Walking the carbon tightrope

CONFIDENTIAL

Walking the carbon tightrope: Energy intensive industries in a carbon constrained world

FINAL REPORT

Prepared for: The Trades Union Congress and

Prepared by:

Orion Innovations (UK) Ltd

Date: 17 March 2014

Walking the carbon tightrope: energy intensive industries in a carbon constrained world

IMPORTANT NOTICE

Whilst reasonable steps have been taken to ensure that the information contained within this Report is correct, you should be aware that the information contained within it may be incomplete, inaccurate or may have become out of date. Accordingly, Orion Innovations (UK) Ltd makes no warranties or representations of any kind as to the content of this Report or its accuracy and, to the maximum extent permitted by law, accept no liability whatsoever for the same including, without limit, for direct, indirect or consequential loss, business interruption, loss of profits, production, contracts, goodwill or anticipated savings. Any person making use of this Report does so at their own risk.

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Contents

1 Executive summary.............................................................................................................32 Acknowledgements..............................................................................................................63 Introduction..........................................................................................................................74 The UK energy and emissions policy landscape................................................................115 Steel sector case study......................................................................................................236 Heavy clay ceramics sector case study.............................................................................307 Mineral products sector case study...................................................................................408 Paper sector case study.....................................................................................................489 Conclusions and recommendations...................................................................................53

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Glossary

BCC British Ceramic ConfederationBIS Department for Business Innovation and SkillsBOS Basic Oxygen SteelmakingCCA Climate Change AgreementCCC Committee on Climate ChangeCCL Climate Change LevyCCS Carbon Capture and StorageCfD Contracts for DifferenceCHP Combined Heat and PowerCHPA Combined Heat and Power AssociationCM Capacity MechanismCO2 Carbon dioxideCPF Carbon Price FloorCPI Confederation of Paper IndustriesCPS Carbon Price Support (under the CPF mechanism)DECC Department of Energy and Climate ChangeEAF Electric Arc FurnaceEDR Electricity Demand ReductionEEF Engineering Employers FederationEIIs Energy Intensive IndustriesEIUG Energy Intensive Users GroupEMR Electricity Market ReformEU ETS EU Emissions Trading SystemFiT Feed in TariffFiT CfD Feed in Tariff Contracts for DifferenceGDP Gross Domestic ProductGVA Gross Value Added, the value of goods and services produced in an area, industry

or sector of an economyGW GigawattsGWh Gigawatt hoursLCF Levy Control Framework, a Treasury cap on how much money can be levied on

consumers’ energy billsLEC Levy Exemption CertificateMPA Mineral Products AssociationMW MegawattsMWh Megawatt hoursNER EU ETS New Entrants ReserveOfgem Office of Gas & Electricity MarketsRO Renewables ObligationROC Renewables Obligation CertificatesTUC Trades Union Congress

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1 Executive summaryEnergy intensive industries1 (EIIs) are walking a tightrope from a high to a low carbon economy. Government policy should, we argue, enable the transition rather than add to its perils.Yet these heavy energy users form the bedrock of the UK manufacturing sector and are vital to our successful transition to an energy and resource efficient economy. They produce primary inputs for much of what we manufacture and consume, and have been clearly shown to contribute significant sums to the social and economic fabric of the country,2 including:

160,000 directly employed skilled workers, with four times that number in supply chains. A combined turnover of £95bn or 3% of UK GDP.

