Energy Intensive Industries Compensation Scheme

HC 669 Published on 4 January 2013

by authority of the House of Commons London: The Stationery Office Limited

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House of Commons

Environmental Audit Committee

Energy Intensive Industries Compensation Scheme

Sixth Report of Session 2012–13

Report, together with formal minutes, oral and written evidence

Ordered by the House of Commons to be printed 19 December 2012

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

Current membership Joan Walley MP (Labour, Stoke-on-Trent North) (Chair) Peter Aldous MP (Conservative, Waveney) Richard Benyon MP (Conservative, Newbury) [ex-officio] Neil Carmichael MP (Conservative, Stroud) Martin Caton MP (Labour, Gower) Katy Clark MP (Labour, North Ayrshire and Arran) Chris Evans MP (Labour/Co-operative, Islwyn) Zac Goldsmith MP (Conservative, Richmond Park) Mark Lazarowicz MP (Labour/Co-operative, Edinburgh North and Leith) Caroline Lucas MP (Green, Brighton Pavilion) Caroline Nokes MP (Conservative, Romsey and Southampton North) Dr Matthew Offord MP (Conservative, Hendon) Mr Mark Spencer MP (Conservative, Sherwood) Paul Uppal MP (Conservative, Wolverhampton South West) Dr Alan Whitehead MP (Labour, Southampton, Test) Simon Wright MP (Liberal Democrat, Norwich South)

The following members were also members of the committee during the parliament: Ian Murray MP (Labour, Edinburgh South) Sheryll Murray MP (Conservative, South East Cornwall)

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Committee staff The current staff of the Committee are Simon Fiander (Clerk), Nicholas Beech (Second Clerk), Lee Nicholson (Committee Specialist), Andrew Wallace (Senior Committee Assistant), Anna Browning (Committee Assistant), Yago Zayed, (Committee Support Assistant) and Nicholas Davies (Media Officer).

Contacts All correspondence should be addressed to the Clerk of the Environmental Audit Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 6150; the Committee’s email address is [email protected]

Energy Intensive Industries Compensation Scheme 1

Contents

Report Page

Summary 3

1 Introduction 5 Carbon leakage 5

European Union Emissions Trading System 5 Carbon Price Floor 6

Our inquiry 6

2 The compensation scheme 9 Establishing the impact of carbon policy costs 9 Spending envelope 14

International comparisons 15 Fairness 18 Taking account of surplus European Union Allowances 19 Eligibility 21 Methodology for calculating compensation 23

3 Transition to a green economy 27 Decarbonising the energy intensive industries 28

Energy efficiency 28 Reducing emissions 29

Decarbonising their electricity supplies 30 An energy intensive industries strategy 32

Conclusions 35

Recommendations 36

Formal Minutes 39

Witnesses 40

List of printed written evidence 40

List of Reports from the Committee during the current Parliament 41


Summary

Energy Intensive Industries, such as iron and steel, chemicals and cement industries, account for 4% of Gross Value Added and employ 125,000 people in the UK. They face particular risks from initiatives to reduce carbon emissions, including the indirect costs of the EU Emissions Trading System and the Carbon Price Floor. The Government is right therefore to set out a scheme to help offset that risk. Government policy should not result in these industries and their emissions relocating abroad. However, the risk of this happening is concentrated in only a small number of sectors, and thus compensation must be tightly focused and linked to helping those industries to reduce their fossil fuel dependency.

Industry has not provided the Government with the data required to establish precisely how much compensation is needed, making any assessment of the adequacy of the compensation package incomplete. We have identified a number of areas, however, where the calculation of compensation must be tightened up to avoid over-compensating businesses, in particular to avoid compensation being paid to companies making windfall profits from accumulating surplus free Emissions Trading System carbon allowances.

The compensation scheme being proposed by the Government has been closely modelled on the calculations and eligibility criteria issued by the European Commission, to ease the State Aid approval process for the scheme. In some areas, however, the Government has applied elements of the Commission’s calculation in a potentially more stringent way than some other countries might be doing. The Government should review the operation of the compensation scheme after its first year, to ensure that it remains reasonable in view of the costs actually being incurred by energy intensive industries and does not put UK businesses at a competitive disadvantage.

Energy intensive industries, like all other sectors of the economy, must decarbonise if we are to meet our emissions targets. Barriers hampering this include the availability of innovative technologies and investment funding. The current compensation package is simply a short term measure to help offset some carbon policy costs and does nothing to address these barriers. We recommend therefore that the Government sets out a strategy for energy intensive industries, as part of the wider manufacturing strategy needed to ensure that the UK retains a robust manufacturing sector, which sets out a path for their maximum feasible decarbonisation and incorporating sector-specific roadmaps. Such a strategy should identify by how much industries should be required to decarbonise and improve their energy efficiency and how the Government will help to ensure that this is achieved, including through energy consumption reduction measures and incentives, and support for innovation, technological research, development and investment. Such an analysis would allow a clear articulation of the feasible limits of decarbonisation over the medium and longer term, and thereby provide an assessment of the scale of future compensation requirements. At the same time the Government should set out the extent of the compensation that it is willing to pay in a longer term compensation budget.

4 Energy Intensive Industries Compensation Scheme

In the main body of this report, conclusions are printed in bold and recommendations are printed in bold italics.


1 Introduction

Carbon leakage

1. ‘Carbon leakage’ is the term used to describe occasions when emissions in one country increase as a result of industries relocating there from a second country with more stringent climate change policies or carbon taxes. Carbon leakage can take the form of ‘production leakage’ where market share is lost to other countries or ‘investment leakage’ where investment is moved abroad, and in extreme cases could involve plant closures or even the relocation of activities to other countries.1 Carbon leakage is a risk to a small set of industries.2 Concerns have been raised that without protection such industries in the UK could be at risk from carbon leakage due to European and UK policies being more stringent than those elsewhere. Principal among these industries are those generally described as energy intensive. These are characterised by the exceptional energy demands of their key processes. They include iron and steel, chemicals and cement industries.

European Union Emissions Trading System

2. The EU Emissions Trading System (ETS) has created a Europe-wide cap-and-trade market for carbon that aims to reduce emissions at the lowest possible cost. Implicit in that scheme is a price signal—the price of carbon emission allowances—which aims to drive low carbon investment by internalising the external cost of emissions on the environment.3 The third phase of the ETS will operate in 2013–2020 and is intended to deliver two-thirds of the EU’s target to reduce emissions by 20% by 2020.4 In the UK, the Government believes that 48% of national CO₂ emissions will be covered in Phase III and will deliver two-thirds of the emissions reductions needed to meet the first three UK Carbon Budgets (which run until 2022).5

3. Member states are permitted, but not obliged, to compensate those at risk of carbon leakage for the direct and indirect costs of the ETS.6 Energy intensive industries face direct costs from the ETS by burning fossil fuels themselves—the cost of buying allowances to match their emissions. However, if an installation is within one of 151 industrial sectors or 13 sub-sectors determined by the European Commission to be at risk of carbon leakage, member states are able to provide EU allowances free to enable these sectors to emit CO2 throughout 2013–2020.7

1 European Commission Staff Working Document, Impact Assessment Report accompanying Guidelines on certain

State aid measures in the context of Greenhouse Gas Emission Allowance Trading Scheme, 22 May 2012 (http://ec.europa.eu/competition/sectors/energy/impact_assessment_main%20report_en.pdf).

2 Environmental Audit Committee, Seventh Report of Session 2010–12, Carbon budgets, HC 1080, (www.publications.parliament.uk/pa/cm201012/cmselect/cmenvaud/1080/1080.pdf).

3 Impact Assessment Report accompanying Guidelines on certain State aid measures in the context of Greenhouse Gas Emission Allowance Trading Scheme, op cit.

4 The first phase of the scheme ran between 2005–2007. The second between 2008–2012.

5 See DECC’s website (www.decc.gov.uk/en/content/cms/emissions/eu_ets/phase_iii/phase_iii.aspx)

6 European Emission Trading Directive of the European Union—Directive 2003/87/EC.

7 A benchmarking method is used by the European Commission to decide on the number of free EU Allowances that eligible installations should receive. That method is designed to “preserve the incentives created by the EU ETS CO2 price signal as far as possible”.


4. Indirect costs also arise for energy intensive industries because they will pay higher electricity prices as a result of generators burning fossil fuels and passing ETS costs onto them.8 The European Commission has set out guidelines that explain the ‘compatibility criteria’ that it will apply when considering State Aid measures brought forward by member states to compensate for these indirect costs. The guidelines seek to address three specific objectives: minimising the risk of carbon leakage, preserving the ETS’s ability to achieve cost-efficient decarbonisation and minimising competition distortion in the EU internal market. The guidance lists 13 sectors and 2 sub-sectors that would be eligible for indirect costs compensation and how such compensation should be calculated.9

Carbon Price Floor

5. In the UK, the Government has introduced a UK Carbon Price Floor to ‘top up’ the carbon price to a target rate, thus “reducing revenue uncertainty and improving the economics for investment in low-carbon generation”. The target carbon price will start at around £16 per tonne of CO2 in 2013 rising to £30 per tonne in 2020. This equates to a Carbon Price Floor support rate of £4.94 per tonne in 2012-13 and is expected to raise £740 million in 2013-14 for the Treasury.10 The Carbon Price Floor was introduced because the low carbon price in the ETS would not incentivise lower carbon investment. EDF energy believed that whilst the Carbon Price Floor “will play a key role in delivering low carbon investment in the UK”, it “does not remove the need for reform of the ETS at the European level”. It believed that any “cost differentials that may arise” for UK businesses from the Carbon Price Floor would be “significantly reduced or even eliminated by a “strong EU ETS carbon price”.11 The Energy and Climate Change Committee noted in its 2012 report on the EU Emissions Trading System that the Carbon Price Floor will not achieve “any additional emissions reductions in the EU” and “is likely to reduce the efficiency of the ETS at “the expense of UK taxpayers”, believing that the Price Floor raises the prospect of “Intra-EU leakage for the first time”.12 The Government believes that supporting the carbon price is “likely to increase retail electricity prices in the short to medium-term” and might therefore “pose a risk” to the competitiveness of the most intensive-users of electricity who are unable to pass these costs through to their customers.13

Our inquiry

6. The Government announced in Autumn Statement 2011 that it had allocated £250 million over the remainder of the Spending Review period (up to 2014–15) to help “reduce

8 Impact Assessment Report accompanying Guidelines on certain State aid measures in the context of Greenhouse Gas

Emission Allowance Trading Scheme, op cit.

9 European Commission, Guidelines on certain State aid measures in the context of the greenhouse gas emission allowance trading scheme post-2012, 2012/C 158/04, Official Journal of the European Union, 5 June 2012 (http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2012:158:0004:0022:EN:PDF).

10 HM Treasury, Budget 2011, HC 836, March 2012, (http://cdn.hm-treasury.gov.uk/2011budget_complete.pdf).

11 Ev 47

12 Energy and Climate Change Committee, Tenth Report of Session 2010-12, The EU Emissions Trading System, HC 1476 (www.publications.parliament.uk/pa/cm201012/cmselect/cmenergy/1476/1476.pdf).

13 BIS, Compensation for the indirect costs of EU ETS and Carbon Price Support—Consultation on scheme eligibility & design, October 2012 (www.bis.gov.uk/assets/biscore/business-sectors/docs/e/12-1179-energy-intensive-industries-compensation-consultation-on-scheme.pdf).


the impact of policy on the costs of electricity for the most electricity-intensive industries”. It was not intended to address any of the other issues these industries face from operating in internationally competitive markets or as a result of the recession.14 The measures announced were:

• Increasing the level of relief from the Climate Change Levy on electricity for Climate Change Agreement participants to 90% from 2013 (at a cost of £35 million).15

• A scheme to compensate key electricity-intensive businesses for the indirect costs of the Carbon Price Floor and ETS—up to £100 million and £110 million respectively.16

In March 2012 the Government launched a call for evidence to capture energy cost information from energy intensive industries, and in October 2012 it launched a consultation on the design of the compensation scheme to operate from 2013. Separately, in February 2013 the Committee on Climate Change is expected to report on its “detailed analysis of competitiveness risks and potential mitigating measures” for energy intensive industries as part of its review of the Fourth Carbon Budget.17

7. We previously explored the issue of ‘carbon leakage’ as part of our 2011 inquiry on carbon budgets. Two main findings on carbon leakage emerged from that inquiry. The first concerned the need to ensure that any ‘policy cost’ compensation would be based on robust data on the risk of carbon leakage to the industries concerned. The second concerned how any mitigating action would be structured, and we recommended that any measures put in place should focus on providing incentives to invest in lower carbon infrastructure and should keep a strong incentive to reduce emissions.18

8. In this latest inquiry we examine how the Government has addressed those findings in designing its compensation scheme. Our report is intended to contribute to the Government’s consultation exercise, which concludes at the end of 2012.

9. We do not address the issue of compensation for other energy and climate change policies that will raise the price of electricity for energy intensive industries over the medium term, such as Electricity Market Reform arrangements, the Renewables Obligation and Feed-in Tariffs, which are not within the scope of the current consultation package. Since we launched our inquiry, the Secretary of State for Energy and Climate Change announced the Government’s intention to “exempt energy intensive industries from additional costs arising from new electricity market [reform] arrangements”. The scope of that exemption is currently being considered by DECC and BIS and there will be a further consultation on that in 2013.19

14 Ev 17

15 Estimated to be worth £1 million a year for the average energy-intensive industry.

16 HM Treasury, Autumn Statement 2011, Cm 8231, November 2011, A.65, A.66 and Table 2.1 (http://cdn.hm-treasury.gov.uk/autumn_statement.pdf).

17 Ev 59

18 Environmental Audit Committee, Seventh Report of Session 2010–12, Carbon budgets, HC 1080, pp 29-33 (www.publications.parliament.uk/pa/cm201012/cmselect/cmenvaud/1080/1080.pdf).

19 DECC, Press Notice — Energy Intensive Industries to be exempt from new low carbon costs, 29 November 2012 (www.decc.gov.uk/en/content/cms/news/pn12_149/pn12_149.aspx).


10. We received 14 submissions and took oral evidence from Friends of the Earth, the Committee on Climate Change secretariat, Dimitri Zenghelis,20 Sandbag Climate Campaign, British Ceramic Confederation, Energy Intensive Users’ Group, EEF, TUC, officials from the Department of Energy and Climate Change and the Department for Business, Innovation and Skills and Rt Hon Michael Fallon MP, Minister of State for Business and Enterprise. We are grateful to them all.

20 Mr Zenghelis wrote the competitiveness chapter of the Stern Review.


2 The compensation scheme

Establishing the impact of carbon policy costs

11. In our previous inquiry on Carbon Budgets we found that the Government lacked the data needed from energy intensive industries to quantify the risk of carbon leakage.21 Subsequently, a review by the European Commission found a “severe lack of data at both EU and national level”. Specifically, there was a paucity of disaggregated information on electricity consumption by sectors and sub-sectors, little comparable data on how much electricity different sectors were generating themselves (‘auto-generation’)22 and limited data on differences in price-elasticity of demand between EU and non-EU countries in the sectors concerned.23 The TUC and Energy Intensive Users’ Group were concerned that policy decisions were being made on “inaccurate data on company energy use”.24

12. In March 2012 the Government launched a ‘call for evidence’ to improve its data on electricity usage in industry.25 Data was sought on the ‘electricity intensity’ of companies and their ‘trade intensity’ (how widely traded the produced goods are, and whether cost increases could be passed on to consumers), the effects of increased electricity prices on investment decisions and views on how criteria might be applied for a compensation scheme.26 Only 48 responses were provided to the Government, largely from trade associations and energy intensive industries which, the Government concluded, “provided no clear consensus on the metrics that should be used to assess eligibility for compensation”. The Government faced difficulties in collecting the data it needed due to the different ways that companies collated their accounts, commercial confidentiality issues and the administrative burdens for companies of collecting new data.27

13. Alex Kazaglis from the Committee on Climate Change told us that very detailed information was still needed on both electricity consumption and trade intensity.28 Poorly targeted compensation that over-compensated particular sectors would undermine the price of carbon, increasing overall costs and “may result in distortions of competition in

21 Carbon budgets, op cit.

22 Electricity generated on-site will be exempt from a number of costs which may affect the retail price of electricity purchased from the main grid.

23 European Commission Staff Working Document, Impact Assessment Report accompanying Guidelines on certain State aid measures in the context of Greenhouse Gas Emission Allowance Trading Scheme, 22 May 2012 (http://ec.europa.eu/competition/sectors/energy/impact_assessment_main%20report_en.pdf).

24 TUC and Energy Intensive Users Group, Building our low-carbon industries, June 2012 (www.tuc.org.uk/tucfiles/352/Buildingourlowcarboninds.pdf).

25 BIS, Compensation for the indirect costs of the Carbon Price Floor and EU Emissions Trading Scheme–call for evidence, March 2012 (www.bis.gov.uk/assets/biscore/business-sectors/docs/c/12-660-compensation-for-carbon-price-floor-emissions-trading-call.pdf).

26 Ev 17

27 Compensation for the indirect costs of the Carbon Price Floor and EU Emissions Trading Scheme – call for evidence, op cit, Carbon Budgets, op cit; Qq 41, 65

28 Q 2


the internal [European Union] market”, particularly where companies in the same sector were treated differently in different member states.29

14. The Minister told us that “hard data” on carbon leakage “are difficult to obtain”. The call for evidence did not provide “a definitive answer”, but it “certainly helped to steer our approach” and “obviously it might have been better to have had more responses”.30 In order to process applications for compensation for the first time the Government would require companies to provide data on their baseline electricity consumption in 2005–2011, or data on their baseline output.31 He did not see a risk of data being deliberately withheld because “if they don’t give us any data at all, they are unlikely to get compensation”.32

15. There continues to be a paucity of data to understand how the cost of electricity for energy intensive industries will affect them. Without reliable data on the risk of carbon leakage, it is impossible for the Government to demonstrate that its compensation package is proportionate. Getting the amount of compensation wrong risks creating further distortion and poor value for money for the taxpayer. Applications from companies for compensation will provide much needed data, but that will come too late to help design the current compensation package.

16. In considering the impact on business of energy and climate change policies, it is important to look at wider fiscal policies. In our Budget 2011 and Environmental Taxes report we urged greater Government action to deliver a ‘green tax shift’—reduced taxes on the things that are valued by society (jobs, incomes and profits) funded by taxes on things that damage society (pollution and environmental damage). Such an environmental tax shift could help the UK meet its 2020 climate change targets in a fiscally neutral way.33 Increasing the carbon price might therefore be seen as part of such a green tax shift if taxes in other areas were corresponding reduced by the same amount. Carbon taxes could increase companies’ costs, but the Government has also announced plans to reduce Corporation Tax to 21% from April 2014.34 For most businesses direct energy costs are a “relatively small proportion of total costs”.35 The European Commission believed that it was “often difficult to distinguish the real drivers behind business decisions on production, investment and location” and that attempts to disentangle decisions which could specifically be attributed to carbon costs were therefore “fraught with difficulty”.36 In any

29 BIS, Compensation for the indirect costs of EU ETS and Carbon Price Support—Consultation on scheme eligibility &

design, October 2012 (www.bis.gov.uk/assets/biscore/business-sectors/docs/e/12-1179-energy-intensive-industries-compensation-consultation-on-scheme.pdf).

30 Qq 38, 40

31 Compensation for the indirect costs of EU ETS and Carbon Price Support – Consultation on scheme eligibility & design, op cit.

32 Q 42

33 Environmental Audit Committee, Sixth Report of Session 2010–12, Budget 2011 and environmental taxes, HC 878, (www.publications.parliament.uk/pa/cm201012/cmselect/cmenvaud/878/878.pdf).

34 HM Treasury, Budget 2010, HC 61, June 2010 (http://cdn.hm-treasury.gov.uk/junebudget_complete.pdf), HM Treasury, Budget 2012, HC 1853, March 2012 (http://cdn.hm-treasury.gov.uk/budget2012_complete.pdf), HM Treasury, Autumn Statement 2012, Cm 8480, December 2012 (http://cdn.hm-treasury.gov.uk/autumn_statement_2012_complete.pdf).

35 HC Deb, 29 February 2012, col 306W.



case, purchases of energy accounted for less than 3% of the costs for the UK manufacturing sector whereas employment costs represented around 20% of total costs.37

17. Potentially higher carbon costs could be seen as part of a wider green taxation ‘shift’ if such increases are offset by decreases in other company taxes. It is the overall cost burden, rather than energy costs in isolation, that help determine the risk of carbon leakage. In developing a dedicated strategy for energy intensive industries, which we recommend below (paragraph 75), the Government should identify the overall extent of cost burdens on companies and how they compare with competitive countrie , along with how the mix of costs would be adjusted to help deliver the required overall increase in the proportion of tax made up of environmental taxes.

18. Data collection problems aside, analysing the general impact of carbon policies on the electricity bills of energy intensive industries is also hampered by the range of companies’ energy usage levels, different energy prices faced by different industries, and the range of different production processes within a sector which require different mixes of gas and electricity. The Government has therefore modelled a number of illustrative users and calculated a range of impacts on energy bills (Figure 1). This modelling showed that by 2030 a ‘large’ user’s energy bill will increase by between 11% and 34% by 2030.

Figure 1: Government’s assessment of the impact of polices on energy bills

Real 2010 prices 2011 2020 2030

Household £19 (2%) -£94 (-7%) -£46 (-3%) Medium-sized business user

£271,000 (18%) £335,000 (19%) £508,000 (28%)

Large energy intensive industrial user

£0.3 to 1.9m (3 to 12%)

£0.2 to £3.5m (2 to 20%)

£1.1 to £6.1m (11 to 34%)

Source: Table 1 (modified), Estimated impacts of energy and climate change policies on energy prices and bills, DECC, November 2011.

19. The Government had calculated that an energy intensive business’ bill would be between £10 and £14 per megawatt-hour (MWh) higher in 2011 (2010 prices), but £29 to £43 per MWh higher by 2030.38 The ETS and Carbon Price Floor would account for the majority of those cost increases in 2030 (Figure 2 overleaf).

20. There were other estimates of potential electricity price rises from the indirect impacts of carbon policies. These tended to be at the higher-end of the Government estimates:

• A study commissioned by the Energy Intensive Users’ Group, based on a survey of employers, predicted that the increase in electricity bills would be between 15% and 22% higher by 2020 (compared with a Government estimate of 2% to 20% (Figure 1)).39

37 DECC, Estimated impacts of energy and climate change policies on energy prices and bills, November 2011,

(www.decc.gov.uk/assets/decc/11/about-us/economics-social-research/3593-estimated-impacts-of-our-policies-on-energy-prices.pdf). See also Ev 59.

38 Estimated impacts of energy and climate change policies on energy prices and bills, Table E6, op cit.

39 it is important to note that this does not include the cost of EU ETS Phase III but does include the Renewable Heat Incentive. Since this report was published the Government decided that the Renewable Heat Incentive will be paid from generation taxation and not through a levy on bills. TUC and Energy Intensive Users Group, Building our low-carbon industries, June 2012 (www.tuc.org.uk/tucfiles/352/Buildingourlowcarboninds.pdf).


Jeremy Nicholson believed that the predicted impact was already “material” and could be “very significant” by the end of the decade.40

• A study commissioned for the Energy Intensive Users’ Group in March 2011 estimated that the cumulative impact of policies on a representative energy intensive user’s costs41 was nearly £18 million by 2020 (compared with a Government estimate of £0.2m to £3.5m (Figure 1)), equivalent to nearly twice the profit made by that representative company.42

• The CBI estimated that EU and UK policies would add over £130 per MWh to energy intensive industries’ bills in 2020 (compared with a Government estimate of £8 to £28 per MWh) and that the Carbon Price Floor “risks becoming a tipping point” which would remove energy intensive companies’ ability to remain competitive.43

• INEOS ChlorVinyls believed that UK electricity prices were “already uncompetitive”, estimating that businesses would be paying 75 Euros per MWh for electricity in the UK (base electricity price and indirect policy costs) compared to 50 Euros per MWh in Germany and France and under 30 Euros per MWh in the US. It told us that if steps were not taken to protect energy intensive businesses “they will be driven out of the country”.44 (The Government’s modelling used an estimate of £104 per MWh after the impact of policies (c.128 Euros) in 2011 (Figure 2)).

Figure 2: Estimated impact of energy and climate change polices on average retail electricity prices paid by large energy intensive industrial users.

£/MWh (real 2010 prices) 2011 2020 2030

Estimated average price without policies 90 101 104

Of which: wholesale energy costs 62 68 66

Estimated impact of policies 10 to 14 8 to 28 28 to 43

Of which: CCL 2 1 1

Merit order effects 3 -4 1

EU Emissions Trading System 5 10 12 to 27

Carbon Price Floor N/A 1 15 to 0

Renewables Obligation support cost 0 to 4 0 to 10 0 to 3

Electricity Market Reform support cost N/A 0 to 9 0 to 11

Feed-in Tariffs support cost 0 0 to 1 0 to 1

Estimated average price with policies 100 to 104 109 to 129 132 to 147

% impact (on baseline) 11 to 16% 8 to 28% 27 to 41% Source: Table E6, Estimated impacts of energy and climate change policies on energy prices and bills, DECC, November 2011.

40 Q 28

41 Representative energy intensive company was defined as using a company using 100,00 MWh of electricity a year, at a baseline price of £70 per MWh with other electricity costs amounting to £9 per MWh. Gas consumption was set at 20,000,000 therms a year at a baseline gas price of 50p per therm with other gas costs amounting to 5p per therm. Purchases emissions in 2013 were set at 100,00 tonnes of CO2 and the company was subject to a Climate Change Agreement, assumed to remain at 65% discount from 2011. Energy costs were estimated to represent 25% of the operating costs of the company which has revenues of £100 million and made a profit of 10% (£10 million).

42 Waters Wye Associates, The Cumulative Impact of Climate Change Policies on UK Energy Intensive Industries—Update Against New Government Policy, March 2011 (www.eiug.org.uk/publics/r1403w1.pdf).

43 CBI, Protecting the UK’s foundations: A blueprint for energy-intensive industries, August 2011 (www.cbi.org.uk/media/1057969/cbi_eii_report_0811.pdf).

44 Ev 39


21. Some of the differences between the estimates made by Government and industry can be accounted for by the different assumptions used. The Government assumed that policy costs are fully passed on by energy companies and that energy intensive industries will not use their buying power to negotiate lower prices. It also assumed that energy intensive industries consume no electricity generated on-site (‘auto-generation’), 45 despite separate Government data showing that energy intensive users source a “significant amount of their electricity through auto-generation” (Figure 3).46 Such direct electricity usage should not be included in the calculation of indirect costs eligible for compensation. A major weakness of the compensation scheme is that the Government is not planning to take into account self-generation of electricity by energy intensive industries in determining the compensation due, which would therefore over-compensate them. We recommend that the Government require energy intensive industries to remove the cost of any self-generated electricity when calculating the sums due under the proposed compensation scheme. Figure 3: Auto-generation of electricity generation by main industrial groups in 2011

Iron and steel and non-ferrous metals

Chemicals Metal products, machinery and equipment

Food, beverages and tobacco

Paper, printing and publishing

Other industries

Total

Electricity auto-generated (GWh)

4,976 4,830 419 2,201 2,297 1,358 16,081

Electricity consumed from own generation (GWh)

4,065 2,650 361 1,309 1,476 1,208 11,069

Electricity sold back to the grid and other users (GWh)

911 2,180 58 892 821 150 5,012

Source: Table 1.9, Digest of UK Energy Statistics (DUKES) 2012.

22. Although energy intensive industries face relatively higher electricity bills, the unit price they pay is comparatively low (Figure 4). Government data show that UK electricity unit prices have historically been similar to the EU-15 median for medium, large and extra-large industrial users.47 Jeremy Nicholson from the Energy Intensive Users’ Group told us that some businesses could avoid local distribution charges because they were directly connected to the grid: it was “not so much the case that industry gets a discount”.48

45 Estimated impacts of energy and climate change policies on energy prices and bills, op cit.

46 Ev 17

47 DECC, Estimated impacts of energy and climate change policies on energy prices and bills, November 2011, (www.decc.gov.uk/assets/decc/11/about-us/economics-social-research/3593-estimated-impacts-of-our-policies-on-energy-prices.pdf).

48 Q 29


Figure 4: Cost of fuel for a range of customers, second quarter 2012

Type of customer Electricity, pence/kWh Gas, pence/kWh

Small industry 9.1 3.4

Medium industry 8.3 2.5

Large industry 6.5 2.2

Domestic 13.7 4.0 Notes: Prices are rounded to one decimal place. Prices exclude the Climate Change Levy. Great Britain only. Prices are shown for various sizes of consumers, defined in terms of the approximate annual purchases by the consumers purchasing them, see methodology pages of DECC quarterly energy prices. Domestic prices are the averaged price over the 2011 calendar year for all households.

Source: Tables 2.2.3, 2.3.3 & 3.1.2, Quarterly Energy Prices, DECC, September 2012, (www.decc.gov.uk/en/content/cms/statistics/publications/prices/prices.aspx).

23. The TUC argued that many energy intensive industries, especially SMEs, were “not in a position to negotiate significantly lower prices”.49 The Government wanted to help energy intensives form long-term collective buying arrangements with electricity suppliers to get better prices, although it could not be part of the commercial negotiations.50 In France the ‘Exeltium’ agreement was reducing the prices that energy intensive businesses faced there and providing certainty of demand for electricity suppliers’ long-term investments.51 Consortiums of energy intensive industries may potentially allow lower electricity prices to be agreed with electricity suppliers through bulk-purchasing agreements, and thereby offset some of their indirect electricity costs. The Government should help energy intensive industries, possibly through the Green Economy Council, to form consortiums for bulk-purchasing energy, and thereby reduce their costs and potentially the compensation that the Government would pay.

Spending envelope

24. Of the £250 million earmarked for the compensation scheme, £110 million for the Carbon Price Floor part of the scheme will be found from an under-spend on DECC’s existing budget. In correspondence with the Committee, Greg Barker MP clarified in February 2012 that this “came from an under-spend in this financial year [2011–12] and not from DECC’s future budget”.52 The 2011 Autumn Statement reported that £100 million of Treasury and BIS savings in 2013–14 and 2014–15 will fund the Emissions Trading System part of the scheme.53 The compensation package only covers the Spending Review period up to 2014–15, after which point a new compensation scheme and spending envelope will need to be agreed to avoid a ‘fiscal cliff’. The Mineral Products Association

49 Ev 22

50 Q 64 [Niall Mackenzie]

51 Q 47; INEOS ChlorVinyls believed that “Exeltium is an innovative special purpose vehicle that delivers investment in low-carbon energy through establishing long-term supply contracts between producers and consumers of energy. This offers energy intensive industries competitive long-term prices, and promotes the transition to the green economy without imposing punitive taxes on business”: Ev 39

52 Unpublished correspondence.

53 £35 million of the remaining £40 million is the cost of extending the Climate Change Agreement relief: HM Treasury, Autumn Statement 2011, Cm 8231, November 2011, table 2.1 (http://cdn.hm-treasury.gov.uk/autumn_statement.pdf).


wanted to see the Government commit immediately to a second phase compensation scheme so as not to disadvantage UK companies beyond 2014–15.54

25. The Minister told us that the Government calculated the spending envelope for the scheme through modelling and working within the bounds of European Commission rules. He told us that “it was an estimate and we may be right or we may be wrong but we think it should be roughly there”.55 The Government thought that any new sectors identified through the consultation as at risk of carbon leakage could be “accommodated within the £250 million ceiling”.56 The TUC was critical of how the spending envelope was determined, which it thought reflected a “Treasury-led control cap” rather than an “objective review on industries’ cumulative costs and how best to alleviate them”.57 Some of our witnesses believed that the spending envelope was too small and would not address all indirect costs:

• The TUC and Energy Intensive Users’ Group estimated that the package would cover one twentieth of industries’ indirect and direct costs of the ETS and Carbon Price Floor.58 Compared to other countries, the scale of support was “not sufficient”.59

• The British Ceramic Confederation believed that there should not be a cap at all because the compensation scheme should return new taxation to those affected as “a self-balancing mechanism”.60

• INEOS ChlorVinyls believed the compensation package only offered a “fraction of the compensation our competitors will receive for the ETS in other countries and will only provide partial compensation for the Carbon Price Floor which our competitors do not face at all”.61

26. The Government should be ready to reduce or increase the budget cap available for compensating energy intensive industries for the indirect costs of the Emissions Trading System and Carbon Price Floor in light of actual cost data identified in compensation claims. To facilitate scrutiny by Parliament, the Government should provide a statement to the House on the budgetary position of the scheme after the first year of operation, including projections of expected outturn.

International comparisons

27. Some witnesses wanted a comparison of compensation for energy intensive industries in competitor countries to help determine whether the UK Government was providing

54 Ev 32

55 Q 47

56 Q 48

57 Ev 22

58 TUC and Energy Intensive Users’ Group, The Cumulative Impact of Climate Change on UK Energy Intensive Industries—Are Policies Effectively Focussed, July 2010 (www.tuc.org.uk/extras/wwastudy.pdf ).

59 Q 22 [Philip Pearson]

60 Ev 44

61 Ev 39


adequate support.62 Laura Cohen from the British Ceramic Confederation called for a level playing field with the main competitors in Europe.63 The TUC believed that support from the UK Government was “highly inadequate relative to the support given to energy intensive industries in other countries”.64 It had recently produced a report looking at the compensation given to energy intensive industries in Germany which were largely exempt from paying a renewable energy surcharge on electricity and other electricity taxes, amounting to £9 billion per year (Figure 5). However, these exemptions were paid for by increases in household and small business electricity bills (Figure 6). The TUC believed “compensation in Germany is evidently an integral, long-term and substantial part of the [German] Government’s energy and industry strategy”.65 We note, however, that a comparison with the UK is hampered because the compensation identified in Germany was for only direct costs.66 Figure 5: Total support for Energy Intensive Industries in Germany 2010-2013 (Euros, millions)

2010 2011 2012 2013 Ecotax (Okostuer) 5,740 4,730 5,110 d/k

CHP bonus allocation 40 4 20 d/k Special compensation rule, section 40 ff. of the German Renewable Energies

Act (EEG)

1,125 2,080 2,315 2,500-3,200

Certificate allocation 1,643 1,408 1,408 d/k Energy & climate funds - - - 500 Network fee exemption 43 d/k 319 d/k

Industry levy - - 12 d/k Total relief 8,591 8,223 9,185 d/k

Source: TUC submission

Figure 6: Energy-intensive industries in Germany A report by WWF Germany in September 2012 found that a third of the increase in the price of electricity in Germany was accounted for by a renewable energy surcharge (EEG).67 The remaining two-thirds came from energy procurement costs, cost of sales and energy companies’ profit margins. In Germany, 48 per cent of demand for electricity comes from energy-intensive industries but these are largely exempt from the EEG, which along with other reductions in electricity taxes and grid charges and federal subsidies, amount to a benefit of 9 billion Euros. Of the 14 billion raised annually by the EEG, energy-intensive industry contribute 37 million Euros (major industry and bulk customers, SMEs and small scale service industry and private households pay 4.5 billion Euros each per annum). WWF Germany believed that “ever increasing privileges for energy-intensive industry have pushed the EEG surcharge for other consumers up sharply” because “if increasing loads have to be borne by a dwindling number of shoulders, it is individuals and household customers who will end up having to carrying more and more of the weight”.68 Source: Myths and facts about the role of renewable energies in Germany’s “Energy Transition”, WWF Germany, September 2012.

62 Q 22 [Jeremy Nicholson and Philip Pearson]

63 Q 24


65 Ev 22

66 Ev 59

67 Renewable Energy Sources Act, Germany (EEG)

68 Myths and facts about the role of renewable energies in Germany’s “Energy Transition”, WWF Germany, September 2012 (www.wwf.de/fileadmin/fm-wwf/Publikationen-PDF/Myths_and_facts_about_Germany_s_energy_transition.pdf).


28. The Government had commissioned its own research to understand the comparative policy frameworks in particular countries.69 This showed that in the UK the ‘base’ price of electricity for energy intensive businesses was higher than in Germany but lower than in Italy and Denmark (Figure 7). Energy taxes in some other EU member states were relatively low due to “significant re-imbursements that are possible” (Figure 8).70 Paul Drabwell from BIS told us “that is why Germany looks much more favourable”.71

Figure 7: Base electricity price and indicative incremental impacts in 2011 on electricity price of energy and climate change policies (£/MWh, 2010 prices)

Source: An international comparison of energy and climate change policies impacting energy intensive industries in selected countries, ICF International for the Department of Energy and Climate Change, July 2012.

29. Electricity costs for UK energy intensive industries are higher than those in some EU countries, but lower than others. In considering whether UK firms have a level playing field, further research would be needed to establish whether particular countries provide subsidies or tax reimbursements beyond those linked to the EU Emissions Trading System. The Government should monitor development of compensation schemes for indirect energy and climate change policy costs in other EU member states for signs of competitive disadvantage. It should review the case for a UK compensation scheme beyond 2014-15 using such data, taking account of aggregate

69 Sectors examined were iron and steel, aluminium, cement, chemicals (Chlor alkali, fertiliser and industrial gases).

Countries include were China, India, Japan, Russia, Turkey, US, Denmark, France, Germany, Italy and the UK.

70 ICF International for the Department of Energy and Climate Change, An international comparison of energy and climate change policies impacting energy intensive industries in selected countries, July 2012 (www.bis.gov.uk/assets/biscore/business-sectors/docs/i/12-527-international-policies-impacting-energy-intensive-industries.pdf).

71 Q 44

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Other ET - Energy taxes RE - Renewable energy policy e.g. RO and EMREE - Energy efficiency policy measures GHG - GHG policy measures e.g. EU ETS and CPF Base


subsidies and disbursements in other countries beyond those linked to the EU Emissions Trading System.

Figure 8: Indicative incremental impacts in 2011, 2015 and 2020 on electricity price of energy and climate change policies (£/MWh, 2010 prices)

Source: An international comparison of energy and climate change policies impacting energy intensive industries in selected countries, ICF International for the Department of Energy and Climate Change, July 2012.

Fairness

30. On 29 November 2012, the Government presented the Energy Bill to Parliament. The Secretary of State for Energy and Climate Change announced the Government’s intention to “exempt energy intensive industries from additional costs arising from new electricity market arrangements”.72 The BIS Minister told us that the exemption from electricity market reform costs and the compensation package would together “remove about 50% of policy costs by 2020”, which “would certainly bring the costs in line with other countries.73 The Minister told us that the Government had not yet assessed the impact of the exemption on household energy bills, but he thought it would be “relatively small”.74

72 DECC, Press Notice - Energy Intensive Industries to be exempt from new low carbon costs, 29 November 2012

(www.decc.gov.uk/en/content/cms/news/pn12_149/pn12_149.aspx).

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Other ET - Energy taxes RE - Renewable energy policy e.g. RO and EMR

EE - Energy efficiency policy measures GHG - GHG policy measures e.g. EU ETS and CPF Net impact


31. The Government had sought to fund some energy policies through general taxation, rather than a levy on bills, in order to manage the impact on energy bills.75 New arrangements for DECC’s levy-funding Spending Control Framework have also been set out.76 Nevertheless, fuel price rises have been the biggest driver in an increase in fuel poverty, up from 4 million people in 2011 to 5 million in 2012.77 National Energy Action was concerned that low income vulnerable consumers “may end up picking up the tab” for energy intensive industries as a result of the electricity market reform exemption.78 Imposing costs of policies through energy bills was “regressive” because the poor spend disproportionately more of their income on energy bills and because of the way that these costs are passed onto consumers.79 Jeremy Nicholson saw a need for debate on the “equitable balance” between taxpayers and consumers paying for the exemptions.80

32. The Fuel Poverty Advisory Group for England saw a “significant inequity” in that the Government would “seek to protect energy intensive industries’ fuel bills” from energy policy but would “not do something similar to protect the most financially disadvantaged energy consumer”.81 Existing Government schemes such as the Green Deal, Energy Company Obligation, Warm Home Discount and Winter Fuel Payments were seen as a “series of disparate, incremental initiatives” that do not benefit all those in fuel poverty.82 In taking forward the electricity market reform cost exemption for energy intensive industries, the Government stated that it would “establish a framework to ensure that the costs to other consumers are minimised”.83

33. We recommend that the Government publish at the earliest opportunity its assessment of the impact on electricity bills, and the effect on other companies of having to pay additional levies, of its proposal to exempt energy intensive industries from the costs of electricity market reform.

Taking account of surplus European Union Allowances

34. Sandbag believed that large energy intensive industries have benefited financially from the Emission Trading System. It claimed that “overly optimistic forecasts of growth and fierce lobbying by heavy industry” had resulted in 240 million surplus emissions allowances in Phase II of the EU ETS, with a value of 4.1 billion Euros being available to be

75 The Renewable Heat Incentive will be funded through general taxation rather than a levy on fossil fuel suppliers.

Carbon Capture and Storage commitments will be funded through Contract for Differences rather than a specific levy. A saving of £40 million in 2014/15 on spending and new tariffs and eligibility criteria for small scale Feed-in Tariffs. [DECC, Estimated impacts of energy and climate change policies on energy prices and bills, November 2011, (www.decc.gov.uk/assets/decc/11/about-us/economics-social-research/3593-estimated-impacts-of-our-policies-on-energy-prices.pdf).]

