall cost of meeting the 20% reduction in greenhouse gas emissions would be very much less than previously estimated, and explored the implications of the EU moving to a 30% emissions target in 2020 if the scheme was to return the carbon price to the levels projected before the downturn. On 5th July 2011 the European Parliament voted against increasing the EU's greenhouse gas emissions reduction target to 30% by 2020. 2 Report on 2009 EU Emissions Trading System emissions data October 2010