Together they also account for over 50% of industry-related emissions and, in order to contribute to the UK’s legally binding carbon targets, are expected to deliver reductions of 70% or more from 2009 levels by 2050. Government policies aimed at reducing carbon emissions from industry rely heavily on measures that both enhance energy efficiency and put a price on industry’s carbon emissions. The TUC and Energy Intensive Users Group (EIUG) support this objective and the contribution that is required from heavy energy users. However, there is considerable concern that, despite industry delivering substantial energy and carbon savings over recent decades through investment and innovation, the cumulative impact of energy and climate policies is now putting extraordinary pressure on these industries, and reducing their capacity to invest in the UK. In particular, unilateral UK policies risk distorting international competition and increase the likelihood of carbon leakage – the loss of jobs, investment and carbon controls to competitors with weaker, or no, climate change policies. The government responded to these concerns raised by industry and trade unions with a compensation package of £250 m announced in Budget 2011 for the period 2013-2015, boosted by a further £150 m and extended to 2016 in Budget 2013. By December 2013, the ETS compensation scheme had paid out £18 million to 29 companies in the energy intensive industries sector. Table 1 provides an overview of policies, proposed support packages, and their impact on heavy energy users.Industry and the TUC have welcomed the package but remain concerned that the support provided is too short term and narrow in scope, and not on a scale comparable with that provided by our European competitors. Furthermore, there is no compensation as yet for the passed through cost to industry of the Renewables Obligation or the UK-specific carbon price floor. Thus the intense debate between Government and industry over the means and necessity of mitigating the impact of energy policy on energy intensive industries continues. This report aims to contribute to that debate by asking whether the scale and scope of the current industry support packages and the timescales over which they are provided are appropriate and what their impact on investment decisions are likely to be. In order to do this, the report looks at four case studies in detail:

Steel: an electro-intensive UK steel company that is part of a Europe-wide business group, with competition for capital and day to day operating costs within the group and high visibility of the impact of policies on UK operations relative to other European jurisdictions.

Ceramics: the heavy clay ceramics sector, which has not historically been exposed to extensive international trade, but is showing significant up-lift in imports in recent months.

Cement and lime: sectors within the mineral products industry where we assess the impact of government policy on the climate for investment in these capital intensive sectors.

Combined Heat and Power (CHP) generation: one of the primary options for industrial carbon abatement, illustrated by a specific installation in the paper sector.

1 Primarily iron and steel, cement and lime, ceramics, chemicals, glass, industrial gases, non-ferrous metals, pulp and paper, and coke and refined petroleum products2 Building our low carbon industries: Economic, employment and fiscal benefits of securing the energy intensive industries in the UK; Orion Innovations report prepared for the TUC, 2012

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Key findings from case studies

Evidence from these four case studies suggests that well-intentioned energy and environmental policies, and inadequate support packages, are adding significant cost to UK manufacture relative to both EU counterparts and international competition.

Steelmaker Celsa, Cardiff, has shared insights from their European operations that show that its UK plant is one of the most energy and labour efficient in Europe, but faces the highest electricity prices within the Group. Planned unilateral UK climate change policies and tariffs, such as Carbon Price Floor (CPF) and Contracts for Difference (CfD) are expected to exacerbate this situation. This is undermining the long-term prospects of this highly efficient, low carbon business.

Many electro-intensive ceramics companies have already relocated away from the UK due to high electricity costs. Recent trade data suggests that heavy clay sectors, such as clay roof tiles and bricks, previously less exposed to carbon leakage are now seeing significant increases in imports. Uncompetitive energy prices, unpredictable future energy tariffs, lack of access to compensation and gas supply insecurities have been cited as significant contributing factors.

The mineral products cement and lime sectors, in common with most other EIIs, are capital intensive and operate on long investment cycles. Policy uncertainty and support mechanisms that extend no further that the current Treasury spending review period are adding risk and discouraging investment. Rather than encouraging a transition to low carbon technologies, the uncertain policy framework, unilateral burdens on UK producers, and unrealistically short timeframes for support packages, are having a corrosive impact on the investment climate and long term viability of these businesses. In particular, they are stifling innovation and making offshoring of new investment a more attractive proposition to multi-national parent companies.

Eligibility criteria for support packages are inappropriate. For example, although some ceramics firms are the most electro-intensive in Europe, about 85% of energy demand across the whole sector is supplied by gas. As eligibility is currently defined at a sector-wide level, these highly vulnerable installations are considered out of scope. Furthermore, the use of policy impact costs as a proportion of Gross Value Added (GVA) to determine eligibility for support discriminates heavily against companies and sectors that are more labour-intensive, creating further unintended distortions.

Combined Heat and Power policy changes, in particular the removal of CHP Levy Exemption Certificates (LECs) from the market and the imposition of the CPF from April 2013, have undermined incentives to deploy one of the most effective and proven means of industrial carbon emissions abatement.