76 DECC, Annual Energy Statement 2012, November 2012 (www.decc.gov.uk/assets/decc/11/meeting-energy-demand/annual-energy-statement/7086-annual-energy-statement-2012.pdf).

77 Ev 56

78 Ev 54

79 Ev 56

80 Q 30

81 Ev 56

82 Ev 54

83 DECC, Press Notice—Energy Intensive Industries to be exempt from new low carbon costs, 29 November 2012 (www.decc.gov.uk/en/content/cms/news/pn12_149/pn12_149.aspx).


carried over to Phase III (2013–2020). Sandbag estimated that although the free allowances granted in Phase III to heavy industry would be tightened, this carry-over of surplus allowances would mean that it was likely that those companies which had accumulated the most allowances would not need to make any reductions in their emissions until after 2020. The majority of industrial sectors were found to have a surplus of allowances, with the iron and steel and cement sectors having the largest.84 Sandbag considered that Tata Steel had double the allowances they needed, worth more than the compensation scheme itself.85 From a review of companies’ annual reports, Sandbag calculated that 1.8 billion Euros of revenue was raised from sales of surplus allowances by companies in these industrial sectors.86 These surpluses were in contrast to the power sector which was facing a deficit (and having to purchase allowances).87

35. Damien Morris from Sandbag believed that by not taking into account these surplus allowances the Government was in “jeopardy of pouring good money after bad” and that the compensation scheme was an “excellent opportunity to limit that”. Compensation could be withheld until the value of the surplus allowances was surpassed, though taking care to recognise where surplus allowances had been earned through energy efficiency.88 Gareth Stace of EEF considered that some companies had sold allowances “in part to keep themselves afloat”: the steel sector was “suffering in economic terms very badly”.89

36. The Government acknowledged that “most UK and EU energy intensive industries have built up a surplus of allowances in Phase II (34% more free allowances were allocated to these UK industries in 2008–10 compared to their emissions)” and that this surplus would “remain significant” to 2020.90 Niall Mackenzie from DECC highlighted, however, that the allowances could reduce their direct emissions costs, not their indirect costs. Using allowances to reduce indirect costs “would be taking away property rights that these companies legitimately have for these allowances” and “runs the risk of being very unfair and arbitrary in trying to make the link between electricity use and direct emissions”.91 The Minister told us that care was needed “to distinguish if they are profiting” or if their surplus allowances were due to “their own carbon reduction efforts”.92

37. It is nonsensical that the Government will compensate energy intensive companies for the impact of the Emissions Trading System on their electricity bills when those companies are making windfall profits from the very same programme. We do not accept the Government’s argument that it is not appropriate to offset the benefit of

84 Sandbag, Carbon Fat Cats 2011–The Companies profiting from the EU Emissions Trading Scheme, June 2011

(www.sandbag.org.uk/site_media/pdfs/reports/Sandbag_2011-06_fatcats.pdf).

85 Q 14

86 Sandbag, Losing the lead? Europe’s flagging carbon market, June 2012 (www.sandbag.org.uk/site_media/pdfs/reports/Losing_the_lead_modified_3.8.2012.pdf).

87 Carbon Fat Cats 2011–The Companies profiting from the EU Emissions Trading Scheme, op cit.

88 Q 14

89 Q 37


91 Q 54

92 Qq 54-59


surplus emissions allowances against the compensation due on their bills. The Government must restrict the compensation payable for those companies who have financially benefited from the EU ETS by selling surplus European Union Allowances, by reducing the compensation payable by the same amount.

Eligibility

38. The Government aims to “target compensation at those business sites which are most at risk” through the scheme’s eligibility and aid criteria.93 Reflecting the difficulty in collecting data from energy intensive industries, the Government is proposing that eligibility should be determined at a company, rather than industrial process, level. There are slightly different eligibility rules for the Emissions Trading System and Carbon Price Floor parts of the compensation package.

39. The Government proposes that in order to be eligible for the EU ETS part of the compensation package, a company must be within one of the 13 sectors and 2 sub-sectors identified by the European Commission as at risk from carbon leakage from indirect energy costs. In determining these sectors the Commission applied thresholds for the size of a sector’s carbon cost as a percentage of overall costs, and also for its ‘trade intensity’. 94 The UK Government is proposing that in addition, to strip-out companies in these sectors which are much less electro-intensive than the norm, eligibility would be limited to companies with a carbon cost (EU ETS and Carbon Price Floor) in 2020 of 5% or more of their Gross Value Added.95 Damien Morris from Sandbag believed that these criteria were based on an “obsolete” carbon price expectation of 30 Euros per tonne of CO₂, which meant that they would “multiply the companies” that would be eligible.96 Also, our witnesses were surprised that the UK Government’s eligibility criteria did not also include ‘trade intensity’.97

40. Simon Bullock from Friends of the Earth favoured incorporating an “additional energy efficiency” requirement for compensation, as the German Government had recently introduced.98 Niall Mackenzie from DECC rejected this idea. He told us that the UK compensation scheme aimed to reimburse costs incurred by energy intensive businesses and was “not a grant or free money”. Companies had already signed up to make energy efficiency improvements in Climate Change Agreements, so the Government did not “see it as necessary to put extra burdens on companies”.99




95 Gross Value Added Is calculated as “earnings before interest, taxes, depreciation and amortisation (EBITDA) plus staff costs (including employer’s pension and national insurance contributions)”. GVA is in real terms and calculated by adjusting nominal GVA using HMT’s GDP deflator.

96 Q 4

97 Qq 1, 8 [Simon Bullock], Q 9 [Alex Kazaglis]; Ev 59

98 Q 10

99 Qq 60, 61


41. For the Carbon Price Floor part of the scheme, the Government proposes that the company must be in one of the sectors identified by the European Commission because “the close analogy between how ETS and Carbon Price Floor costs affect businesses” makes this a “reasonable approach”. However, to reflect any effects on UK companies’ competitiveness in Europe as a result of the Carbon Price Floor, the Government proposes to be ready to seek approval from the Commission to also compensate specific companies in other sectors for the indirect costs of the Carbon Price Floor. It would do so if quantitative “firm evidence in favour of eligibility” could be provided by those companies that their carbon costs (EU ETS and CPF) in 2020 will amount to at least 5% of their Gross Value Added and that their products were “significantly traded within or beyond Europe or that imports would become more economically viable as a result of increased carbon costs”.100

42. The TUC believed that by following the Commission’s guidance on eligibility for the Carbon Price Floor part of the compensation scheme the Government was excluding companies in other electro-intensive industries “identified by the Treasury as exposed to the Carbon Price Floor”.101 Similarly, the Mineral Products Association believed that linking eligibility to the EU ETS “was a disappointing development which leaves vulnerable sectors such as cement and lime disadvantaged”.102 Ceramics are not on the Commission’s list of those sectors facing carbon leakage. The British Ceramic Confederation believed that some ceramic installations “must surely be amongst electro-intensive in Europe”.103 The Minister told us that the Government was looking again at whether particular parts of the ceramic sector were electro-intensive and would therefore come within the scope of the compensation scheme. He told us that the Government was also looking at other ways of helping the ceramic industry, noting that it had considered bids from ceramics companies to the Regional Growth Fund and that Stoke-on-Trent/Staffordshire was a candidate for the second wave of City Deals.104

43. ‘Trade intensity’ is a key factor in the risk of carbon leakage, but the additional eligibility rules proposed by the Government for the Emissions Trading System part of the compensation scheme do not take this into account. For consistency with the compensation principles set out by the European Commission, the Government should seek to ensure that this trade intensity factor is better reflected in its eligibility rules for compensation. Businesses in sectors deemed to be at risk of carbon leakage from indirect carbon costs of the Emissions Trading System should be required to demonstrate that they are ‘trade intensive’ as well as facing significant carbon costs. Similarly, in considering the trade intensity of businesses for compensation for the Carbon Price Floor, the Government should apply a trade intensity ratio consistent with that applied by the European Commission in its guidelines on compensation for indirect costs.



101 Ev 22

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44. We welcome the Minister’s commitment to consider the eligibility of sub-sectors of the ceramic industry for the compensation scheme. We urge the Government to engage with that sector and its representative bodies, including the British Ceramic Confederation, to collect the data needed to demonstrate eligibility for compensation. That data should also be used to help develop wider policies aimed at strengthening UK business and delivering growth. We explore the need for a longer term strategy for energy intensive industries in Part 3.

Methodology for calculating compensation

45. Protection against the risk of carbon leakage could be provided in theory in a number of ways, not just by providing exemptions from costs but also by encouraging greater energy efficiency or switching to renewable fuels. Alex Kazaglis from the Committee on Climate Change highlighted the need for an assessment of such different routes and their scope on a sector by sector basis.105 Investigation was also needed on the best way to distribute compensation because using cuts to payroll taxes or national insurance might be “more likely to prevent leakage” than a one-off lump sum.106 The Minister told us that there were “limited options” for structuring compensation.107 The ‘type’ of compensation that the Government was permitted to provide was limited by the European Commission to ‘operating aid’ (relieving beneficiaries of day to day costs that form part of their operations).108

46. Any compensation scheme that constitutes ‘State Aid’ can only start once State Aid approval has been secured from the European Commission. The Government put a pre-notification to the Commission in October 2012 and final approval was expected “by summer of 2013” and “shortly after businesses begin to face the indirect costs from the EU ETS and Carbon Price Floor”.109

47. The Government proposes that companies calculate the maximum compensation they can claim for the indirect costs of the Emissions Trading System and the Carbon Price Floor separately, although following a similar calculation.110 The Commission has set out guidelines to be followed for the ETS part of the scheme.111 The guidelines require interpretation and require policy decisions from member states on sector eligibility, ‘aid intensity’ (paragraph 48), CO₂ ‘emissions factor’ (paragraph 49) and efficiency benchmarks (paragraph 50), which we explore below. The Government proposes following the European Commission’s approach when devising the compensation scheme for the indirect cost of the Carbon Price Floor because the Commission had “undertaken

105 Q 5 [Alex Kazaglis]

106 Q 5 [Dimitri Zenghelis]

107 Q 60


109 Ev 17

110 Compensation for the indirect costs of EU ETS and Carbon Price Support – Consultation on scheme eligibility & design, op cit.

111 Following application of quantitative and qualitative criteria in the areas of trade intensity and cost impact measures. See page 13 of consultation document.


considerable analysis to support its approach”, and this would “minimise administrative burdens” from administering two separate schemes.112 If the methodology were “to be any different” it would be “very difficult to get State Aid” clearance.113

48. The compensation is effectively a rebate for only a proportion of electricity costs because under EU Commission rules State Aid must not cover all costs and must reduce over time (‘degressive’).114 Consequently, in the calculation the Commission’s ‘aid intensity’ variable will be used to taper the maximum amount of compensation that can be paid: starting with a maximum of 85% of the eligible cost increase in 2013, 2014 and 2015, 80% in 2016 through to 2018 and 75% of eligible cost in 2019 and 2020. The Government’s scheme reflects the Commission’s model.

49. The European Commission has determined that the calculation of compensation must include a ‘CO₂ emissions factor’. This factor is set by the Commission for each member state with reference to the carbon content of electricity generation to ensure that aid “is proportionate and that it maintains the incentives for electricity efficiency”.115 The UK Government disagrees with the 0.58 emission factor arrived at by the Commission because it “does not reflect the carbon intensity of electricity price faced by energy intensive industries in the UK, which is driven by the marginal producer (deemed to be gas) and not the average producer”, and proposes using a lower factor of 0.411 instead. Using this lower factor would mean that companies in the UK would receive less compensation than the Commission would technically allow. Jeremy Nicholson from the Energy Intensive Users’ Group “strongly suspected” that the reason for this choice was that “there is not enough money to go around”.116 Others raised concerns that the Government was disadvantaging UK companies by not following the Commission’s factor:

• The British Ceramic Confederation cited other EU countries, such as Germany and the Netherlands, which they said were planning to compensate their energy intensive industries to the maximum allowed by the Commission, and called on the UK Government to “do the same to preserve a level industrial playing field”.117

• EEF and UK Steel believed that this would put them at a disadvantage compared to other member states “which is not the aim of the scheme”.118

• INEOS ChlorVinyls stated that the proposed factor for the UK was lower than for “most competitors in the EU, such as Germany (0.76) and France (0.76)” meaning that even if the UK gave the maximum permitted, UK companies “would still receive significantly less compensation” than European counterparts. It believed that once

112 Compensation for the indirect costs of EU ETS and Carbon Price Support—Consultation on scheme eligibility &

design, op cit.

113 Q 50

114 Impact Assessment Report accompanying Guidelines on certain State aid measures in the context of Greenhouse Gas Emission Allowance Trading Scheme, op cit.


116 Q 26

117 Ev 44

118 Ev 47


combined with the UK’s choice of a lower emissions factor, UK businesses would receive half the level of compensation paid in Germany, France and Belgium.119

• The Mineral Products Association believed that the Government’s justification for using the lower factor was “weak” as the costs actually faced by electricity users would be the “worst case generation fuel mix” and not that implicit in the chosen emissions factor.120

Paul Drabwell from BIS accepted that there were arguments to counter the Government’s approach and that it “was listening” to these.121

50. The Commission’s guidelines also require ‘efficiency benchmarks’ to be used in the calculation of compensation to ensure that compensation takes account of the energy efficiency of specific manufacturing processes. The Commission had set out benchmarks for specific energy intensive products within eligible sectors122 but there would be a ‘default’ value where data limitations prevented a benchmark being calculated (set at 75%). The Government propose using these benchmarks for the EU ETS part of the compensation scheme, but not for the Carbon Price Floor part, because the application of benchmarks could “increase distortion between costs in the UK and the rest of Europe”. EEF and UK Steel believed that the benchmarks “will for many processes be arbitrary”.123

51. The overall calculation of compensation is complex and the Government has not yet set out details of how it expects information will be submitted, audited and verified, and which organisation will administer the compensation scheme.124 Paul Drabwell from BIS told us however that the Government had tested the scheme with a number of companies.125

52. INEOS ChlorVinyls believed that “the current threshold for eligibility is quite low” and the Government is proposing compensating all qualifying companies for the same proportion of their costs. With a limited Government spending envelope it recommended that a ‘banded approach’ be used where the proportion of compensation corresponds to exposure to relative energy costs.126 The Mineral Products Association wanted to see the Government tackling the “perverse incentive that the least energy efficient businesses qualify more easily than those that are more efficient”.127 EEF similarly did not want to see the scheme “diluted” with more sectors compensated with smaller amounts. In a different vein, the British Ceramic Confederation wanted to see flexibility between the budget for the Carbon Price Floor and EU ETS parts:

119 Ev 39

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122 Based on the top 10% most efficient process for manufacturing that specific product.

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125 Q 50

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At present more is allocated to EU ETS compensation, even though both the current price of carbon and the number of companies/processes the fund would be distributed over is lower than for the Carbon Price Floor fund. This introduces even more distortion for electro-intensive processes (such as those in ceramics) outside sectors previously deemed eligible for EU ETS compensation.128

53. The compensation scheme being proposed by the Government has been closely modelled on the calculations and eligibility criteria issued by the European Commission, to ease the State Aid approval process for the scheme. In some areas, however, the Government has applied elements of the Commission’s calculation in a potentially more stringent way than some other countries might be doing. The Government should review the operation of the compensation scheme after its first year, to ensure that it remains reasonable in view of the costs actually being incurred by energy intensive industries and does not put UK businesses at a competitive disadvantage.

128 Ev 44


3 Transition to a green economy 54. Energy intensive industries account for 4% of Gross Value Added in the UK.129 They are often located in ‘clusters’ and employ 125,000 people or 2% of the UK work force, with perhaps four times that number working in their supply chains.130 Many energy intensive industries are located in areas of higher unemployment and so the Government see their continued operation as “vital to the economies of those regions” with “foregone jobs often difficult to replace”.131 Data from the TUC and Energy Intensive Users’ Group suggested that these industries had declined by 7% in employment between 2008 and 2011, and by 9% in turnover.132

55. However, the CBI believed that a transition to a low carbon economy would depend on products produced by these industries. New power plants, wind turbines, low-emission cars, higher-efficiency home appliances, insulation and machinery all required energy intensive materials such as steel, cement, rubber, chemicals, glass and ceramics.133 This view was shared by the Government.134 INEOS ChlorVinyls believed that energy intensive products saved emissions, estimating that for every tonne of CO₂ emitted by the chemicals industry over two tonnes were saved downstream from its products.135

56. The TUC and Energy Intensive Users’ Group believed that without energy intensive industries in the UK, “their products would need to be transported, often great distances, to serve UK demand”, resulting in a “loss of UK jobs, output and tax revenues”.136 The Government saw these industries “as critical to growth of the economy” and contemplated “no advantage, both for the UK economy and in terms of global emissions reductions, in simply forcing UK businesses to relocate to other countries”. It wanted to see energy intensive industries remain competitive and the UK remaining an attractive location for them.137

57. Nevertheless, to avoid dangerous climate change all sectors of the economy will need to transition to a low carbon economy, including energy intensive industries.138 The 55 million tonnes of industrial CO₂ emissions each year accounted for 66% of all UK industry

129 Based on 2008 data: DECC, Estimated impacts of energy and climate change policies on energy prices and bills,

November 2011, (www.decc.gov.uk/assets/decc/11/about-us/economics-social-research/3593-estimated-impacts-of-our-policies-on-energy-prices.pdf).

130 Friends of the Earth, Energy-intensive industry and climate change, September 2011 (www.foe.co.uk/resource/briefings/energy_intensive_industry.pdf), TUC and Energy Intensive Users Group, Building our low-carbon industries, June 2012 (www.tuc.org.uk/tucfiles/352/Buildingourlowcarboninds.pdf), CBI, Protecting the UK’s foundations: A blueprint for energy-intensive industries, August 2011 (www.cbi.org.uk/media/1057969/cbi_eii_report_0811.pdf).

131 Ev 17

132 Building our low-carbon industries, op cit.

133 Protecting the UK’s foundations: A blueprint for energy-intensive industries, op cit.

134 Ev 17

135 Ev 39


137 Ev 17

138 Environmental Audit Committee, Twelfth Report of Session 2010---12, A Green Economy, HC 1025 (www.publications.parliament.uk/pa/cm201012/cmselect/cmenvaud/1025/1025.pdf).


emissions and a tenth of the UK’s total emissions, but such emissions were concentrated in a small number of energy intensive industries. 139

58. To reduce the carbon costs of energy intensive industries, and thereby reduce the imperative to compensate them for some of those costs, action would be needed on at least two fronts, which we discuss below: decarbonising their operations, and decarbonising the sources of their energy.

Decarbonising the energy intensive industries

59. Dimitri Zenghelis believed that strong carbon tariffs now could produce industries in a “much better competitive position in 10 years time”, with lower costs and improved energy efficiency.140 In a similar vein, Friends of the Earth considered that measures that cut the price of carbon were “counter-productive” as they would make it less likely that energy-intensive users would invest in low carbon technology and energy efficiency.141 EEF and UK Steel, on the other hand, believed that providing compensation would not impact on incentives because energy intensive industries were already subject to a “multitude of other climate change related costs” in addition to energy and raw material costs which were driving efficiency and emissions reductions.142 The Government too believed that incentives were “already strong for many energy intensive industries”, and because companies would not be fully compensated for all their indirect energy costs “there remains a further incentive for firms to continue to examine ways to become more energy efficient”.143

Energy efficiency

60. The UK has the sixth lowest energy intensive economy in Europe.144 The Government estimated that in the last 10 years energy intensity had fallen by 27% in the UK compared to 14% in France, 16% in Japan and the US and 20% in Germany. Overall, energy intensity in the ‘industrial sector’ had improved by 45% since 1980, with the largest contribution from the chemicals industries (a 79% reduction since 1980). Nevertheless, the chemicals, iron and steel and cement sectors were still more energy intensive than the European average.145


140 Grantham Institute on Climate Change and the Environment, The Basic economics of low-carbon growth in the UK, June 2011 (www2.lse.ac.uk/GranthamInstitute/publications/Policy/docs/PB_economics-low-carbon-growth_Jun11.pdf).

141 Energy-intensive industry and climate change, op cit.

142 Ev 47


144 Energy intensity is measured as primary energy consumption per unit of GDP. DECC, European Energy Efficiency: Analysis of ODYSSEE indicators, February 2012 (www.odyssee-indicators.org/publications/PDF/Analysis-of-odyssee-indicators-2012.pdf).

145 DECC, Energy Efficiency Statistical Summary, November 2012 (www.decc.gov.uk/assets/decc/11/tackling-climate-change/saving-energy-co2/6928-the--energy-efficiency-strategy-statistical-strat.pdf).


61. There are fewer data available on energy efficiency measures or savings in industrial sectors than in the domestic sector.146 In setting out its Energy Efficiency Strategy in November 2012, the Government concluded that there was “significant energy efficiency potential” in the commercial and industrial sectors that were not already covered by existing energy efficiency policies.147 The Government saw industrial energy efficiency as “good for growth and good for competitiveness”.148 Longer-term investment in energy efficiency could “lead to a virtuous circle as innovation leads to cost reductions which can make it cheaper and easier to invest in energy efficiency in the future” and open up “increasingly significant export opportunities for the UK”.149 Through “socially cost-effective investment”,150 196 TWh of energy could be saved in 2020 (11% less than ‘business as usual’).151 Initiatives to improve energy efficiency in iron and steel, chemicals, cement and glass sectors, and industrial retrofit measures, accounted for only 14 TWh of that total, 152 which Alex Kazaglis from the Committee on Climate Change explained was only around 14% of the potential for energy efficiency by 2020. He believed there were “real barriers” to achieving more than that.153

62. The Energy Efficiency Strategy does not set out how sufficient capital would be made available to fund energy efficiency improvements. As energy intensive industries are frequently owned by large foreign companies, UK management will have to “compete internally over a limited pot of capital for additional investments”.154 One of the Green Investment Bank’s priorities, set by Government, is to facilitate industrial energy efficiency with £100 million earmarked for such investments.155

Reducing emissions

63. The European Commission have calculated that there is potential for energy intensive industries, and the wider industrial sector, to reduce emissions by up to 87% by 2050. That would require more advanced resource and energy efficient industrial processes and equipment, increased recycling and abatement technologies for non-CO2 emissions (e.g. nitrous oxide and methane). In addition, carbon capture and storage would also “need to be deployed on a broad scale after 2035”, notably to capture industrial process emissions in

146 ibid.

147 DECC, The Energy Efficiency Strategy: The Energy Efficiency Opportunity in the UK, November 2012 (www.decc.gov.uk/assets/decc/11/tackling-climate-change/saving-energy-co2/6927-energy-efficiency-strategy--the-energy-efficiency.pdf).

148 Ev 17

149 The Energy Efficiency Strategy: The Energy Efficiency Opportunity in the UK, op cit.

150 The Government defines socially-cost effective as encompassing the costs and benefits from the societal perspective and in line with the guidance set out in the Green Book and supplementary guidance.

151 “Equivalent to 22 power stations”: The Energy Efficiency Strategy: The Energy Efficiency Opportunity in the UK, op cit.

152 Committee analysis of Annex of Energy Efficiency strategy (page 83).

153 Q 6

154 Ev 17. (See also TUC and Energy Intensive Users Group, Building our low-carbon industries, June 2012 (www.tuc.org.uk/tucfiles/352/Buildingourlowcarboninds.pdf).

155 HM Government, Update on the design of the Green Investment Bank, August 2011 (www.bis.gov.uk/assets/biscore/business-sectors/docs/u/11-917-update-design-green-investment-bank).


the cement and steel sectors, entailing an annual investment of more than 10 billion Euros.156

64. However, the CBI believed that in the UK many energy intensive industries had already implemented the majority of CO2 abatement options available and that for some companies additional savings would only be possible through technology breakthroughs or innovation or through the replacement of production assets when they are due to be retired.157 The TUC and Energy Intensive Users’ Group believed that energy intensive industries in the UK use “some of the most advanced plants of their kind globally”.158 Gareth Stace from the EEF told us that moving away from tried and tested technology, such as electric arc furnaces, would require billions of pounds of investment that would not “happen unilaterally here in the UK or even the EU”: it required a “global solution”.159 EEF and UK Steel therefore called on Government to “place the role of innovation and technology at the heart of the low-carbon transition” of global energy intensive sectors.160

65. The Government is keen to work with industry to “see what more they can do” on innovation and technology “game changers”.161 The Government has commissioned a Technology Innovation Needs Assessment for the industrial sector to identify specific low carbon technologies needs, to inform the prioritisation of public sector investment. The Assessment estimated carbon abatement potential from innovative technologies to be 270-500 million tonnes of CO2, with a cost saving of £17-32 billion up to 2050. The energy intensive industries of chemicals, iron and steel and cement were identified as three of the four key industrial sectors requiring innovation support, reflecting their emissions abatement potential, their importance in the economy and their potential for public sector intervention.162 The Assessment indentified a number of technologies that “offered maximum benefit to the UK”, but which would require a significant increase in public sector funding to secure the necessary innovation.163 The British Ceramic Confederation and its European counterparts have identified a set of “breakthrough technologies” that they would like to be developed in a ‘sector roadmap’ (paragraph 72).164

Decarbonising their electricity supplies

66. Wholesale costs represent the largest proportion of retail gas and electricity prices for energy consumers, and 30% of electricity was generated from coal and 40% from gas in

156 European Commission, A Roadmap for moving to a competitive low carbon economy in 2050, May 2011 (http://eur-

lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2011:0112:FIN:EN:PDF).

157 Protecting the UK’s foundations: A blueprint for energy-intensive industries, op cit.


159 Q 31

160 Ev 47

161 Q 62

162 Food and Drink is the remaining industrial sector.

163 Low Carbon Innovation Coordination Group, Technology Innovation Needs Assessment for the Industrial Sector: summary report, November 2012 (www.lowcarboninnovation.co.uk/working_together/technology_focus_areas/industrial_sector/).

164 Q 32, www.ceramfed.co.uk/news/press-release-european-ceramic-industry-launches-2050-roadmap-paving-the-way-to-a-better-future/


2011.165 Global fossil fuel prices, not climate change policies, are therefore the main drivers of retail energy prices in the UK. DECC argued that sustained movements in international prices for fossil fuels would be a key factor influencing retail gas and electricity prices in the future.166 Electricity prices had moved with gas prices, which were in turn linked to the price of oil, and that link was not expected to loosen in the short-term.167 Friends of the Earth believed therefore that “staying on fossil fuels will leave the UK and our industry at the mercy of global energy markets”. They believed it was imperative that the UK get “off the fossil-fuel hook” and invest in energy efficiency and low-carbon technologies.168 This has been a recurring message from several of our recent reports.169

67. The Energy Bill introduces a new mechanism to fund low carbon generation. However, it stops short of introducing a decarbonisation target to ensure that the energy sector is “largely decarbonised by 2030”, as called for by the Committee on Climate Change.170 An Emissions Performance Standard, announced by DECC in November 2012, which would provide a “regulatory back-stop on the amount of emissions that a new fossil fuel power station can emit”, will not prevent the lock-in of emissions from new plant because it will be initially set higher than the current average carbon intensity of electricity plants.171 The Committee on Climate Change has warned that “extensive use of unabated gas-fired capacity (i.e. without carbon capture and storage technology) in 2030 and beyond would be incompatible with meeting legislated carbon budgets”.172

68. The Government believe, however, that gas “will continue to play a major role in our electricity mix over the coming decades” and that in “2030 we could need more overall gas capacity than we have today”.173 Alongside the Autumn Statement 2012, the Chancellor

165 DECC, Annual Energy Statement 2012, November 2012, (www.decc.gov.uk/assets/decc/11/meeting-energy-

demand/annual-energy-statement/7086-annual-energy-statement-2012.pdf).


167 In general, electricity prices had because in the GB wholesale electricity market, the marginal (price-setting) plant is “usually a gas generator, which can pass through any changes in gas or carbon prices to the electricity price”. The interconnection provided by pipelines links the UK with continental gas markets “where gas contracts are priced against the price of oil products” meaning that “a key factor to explain the increase in UK gas prices ... is the significant rise in oil prices”. The UK market’s exposure to oil-indexed pricing has intensified as UK Continental Shelf gas production has declined over time, and imports have grown as a share of total supplies. The Government expects the UK to become increasingly more dependent on imports and by 2025 we could be importing 60% of our oil and 68% of our gas (up from 17% and 35% respectively that is imported now). [Estimated impacts of energy and climate change policies on energy prices and bills, op cit].

168 Friends of the Earth, Energy-intensive industry and climate change, September 2011 (www.foe.co.uk/resource/briefings/energy_intensive_industry.pdf).

169 Environmental Audit Committee, Sixth Report of Session 2010-12, Budget 2011 and environmental taxes, HC 878, (www.publications.parliament.uk/pa/cm201012/cmselect/cmenvaud/878/878.pdf), Environmental Audit Committee, Seventh Report of Session 2010-12, Carbon budgets, HC 1080 (www.publications.parliament.uk/pa/cm201012/cmselect/cmenvaud/1080/1080.pdf), Environmental Audit Committee, Twelfth Report of Session 2010---12, A Green Economy, HC 1025 (www.publications.parliament.uk/pa/cm201012/cmselect/cmenvaud/1025/1025.pdf).

170 Annual Energy Statement 2012, op cit; Environmental Audit Committee, Fourth Report of Session 2012–13, Autumn Statement 2012: Environmental issues, HC 328 (www.publications.parliament.uk/pa/cm201213/cmselect/cmenvaud/328/328.pdf).

171 New EPS will be initially set at 450g CO2/kWh for all new fossil fuel plants, grandfathered until 2045, compared to the average carbon intensity of electricity generated in the UK in 2011 of 443gC02/kWh [Annual Energy Statement 2012, op cit].

172 Committee on Climate Change letter to the Energy Secretary dated 13 September 2012 (http://hmccc.s3.amazonaws.com/EMR%20letter%20-%20September%2012.pdf).

173 Annual Energy Statement 2012, op cit.


announced a Gas Generation Strategy. This included the future gas-powered electricity generating capacity implied by the decarbonisation ‘trajectory’ to 2030 previously advocated by the Committee on Climate Change, but only ‘two scenarios’ quantifying the number of gas-powered stations required—the first equivalent to the building of 30 new gas power stations, the second equivalent to 40.174 The Chief Executive of the Committee on Climate Change called the second scenario “completely incompatible” with its recommended decarbonisation trajectory and “not economically sensible”.175

69. Irrespective of the extent to which energy intensive industries might feasibly improve their own energy efficiency, current electricity market reform arrangements will not adequately decarbonise the generation of the electricity they use. Consequently, the indirect costs of the Emissions Trading System and Carbon Price Floor will continue to be significant burdens for energy intensive industries once the compensation scheme finishes.

An energy intensive industries strategy

70. Simon Bullock from Friends of the Earth believed that the Government should be looking at “how we help [energy intensive industries] make that transition [to a low carbon economy] rather than just shielding them from the costs of carbon and energy prices as they go forward”.176 The TUC, on the other hand, wanted a set of long term measures commensurate with the support given by other European countries”. It cited Germany as an example of where compensation was “an integral, long-term and substantial part of its energy and industry strategy”.177 Philip Pearson from the TUC advocated a “predictable long term decline in support” against which investment decisions could be made, rather than the “short-term piecemeal approach” represented in the current consultation package.178

71. INEOS ChlorVinyls believed that a long-term strategy for energy intensives could provide the necessary “investment climate to secure the future of energy intensive industries over the next couple of decades”.179 Similarly, EEF and UK Steel argued that longer term investment certainty from Government that “aligned with manufacturing companies’ investment cycles” would give manufacturers “robust assurance of the Government’s intention to commit to a solution for energy intensive industries in the longer term”.180 There were also calls for a long term manufacturing strategy to ensure that a “strong manufacturing sector stays at the heart of the UK economy”.181

174 HM Treasury, Autumn Statement 2012, Cm 8480, December 2012 (http://cdn.hm-

treasury.gov.uk/autumn_statement_2012_complete.pdf).

175 “Gas strategy should be plan Z government’s climate adviser warns”, The Guardian, 4 December 2012, (www.guardian.co.uk/environment/2012/dec/04/gas-strategy-plan-z-climate-adviser).

176 Q 5

177 Ev 22

178 Q 22

179 Ev 39

180 Ev 47

181 Ev 22


72. The CBI believed that “greater visibility and clarity of future steps” that were required to decarbonise energy-intensive industries would help encourage innovation and investment, principally through the development of “sector decarbonisation roadmaps”.182 This sector roadmap approach was also favoured by the European Commission.183 Such a ‘sectoral approach’ would identify policies designed around individual sectors, their locations and technologies to encourage energy efficiency improvements and stimulate investment in new technology.184

73. The Government announced in 2010 that it was developing an Energy Intensive Industries Strategy.185 In our current inquiry, Paul Drabwell from BIS told us that this work was still underway, but when complete would not necessarily be called an ‘Energy Intensive Strategy’.186 Currently BIS were “looking at roadmaps for energy efficiency in particular sectors”.187 The adequacy of such a strategy will hinge on cross-cutting working by Government to incorporate business policy, climate change, energy and environmental protection, to ensure that policy proposals are sustainable and consistent with the transition to a green economy.

74. Energy intensive industries are an important part of the economy and provide many of the components needed for a low carbon economy. They, like all other sectors of the economy, must decarbonise if we are to meet our emissions targets. The Government must not lock itself into subsidising these industries in the longer term without a clear plan for their maximum feasible decarbonisation. Barriers hampering this include the availability of innovative technologies and investment funding. The current compensation package does nothing to address these barriers.

75. We recommend that the Government sets out a strategy for energy intensive industries, as part of the wider manufacturing strategy needed to ensure that the UK retains a robust manufacturing sector, which should set a path for their maximum feasible decarbonisation and incorporating sector-specific roadmaps. Such a strategy should identify by how much energy intensive industries should be required to decarbonise and improve their energy efficiency and how the Government will help to ensure that this is achieved, including through energy consumption reduction measures and incentives, and support for innovation, technological research, development and investment. Such an analysis would allow a clear articulation of the feasible limits of decarbonisation over the medium and longer term, and thereby provide an assessment of the scale of future compensation requirements. At the same time the Government should set out the extent of the compensation that it is willing to pay in a longer term compensation budget.

182 CBI, Protecting the UK’s foundations: A blueprint for energy-intensive industries, August 2011

(www.cbi.org.uk/media/1057969/cbi_eii_report_0811.pdf).

183 European Commission, A Roadmap for moving to a competitive low carbon economy in 2050, May 2011 (http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2011:0112:FIN:EN:PDF).

184 Ev 47

185 The then Secretary of State for Energy and Climate Change Chris Huhne’s speech to the TUC Annual Climate Change Conference, October 2010 (www.decc.gov.uk/en/content/cms/news/tuc_chspeech/tuc_chspeech.aspx); The then Minister of State, Department for Business, Innovation and Skills Mark Prisk MP (HC Deb, 23 March 2011, Col 288WH).

186 Q 70

187 Q 67


76. An energy intensive industries’ strategy should not be limited to using piecemeal funding but look more broadly at the measures needed to help energy intensive industries develop in a sustainable way. Greater emphasis should be given by BIS to energy intensive industries and using existing mechanisms such as the Regional Growth Fund and City Deals to support those industries and their supply chains.


Conclusions

1. There continues to be a paucity of data to understand how the cost of electricity for energy intensive industries will affect them. Without reliable data on the risk of carbon leakage, it is impossible for the Government to demonstrate that its compensation package is proportionate. Getting the amount of compensation wrong risks creating further distortion and poor value for money for the taxpayer. Applications from companies for compensation will provide much needed data, but that will come too late to help design the current compensation package. (Paragraph 15)

2. Potentially higher carbon costs could be seen as part of a wider green taxation ‘shift’ if such increases are offset by decreases in other company taxes. It is the overall cost burden, rather than energy costs in isolation, that help determine the risk of carbon leakage. (Paragraph 17)

3. A major weakness of the compensation scheme is that the Government is not planning to take into account self-generation of electricity by energy intensive industries in determining the compensation due, which would therefore over-compensate them. (Paragraph 21)

4. Consortiums of energy intensive industries may potentially allow lower electricity prices to be agreed with electricity suppliers through bulk-purchasing agreements, and thereby offset some of their indirect electricity costs. (Paragraph 23)

5. Electricity costs for UK energy intensive industries are higher than those in some EU countries, but lower than others. In considering whether UK firms have a level playing field, further research would be needed to establish whether particular countries provide subsidies or tax reimbursements beyond those linked to the EU Emissions Trading System. (Paragraph 29)

6. It is nonsensical that the Government will compensate energy intensive companies for the impact of the Emissions Trading System on their electricity bills when those companies are making windfall profits from the very same programme. We do not accept the Government’s argument that it is not appropriate to offset the benefit of surplus emissions allowances against the compensation due on their bills. (Paragraph 37)

7. ‘Trade intensity’ is a key factor in the risk of carbon leakage, but the additional eligibility rules proposed by the Government for the Emissions Trading System part of the compensation scheme do not take this into account. (Paragraph 43)

8. The compensation scheme being proposed by the Government has been closely modelled on the calculations and eligibility criteria issued by the European Commission, to ease the State Aid approval process for the scheme. In some areas, however, the Government has applied elements of the Commission’s calculation in a potentially more stringent way than some other countries might be doing. (Paragraph 53)


9. Irrespective of the extent to which energy intensive industries might feasibly improve their own energy efficiency, current electricity market reform arrangements will not adequately decarbonise the generation of the electricity they use. Consequently, the indirect costs of the Emissions Trading System and Carbon Price Floor will continue to be significant burdens for energy intensive industries once the compensation scheme finishes. (Paragraph 69)

10. Energy intensive industries are an important part of the economy and provide many of the components needed for a low carbon economy. They, like all other sectors of the economy, must decarbonise if we are to meet our emissions targets. The Government must not lock itself into subsidising these industries in the longer term without a clear plan for their maximum feasible decarbonisation. Barriers hampering this include the availability of innovative technologies and investment funding. The current compensation package does nothing to address these barriers. (Paragraph 74)

Recommendations

11. We recommend that the Government require energy intensive industries to remove the cost of any self-generated electricity when calculating the sums due under the proposed compensation scheme. (Paragraph 21)

12. The Government should help energy intensive industries, possibly through the Green Economy Council, to form consortiums for bulk-purchasing energy, and thereby reduce their costs and potentially the compensation that the Government would pay. (Paragraph 23)

13. The Government should be ready to reduce or increase the budget cap available for compensating energy intensive industries for the indirect costs of the Emissions Trading System and Carbon Price Floor in light of actual cost data identified in compensation claims. To facilitate scrutiny by Parliament, the Government should provide a statement to the House on the budgetary position of the scheme after the first year of operation, including projections of expected outturn. (Paragraph 26)

14. The Government should monitor development of compensation schemes for indirect energy and climate change policy costs in other EU member states for signs of competitive disadvantage. It should review the case for a UK compensation scheme beyond 2014-15 using such data, taking account of aggregate subsidies and disbursements in other countries beyond those linked to the EU Emissions Trading System. (Paragraph 29)

15. We recommend that the Government publish at the earliest opportunity its assessment of the impact on electricity bills, and the effect on other companies of having to pay additional levies, of its proposal to exempt energy intensive industries from the costs of electricity market reform. (Paragraph 33)


16. The Government must restrict the compensation payable for those companies who have financially benefited from the EU Emissions Trading System by selling surplus European Union Allowances, by reducing the compensation payable by the same amount. (Paragraph 37)

17. For consistency with the compensation principles set out by the European Commission, the Government should seek to ensure that this trade intensity factor is better reflected in its eligibility rules for compensation. Businesses in sectors deemed to be at risk of carbon leakage from indirect carbon costs of the Emissions Trading System should be required to demonstrate that they are ‘trade intensive’ as well as facing significant carbon costs. Similarly, in considering the trade intensity of businesses for compensation for the Carbon Price Floor, the Government should apply a trade intensity ratio consistent with that applied by the European Commission in its guidelines on compensation for indirect costs. (Paragraph 43)

18. We welcome the Minister’s commitment to consider the eligibility of sub-sectors of the ceramic industry for the compensation scheme. We urge the Government to engage with that sector and its representative bodies, including the British Ceramic Confederation, to collect the data needed to demonstrate eligibility for compensation. That data should also be used to help develop wider policies aimed at strengthening UK business and delivering growth. (Paragraph 44)

19. The Government should review the operation of the compensation scheme after its first year, to ensure that it remains reasonable in view of the costs actually being incurred by energy intensive industries and does not put UK businesses at a competitive disadvantage. (Paragraph 53)

20. We recommend that the Government sets out a strategy for energy intensive industries, as part of the wider manufacturing strategy needed to ensure that the UK retains a robust manufacturing sector, which should set a path for their maximum feasible decarbonisation and incorporating sector-specific roadmaps. Such a strategy should identify by how much energy intensive industries should be required to decarbonise and improve their energy efficiency and how the Government will help to ensure that this is achieved, including through energy consumption reduction measures and incentives, and support for innovation, technological research, development and investment. Such an analysis would allow a clear articulation of the feasible limits of decarbonisation over the medium and longer term, and thereby provide an assessment of the scale of future compensation requirements. At the same time the Government should set out the extent of the compensation that it is willing to pay in a longer term compensation budget. (Paragraph 75)

21. An energy intensive industries’ strategy should not be limited to using piecemeal funding but look more broadly at the measures needed to help energy intensive industries develop in a sustainable way. Greater emphasis should be given by BIS to energy intensive industries and using existing mechanisms such as the Regional Growth Fund and City Deals to support those industries and their supply chains. (Paragraph 76)


22. In developing a dedicated strategy for energy intensive industries, the Government should identify the overall extent of cost burdens on companies and how they compare with competitive countries, along with how the mix of costs would be adjusted to help deliver the required overall increase in the proportion of tax made up of environmental taxes. (Paragraph 17)


Formal Minutes

Wednesday 19 December 2012

Members present:

Joan Walley, in the Chair

Neil Carmichael Mark Lazarowicz Caroline Lucas Caroline Nokes

Dr Matthew Offord Mr Mark Spencer Dr Alan Whitehead Simon Wright

Draft Report (Energy intensive industries compensation scheme), proposed by the Chair, brought up and read. Ordered, That the Draft Report be read a second time, paragraph by paragraph. Paragraphs 1 to 76 read and agreed to. Summary agreed to. Resolved, That the Report be the Sixth Report of the Committee to the House. Ordered, That the Chair make the Report to the House. Ordered, That embargoed copies of the Report be made available, in accordance with the provisions of Standing Order No. 134. Written evidence was ordered to be reported to the House for printing with the Report, in addition to that ordered to be reported for publishing on 28 November, and 4 and 12 December 2012.