Government, industry, Trades Unions and trade associations have a common objective in delivering a low carbon future that is affordable to both domestic consumers and industry. However the challenge comes in putting this into practice, in ‘walking the carbon tightrope’ between creating the right environment to encourage investment in decarbonising energy supply, and sustaining vital energy intensive industries in the UK. Both are needed in order to deliver our low carbon future.EIIs are generally mature, making use of similar manufacturing processes and technologies across all countries. The responsible approach is therefore to ensure that UK heavy energy users:

Remain in the UK and do not succumb to carbon leakage; Deploy the most carbon-efficient processes available to them; Invest in innovation to reduce the environmental impact of their activities; Have available to them, proven and commercially viable cross-sector solutions such as

CHP and carbon capture and storage (CCS).Most EIIs supply commoditised products to internationally competitive and price-sensitive markets, and are highly capital-intensive, dependent upon long term fiscal and regulatory stability in order to attract investment. Many are multi-national concerns, with inter-company competition for capital and operational investment. Government policies therefore need to:

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Ensure that energy prices faced by all levels of UK industry, and in particular EIIs, are no higher than competitor nations in Europe and beyond, now and in the long term;

Deliver a long-term stable environment that encourages industry to invest in new plant, innovation and emissions abatement, just as the Government is endeavouring to do for nuclear and renewable energy sectors. Investment cycles for EII can be several decades in length;

Encourage deployment of cross-sector carbon emissions abatement solutions such as CHP and CCS.

Rethinking government policy

Given the insights gained from these case studies, we believe that there is a need for a fundamental re-think of Government policies. Current policies have the perverse and unintended consequence of undermining investment in UK industry and corroding international competitiveness, and therefore result in carbon leakage.Near-term measures to limit the adverse impact of energy and environmental policies on EIIs are urgently needed in order to allow time for appropriate longer-term measures to be developed. In particular, we would recommend that the Government:

Freeze the CPF at its current level. The near doubling of Carbon Price Support (CPS) rates in 2014 and in 2015 is unaffordable, and in the absence of State Aid approval for a long-term durable compensation package, risks causing significant damage to the competitiveness of UK electro-intensive industries. If state aid approval cannot be secured, CPF should be abandoned.

Extend and widen the scope of proposed compensation packages for electro-intensive installations. Eligibility for compensation should be determined at a company, rather than a sector-wide level; and the duration of these measures should reflect the length of the policy impacts that they are intended to mitigate and the investment cycles of the industries concerned.

Exempt Combined Heat and Power from the CPS costs that it incurs on fuel used to generate electricity. Given the need for significant investment in electricity generation, and the proven efficiency benefits of CHP, industrial CHP should be encouraged. Exempting CHP from CPS will compensate for the recent removal of LECs.

Consult with industry on the effects of the Renewables Obligation (RO), the main support mechanism for larger scale renewable electricity projects in the UK, which also has a considerable impact on industries’ costs.

Create a well-funded programme to support industrial energy efficiency, with incentives for investment. The current reliance on driving energy efficiency through higher energy prices risks carbon leakage if undertaken unilaterally in the UK.

Create a high level Energy Intensive Industries Council, with representation from industry, trade unions and government, tasked with developing comprehensive long-term industrial strategy to secure jobs, growth and the low carbon transition.

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2 AcknowledgementsThis study was commissioned by the Trades Union Congress, in collaboration with the Energy Intensive Users Group and its members. We would like to express our appreciation for the support provided to us by TUC affiliates Community, Unite, GMB and Unity, trade associations and individual companies in drafting this study, and in particular to British Ceramic Federation, Celsa UK, Combined Heat & Power Association, Confederation of Paper Industries, Ibstock, Lafarge Tarmac, Marley Eternit, Mineral Products Association, Northwood and WEPA, Singleton Birch and UK Steel in preparing the individual case studies.

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3 Introduction

3.1 What is the context for this report?

Energy intensive industries3 (EIIs) are walking a tightrope from a high to a low carbon economy. Government policy should, we argue, enable the transition rather than add to its perils.Energy intensive industries are the bedrock of the UK manufacturing sector and are vital to our successful transition to a low carbon economy. The eight most energy intensive industries, including iron and steel, cement and lime, ceramics, chemicals, glass, industrial gases, non-ferrous metals, pulp and paper, and coke and refined petroleum products, have delivered substantial energy and carbon savings over recent decades through investment and innovation. However, they now face extraordinary pressures in coping with the cumulative impact of climate change and energy policies. This report is focused on examining the impact of these policies and on government support for these vital industries. Both employers and trade unions in these manufacturing industries have a major interest in securing their future within a low carbon economy, both to protect and promote reasonable terms and conditions of employment for the long term, and achieve a “just and fair transition” for these industries who make a significant contribution to the UK’s economy.In order to meet the UK’s carbon targets, significant further reductions in emissions are required across the economy. This will be achieved by decarbonising electricity generation, and from making homes and transport more energy efficient. Industry, which accounts for approximately a quarter of UK emissions, and the energy intensive industries (EIIs) in particular, will be expected to make a substantial contribution too.The UK is the first country in the world to have set legally binding carbon emission reduction targets: at least a 34% reduction on 1990 emissions by 2020, and at least 80% by 2050. The Climate Change Act of 2008 establishes a long-term carbon budget framework to achieve these targets, and successive five year carbon budgets through to 2027 and beyond set out the manner in which these will be met.The energy intensive sectors produce primary inputs for much of what we manufacture and consume, and contribute significant sums to the social and economic fabric of the country. Their economic contribution includes:

160,000 directly employed skilled workers, with four times that number in supply chains; A combined turnover of £95bn or 3% of UK GDP.

Together they also account for over 50% of industry-related emissions, and are expected to deliver reductions of 70% or more from 2009 levels by 2050. Government policies aimed at reducing carbon emissions from industry rely heavily on measures that both enhance energy efficiency and put a price on industry’s carbon emissions. In practice, as earlier research by the TUC and the Energy Intensives Users Group (EIUG) has shown, the cumulative impact of energy and climate policies risks reducing the capacity of industry to invest, and if applied unilaterally in the UK, will distort international competition and compromise the sustainability of UK businesses.In response to representations from industry and trade unions, in the Autumn Statement in 2011, the Chancellor announced the government’s intention to implement measures to reduce the impact of policies on the cost of electricity for the most electricity-intensive industries. A commitment of £250 million was given for the period 2013-2015 to offset the impact of rising electricity prices, including:

Up to £100 million in compensation for impacts from the Carbon Price Floor pass-through; £110 million compensation for indirect impacts of the EU ETS on electricity prices, in line

with European Commission state aid guidelines;

3 Primarily iron and steel, cement and lime, ceramics, chemicals, glass, industrial gases, non-ferrous metals, pulp and paper, and coke and refined petroleum products

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£40 million uplift on relief from the Climate Change Levy (from 65% to 90%) from April 2013.

In Budget 2013, this package was boosted by a further £150 million and extended to 2016.In November 2012, further exemptions were announced to offset the additional costs arising under the government’s Electricity Market Reform Contracts for Difference, provided for in the Energy Act 2013. Although the value of these exemptions has yet to be specified, the Committee on Climate Change estimates that they will amount to around £350 million a year for electricity-intensive industries in 2020.The TUC has welcomed the shield provided by the government’s compensation package. However it remains concerned that the support is too short term and narrow in scope, and not on a scale comparable with that provided by our European competitors, notably Germany. Furthermore, there is no compensation as yet for the passed through cost to industry of the Renewables Obligation or the UK-specific carbon price floor.Tata Steel UK Limited recently commissioned PricewaterhouseCoopers LLP (PWC) to assess the current and potential future economic contribution of the Foundation Industries to the UK economy. This study4 concluded: “Government policy in relation to climate change influences energy prices and, therefore, potentially affects the competitiveness of the Foundation Industries.” UK firms face higher incremental policy costs mainly due to renewable energy costs and the carbon price floor. “Looking forward, the risk is that relatively high energy costs will adversely affect the competitiveness of Foundation Industries in the UK as well as that of their potential customers. This will impact negatively on UK firms’ ability to compete in both domestic and overseas markets and deter foreign investors.”These concerns are reflected in continued intense debate within and between political, industrial and media circles over the means and necessity of mitigating the impact of energy policy on energy intensive industries. For example:

December 2013, during a Westminster debate on the energy intensive industries and their ability to compete globally in the face of rising energy prices, Paul Farrelly (Labour MP for Newcastle-under-Lyme) said the government’s compensation package for energy intensives should be linked to the Carbon Price Floor (CPF), so that it remains for the duration of the policy, and so that its value would reflect the trajectory of the CPF. This debate has continued fiercely with Energy Minister, Michael Fallon, speaking in February at the City and Financial’s Electricity Market Reform (EMR) Summit ‘I don’t think it’s any secret that the trajectory of the CPF is way out of line with the carbon price itself and there are, as a result, significant difficulties for our industry’.

January 2014, Vince Cable responded to the Tata Steel commissioned Foundation Industry report (PwC), by saying that the Government recognised that ‘rising energy costs pose a major stumbling block for the competitiveness of British industry’, but he stopped short of offering new government initiatives to tackle the problem.5

February 2014, continued lobbying of Government by EEF, the manufacturers’ organisation, to counter rising energy costs for EIIs, with demands to:6,7

o Freeze and then reduce the cost of the unilateral Carbon Price Flooro Address the costs of the Renewables Obligation and Small Scale Feed in Tariffs

commit to extend all the measures in the current EII package for as long as is required, up to and possibly beyond 2020/21.

o Commit to extend all the measures in the current EII package for as long as is required, up to and possibly beyond 2020/21.

4 Tata Steel’ Understanding the economic contribution of the Foundation Industries 20145 http://uk.reuters.com/article/2014/01/16/uk-cable-industrial-sector-idUKBREA0F13E201401166 http://www.eef.org.uk/releases/uk/2014/Budget-must-fire-starting-gun-on-plan-to-tackle-escalating-industrial-energy-costs.htm; Executive Survey 2014, EEF.7 Cornwall Energy, Energy Spectrum, 413, February 2014.

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http://www.eef.org.uk/releases/uk/2014/Budget-must-fire-starting-gun-on-plan-to-tackle-escalating-industrial-energy-costs.htm

http://www.eef.org.uk/releases/uk/2014/Budget-must-fire-starting-gun-on-plan-to-tackle-escalating-industrial-energy-costs.htm


February 2014, a consensus that resolving state aid issues is now the key challenge to address in order to ensure that proposed compensation packages are legitimate.8

3.2 What questions is this report looking to address?

The TUC and EIUG have commissioned a number of studies with the intention of enhancing the evidence base on the impact of climate change and energy policies on industry, and catalysing discussion between government, industry, and other stakeholders about the manner in which emissions abatement targets can be realized without jeopardizing EIIs, employment and value creation in the UK:

The Water Wye Associates report prepared for the TUC in 2010 showed that EIIs in the UK were being placed at risk as a result of the cumulative impact of climate change policies, and that these policies are undermining the capacity of industry to invest.

The Centre for Low Carbon Futures report prepared for the TUC in 2011 examined technology options for realising significant decarbonisation of manufacturing, including the use of carbon capture and storage; process change; and switching to the use of biomass. This report reiterated concerns about the ability of EIIs to raise the funds and make the necessary investment.

Building our low carbon industries, the Orion Innovations report prepared for the TUC and EIUG in 2012, showed how investment in the most up-to-date and efficient plant is key to delivering emissions abatement targets as well as securing energy intensive industries in the UK. It also showed the significant economic, employment and fiscal costs of failing to do so.

This study is intended to build on these studies and address the following key questions: Will the scale and scope of the current industry support packages and the timescales over

which they are provided, be sufficient to support the UK’s EIIs during our low carbon transition?

Is the Committee on Climate Change (CCC) assessment that the value of all these measures is at the high end of the range of modelled profit impacts for electricity-intensive sectors in 2020, fair? If so, is this sufficient? If not where are the key gaps?

If the sustainability of these businesses is dependent upon investment, how does the longevity and political certainty of these measures impact upon investment decisions?