* * *

[Adjourned till Wednesday 9 January 2013 at 2 pm


Witnesses

Tuesday 4 December 2012 Page

Damien Morris, Senior Policy Adviser, Sandbag; Dimitri Zenghelis, Senior Visiting Fellow, Grantham Research Institute on Climate Change, London School of Economics; Simon Bullock, Senior Campaigner, Policy and Research Unit, Friends of the Earth; and Alex Kazaglis, Senior Analyst, Energy Use in Buildings & Industry, Committee on Climate Change Secretariat. Ev 1

Dr Laura Cohen, Chief Executive, British Ceramic Confederation, Jeremy Nicholson, Director, Energy Intensive Users’ Group; Gareth Stace, Head of Climate & Environment Policy, EEF; and Philip Pearson, Senior Policy Officer, TUC. Ev 6

Rt Hon Michael Fallon MP, Minister of State for Business and Enterprise; Paul Drabwell, Head of Domestic Energy and Climate Change, Department for Business, Innovation and Skills; and Niall Mackenzie, Head of Industrial Energy Efficiency, Department of Energy and Climate Change. Ev 11

List of printed written evidence

1 Wood Panel Industries Federation Ev 17

2 The Government Ev 17

3 TUC Ev 22

4 Mineral Products Association Ev 32

5 INEOS ChlorVinyls Ev 39

6 EDF Energy Ev 42

7 British Ceramic Confederation Ev 44

8 EEF/UK Steel Ev 47

9 Energy Intensive Users’ Group Ev 53

10 National Energy Action (NEA) Ev 54

11 Fuel Poverty Advisory Group for England Ev 56

12 Committee on Climate Change Ev 59

13 Friends of the Earth, England, Wales and Northern Ireland Ev 59

14 Sandbag Climate Campaign Ev 63


List of Reports from the Committee during the current Parliament

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

Session 2012–13

Session 2010–12

First Report Embedding sustainable development across Government, after the Secretary of State’s announcement on the future of the Sustainable Development Commission

HC 504 (HC 877)

Second Report The Green Investment Bank HC 505 (HC 1437)

Third Report Sustainable Development in the Localism Bill HC 799 (HC 1481)

Fourth Report Embedding sustainable development: the Government’s response

HC 877

Fifth Report The impact of UK overseas aid on environmental protection and climate change adaptation and mitigation

HC 710 (HC 1500)

Sixth Report Budget 2011 and environmental taxes HC 878 (HC 1527)

Seventh Report Carbon Budgets HC 1080 (HC 1720)

Eighth Report Preparations for the Rio +20 Summit HC 1026 (HC 1737)

Ninth Report Air Quality a follow up Report HC 1024 (HC 1820)

Tenth Report Solar Power Feed-in Tariffs (Joint with the Energy and Climate Change Committee)

HC 1605 (HC 1858)

Eleventh Report Sustainable Food HC 879 (HC 567)

Twelfth Report A Green Economy HC 1025 (HC 568)

First Report The St Martin-in-the-Fields seminar on the Rio+20 agenda

HC 75

Second Report Protecting the Arctic HC 171

Third Report Wildlife Crime HC 140

Fourth Report Autumn Statement 2012: environmental issues HC 328

Fifth Report Measuring well-being and sustainable development: Sustainable Development Indicators

HC 667

cobber Pack: U PL: COE1 [SO] Processed: [02-01-2013 11:45] Job: 025695 Unit: PG01Source: /MILES/PKU/INPUT/025695/025695_o001_db_HC 669-i CORRECTED.xml

Environmental Audit Committee: Evidence Ev 1

Oral evidenceTaken before the Environmental Audit Committee

on Tuesday 4 December 2012

Members present:

Joan Walley (Chair)

Peter AldousZac GoldsmithMark LazarowiczCaroline Lucas

________________

Examination of Witnesses

Witnesses: Damien Morris, Senior Policy Advisor, Sandbag, Dimitri Zenghelis, Senior Visiting Fellow,Grantham Research Institute on Climate Change, London School of Economics, Simon Bullock, SeniorCampaigner, Policy and Research Unit, Friends of the Earth, and Alex Kazaglis, Senior Analyst—Energy Usein Buildings and Industry, Committee on Climate Change Secretariat, gave evidence.

Q1 Chair: I am very pleased to welcome all four ofyou before the Environmental Audit Select Committeethis afternoon. We have a very full agenda because wehave two more sessions following on and I think youhave noted that the divisions downstairs in theChamber have already delayed proceedings a little bit.With that said, we will get straight into the questions,if that is okay. Please do try to catch my eye if youwant to add to questions that perhaps one of you mayhave replied to. This is a very timely inquiry and oneto which we have a very small amount of time todevote, so I think these sessions will be veryimportant this afternoon for all our witnesses.We are really interested to know how the data gap oncarbon leakage is being addressed. We are looking atthe Government’s £250 million compensation schemefor the indirect costs of carbon policy on energyintensive industries. One of the things that concernsus is the extent to which the Government has or hasnot assessed the level of energy intensity whereindirect energy policy costs represent a seriouscompetitive risk. Do you have comments about theassessment that the Government has made in terms ofwhere compensation will go and what needs to bedone about it?Simon Bullock: To take a very quick step back fromit, the context of this is that we have seen in the lastweek and in the run-up with Doha just how importantclimate change is. A carbon price through UK climatepolicy is really important to help industry and thepower sector decarbonise but we accept that powerpricing rules are different in different countries andthe EU vis-à-vis the rest of the world. It is importantto reflect on the fact that carbon prices may bedifferent in different regions. If there is a genuinecompetitiveness threat then, yes, we accept it is rightto compensate industry. It is great that DECC havedone this assessment of whether or not there is agenuine carbon leakage problem.There are two issues that seem to us to be perhaps notfully addressed. The first is the extent to which this isabout electricity intensity or energy intensity. In thisinquiry, it seems that they are very clear that it is aboutelectricity intensity, but the signals from the Secretary

Caroline NokesDr Matthew OffordMark SpencerSimon Wright

of State in the Energy Bill that was set out last weekseem to suggest that it is about energy intensity ratherthan electricity. It is very important to be clear aboutthe distinction between electricity and energy here.The second point is that the consultation seems to besuggesting that there are two important components,electricity and trade intensity, and yet the eligibilitycriteria seem to apply to electricity only and there isnothing much in there about trade intensity, which wefeel is a gap.Dimitri Zenghelis: I was going to add from a slightlybroader economics point of view, because I am not anexpert on the specifics of UK policy but I was theauthor of the competitiveness chapter in the Sternreview. As part of that work, we looked at a numberof studies on this important question of carbonleakage that have been undertaken across the world,including, for example, in America where, inprinciple, the ability to relocate across borders whenyou are in the same country, with the same languageand same currency but in a different state provides avery rich test bed for analysis. Most of the studiesfound that there is very little if any evidence of so-called carbon leakage. The reason for that is partlythat one needs to be very careful. You will never knowthe counterfactual of what would have been the caseif various policies had not been applied, so it isdifficult to assess definitively on the basis of whatevidence you have. There are issues of aggregation,so what you might find applies for a sector does notnecessarily apply to a specific firm in a specificlocation under specific circumstances. The issue oftrade intensity, of course, is very important andapplies to different sectors.From a point of principle, you have to acknowledgethat for even the most energy intensive sectors withthe kind of orders of magnitude of carbon pricing thatyou are talking about, you are looking at changes incosts. For the most part, if you are talking aboutsomething like £30 per tonne of CO2 costs—and I amnot talking about the rest of the UK policyenvironment, which may have very differentimplications—that tends to mean for almost all of thetradable energy intensive sectors cost increases of

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Ev 2 Environmental Audit Committee: Evidence

4 December 2012 Damien Morris, Dimitri Zenghelis, Simon Bullock and Alex Kazaglis

around 5% or so. When you compare that to changesin labour costs, issues related to changes in exchangerates or even just the normal fluctuations in energycosts that you get over the cycle, you can see whythat, plus the fact that any policy differentials acrossjurisdictions would have to endure for the lifespan ofan investment—so you are not just talking about adifferential in policy this year but you are talkingabout a differential in policy you would expect toendure for five, 10, 20 years—means it does seemplausible, at least, that these kinds of locationdecisions will be based on a lot more than just energycosts. They will be based on access to markets, accessto labour, labour costs, access to skills, access to rawmaterials and so on. That is why you have steelproducers in Germany where labour costs, the biggestpart of costs, are 10 times higher than those of steelproducers in Indonesia and China and so on.

Q2 Chair: In terms of the actual carbon leakage andhow that is being quantified and the basis on whichDECC has sought to say that certain sectors will beaffected by it and certain sectors will not, isn’t itimportant that that information is there at the verybeginning, especially if it is going to have those long-term effects?Dimitri Zenghelis: That is absolutely right. Once youhave identified vulnerable industries, it is veryimportant that you consider what is the best approachto helping them transition to what inevitably willbecome a higher fossil fuel cost economy, whether itbe through policy or through the fact that Asia—China and India—are parts of the world that areindustrialising so demand is outstripping supply.Alex Kazaglis: In an assessment of how to allocatecompensation, there are a couple of things that youhave to know and both of them you need to know ata very detailed level so detailed data are required. Thefirst is you need to know who is facing these coststhat you are trying to compensate for. I note in theBIS consultation they look at electricity consumptionand they look at it as if all of it incurs these costswhereas actually there are details you need to know.For example, a lot of industry auto-generate theirelectricity and in some cases they are auto-generatingtheir electricity using fuels that are exempt from theCarbon Price Floor, such as blast furnace gas on asteel site. In many cases they are facing rates of theCarbon Price Floor that is reduced, so you have toestablish if they are facing these costs and for that youneed detailed information.The second thing you need to establish if they arefacing these costs is whether those costs are makingthem more vulnerable as a sector. If they can simplypass on the costs or there are ways that they canabsorb the costs, or if there are things about themarket that mean that that market can cope with thesecosts, then it is probably not the best place to allocatea small pot of compensation. To answer that questionyou need detailed information about trade intensitiesbut you also need to know a little bit about how themarket works in each of these commodities. Forexample, for parts of the steel sector it might makesense for the manufacturer to be close to their market

and there is not a risk of their leaking overseasbecause of specific aspects of that market.Chair: I think Caroline Nokes wanted to come in onthat point.

Q3 Caroline Nokes: I am not sure it is specificallyon that point but I have a general question with regardto the focus of this. Do you think that it is too tightlyfocused in on electricity and that there should be awider recognition of those industries that are notnecessarily reliant on electricity but, for example, ongas?Alex Kazaglis: It depends on what the compensationis for. If the objective of the compensation is tocompensate for indirect costs of the Carbon PriceFloor, and EU ETS, as it is stated that it is, then it isright to focus on electricity and within that to focuson electricity from the grid in the main.

Q4 Chair: Damien Morris, you wanted to come in.Damien Morris: If I could pitch in on that first point,I wanted to highlight that the European Commissionhas already done a carbon leakage assessment here,using its own criteria but among those criteria itapplied a carbon price expectation of €30 per tonne,which is by all accounts obsolete. We are currently ata carbon price of around €6. It is not set to rise above€10 under quite optimistic expectations goingforward. That list of sectors, as it has been defined,has multiplied the number of eligible sectors. It waswelcome to see that the BIS consultation had appliedan additional filter on companies, but we note therethat it uses a 2020 carbon price against 2020 GVAwhen we are talking about a spending review periodthat ends in 2015. Again, this is multiplying thecompanies that would be eligible for compensation.

Q5 Simon Wright: Do you agree with the principleof compensation and what are your views on the sizeof the package, £250 million over two years?Alex Kazaglis: From the perspective of the Committeeon Climate Change, I think there are a number ofways. Clearly there is likely to be a competitivenessor leakage implication for a very small number offirms at the minimum, which has not been quantifiedyet but let’s assume that there is that risk. There is anumber of ways that you could respond to it. You canrespond to it by energy efficiency, which means theyare not using the energy any more so they are notpaying the cost. You can respond to it by switching torenewable fuels, which are not subject to these costs.You can respond to it through compensation, which isone of the means, or exemptions from the cost in thefirst place. I would agree with the principle ofmitigating these costs but just to note that there are anumber of ways you can do it. You need a fullassessment of all those different routes and how faryou can go, and it is different in each of these sectors.Simon Bullock: I think the compensation for genuinecompetitive threats does deal with a real short-termproblem, but I would like us to step back and look atthe needs of British industry in the future. It is clearthat British manufacturing has to be strong andresilient in the face of global threats but also it has acrucial role to help the UK decarbonise and meet its

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carbon budgets. I am concerned that over the lastcouple of years we have had maybe six or sevenoccasions where climate policy has retrofitted orbolted onto it measures to help electricity intensiveindustries out, which is right, but I think we also needto be looking at how do we help them make thattransition rather than just shielding them from thecosts of carbon and energy prices as they go forward.What do we need to do to help them to invest in low-carbon technology and become energy efficient? Thatis the thing that is critical in the medium to long termand we can’t just have a programme based oncompensation.Dimitri Zenghelis: I would echo that. I think that isright. The question here is you want to legitimatelycompensate those firms that are vulnerable withoutover-compensating and therefore using excessresources. To distribute that compensation in the formof a lump sum should not, in principle, blunt theincentive to improve efficiency. In practice, that wouldneed looking into. As Simon says, one might wantto consider other market failures in terms of energyinefficiency and waste, so might that compensation bedistributed better if it is targeted at improving energyefficiency or might it be distributed better in terms ofcutting payroll taxes or national insurance, which areprobably more likely to prevent leakage anddislocation to other countries than merely handing alump sum to their profits?Damien Morris: I wanted to highlight a couple things,both in the Commission guidelines and in the BISconsultation, that we felt were quite welcome.Naturally, there is some level of trade-off betweenabatement incentives and compensation but it waswelcome to see that in both of these documents therewas text saying that the aid must not fully compensatefor the carbon price to retain some level of theseincentives. The question is whether in the detail thatprinciple is actually being fulfilled.

Q6 Simon Wright: To what extent are there alreadyincentives for energy intensive industries to be moreenergy efficient? Will the compensation schemereduce existing incentives to decarbonise?Alex Kazaglis: There are incentives. There is a lot ofincentives for energy intensive industries just by theirnature that they are energy intensive and they arefacing high energy costs. They are seeing electricityprices that have risen around 140% since 2004, mainlydue to the rising wholesale gas price, so there is a lotof incentives there. Is it enough? A couple of weeksago, DECC released an energy efficiency strategy andin that strategy they stated that current policy will onlyachieve around 14% of the potential for energyefficiency by 2020, so there is a lot there that is notgoing to be achieved in the current incentives but toget that extra bit is very difficult because there arevery real barriers that stop it from happening. Thoseare things like the long lead times taken for a blastfurnace at a steel factory to turn over once every 20years; there is only a small window of opportunity toget in those energy efficiency benefits. The incentivescould go a lot further. It requires something verydifferent from what we have at the moment. TheGreen Investment Bank is in the right area, but it

would need to be targeted very specifically atparticular measures in order to get that full potential.

Q7 Zac Goldsmith: Can you describe how youwould see the Green Investment Bank being useful inthe context of existing infrastructure that will bereplaced maybe 10, 15 years down the line which iscurrently energy inefficient? How specifically wouldthe Green Investment Bank be useful there?Alex Kazaglis: When the Committee put together thefourth carbon budget in 2010 and we spoke to industryat that time—and this may still be the case—it wasdifficult for parts of the energy intensive industry toaccess the capital to pay for energy efficiency projects.In many cases they were competing with other partsof their businesses that had more attractive investmentreturns for the limited capital. For example,optimising refineries, energy efficiency refineries, isdifficult because the same firm is exploring oil andgas in the Arctic, which is a much more high returnactivity. There were lots of examples like that. Whatthe Green Investment Bank does is provide thattargeted capital for those projects so it overcomes thatlack of access to capital barrier.

Q8 Mark Lazarowicz: I would like to pursue a pointabout how the compensation formulas would relate tothe areas of activity that are most susceptible tocarbon leakage. In your view, how far do the formulassucceed in targeting those activities where there is arisk of carbon leakage or how far is it effectively justa general overall electricity bill subsidy? Could thecompensation formulas be improved to meet what arethe desired objectives?Chair: Who wants to come in? It is complex.Simon Bullock: It is. It is surprising to me that theeligibility for the indirect EU ETS compensationpackage for companies—not for sectors but forcompanies—does not include a trade intensitycriterion within it. It has one for electricity intensitybut not for how much you compete with othercountries and which countries. I think that DECC havethe devil’s own job in doing this. It is verycomplicated and their approach of trying to mirror theEU proposals as far as possible seems to make a lotof sense. It is less bureaucratic and less complex thatway. The EU say that you should have a tradeintensity criterion so it is surprising that that criterionis not there in the BIS proposal.Damien Morris: A lot of the compensation metricshave been taken directly from the European legislationand it is good to see that these have been set up in theway that they are calculated in arrears and they are setto evolve with things like the carbon price, andevolves as the emissions intensity of the grid evolves.We particularly welcome the way that the BISconsultation specifies a new grid emissions intensityfactor that is a more realistic representation of whatelectricity consumers are expected to be paying forthan the assumptions in the Commission document.We do note, however, that one factor of theCommission guidelines is that the aid given does notdrop proportionally with output. So if a company’soutput drops by 49%, its aid is not lowered at all; itis not until it passes the 50% threshold. Then again, if




the output drops by 74%, they still receive 50% oftheir aid. In terms of recommendations on that pointwe would, as a minimum, recommend narrower bandsof compensation, 10%, 15% perhaps, rather than thesemassive 50%, 25% gulfs that could perverselyincentivise running uneconomic facilities. Moreboldly, we would perhaps recommend making thedefault risk of under-compensating rather than over-compensating industries in these situations. Again,that is in line with the spirit of those—

Q9 Mark Lazarowicz: Are you saying the defaultposition is over-compensating?Damien Morris: In this particular set of guidelines thesituation is that if output drops by, say, 74%compensation only drops by 50%. If we did somethinglike reverse the assumptions there and pay at the lowerlevel, again probably within a narrower set ofperformance bands than are currently laid out—as Ihighlighted earlier, there is a set of principlesexpressed in both the BIS document and theCommission guidelines that say we should maintainsome incentives and not cover all of the costs ofcarbon here. I think this preference for under-compensation on this particular point is in line withthat.Alex Kazaglis: I would just reiterate or put in contextthe points I was making before about it does notappear that in the equation it picks up on differentrates of the Carbon Price Floor paid by auto-generators and therefore that is not picked up in thecompensation. It also makes sense, I think, to considertrade intensity as well and other aspects of the marketthat might make it less of a competitiveness concernif the industry is facing these costs.

Q10 Mark Lazarowicz: Do you think that thosedeficiencies could be remedied by making the formulareflect that in some way? Can that be done withoutmaking it too complex?Alex Kazaglis: Yes, I do. It sounds complicated butwhat we are talking about here is not a pervasiveproblem that is right across the industry but anisolated problem in a small number of firms. It ispossible to get a handle on those things using thevarious sources of data and also perhaps some sort ofqualitative understanding of how these sectors work.Simon Bullock: It may not be directly related, but onefinal point is that BIS and DECC are very clear thatthere would not be any additional energy efficiencyrequirement to receive the compensation, and that issurprising. I note the German scheme forcompensating industry for their renewable energy wasrenegotiated this November and in that their newscheme has committed the industry to reducing theirenergy demand year on year. Part of your inquiry isabout the whole package but this consultation is onlyabout the Carbon Price Floor and EU ETS. There isnothing in there about the Climate Change Levyexemption increase from 80% to 90%, so it would beinteresting to know whether there are proposals fortightening the climate change agreement tocompensate for the increase in the exemption to 90%.

Q11 Mark Lazarowicz: That takes me to anotherpoint I was going to ask you about. As far as I canunderstand it, as best I can, there is no provision inthe compensation formula that would take intoaccount the energy efficiency or the electricity usageof the actual intensive industries themselves. Am Iright in assuming that?Alex Kazaglis: I think it is contingent on meetingcertain efficiency benchmarks, from my reading of theconsultation. Those benchmarks are taken from theEU benchmarking of particular processes, so there issome incentive, I think.

Q12 Mark Lazarowicz: To get compensation youhave to reach that benchmark in some way.Alex Kazaglis: You will only be compensated for thebit.Simon Bullock: As I understand it—and I will checkand get back to you if I have this wrong—there is anefficiency benchmark for the compensation forindirect EU ETS costs but there is no efficiencybenchmark for the Carbon Price Floor. That is myunderstanding of how it is set up.

Q13 Caroline Lucas: Off the back of what you weresaying a moment ago about the trade intensity, haveyou been able to do any assessment about whethertrade intensity was properly included in thecalculations? Do you have any sense of how manyfewer companies would need to be compensated, forexample? Is there enough information in the publicdomain for you to be able to make that kind of anassessment or not?Alex Kazaglis: You end up with the same sort ofsectors that are already identified in the BISconsultation document. There is fairly broadagreement on what those sectors are. There are a fewthat maybe should be included and are not, or are andshould not be, but you get to the same category ifyou look at trade intensity. Trade intensity data areavailable at a fairly aggregated level and not belowthat, so it gives you an indication but it is not quitewhat you need to know in order to allocatecompensation. You would need to do a bit more thanjust looking at trade intensities. Also, we arecompensating for a period in the future, somethingthat has not happened yet, so trade intensities for thepast carry inherent problems as well.Dimitri Zenghelis: Trade intensity with who matters.For most of these sectors, trade intensity falls by afactor of between three and seven when you lookoutside the EU. That is because many of these sectorsare tradable but only over relatively short distances,or they act as intermediary products for similarindustries that agglomerate in one part of Europe, forexample. You need to be mindful that a firm that hasstrong trade with China may have a stronger case evenin a world where the Carbon Price Floor provides anasymmetry within the EU vis-à-vis some of our EUcompetitors, versus a firm that trades with Germany,which may have similarly ambitious if rather differentsets of environmental and greenhouse gas policiesaffecting them.




Q14 Caroline Lucas: I have a question for Sandbagspecifically about the emissions trading programme inthe EU. Do you feel that the amount that the energyintensive industries are gaining from the EU ETS isproperly being taken into account when it comes tolooking at the compensation that they are also goingto be receiving?Damien Morris: Thank you for asking that question.Certainly we don’t feel this and we really think theUK Government is in jeopardy of pouring goodmoney after bad in terms of the compensations forcarbon leakage threats that it has awarded itsindustries. This is an excellent opportunity to limitthat. I have a few figures here. We have seen some 64million surplus allowances awarded to industry justover the period 2008 to 2011. One critical example isthat Tata’s operations just in the UK over 2008 to 2011have accrued a surplus of 31 million allowances. Thevalue of those is probably in excess of the whole £250million compensation package that is being exploredhere. We definitely feel that these direct assets forprotecting against carbon leakage that the Governmenthas already awarded should be taken into accountsomehow. There are a few ways this could be done. Itcould somehow be factored into the eligibility criteriaas to whether that 5% GVA threshold is passed,although again you would probably have to push thetime horizon back within the spending review periodthere. Probably more realistically what you could dois withhold compensation until the cost of carbonequivalent to the surpluses that have been accrued hasbeen passed through to that firm. Naturally if you dothat, not all surpluses have been acquired because ofthe recession and because production has beenlowered. In some cases this has been because realabatement has taken place and if industries couldprove that then those costs should be given to them.

Q15 Zac Goldsmith: Could you explain how it isthat Tata managed to secure an over-allocation? Yousaid 31 million. Can you explain how that happenedand what that actually means?Damien Morris: Yes. I think the Government hasbeen fairly forthcoming before that it had the intentionof basically protecting industry from all of its directcosts under the EU ETS by giving out freeallowances. When it was consulting with industry ittried to determine what their emissions were going tobe over the course of Phase II and essentially gavethem allowances sufficient to cover that.

Q16 Zac Goldsmith: Would Tata have made an over-estimate of what kind of emissions they were likelyto generate?Damien Morris: I wouldn’t claim that necessarily, butwhat definitely happened is that the recession camealong and blindsided everybody. The free allocationsthat were sufficient to protect business-as-usualemissions as expected back then never materialisedand we were left with Government assets far in excessof what was awarded to most of UK industry.

Q17 Caroline Lucas: So Tata is not an exception, ina sense? Tata is always used as the example to prove

the point. Are there plenty of other cases we could belooking at where there is over-allocation?Damien Morris: Absolutely. I don’t mean to pick onTata. It is just because they are such a large companythat it is more obvious there, but the steel industry inthe UK has basically doubled the allowance it needsoverall. It is a similar story with ceramics. The cementindustry also has not quite the same proportionaloversupply. Tata is not alone, the steel sector is notalone, and we really think this should be taken intoaccount in terms of compensation for all energyintensive users—Caroline Lucas: Sorry, I was just scribbling. Wereyou saying cement and ceramics both have at leastdouble the allocation that they would need?Damien Morris: Ceramics has roughly double.Cement has a little less than that.Chair: I presume you have the evidence on whichyou are basing that. It would be very useful to have it.Damien Morris: Yes. I would be very happy to submitsome documentation to support the numbers I havegiven today.

Q18 Mark Lazarowicz: I can see members of thegallery shaking their heads. No doubt we will hearsomething in due course. Just to put it in perspective,what has been the value of that over-allocation, asyou see it, to the industries concerned? Obviously themarket price will change day to day, but what kind offigure can you put on that?Damien Morris: It is hard to put a figure because thecarbon price fluctuates so much. Over the last year ithas been much lower than it has been over the rest ofthe phase. As I said before, the market price today orrecently is around €6 per tonne. It hovered around the€14 or €15 mark for a lot of Phase II. From forecastprojections across the next eight years, it is notexpected to go above €10.

Q19 Mark Lazarowicz: It is probably a sillyquestion but in terms of EUA how many are wetalking about or would you prefer to work out thecarbon price after that?Damien Morris: Yes, sorry. For Tata the specificexample I gave before, that is 31 million, so if youassumed a €10 carbon price you are talking about€310 million.Mark Lazarowicz: Over what period?Damien Morris: Over 2008 to 2011.Chair: I am very conscious that we have the industryrepresentatives coming and we need to finish our nextsession at 6.00pm. It would be very useful if youcould provide any evidence in writing to theCommittee.

Q20 Caroline Lucas: Do the other people on thepanel agree in principle with that rough kind of backof the envelope type of assumption that ceramics andcement, and indeed steel, will have been givensignificant over-allocations and therefore in principleneed less compensation?Alex Kazaglis: From the perspective of the Committeeon Climate Change, yes, the free allowances aredefinitely there. I want to take the opportunity to traila report that the Committee are doing that will look




at this. It is coming out next Spring so we will be ableto quantify them to some extent. Also, these could beused to offset the costs but there are reasons why theymight not be able to be used to offset the costs. Forexample, money given a couple of years ago is notnecessarily good for a business to offset costs thatthey are facing today. There are real competitivenessissues going forward. You would need to take intoaccount, after you had worked out how big the freeallowances were and how much the surplusallowances were, whether indeed they do offset coststhat go into the future.

Q21 Caroline Nokes: It is a bit of a hypothetical, butIf carbon leakage were not an issue, do you think thatthe Emissions Trading System and Carbon Price Floorwould be effective leaders in driving decarbonisation?Dimitri Zenghelis: I was going to chip into the lastpoint, but this is a nice link. The question that isclearly begged over the degree to which there is over-allocation is to what extent ought the EU ETS havetightened the cap to track the slowdown in demand asa result of the global economic slowdown. To theextent that it has not, to what extent has policy beenloosened in terms of emissions reductions. That alsohas a bearing on the relationship between the CarbonPrice Floor, of course, because for those sectors thatoverlap with the EU ETS, the Carbon Price Floor willlead, one for one, to carbon leakage because theEuropean cap will still hold. To the extent that UKfirms reduce their demands, that reduces demand inthe market as a whole so the price goes down untilthat cap is met, so someone somewhere else in Europewill be commensurately increasing their emissions.


Witnesses: Dr Laura Cohen, Chief Executive, British Ceramic Confederation, Jeremy Nicholson, Director,Energy Intensive Users’ Group, Gareth Stace, Head of Climate and Environmental Policy, EEF, and PhilipPearson, Senior Policy Officer, TUC, gave evidence.

Q22 Chair: Thank you very much indeed to each ofyou for making yourselves available this afternoon. Iam really sorry that the division has curtailed oursession. I am trying to allocate the reduced time fairlyand we will go straight into the questions. I am veryconscious that you sat through the earlier session andI would say from the outset that if there werecomments made that you feel you wish to have a rightof reply to, please feel free to contact the Committee,but if we may we would like to proceed with ourquestions now.I will begin by asking to what extent you think the£25 million compensation package will be enough?To what extent does it suit your members or suit yourinterests or to what extent has it overlooked certainthings that should be included? Mr Nicholson, Isuspect you wish to start.Jeremy Nicholson: Very briefly, before handing overto my colleague, the benchmark for us is what ourcompetitors elsewhere are doing in Europe. I thinkPhilip Pearson and his colleagues in the TUC havedone some particular analysis on that, which I thinkis highly relevant here.

There are good reasons that you might argue for doingthat but it is a pretty bold move and one that needs tobe looked at very carefully in the context of thebroader emissions reductions through the tradingprocess.The only other thing I would say is I think carbonpricing is a prerequisite for effective emissionsreductions but of itself it is not sufficient. There areother market failures that are not price sensitive,energy efficiency and waste being a classic example.If people were fully price sensitive there would be alot less of it. Another might be innovation andresearch and development. A lot of the returns toinnovation and research and development at the firmlevel are very long term, they are very risky, theycannot be captured by the firms to the extent thatknowledge spill-overs are free. So there is a case therefor public support as well.Finally, the public sector has a huge role to play incapturing policy risk. One of the things that puts offprivate investors is the very rational fear that whenpolitical parties change or the environment changes,the policy will change. You would need some kind ofskin in the game—and the Green Investment Bank isone such example of an institution that providesthat—that says that if the policy environment changes,the public sector stands to lose alongside the privatesector, and that instils confidence that brings forthinvestment.Chair: If I may, I would like to move us on to ournext witnesses. Thank you for coming along thisafternoon. I am sorry that it has been curtailed. Thankyou very much indeed for your time.

Chair: Okay. Mr Pearson.Philip Pearson: Thank you very much. The packageis not adequate and the key test of this for us is whatcompetitors are doing and that is the measure againstwhich one would need to discuss carbon leakage.Simon Bullock used the word “retrofitting” and thatis the inherent problem of the approach to industrypolicy that we have been faced with, not just underthis Administration but previously. It does not bearcomparison as an industrial-cum-energy strategy withthat of our leading competitor in Europe, which isGermany. If you look at the detailed support providedby the German Government you will see that it is anintegrated industrial and energy policy at the heart ofwhich is compensation for the costs of climate changethat industry has difficulty bearing in the transition. Ithink the word “transition” is really important. Youcan criticise the German scheme—and the study thatwe have cited is not uncritical—for a blanket-styleapproach, which is not really what we are advocating.What the consultant’s report that I referred to isadvocating is a predictable long-term decline insupport, but it is predictable, it is long term and it is



4 December 2012 Dr Laura Cohen, Jeremy Nicholson, Gareth Stace and Philip Pearson

known and it is a bankable policy against which long-term investment decisions can be made. So it is theshort-term, piecemeal approach that is the firstproblem and, secondly, the scale of support. Youshould not exaggerate, but just the numbers appear tostand out really starkly to show that the annualpackage of support is around €6.5 billion—€8billion—across a range of climate change and energypolicies in Germany. So, is £210 million enough overtwo years? The answer is probably not, particularly ifyou see what other countries are doing.

Q23 Caroline Nokes: A specific question, MrPearson, about the German scheme. You haveidentified that the numbers are significantly larger butare you also aware of industries in Germany thatwould be eligible for compensation that simply arenot going to be or are struggling to ascertain whetherthey are eligible in the UK?Philip Pearson: I can answer that very quickly andthen invite people on the panel to also answer. Thereis a schedule in the TUC report that sets out theextraordinary range of carbon cost compensation thatis available in Germany, from baking to the railwayindustry. Why shouldn’t they if they have intensiveindustries—the German railway industry competeswith other railway networks because it is in theEuropean system. This is not to say subsidiseeverything and turn away from the need todecarbonise, because that is not what we think. Wethink high energy use is not the same as energyinefficiency. What we are looking for is anunderpinning of decarbonisation in a range ofindustries where there is a transitional need. Theindustrial security question should come to the fore.Jeremy Nicholson: The German compensationscheme is fundamentally different in scale and scope.My colleagues may add about that in terms of thesectors that are covered but also the intensity of aidthat is given. I am sure as we go through the questionsthere will be some issues about that and we will touchon them later.

Q24 Chair: Dr Cohen, do you want to come in onthe £250 million and how adequate or inadequate itis, qualitatively as well?Dr Cohen: As the other speakers have said, it is aboutgetting a level playing field with our main competitorsaround Europe. Certainly on sectors, for example,there are some brick and roof tile companies that aregoing to be compensated in Germany but are notlikely to be compensated in the UK. Some other tilecompanies1 and so on in the UK may be in a similarsituation, so it is a much more generous scheme withdifferent criteria, but if those criteria were applied inthe UK it would include many more sectors.

Q25 Caroline Lucas: One of you said that the keything to ask is what package is being given to ourcompetitors and therefore to compare with that. Isn’tthat immensely difficult because there are going to beso many different factors that will have a bearing onwhat the price of something is in Germany or China,or anywhere else come to that, versus the UK? Isn’t a1 Note by witness: Wall and floor tile manufacturers

better litmus test to try to get to what one of the earlierpanellists called the counterfactual, which is difficultto get to, in other words what would the case havebeen like without this particular extra measure? Itworries me if we simply say that the benchmark iswhat is happening in competitor countries, becausethat does not necessarily properly take into accounttrade intensity or a whole range of other issues fromlabour costs to whole set of other incentives andpolicies.Jeremy Nicholson: You are absolutely right that otherfactors like trade intensity and, where relevant, labourand other taxation costs and so on need to be takeninto account. We are after all talking about energyintensive industries here. The one thing that all ofthem have as a characteristic is that energy accountsfor a high proportion of their operating costs, althougheven within the intensive sector there is a big rangethere and some are more gas or more electricityintensive and so on. You are also right that because thepolicy measures even within Europe for supportingrenewables, for example, are radically different fromone another, comparability here is not straightforward.However, I think it is right to say that there areelements of compensation that are not yet available atall to intensive industries in the UK, particularly forthe impact of renewable costs specifically, which arenot covered by this package. As your Committee isvery well aware, the Carbon Price Floor is a unilateral,UK-only measure. I think it is right, therefore, thatparticular attention is paid to those costs that riskdistorting trade within the single market. Obviouslythere are much more complex questions about howone protects against carbon leakage internationally,outside the EU altogether.

Q26 Mark Lazarowicz: What would you regard asa comparative level of expenditure on a scheme thatwould put you on a level playing field, say withGermany, here in the UK? How is the German schemefunded and how would it be funded in the UK if youhad what would be your preferred option?Jeremy Nicholson: The starting point is the guidelinesthat the Commission themselves have produced. If welook at the EU ETS component first, the guidelinesstipulate a maximum level of aid that can be granted.In certain instances there are benchmarks for energyefficiency that apply too. They also propose amaximum carbon intensity factor. This takes intoaccount the degree to which our generating systemhere is carbon intensive and the extent to which thecarbon price is passed on to consumers. The principaldifference in the way that the German Government isapproaching this and the UK Government currentlyproposes to grant compensation is that the Germansystem will apply the maximum carbon intensityfactor that is allowed under the guidelines and the UKGovernment is proposing a much lower one. If youtake into account the maximum aid intensity and thelower carbon factor that the Government intends toapply here, only about 50% of the uplift in costscaused by the EU ETS will be compensated for in theUK, even for those industries that qualify. As you willbe aware, there are some electro-intensive industriesthat will not qualify for this aid. There are similar




concerns about this being applied for the Carbon PriceFloor as well.Doubtless you will hear from the Government in duecourse as to why they would like this lower figure toapply. We strongly suspect, on the basis of what wehave heard from a number of GovernmentDepartments, the basic reason is there is not enoughmoney to go round. We don’t think the solution to thatis to fiddle the figures. We think the Governmentneeds to be open. If they are not in a position toadequately compensate industry in the way that theGerman Government and some other Europeancountries are then they should say so.

Q27 Zac Goldsmith: I was going to ask to whatextent the over-allocation of permits might havealleviated, just to respond to some of the points madein the previous session, but if that is coming up thenI apologise.Chair: Okay then. Philip?Philip Pearson: In terms of the scale of the package,these companies pay their taxes by and large. This isnot the Starbucks sector. The Building our low-carbonindustries report, which we did with the EnergyIntensive Users’ Group, demonstrates quite clearlythere is around £13 billion of revenue to theExchequer from these core industries alone, let alonethe supply chain benefit to the economy. This is thekind of mind set that is missing from the approach tothe package. Is it big enough? We don’t know butwhat we do know is we are trying to secure industriesthat contribute to the economy and regionally andlocally have a great deal to offer. That is the kindof yardstick.Dr Cohen: We have shared with the BusinessDepartment and also we have shared with thisCommittee previously, in confidence, some examplesof electro-intensive companies that are part of thesolution to a low-carbon economy. They createproducts that reduce energy with their users but havealready relocated2 to other European economies andare citing, in private,3 electricity price as the mainfactor. These are countries like France where they canget access to an Exeltium contract—bills are typicallya third lower4 at the moment—and Germany wherethey are getting much more compensation as a whole.These companies make the technical ceramics andrefractories. They are not in EU ETS already so theydon’t have any allowances. They are generally prettysmall installations. So there is genuine carbon leakagegoing on here. And these companies are not going toget any of the EU ETS in direct compensation either.There is a genuine problem. The BIS officials are verysympathetic to it and we appreciate their help inworking with us and our members to ensure thosecompanies submit the right evidence.

Q28 Dr Offord: I am going to approach it from adifferent angle. If there wasn’t any compensation atall, I am particularly asking this to Dr Cohen and MrNicholson, have you estimated how much theEmissions Trading System and also the Carbon Price2 Note by witness: relocated some of their production3 Note by witness: because this is commercially sensitive4 Note by witness: than in the UK

Floor would increase the price of electricity yourmembers pay?Jeremy Nicholson: I would direct you in the firstinstance to what I think is an extremely useful reportproduced by BIS in July this year, the results of whichaccorded very much with our own internal analysis.They assessed the impact of a number of climatepolicy measures in the UK and in a number ofcompetitor economies, both now and where they willlikely be, given all the uncertainties, by 2020. Weunderstand, for example, that the EU EmissionsTrading Scheme, albeit with a low price of carbon atthe moment, has probably added around £5 amegawatt hour to the price of electricity paid by ourmembers. The Carbon Price Floor will probably addaround another £3, so that is around £8 a megawatthour currently. That figure will rise very substantiallyby the end of the decade, largely as a result of theCarbon Price Floor. Although there are disagreementsbetween ourselves and some GovernmentDepartments about the precise carbon intensity factorthat should apply, in order of magnitude terms I don’tthink there is a great disagreement about this. It ismore problematic to know what that means for thebusiness, but in terms of the calculation of the effectI think there is a fair amount of consensus there. It isalready material and it is going to be very significantby the end of the decade.To put that in context, the combined cost of therenewables subsidies and of energy taxation, albeitwith rebates for intensive sectors, and the CarbonPrice Floor and Emissions Trading Scheme takentogether, are likely to add something of the order of40%, around £28 a megawatt hour, to large industrialusers’ supply costs by the end of this decade. Plainlythat is a material impact if you are an energy intensivebusiness that is trading globally.Dr Cohen: Our members are also talking aboutmaking dispassionate decisions about where theyinvest. Some are talking about do they invest in theUK or in France, for example, and they have to lookat the cumulative costs of all these policies both nowand in the future. Again, they have shared with theBusiness Department some instances where they havenot got the investment into the UK and it has goneoverseas.Gareth Stace: Can I add that we have to look at thecumulative cost but also the uncertainty goingforward. If our members in the steel sector operatingat a global level are going to their main board forfunding for a project—and their main board won’t bebased in the UK, they will be based somewhere else—how can they give the certainty to that main boardthat costs are going to be X going forward when thelifetime of this package that we are talking abouttoday is two years? We have no certainty what thepackage will be after that. How can somebody in theUK go to a global board and say, “Please give us themoney” when the guy standing next them is notsubject to the costs and also has much more certaintygoing forward in terms of investment certainty? Weare not going to get that funding; someone else willget the funding.




Q29 Chair: In terms of the UK electricity prices thatthe energy intensive users are paying, do you thinkthe comparison is fair with the amounts that domesticusers pay? How do you look to see how the wholefairness issue can be incorporated into the agenda?Jeremy Nicholson: I think there are two aspects ofthat. One of them is the international one in the sensethat what is fair for industrial users is judged naturallyby what our competitors are paying elsewhere. Youraise an important point about domestic prices andthere are all sorts of issues about domestic electricitysupply that go well beyond what we can deal withhere. I would say that prices are cost reflective toindustrial users, even if we don’t necessarily like someof those costs at the moment. For all consumers,whether domestic or industrial, an element of theirbills reflects the wholesale price of electricity, whichis the same for everyone. Some of our members areconnected directly to the National Grid and thereforedon’t pay local distribution charges. Of course, thereare certain fixed costs associated with supply,metering and billing and so on, which per kilowatthour are considerably cheaper for a large industrialsite using 10s or sometimes 100s of megawatts ofcontinuous power compared with the relatively smallamounts we use at a multiple number of sites in thedomestic sector. It is not so much that industry gets adiscount but the costs reflect the economies of scalefor industrial supply.

Q30 Mark Lazarowicz: On that point, but also itrelates to a question that was not fully answeredearlier, if you were to get the higher level ofcompensation that Germany has how would that befunded in the UK? Someone will get paid, someonepays for, so where does the money come from?Jeremy Nicholson: That remains to be seen, anddoubtless the Minister and others will want tocomment on that, but it is likely that unless we changeour targets, if the UK remains committed to the sameends, that those costs are likely to be picked up byother energy consumers. I have to say this is notsomething that industry has argued for. We have notargued for these costs to be imposed in the first placeand I think it is always open to Government toconsider whether some or all of these costs should bespread across taxation more generally as opposed toenergy consumers. That was a decision that was madeby the incoming Government with respect to theRenewable Heat Incentive, which was originallygoing to be funded by a levy on fuel bills, principallygas bills, which would have hit all of us as consumers,and the decision was taken to fund it out of generaltaxation. The scale of this compensation is a lot largerand I realise there are state aid implications that wouldlimit what could be done. I think there is a debate tobe had about the equitable balance between whetherit is the taxpayer generally or electricity consumersspecifically that should be footing the bill.

Q31 Caroline Lucas: Mr Stace was making a pointearlier about the importance of policy certainty, whichI accept is an important thing but, given thefluctuation in any case on fossil fuel prices, wouldn’tyou argue that because we know that fossil fuel prices

are going in an upward direction but on the way thereare certainly some fluctuations, in a sense the statusquo is not providing you with the policy certainty thatyou would want? What kind of measures would yousuggest putting in place? You said before that youonly have the compensation for two years. Presumingthat the compensation is somehow linked to anestimation that there will be some kind of transitionwhere energy intensive industries would start to useslightly less energy over time due to energy efficiencyor switching away from more carbon intensive fuels,how are you going to get this transition with thecertainty that you want at the same time as you havea backdrop of fluctuating fossil fuel prices?Gareth Stace: There are two points there. In terms ofthe fluctuation, that means there is more of a levelplaying field because globally they are feeling thosesame fluctuations whereas globally they are notfeeling the Carbon Price Floor and the EU ETS. Tome that is not so much the uncertainty of gettinginvestment certainty going forward. In terms of thetransition, we should remember that this package onlyaddresses electro-intensive sectors and compensatesthem for two elements of climate change policyhere—but I would be delighted if in two years anelectric arc furnace in the steel sector coulddramatically reduce the energy intensity of its process.It is using very tried and tested technology and inorder to change that technology so significantly wouldrequire billions of pounds of investment that is notgoing to happen in the next two years and it is notgoing to happen unilaterally here in the UK or evenin the EU. It requires a global solution to make steelin a very different way.

Q32 Caroline Lucas: Can I press you on that,because that does seem to come to the crux of it?What would you put in its place? If you accept thatultimately one would like to replace processes that arevery energy intensive and carbon intensive and if weare going to sit around and wait for globalagreement—Doha is happening now and not much ishappening out of that—being practical what wouldyou suggest?Gareth Stace: When you say processes, you meanwhat policy framework rather than what technology?Caroline Lucas: Yes.Gareth Stace: Yes. We are going to wait far too longfor an international climate change agreement so whatwe believe we need in the meantime is global sectoragreements for certain sectors that operate on thisglobal level, such as the steel sector, which means thatsector coming together to tackle the problem as awhole rather than individual pockets. The EUEmissions Trading Scheme does nothing to reduceglobal emissions from the steel sector because there isvery little abatement in the steel sector so if we don’tproduce the steel here it is going to be producedsomewhere else, so globally it doesn’t do anything.That is a real problem because the steel sector is asignificant emitter and we need desperately to reduceemissions from that sector significantly. In order tomake steel in a different way, we need that globalfunding, that global solution, and that is what we




would be calling for but that needs global co-operation with countries such as China who may notco-operate at this time. What we see is that we havedeveloped sectors such as the steel sector indeveloping economies and therefore those developedsectors need to be treated on that level playing field asone moving forward. I think that could happen muchquicker than a global international agreement ingeneral.Dr Cohen: Something very positive the UKGovernment could be doing is working withindividual sectors on breakthrough technologies, tohave technology demonstrators, perhaps by usingsome of the green taxes recycled into these. Forexample, we as a sector published our roadmap lastweek, identifying some of these critical breakthroughtechnologies.5 We want to use this as a starting pointfor our discussions with Government in the UK and inEurope to try to get things moving in a positive way.Philip Pearson: On process, I wanted to add that theTUC really welcomes the package. It may sound likewe don’t, but we think it is a really important firststep and we would like the comments about package1 resolved very quickly to get it going. But there is amuch bigger debate to be had and one vehicle for thatis through the Green Economy Council, which has anenergy intensive task group that is tripartite withGovernment involved at ministerial level. We feelthere are places where we can resolve these issues anddevelop something much more long term, much moreambitious, much more like our competitors.Jeremy Nicholson: We would certainly much preferto be having a conversation with your Committee andothers about what can be done to supportdecarbonisation efforts in industry, the as yet non-existent ‘Green Deal’ for industry, which iscomparable or perhaps rather better than that proposedfor the domestic sector. The Green Investment Bankis obviously a part of the solution here. But if youthink of the level of taxation that is being supportedby Climate Change Levy, Carbon Price Floor, EUETS and the auctioned allowances and so on that isbeing directly funded through energy intensiveindustries, even under the maximum compensation weare likely to receive, that is going to be running intobillions per annum by the end of the decade. It is notunreasonable to ask how much of that is coming backto support industry decarbonising.

Q33 Simon Wright: If there was scope for adjustingthe compensation scheme but sticking within the £250million budget, what adjustments would you like tosee made?Dr Cohen: I would like to see a bit of flexibilitybetween the split between Carbon Price Floor and theEU ETS because many more companies, potentially,can gain access to the Carbon Price Floorcompensation. At the moment it seems that that theUK Carbon Price Floor could be higher than that ofEU ETS, so it is about a fairer distribution, althoughit is recognising there is not enough to go round asit is.5 “Paving the way to 2050” Ceramic Industry Roadmap

(Cerame-Unie, Nov 2012) http://www.cerameunie.eu/en/doc/198/CU+Ceramic+Roadmap+1p.pdf

Gareth Stace: I would like to see that we revisit theaim of this scheme, which is to compensate electro-intensive sectors for Carbon Price Floor and the EUETS, and make sure that we stick to that aim ratherthan diluting the scheme to try to compensate moresectors but compensating everyone less. We need tostick with what was the original aim of the scheme.Jeremy Nicholson: The only thing I would add is thatone of the aims of the scheme is to keep business inbusiness, profit-making business located here, and toavoid the threat of carbon leakage. If thecompensation fund for the spending review period isinadequate, and perhaps unintentionally sends amessage to industry that Government is notsufficiently committed to this over the long run, thenthat would be counterproductive. One appreciatesfinances are tight at the moment but given what is atstake, given the sort of job losses we have heard aboutin energy intensive industries in recent weeks, I don’tthink that a small expansion of that fund towards agreater end would be an unreasonable thing to ask for.

Q34 Mark Lazarowicz: You probably can’t give ananswer now but it would be useful to get in writingyour perspectives on the issue of the effect of freeallowances on industry. Obviously going forward freeallowances may well become—it will depend on whathappens at Doha and other things, but I think it wouldbe useful to us if you could give some reaction inwriting on that particular point. With the timing Iwould say you have one minute now so I don’t needyour answer in one minuteChair: We are expecting the vote very shortly. Didyou want to comment on this?Gareth Stace: Shall I quickly try to answer that fromthe steel sector point of view? In terms of allocationthat we receive under the EU ETS, we need toremember that the scheme we are talking about todayrelates to indirect costs on electro-intensive sectors.The EU ETS is about direct costs on carbon intensivesectors, so let’s not mix the two up.

Q35 Mark Lazarowicz: I think the suggestion is youmay get a bonus to make up for what you are seekinghere, to put it in a crude term. That is perhaps theindicator and that is why value is quite useful to know.Gareth Stace: Sorry, I thought you were talking aboutthe issue that you had in the previous session aboutwhat was potentially called over-allocation and couldthat be compensated with this package.Mark Lazarowicz: Yes.

Q36 Caroline Lucas: I think we are going to cometo direct compensation, in the sense that we realisethey are different things, but if you are paying out alot under one system but gaining quite a lot underanother one, why can that not be seen as ajustification?Gareth Stace: Because they are potentially twodifferent companies that are getting this free allocationin EU ETS, and then the electro-intensives for theirdirect emissions might be very small, but their indirectemissions are very high, so they can’t really cross-fertilise each other because they might be two verydifferent populations. But in terms of tackling the




issue of what is considered—or some people say—over-allocation, we should remember that we didn’task to be in this scheme in the way it is, in the senseof we are following the rules of the scheme. Nobodycould predict the recession in 2008 and nobody couldpredict that what we had was ex-ante allocation. Wesaid at the time that we should have ex-post allocationthat took into account changes and fluctuations inproduction, and therefore we wouldn’t have thisproblem that we have now if Government hadaccepted our position at the time. But Governmentwanted the certainty of the cap at the time and told usthat is what they had to have, and that is why theyhad to go for ex-ante allocation and we have theproblem we have.Chair: We have a Division.

Q37 Caroline Lucas: I know, but just a really quickone. Tata is the example that was given earlier withthe 31 million allowances. Would you not see that, asfar public perception at any rate is concerned, if Tata,which has received that much in free allowances, isthen also going cap in hand saying, “Please can we


Witnesses: Rt Hon Michael Fallon MP, Minister of State for Business and Enterprise, Paul Drabwell, Headof Domestic Energy and Climate Change, Department for Business, Innovation and Skills, and NiallMackenzie, Head of Industrial Energy Efficiency, Department of Energy and Climate Change, gave evidence.

Q38 Chair: Welcome you to what is, certainly forthis Committee, the third of a long series of sessionsthis afternoon, and I understand as well for theMinister. You are most welcome and we thank yousincerely for coming straight to our Committee froma previous committee, and also from Divisions in theCommons, which have just delayed our proceedings.With no more ado, I would like to welcome you to theEnvironmental Audit Select Committee this afternoon,and by way of introduction say that we wanted to raceahead with this inquiry, with this session today,because we understand how timely it is and we don’twant to be too late with any recommendations thatwe have.We would like to go straight into the questions andstart off by asking what your assessment is of the riskof carbon leakage among energy intensive industries.The reason for this question is that we have found thatthe evidence has been quite patchy in places and wehave not really been convinced that there has beenthorough investigation, research and scrutiny done ofthe extent of carbon leakage across all sectors. Wewould be very interested, in terms of the role that youhave as Minister—and indeed the Department, and itis good to welcome the officials as well—in just howmuch work has been done. We understand that therehave only been 48 submissions on the consultation.Does that give a basis for going ahead withcompensation in the way that it is going to bestructured?Michael Fallon: Thank you very much, MadamChairman. I am sorry that you have had a longafternoon.Chair: We understand that you have too.

have some money from your compensation scheme”it doesn’t add up?Gareth Stace: I think we would need to think aboutthose allowances and what it has done to thatcompany in terms of I have heard the term “windfallprofits”. We need to think, Tata Steel is in a sectorthat since 2008 has lost one in three of its employees.It is a sector that is suffering in economic terms verybadly and therefore I can’t see that in those sectors—and I can’t speak for Tata at all—they are swimmingaround with lots of surplus allowances they don’tknow what to do with. We know that many companieshave sold those allowances potentially in part to keepthemselves afloat, so I suspect Tata would be thesame.Chair: I am afraid I am going to have to bring thesession to a close. We know it is a complicatedtechnical issue. Please do feel free to give furtherevidence if you wish to. Thank you very much indeedfor your attendance.Sitting suspended for a Division in the House.On resuming—

Michael Fallon: That is the way of it, and can I alsoapologise for the absence of the Minister at theDepartment of Energy and Climate Change. I amaccompanied here by Paul Drabwell, who is Head ofDomestic Energy and Climate Change at myDepartment, BIS, but also by Niall Mackenzie, whois the Deputy Director of Industrial Energy Efficiencyat DECC, so I am hoping they will help me out if thequestions get too technical.On carbon leakage, yes, I think you must be right,hard data are difficult to obtain. We have drawn onthe range of published carbon leakage studies,including some that have been commissioned byDECC, looking at the risks to various UK sectors andacross the EU, and our own data from nationalstatistics and we have looked at data supplied by theindustry. But I accept very hard data are difficult toobtain. We have to try to understand the investmentdecisions that companies have made and why theyhave made them, and the further difficulty of courseis that much of that information is commerciallysensitive and they don’t want to share it with us incase it is then shared more widely. Finally, I supposeI should say that when companies finally make thedecision to shift their investment or operations, it willusually be done on the basis of several factors, notjust the one factor.Chair: I suppose this is the difficulty, isn’t it?Michael Fallon: This is the difficulty.

Q39 Chair: I think that is very much an issue forBIS and also a linked issue for DECC, because howdo you quantify those other short, medium and long-term costs that businesses have when making



4 December 2012 Rt Hon Michael Fallon MP, Paul Drabwell and Niall Mackenzie

investment decisions and not relying exclusively onthe issues around carbon leakage? I think that it isbecause it has not been quantified to the extent itneeds to be, that certain sectors particularly feelperhaps quite hard done by.Michael Fallon: We may come to some of thespecific sectors. It would be interesting to have theCommittee’s view on which sectors you think havebeen particularly hard done by.

Q40 Chair: I would name my constituency interestspossibly and declare them, but certainly the ceramicssector.Michael Fallon: Perhaps I could say something aboutceramics, but you did ask a question just before thatas to whether only 48 responses really were sufficient.I think it is fair to say the call for evidence didn’tprovide us with a definitive answer, but it certainlyhelped to steer our approach. Obviously it might havebeen better to have had more responses. Our intentionwas to try to gather evidence as to how an increase inelectricity prices drives investment decisions and toexplore our thoughts on how the scheme might beadministered, so we did get some useful evidence butI wholly accept that it looks relatively limited.

Q41 Chair: Given that it was only 48, are thereattempts being made to set up bilaterals with peoplewho perhaps did not respond, or do you know thereasons why perhaps there was a reluctance torespond? Is it because of these other factors?Michael Fallon: I gave the reasons of commercialsensitivity and other factors affecting investmentdecisions. DECC called for evidence themselves. Ithink DECC held a summit last year at which GregBarker, the Minister, asked for more detailedinformation. That helped a bit. DECC did a report onthis, and there is going to be an updated assessmentaccounting for some of the more recent policydecisions, like the levy control framework that isgoing to be published in due course. But I fully acceptthat the picture is not a complete one and it wouldhave been better if it had been more complete.

Q42 Chair: It has been put to us that maybe somecompanies have been a bit reluctant to share thatinformation because they might end up with a betterdeal. Is there any truth in that?Michael Fallon: If they don’t give us any data at all,they are unlikely to get compensation, so that is theother side of the coin.Do you want me to answer the question on ceramics atthe moment or do you want me to deal with that later?

Q43 Chair: You did ask about specific sectors, and Imentioned that as one. I do declare a constituencyinterest and obviously will be impartial in all of this,but it would be interesting to hear your take on that,given that we had them before us just now.Michael Fallon: When I first came to this, I had alook at it and I was told that in ceramics the issue isnot so much the use of electricity, it is the use of gas,where prices obviously have been favourable. I amnot persuaded yet that is the whole story and I wouldlike to look a bit harder at maybe whether one of the

subsets of the ceramics industry would come withinthe scope of the scheme, and that is something youmay be considering as well. I administer some of theother funding streams and so I have also been lookingat whether there are other ways of helping the industryor helping the leading companies, or indeed theleading areas in it. There were a couple of bids, Ithink, that were selected under a second round of theRegional Growth Fund and at least one was selectedunder the third round of the Regional Growth Fundthat was announced on 19 October. My otherresponsibilities include the Local EnterprisePartnerships, and of course your particular area ofStoke is one of the candidates for the second round ofCity Deals.Chair: I think I am going to be in huge trouble withmy colleagues if we concentrate on Stoke, so wewon’t go down that route at this stage.Michael Fallon: But let me just say that I am awareof the issues facing the ceramics industry. I think it isworth another look, without committing to anything,but I am certainly prepared to do that.

Q44 Simon Wright: Government-commissionedinternational comparison of the indirect cost of energyand climate change policies shows that companies inthe UK will face the highest incremental impacts ofthose countries reviewed. I wonder if you couldcomment on the limitations and assumptions made inthe methodology behind this comparison?Michael Fallon: I might ask officials to help on that,but the compensation on which we are consulting atthe moment addresses the Carbon Price Floor and theETS indirect costs only. As we develop the energyindustry’s exemption from the EMR, we willobviously publish more detail on the specific impacts.Would you like to add to that?Paul Drabwell: Yes. On the international comparisonreport, what that report looked at was the policy costsin the UK going forward, so that includes CarbonPrice Floor, EU ETS and also the cost of renewablessubsidies through both the renewables obligation andthe Electricity Market Reform. It looked at thosepolicies in the UK and it looked at similar policies inother countries, and one of the assumptions it madeand one of the things it included is the exemptionsthat exist in other countries as well. That is why youheard some people talking earlier about Germanyindustries. That is why Germany looks much morefavourable, because it includes the exemptions fromthe costs renewables that exist in Germany, hence thedifferential. But what you can’t do, of course, ispredict what is going to happen to future policies inthose countries so, like any report, it has itslimitations.

Q45 Simon Wright: How much of the indirect costimpact will be offset by the compensation package?Is it possible to say what sort of percentage of costscompanies will typically receive?Michael Fallon: We think that the combined steps ofthe price floor, ETS and the EMR will probablyremove about 50% of the policy cost by 2020. Thatwould certainly bring the costs more into line withother countries but, as Paul has said, we can’t predict




what policy changes those other countries are likelyto make between now and 2020.

Q46 Simon Wright: DECC has said that they willexempt energy intensive industries from the costsarising from Electricity Market Reform. Have youlooked at how much an average domestic electricitybill will increase as a result of this exemption?Michael Fallon: No. As we develop the proposal forthe exemption, we are trying to be clearer about thedetails of the potential impact on consumer bills but Ithink they are going to be relatively small. We willcertainly be looking at the impact, but we have notdone that yet.Chair: At what stage would you be looking to fill insome of the detail of that?Michael Fallon: As we develop the proposal for theexemption, and that will be in the next few months,there are lots of pieces to put together, not least yourown report.

Q47 Dr Offord: How did you determine the overallsize of the spending envelope for the compensation?Michael Fallon: We drew on the evidence we hadfrom the various carbon leakage studies, we looked atdata, national statistics, and we looked at data that hasbeen supplied direct to us from the industry. We madean estimate of various costs based on the price floortrajectory and we made an early assessment of whichsectors were most likely to be in need, based on theearly draft Commission proposals. It was an estimate,£250 million, and we may be right or we may bewrong but we think it should be roughly around there.

Q48 Dr Offord: In the consultation document, it saysthat you will consider compensating additionalsectors. If that is the case, and let us presume that the£250 million is fully committed, where is that moneygoing to come from?Michael Fallon: We don’t know yet exactly how themoney will be spent. We are not anticipating anysignificant under or overspend. It is a two-yearpackage and we cannot again commit to anythingbeyond that, but there is logic to the package and theremay well be logic to that package continuing afterthat. But we think if we have to add anything, anyparticular subsector, I think I would rather rest it onrather than a whole new sector. If we have to add anew subsector and there is a case for doing that, wethink we can accommodate that within the £250million ceiling.

Q49 Dr Offord: I do have a third question. TheAutumn Statement showed there was £100 millionworth of savings that were to be found in 2013–14and 2014–15 to fund the compensation, but previouslywhen Greg Barker had spoke to this Committee hesaid that savings were from underspends from2011–12 and no future budgets would be used. Whichwould be the correct assumption?Michael Fallon: I think he made it clear that DECC’sfinancial contribution for the CSR period was paidfrom one financial year. I think he has subsequentlywritten to you confirming that DECC funded thispackage from a combination of contingency funds and

additional energy efficiency loan repayments in excessof the amounts originally included in our plans, butperhaps DECC might like to say something about that.Niall Mackenzie: I think what the Minister has saidcovers it in terms of what DECC’s contribution was,and obviously BIS and the Treasury’s funding isspread over the two years, so there is no sleight ofhand or massaging of figures here.Dr Offord: I wouldn’t expect there to be.Niall Mackenzie: It is just the way that Governmenthas found the money to put the package together thatwe have agreed between the Departments how to getthe £250 million spread across the two years.Chair: Thank you. Just moving on then to the actualcompensation calculation itself and how complex it is,Peter, you were—

Q50 Peter Aldous: Yes, I would like to put this one,Chair, if that is all right. Thank you. With regard tothe compensation calculation, which is complex, haveyou piloted the scheme with business to see how itworks and to test the verification procedures?Paul Drabwell: I can talk to that, because the firstthing to say about the formula for both Carbon PriceFloor and ETS compensation—and indeed theeligibility—is that it comes from largely theCommission, so we mirror what the Commission hasdone on this and we mirror the Commission’s work,and hence why the formula is the way it is. If it wasto be any different, it would be very difficult to getstate aid clearance on this. We are testing it withcompanies. My team have met with a number ofsectors and a number of companies to work thisthrough since we published the consultation to try towork out whether there are any significant issues withthe way we have gone about it.

Q51 Peter Aldous: Thanks for that. You say youhave very much copied the Commission, but theCommission criticised your scheme a little bit. Youused a lower carbon emission factor than they allow.Is this going to disadvantage UK companies comparedto European competitors?Paul Drabwell: Firstly, it is not the Commission thathave criticised us on that. There are a number ofenergy intensive industries that are concerned aboutus using that emissions factor because it would lowerthe amount of aid that goes to those energy intensiveindustries. It is based on the fact that what often setsthe wholesale price of electricity in the UK is themarginal plant, that is the last piece of technologygeneration that comes on the grid, and that is oftengas. Gas has a lower carbon intensity and thereforethe argument runs that that could be the amount ofcarbon price or ETS costs that are passed through tobusiness. For example, we think it reflects whatdomestic consumers and industrial consumers mayface. However, there are arguments counter to that.We are listening, and that is why it is a consultationquestion. As I say, we are open and listening to that.

Q52 Peter Aldous: Do you think UK companies willbe disadvantaged compared to their Europeancompetitors or not?




Paul Drabwell: All I can say is we are listening tothe evidence. It depends what you believe in terms ofwhether that is reflective of the costs.Niall Mackenzie: I think the issue is, are wecompensating people for the costs they face or is itsome other kind of metric? If the electricity price theypay is set on the marginal price set by gas, then thecompensation or the taxation of gas through the EUETS or the Carbon Price Floor is what they need tobe compensated for, not for other issues. That is theissue that we are very keen to discuss with industry.A number of companies and sectors have said theydispute the assumptions we have made about the waythey set the price or the price they pay, so if they cangive us the evidence for that obviously we will listento it and understand it fully to make sure they arecompensated for the costs that they are facing, notsome arbitrary figure that is plucked out of the air.

Q53 Peter Aldous: Thank you for that. On atechnical point, we have been told that you have yourcarbon emissions factor wrong, because the emissionsvalue is already the marginal cost. How would yourespond to that criticism?Niall Mackenzie: The Commission’s figure is basedon the average cost across the average carbon contentof the whole grid in the UK and, as Paul explained,what we are saying is that the value that thecompanies need compensation for is the carbon costin the electricity which would set the market price. Ithink a figure of something like 0.41. We are sayingthat that is what is reflected in the prices companiespay, the market price, not an average of annual carboncontent of grid consumed by UK companies.

Q54 Peter Aldous: Thank you. Large cement andsteel companies are benefiting from large stocks ofEmissions Trading System allowances. Is it possibleto add further criteria to your compensation schemeso that this is taken into account and you avoidcompensating firms when they are profiting from theemissions allowances?Michael Fallon: I think we need to be careful todistinguish here that they are profiting—if they areprofiting—from free allowances to cover their directcarbon emissions not their electricity costs. I don’tthink there is a direct correlation between what theyare gaining on ETS and what they might well gainfrom our particular scheme. Do you want to add tothat, Niall?Niall Mackenzie: Entirely right, Minister. I think thatis the point that sectors and individual companies mayhave a lot of surplus allowances, quite often from theirown efforts as well as from the recession—although Iwould not dispute the broad figures that Sandbag werequoting earlier—but that is for their direct emissions,whereas we are looking at the compensation for theindirect costs that are coming through the electricityprice. So there are two separate things. If we try tomake a link between the two, first of all we wouldbe taking away property rights that these companieslegitimately have for these allowances and we wouldalso run the risk of being very unfair and arbitraryin trying to make a link between electricity use anddirect emissions.

Q55 Caroline Lucas: How do you have propertyrights on the emissions that were not paid for, whichwere given away for free for the permits?Niall Mackenzie: As you know, the EU EmissionsTrading System was set up as a market-basedinstrument to give companies certainty of investment,and taking away allowances that—

Q56 Caroline Lucas: If you are given a freeallocation, I don’t see why that gives you a propertyright over it, and if you look at it more broadly aroundwhat we are doing with public money, then I thinkthere would legitimately be question marks raisedabout a company that on the one hand is makingsignificant windfall profits as a result of free allocationof the permits and at the same time is then also beingcompensated under this scheme. I appreciate there isa difference between direct emissions and indirectemissions, but nonetheless, if there is a case whereyou can demonstrate it is exactly the same companythat is benefiting from both, it seems perverse.Michael Fallon: But they may have legitimatelybenefited from the first one and their excess may bedue directly to their own carbon reduction efforts. Isthat not legitimate?

Q57 Caroline Lucas: If you have £1 million, as thecase of Tata in the UK, we were told earlier 31 millionfree allowances essentially that are not being used,then that seems to me to be—Michael Fallon: But they might be used because oftheir own success in reducing carbon.

Q58 Caroline Lucas: Why aren’t they selling themthen?Michael Fallon: They may be holding an excess andthey choose to hold them, but should they bepenalised for that?

Q59 Caroline Lucas: I would be fascinated to seesome demonstration of evidence that that 31 millionallowance was as a direct result of Tata’s energyefficiency. If you can demonstrate that, I would bedelighted, but I suspect it is more to do with the factthat the ETS system simply isn’t working, but thatthese allowances were given as free allocation ratherthan being auctioned and therefore we have given awindfall profit to energy-efficient companies.Michael Fallon: I think we are probably going todisagree on the principle, and I want to be clear I amnot commenting on whether Tata’s excess was due totheir own carbon reduction efforts at all. I simply saidthat might be a reason why a company had an excess,and I don’t think they should be penalised for that. Doyou want to add to that, Niall?Niall Mackenzie: I think the only thing to add is thatthere may an issue about the supply of allowances inthe EU ETS, and this Committee may want to look atthat in future proposals from the Commission. I thinkall I am saying is that I would question whether it issensible to take things away from a company to fix aproblem with the system when maybe you want toadjust the free allocation going forward or there arechanges to the system.Caroline Lucas: I want to do that too, don’t worry.




Niall Mackenzie: But I think that is the correct wayof doing it rather than arbitrarily stepping in withwindfall taxes or taking allowances away, butobviously that is an issue for Ministers.

Q60 Caroline Lucas: I wanted to ask about why youdecided to particularly use the mechanism of a rebate,and in particular what consideration you might havegiven to using the money instead, for example, toprovide loans for energy efficiency improvements orinvesting in innovation. Unless those things happen,we are going to be having a blank cheque to energyintensive companies for many years, which doesn’tseem very sensible. What consideration was given tousing the money for—Michael Fallon: Last year we explored a number ofoptions on this after it was announced by theChancellor, but the compensation is for the indirectpass-through costs of both the ETS and the CPF, sowe have limited options for addressing those costs.The Commission published its own guidelines for howmember states could compensate for the indirect costsof ETS and to minimise the burden on industry andsupport the state aid case, because all this has to beapproved in the end by Brussels, and we decided tofollow a similar approach for CPF compensation. Doyou want to add to that, Niall?Niall Mackenzie: Again, I think it is worth makingclear—and there is a section in the consultationdocument about whether we should have hadadditional environmental requirements with thecompensation package—this is compensation forcosts industry face. It is not a grant, it is not freemoney. It is the fact that they are facing theseincreased costs.

Q61 Caroline Lucas: Presumably you want them tomake, over time, a transition to less carbon-intensiveforms of energy generation, otherwise why would youeven have a Carbon Price Floor? It is not there to—Niall Mackenzie: But I think that is why we have thisin the context of a lot of other policies. Virtually allthe industries that will be eligible for compensationunder the proposals we have made already haveClimate Change Agreements with the Department,with DECC, here they are signing up to energyefficiency improvement targets until 2020 in return fordiscounts on the Climate Change Levy. A lot ofsectors are making some quite big commitments,which shows there is still a potential for energyefficiency and they are committed to do their utmostto meet those energy efficiency improvements. So wecertainly did not feel it was necessary to put extraburdens on companies who are getting compensationfor costs that they are facing because of the EU ETSprice and the Carbon Price Floor in addition to thecommitments many of these industries are alreadymaking.

Q62 Caroline Lucas: What about the bits of theindustry that are not already making those effortsthrough the existing mechanism that you weredescribing with DECC and the—Niall Mackenzie: I think one of the interesting thingsto do when we have started funding sectors is to see

whether there are any who are in that position whoaren’t already committed.Caroline Lucas: You don’t think there are?Niall Mackenzie: I would doubt it. I never say never,but one of the things that we would look at in termsof future spending reviews and continuing the shapeof the package is whether there are people who aremaking no effort. But remember these are energy-intensives or electricity-intensives that are using anawful lot of electricity, so we would expect them tobe doing their utmost to improve energy efficiency.As some of the previous witnesses said, the issue nowfrom any of these sectors is what innovation and whattechnology game changer there is, and that issomething on which we are very keen to work withindustry to see what more they can do.

Q63 Caroline Lucas: I guess on that point, and ifyou were listening to the earlier sessions, you willhave heard that there was a question on the GreenInvestment Bank and the role that the GreenInvestment Bank might play as it evolves in terms ofassisting industrial energy efficiency.Michael Fallon: As you know, it was set up finallylast month, fully operational, and I hope you welcomethat. It will be investing in industrial energy efficiencyprojects. That is a priority area for the bank, as youmight expect, and I think it has set aside roughly £100million for investment in that particular area, so it willbe a variety.

Q64 Caroline Lucas: The last question is Iunderstand the CBI has made some recommendations,for example about energy intensive industries beinghelped to form collective purchasing agreements toget better prices or indeed about whether or not theGovernment has explored how energy intensiveindustries could reduce their power consumption atcertain times to help balance demand in the electricitynetwork. Has any consideration been given to thoseoptions?Michael Fallon: We certainly would encouragecollective purchasing of energy by industry, but thatwould be additional to the compensation through theTF and CPF. Do you want to add to that?Niall Mackenzie: Yes. Reference was made by theprevious witnesses to the Exeltium process in France,where there is a deal between a nuclear generator anda collection of industry companies. We have beentalking in DECC directly with a wide range of theenergy intensive users, helpfully with the auspices ofJeremy Nicholson’s Energy Intensive Users’ Groupand through the Green Economy Council, to see thelevel of interest. Tim Stone from our Office of NuclearDevelopment has been trying to give details of whoindustry could talk to. We can’t step in and do thenegotiation because it is a commercial negotiation, butwe are very happy to try to help facilitate this. Thusfar, I think competitive tensions between industrieshas prevented them from signing up to a collectiveagreement, because some of the larger users feel thatthey can get a better deal with their larger purchasingpower, but if a consortium of industry could beformed I am sure the Department will do what it can




to help them get the right people on the other side ofthe table to do a deal.

Q65 Chair: Finally, in terms of the dangerousclimate change that we wish to avoid and havelegislated to avoid, given that we don’t have theEnergy Minister here with us as well, I wonder howmuch there is a joined-up approach between the twoDepartments, not least in respect of the Treasury aswell. Given that industry is looking for certainty interms of long-term investments and also looking fortransitional arrangements, I am interested to knowwhat co-operation or common ground or, if you like,problem solving there has been between the twoDepartments and with the Treasury to make sure thatwe are on course with the carbon reductions that needto be made.Michael Fallon: We do co-ordinate these things.Obviously, our responsibility in BIS is to look at itfrom the industry point of view and the Departmentof Energy looks at it from the energy point of view.We have just inherited in my Department a Ministerfrom the Department of Energy and Climate Change,Lord Marland, who brings his particular expertise andpolicy experience from that Department, and I thinkwe are working even more closely together. Forexample, the Nuclear Industry Working Group is nowto be co-chaired by the Secretary of State for Energyand Climate Change and myself from Business, andwe are looking together at, for example, thetechnological developments in the supply chain sideof offshore wind investment and so on. So we areincreasingly working together with the Departments.Are we working successfully with the Treasury? Iwould like to think we are, but you can always bemore joined up.

Q66 Chair: In terms of how policy is translated withsupport for industry—I am looking now particularlyat your own Department and looking at BIS—it seemsto me that there is going to have to be decarbonisationwithin the energy intensive industries at some stageso therefore the issue is how we get to where we needto be. We have heard earlier on about the transitionalarrangements and the particular issues that certainsectors have. How is the Government intending tostart to go down that route of decarbonisation ofintensive users of the energy sector?Michael Fallon: I think you are assuming we are atthe start of this process. A lot of industries are alreadymaking enormous efforts to decarbonise theirprocesses to become more energy efficient, and therecomes a point beyond which they can’t reduce further,and we also have to make sure they remaincompetitive. Do you want to add anything, Paul?Paul Drabwell: No, exactly, I think that is a key point.The other point I would make is that electrification isone of the key ways in which these industries candecarbonise. For example, in steel, electric furnace, ifyou move across to that, most of your carbonemissions are tied up in the grid so it depends how

clean your grid is. That is why we need to be carefulnot to put too much pressure on the price of electricityand why this exists. The other point is we did do somework jointly with DECC on looking at some energyintensive sectors and looking at what they might needto do in the future.

Q67 Chair: What has happened to that?Paul Drabwell: We did that, but when the CarbonPrice Floor was announced and the EU ETScompensation was brought forward by theCommission, we very much focused our efforts onthat because we realised how important that was.There is now some work being done in DECC, withmy team in BIS, looking at sector roadmaps forenergy efficiency in particular sectors. Niall may wantto talk a little bit more about that.

Q68 Chair: Does that come under the energyintensive industry strategy?Paul Drabwell: Basically, the thing I referred toearlier was the energy intensive industry strategy, butthat work can feed into this decarbonisation work. Wewill be working with the Green Economy Council,Energy Intensive Industries Group to work out whatthat thing should look like.Chair: Just so I am clear, is that energy intensiveindustry strategy still ongoing?Paul Drabwell: What I am saying is some work wasdone and it will feed into—

Q69 Chair: So has it finished? No.Paul Drabwell: No, it hasn’t finished at all. We intendto do something with DECC in the New Year, andwhether it is called an energy intensive—

Q70 Chair: Right, and who is leading on that?Paul Drabwell: The DECC team are leading on that,but it is not necessarily going to be called an energyintensive industry—Niall Mackenzie: To reassure the Committee, we seea lot of scope in particular in decarbonising heat. AsPaul said, moving to electricity is long term, but thereis scope for a lot of decarbonising heat. Our heatstrategy was published in March and we will have tofollow that up, but we recognise, not least fromtalking to the sectors a lot, that we need to work outhow we get from 2030 to 2050 for these sectors. Ourcarbon plan published in December set out the rangeof scenarios. We need to colour that in in a lot moredetail and help industry get there. It is not about ourstanding back in Government and saying, “You shoulddo this”. It is, “How can we help you do it?”Chair: I am mindful that the Division is being calledyet again, so I do need to bring this session to an end.Thank you to all three of you for coming along and Iapologise again for a shortened session. I hope thatthe conclusions that we have will contribute, as yousuggested, Minister, to the long-term policy that theGovernment comes up with.

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Written evidence

Written evidence submitted by the Wood Panel Industries Federation

The Wood Panel Industries Federation represents all companies based in the UK which produce wood panelproducts. The wood panel industry has been recognised as being at risk of carbon leakage by the EuropeanCommission, and is designated as a NACE-4 sector. However, the sector was not included in the Commission’slist of sectors to which compensation can be granted by Members States.

WPIF believes that the criteria for inclusion in the compensation scheme are overly restrictive. The schemeis penalising those sectors which are known to be energy intensive by not including them on the list of eligiblesectors. For example, the wood panel industry’s energy intensity is not dissimilar to the paper industry—however the paper industry is included in the scheme and the wood panel industry is not.

The Commission’s criteria have taken a generalised view of the European industry as a whole. WPIF believethe UK Government should examine those sector’s considered at risk of carbon leakage but not included inthe Commission’s list, and assess the financial assistance which can be provided to these sectors.

The Commission states that they may carry out a review of the eligibility guidelines every two years. Thewood panel industry will again make a case for its inclusion in these guidelines at that point. However, it isessential that the UK compensation scheme is established in such a way as to allow it to be immediatelyupdated once new schemes are included on the list, to allow companies in those sectors to start receiving thebenefit of the compensation scheme.

22 November 2012

Written evidence submitted by the Government

Introduction

1. The UK Government is committed to pursuing its ambitious approach to tackling global climate change.The UK has a range of policies in place, underpinned by the Climate Change Act which includes our legallybinding target to reduce greenhouse gas emissions by 80% by 2050. In addition to tackling climate change,our energy and climate change policies can help UK businesses to manage risks, such as those from increasingand fluctuating fossil fuel prices; increase resilience, such as to the impacts of climate change and seize theopportunities from new and emerging markets, both nationally and internationally.

2. Industrial energy efficiency is also an important part of the Government’s approach, being good for growthand good for competitiveness. It aids energy security and will enable us to meet our targets for reducing carbonemissions, in particular our target for 2050, more cheaply. Because a number of barriers exist to the take-upof cost-effective energy efficiency measures, the UK Government has therefore targeted policies to encourageindustrial energy efficiency and carbon reduction.

3. However, in addition to the benefits and new market opportunities which will emerge from the movetowards a lower carbon economy, for some sectors there will be transitional costs and risks. In particular, theGovernment considers that it is important to ensure that the competitiveness of UK-based electricity intensiveindustries is not compromised. These industries are critical to growth of the economy and, in many cases, willbe providing the components for renewable energy generation or the materials required to lower the carbonintensity of consumer products.

4. For this reason, in the 2011 Autumn Statement, the Chancellor announced that the Government wouldcompensate those electricity-intensive industries most at risk of carbon leakage to help offset the indirect1

cost of the Carbon Price Support Mechanism (CPS) and the EU Emissions Trading System (EU ETS), subjectto state aid approval from the European Commission. The Government also announced that it will exploreoptions for reducing the impact of electricity costs on electricity-intensive industries as a result of electricitymarket reform policies where this has a significant impact on their competitiveness.

Background

5. The Department for Business, Innovation and Skills (BIS) has been allocated £210 million for the rest ofthe spending review period to cover indirect CPS and EU ETS compensation. These will compensate for costswhich businesses will start to face from next year (electricity generators will face ETS costs from January2013 and CPS costs from April 2013). With a finite amount of money to distribute, we have sought to developappropriate criteria to identify who should be eligible.

6. In March, the Government published a call for evidence. The purpose of this was to improve the evidencewe have regarding electricity usage in industry across the UK. In particular, we sought information and dataconcerning the electricity and trade intensity of companies, the effects of increased electricity prices on1 Indirect costs arise when electricity prices increase as a result of fossil fuel based electricity generators passing on policy costs

to their customers.

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investment decisions, and views on how criteria might be applied. We received 48 responses, which providedstrong evidence from a few respondents on the need to take action on the risk of carbon leakage and delivercompensation to companies at risk. However, the responses provided no clear consensus on which metricsshould be used to assess eligibility for compensation or the level at which eligibility should be assessed (ie atsector, company, site or process level).