3.3 How has it been prepared?

This study does not seek to replicate the EII sector-wide economic modelling undertaken by the Department of Energy and Climate Change (DECC), the CCC and others. Nor does it seek to replicate industry’s response to government consultations. But it does seek to shed light on the impact of policies and proposed support packages on four specific industries and sectors:

An electro-intensive UK steel company that is part of a Europe-wide business group. There is competition for capital, and in day to day operating costs within the group and high visibility of the impact of policies on UK operations relative to other European jurisdictions.

The heavy clay ceramics sector in the UK. This sector has not historically been exposed to extensive international trade, but has experienced a significant up-lift in imports in recent months.

Cement and lime sectors within the mineral products industry, in particular the impact of policy and regulatory uncertainty on the climate for investment in these capital intensive sectors.

Combined heat and power (CHP) generation, one of the primary options for carbon emissions abatement and energy efficiency in EIIs. We illustrate this impact by looking at a specific installation in the paper sector.

8 Cornwall Energy, Energy Spectrum, 412, February 2014.

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This study is not intended to be exhaustive. We have however found that there are common themes across all four case studies. Furthermore, engagement with businesses, trade associations, and TUC affiliates from other sectors, suggest that these case studies, and the resulting conclusions and recommendations, are applicable to EII sectors as a whole.

3.4 Report structure

The report is structured as follows: Section 3: Introduction to the study, its background and methodology; Section 4: Overview of the current energy and environment policy landscape, as it relates to

EIIs, their energy use. Sections 5-8: Case studies. Section 9: Conclusions and recommendations.

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4 The UK energy and emissions policy landscape

4.1 Introduction

Mounting scientific evidence of potentially damaging anthropogenic climate change has resulted in both national and international efforts to stem the growth in greenhouse gas emissions.The UK Government has set the first four carbon budgets in law, covering the period from 2008 to 2027, by which time emissions will have been reduced by 50% relative to 1990. Multiple policy measures have been put in place in order realise the UK’s overall energy policy objectives of providing secure, low carbon and affordable energy. The EU has made a commitment to cut greenhouse gas emissions to 40% below 1990 levels by 2030. In 2008, the UK broke new ground in establishing the first legally binding commitment to reduce emissions by 34% by 2020 and 80% by 2050.The primary EU-wide mechanism is the EU emissions trading scheme (EU ETS), which promotes industrial energy efficiency through the first international system for trading greenhouse gas emissions allowances. This cap and trade scheme covers power stations, industrial plants and aviation in 31 countries, including the UK.Each EU Member State has its own additional domestic actions. In the UK, these include measures to raise the share of energy produced from renewable sources, whilst simultaneously encouraging energy efficiency.As part of its EU obligations, the UK must obtain 15% of its energy consumption from renewable sources by 2020, a fourfold increase on 2010. Electricity generation is expected to contribute most to meeting this target, primarily through the use of wind and nuclear power generation, and carbon capture and storage, although the Government has introduced incentives for the use of renewable heat and obligations on transport fuel too. Meanwhile, the UK is facing an energy security crisis in 2016, due to factors such as decades of under investment in new power capacity, and the impact of compliance with EU environmental regulations on existing coal fired generation. Around 12 gigawatts (GW) of coal and oil-fired power generating capacity and 7 GW of nuclear power, accounting for a fifth of total UK electricity generating capacity, are scheduled to close by the end of this decade. Ofgem, the energy-sector regulator, estimates that around £110 billion needs to be invested in plants and networks. The critical challenge for the Government is to encourage adequate investment in new low carbon generating capacity, whilst ensuring continuing reliability of the power network, and maintaining the cost competitiveness of UK business.Since 2002, investment in renewable power generation has been incentivised by Renewable Obligation Certificates (ROCS) which place an obligation on UK electricity suppliers to source an increasing proportion of the electricity they supply from renewable sources. These costs are passed through to domestic and industrial consumers.The Energy Act 2013 introduced significant electricity market reforms intended to stimulate investment in infrastructure and electricity generation capacity to deliver secure, affordable and low carbon energy supply. These reforms include:

Contracts for Difference (CfD) with Feed-in Tariffs to stimulate investment by providing stable long-term prices for low carbon electricity.