7. The Call for Evidence and the Commission’s work on eligibility for indirect EU ETS compensation hasinformed our proposed approach which is set out in the consultation published in October.

8. A number of energy and climate change policies will increase the price of electricity for industrialconsumers in the short and medium term (see Chart 1). In particular, the costs from the EU ETS, the CPS, andlow carbon generation subsidies (Electricity Market Reform and the Renewables Obligation) place costs onenergy companies. These costs are subsequently passed on to consumers through increased electricity bills.

Chart 1

ESTIMATED IMPACT OF ENERGY AND CLIMATE CHANGE POLICIES ON AVERAGE RETAIL GASAND ELECTRICITY PRICES FACED BY LARGE ENERGY INTENSIVE USERS2

Source: DECC 2011

FITs

EMR support cost

RO support cost

EU ETS and CPF carbon price impact

CCL

Merit order effects

Base electricity price

Base gas price

Final eletricity price Upper bound)

Final electricity price (Lower bound)

175

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75

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0

-25

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age

larg

e en

ergy

inte

nsiv

e us

er g

as a

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ectri

city

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es (R

eal 2

010

£/M

Wh)

Gas Electricity Gas Electricity Gas Electricity

2011 2020 2030

9. This additional increase in electricity price can create a competitiveness issue for the most electricityintensive sectors with sites in the UK, many of whom will face a significant increase in costs when comparedto sites in other countries. While electricity is a key input to many industrial processes in the UK, other energyintensive users are more gas intensive. The issues facing gas-intensive industries are somewhat different, withenergy and climate change policies having very little effect on the price of gas.

10. BIS commissioned a study into the effect of Government policy costs on the price of electricity facedby different industrial sites across the world—see below.

2 Taken from the Government’s 2011 report Estimated Impacts of Energy and Climate Change Policies on Energy Prices andBills. Available online at: http://www.decc.gov.uk/en/content/cms/meeting_energy/aes/impacts/impacts.aspx.

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Chart 2

IMPACTS ON ELECTRICITY PRICE (£/MWH) OF ENERGY AND CLIMATE CHANGE POLICIES3

IN SELECTED YEARS4

£10

£5

£0

£5

£10

£15

£20

£25

£30

£35110251020202

110251020202

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110251020202

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110251020202

110251020202


Other

ET

RE

EE

GHG

11. Based on countries’ current policies, the study highlights that, for the most electricity intensive industrialusers in the UK, policy costs affecting the price of electricity may be higher over the medium term whencompared with other countries existing plans, without Government intervention to alleviate some of these costs.It should be noted that the above graph focuses on the estimated policy costs impact on retail electricity prices.The wholesale cost component is not included—current UK “base” electricity prices (ie excluding policy costs)for energy intensive industries are within the range of the other countries. The chart also takes into account thevarious cost exemptions that exist for the industrial sector in other countries and assumes no cost exemptionsfor industry in the UK. As such, the existence of compensation for the costs of EU ETS and Carbon PriceSupport would improve the outlook for the UK-based EIIs, as would any future policies which may reduce theexposure to other policy costs. It is worth noting, however, that a number of energy intensive users source asignificant amount of their electricity through on-site generation, the cost of which will not be subject to manyof these other policy costs. In addition, there remain significant uncertainties as to the future policy cost impactsin other countries.

12. Relatively high electricity costs will make it difficult for UK-based energy intensive industries to competeat international prices, thereby exposing them to the risk of carbon leakage—ie the prospect of an increase inglobal greenhouse gas emissions when a company shifts production outside a country because they cannotpass on the cost increases induced by climate change policies to their customers without significant loss ofmarket share.

Characteristics of Energy Intensive Industries

13. Energy Intensive Industries5 employ around 2% of the UK’s workforce (around 600,000), contributingaround 4% of the UK’s GVA6. Many of industrial sites in the UK are based in regions of relatively highunderemployment and low standards of living. As such, their continued operations are vital to the economiesof those regions, with foregone jobs often difficult to replace.3 GHG—GHG policy measures eg EU ETS and CPF; EE —energy efficiency policy measures; RE—renewable energy policy eg

RO and EMR; ET—energy taxes4 Source: ICF, An international comparison of energy and climate change policies impacting energy intensive industries in selected

countries—Figure 1-b, available at: http://www.bis.gov.uk/assets/BISCore/business-sectors/docs/i/12–527-international-policies-impacting-energy-intensive-industries.pdf

5 Defined as those industries where energy costs are greater than or equal to 10% of gross value added6 Energy Intensive Industries data 2009–10



14. Energy intensive industries are frequently owned by international companies and are sometimes verticallyintegrated. The companies often also own energy intensive business sites outside the UK. This can mean thatUK management has to compete internally over a limited pot of available capital for new or additionalinvestments. The ability to raise the capital to invest depends on projects being able to deliver risk adjustedrates of return above those from other investment opportunities available to the firm.

15. Businesses will often use hurdle rates of return and defined pay-back periods in making their investmentdecisions. For example, projects relating to different internal sites of a multi-national business will need tomeet a particular “hurdle rate” to enable them to successfully bid for finance. Energy costs will be one factorinfluencing hurdle rates and investment decisions. Of course, firms will also take into account issues such aslabour costs, stability of the tax regime—including corporation tax—and proximity to markets and planningprocesses/systems. Where UK costs rise relative to other countries, and this cannot be passed on to customers,the business’ required hurdle rate of return becomes more difficult to reach for UK-based projects relative tothe sites based in other countries.

European Commission & State Aid

16. The UK’s intention to compensate energy intensive industries for the indirect costs of both the EU ETSand the carbon price support mechanism is subject to state aid approval from the European Commission. UnderEU law, a Member State must notify the European Commission of its plans to grant new aid and must not putthe aid into effect before the Commission has authorised it. The European Commission has sole competenceto decide whether state aid is permissible and they will consider whether it is necessary to achieve a particularobjective, limited to the minimum amount to realise that objective and that overall distortions to competitionare minimised and outweighed by the positive effects the aid will have.

17. However, the EU ETS Directive states that from 2013 Member States may choose to compensate sectorsat significant risk of carbon leakage as a result of indirect EU ETS costs, providing schemes are designedwithin the framework set by the European Commission. The Commission adopted state aid guidelines7 forthis purpose in May 2012. The guidelines list the sectors deemed to be exposed to significant risk of carbonleakage due to indirect emissions costs and provide details of the maximum levels of compensation that canbe made available to them.

18. The UK Government has submitted two pre-notifications—for compensation of the indirect cost of theEU ETS and Carbon Price Support mechanism. It is likely that the Commission will approve indirect EU ETScompensation, provided we can demonstrate that our approach falls within the requirements in theCommission’s published guidelines. However, CPS does not have an approval framework of this type, so it ismore difficult to assess the likelihood of the Commission approving compensation for the costs of the CPS.Nevertheless, we consider that the UK has a reasonable case for this compensation scheme, which is analogousto the Commission-backed scheme for EU ETS compensation.

19. The process is usually that any doubts that the Commission have about the scheme will need to beresolved during pre-notification discussions ahead of final notification being submitted which can then quicklybe approved. Whilst we cannot be certain about timing of the state aid clearance process, we are workingtowards a final decision by the Commission by the summer of 2013—shortly after businesses begin to face theindirect costs from ETS and CPS.

The Proposed Approach

20. Energy and Climate change policies impact mostly on the price of electricity rather than the price ofgas. The Government’s focus is on mitigating some of the cumulative costs of Government policy faced bythese industries. EIIs will face many other issues as a result of operating in internationally competitive markets,or as a result of recession/reduced demand, or even the price of gas-generated heat. This package is not intendedto address any of these issues.

21. As such, the EU ETS and Carbon Price Support compensation package is focused on sectors which areelectricity intensive and trade intensive—ie operate in internationally competitive markets. The table belowsets out the top 20 electro-intensive sectors in the UK based on information collected by the Office of NationalStatistics. It ranks sectors according to the size of their electricity costs as a percentage of gross value added(GVA)8.

7 http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2012:158:0004:0022:EN:PDF8 Data comes from DECC’s Energy Consumption UK and the Annual Business Inquiry. 2007 is the most recent year for which

a detailed sectoral breakdown of energy consumption is available.



Top 20 electro-intensive sectors

Electricity costs as a percentage ofRank Sector GVA (average 2004–07)

1 Aluminium 552 Electric arc steel9 373 Fertilisers and nitrogen compounds 364 Paper and paperboard 355 Throwing and preparation of silk 326 Industrial gases 317 Inorganic basic chemicals 308 Non-wovens and articles made from nonwovens 229 Household and sanitary goods 2010 Preparation and spinning of worsted-typefibres 1811 Clays and kaolin 1712 Veneer sheets, plywood, fibreboard etc 1713 Cement 1614 Hollow glass 1515 Iron and steel10 1516 Copper 1517 Synthetic rubber in primary forms 1418 Refineries 1419 Man-made fibres 1420 Sewing threads 13

22. In line with the Commission’s guidance, we propose that, in order to be considered for indirect EU ETScompensation a company must be in one of the above sectors. However, we are aware that within electricityintensive sectors, there will be some processes which use much less electricity and, as such, will be much lessexposed to electricity price increases. In order to ensure that compensation is appropriately targeted, we proposeto apply an additional filter—that companies applying for compensation must demonstrate that their carboncost (EU ETS and CPF) in 2020 will amount to 5% of their GVA. This is based on the quantitative test whichthe Commission applied when developing the eligibility list.

23. With regard to eligibility for CPS compensation, it has been difficult to draw strong conclusions fromthe call for evidence regarding where the risk of carbon leakage impacts is greatest—ie we understand that itis those industrial sites which are both electricity intensive and trade intensive which are placed at risk ofcarbon leakage from increases in electricity prices, but at what levels of electricity intensity and trade intensitywill indirect costs represent a serious carbon leakage risk?

24. Given this, we consider that it makes sense for the UK to base its approach to CPS compensation on theCommission’s approach to indirect EU ETS compensation for the following reasons:

— The Commission has undertaken considerable analysis in assessing which sectors are atsignificant risk of carbon leakage from indirect EU ETS costs.

— The CPS effect is analogous to indirect EU ETS costs, largely affecting the same sectors in thesame way.

— Administering the two schemes—CPS and EU ETS compensation—in broadly the same waywill minimise burdens and cost for businesses and Government.

The recently published consultation document11 sets out the Government’s proposal for eligibility andadministration of the scheme. A summary of the eligibility and methodology for assessing compensation isavailable in the consultation document.

Energy Efficiency

25. In designing compensation for the indirect costs of EU ETS and CPF, Government has been keen toensure that environmental objectives are fully considered.

26. The incentives for greater energy efficiency are already strong for many energy intensive industries, asenergy costs represent a significant element of their overall costs. The presence of an aid intensity which is ata level of less than 100% and which reduces over time will mean that eligible companies will continue to paya proportion of the additional passed-through costs from EU ETS and CPF. As such, there remains a furtherincentive for firms to continue to examine ways to become more energy efficient. For EU ETS compensation,we will also be applying efficiency benchmarks. The benchmarks have been developed by the Commissionand are based on the top 10% most efficient process for manufacturing that specific product. Companies with9 2005–2007 data10 Total iron & steel sector.11 Energy intensive industries compensation scheme—available at: http://www.bis.gov.uk/Consultations/energy-intensive-

industries-compensation-scheme?cat=open



processes below the very best level of energy efficiency will, as a result, find that their compensation isfurther reduced.

27. Many Energy Intensive Industries also sign up to voluntary Climate Change Agreements, which set outstretching energy efficiency targets in return for relief from the Climate Change Levy. DECC is currentlyengaged in the target setting process with the 54 eligible sectors for the new CCA period which runs fromApril 2013 to 2023.

27 November 2012

Written evidence submitted by TUC

Section One

Executive Summary

1.1 The TUC is the voice of Britain at work. Our overall objectives are to raise the quality of working lifeand promote equality for all. The TUC believes that a strong manufacturing sector belongs at the heart of theBritish economy. We have for many years championed the need for the development of a comprehensive andmodern industrial policy. So while we have welcomed the government’s recognition of manufacturing’simportance, we also know this will require a commitment to actively support a future for manufacturing in alow carbon economy.

1.2 Reflecting a shared concern over the future of the energy intensive industries in the UK, the TUC andthe EIUG (Energy Intensive Users Group) have undertaken a number of joint initiatives in support ofgovernment policy to align manufacturing and energy policy. A joint study in 2012, Building our low carbonindustries12, found that energy intensive industries (EIIs) provide direct employment for 160,000 workers inthe UK and total employment including supply chains of 800,000 jobs. They are among the largest contributorsto our Gross Domestic Product (GDP), with a combined turnover of £95bn in 2008, or 20% of UKmanufacturing. And they pay around half of all manufacturing taxes.

1.1 We therefore welcomed the Autumn Statement 2011 announcement that the Government intends toimplement a package of measures to reduce the impact of policy on the costs of electricity for the mostelectricity-intensive industries, beginning in 2013. It earmarked up to £250 million for this over the SpendingReview period, of which £210m will help alleviate some of the escalating cost of the EU Emissions TradingScheme (EU ETS) and the Carbon Price Floor (CPF), or carbon tax (Figure 1).

1.2 The Government has not published an estimate of industry’s costs under the CPF and EUETS over theremainder of the Spending Review period (2012–2016). However, the TUC estimates that these costs areapproximately £4.1bn (table 1 and figure1). The three-year, £210m package will therefore account for aboutone twentieth of heavy industry’s costs attributable to these two climate change and energy policies alone overthe Spending Review period. Of course, other UK climate change policies13 also contribute to the productioncosts and overall industrial competiveness of energy intensive industries, such as the grid access charges andthe Climate Change Levy.

1.3 The Government should therefore move as rapidly as possible to set up and run the UK’s initialcompensation scheme, including taking on board during the current consultation such improvements as can beaccommodated to improve the scope and level of support.

1.4 In drafting this submission we have also turned to Germany for insights into that country’s approach toindustrial policy. The TUC’s report, German lessons: developing industrial policy in the UK14 (December2011) set out to understand the practical measures the UK could take to rebalance our economy in the yearsahead. The report highlighted the German Government’s predisposition to support its manufacturing base.Referring to industrial policy in the context of tackling climate change, German Lessons noted: “A goodexample is the need for a package of measures to support the UK’s energy intensive industries, an issue thathas already been addressed in Germany.”

1.5 As this submission shows, a range of German Government industry policy interventions provide Germanindustry as a whole, including its energy intensive industries, with a range of long established reliefs fromenergy and climate change-related duties, levies and taxes:

— Over the period 2010–2012 Germany’s support for its EIIs were worth 26bn euros, or some8bn euros (£6.4bn) a year (table 2).

12 Building our low carbon industries, TUC-EIUG, 2012: http://www.tuc.org.uk/tucfiles/352/Buildingourlowcarboninds.pdf13 Other UK climate change policies contribute to the production costs and overall industrial competiveness of energy intensive

industries. More information on some of them is given in TUC and the Energy Intensive Users’ Group, The Cumulative Impactof Climate Change Policies on UK Energy Intensive Industries—Are Policies Effectively Focussed? (July 2010)—such as ClimateChange Levy—where even if complying with the strict energy efficiency improvements of their Climate change Agreement, anenergy intensive user will pay 35% of the tax on direct fuel such as gas. Moreover other increased costs for grid / transport /network and balancing charges and higher “red, amber green charges” are partly attributable to incorporation of intermittent anddistant renewables such as offshore wind: http://www.tuc.org.uk/extras/wwastudy.pdf

14 German Lessons (TUC, 2011): http://www.tuc.org.uk/industrial/tuc-20509-f0.pdf



— Support covers thousands of firms. Unlike the UK package, support is not confined to specificsectors.

— At company level, in Germany compensation is available for 90% (or in the case of larger andenergy intense consumers, 100%) of electricity taxes.

— In contrast, the UK package appears to cover about 10% of total UK additional costs onelectricity attributable to the EU ETS and CPF.

1.6 In Germany an array of schemes are well established and provide long-term policy certainty, againstwhich companies are better placed to assess long-term investments in new plant and technology.Comprehensive compensation arrangements for businesses competing at the international level is an integralpart of Germany’s energy and industrial strategy, and is set to continue for the longer term.

1.7 The TUC therefore believes that in parallel with its work on the current compensation package, theGovernment should urgently undertake a further round of discussions with industry and trade unions acrossthe energy intensive industries with a view to developing a second, fully comprehensive, long term set ofmeasures supporting energy costs and investment commensurate with support given to our leading Europeancompetitors. Integral to this review is the development of a long term low carbon manufacturing strategy inthe UK.

Figure 1

GOVERNMENT REVENUE ESTIMATES FROM THE EU ETS AND CARBON PRICE FLOOR

1.9 2.0 2.2 2.3 2.5 2.7 2.9 3.03.3

3.64.1

4.75.2

5.76.2

.6.7

.7.7

.8.8

1.0

1.0

.9

.8

.7

.7

.6

£bn

£1bn

£2bn

£3bn

£4bn

£5bn

£6bn

£7bn

£8bn

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027

EUETS Revenue Carbon Price Floor Revenue

Carbon Revenue Estimates 2013-2027

Rev

enue

Source: Jobs, growth and warmer homes, Consumer Focus 2012.

Section Two

The Government’s Compensation Package

2.1 The Government’s proposed approach15 to the compensation package provides for £110m to addressthe indirect impacts of the EU ETS on energy intensive industries (EIIs) over the Spending Review (SR)period; and a further £100m to offset the impacts of the carbon price floor (CPF). The scheme is subject tostate aid guidelines. We also note that the package is to be funded “from existing departmental budgets,” anapproach which reflects a Treasury-led control cap on the compensation package, rather than an objectivereview on industries’ cumulative costs and how best to alleviate them.

2.2 The Government’s decision to develop a compensation package was conditioned by several factors:15 Compensation for the indirect costs of EU ETS and Carbon Price Support—Consultation on scheme eligibility & design, BIS,

October 2012.



1.International comparisons of energy costs: a BIS study16 of energy policy costs faced by EIIs in a sampleof OECD countries found that, “The UK has relatively high incremental policy costs mainly due to renewableenergy costs (in Germany for example, renewable energy costs for EIIs are very low due to the policy to limitadded renewable energy costs to these installations) and also the UK carbon price floor (which is additional tothe EU ETS which impacts all EU member states)” (page 12). However, perhaps because of its remit, thisstudy did not quantify the scale of OECD states’ support to offset climate policy cost burdens on their domesticenergy intensive industries.

2.Representations by industry and trade unions: as noted above, the TUC and its affiliates Community,Unite, GMB and Unity, have developed a shared concern with the Energy Intensives Users Group (EIUG) overthe future of the energy intense industries in the UK. A joint evidence-based study, The Cumulative Impact ofClimate Change Policies on UK Energy Intensive Industries—Are Policies Effectively Focussed? (July 2010)found that, “The cumulative impact of all climate change policies is significant, especially on energy intensivesectors. If the government continues to simply add one energy or carbon reduction levy after another on to theenergy intensive sectors then the risk is that these industries will no longer be able to compete internationallyand will simply cease to operate in the UK.” Both the TUC and EIUG both firmly support the shift to a lowcarbon economy as an essential response to the challenge of climate change, and believe that the energyintensive industries are vital to the success of this transition.

3.DECC’s report, Estimated impacts of energy and climate change policies (2011): DECC concluded that,“Policies are estimated to be adding between 3% and 12% to energy bills for [energy intensive] users in 2011,and between 2% and 20% in 2020. Businesses that are large energy intensive users [Figure 2]—where energycosts represent a significant proportion of their total operating costs—directly account for around 4% of grossvalue added (GVA) in the UK. Impacts depend on their mixture of gas and electricity use, on-site generatedelectricity and their ability to use their buying power to negotiate lower prices.” In reality, many energyintensive industry companies, especially SMEs, are not in a position to negotiate significantly lower prices.

4.HMT’s impact assessment of the CPF17: This assessment concluded that “Carbon price support scenariosmight lead to increases in average non-domestic retail electricity prices of between 1% and 2% in 2013 andbetween 1% and 6% in 2020. This is likely to have a significant impact on a small, but important number ofenergy intensive sectors: aluminium production; cement production; chemicals-industrial gases, fertilisers; claysand kaolin; glass manufacture; iron and steel manufacture; lime production; malt production; non-woventextiles; and paper manufacture and wood board manufacture.”

5.For HMT, “A key concern when considering the impact on businesses is competitiveness and the risk ofcarbon leakage—the relocation of investment or production to countries without carbon constraints—resultingin an overall increase in global emissions and a loss of employment and economic activity for the carbonconstrained economy.”

16 An international comparison of energy and climate change policies impacting energy intensive industries in selected countries,BIS, July 2012.

17 Carbon price floor consultation: the Government response, HMT 2011: http://www.hm-treasury.gov.uk/d/carbon_price_floor_consultation_govt_response.pdf



Figure 2

IMPACT OF ENERGY AND CLIMATE POLICIES ON ENERGY PRICES AND BILLS, DECC

Source: DECC 2011

16

14

12

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Merit order effects

CCAs

Base electricity price

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Final electricity bill (Upper bound)

Final electricity bill (Lower bound)

Final gas bill

Gas Electricity Gas Electricity Gas Electricity

2011 2020 2030

Estimated impact of energy and climate change ;olicies on averageretail gas and electricity bills faced by large energy intensive users whoconsume 100,000MWh of gas and 100,000MWh of electricity before policies

SECTION THREE

COST IMPACTS OF ENERGY POLICY ON UK ENERGY INTENSE INDUSTRY

3.1 Government economic modelling of energy costs impacts on industry does not include publishedestimates of the total costs of the CPF and EU ETS to energy intensive industries as a whole. However, usingavailable data, we estimate that over the remainder of the Spending Review period (2012–2016) the costs toall industries of CPF and EUETS policies combined will be approximately £4.1bn—see table 1. The TUC’sestimates are in the footnote.

3.2 The three-year, £210m package will therefore account for about one twentieth of heavy industry’s costsattributable to the two taxes alone over the Spending Review period.

3.3 The carbon price floor announced in Budget 2011 begins at £16/tCO2 in 2013 and follows a straightline trajectory to £30/tCO2 in 202018, rising to £70/tCO2 in 2030 (2009 prices). The carbon price floorescalator will increase by £2/tCO2 per year from 2013 to 2020. The carbon price support rates for 2013–14represent the difference between the Government’s target carbon price (the floor) and the futures market pricefor carbon in the EU ETS in 2013. Budget 2012 set the 2014/15 carbon price support rate at £9.55/tCO2.

Table 1

BUDGET 2012—OFFICE FOR BUDGET RESPONSIBILITY FORECAST REVENUES FROM EU ETSAND CPF 2010–2016

Tax Actual Actual Revenue Revenue Revenue RevenueRevenue Revenue Forecast Forecast Forecast ForecastRaised 2010/ Raised 2012/13 2013/14 2014/15 2015/1611 2011/12

EU ETS £0.4bn £0.3bn £0.7bn £1.5bn £1.6bn £1.7bnCarbon Price Floor 0 0 0 £0.6bn £1bn £1.2bnTotal £0.4bn £0.3bn £0.7bn £2.1bn £2.6bn £2.9bn

HMT, environmental taxes, July 2012.18 Carbon price floor consultation: the Government response, HMT 2011: http://www.hm-treasury.gov.uk/d/carbon_price_floor_

consultation_govt_response.pdf



Footnote: TUC estimates—

Taken together, CPF and EU ETS will add approximately £4.1bn to industry’s costs over the Spendingreview period.

According to the HMT impact assessment19 of the costs of the CPF, 60% will be borne by industry, thebalance by households. Over the remainder of the Spending Review period (2012–2016) industry’s costs ofthe CPF will be approximately £1.7bn (ie industry’s 60% share of the £2.8bn raised from the CPF).

Over the remainder of the Spending Review period (2012–2016) industry’s costs from the EU ETS will be£4.8bn. There is no official data20 on the extent to which heavy energy users purchase these allowances.However, in a previous study, we estimated that the energy intensive industries (EIIs) account for roughly halfof UK industrial energy consumption. On this basis, we estimate that energy intensive industry’s costs due tothe EU ETS will be £2.4bn.

Energy intensive industries: contribution to the UK economy

Jobs

Direct employment: 160,000 workers in the UK. Total employment including supply chains: 800,000workers.

Economic Power— EIIs are among the largest contributors to our Gross Domestic Product (GDP), with a combined

turnover of £95bn in 2008, or 20 per cent of UK manufacturing total and 3 per cent of UK GDP.

— As capital-intensive industries, they generate higher added value in their production processes.Their combined Gross Value Added (GVA) was £14bn in 2008, or 11 per cent of the UKmanufacturing total. And in most industries, value added is significantly above the UK average.

Purchasing Power

EIIs play an important role in sustaining their suppliers through the purchase of goods, materials and services,with a purchasing power of £68.6bn (2008), or a fifth of the UK manufacturing total.

Wages and Taxes— Employment costs: £6.6bn (2008) in wages, national insurance and pension contributions, or

an average of £38,000 per employee.

— Corporate taxes and levies: £12bn in 2008 from the Climate Change Levy and other taxes, oraround half (47 per cent) of all manufacturing taxes.

Source: Building our low carbon industries, TUC-EIUG, 2012 http://www.tuc.org.uk/tucfiles/352/Buildingourlowcarboninds.pdf

Section Four

How a key competitor, Germany, supports its heavy industries

4.1 The TUC’s report, German lessons: developing industrial policy in the UK21 (December 2011) set outto understand the practical measures the UK could take to rebalance our economy in the years ahead. “Thesearch for expertise led to Germany, a powerhouse of the European economy and a country that has never lostsight of the value of its manufacturing sector. Through meetings with senior managers, works council membersand trade union officials in leading German companies, including Volkswagen, Siemens and BMW, we triedto see how the UK could learn from German manufacturing successes.”

4.2 The report called for a “new manufacturing ecosystem for the UK: a range of policies needed to bringthe country back to its rightful place as a major manufacturing nation. Skills, investment, procurement, helpingsmall firms to expand, finance for strategic sectors and the role of government.”

4.3 The EAC inquiry into Carbon Budgets (2011) recognised the importance of policy measures to helpenergy intensive industries, but concluded: “Before any are introduced a comprehensive and robust assessmentof the actual risk to each sector affected, on a case by case basis, should be made.” (para. 19).

4.4 For the TUC, carbon leakage risk assessments should take account not only of the impact of CO2mitigation policies in competitor countries, but the extent to which Governments offset these effects through“transitional” measures such as subsidies and tax or cost reliefs. Within the EU, the EUETS provides for an19 Impact Assessment of proposals to amend the climate change levy and fuel duty to support incentives for low-carbon electricity

generation, HMT, 2010.20 DECC communication, November 2012: The UK’s auctions are open to those that fulfil the criteria set out in the relevant EU

legislation and the membership requirements of the auction platform, and are therefore not limited to energy intensive industryoperators. Therefore it is not possible to estimate how much of this revenue will be derived from energy intensive industries.

21 German Lessons (TUC, 2011): http://www.tuc.org.uk/industrial/tuc-20509-f0.pdf



apparent “level playing field”, policed by supposedly clear state aid guidelines. But European competitors havenevertheless introduced national level policies to protect their energy intensive industries (EIIs).

4.5 Here, we consider the case of Germany.

Germany’s Energy Package 2012

4.6 The German Government is undertaking a complete restructuring of its energy system. The bulk of itsenergy is to come from renewable sources by the middle of the century. At the same time, Germany aims toremain a competitive business location. The Government has therefore embarked on a long process toward arestructured energy supply, with a wide range of measures covering grids, power plants, energy efficiency,renewables, energy research and compensatory arrangements for businesses competing at the internationallevel.

4.7 A key part of the Energy Package 201122 involves far-reaching compensatory payments for energy-intensive businesses. Building on well established schemes, it includes measures to offset increases in the priceof electricity due to emissions trading and renewable energy.

4.8 In summary, over the period 2010–2012, German industries, including energy intensive industries,benefitted from a range of reliefs from duties, levies and taxes worth 26 billion euros, or some 8bn euros ayear—see table 2. These reliefs are set to continue for the longer term.

4.9 A review of Germany’s environmental taxes by Germany-based energy consultants, Arepo, Immunitiesof the energy-intensive industries in Germany from energy taxes23 (March 2012) showed that:

— The largest reductions in the years 2010 and 2011 resulted from exemptions from environmentaltaxes (Ecotax), together worth 5.7 and 4.7 billion euros respectively.

— Special compensation is provided for the additional costs of Germany’s rapid expansion ofrenewable energy under the Renewable Energies Act (EEG) worth 1.1 and 2.1 billion euros in2010 and 2011;

— Free allocations of CO2 allowances for industry were worth 1.6 and 1.4 billion eurosrespectively.

— Industry, especially energy-intensive industries, were subsidised in the years 2010 and 2011 bya total of 8.591 and 8.223 million euros respectively. In 2012, this amount is expected toincrease to 9.185 million euros—table 2.

4.10 Starting in 2013, an additional Euros 500 million will be set aside annually for this purpose in theEnergy and Climate Fund. To this end, the European Commission will issue State aid guidelines on the basisof which compensation payments must be approved. In another move to relieve the burden on businesses, thecompensation regulation for the renewables surcharge under the Renewable Energy Sources Act was eased. Asa result, starting in 2012 more businesses can apply for a limit to their renewables reallocation charge. Industry’senvironmental taxes and their reliefs are shown in table 2.

Table 2

Total support for energy intensive industries (EIIs) in Germany 2010–2013

In millions of euros 2010 2011 2012 2013

Ecotax (Okostuer) 5,740 4,730 5,110 d/kCHP bonus allocation 40 4 20 d/kSpecial compensation rule, section 40 ff. of the 1,125 2,080 2,315 2,500–3,200German Renewable Energies Act (EEG)Certificate allocation 1,643 1,408 1,408 d/kEnergy & climate funds - - - 500Network fee exemption 43 d/k 319 d/kIndustry levy - - 12 d/kTotal relief 8,591 8,223 9,185 d/k

Immunities of the energy-intensive industries in Germany from energy taxes, March 2012: www.arepo-consult.com

4.11 As the table shows, the main policy tools in Germany (Figure 3) include the power and energy control(Okostuer: 56%), emissions trading scheme (ETS), the Renewable Energy Sources Act (EEG: 25%) and theCombined Heat and Power Act (KWK-G), through which measures markets for preferred technologies arecreated. The rise in prices for energy, which is caused by all these instruments, aims to provide “an incentiveto conserve energy resources.”22 Germany’s new energy policy: Heading towards 2050 with secure, affordable and environmentally sound energy, Federal Ministry

of Economics and Technology (BMWi), April 201223 Immunities of the energy-intensive industries in Germany from energy taxes (Befreiungen der energieintensiven Industrie in

Deutschland von Energieabgaben), 2012: www.arepo-consult.com



Figure 3

SHARE OF INDIVIDUAL REDUCTIONS IN THE TOTAL RELIEF PACKAGE, 2012

§55 EnergieStg:Spitzenausgleich

§54 EnergieStG:allgemeine Entlastung

§51 EnergieStG:Prozesse

§10 StromStG:Spitzenausgleich

§9b StromStG:allgemaine Entlastung

§9a StromStG: Prozesse KWK-Umlage

Netzengeltbefreiungund §19-Umlage

Herrstellerprivileg

Geschätzte Gesamtentlastung 2012:9.185 Mio. Euro

Abbildung 23: Anteile der einzelnen Entlastungen an der Gesamtentlastung in 2012

Ökosteuer56%

§41 EEG 201225%

kostenloseZertifikate

15%

Source: Arepo, 2012.

Special compensation under section 40 ff. of the German Renewable Energies Act (EEG)

4.12 According to a report24 from the Federal Office of Economics and Export Control (BAFA: Annualreport 2011–2012), in Germany, public utility companies are subject to priority purchase of electricity generatedby renewable energy from the transmission system operators. Since the revenues thus generated are lower thanthe feed-in tariffs payable under the Renewable Energies Act, a revenue shortfall has to be met. This shortfallis passed on as a surcharge by the public utilities to all consumers in Germany.

4.13 The Federal Office of Economics and Export Control (BAFA) may upon request by electricity-intensivemanufacturing enterprises and rail operators limit this surcharge to Euros 0.05 cents per kilowatt hour “tomaintain the international competitiveness of manufacturing enterprises and rail operators.” For consumers asa whole, the surcharge on electricity bills is Euros 3.59 per kilowatt hour in 2012.

4.14 Up until 2012, the eligibility criteria for electricity-intensive manufacturing enterprises were:

— electricity consumption of more than 10 GWh per delivery point; and

— electricity costs of more than 15% of the gross value added.

4.15 These companies shared the cost of the first 10% of the electricity consumption, for which they had toaccept the full Renewable Energies Act surcharge. The qualifying companies, the added costs cannot exceedEuros0.05 cents per kilowatt hour. Companies with over 100 GWh electricity consumption and whoseelectricity costs represent 20% of gross value added were exempted from cost sharing.

4.16 Information from the Federal Ministry of Economics and Technology (2012) shows that 979 businessesreceived support in a wide range of qualifying sectors—see box below. In addition to the ten sectors that theTUC and EIUG consider to be energy intensive industries, the German compensation scheme covers: miningand quarrying; rail track; services for the production of oil and natural gas; food and drink industries, includingbaking; textile industry; distribution of electricity; heat and air conditioning supply; water, gas, heat and air-conditioning installation; hazardous waste; and rail track companies.

4.17 In 2011, the Federal Office of Economics (BAFA) received 821 applications from businesses for relief(covering 1,142 sites). The scope of relief to be decided upon for 2012 is in the region of 2.5 billion euros.24 http://www.bafa.de/bafa/en/the_office/publications/bafa_report_2011_2012.pdf



4.18 The added costs of electricity are distributed among all consumers. This year, electricity consumerswill pay over 14 billion euros due to the energy levy. In July, the Government announced25 an increase in theenergy levy in 2013 means that costs are set to rise to around 20 billion euros next year.

As noted above, amended EEG compensation rules from 2012 propose that the maximum added cost to EIIsfrom renewable energy is Euros 0.05 cents per kilowatt hour (KWh) for enterprises consuming more than 200GWh; and for which the cost of electricity exceeds 20% of gross value added (GVA). For consumers as awhole, the surcharge on electricity bills is Euros 3.59 cents per kilowatt hour in 2012.

Sectors eligible for compensation under section 40 ff. of the German Renewable Energies Act (EEG)

— Rail track

— Mining (including lignite); quarrying: limestone, gypsum, chalk and slate

— Food and drink: Meat and meat products, meat processing; fruit and vegetable manufacture &processing; milk processing; grain milling; bakeries; animal feed; soft drinks, mineral waters.

— Clothing & textiles: spinning, weaving; manufacture of other textiles.

— Timber & wood products: sawmills; manufacture of wood products, containers.

— Pulp and paper: manufacture of paper and board products; printing newspapers.

— Chemical: refined petroleum products, industrial gases, dyes and pigments; manufacture ofinorganic basic chemicals, fertilizers, nitrogen compounds; manufacture of plastics & syntheticrubber; plastic products.

— Glass: manufacture, shaping and processing

— Ceramics: manufacture of ceramic wall and floor tiles and slabs

— Cement, lime and plaster manufacture

— Iron, steel and ferro-alloys; casting of light metals, forging, pressing.

— Electronics: manufacture of electronic components and boards; batteries, accumulators; otherelectrical equipment

— Electricity, gas and water: gas trade by pipeline; water supply; treatment and disposal of non-hazardous waste; gas, water, heat and air-conditioning installation; services for production ofoil and natural gas.

Source: Federal Ministry of Economics and Technology (2012).

Ecotax Changes

4.19 Exemptions from the environmental tax (Ecotax) represent more than half of the energy-relatedsubsidies to industry and are one of the largest industry subsidies in Germany. The Ecotax is made up of theelectricity and energy tax.

4.20 There are broadly three reasons for exemptions from these taxes:

— Exemptions for certain energy-and energy-intensive processes

— A “general discharge” for companies above a certain total consumption.

— A tax cap for those firms that benefit relatively little from relief on the pension system.

As part of the strategic Energy Concept of the Federal Government (2011) the Electricity Tax Law(Stromsteuergesetz, StromStG) was amended in 2011 so that the Ecotax (Euros 12.3/MWh up to 2011) is fullyreimbursed for the following production processes: electrolysis, glass, ceramics, cement, lime, metals, fertilizersand chemical reduction methods. The company pays the tax in full and then applies for 100% reimbursementfor the electricity used in eligible processes.

Overview of support for energy-intensive industries in Germany

4.21 According to Arepo, almost 97,000 companies benefit from the “general discharge” from environmentalpolicies. In 2011, 23,000 companies were given compensation for peak power costs. About 1,000 firms involvedin certain processes, such as metal fabrication, are entirely exempt from the electricity tax. Since the year 2011,up to 600 highly energy-intensive companies are completely free of net fees (Netzgebühren), representing asaving of 300 million euros.

Policy justification and commentary

4.22 The policy relief available to energy-intensive industries is based on the grounds that increased energycosts put them at a competitive disadvantage and threaten profitability. “Electricity costs in Germany havetraditionally been higher than in many neighbouring countries in Europe, so that the loss of jobs and economicstrength is feared,” Arepo argues. Some industries “are in strong competition with non-European sites and verylow energy prices.”25 http://www.bmwi.de/English/Navigation/Press/press-releases,did=520702.html



4.23 However, the Arepo study also looks at policy alternatives to the Government regularly negotiating“blanket exemptions”. There is a case, Arepo argues, for the Government to set long term and consistent pricesignals for emissions and energy consumption, specifically as a motivational tool in combination with“innovation-oriented aid.” A long-term industrial policy is needed, comprising long-established and predictablereduction of subsidy accompanied by an equally long-term industrial innovation (decarbonisation) andinvestment strategy “to mobilize the strengths of innovation in Germany for climate policy.”

4.24 Meanwhile, the Federal Ministry of Economics points out that electricity prices are central to thecompetitiveness of German industry, claiming that Germany “has been placed at a competitive disadvantage inthis respect for many years. This is also linked to the associated taxes and levies which have risen steadilysince 2000, accounting for almost 40 % of the price of industrial electricity in 2011. Benchmarked against ourEuropean neighbours, the price of electricity in Germany is above average. Industrial electricity is availablefor less in France and Scandinavia.”

4.25 The energy cost burden has also increased significantly for private consumers in recent years, climbingfrom an average of Euros 2,295 per year in 2000 to over Euros 3,900 in 2011. As a percentage of net income,energy costs have risen from over 5% to over 7% during this period. “Against this backdrop, any restructuringof the energy system must not lead to an excessive cost burden and competitive disadvantages. Therefore thecost-competitive and market-based implementation of the Energy Package is of central importance.”

Section five

UK compensation package: review and next steps

Eligibility for compensation

5.1 BIS is now consulting on the qualifying criteria it proposes to adopt to target the £210m compensationpackage. The criteria include:

1. Sectors most at risk for carbon leakage. Based on “objective and transparent criteria” adopted by theEU, this covers 14 energy intensive industry sectors/sub-sectors.

2. An additional filter, carbon intensity, defined as carbon costs (EU ETS and CPF) in 2020 of at least 5%of company-level GVA. For carbon price floor compensation, the Commission’s sector list will also apply,but with an additional test at company level concerning costs of carbon in electricity as a proportion ofGVA in 2020.

3. A carbon intensity factor applied to the compensation calculation that is based on the marginal carboncontent of energy supplied to the UK grid. Currently, gas is considered to be the marginal supplier, witha CO2 intensity of 0.411 tonnes of CO2 per Megawatt hour (0.411tCO2/MWh). The UK average acrossall energy supplied, including higher carbon coal, is 29% higher at 0.58tCO2/MWh.

4. Company-level compensation, rather than process/plant level. This is because of “the difficulty incollecting data needed to calculate electricity intensity at the site or process level. Companies collate theiraccounts at different levels, with only some able to provide financial data at site or process level26.”

Compensation package issues

5.2 The EU ETS compensation fund will only be available to businesses in the sectors identified by theEuropean Commission as being exposed to significant risk of carbon leakage. This excludes key electro-intensive installations in other energy intensive industries identified by HMT as exposed to the Carbon PriceFloor, including ceramics, glass and cement and lime manufacture.

5.3 However, BIS has indicated that there may be some scope to compensate businesses in other sectorsfrom Carbon Price Floor costs. They must demonstrate that their extra carbon cost (EU ETS and CPF) forelectricity in 2020 will amount to 5% of GVA. However, the UK will still have to make a case for State Aidto the European Commission here and there is no guarantee at this stage of a success.

5.4 According to the British Ceramic Confederation, some ceramics installations are amongst the mostelectro-intensive in the UK, eg electric arc furnaces and electric induction furnaces. The TUC is concernedthat there has been some relocation of jobs from these types of installations recently to those in other EUcountries such as France and Germany with electricity prices/taxes cited as a major contributory factor. It isessential to ensure that the most electro-intensive ceramic companies and processes within such sectors arecompensated to the same extent as those in other sectors. But this is impossible with the current proposals.Acknowledging this concern, the consultation asks companies or trade association for further evidenceeligibility.

5.5 A further concern is that the Government intends to use a “carbon intensity” factor that potentiallyreduces the level of compensation available to companies. The compensation available to businesses includesa calculation that factors in the carbon intensity of UK electricity supply—in this case, the marginal carboncontent of gas energy supplied to the UK grid, which is a third lower than the average carbon intensity of UKenergy. Of course, the average carbon intensity is higher because its takes account of energy from high carbon26 Compensation for the indirect costs of EU ETS and Carbon Price Support—Consultation on scheme eligibility & design, BIS,

October 2012, para. 6.11.



coal as well as zero carbon renewables. The proposed formula will therefore depress the compensationavailable. A CO2 intensity factor does not appear to apply in Germany.

Wider considerations

5.6 More broadly, a range of other factors will add significantly to the energy intensive industries’ cost baseover the next few years. For example, the EU’s Briefing for the Pulp and Paper Industry27 is currently beingrevised with proposed environmental limits and best available technique approaches that will inevitably addsignificantly to industry’s costs.

5.7 Companies participating in the TUC-EIUG study28 on cumulative energy costs “reported increasingreluctance by their owners to commit to any investment in the UK given not only the scale of climate changecosts, but the ongoing uncertainty surrounding the climate change regime and its impact on energy prices.” Itis this investment that helps maintain a well paid, skilled work force and delivers lower carbon products.

Comparison with Germany

5.8 The British Chambers of Commerce29, in its recent energy market survey among 3,500 members,commented: “The UK should follow the example of countries, such as Germany, and offer more substantialrelief to industries during the transition to a less carbon-dependent economy. The £250 million package ofmeasures announced in 2011 to help offset the impact of rising costs is welcome but it will only make a dentin some of these companies’ rising costs and tax obligations.”

5.9 The following schematic comparison between the compensation packages offered in Germany and theUK (table 3) shows that compensation in Germany is evidently an integral, long-term and substantial part ofthe Government’s energy and industry strategy. Key points include:

— Coverage: Germany support covers thousands of firms, and is not confined to specific sectors.

— Total compensation appears to be far more generous in Germany: some 8bn euros (£6.4bn)annually, compared with £70m annually in the UK (ie £210m over the SR period 2013–2015).

— At company level, in Germany compensation is available for 90% (or in the case of largerconsumers, 100%) of energy costs. The UK package appears to cover about 10% of additionalcosts attributable to the EU ETS and CPF.

— Duration: the Germany scheme is well established and provides long-term policy certainty,against which companies are better placed to assess long-term investments in new plant andtechnology.

Table 3

SCHEMATIC COMPARISON BETWEEN COMPENSATION ARRANGEMENTS IN THE UK ANDGERMANY

Factor UK Germany

Amount of £210m over 3 years, £70m pa 8bn euros annual averagecompensationTime period 2013–2015 Not time limitedSectors 15 of European Commission’s sectors Wide range of industrial sectors under

at risk from carbon leakage, based on section 40 special compensation: notrade intensity and cost impacts. apparent sector limit.

Level Company Company and process level: for example,about 1,000 firms in certain processes, suchas metal fabrication, are exempt fromelectricity tax.

Number of companies Figure not available 97,000 cos benefit from the “generalbenefitting discharge”.

23,000 cos compensated for peak power.1,000 firms 100% exempt from electricitytax.

Energy intensity Company carbon costs (CPF and Electricity consumption of more than 10ETS) in 2020 = at least 5% GVA GWh per delivery point (subject to 10%

cost share); and electricity costs of morethan 15% of GVA added.Companies >100 GWh electricity andelectricity costs > 20% GVA exemptedfrom cost sharing.

27 http://eippcb.jrc.es/reference/BREF/PP_D1_0410.pdf28 http://www.tuc.org.uk/extras/wwastudy.pdf.29 http://www.britishchambers.org.uk



Factor UK Germany

Maximum compensation Linked to UK marginal emissions Information not availableper eligible installation factor: gas emissions at 0.411tCO2/

MWhExemption from energy None Exemption for mineralogical transformationtaxation of processes (applies to ceramics, cement,mineralogical processes lime, glass), for example, €5.50/MWh on

gas.

Recommendations

1. The Government should move as rapidly as possible to set up and run the UK’s initial compensationscheme, including taking on board during this consultation such improvements as can be accommodated toimprove the scope and level of financial support.

2. In parallel, the Government should undertake a further round of discussions with industry and trade unionsacross the energy intensive industries (EIIs) with a view to developing a second, long-term and comprehensiveset of measures applicable across all energy intensive industries supporting energy costs and investment,commensurate with support given to our leading European competitor.

3. As an integral part of this review, the Government should consult with industry partners on thedevelopment of a long term, low carbon manufacturing strategy in the UK.

23 November 2012

Written evidence submitted by the Mineral Products Association

Executive Summary

1.1 With electricity costs at 25% of sector GVA the cement industry is electro-intensive. Electricity cost asa proportion of GVA has doubled since 2004.

1.2 The UK lime producers30 have electricity costs that are now 11% of GVA (68% higher than in 2004).

1.3 The £250 million EII package is a welcome first step but insufficient to prevent carbon leakage resultingfrom cumulative carbon costs. Government should be prepared to provide additional funds and/or reallocatefunds from EU ETS to CPF if there is a need.

1.4 The Commission’s list of sectors that can receive compensation for increased electricity prices as a resultof the EU Emissions Trading System penalizes some UK operators that would otherwise meet the criteria forcompensation if the assessment was carried out at UK and not EU level.

1.5 The UK Government should seek to amend the EU Communication on State Aid that prevents some UKsectors, sub-sectors and companies from gaining access to the available compensation for increased electricityprices resulting from the EU Emissions Trading System.

1.6 Government should seek to reduce unilateral tax burdens on industry rather than devising complex anduneven compensation arrangements.

1.7 Until the tax burden on manufacturers can be reduced, the UK Government should immediately committo a second phase compensation scheme for the impacts of the Carbon Floor Price so as not to disadvantageUK operators against our European competitors.

1.8 For a long term approach the Government needs to address the perverse incentive that the least energyefficient sectors and operators qualify more easily for compensation than those that are more efficient becausethe metric is added cost (from energy consumption and an emission factor) compared to GVA.

1.9 Trade intensity is an historic measure and does not equate to future trade exposure, so future marketcharacteristics need to be part of the assessment process. Government needs to consider sectors that are tradeexposed as well as those with high historic trade intensity. Trade exposure can result from a high cumulativecost of direct + indirect CO2 costs per unit of economic metric.

1.10 The cumulative burdens of direct+indirect costs are considerable. Investment decisions are influencedby the cumulative taxation costs. Direct+indirect policy costs by 2020 could be around the same value astoday’s GVA for the UK cement industry using DECC’s assumptions. For the Lime sector cumulative costs ofcarbon and energy taxation are set to increase costs by nearly £18 million from 2013 which is nearly a thirdof the sector GVA.

1.11 Government should recognize that some sectors will receive compensation under compensationarrangement (EU ETS and CPF) whereas other completing in the same market may not receive the same levelof compensation, if any.30 British Lime Association members



2. Introduction

2.1 The Mineral Products Association (MPA) is the trade association for the aggregates, asphalt, cement,concrete, dimension stone, lime, mortar and silica sand industries. With the recent addition of The BritishPrecast Concrete Federation (BPCF) and the British Association of Reinforcement (BAR), it has a growingmembership of 450 companies and is the sectoral voice for mineral products. MPA membership is made up ofthe vast majority of independent SME companies throughout the UK, as well as the nine major internationaland global companies. It covers 100% of GB cement production, 90% of aggregates production and 95% ofasphalt and ready-mixed concrete production and 70% of precast concrete production. Each year the industrysupplies £9 billion of materials and services to the £120 billion construction and other sectors.31 Industryproduction represents the largest materials flow in the UK economy and is also one of the largestmanufacturing sectors.

2.2 This response relates largely to the MPA Cement and British Lime Association activities which are partof the Mineral Products Association.

General Comments

3. The Need for a Compensation Scheme

3.1 MPA is reassured that the Government has announced a package of compensation measures to partiallyaddress the imbalance that a national or regional carbon price can introduce when passed on to energyintensive consumers.

3.2 However, the pressures on UK business are considerable and the compensation package addresses onlya portion of the full impact faced by businesses that operate directly under the EU Emissions Trading Schemethat are also faced with the indirect costs of that scheme in the electricity that they consume.

3.3 With electricity costs at 25% of sector GVA the cement industry is electro-intensive. Electricity cost asa proportion of GVA has doubled since 2004.

3.4 For the Lime sector cumulative costs of carbon and energy taxation are set to increase costs by nearly£18 million from 2013 which is nearly a third of the sector GVA. By 2020 the costs will be greater than thesector GVA.

3.5 The primary objective for the UK Government should be to seek to reduce unilateral tax burdens onindustry rather than devising complex and uneven compensation arrangements.

3.6 The Government’s Carbon Price Floor places a financial cost on UK business that is additional tothe EU ETS costs and importantly adds further to the imbalance that the UK operators face compared toEuropean counterparts.32

3.7 Cement and Lime manufacture are the only two activities listed in the Commission’s EU ETS carbonleakage assessment that qualify solely because their indirect+direct carbon costs are so high compared to theirEU sector gross value added (GVA). This means that cement and lime production are the two most sensitivesectors to the introduction of a “carbon price”.33

3.8 Cement is an essential ingredient in concrete and vital for construction. Lime is a critical component iniron and steel manufacture but also used in water/waste water treatment, food and agriculture and the chemicaland environmental controls sectors. Cement and lime are therefore strategically important basic mineralsrequired for our modern society and that will be essential for our low carbon economy. It is therefore paramountthat these industries are compensated for the carbon price imbalance until there is a global agreement onclimate change and all global operators have built in the cost of carbon in their products and services. Therecent analysis by Capital Economics34 illustrates this point very well.

4. Cumulative Burden

4.1 The pressure from globally unequal carbon pricing is increasing on UK manufacturing installations and“carbon leakage” threatens to increase the rate of manufacturing loss from the UK. Annex I shows thecumulative burden of carbon taxation on UK cement manufacture in 2013 when the UK’s Carbon Price Flooris introduced. Annex II shows the added cost for the BLA Lime producing members of MPA.

4.2 Without the free allocation of CO2 under the EU ETS both cement and lime production in the UK isseverely threatened. Even with free allocation the impact on UK cement and lime operators is considerable.31 “Make the Link: The Mineral Products Industry’s Contribution to the UK”, 2012, http://www.mineralproducts.org/documents/

MPA_MTL_Document.pdf32 The implementation of the Taxation of Energy Products Directive is another example of the imbalance where the UK taxes

mineralogical transformation processes that are excluded by the directive.33 It is predominantly the high “process emissions” that mean that cement and lime emit higher quantities of CO2 than from

burning of fuel. To produce both products calcium carbonate (CaCO3) is heated to drive off the CO234 The Foundation for a strong economy: initial assessment of the contribution of the mineral products industry to the UK economy.

Capital Economics 1 October 2012.



5. Trade Exposure

5.1 Most of the UK cement producers are owned by global companies with head offices outside of the UK.These companies have closed plants in the UK in recent years and issued announcements35 that investment isbeing put on hold because of increased pressure from carbon taxation. This is at the same time that imports ofcement are increasingly made up from companies that do not manufacture in GB. The amount of cementimported by companies that do not have cement manufacture in GB has increased dramatically.

5.2 Moreover, it is important that investors are not given the signals that it is acceptable to invest in lesscarbon constrained nations and import goods into the UK. At a time when economic growth is vital to the UKeconomy the signals for investors are of paramount importance.

5.3 Over the period 2001 to 2011 sales of cement have decreased by 22% but imports by non GBmanufactures have increased threefold. As a result the market share of non GB manufacturer imports has risenfrom only 3% in 2001 to 12% in 2011, Annex III. So the threat of “carbon leakage” is real.

5.4 Lime is internationally traded. Using the Commission’s36 calculation of trade intensity the lime sectoris consistently above 15% and in more recent years (2009–2010) is higher than 20%, Annex IV. As UKconsumption has slowed, Lime exports are an increasingly important contribution to the economy. Thecumulative burden of UK direct and indirect taxes on UK lime producers is slowing the growth of the limeexport market. Another recent (November 2012) example of carbon leakage has been brought to the attentionof MPA by one of its members in the lime sector. The case shows that a lime consumer in the UK has chosento source material from China to replace previously supplied UK material as the UK producer attempted topass on its carbon costs

6. Qualification

6.1 The Commission’s list of sectors that can receive compensation for increased electricity prices as a resultof the EU Emissions Trading System penalizes some UK operators that would otherwise meet the criteria forcompensation if the assessment was carried out at UK and not EU level.

6.2 The EU has carried out its assessment at EU level which favours some sectors but disadvantages someUK operators.

6.3 The UK Government should therefore seek to amend the EU State Aid Guidance that prevents some UKsectors, sub-sectors and companies from gaining access to the available compensation for increases electricityprices resulting from the EU Emissions Trading System.

6.4 Qualification for the Carbon Price Floor compensation has been linked to the EU ETS list of qualifyingsectors to assist with the UK’s application for State Aid. This is a disappointing development which leavesvulnerable sectors such as cement and lime disadvantaged against both their EU counterparts and other UKsectors which appear to “automatically” qualify.

7. Emission Factors

7.1 The BIS consultation document states that the UK’s regional emission factor, as set out in Annex IVof the Commission’s guidelines on certain state aid measures in the context of the EU ETS post 2012, is0.58tCO2/MWh.

7.2 However, the Government proposes to use an emissions factor different to the Commission’s assessmentto apparently reflect the average carbon intensity of the price electricity consumers actually face calculatedusing reference plant for “spark spreads”.37 The consultation states that reference plant for calculating clean“spark spreads” has a marginal emission factor of 0.411 tCO2/MWh and Government intends to use this 30%lower factor.

7.3 The justification of using the lower emission factor is weak. Consumers are not paying the CO2 costs ofthe actual emission factor but paying the CO2 costs of the worst case generation fuel mix.

7.4 The UK Government should use the same emission factor as the Commission otherwise UK operatorswill be disadvantaged by a further 30%.

8. Technical Issues to be considered by BIS in the Assessment

8.1 There are number of issues that BIS need to address in their assessment.

8.2 Firstly is how to treat multi-activity companies ie those companies that have an energy intensive part oftheir business (eg cement) but also a range of other activities and products that are not energy intensive andmay not be internationally traded. MPA believes that BIS should allow the energy intensive part of the businessto be separated in the calculation. It would then only be the energy intensive part of the business that receives35 14 Feb 2008. Lafarge announce 1 billion investment hold in Europe citing carbon taxation as an uncertainty36 Guidelines on certain State aid measures in the context of the greenhouse gas emission allowance trading scheme post-201237 “Spark spread” is the theoretical gross margin of a gas-fired power plant from selling a unit of electricity.



compensation ie qualification for compensation and the compensation payment calculation would be based onthe same boundaries of the organization.

8.3 The method used by operators to separate the energy intensive costs of the business from other activitieswill need to be clearly justified and able to withstand scrutiny (eg through a third party audit).

8.4 Sectors appearing on the Commission’s list, and therefore eligible to receive compensation for indirectCO2 costs, will have benchmarks set for the calculation on the maximum amount of aid that can be attributed.These benchmarks need to be developed in a transparent way. The boundaries of the energy included in thebenchmarks should be known so that there is a consistent approach with those industries that will not be subjectto benchmarks, particularly on the issue of including energy that is not part of the energy intensive business.

8.5 For a long term approach the Government need to address the perverse incentive that the least energyefficient sectors and operators qualify more easily for compensation than those that are more efficient becausethe metric is added cost (from energy consumption and an emission factor) compared to GVA.

9. EII Package Phase II

9.1 Until the tax burden on manufacturers can be reduced, the UK Government should immediately committo a second phase compensation scheme for the impacts of the Carbon Price Floor so as not to disadvantageUK operators against our European competitors.

9.2 Until the Phase II plans are announced Government should be prepared to reallocate the funds from theEUETS indirect CO2 monies available for compensation to the CPF pot if there is a clear need from theapplications that are made to BIS for compensation. Furthermore, if it is clear that the total pot of compensationis not sufficient to compensate all of the companies that are evidently in need of the support then Governmentshould make further funds available.



Annex I

ESTIMATED DIRECT AND INDIRECT COSTS ASSOCIATED WITH UK PORTLAND CEMENTMANUFACTURE (2013 ONWARDS)

MEASURE 2013 2015 post 2020 NOTES

INDIRECT via Electricity Prices

EU ETS CO2 in electricity 9,323,378 11,082,506 16,711,716

Electricity CO2 derived from Defra grid rolling average conversion factors and pro rated CCA data.


Carbon Floor Price tax on fossil fuel use in power generation

3,794,928 7,574,492 7,574,492

Estimates derived from HMRC CPF projections for 2013/14 and 2015/16 but doesn't assume any further decarbonisation of power generation


Cost of Feed in Tarrifs 2,432,638 3,030,053 3,030,053

Based on 2011 DECC impact assessment of FiT's on 2020 electricity prices for large energy users.


Cost of Renewable Obligation

6,948,546 8,643,628 12,939,563

Based on DECC impact assessment of RO on 2020 electricity prices for large energy users.


Cost of EMR 2,587,913 5,175,825 11,645,607

Based on DECC impact assessment of EMR on 2020 electricity prices for large energy users. Includes cost of contracts for difference and capacity mechanism.

Indirect Cost (€million)


25.09 35.51 51.90

DIRECT cost EU ETS CO2 18,748,783 77,033,509 274,362,598Assumes emissions up to 2020 are similar to the PIII baseline (normalised to 10 Mt PCe).

DIRECT cost Climate Change Levy 4,732,718 4,827,846 5,074,114

Estimates inc a 90% CCA rebate for electricity and 65% for all other fuels but not the cost of acheiving the reduced rates by participating in CCAs (with potential carbon costs for target shortfall)

Transport CO2 tax

Taxation of energy products (amendment) directive

2,541,568 2,478,029 2,414,490

Based on the transport of cement product only. Assumes modal transport is the same as 2010 but efficiency increases by 2.5% in 2015 and 5% in 2020 (no efficiency improvement in 2013 compared to 2010).

Industrial Emissions Directive

Cost of meeting new Emission Limits

17,742,488 17,742,488 17,742,488

Assumes plants not currently meeting BAT AELs for NOx,SO2, particulate matter invest capital on new /upgraded equipment with a 10year depreciation and annualised including operating costs.

Direct Cost (€million)

Direct Cost (€million) 43.77 102.08 299.59



25.09 35.51 51.90TOTAL Cost

TOTAL Cost 68.85 137.59 351.50

Assumptions 2013 2015 post 2020 NOTES

15.90 18.90 28.50

Changing this price will alter the values in the table above. Curent values taken from central scenario of ‘Carbon Values Used in DECC’s Energy Modelling’, October 2011, DECC.

0 34.29% 100% Assumes carbon leakage status is lost in 2014 review

10Mt 10Mt 10Mt Removes inteference from output changes

Based on 2010 use

Based on 2010 use

Based on 2010 use

Calculations based on 2010 electricity use normalised to 10Mt PCe production.

2010+X% 2010+X% 2010+X% Assume CCL tax rate increases by 1% each year from 2010.

2009 grid rolling average



Assumes no change in carbon intensity of power generation

20 20 20Assumes that the taxation of energy products directive amendments will be passed

same as 2010 2010-2.5% 2010-5%Assumes modal transport is the same as 2010 but efficiency increases by 2.5% in 2015 and 5% in 2020

1.15 1.15 1.15

Transport efficiency

Exchange rate £1=€1.15

Assumed level of Auctioning for industryAssumed output constant at 10Mt Pce

Assumed electricity use

CCL inflation 1% per annum from 2010

Power generation carbon intensity

Transport CO2 tax (€/tCO2)

Estimated Direct and Indirect costs associated with UK Portland Cement manufacture (2013 onwards)

All in €

INDI

RECT

COS

TS

All in €

DIRE

CT C

OSTS

Assumed Carbon Price (£/tCO2)



Annex II

MEASURE 2013 2015 post 2020 NOTES


EU ETS CO2 in electricity 1,992,281 2,490,351 2,988,421 Electricity CO2 derived from Defra grid rolling average conversion factors and pro rated CCA data.


Carbon Floor Price tax on fossil fuel use in power generation

644,685 1,286,761 1,286,761Estimates derived from HMRC CPF projections for 2013/14 and 2015/16 but doesn't assume any further decarbonisation of power generation

INDIRECT via Electricity Prices Cost of Feed in Tarrifs 50,558 87,927 219,818

Based on 2011 DECC impact assessment of FiT's on 2020 electricity prices for large energy users.

INDIRECT via Electricity Prices Cost of Renewable Obligation 1,180,425 1,468,387 2,198,183

Based on DECC impact assessment of RO on 2020 electricity prices for large energy users.

INDIRECT via Electricity Prices Cost of EMR 439,637 879,273 1,978,365

Based on DECC impact assessment of EMR on 2020 electricity prices for large energy users. Includes cost of contracts for difference and capacity mechanism.


4.31 6.21 8.67

DIRECT cost EU ETS CO2 3,738,939 21,154,182 62,691,377Assumes emissions up to 2020 are similar to the Phase III baseline (normalised to 1Mt quicklime, 0.5 Mt Dolime and 0.5Mt associate lime).

DIRECT cost Climate Change Levy 1,725,755 1,760,443 1,850,243

Estimates include a 90% CCA rebate for electricity and 65% for all other fuels but not the cost of acheiving the reduced rates by participating in CCAs (with potential carbon costs for target shortfall)

Transport CO2 tax Taxation of energy products (amendment) directive

0 0 0 No lime transport data available

Industrial Emissions Directive

Cost of meeting new Emission Limits

10,547,800 10,547,800 10,547,800

Figure based on full member's estimates. Worst case scenerio if no derogation for CO is given. Assumes plants not currently meeting BAT AELs for NOx,SO2, particulate matter invest capital on new /upgraded equipment with a 10year depreciation and annualised including operating costs.

Direct Cost (€million) 16.01 33.46 75.09TOTAL (€million) 20.32 39.68 83.76

Assumptions 2013 2015 post 2020 NOTESAssumed Carbon Price € 20 € 25 € 30Assumed level of Auctioning for industry 0 34.29% 100% Assumes carbon leakage status is lost in 2014 review

0.5Mt 0.5Mt 0.5Mt Removes inteference from output changes

Assumed electricity useBased on 2010 use

Based on 2010 use

Based on 2010 use

Calculations based on 2010 electricity use normalised to 1 Mt quicklime, 0.5Mt dolime and 0.15Mt associates lime production.

CCL inflation 1% per annum from 2010 2010+X% 2010+X% 2010+X% Assume CCL tax rate increases by 1% each year from 2010.

Power generation carbon intensity 2009 grid rolling average



Assumes no change in carbon intensity of power generation

Transport CO2 tax €20/tCO2 €20/tCO2 €20/tCO2 Assumes that the taxation of energy products directive amendments will be passed

Transport efficiency same as 2010 2010-2.5% 2010-5%Assumes modal transport is the same as 2010 but efficiency increases by 2.5% in 2015 and 5% in 2020

Exchange rate £1=€1.15

1.15 1.15 1.15

Estimated Direct and Indirect CO2 costs associated with UK lime manufacture (2013 onwards)

All in €IN

DIR

ECT

CO

STS

DIR

ECT

CO

STS

Assumed output constant at 1 Mt quicklime, 0.5Mt dolime and 0.15Mt associates lime



Annex III

MARKET SHARE BY SOURCE OF PRODUCTION

Non-manufacturers are independent importers that do not manufacture cement clinker in the UK



Annex IV

TRADE INTENSITY OF BLA LIME PRODUCTION IN THE UK

23 November 2012

Written evidence submitted by INEOS ChlorVinyls

Executive Summary

— INEOS ChlorVinyls operates in competitive global markets and energy is the largest cost in theproduction of chlorine. We are acutely vulnerable to energy price rises as a consequence, andcan only operate in countries with competitively priced energy and where there is long-termcertainty about energy costs.

— UK electricity prices are already uncompetitive and the introduction of Carbon Price SupportRates and Phase III of the Emissions Trading System in 2013 will cause prices to increasedrastically over the next decade. If steps are not taken to protect energy-intensive industries,they will be driven out of the country.

— Energy-intensive industries make a significant contribution to the UK, employing hundreds ofthousands of skilled employees, and producing vital raw materials that underpin themanufacturing sector and contribute to the transition to the green economy.

— INEOS welcomes the Government’s commitment to introducing mitigation to secure thiscontribution, safeguarding jobs and preventing global emissions increasing through productionmoving to less-regulated jurisdictions. We are seriously concerned, however, that the proposedcompensation methodology is flawed and will mean that mitigation is inadequate.

— The Government is proposing using a carbon intensity measure that is far lower than the onerecommended and allowed by the European Commission. This is factually incorrect anddrastically underestimates the exposure of energy-intensive industries in the UK to indirect CO2

costs. Using this measure would result in mitigation that is inadequate and lower than will beavailable in other European countries.

— The Government must use the carbon intensity measure recommended by the EuropeanCommission, providing the full amount of compensation permitted under State Aid rules forETS indirect costs and ensuring that full protection is provided for CPS costs.

— To succeed in its purpose, the mitigation package should be targeted at those electro-intensiveindustries most at risk of carbon leakage. The current threshold for eligibility is quite low andthe Government is proposing compensating all qualifying companies for the same proportionof their costs. With funding capped we would recommend a banded approach where theproportion of compensation corresponds to exposure to costs.



— The compensation package for energy-intensive industries is only a short-term measure for thisSpending Review. The UK needs a long-term strategy to provide the necessary investmentclimate to secure the future of domestic energy-intensive industries over the next couple ofdecades. The UK should learn from best practice in Germany and France in this respect,exploring how fiscal policy and financial vehicles could be used to offer energy-intensiveindustries long-term competitive prices while making the transition to the green economy.

INEOS is the UK’s largest chemicals company and uses highly energy-intensive processes

1. INEOS is a global manufacturer of refined oil products, petrochemicals and plastics. Our products are theraw materials used extensively by the manufacturing sector and can be found in a wide range of essential itemsincluding construction materials, medicine, clothing, vehicles, and computers. INEOS is the largest chemicalscompany in the UK and the third largest in the world. With 51 manufacturing sites in 11 countries, we employaround 15,000 people, and our sales in 2011 were $43.5 billion.

2. INEOS ChlorVinyls—one of INEOS’ 9 businesses—makes chlorine and caustic soda, and is the Europeanmarket leader in PVC manufacture. We operate in the UK, Norway, France, Belgium, Holland, Germany, andSweden. In the UK we employ around 2,000 people at our sites in Runcorn and Newton Aycliffe. The chlorineproduced at Runcorn purifies the UK’s water, and our plastic and chemicals are used across the domesticmanufacturing sector in a vast array of applications, supporting tens of thousands of jobs.

3. INEOS ChlorVinyls uses electrolytic processes to manufacture its products, which means electricity isone of our key raw materials. Electricity constitutes approximately 70% of variable production costs at ourRuncorn site, and we consume almost 1% of electricity used in the UK. Because our electricity costs are sosignificant and our products are internationally traded, we are acutely vulnerable to uncompetitive electricityprices. We can only operate successfully in countries that have competitive energy prices, and we need long-term certainty that prices will remain competitive to continue to invest with confidence in a country.

Energy prices in the UK are already uncompetitive for energy-intensive industries

4. Wholesale electricity prices are already less competitive in the UK than in other countries. For example,the UK wholesale electricity price for 2013 will be approximately 25% higher than in Germany and nearly70% higher than Scandinavia. The price difference is even greater in the USA, as a result of gas prices being70% lower than in the UK currently.

5. After tax, the price gap is even more severe. Energy taxes are comparatively high in the UK, and there isno long-term policy to protect domestic energy-intensive industries from the associated costs. Germany, on theother hand, has a clear and longstanding policy of protecting energy-intensive industries from energy taxation,offering generous rebates worth over €5bn a year. The result is that the largest consumers in Germany currentlypay close to the wholesale price for delivered electricity and they have the long-term confidence that this willcontinue. This approach is now being replicated in many other European countries, such as Belgium, whereimportant exemptions for energy-intensive industries have recently been announced. Outside of Europe our UScompetitors face no energy taxes on the electricity they consume.

Policy changes in 2013 will seriously threaten UK energy-intensive industries

6. Currently the UK is already a less competitive location for energy-intensive industries than many othercountries, and is being left behind. The introduction of Carbon Price Support Rates in 2013 will make thesituation much worse, threatening the future of the UK’s energy-intensive industries. This unilateral tax onfossil fuels used to generate electricity will initially support a carbon price of £16/tonne, and rise quickly totarget £30/tonne in 2020, and £70/tonne in 2030. This will cause electricity prices to increase dramatically inthe UK. We estimate that in 2013, we will have to pay €75/MWh in the UK for delivered electricity, comparedto under €50/MWh in Germany and France, and under €30/MWh in the USA.

7. The direction of policy in the UK will increase electricity prices for energy-intensive industries moreaggressively than in any other major country over the next ten years. A report recently published by theDepartment for Business, Innovation and Skills (An international comparison of energy and climate changepolicies impacting energy intensive industries in selected countries) shows that by 2020, energy and climatechange policies will add £28.30 to the price of each MWh of electricity in the UK, compared to £17.30/MWhin Germany, £15.20/MWh in France, £10.30/MWh in China, -£0.50/MWh in Russia, and -£0.20/MWh inthe USA.

8. Phase III of the Emissions Trading System (ETS) will start at the same time as Carbon Price SupportRates are introduced next year, creating a perfect storm for energy-intensive industries. This will significantlyincrease electricity prices across Europe, having the greatest impact on countries that rely predominantly onfossil fuels to generate electricity, such as the UK. The EU has rightly recognised that energy-intensiveindustries are at risk of carbon leakage from rising prices, and must be protected.

9. The combined impact of Carbon Price Support and ETS Phase III poses a serious threat to energy-intensive industries in the UK. We calculate that by 2020, ETS and CPS will add a total of £30 million to ourcosts. This is equivalent to 1.5 times our average annual earnings over the last four years (EBITDA). Without



appropriate measures to protect energy-intensive industries in the UK, this will be an unsustainable situationfor the business.

Mitigation is needed to protect the contribution of energy-intensive industries

10. Energy-intensive industries directly employ 225,000 people and contribute £15bn to the UK’s GDP. Theyare crucial to regional economies and provide the raw materials that underpin UK manufacturing. If priced outof the UK, thousands of jobs would be lost, investment would be redirected abroad, and tax revenue wouldfall. This would seriously damage UK manufacturing and regional economies and undermine growth.

11. Energy-intensive industries already operate to high efficiency and emissions standards in the UK. Globalemissions would significantly increase if energy-intensive manufacturing moved to countries with lowerstandards. Energy-intensive industries also invest in low-carbon technology and manufacture a range ofenvironmentally beneficial products including catalysts, insulation, lightweight plastics, and components forwind turbines. It is estimated that for every tonne of CO2 emitted by the chemicals industry, for instance, overtwo tonnes are saved downstream due to its products. It is important to safeguard this environmentalcontribution, and ensure domestic energy-intensive industries continue to play their necessary part in the UK’stransition to the low-carbon economy.

12. INEOS welcomes the Government’s announcement of a £250 million mitigation package to compensateenergy-intensive industries threatened by rising electricity prices as a result of CPS and ETS Phase III. TheGovernment is right to take steps to secure the important contribution that energy-intensive industries make inthe UK, safeguarding jobs and investment, and preventing carbon leakage.

The current proposals for mitigation are inadequate to protect energy-intensive industries

13. We have serious concerns, however, that the compensation methodology recently proposed by BIS isflawed and will result in inadequate mitigation that will not sufficiently protect the most vulnerable electro-intensive industries in the UK. It will only offer a fraction of the compensation our competitors will receivefor EU ETS in other countries and will only provide partial compensation for CPS, which our competitors donot face at all. We are similarly concerned that the compensation package announced is only a short-termmeasure for this Spending Review only.

14. The Government intends to calculate the amount of mitigation it awards using a Carbon EmissionsFactor (CEF) that is significantly lower than the one allowed by the European Commission. As a consequencethe UK will be providing far less compensation than EC rules provide for, and far less than other MemberStates. This will mean the mitigation package fails to rectify the competitiveness problem threatening theindustry.

15. The EC has calculated a CEF for each Member State based on the carbon intensity of marginal producers’power generation in that country. The CEF indicates exposure to electricity price and thereby the appropriatelevel of mitigation that should be awarded for ETS indirect costs in each Member State. The CEF proposedfor the UK (0.58) is significantly lower than most major competitors in the EU, such as Germany (0.76) andFrance (0.76). This means that even if the UK were to provide the maximum compensation permitted, UKenergy-intensive industries would still receive significantly less compensation than their European counterpartswho already enjoy lower energy prices. Germany and France, for instance, can provide over 30% more underEU rules.

16. Unfortunately, the Government is compounding the situation by proposing to use a significantly lowerCEF than the EU recommends (0.411). While countries such as Germany are providing the maximum StateAid permitted for ETS indirect costs, and indeed lobbying the EU for a higher CEF, the UK will be providingalmost a third less than it is allowed. This will mean that the levels of compensation in Germany, France, andBelgium for ETS indirect costs will be almost twice those in the UK.

17. The Government’s proposed CEF is factually incorrect. The Government has correctly identified that itis the carbon content of marginal electricity production (rather than the average carbon content of all electricityproduction) that should be used to calculate compensation levels. They have, however, incorrectly interpretedthe EU’s recommended CEF to be a general average, when it is in fact already based on marginal electricityproducers’ carbon intensity. This has led the Government to understate the CEF for the UK by almost 30%compared to EU data.

18. This would be serious enough, but our own calculations suggest that the UK’s real carbon emissionsfactor is in fact higher than the EU estimates, which means the Government’s CEF is an even greaterunderestimate of the true exposure of the UK’s energy-intensive industries. This is because coal generationplays a more important price-setting role in the UK power market than the EU calculation acknowledges.Recognising that coal and gas generation typically exert an equal amount of influence on power prices in theUK, we have calculated that the UK’s CEF is actually over 0.6. We are preparing detailed data on this tosubmit to BIS currently, and would be happy to share this with the EAC in due course.



The UK’s most electro-intensive industries will still be at risk of carbon leakage under the current proposals

19. By providing significantly less compensation for ETS indirect costs than the EU permits, the UK isplacing its domestic energy-intensive industries at a competitive disadvantage with respect to competitors inEurope, who will be more adequately protected from the effect of electricity price rises. EU State Aid rulesonly permit compensating for 85% of ETS indirect costs in 2013 (based on costs incurred by the most efficientproducers), declining to 80% in 2016, and 75% in 2019. This already leaves European energy-intensiveindustries with significant exposure to increased costs. The Government’s proposal not to even go this far,means that even the most efficient UK sites will in fact be exposed to around 40% of ETS indirect costs in2013, increasing to approximately 47% by 2019 (based on the EU CEF). This will mean UK sites areparticularly under threat of carbon leakage.

20. The CEF is also used to calculate compensation for CPS, which means that under the proposedmethodology, the UK will also be underestimating the exposure of domestic energy-intensive industries tounilateral carbon pricing measures by 30%. The Government intends to compensate for 85% of the costsresulting from the introduction for the carbon price floor, but by underestimating the CEF the UK’s energy-intensive industries will in fact be exposed to approximately 40% of the indirect costs of CPS, not 15% (basedon the EU CEF). These are unilateral costs not faced by competitors in Europe or further afield. This willseriously undermine the competitiveness of UK energy-intensive industries, and the situation will becomeincreasingly grave as CPS rates increases dramatically over time.

21. The significant and increasing exposure to unilateral costs associated with the carbon price floor, and aless than competitive ETS compensation package compared to other Member States, means that the UK willbecome an increasingly uncompetitive location for energy-intensive industries. Under the current methodologyRuncorn would still face increased costs of at least £13 million in 2020—approximately two thirds of ouraverage annual earnings over the last four years (EBITDA).

The Government must use an accurate Carbon Emissions Factor and target mitigation at the mostvulnerable industries

22. It is vital to use the correct CEF so the risk to energy-intensive industries is not underestimated, andadequate compensation is provided. As a minimum the UK must use the CEF calculated by the EU to ensurethat ETS compensation is competitive with other Member States, and that compensation does in fact cover theintended proportion of costs associated with the introduction of the carbon price floor. Under the currentmethodology there is still a serious risk of carbon leakage in the UK, which must be addressed.

23. To ensure that mitigation serves its purpose of preventing carbon leakage it is also vital to target themost vulnerable industries that are most electro-intensive. Under the current proposals any companies withcarbon costs that exceed 5% of GVA will be eligible for compensation, and the same proportion of their costswill be covered. We believe that this threshold is low, and a banded rather than “all or nothing” approach toallocation would more effectively protect the industries at serious risk of carbon leakage. For instance,companies with carbon costs equivalent to 5–7.5% of GVA might be awarded 50% compensation. Companieswith 7.5–10% of GVA might be awarded 75% compensation, and companies with over 10% could get 100%compensation.

The Government needs a long-term strategy to secure the future of domestic energy-intensive industries

24. Getting the mitigation package right is vital for this Spending Review, but it is only a short-term measurethat will not address the bigger problem. The Government must also bring forward a long-term strategy toprotect the future of energy-intensive industries in the UK, which remains seriously under threat due to thepolicy outlook for the next ten to twenty years. The UK should look to learn from examples of best practicein Europe, such as the longstanding fiscal arrangements in Germany for energy-intensive industries, or theExeltium deal in France. Exeltium is an innovative special purpose vehicle that delivers investment in low-carbon energy through establishing long-term supply contracts between producers and consumers of energy.This offers energy-intensive industries competitive long-term prices, and promotes the transition to the greeneconomy without imposing punitive taxes on businesses.

23 November 2012

Written evidence submitted by EDF Energy

Executive Summary

— EDF Energy supports the intent of the Energy Intensive Industries consultation. We agree withthe approach to align the eligibility and compensation criteria for the carbon price supportmechanism with the existing framework for indirect costs of the European Union EmissionsTrading System (EU ETS) proposed by the European Commission. This will minimiseadministrative burden and should facilitate EU State Aid clearance.



— We believe that relief for the indirect costs of the EU ETS and carbon price support mechanismshould be targeted at those industrial sectors and installations where the evidence base suggeststhere is significant risk of carbon leakage and that the levels awarded are proportionate to need.In addition, it is important that any financial support is time-limited in order to drive thebehavioural change required to permanently reduce emissions.

— We note that the EU ETS Directive provides for temporary measures to compensate certainsectors for increases in electricity prices that result from the inclusion of the cost of carbonemissions as a result of the EU ETS. We therefore welcome the Government’s intention toprovide £250 million from April 2013 over the Spending Review period to mitigate the impactsof it on electricity costs to businesses that are electricity intensive and operate in internationallycompetitive markets.

— EDF Energy supports proposals to assist those energy intensive industries (EIIs) exposed tocarbon leakage as a result of the indirect costs of UK and EU climate policies. However, theGovernment should ensure that any such relief does not undermine the effectiveness of policiesto drive decarbonisation in the power sector, such as the Contracts for Difference (CfD)mechanism within its proposed Electricity Market Reform (EMR) package.

— Should the Government be minded to provide any direct relief for electricity costs, it will becritical to maintain the integrity of the EMR proposals. In particular, it is essential that theprimary legislation in the Energy Bill provides the counterparty, which will enter into contractswith generators, with the unequivocal ability to levy suppliers to honour its contractualcommitments. There should be no exemptions; otherwise we are concerned that this willintroduce an unwelcome precedent and could undermine the EMR proposals as it means thatthe CfD costs will be recovered from a smaller base and will introduce investor uncertainty.EDF Energy recommends that qualifying EIIs should be allowed to claim a rebate based on thesupport criteria that the Government may choose to adopt. We believe that this will be the mostefficient method and will also help to keep the process simple to administer.

EDF Energy’s Response

1. EDF Energy is one of the UK’s largest energy companies with activities throughout the energy chain. Weprovide 50% of the UK’s low carbon generation. Our interests include nuclear, coal and gas-fired electricitygeneration, renewables, and energy supply to end users. We have over 5 million electricity and gas customeraccounts in the UK, including both residential and business users.

2. EDF Energy is committed to delivering affordable, secure, and diverse low carbon supplies based on adiverse energy mix, including nuclear and renewables. We plan to invest in four new nuclear plants in the UK,starting with two at Hinkley Point in Somerset. With our co-investor Centrica, we are making continuedprogress on this project, including on site preparations, with a view to taking the Final Investment Decision(FID) at the end of 2012. Our shareholders remain committed to this project going ahead, subject to the rightbusiness case and to the legal framework being in place.

3. The forthcoming publication of the Energy Bill reflects the Government’s continued momentum onElectricity Market Reform (EMR). Reform of the existing electricity market arrangements is necessary toensure the market is capable of delivering the reliable diverse energy mix required to deliver the UK’s energypolicy objectives. We believe that the Government’s proposals will provide the investment framework that iscrucial for the low carbon investment that the country needs, and will keep costs down for consumers.

4. We have long advocated the need for a credible carbon price to drive investment in low carbon generation.However, it is commonly accepted that the European Union Emissions Trading System (EU ETS), as currentlystructured, is not providing the long-term signal to make this investment. With a quarter of the UK’s generatingcapacity due to close over the course of the decade, the reality is that the UK needs to move faster to renewits infrastructure than other Member States to ensure that it can maintain the physical and economic securityof its energy supplies. Otherwise there is a serious risk that a delay could expose UK customers to volatile andprobably higher energy prices.