A Capacity Mechanism, intended to give investors the revenue certainty they need in order to put adequate reliable energy generation capacity in place and protect consumers against the risk of supply shortages.

In addition, the government introduced a Carbon Price Floor (CPF), a UK-specific tax on fossil fuels used to generate electricity that is intended to provide a transparent and predictable minimum price for carbon in the period to 2030.Further mechanisms include:

Feed in Tariffs (FiT), introduced in 1 April 2010, in order to encourage the uptake of small scale renewable and low carbon electricity-generating technologies; and

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the Climate Change Levy (CCL), and Carbon Reduction Commitment (CRC), intended to encourage industrial energy efficiency and penalise emissions.

UK and EU-wide measures are summarised in Sections 4.2 to 4.8 and Table 1, below.Each of these measures impacts upon EIIs, either in the form of climate levies, or in a pass through of costs from their energy suppliers. There is growing concern that the cumulative impact of these policy mechanisms will lead to carbon leakage, the transfer of business production to countries with lesser and lower cost climate policies, as outlined in Section 4.9.This has been recognised at both a national and international level and is reflected in the EU ETS and EMR support packages that have been put in place or are in development, as described in Section 4.10. Subsequent sections of this report are focused on the questions listed in Section 3.2, namely whether these support packages are adequate to militate against carbon leakage and the adverse impact of policies on the long term sustainability of energy intensive industries in the UK.

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Table 1: Summary overview of climate change policies and support packagesName Description How energy intensive industries are

impactedEst. UK tax revenue9 Compensation2012/13 2013/14

EU ETS

EU-wide cap and trade scheme for CO2 emissions from power plants; EIIs and commercial airlines.

Companies receive or buy emissions allowances which they trade as needed. At the end of each year a company must surrender sufficient allowances to cover all its emissions, or risk heavy fines.

£0.7 billion £1.5 billion Compensation for indirect costs of EU ETS (i.e. costs reflected in electricity prices) for eligible sectors if indirect carbon costs (combined cost of EU ETS and CPS) amounts to 5% or more of GVA.

RO Renewables Obligation suppliers must source an increasing proportion of electricity from renewable sources; proved by acquiring ROCs, issued to generators of accredited renewable electricity.

Suppliers pass the cost of compliance with the RO on to customers through their electricity bills.

£1.5 billion10 (2011/12)

Not available No compensation currently proposed.

CfDs Contracts for Difference (CfDs) provide guaranteed stable long-term prices for low carbon electricity.

Suppliers pass the costs of CfDs on to customers through their electricity bills.

To be introduced 2014/15 Under consultation. Potential exemption of eligible industries from 80% of the pass through costs of CfDs. Eligibility criteria may be the same as for EU ETS and CPF.

CM The Capacity Mechanism (CM) guarantees revenue to generators that provide reliable electricity on demand.

The costs of capacity payments will be recovered from electricity suppliers, who pass these costs on to their customers.

To be introduced 2014/15 for capacity delivery in 2018/19

No compensation currently proposed.

CPF UK-specific carbon tax on fossil fuels used to generate electricity. Reflected in a carbon price support (CPS) charge collected via an extension to the CCL.

Suppliers of fuel used to generate electricity add CPS costs to their bills. These are reflected in electricity prices. EIIs pay for CPS in their electricity bills or, for self-generation, in their fuel bills.

(introduced 2013/14)

£0.6 billion Under consultation but subject to state-aid approval. UK Government may use same eligibility criteria as for EU ETS.

FITs A guaranteed FITs for small scale generators of low carbon electricity (< 5 MW)

Suppliers pay the FITs to generators and pass these costs on to customers through their electricity bills.

£0.15 billion11 (2011/12)

Not available No compensation currently proposed.

CCL Environmental tax on energy supplies to industry (electricity, gas, LPG, coal and other solid fuels)

Industry pays the CCL to energy suppliers £0.7 billion £0.7 billion EIIs eligible for 90% reduction on electricity and 65% on other fuels if signed up to Climate Change Agreements, which set targets for energy efficiency.

CRC Mandatory emissions reporting and pricing scheme for large energy users not covered by EU ETS or CCL

Industry purchases allowances to cover emissions.

£0.7 billion £0.8 billion No compensation currently proposed.