5. In light of this, we have welcomed the UK Government’s initiative to introduce a carbon price floor. Theintroduction of the carbon price floor helps restore the long-term price signal that the EU ETS was expectedto achieve, and will provide much needed price stability for UK investors in low carbon generation. Althoughthe direct impact of this measure is limited to the electricity sector, we recognise that it does have an indirectimpact on energy intensive users and creates a potential carbon leakage risk.

6. EDF Energy supports proposals to assist energy intensive industries (EIIs) potentially exposed to carbonleakage as a result of the indirect costs of UK and EU climate policies. However, any relief should ensure thatthe effectiveness of policies to drive decarbonisation in the power sector is not undermined.

7. In considering carbon leakage risks, we urge BIS to make a clear distinction between relocation ofproduction from Europe to the rest of the world as a result of the EU ETS, and any that may occur from UKto other EU Member States due to the carbon price floor. We believe that this will help to better inform thedevelopment of appropriate relief measures.



8. We note that the EU ETS Directive provides for temporary measures to compensate certain sectors forincreases in electricity prices that result from the inclusion of the cost of carbon emissions as a result of theEU ETS. We therefore welcome the Government’s intention to provide £250 million from April 2013 over theSpending Review period to mitigate the impacts of it on electricity costs to businesses that are electricityintensive and operate in internationally competitive markets.

9. We believe that UK Government relief for the indirect costs of the EU ETS and carbon price supportmechanism should be targeted at those industrial sectors and installations where the evidence base suggeststhere is significant risk of carbon leakage and that the levels awarded are proportionate to need. We feel thisis important in order to minimise the risk of competitive intra-EU distortions which could disadvantage industryin individual Member States. A combination of electricity intensity and trade intensity criteria provide a soundand fair basis to assess the risk of indirect carbon leakage.

10. It is important that any financial support is time-limited in order to drive the behavioural change requiredto permanently reduce emissions. We believe that the issue of carbon leakage should be progressed via a co-ordinated approach at the EU level, to help ensure that European energy intensive industries are able to competeon a level playing field against their main economic competitors.

11. In a wider context, it should be recognised that the carbon price floor complements the existing EU ETSand will play a key role in delivering low carbon investment in the UK electricity sector. However, it does notremove the need for reform of the EU ETS at the European level. We believe that any impact on UK businesseswill be further limited by a strong EU ETS carbon price, which will significantly reduce or even eliminate anycost differentials that may arise from the carbon price floor in the UK electricity sector. A robust and credibleEU carbon price will remove the need for unilateral remedial Member State actions.

12. EDF Energy strongly supports the UK Government’s aim in forthcoming talks to secure EU-wideagreement on proposed amendments to the auction timeline (‘back-loading’) to strengthen the EU ETS. Wealso support structural measures to improve the functioning of the scheme, including a move to a 30% reductiontarget for 2020 relative to 1990 levels. As the supply side of the EU ETS is totally inelastic, we believe asupply response mechanism, based on transparent and objective criteria, and resulting in a minimum level ofscarcity, would help UK industry avoid any unnecessary differential competitive impacts and help addresscarbon leakage concerns.

13. Should the Government be minded to provide any relief for electricity costs, it will be critical to maintainthe integrity of the EMR proposals. In particular, it is essential that the primary legislation in the Energy Billprovides the counterparty, which will enter into contracts with generators, with the unequivocal ability to levysuppliers to honour its contractual commitments. There should be no exemptions; otherwise we are concernedthat this will introduce an unwelcome precedent and could undermine the EMR proposals as it means that theContracts for Difference (CfD) costs will be recovered from a smaller base and will introduce investoruncertainty.

14. EDF Energy recommends that qualifying EIIs are not exempt from making their usual payments forelectricity supply and should instead benefit from a separate rebate based on the support criteria that theGovernment may choose to adopt. We believe that this will be the most efficient method and will also help tokeep the process simple to administer.

23 November 2012

Written evidence submitted by the British Ceramic Confederation

Summary

— Cumulative tax burden and carbon leakage. The British Ceramic Confederation (BCC) supportsthe long term goal of shifting to low carbon energy supplies. However our members havebecome increasingly concerned about the mounting cost of the UK’s unilateral climate changecommitments, their cumulative impact when considered in addition to UK and EU taxes ondirect emissions on trade-exposed energy intensive industries, and the consequent risk of carbonleakage. We note that the carbon leakage risk is explicitly recognised within European climatelegislation, and has also recently been recognised by the government with respect to UK-onlyclimate policies.



— Initial comments on package. BCC welcomed the announcement of a compensation package inthe Chancellor’s 2011 Autumn Statement. We noted at the time however that the proposed £250million funding would be insufficient to ensure full mitigation of the indirect effects of EUEmissions Trading (EU ETS) and the Carbon Price Floor (CPF) on our industry and otherenergy intensive industries. We understand that the package is a fraction of what is available inother competitor economies such as Germany. Also that no firm measures had yet been proposedto address the equally significant impact of renewable subsidies such as the RenewablesObligation or costs arising from Electricity Market reform. We welcomed the 90% ClimateChange Agreement rebate on electricity from 2013—but this is a trivial extra amount and doesnothing to mitigate the extra costs of the Carbon Price Floor in 2013—let alone later when CPFcosts escalate to £70/tonne (in real terms—actual £ higher than this) in 2030. We welcomedthat Green Investment Bank funds are available for industrial energy efficiency and emissionsreduction projects.

— Further comments on adequacy of package. If the Government is genuine in seeking a greaterrole for manufacturing and a long term UK future for Energy Intensive Industries, then thesupport offered to eligible installations should not be capped at all—it is simply returning aportion of new taxation to those affected—there is a self-balancing mechanism. Losing UKmanufacturing through policies such as CPF simply reduces the UK tax-paying base in thelonger term.

— Duration of package. We are concerned that the compensation for CPF and EU ETS indirectcosts are only proposed at present for the current spending review term whereas the taxes willpersist beyond this: manufacturers need to be able to plan on a longer term basis. We wouldlike to see a firm commitment to a second phase of compensation with a larger budget toaddress the risk of carbon leakage from a broader range of exposed electro-intensive businesseson a wider range of taxes.

— Evidence of UK cumulative climate change cost on electricity prices. BCC also welcomed thepublication by BIS in July of an independent consultant’s report: “An international comparisonof energy and climate change policies impacting energy intensive industries in selectedcountries”. The report confirmed our members’ earlier assertions that UK intensive industriesalready face higher electricity prices than competitors in Germany, France, USA, China andIndia. The report also confirmed that the expected uplift in UK electricity prices by 2020 as aresult of climate policies (£28.30/MWh) will be higher than in any other country surveyed.

— Evidence of unilaterally high UK electricity prices on carbon leakage on ceramics. Wesubmitted to you in confidence in September 2011 information from several companies showinghow either investment decisions were unfavourable or more importantly, how the UK’s highelectricity price has led to the relocation of highly electro-intensive processes from the UK toother countries. Since then other members operating electro-intensive processes have comeforward also citing how UK jobs have been lost in recent years to developed economies suchas France, Germany and the USA—and that the UK’s relatively high electricity bills (prices+taxes) were a key part of these relocation decisions. This does not bode well for future UK joband business security when the differential pricing between the UK and these economies willincrease further in the next decade (see point above). Moreover, a significant proportion of ourmembers not deemed “electro-intensive” that will not be compensated for CPF have said thatthe proposed cumulative increases in electricity bills exceed current profits before 2020. Thisis before extra environmental charges such as EU ETS and CCL/CCA are added on for directemissions.

— Exclusion of ceramics from EU ETS indirect compensation. All ceramic installations areexcluded from EU ETS indirect compensation as the sector as a whole is not electro-intensive(see point 3 below). This is regardless of the fact that some of the installations in our sectormust surely be amongst electro-intensive in Europe (eg electric arc furnaces at 2750 deg C)and where carbon leakage from the UK has already been demonstrated. This denies these highlyvulnerable installations access to the major part of the £210 million (EU ETS + Carbon PriceFloor) compensation pot.

— Carbon Price Floor compensation availability. We agree with the government that CPFcompensation should be available for all vulnerable energy intensive industries, not just thosein sectors previously deemed eligible for EU ETS compensation, and support the eligibility ofelectro-intensive processes or products outside these sectors—such as those in ceramics (seepoint 3 below) where robust evidence is available to justify their inclusion.



— Request for flexibility in compensation pot. We would like to see a better and fairer distributionbetween the relative amounts available in the EU ETS indirect compensation and Carbon PriceFloor funds. At present more is allocated to EU ETS compensation, even though both thecurrent price of carbon and the number of companies/processes the fund would be distributedover is lower than for the Carbon Price Floor fund. This introduces even more distortion forelectro-intensive processes (such as those in ceramics) outside sectors previously deemedeligible for EU ETS compensation. There is the need for more flexibility between the funds—HMT will be receiving as new revenue, the proceeds from both EU ETS auctioning and CarbonPrice Floor.

— Need for maximum compensation under State Aid rules—especially important for thoseexcluded from EU ETS indirect compensation. The UK should seek to compensate for themaximum possible amount allowed under State Aid rules—the Commission rules ensure (anunnecessary) incentive for continued electrical efficiency remains by limiting to 85% (andreducing over time) the total compensation that can be offered. This is clearly not the policybeing followed through the current proposals. In line with Commission guidelines for EU ETScompensation, the government proposes that aid intensity must not exceed 85% of the eligiblecost increase in 2013–15, 80% in 2016–18 and 75% in 2019–20. We agree with the proposalto apply the same intensity limits for CPF compensation in order to secure state aid approval,but note however that even under the maximum level of CPF compensation UK industry willbe exposed to an increase in electricity prices reflecting the uncompensated 15–25% of CPFimpact that will not be experienced anywhere else in Europe. We note that many electro-intensive products and processes such as those in the ceramics sector will not receive EUETS indirect compensation if they are outside sectors previously deemed eligible for EU ETScompensation—and so they will be even more radically under-compensated.

— Need for a fair emissions factor. We profoundly disagree with the government’s arbitrary andtechnically unjustifiable proposal to use an unrealistically low emissions factor for EU ETS andCPF compensation purposes. The Commission’s guidance states that the UK may use amaximum figure of 0.58t/CO2/MWh, reflecting the average carbon content of electricity fromUK fossil fuel plants. We are aware that a number of countries such as Germany and theNetherlands intend to compensate at their maximum level, and we believe the UK should dothe same to preserve a level industrial playing field. If we accept the government’s argumentthat the CO2 emissions factor should be consistent with that of the marginal fuel in generation,the proposal to use 0.411tCO2/MWh, representing gas fired generation, is inappropriate as thereare occasions when the marginal plant is coal, oil or gas in open cycle.

— Other approaches to mitigate the effects of the 4th carbon budget on energy intensive industries.We remind the committee that the package for energy intensive industries arose from theGovernment’s tightening of the 4th Carbon Budget targets to 50% emissions reduction (vs.1990) by 2023–27. We think that it is essential that Government helps industries adapt withbreakthrough technologies to improve energy efficiency and reduce emissions. We wereconcerned by the recently published Industrial38 and Heat39 Technology Innovation NeedsAssessment TINAs which advocate focus on particular industries—and did not appear to evenconsider ceramics. This represents a “double whammy” for our sector—being given little rebatefrom new environmental taxes—yet with minimal access to funds to develop emissionsreduction technologies. We would also want to see UK Government adopt in a timely mannerthe “Mineralogical Processes Exemption” in the Taxation of Energy Products and ElectricityDirective (2003/96/EC) which has been successfully used by other EU countries40 to mitigateenergy taxes and charges on energy for the ceramics, cement, lime and glass sectors. TheClimate Change Levy (CCL) is clearly an economic instrument that could be quickly and easilymitigated in this way.41 Our proposal is that full tax relief should be extended to all fuels usedfor mineralogical transformation. There is no suggestion that the Climate Change Agreementsthemselves should be terminated or undermined. Our proposal includes retention of theagreements to provide confidence that energy efficiency is controlled in line with UK energypolicy and of course this would include retention of the buy-out mechanism.

Brief Introduction to the British Ceramic Confederation

1. The British Ceramic Confederation (BCC) is the trade association for the UK Ceramic ManufacturingIndustry, representing the common and collective interests of all sectors of the Industry. Its 100 membercompanies cover the full spectrum of products and materials in the supply chain and comprise over 90% ofthe Industry’s manufacturing capacity.38 http://www.lowcarboninnovation.co.uk/document.php?o=1339 http://www.lowcarboninnovation.co.uk/document.php?o=1040 Including France, Germany, Luxembourg, Greece, Belgium and Italy.41 The CCL is obviously not the only financial instrument that could be considered and the exemption principle of state aid could

be highly relevant to our sectors when the UK makes provision for mitigation of other policy measures such as, but not limitedto: Renewables Obligation, Carbon Price Floor, Costs associated with Electricity Market Reform / Feed in tariffs, CRC EnergyEfficiency scheme.



2. Membership of the Confederation includes manufacturers from the following industry sectors:-

Gift and Tableware Floor and Wall Tiles SanitarywareBricks Clay Roof Tiles Clay PipesRefractories Industrial Ceramics Material Suppliers

Our sector and its suppliers employs approximately 20,000 people and generates £2 billion sales of whichapproximately £500 million are exports. The sector is a solution provider for the low carbon economy includingdurable construction materials with low lifecycle carbon footprints; industrial ceramics providing criticalcomponents for low carbon energy and electricity distribution; long-life refractory materials are essential forglass, steel and ceramic production.

3. Ceramics is an energy-intensive industry: energy bills/taxes can be up to 30–35% of total productioncosts. 85% of the energy used is natural gas. BCC is a member of the Energy Intensive Users Group andsupports their response to this enquiry. The information in our response is to reinforce and supplement theissues with examples relevant to our sector. Although the ceramics sector uses more gas than electricity, theamount of electricity used is still significant. (About 85% of the total energy used is from gas). There are asignificant number of highly electro-intensive ceramics processes such as electric arc furnaces and electricinduction furnaces manufacturing technical ceramics and refractories at above 2000 deg C. In the bulk of theindustry, much of the electricity used is for process control or essential safety and environmental equipment.It is therefore more difficult to reduce consumption for these essential functions.

27 November 2012

Written evidence submitted by EEF/UK Steel

About EEF

EEF, the manufacturers’ organisation is the representative voice of UK manufacturing, with offices inLondon, Brussels, every English region and Wales. We are a not for profit organisation with a growingmembership of almost 6,000 companies of all sizes, employing some 900,000 people from every sector of theengineering, manufacturing and technology based industries. UK Steel, a division of EEF, is the tradeassociation for the UK steel industry. It represents all the country’s steelmakers and a large number ofdownstream steel processers.

Response

EEF welcomed the announcement of a package of measures in the Chancellor’s 2011 Autumn Statement toaddress unilateral electricity cost increases, resulting from certain climate change policy instruments (thePackage). We welcome the opportunity to provide the Committee with our thoughts on the details of thePackage and also our wider views on how Energy Intensive Industries (EIIs) can best contribute to the shift toa low carbon economy.

We set out below why there is a desperate need for such a package of measures to create a more levelplaying field for UK EIIs both within the EU and globally.

Summary

— The government’s current proposals for the EII package will be inadequate to shield manyenergy intensive businesses from the impact of unilateral measures to address climate change

— Support must be aligned to the support being provided by other member states to their energy-intensive industries.

— The government must review the current EII package to ensure adequate funds are availableand provide the right-level of required cost offset.

— The government should commit to extending the solution for electro-intensive industry beyondthe current Spending Review period

— The government should begin a wholesale review of the Climate Change policy landscape inthe run up to the next Spending Review, as recommended in EEF’s Green and Growth Reportpublished December 2011

— This review must address the unnecessary complexity and overlaps contained in the currentmix of policies and seek to deliver the required reduction in greenhouse gas emissions in amore cost-effective and less bureaucratically burdensome way.

Scope and cost of delivery

Whilst we welcome the efforts of government to ring fence £250m to fund the Package, we question whetherthis figure is sufficient to achieve its aim. If Department for Business, Innovation and Skills (BIS) finds that tobe the case, then the department must seek further options to compensate affected sectors. EEF is fully awarethat with very limited government finances, increasing total spending is not an option. If the required level of



funding cannot be found without breaching current overall spending limits, then government must ensure thatthe most electro-intensive sectors are fully compensated, rather than compensating a greater number ofcompanies at a lower level. All stakeholders should be minded that this Package was developed to addressincreased unilateral costs faced by electro-intensive sectors who are exposed to global competition.

Aim of the Package

We fully support the stated aim of the Package, namely “[the] aid aims to avoid the risk of increased globalgreenhouse gas emissions due to shift of production from EU countries to those outside the EU that are notsubject to emissions reduction targets”. But we remain concerned that the proposed details of the Package willresult in failure to meet this aim.

In deciding the extent of the Package, the UK government is limited in how much it can provide as assistanceto companies. Government must adhere to the EU Commission State Aid guidelines, published in May 2012.Government can therefore interpret the following factors up to the limit of the Commission’s guidelines42:

— Sector eligibility.

— Aid intensity.

— CO2 emission factor.

— Electricity efficiency benchmarks.

The electricity efficiency benchmark is designed by the Commission to ensure that less efficient EIIs are notcompensated for their inefficiency: the level of compensation in theory should be calculated by reference tothe amount of electricity that the most efficient operator would consume for specific types of technology, butin reality the actual benchmark values will for many processes be arbitrary. The aid intensity calculationimposes an artificial cap on the amount of compensation that can be paid. The effect of both factors will besignificantly to reduce the amount of compensation that can be paid.

It is therefore vital that for the most electro-intensive sectors, government must ensure that the Packagedelivers the maximum assistance allowed under the Commission guidelines. EIIs operating in internationalmarkets are most at risk from policy-driven electricity price rises.

Understanding the real cost impacts

In this debate, it is vitally important to consider the publication by BIS in July of an independent consultant’sreport: “An international comparison of energy and climate change policies impacting energy intensiveindustries in selected countries”. A report that was funded by BIS and supported by DECC. The followingchart shows clearly that EIIs in the UK are currently disadvantaged and will be significantly more exposed toincreased policy-induced electricity prices, than their direct competitors in the EU and globally.

Government figures show that we are heading into a very serious situation. That of how we can ensure thatglobal EIIs have the right incentives to continue to invest in the UK, as opposed to other economic regions,where these costs are either significantly lower, or non-existent.

42 The Guidelines in fact apply only to compensation for the increase in electricity prices arsing from the EU Emissions TradingScheme. However, in order to maximise its chances of obtaining State aid consent, the government will apply these sameprinciples to its Carbon Price Floor compensation proposals.



Chart 1:Indicative incremental impacts in 2011, 2015 and 2020 on electricity price (£/MWh, 2010 prices) of energyand climate change policies—Sensitivity using market forecasts of EUA prices

£10

£5

£0

£5

£10

£15

£20

£25

£30

£35110251020202

110251020202

110251020202

110251020202

110251020202

110251020202

110251020202

110251020202

110251020202

110251020202

110251020202


Other

ET

RE

EE

GHG

Source: BIS, An international comparison of energy and climate change policies impacting energy intensiveindustries in selected countries. July 2012

Significant gap in other climate change costs

The current BIS Consultation on the EII Package addresses only two of the four elements of the Package,namely the unilateral costs arising from the EU ETS and Carbon Price Floor. It doesn’t address the issue ofunilateral costs that will result from the forthcoming Energy Bill, namely the Contracts for Difference or theexisting Renewable Obligation. We have called on DECC to ensure that consideration of costs for EIIs resultingfrom both these measures are addressed directly within the Bill, rather than designing a fix retrospectively. Weare hopeful that government understand our concerns here and have listened to our proposed solution.

Not in line with other Member States

As we have stated, government has the option to decide how much it wishes to assist EIIs. In addressingthese variables, our greatest concern is that the UK intends to differ from the European proposal in relation tothe regional emission factor, ie the amount of carbon dioxide emitted per unit of electricity generated. Theconsultation proposes to use a factor of 0.411tCO2/MWh, rather than the regional emission factor of 0.58tCO2/MWh proposed by the Commission. By using this lower figure, the UK would effectively be compensating itsEIIs less than other Member States.

EEF believe that the UK should be using the higher figure in line with the Commission guidelines. To notuse the higher figure puts UK manufactures at a disadvantage to their EU competitors. This is not the aim ofthe EII Package.

EIIs are already subjected to a multitude of other climate change related costs, in addition to energy and rawmaterial costs which drive efficiency and emissions reductions. It is therefore necessary to address the callfrom some commentators that all climate change related cost increases for EIIs will provide “incentives” thatwill lead to further reductions in emissions and increased efficiency of resources use. We would argue that thecumulative unilateral costs that are placed on EIIs in the UK have a negative impact on both intra and extraEU competitiveness, as highlighted by the Welsh Assembly Government, following the announcement by TataSteel to restructure its operations in Wales, resulting in further job losses from the steel sector.



Longer term certainty is needed

The report for BIS clearly shows that climate change related taxes applied to EIIs are set to increase. Indeedthey are set to increase at a much faster rate than both our EU and global competitors’.

To deliver on the government’s aims to both grow and green the economy in parallel it must provide long-term investment certainty. However, the Package currently only has a shelf life of two years, ie only for thiscurrent Spending Review term.

To address future, foreseeable increases and to align with manufacturing companies’ investment cycles,which inevitably stretch out much further than the lifetime of the Package, government must give manufacturersrobust assurance of its intention to commit to a solution for EIIs in the longer term.

Future aims

Although the Package is very welcome and much needed, we should remember that it is an attempt to backengineer a fix, rather than tackling the issue head on. We need to see government place the role of innovationand technology at the heart of the low-carbon transition for these global sectors. This needs to be done at theglobal scale for many carbon intensive, globally traded sectors.

Below we set out our view of the longer term solution to tackle the direct impact of climate change policyon EIIs. However, it is plain to see that government must, from the outset, assess each policy on both greenand growth ambition and design smart policies which ensure both are achievable, rather than revenue raisinginstruments, such as CRC and CPF.

We believe sector approaches have the opportunity to offer faster, more effective, large-scale responses toclimate change. Therefore, EEF has previously called on government to set this as a priority action.

While not suitable for all sectors, a sector-based analysis of the problem can offer distinct advantages overtraditional geographical organised responses. A sector approach consists of a combination of policies designedaround individual sectors’ unique characteristics, location and technologies to push efficiency and stimulatedevelopment and investments in break-through technologies which lead to profound decarbonisation.Harmonisation in measurement, reporting and verification practices provides the potential for financingmechanisms to be linked internationally in future.

Work43 by the World Business Council for Sustainable Development’s Cement Sustainability Initiative hasdemonstrated that a combination of different sector-specific policies and measures in different countries couldresult in effective and efficient CO2 emissions reductions.

However, it does require international cooperation within an industry sector. Voluntary industry-ledschemes—while being successful in driving the efficiency of participants and harmonising measuring, reportingand verification—have suffered from coverage issues. In particular, Chinese participation has been limited (seeAnnex I). Goal setting under the schemes have subsequently reflected limited ambition.

This is an understandable consequence of uneven participation. For most energy-intensive installations,massive decarbonisation can only be achieved via incredibly expensive and untried technology. Sectorapproaches therefore must aim to strengthen incentives for innovation. In a globally competitive market,shouldering these costs alone can price an operator out of the market—as can unilateral policy measuresdesigned to incentivise carbon efficiency by internalising carbon costs. Production subject to these costs wouldstruggle to compete, as the ability to pass on these costs is severely limited. Numerous studies have nowidentified sectors such as steel, cement and aluminium as being at risk from leakage of production (and relatedemissions) from jurisdictions with carbon constraints to jurisdictions without (appropriate) constraints. Anyscheme that is realistically going to achieve substantial emission reductions in global sectors must seek toestablish a cost of decarbonisation that is the same for all the sectors’ installations across the world.

Conclusion

While we welcome the Package in its current design, it fails to achieve on its original aim. There are someimmediate steps that government can undertake to help address this. However, what is needed is fundamentalreform of the climate and environment policy as soon as possible with a view to the years towards and beyond2020. Policy makers must accept that a “one size fits all” approach simply doesn’t work for all sectors,particularly EIIs. It both slows down innovation and decreases industrial competitiveness. Government mustacknowledge and champion sector approaches as the most effective way to decarbonise these sectors in thefuture, whilst ensuring that wider policies do not indirectly impact on their competitiveness.43 CSI, ERM and , 2009, CSI Model Scenarios and Results Overview www.wbcsdcement.org/pdf/

CSI%20model%20scenarios%20and%20results%20overview_May09.pdf



Annex 1

VOLUNTARY INDUSTRY SECTOR APPROACHES

1. World Steel Association: Climate Action Recognition Programme

The World Steel Association represents approximately 170 steel producers (including 17 of the world’s 20largest steel companies), national and regional steel industry associations and steel research institutions. WorldSteel members represent around 85% of world steel production.

CO2 emissions data collection programme

In 2008, the Association launched a “Climate Action recognition programme” which aimed to giverecognition to steel producers who participate in its global CO2 emissions data collection programme.

The reporting framework uses a common agreed methodology and work is underway for this to be recognisedas an ISO standard. It uses an intensity-based approach which measures the amount of CO2 generated for eachtonne of steel produced.

All data are held on dedicated servers at a company with ISO 27001 accreditation. Great care has been takento ensure that data from individual companies’ steel plants are known only to the company itself and WorldSteel staff administrating the project. A tool has been developed to ensure that steel plants report on acomparable basis. All data are verified by third party assessment.

The data collection will lead to benchmarking improvements based on actual performance data. This enablesindividual steel plants to position themselves against both the average and the best performance and to identifyscope for improvement.

The approach was never designed to “level the playing field” but as a voluntary energy or CO2 reducingmechanism.

Steel producers which participate in the scheme are granted use of a logo for two years which has been usedto encourage recognition of their efforts. Some procurers, for example, Australia’s Green Building CouncilGreen Star rating, require suppliers to participate in the scheme.

The intention was to follow up with reporting and the setting of commitments on a national or regional basisfor implementation post 2012. This was intended to form the core of a global steel sectoral approach.

However, while some 200 plants from around the world are submitting data, representing 30% of globalproduction from almost 70% of Worldsteel’s members, the vast majority of Chinese steelmakers are notparticipating in the scheme.

Nevertheless, the Asia Pacific partnership is using the methodology so while the data haven’t been receiveddirectly, World Steel can make a very confident estimate of the emissions trajectory.

CO2 breakthrough programme

Worldsteel provides a forum where various national and regional research and development programmes onidentifying breakthrough technologies for steel manufacturing can exchange information on projects.

This includes the ULCOS programme funded by the European Commission and the European steel industry;the COURSE 50 research programme in Japan; the US steel industry and US Department of Energyprogrammes; the POSCO programme in Korea, and others.

2. World Business Council for Sustainable Development: Cement Sustainability Initiative

The World Business Council for Sustainable Development’s Cement Sustainability Initiative commenced inMay 2008. It is a voluntary, member-led initiative which currently is comprised of 24 major cement producerswith operations in over 100 countries.

Getting the numbers right

While encompassing a range of different environmental issues,44 climate protection is a key strand ofactivity. Harmonised data reporting is a key output. In 2011, the CSI published the third version of its CO2accounting and reporting standard for the cement industry. Data is collected to allow for the CO2 emissionsrelated to production to be explored on both absolute and specific or unit-based terms.

The methodology is used by most international cement firms, the EU Emissions Trading Scheme, the USEPA mandatory reporting of greenhouse gas rule and the Global Superior Energy Partnership (formally theAsia Pacific Partnership). It has three elements: guidance, an excel spreadsheet and a step by step guide tofilling it out.44 The Cement Sustainability Initiative also looks at fuels and materials, health and safety, local impacts, emission reductions and

wider sustainability issues. See www.wbcsdcement.org



Data are third party assured and 83% has been independently assured at company-level. Confidentiality ofthe data is crucial. In this case, a third party operator manages the data. It provides a guarantee of non-disclosure of confidential information and compliance with competition law.

Data collection currently covers 26% of global production, covering all geographical regions—but to varyingextent. In Europe, coverage is 93% of all producers and is the highest in the world. High representation hasalso been achieved in the Americas and India. But coverage is lower for the Middle East, Africa and Asia.Just 5% of Chinese production is currently covered however new Chinese members have recently joined theInitiative and are expected to report from next year.

In return for submitting data, producers are benchmarked against their peers.

Technology roadmap

In 2009, the International Energy Agency and the WBCSD together developed a cement industry technologyroadmap.45 It outlines the existing and potential technologies and how they may help the industry support ahalving of global CO2 emissions by 2050.

The roadmap is based on IEA modelling and on 38 technology papers developed for the CSI by the EuropeanCement Research Academy. It was one of the first sector-specific roadmaps to be developed and provides avision of potential future emissions reductions.

The CSI is currently working to develop an India-specific technology roadmap in a project supported by theInternational Finance Cooperation. It explores what is available to the cement industry in India. Data collectionon industrial energy use and emissions has been carried out, data analysis and modelling is underway to assessemission reduction potentials with these technologies.

The process has been underpinned by wide stakeholder engagement (the latest consultation closed mid-March). The next phase of the project will see CSI member companies overseeing the development of theroadmap at selected plants, identifying where specific investments related to technology can lead to emissionreductions. The Indian CSI members in the roadmap project represent 54% of the country’s cement production.

3. International Aluminium Institute: Aluminium for Future Generations

The IAI is a global forum of the world’s aluminium producers. The Institute has 27 member companieswhich together represent 80% of world primary aluminium production.

The aim of the IAI’s sector approach is to improve efficiency of production, increase light weighting,stimulate more recycling and recovery of aluminium and to improve occupational health.

Climate-related goals included targets to reduce emissions of perfluorocarbons (powerful greenhouse gaseswhich are produced during aluminium) by 50% by 2020 compared to 2006. This is the second such target. Itbuilds on an initial target to reduce emissions by 80% by 2006 compared to 1990, which has already beenachieved. This has been driven by investment in modern technology and operational improvements. Theultimate goal is a complete elimination of these emissions from production.

The industry has an additional goal to reduce energy use by 10% by 2010 compared to 1990. This was metand new goals for the industry include a commitment to reduce by 5% the global smelting electrical energyintensity by 2020. A further climate-related goal requires member companies to reduce emissions of greenhousegases per tonne of alumina produced. A summary of performance to date is detailed in Table 1, below. Despitegrowth in the sector between 1990 and 2008 direct emissions from all processes have remained flat.

The Institute has worked with the World Resource Institute and the World Business Council for SustainableDevelopment to develop protocols for greenhouse gas reporting in the sector and regularly publishes globalstatistics, including benchmarking data. Reporting occurs annually. A CEO peer group helps to stimulate furtherimprovements. The IAI also engages with the Asia-Pacific Partnership on Clean Development and Climate toprovide benchmark data, emissions measurement expertise and capacity building in data collection and analysis.All data is collected by a “confidential statistical officer” and is quality checked in house.

Reporting currently covers 64% of the industry’s production. IAI is aiming to increase this to 80%.Engagement from China is similar to other voluntary industry led approaches.

Coverage Reduction Baseline Target 2010Target Year Year Performance

Alumina refining energy intensity Global 10% 2006 2020 9%Smelter electrical (AC) energy intensity Global 10% 1990 2010 10%Electrolytic process electrical (DC) Global 5% 2006 2020 4%energy intensityFluoride emissions intensity Global 33% 1990 2010 50%

35% 2006 2020 13%45 http://www.wbcsdcement.org/pdf/technology/WBCSD-IEA_Cement%20Roadmap.pdf



Coverage Reduction Baseline Target 2010Target Year Year Performance

Perfluorocarbon emissions intensity Global 80% 1990 2010 85%50% 2006 2020 26%

Alumina refining energy intensity Global 10% 2006 2020 9%

Table 1: AFFG Objectives & Global Industry 2010 Performance

27 November 2012

Written evidence submitted by the Energy Intensive Users Group

The Energy Intensive Users Group (EIUG) represents the UK’s energy intensive industries includingproducers of steel, chemicals, paper, mineral products, glass, ceramics, aluminium and industrial gases, thatoperate in global markets and depend on access to secure, internationally competitive energy supplies to remainin business. These industries employ 225,000 workers directly and contribute over £15 billion to UK GDP.

1. EIUG supports the long term goal of shifting to low carbon energy supplies, although our members havebecome increasingly concerned about the mounting cost of the UK’s unilateral climate change commitments,their cumulative impact when considered in addition to UK and EU taxes on direct emissions on trade-exposedenergy intensive industries, and the consequent risk of carbon leakage. We note that the carbon leakage risk isexplicitly recognised within European climate legislation, and has also recently been recognised by thegovernment with respect to UK-only climate policies.

2. EIUG welcomed the announcement of a compensation package in the Chancellor’s 2011 AutumnStatement. We noted at the time however that the proposed £250 million funding would be insufficient toensure full mitigation of the indirect effects of EU Emissions Trading (EU ETS) and the Carbon Price Floor(CPF) on the UK’s energy intensive industries, and firm measures had yet to be proposed to address the equallysignificant impact of renewable subsidies. We would like to see flexibility between the relative amountsavailable in the EU ETS indirect compensation and Carbon Price Floor funds, currently set at £110 millionand £100 million respectively, allowing them to properly reflect the relative burdens of these two policies atthe time the compensation is applied. In addition, this compensation is only proposed at present for the currentspending review term, whereas the taxes will persist well beyond this: manufacturers need to be able to planon a longer term basis. In this regard, EIUG would like to see a firm commitment to a second phase of morecomprehensive compensation with an adequate budget to address the risk of carbon leakage from a broaderrange of trade exposed electro-intensive businesses.

3. EIUG also welcomed the publication by BIS in July of an independent consultant’s report: ‘Aninternational comparison of energy and climate change policies impacting energy intensive industries inselected countries’. The report confirmed EIUG’s earlier assertion that UK intensive industries already facehigher electricity prices than competitors in Germany, France, USA, China and India. The report also confirmedthat the expected uplift in UK electricity prices by 2020 as a result of climate policies (£28.3/MWh) will behigher than in any other country surveyed. The findings of this report underline the need to mitigate the equallysignificant impact of renewable subsidies from the RO and EMR on EIIs, in addition to the indirect costs ofETS and CPF.

4. In line with Commission guidelines for EU ETS compensation, the government proposes that aid intensitymust not exceed 85% of the eligible cost increase in 2013–15, 80% in 2016–18 and 75% in 2019–20. Whilewe disagree with economic logic of the Commission’s capping EU ETS compensation at 85–75%, we recognisethat it is pragmatic for government to propose similar capping for CPF compensation in order to optimise thechances of getting state aid approval. We note however that even under the maximum level of CPFcompensation, UK industry will be exposed to an increase in electricity prices reflecting the uncompensated15–25% of CPF impact that will not be experienced anywhere else in Europe.

5. We agree with the government that CPF compensation should be available for all vulnerable energyintensive industries, not just those in sectors previously deemed eligible for EU ETS compensation, and supportthe potential eligibility of electro-intensive processes or products outside these sectors where robust evidenceis available to justify their inclusion. We note that many electro-intensive products and processes will notreceive EU ETS indirect compensation if they are outside sectors previously deemed eligible for EU ETScompensation, leaving them especially under-compensated.

6. We profoundly disagree with the government’s arbitrary and technically unjustifiable proposal to use anunrealistically low emissions factor for EU ETS and CPF compensation purposes. The Commission’s guidancestates that the UK may use a maximum figure of 0.58t/CO2/MWh, reflecting the average carbon content ofelectricity from UK fossil fuel plants. We are aware that a number of countries such as Germany and theNetherlands intend to compensate at their maximum level, and we believe the UK should do likewise in orderto preserve a level industrial playing field. The current proposals, for example, would mean the level of ETScompensation for UK industry will only be 50% of the level available in Germany. Even if one accepts thegovernment’s argument that the CO2 emissions factor should be consistent with that of the marginal generator,



their proposal to use a figure of 0.411tCO2/MWh, representing gas fired generation, is clearly inappropriate asthere are occasions when the marginal plant is coal, oil or indeed gas in open cycle. We strongly suspectgovernment has proposed a lower figure simply because there is not enough to go round in the compensationfund. If so, the solution is to ensure adequate funding is available, not to fiddle the emissions figures and leavevulnerable electro-intensive industries under-compensated.

23 November 2012

Written evidence submitted by National Energy Action (NEA)

Energy prices are currently at an unprecedented level and all projections indicate a continued upwardstrend.46

The UK Government is seeking to attract investment estimated at £200 billion in energy infrastructure withclear implications for domestic energy bills. The impact of these proposals can be mitigated through adequateand proportionate assistance to vulnerable households; however, according to an independent review of fuelpoverty commissioned by the UK Government earlier this year, existing and future policy proposals fall farshort of what is required to protect the health and welfare of fuel-poor households.47

NEA, along with other consumer groups, have been highlighting to Government the urgent need for DECC,the Climate Change Committee (CCC) and the Regulator Ofgem to analyse and quantify the implications ofthe final EMR proposals to further assess what benefits and risks accrue to different income groups as a resultof existing policies and, most importantly, the planned EMR proposals.

During the questioning of the Energy Secretary Ed Davey and his officials on the 22nd November by theEnergy and Climate Change Committee it was revealed that the Government would not be publishing theirannual assessment of energy and climate change policies on domestic energy prices and bills alongside theAnnual Energy Statement. The Government has yet to confirm when the revised analysis will be published.NEA highlights that the commitment to publish, each year alongside the Annual Energy Statement anassessment of energy and climate change policies on domestic energy prices and bills, was a key commitmentwhen the Coalition took office.

NEA believes that transparency in this area of public policy is critical. Not only does the assessment ofenergy and climate change policies on domestic energy prices and bills publication enable Parliament to carryout its duty of scrutiny in a predictable manner, it also helps a range of interested parties define and mitigatethe imposition of new and additional costs to low income and vulnerable energy consumers. As Professor Hillsnoted in his recent independent review of fuel poverty; “Distributional impacts of policy design and deliveryneed to be fully understood and quantified. Only through rigorous assessment of these impacts can futurepolicies be drawn up and delivered that have the desirable impact of assisting those households in fuel poverty”.

On the 28 November the Government announced its intention to exempt energy intensive industries fromadditional costs arising from new long term “contracts for difference” designed to bring on investment in lowcarbon power plant such as nuclear power stations and wind farms. A separate £250 million scheme tocompensate certain energy intensive industries for additional costs associated with the Carbon Price Floor andEU Emissions Trading Scheme is already likely to be granted.

NEA wishes to highlight to EAC member that despite a high level commitment that any costs incurredshould present value for money, we are alarmed at the potential imposition of (as yet unknown) new andadditional costs and, in particular, that low-income vulnerable consumers may end up picking up the tab forenergy intensive users. This would be a clear contradiction of the principle that the polluter should pay.

In addition, the Government is aware that levies, paid for by energy consumers, disproportionately penalisethe poorest households. This is specifically the case where the problem of low household income is exacerbatedby other factors eg where households are reliant on more expensive and possibly inefficient sources of spaceand water heating and where thermal standards of their dwellings cannot be improved in a cost-effectivemanner.

We are therefore urging the Government to face up to the impact of their proposals on low-income vulnerablehouseholds, quantify the impact and then design and implement mitigating policies to minimise further hardshipfor these households.

Annex

RECENT CHANGES TO FUEL POVERTY PROGRAMMES

The standard response from policy makers when confronted with the aforementioned issues is to name aseries of disparate, incremental initiatives. The UK does have a long established fuel poverty infrastructure46 According to DECC’s Energy Statistics; average domestic expenditure on energy has more than doubled since 2000. Since 2004

the price of domestic energy has more than doubled.47 15 March 2012 Professor Hills published the final report of his independent review of fuel poverty.



incorporating programmes to improve heating and insulation standards, offer discounts on energy bills andsupport through Winter Fuel Payments. However, NEA would highlight that:

— Public funding for heating and insulation measures for low-income and vulnerable householdsin England (the Warm Front programme) terminates at the end of March 2013. England willthen be the only UK nation providing no direct financial support to enable vulnerable andfinancially disadvantaged households to improve heating and insulation standards in theirhomes. Scotland, Wales and Northern Ireland have all continued to maintain or even expandtheir tax-funded energy efficiency programmes.

— Despite recognition that levels of funding under the Energy Company Obligation (ECO) wouldneed to be increased, NEA remains concerned that the fundamental issue of adequate fundinghas not been addressed. From next year, expenditure on heating and insulation programmes forlow income and vulnerable households will be approximately half of the level in 2010–2011.48

— The decision not to retain the higher rate of Winter Fuel Payment, especially for Pension CreditRecipients, will mean that for households where someone is under 80 they will receive £50 less(compared to 2010–11) and where someone aged 80 or over, the winter fuel payment is £100less (compared to 2010–11).

— At the same time, the Government are heralding the Warm Home Discount which will offerrebates to low-income pensioner households; this will involve an automatic reduction of £130on electricity bills for the most financially disadvantaged pensioner households in 2011–2012.However, given the aforementioned changes to the Winter Fuel Payment, the real value of theserebates to low-income pensioner households would be just £30. On top of this the policy (likethe ECO) is paid for by all energy consumers and those that don’t benefit from the programmewill incur the cost.

NEA is therefore urging the Government to provide mandatory assistance to non-pensioner, low income andvulnerable households to help them manage unaffordable energy costs. More than 50% of people living in fuelpoverty are under the age of 65 and more than one in four fuel poor households contain children. Householdersearning low wages are current finding that being employed offers only limited protection from fuel poverty,especially for single parents. NEA believes far more needs be done to protect these groups.

Expanding programmes like the Winter Fuel Payment or Warm Home Discount would make thesehouseholds automatically eligible for support for other programs. Whilst on its own this move would make atremendous difference, it could also make it easier to target existing energy efficiency schemes and make themmuch more cost effective, benefiting all consumers. Funding this additional activity from the Exchequer wouldalso be much more progressive.

NEA appreciates there will be competing priorities for public expenditure through this period. However,higher energy prices increase VAT receipts to the Treasury by some £210 million per annum. Similarly, thecarbon price floor, an intervention by Government to help facilitate the development of low carbon energysources (which will commence in 2013 and will add significant sums to domestic energy bills) will raise morethan £2 billion a year to Treasury, potentially rising to £4 billion each year by 2020 and £7 billion by 2027. Inaddition, work commissioned by Consumer Focus (carried out by independent consultants, Verco andCambridge Econometrics), to support the Energy Bill Revolution campaign, demonstrates that that by tacklingfuel poverty it is not only possible to improve millions of people’s lives, it can significantly boost the economyand local employment.49

In short, the UK currently have a wide range of ad hoc and unstructured responses to fuel poverty howeverNEA recognises the opportunity within the coming months to ensure that as well as the Department for Energyand Climate Change (DECC), HM Treasury and other relevant Government Departments help develop,facilitate and fund an ambitious and reinvigorated Fuel Poverty Strategy.

4 December 2012

48 Eligible low-income households will benefit from the Affordable Warmth obligation (worth an estimated £350 million per year),closely targeted on low-income vulnerable households in the private sector and delivering a wide range of heating and insulationmeasures. In addition, a new Carbon Saving Communities Obligation targeted on financially and materially deprived areas(worth an estimated £190 million per year) will deliver a range of basic energy efficiency measures across all tenures. Finally,15% of the Carbon Saving Communities target must be delivered to the benefit of low-income vulnerable households in ruralcommunities. In total, from next year, annual expenditure on heating and insulation programmes for fuel-poor households willreduce from approximately £1.1 billion (including Warm Front, the Community Energy Saving Programme and CarbonEmissions Reduction Target priority groups) in 2010/11 to around £540 million.

49 Jobs, growth and warmer homes: Evaluating the Economic Stimulus of Investing in Energy Efficiency Measures in Fuel PoorHomes, Final Report for Consumer Focus, October 2012.



Written evidence submitted by the Fuel Poverty Advisory Group for England

The Fuel Poverty Advisory Group (FPAG) is a non-departmental advisory body, which consists of a chairmanand senior representatives from the energy industry, charities and consumer bodies. Each member representstheir organisation, but is expected to take an impartial view. The role of the Group is to:

— Consider and report on the effectiveness of current policies aiming to reduce fuel poverty.

— Consider and report on the case for greater co-ordination.

— Identify barriers to reducing fuel poverty, to develop effective partnerships and to proposesolutions.

— Consider and report on any additional policies needed to achieve the Government’s targets.

— Encourage key organisations to tackle fuel poverty, and to consider and report on the results ofwork to monitor fuel poverty.

Note: In view of the very specific nature of the subject topic the following is submitted on behalf of theFPAG Non-Supplier membership.

Context

1. The Government has a legally binding target to eradicate fuel poverty by 2016.50 FPAG, as theGovernment’s statutory advisory body on fuel poverty, wants to ensure that Government policies are doing allthat is reasonably practicable to meet this target.

2. The Government’s own estimate indicates that in 2011 there were 4.1 million households in England infuel poverty; however some members of FPAG have calculated that with the 2011 energy price rises thiscould now be as high as 5 million.51 Almost 50% are pensioners and overall some 80% can be categorisedas vulnerable.

3. The Government’s Independent Review of Fuel Poverty found that fuel poverty is a distinct and importantissue. As part of the Review’s conclusions, they established a “Fuel Poverty Gap” which measures the averageand aggregate depth of fuel poverty expressed as the difference between costs faced by the fuel poor andtypical costs of achieving a warm home. The Review found that fuel poor households are paying £1.1 billionmore for their fuel compared to typical households across England. The fuel poverty gap clearly demonstratesthe enormous scale of the problem.

4. The Marmot Review Team report52 presented evidence on how cold homes lead to multiple healthproblems including excess winter deaths, respiratory health problems and mental health problems as well asan increased likelihood of poor educational attainment among children.

5. High energy prices have been the biggest driver in the increase in fuel poverty and the long term trend isfor prices to continue rising. With every one% increase in energy prices, another 60–70,000 households areadded to the number of households in fuel poverty.53

6. The recession, unemployment, plus the industry’s investment plans estimated at c. £200 billion to 202054

and uncertainty over new generating capacity and energy prices will exacerbate the problem. FPAG remainsdeeply concerned that the costs and implications of the UK’s transition to a low carbon economy have yet tobe sufficiently explored. Meanwhile, the regressive means of collecting costs added to fuel bills to fund a rangeof related environmental and energy costs will continue to create consumer inequity. The most progressiveapproach to funding Government policy objectives would be through general taxation but equity would alsobe improved if costs were to be recovered on a basis linked to consumption. Initial research undertaken byFPAG reveals that 85% of fuel-poor consumers would benefit from a move to consumption-based cost recoverymechanism. The attribution of these and other costs to consumer bills to fund decarbonisation of energyproduction and its end use requires much greater exploration and transparency.

Response

7. There is a significant inequity that this Government will seek to protect energy intensive businesses fuelbills from the Carbon price floor but will not do something similar to protect the most financially disadvantagedenergy consumer.

8. The Government has declared its intent for a UK carbon floor price that will see the price of carbon riseto £30 per tonne by 2020 subject to the Annual Budget debate. This will be achieved by taxing coal, gas andoil burnt in power stations which are currently exempt from the climate change levy.50 UK Fuel Poverty Strategy 200151 NEA estimate November 201152 The Health Impacts of Cold Homes and Fuel Poverty, written by the Marmot Review Team for Friends of the Earth, published

in May 201153 DECC fuel poverty impact assessments 201054 Ofgem Project Discovery



9. To mitigate the impact of costs of environmental programmes on low-income households, the pace andscale of energy efficiency improvements to their homes needs to be substantially increased. It is therefore ofserious concern that the Government has taken the decision to end the Government-funded Warm Front schemein 2013. In FPAG’s view, this decision makes it questionable that the government is totally committed totackling fuel poverty and its obligation to do all that is “reasonably practicable” to eradicate fuel poverty by2016 as required by the Warm Homes and Energy Conservation Act 2000.

10. For the first time since 1978 there will be no taxpayer-funded scheme to install energy efficiencymeasures in dwellings occupied by vulnerable and low-income households. Meanwhile, higher energy pricesincrease VAT receipts to the Treasury by circa £210 million per annum. Similarly, the Carbon Price Floor,could potentially deliver the Treasury in excess of £1.6 billion per annum when fully introduced. Therefore,there are choices for Government in this context as opposed to only the deficit reduction.

11. The drastic reduction in funding for Warm Front, and the scheme’s complete termination in 2013 isunacceptable, given that heating and insulation improvements represent the most rational and sustainableapproach in addressing fuel poverty. Without Treasury funding, the provision of capital to fund suchimprovements is the most elusive element in the battle to eradicate fuel poverty. FPAG notes that when WarmFront disbands in England, the Devolved Administrations will retain, and in some cases increase, their publiclyfunded equivalent schemes proving that fuel poverty is still a pertinent issue to the Devolved Assemblies.

12. Professor John Hills, in his Interim Report of the Fuel Poverty Review, in October 2011 stated: “It isessential that we improve the energy efficiency of the whole housing stock. But those on low incomes and inthe worst housing can neither afford the immediate investment needed nor afford later repayments withoutadditional help.” FPAG unequivocally agrees with this observation from Professor Hills and also welcomes hisfinding that fuel poverty is a “distinct—and serious—problem” that deserves and requires attention.

13. FPAG has consistently stated that the Green Deal per se will not benefit the fuel poor. Fuel-poorhouseholds are unlikely to engage with a scheme that proposes a customer take out a finance arrangement withan energy company or other Green Deal provider, either because they are on a low income or because theymay already be in debt to their supplier. In addition, it is unlikely that these households will see sufficientsavings in their energy bill to meet the required Golden Rule, as these households often under-heat their homesproviding little or no scope to capitalise on savings from measures installed.

14. FPAG was encouraged by the recent announcement by the Deputy Prime Minister regarding the fuelpoor; and the additional sums to be made available through the Energy Company Obligation (ECO) for low-income areas; now c.£540million per annum. However, as ECO will apply to all of Great Britain and therewill be no publicly funded energy efficiency scheme in England, this will still leave fuel-poor households inEngland at a severe disadvantage. In addition, ECO will be funded through levies applied to customers’ billsrather than through more progressive tax-payer funding.

15. There is, therefore, a significant inequity that this Government will seek to protect energy intensivebusinesses but will not do something similar to protect the most financially disadvantaged in society. The tablebelow illustrates the fundamental difficulties faced by fuel-poor households; not only are they economicallydisadvantaged, they also need to spend more on fuel, in absolute terms, to achieve a warm and healthy livingenvironment ie those who need to spend most on fuel are least able to do so.

Expenditure as % % of housing Number Average income Average fuel Averageof income stock households costs (£) SAP

Up to 5% 43.9% 9,454,000 £41,849 £1,246 585% to 10% 37.7% 8,118,000 £19,894 £1,344 5310% to 15% 11.8% 2,553,000 £12,242 £1,460 4715% to 20% 3.5% 745,000 £9,630 £1,641 41Over 20% 3.1% 666,000 £6,388 £1,894 37Total 100.0% 21,535,000 £27,852 £1,342 53

Source: Detailed Tables published by DECC in 2011

16. In 2003, 96% of all fuel-poor households were in the lowest three income deciles; by 2009, as the tablebelow illustrates, that figure had reduced to 87%. It seems inevitable that, as fuel prices carry on rising andincomes falling, greater numbers of non-affluent households will be defined as in fuel poverty.

Household % households in group Number households in group Total households % of total fuelincome poordecile Fuel poor Not fuel Fuel poor Not fuel poor

poor

1st 85.2% 14.8% 1,812,000 315,000 2,127,000 45.7%2nd 50.0% 50.0% 1,069,000 1,070,000 2,139,000 27.0%3rd 25.9% 74.1% 556,000 1,593,000 2,148,000 14.0%4th 14.1% 85.9% 306,000 1,871,000 2,177,000 7.7%5th 5.0% 95.0% 109,000 2,055,000 2,164,000 2.8%



Household % households in group Number households in group Total households % of total fuelincome poordecile Fuel poor Not fuel Fuel poor Not fuel poor

poor

6th to 10th 1.0% 99.0% 112,000 10,669,000 10,781,000 2.8%Total 18.4% 81.6% 3,964,000 17,571,000 21,535,000 100.0%

Source: Detailed Tables published by DECC in 2011

17. FPAG advocates that the funds raised through the Carbon Price Floor and the EU ETS scheme shouldbe used to provide fuel-poor households with measures to improve the energy efficiency of their homes andthus reduce energy consumption.

18. The Energy Bill Revolution55 estimates that over the next 15 years the Government will raise £64billion in carbon taxes. If this were recycled to households, it could bring 9 out of 10 households out of fuelpoverty, generate 200,000 jobs and, in time, make every UK dwelling super-energy efficient. Their researchshows that on average a fuel-poor household needs financial support of the order of £6,500 to bring them outof fuel poverty. There is enough carbon tax revenue each year, for example, to make energy saving investmentsto the value of £6,500 each in the homes of 600,000 fuel-poor households. This would drive down their energybills by an average of £310 every year. There is enough carbon tax revenue to bring 9 out of 10 homes out offuel poverty.

19. Recycling carbon revenue to make UK homes super-energy efficient is the most fair and effectivesolution to bring down energy bills.

20. The typical dual fuel bill is estimated to be £1,300 per annum and includes some £80 per annum insocial and environmental programme costs. This amount will increase with the advent of the carbon floor pricein 2013 plus the new “agreed price” proposed approach for low carbon generators.

21. It is inequitable that such costs are recovered though bills and even more so when some environmentalcosts are apportioned on a per household basis; a more equitable approach would be based on energyconsumption. Some 85% of low-income households would benefit from this approach.

22. The costs of some energy policy measures are recovered from taxpayers—for example the CarbonCapture and Storage demonstration projects and the new Renewable Heat Incentive. However, there has beena growing trend to “outsource” this activity’ to energy companies and make them responsible for delivering arange of Government climate change and social policy objectives. The funding for this is collected throughconsumers’ energy bills. Initiatives, the costs of which are passed through to electricity consumers, currentlyinclude: Renewables Obligation (RO); Feed-in Tariff (FiT); European Union Emissions Trading Scheme (ETS);Warm Home Discount (WHD); Community Energy Saving Programme (CESP); and Carbon EmissionsReduction Target (CERT). The costs of CESP and CERT are also passed through to gas consumers.

23. FPAG has two main concerns about these costs being imposed on gas and electricity bills. Firstly, it ismuch more regressive to recover such costs from energy consumers than from taxpayers because the poorspend disproportionately more of their income on energy bills. Secondly, the way in which the costs areattributed and thus how they are passed through to consumers emphasises this inequity.

24. But even when costs are collected through bills rather than taxation, the basis on which costs are collectedby energy suppliers varies according to the way in which Government requires them to meet the policyobjectives. Costs of the RO, FiT and ETS fall upon suppliers according to the amount of energy consumed bytheir customers. Assuming costs are recovered where they fall, companies would be likely to pass the costs ofmeeting these policies through to consumers on the basis of units of energy consumed.

25. By contrast, the costs of the Warm Home Discount scheme, CERT and CESP are attributed to suppliersaccording to their market share and, accordingly, companies would be likely to pass on the costs of thesepolicies at a fixed rate per customer, regardless of the level of customers’ energy consumption.

26. FPAG believes that if costs must be recovered through energy bills, it would be more equitable if costswere to be recovered on the amount of energy consumed rather than as a flat rate per household. However, asmall percentage of low-income, high energy users would be adversely affected by this approach. To redressthis effect, FPAG proposes that policies, such as ECO, should encourage suppliers to target support atvulnerable consumers with high levels of energy consumption. The Warm Home Discount could also be re-designed so that help is directed towards households most affected by a move to consumption-based ECOcost recovery.

3 December 2012

55 http://www.energybillrevolution.org



Written evidence submitted by the Committee on Climate Change

Further to oral evidence provided to the Committee, the CCC are publishing a report on the 13 December2012 that has some further relevant evidence within it. The forthcoming report is titled “Energy Prices andBills—impacts of meeting carbon budgets”, and covers households, the commercial sector and industry. Wewish to table the following short extracts of the report that relate to the industrial sector:

— Projected energy bill impacts to 2020. We project that industrial energy bills on average willincrease by 19–23% in real terms to 2020 as a result of low-carbon policies. Given that energycosts make up around 3% of total costs for the industrial sector, the impact of projected energybill increases on the total costs and final prices of goods and services provided by the sector issmall (eg increased energy costs as a result of low-carbon policies to 2020 will add around 6pence on average to every £10 spent on goods and services produced by the industrial sector).

— Energy efficiency opportunities. Opportunities exist to reduce energy consumption, andtherefore costs, by at least 8% overall, potentially offsetting a third of the increase due to low-carbon policies. However, DECC’s recent energy efficiency strategy estimates that less than afifth of the energy efficiency potential will be realised under current policies, implying the needfor additional incentives.

— Projected bill impacts for energy-intensive industries:

— The implications of projected changes in prices of electricity and other fuels for combinedenergy bills will differ across industry groups. The specific impact will depend on the fuelmix, and within electricity specifically, the proportion of this that is sourced via the gridrather than generated on site as auto-generation.

— In practice, energy-intensive industry, which is a relatively large user of electricity (wherethe largest impact of low-carbon policies occurs) also tends to rely more on auto-generation (for which costs of low-carbon policies are smaller). As a result, the share ofenergy spend on electricity from the grid is broadly comparable across industry (ie bothenergy-intensive industries and other sectors), and therefore the projected increase inenergy bills due to low-carbon policies (which primarily affect grid-supplied electricity) isbroadly constant across industry. We project that low-carbon policies will increase averageindustrial bills by 19–23% from 2011 to 2020.

— Under DECC’s central scenario for fossil fuel prices, average energy costs would increaseby a further 15% by 2020 as a result of network costs and wholesale fuel prices (iebringing the total increase in combined energy bills to 33–39%).

— Increases in energy prices will have a larger impact on costs of some energy-intensiveindustries (ie given the higher share of energy costs in total costs for these industries).

— There is therefore a potential concern about competitiveness impacts of low-carbonpolicies for a small number of energy-intensive industries, which may be addressedthrough a combination of energy efficiency and direct measures to offset low-carbon costs(eg the Government has made compensation available for energy-intensive industries to2014). We will provide a detailed analysis of competitiveness risks and potential mitigatingmeasures in our competitiveness report in spring 2013.

7 December 2012

Written evidence submitted by Friends of the Earth, England, Wales and Northern Ireland

Summary

1. Recent reports by the World Banki and many othersii highlight that inaction on climate change means theworld is on track for four degrees of warming. It is desperately urgent that all countries rapidly ramp up theirplans to cut their greenhouse gas emissions.

2. A clear, strong, increasing carbon price is a critical element of effective strategies to prevent dangerousclimate change. However, countries and regions are implementing carbon pricing in different ways and atdifferent rates. The reality is that in the absence of a comprehensive global agreement, this patchwork approachwill continue for a number of years.

3. This reality means that care is needed to ensure that carbon pricing in individual countries or regions doesnot simply lead to industry moving to countries with lower carbon prices. If there is a genuine competitivenessthreat from carbon pricing, it is right that this should be addressed.

4. Exemptions from carbon-pricing for Energy-Intensive Industry (EII) is the focus of the Government’srecent consultation.iii However, the much more important issue is how to ensure that the UK has a thrivingmanufacturing sector which decarbonises rapidly. Exemptions only have a partial role in ensuring this, and wehope that the Government will commit to delivering a broader strategy that helps UK manufacturing invest inlow carbon technologies and energy-efficiency, and thrive in what will inevitably be a highly resourceconstrained global economy in decades to come



5. Friends of the Earth’s submission to this inquiry focusses on:

— The extent to which there is a competitiveness threat (paras 6 to 7).

— Technical issues around the proposed exemption package (paras 8 to 9).

— Whether the £250 million exemption package is the right response (paras 10 to 12).

— A broader approach from Government on EIIs (paras 13 to 20).

— Help in transition (para 21).

Competitiveness

6. The Government is consulting on exempting some industries from the effects of the Carbon Price Floorand the indirect costs of the EU ETS. These policies affect the price of electricity. There may be acompetitiveness threat if an industry’s electricity costs are a high proportion of its total costs, if it is in a sectorwith high levels of international competition, and competition is with countries which do not face higherelectricity costs. In addition, carbon costs are just one factor affecting competitiveness—labour costs,corporation tax rates and a host of other factors also affect whether a business might relocate or invest in adifferent country.iv

— It is right that this consultation is about electricity-intensive industry, not energy-intensiveindustry. The UK has some of the lowest gas prices for large industry in the EU—only Romaniahas lower.v

— It is not just high electricity-use which determines whether there is a threat. The other maincriteria are whether there is a high level of trade intensity for the product, and which countriesthe trade is with.

— Previous analyses for example from the CCC and the Stern report suggest that the number ofsectors and sub-sectors affected by both high electricity intensity and high trade intensity issmall, and that some of the costs are also shared by competitors (for example, the EUETSaffects all EU member states).

7. We’re concerned that in considering competitiveness impacts, people compare total exemptions in the UKwith exemptions in other countries, and conclude that the UK is doing poorly—for example, that the £250million package in the UK is a much smaller sum than the billions German industry receives. However, thesesums are not directly comparable. For example, German industry receives large exemptions from the costs ofits EEG renewable energy policy—but this is an exemption for a much larger programme of support forrenewables than exists in the UK.

Technical issues around the proposed £250 million exemption package

8. Calculating who should be eligible is complex. The Government’s approach is to follow the approachalready taken by the EU. This seems sensible: it will cut down on bureaucracy, and will make the State Aidcase easier to assess.

9. However, Friends of the Earth has some queries regarding how the Government is proposing to apply theEU approach to the UK:

— The approach in paragraph 26 of requiring proof of high carbon costs at a company level isright. However, it is not clear why there is no requirement to show high trade intensity as well.This is an EU requirement.

— Paragraph 26 says that eligibility must show that carbon cost in 2020 must be greater than 5%of GVA. It is not clear why 2020 costs are used, not 2013–2015 costs. Article 10a of the EUrules does not appear to suggestvi that a 2020 cost should be used, rather than the dates overwhich the compensation applies (ie 2013–2015).

— In paras 32–36 the Government is proposing a lower emissions factor (0.411tCO2/MWh) thanthe EU (0.58 tCO2/MWh). This is a complex technical question—the Government is suggestingthat the way EUETS costs are passed down to consumers is more related to the carbon contentof the marginal cost of electricity than to the average carbon content of electricity supplied. Itis not easy to assess whether this is the case—it appears that greater analysis is needed here—inparticular evidence from electricity suppliers on how they pass on EUETS costs to consumers.

— The consultation does not address the issue of auto-generation adequately. Auto-generators willnot face indirect EUETS costs, but the proposed methodology calculation is only proportionalto output—so it appears that autogenerators would be paid for indirect EUETS costs they don’tbear. The scheme should explicitly say they will not receive payments for indirect EUETScosts. Auto-generators’ position regarding Carbon Price Floor is more complicated—some ofthis is CHP, which faces a discounted CPF, and some of this uses fuels which are outside thescope of the CPF—for example blast furnace gases. Only generation which is covered by theCPF should be eligible for compensation—this needs to be clarified in the final scheme.



— The package aims to “compensate” industry for indirect EUETS costs. As Sandbag point out,many of those industries have benefitted from over-allocation of permits in phase 2 of EUETS,which can be carried forward to phase 3, post 2013. Although this over-allocation affects direct,rather than indirect, costs it seems appropriate that it is the total (indirect+direct) EUETS costswhich are considered—the Government should be looking at the net impact of all climate policyon costs, not just negative impacts.

— The Government has not required the exemptions to be conditional on any environmentalimprovements. This needs to be addressed (see paras 16–18)

Is the £250m exemption package the right response?

10. Friends of the Earth believe there needs to be much greater integration of climate policy and industrialpolicy. In recent years, on at least six occasionsvii the Government has announced climate policy and thenretro-fitted exemptions to industry afterwards. This approach has major flaws:

— It is not efficient to keep on having to change policies retrospectively, and to make themmore complex.

— It unnecessarily pits environmental and economic objectives against each other.

— It puts off the issue of how industry can cope with inexorable increases in costs of fossilfuels. Short-term protection from future competiveness pressures such as resource and carbonefficiency will make sectors less internationally competitive in future.

11. Government needs to take a fundamentally different approach, creating a policy environment whichhelps, encourages and supports industry to invest in low carbon technologies and energy efficiency, rather thanjust shield industry from carbon prices. We strongly support the vision set out by the Energy Intensive UsersGroup and TUCviii that the British energy-intensive industry should become the most energy-efficient industryin the world, and the calls from the CBIix and EEFx that Government must integrate its policy on industry andenvironment to deliver on both objectives simultaneously.

12. So, although there should be compensation for unilateral policies if there is a genuine competitivenessthreat, this should only be a small element of a broader strategy for delivering a thriving industrial sector whichalso delivers on the UK’s environmental objectives.

Broader Response From Government

13. In our view there are five critical areas where greater Government action is urgently needed:

Area 1: Demand

14. A major problem facing British industry in the last four years is falling demand. This has beencompounded recently by energy policy uncertainty scaring investors. Investors and industry alike have calledon the Government to introduce a 2030 decarbonisation target into the Energy Bill. This would be a big boostto UK manufacturing. Recent certainty to 2020 has helped, but the period to 2030 is even more important.Recent research by Cambridge Econometricsxi shows major macroeconomic benefits from high offshore winddeployment with investments into the UK supply chain. There is a big prize here, illustrated by two big 2012steel contracts for wind turbines for Steel Engineering of Renfrew and Tata Steel in Scunthorpe.

Area 2: Sectoral strategies

15. Each sector faces very different challenges—the resources and types of energy used, the internationalmarkets they operate in, and the types of investment required and their timescales. DECC and BIS had startedto work with industry on “sectoral road maps”, for example for Steel—but this seems to have gone very quiet.A strong industrial strategy for the UK requires a tailored approach, and we hope the Committee would urgeGovernment to restart their work on sectoral strategies and implement them as soon as possible.

Area 3: Links to carbon budgets

16. The industrial sector has a major role in helping the UK meet its climate change objectives. DECC’sCarbon Planxii notes that further policy progress is needed to deliver the 4th carbon budget; the CCC haverepeatedly calledxiii for a “step change” from Government. The October 2012 Energy Projectionsxiv from DECCnote that the industrial sector has emissions of 87 million tonnes in 2012, and is projected to have emissionsof 82 million tonnes in 2030—a fall of just 6% over 18 years, or less than 0.4% per year.

17. Much greater progress is possible, and indeed would help industry deal with future competitivenesspressures. DECC’s November 2012 Energy Efficiency strategyxv notes that to 2020 there are 42 TWh of costeffective energy savings, of which only 6 TWh (14%) will be delivered from existing policy. There are alsostudies from the AEA,xvi Roland Bergerxvii and the Centre for Low Carbon Futuresxviii which all show majorpotential for savings.



18. The Government is currently renegotiating industry’s Climate Change Agreements—these should beexplicitly linked to ensuring the UK’s carbon budgets are met. The recently re-negotiated exemptions forGerman industry now require annual reductions in energy demand in return for rebates, a similar system shouldapply in the UK.

Area 4: Policy help

19. Some investments require policy support from Government. Many of these have been set out a numberof times by industry bodies such as the CBI, EEF, EIUG and the TUC. Friends of the Earth suggests thatpriority areas are:

— Allowing the Green Investment Bank to borrow and lend as soon as possible, dropping thecurrent arbitrary link to overall deficit reduction.

— Stronger strategy for both industrial CCS and CHP.

— Help for low-carbon power contracts, such as the Remote Net Metering proposal.xix

— Reinstate the Carbon Trust’s Industrial Energy Efficiency Accelerator Programme.

— Revamp of available Enhanced Capital Allowances.

— Support for developing UK supply chains for growth in the renewables sector.

Area 5: International effort

20. Carbon pricing will continue to be problematic in sectors with high levels of trade and energy intensityuntil there is a strong, comprehensive global climate agreement. Interim potential solutions such as border taxadjustments and global sector agreements are also fraught with political difficulties and complexity. Alongsidepressing for a fair global agreement, a big priority is to address the two major failings of the EUETS—its capis far too lax, and offsetting with countries which do not have caps should not be permitted. We also note thatsome corporations operate in the UK and many other countries—these corporations should take a lead in tryingto overcome barriers to global sectoral agreements.

Help in transition

21. The UK urgently needs to make a rapid transition—from the increasingly high costs of being a fossil-fuelled economy, to one which is more energy efficient, and which uses renewable, clean fuel sources. Thistransition will have major medium and long-term net benefits, but it will have short-term costs, and these costsmust be borne fairly. There is a principle here: the Government are saying that electricity-intensive industryneeds help making that transition, and that is right. But similarly, people need help too. The UK has some ofthe least energy-efficient housing in Europe; and there were 24,000 Extra Winter Deaths last year.xx Coldhomes are an unacceptable blight on millions of people’s lives. The Government should be using receipts fromcarbon taxes to help people insulate their homes and bring their bills down. Industry is receiving help; peopleshould receive help also.

References

i World Bank, 2012. http://climatechange.worldbank.org/sites/default/files/Turn_Down_the_heat_Why_a_4_degree_centrigrade_warmer_world_must_be_avoided.pdf

ii Eg Global Carbon Project, 2012.http://www.globalcarbonproject.org/carbonbudget/12/files/CarbonBudget2012.pdf

iii BIS, 2012. http://www.bis.gov.uk/assets/biscore/business-sectors/docs/e/12–1179-energy-intensive-industries-compensation-consultation-on-scheme . Consultation. October.

iv Issues covered in depth in the http://webarchive.nationalarchives.gov.uk/+/http:/www.hm-treasury.gov.uk/sternreview_index.htm, 2006 and Part IV of CCC, 2008. http://www.theccc.org.uk/reports/building-a-low-carbon-economy

v DECC, 2012. Quarterly Energy Prices, September 2012. Table qep581.xls

vi Eg section 14–15 of article 10a of http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CONSLEG:2003L0087:20090625:EN:PDF, amended 2009.

vii CCL exemption up to 80%, CCL exemption up to 90%, CCS levy costs removed, RHI costs removed,indirect EUETS costs exempted, CPF exemption, Energy Bill CfD FITs exemption.

viii TUC and EIUG, 2012. http://www.tuc.org.uk/tucfiles/352/Buildingourlowcarboninds.pdf

ix CBI, 2011. http://www.cbi.org.uk/media-centre/publications/2011/08/protecting-the-uks-foundations-a-blueprint-for-energy-intensive-industries/ . August.

x EEF, 2011. http://www.eef.org.uk/manufacturingagenda/downloads/green-and-growth-final.pdf . December.



xi Cambridge Econometrics, 2012. http://www.camecon.com/Libraries/Downloadable_Files/A_Study_into_the_Economics_of_Gas_and_Offshore_Wind.sflb.ashx . November.

xii DECC, 2011. http://www.decc.gov.uk/en/content/cms/tackling/carbon_plan/carbon_plan.aspx . December.

xiii Most recently in CCC, 2012. 2012 http://www.theccc.org.uk/reports/2012-progress-report

xiv DECC, 2012. http://www.decc.gov.uk/en/content/cms/about/ec_social_res/analytic_projs/en_emis_projs/en_emis_projs.aspx . Annex B. October

xv DECC, 2012. http://www.camecon.com/Libraries/Downloadable_Files/A_Study_into_the_Economics_of_Gas_and_Offshore_Wind.sflb.ashx . November. Figure E3, page 87.

xvi AEA Technologies, 2010. http://downloads.theccc.org.uk.s3.amazonaws.com/4th%20Budget/Final%20Report%20ED56369.pdf . Report for the Committee on Climate Change. December.

xvii Roland Berger, 2011. http://www.rolandberger.com/media/press/releases/511-press_archive2011_sc_content/New_study_on_energy_efficiency.html . Munich, 30th August.

xviii Centre for Low Carbon Futures, 2011. http://www.lowcarbonfutures.org/news/post/65-new-study-technology-innovation-for-energy-intensive-industry-in-the-united-kingdom-released-today

xix Climate Change Matters, 2011. http://renewablematters.biz/resources/High%20Energy%20Users%20and%20renewablesFINAL.pdf . September.

xx Office for National Statistics, 2012. http://www.ons.gov.uk/ons/rel/subnational-health2/excess-winter-mortality-in-england-and-wales/2011–12—provisional—and-2010–11—final-/ewm-bulletin.html .29 November.

7 December 2012

Supplementary written evidence submitted by Sandbag Climate Campaign

Summary

The UK government should ensure energy intensive users are only incompletely compensated for theirindirect carbon costs in order to prevent market distortions, preserve energy efficiency incentives and avoidwasting taxpayer money. To ensure this the government should:

— Assess the real carbon leakage threats posed over the spending review period when determiningwhich companies are eligible for compensation over that timeframe.

— Diminish compensation paid to companies closely in line with any reductions in output; andmost importantly,

— Count any surplus carbon allowances it awarded energy intensive companies in Phase 2 of theEU ETS against any indirect compensations due to them going forward.

Sandbag is a London-based climate change NGO specialising in environmental reform of European andinternational carbon markets.

Avoiding Over-Compensation to Industry

Both the BIS consultation and the European Commission State Aid Guidelines note that the compensationpackage should not aim to shield energy intensive users from all of their indirect costs under the EU ETS orthe Carbon Price Floor.

Both documents clearly recommend that government should err on the side of under-compensating industryrather than over-compensating them in order to avoid market distortions and preserve some incentives forenergy efficiency. Paragraph 12 of the State Aid Guidelines reads:

“Furthermore, in order to minimise competition distortions in the internal market and preserve theobjective of the EU ETS to achieve a cost-effective decarbonisation, the aid must not fullycompensate for the costs of EUAs in electricity prices and must be reduced over time.”

Similarly, paragraph 51 the BIS consultation reads:

“[...] eligible companies will continue to pay a proportion of the additional passed-through costsfrom EU ETS and CPF. As such, there remains a further incentive for firms to continue to examineways to become more energy efficient.”

While industry will naturally seek to maximise its financial support from government, any compensationswhich do not reflect genuine costs will violate the spirit of the guidelines and should be avoided on principle.It would be an abuse of the compensation package to make it an exercise in subsidy-matching Germany orother international competitors.



In this vein, it is welcome to see that the BIS consultation recommends stricter eligibility and compensationcriteria than the Commission’s State Aid Guidelines; however, we do not feel that these go far enough toensure that energy intensives are not over-compensated and that taxpayer money is not wasted.

Strengthening the Eligibility Criteria

Based on its own carbon leakage assessments, the European Commission has defined the list of sectorseligible for any State Aid compensations for indirect ETS costs, but not all actors within these sectors arenecessarily exposed to carbon leakage. Recognizing this, the BIS consultation recommends applying anadditional carbon leakage assessment at company-level to disaggregate those firms that genuinely need leakageprotections from those that do not.

Sandbag welcomes the application of this additional eligibility filter, but note that the BIS consultation seemsto have followed the Commission’s lead in using an exaggerated carbon price to determine carbon leakage risks:

— The Commission used an obsolete €30 carbon price to determine the sectors exposed to carbonleakage. The ETS carbon price is currently €6 and is expected to remain below €10 out to2020 unless the ETS cap is tightened.

— For its company filter, BIS has proposed a carbon price of £33 be used—the 2020 UK carbonprice expected—despite the fact that the relevant spending review period ends at the start of2015, and the average UK carbon price will be approximately £17 over that period.

— In addition the BIS consultation uses the Commission’s grid emissions factor of 0.58tCO2/MWhr to determine eligible sectors rather than the more accurate 0.411tCO2/MWhr BISrecommends for its compensation calculations (see next section).

The inflated carbon prices and grid emission factors used in the eligibility assessment will unduly multiplythe number of companies deemed eligible for compensation. Sandbag therefore recommends that:

Recommendation 1: The government should apply the indirect carbon costs (in £/MWhr) that itactually expects over the spending review period when determining the companies eligible forcompensation in that specific timeframe.

Improving the Metrics for Compensation

The formula for calculating compensations to energy intensive users has essentially been taken straight fromthe Commission State Aid guidelines. The BIS consultation notes, however, that the grid emissions factor thatconsumers will actually face in the UK is 0.411 tCO2/MWhr, significantly lower than the emissions factorprovided by the Commission (ie 0.58 tCO2/MWhr).56

We welcome this BIS proposal, noting again that the package should only aim to compensate for genuineindirect costs, and these only in part.

The State Aid guidelines lay out further measures to prevent energy intensive users from beingovercompensated by compensating a maximum of 85% of indirect carbon costs, and calculating these costsagainst the most energy efficient industries in that sector. They also reduce the aid available to facilities whentheir output declines. We note, however, that these aid reductions do not keep pace with output reductions andmight therefore lead to significant overcompensations.

Under the guidelines, companies’ aid levels are not reduced at all until their output drops 50% below baselinelevels. This could lead to facilities receiving almost twice the compensations their output levels actually merit.This could create perverse incentives to raise or lower output levels to maximise government support. Sandbagtherefore recommends that:

Recommendation 2: The thresholds used to reduce aid when output is lowered should be narrowed(eg to 10% production bands.)

In other words, compensation would be unaffected if output dropped by less than 10%; compensation woulddrop by 10% if output fell by 10–19%, compensation would drop by 20% if output fell by 20–29%, and soon. If output falls by more than 90%, no compensation would be received as per the current guidelines.

Accounting for Surplus Carbon Allowances When Compensating for Indirect Costs

In its National Allocation Plan for Phase 2 of the EU Emissions Trading Scheme, the UK governmentawarded manufacturing sectors sufficient free allowances to protect them from any compliance costs the schememight impose on them. This was a measure to protect UK manufacturers against the threat of carbon leakage.Following the recession, however, these industries were left holding far more free allowances than wererequired to cover their emissions over the period. Over 2008–11 UK industrial sectors were oversupplied bysome 64 million free allowances.57

56 http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2012:158:0004:01:EN:HTML57 The European Environment Agency’s ETS Data Viewer

http://www.eea.europa.eu/data-and-maps/data/data-viewers/emissions-trading-viewer



80

70

60

50

40

30

20

10

-

7

68

14

5016

14

18

36

37 3

3

27

2. Mineraloil

refineries

3.Cokeovens

5. Pig ironor steel

6. Cementclinker or

lime

7. Glassincludingglass fibre

8.Ceramicproductsby firing

9. Pulp,paper and

board

Surplus free allowances Verified emissions

Mill

ion

s

UK industrial sector surpluses 2008-11

(Source: European Environment Agency)

Some of the companies who accrued the largest surpluses from the UK government are the same energyintensive users the government is looking to compensate for their indirect carbon costs. To illustrate, Tatasteel’s UK operations received some 31 million surplus allowances over 2008–2011, with an average value of€15.50 across that period.58 59 This equates to £389 million at current exchange rates, more than the wholecompensation package under discussion.60 The Tata surplus remains roughly equal in value to the £250 millioncompensation package even if we use forward price estimates for the Spending Review Period.61

Table 1

SURPLUS EUROPEAN UNION ALLOWANCES AWARDED TO TATA’S UK INSTALLATIONS(2008–11)

Installation name Free allocation Verified emissions Surplus allowances

Cogent Power-Orb Electrical Steels Ltd. 29,308 18,391 10,917Stocksbridge 0 0 0Shapfell works 1,993,480 1,093,605 899,875Llanwern Steelworks 174,272 82,195 92,077Port Talbot Steelworks 31,228,208 26,140,959 5,087,249Scunthorpe Integrated Iron & Steel Works 33,327,752 23,956,856 9,370,896Tata Steel Colors (Shotton Works) 57,764 48,483 9,281Tata Steel Packaging Plus UK 189,720 102,731 86,989Tata Steel Speciality—Rotterham 683,392 281,741 401,651Teesside Integrated Iron & Steel Works 27,812,904 12,874,372 14,938,532Total 95,496,800 64,599,333 30,897,467

(Source: EU Transaction Log, Sandbag database and Tata Steel)

Whether companies like Tata elected to sell these allowances for revenue in Phase 2, retained them for ETScompliance later on, or intend to sell these allowances at a later date, they represent government assets awardedto defend against carbon leakage over 2008–12. They were not needed for that purpose, and companies haveeither financially benefitted from these assets already or will financially benefit from them in the future.Sandbag therefore recommends:58 Surplus figures directly corroborated by Tata prior to the publication of our report Losing the Lead (July 2012). Some of Tata’s

ETS installations are not defined as steel plant by the EU Transaction Log.59 Average 2008–2011 price calculated using sales data from the Blue Next exchange www.bluenext.eu60 €479million. Current exchange rate taken from http://www.xe.com61 Point Carbon estimates an average of €10.50 over 2013 and 2014. At this carbon price Tata’s 2008–11 surplus is worth

€324million or £263 million (see http://www.pointcarbon.com/news/reutersnews/1.2087144 )



Recommendation 3: No company should receive new government compensations over the spendingreview period until such a time as the volume of CO2 passed through to it in its electricity-useexceeds the number of surplus free allowances it received in Phase 2.*

*Any surpluses a company can clearly demonstrate were achieved through low-carbon investmentshould be disregarded in this calculation.

Some stakeholders will contend that compensations for indirect costs under the EU ETS should be treatedtotally separately from government protections from direct costs. We disagree. Insofar as the EU ETS poses areal carbon leakage threat to companies operating in Britain, we feel the government should have a coherentand cost-efficient policy response to meet it. Direct and indirect costs under the ETS are intimately linked: forinstance, when an energy intensive company sells its carbon allowances onto the market, the most likely enduser of these allowances is an electricity generator who will then pass these costs onto its consumers. In otherwords, the UK Government is at risk of compensating energy intensive companies for the indirect costs ofEuropean Allowances it originally awarded them for free. As it stands, the proposed framework potentiallyexposes government coffers to “double dipping” from energy intensive companies.

By adopting the above measure, the compensation package would better target the companies that genuinelyneed carbon leakage support and would stretch the budgeted £250 million further in assisting them. It couldalso potentially lead to a substantial diminution of that budget.

Conclusion

In the current economic climate, the UK government cannot afford to pay energy intensive companies forcarbon costs they will not actually incur, costs that don’t affect their competitiveness or costs for which it haseffectively compensated them already. We feel the three recommendations outlined above will help make thecompensation package better targeted. We invite and encourage policymakers to implement them.

13 December 2013

Printed in the United Kingdom by The Stationery Office Limited01/2013 025237 19585

Energy Intensive Industries Compensation Scheme

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