9 https://www.gov.uk/government/news/definition-of-environmental-tax-published10 DECC, The Levy Control Framework, HC 815 SESSION 2013-14 27 NOVEMBER 201311 DECC, The Levy Control Framework, HC 815 SESSION 2013-14 27 NOVEMBER 2013

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http://ec.europa.eu/clima/policies/ets/monitoring/index_en.htm

http://ec.europa.eu/clima/policies/ets/cap/index_en.htm


4.2 European Union Emissions Trading Scheme

The EU ETS is the European Union's primary policy mechanism to reduce industrial greenhouse gas emissions. The system, introduced in 2005, covers emissions of carbon dioxide (CO2) from power plants, a wide range of energy-intensive industry sectors and commercial airlines. It works on a 'cap and trade' principle, in which a cap is set on the total amount of gas that can be emitted. This cap is reduced over time so that total emissions fall. From 2013 onwards, it is intended that the cap will reduce by 1.74% per year from power stations and industry, such that total emissions will be 21% lower than 2005 in 2020. A separate cap applies to the aviation sector. Within the cap, companies receive or buy emissions allowances which they can trade with one another as needed. After each year a company must surrender sufficient allowances to cover all its emissions, or risk heavy fines. If a company reduces its emissions, it can keep the spare allowances to cover future needs or sell them to another company that is short of allowances. This flexibility is intended to ensure that emissions are cut at least cost.Participation in the EU ETS is mandatory, although only plants above a certain size are included.Until now, the vast majority of emissions allowances have been allocated to power plants and industry for free, with up to 10% auctioned in certain jurisdictions. It is the intention that auctioning of allowances will increase during the third phase of the EU ETS which runs from 2013 to 2020, and that all free allocation will be phased out by 2027.Power generators were required to buy all of their allowances from 2013, other than in eight Member States that joined the EU post 2004 which have been allowed to give a decreasing number of free allowances to existing power plants for a transitional period until 2019. Experience shows that power generators have passed on the notional cost of allowances to customers even when they received them for free. This will no doubt continue now that they have to pay for them. In manufacturing, the transition to auctioning will be phased. Selected energy intensive industries classified as being exposed to carbon leakage, were to receive 100% of an EU industry benchmark allowance for free in 2013. In sectors not deemed to be at significant risk of carbon leakage, installations which attain a predefined benchmark performance level were to receive 80% of the allowances they needed for free in 2013, reducing to 30% in 2020. Installations falling short of the performance benchmark receive a proportionately lower allocation of allowances. In practice however, as the cumulative number of allowances due to businesses exceeded the maximum amount available under the scheme, free allowances were reduced by a cross sectoral correction factor. Therefore, sectors deemed to be at risk of carbon leakage in the UK will receive about 95% of the EU industry benchmark in 2013, falling to about 82% in 2020.12 Sectors without carbon leakage status will receive about 75% of the benchmark in 2013, falling to 25% in 2020 (Figure 1).13

The definition of those sectors deemed to be exposed to a significant risk of carbon leakage (see Section 4.9 below) has been criticised by industries that do not meet the narrow criteria. Carbon leakage status is currently being reviewed for the period 2015-19.Allowances given to manufacturing industry for free are distributed to companies on the basis of harmonised rules, intended to ensure that installations of a given type are treated equally across the EU. Underpinning these rules are benchmarks for emissions performance, initially drawn up in consultation with industry but now considered by some sectors to be over-ambitious, draining funds for innovation. Most EII companies will therefore have to purchase a proportion of their carbon emissions allowances, regardless of carbon leakage status. It is intended that allowances not allocated for free will be auctioned.

12 Based on cross sectoral correction factor13 The exact amount depends on an cross sectoral correction factor

14

http://ec.europa.eu/clima/policies/ets/monitoring/index_en.htm

http://ec.europa.eu/clima/policies/ets/cap/index_en.htm


Figure 1: EU ETS % benchmark allocation for carbon leakage and non carbon leakage sectors

While the EU ETS initially created a functioning market for carbon emissions, it now faces a challenge. The economic downturn and an oversupply of carbon permits have created a surplus of roughly two billion credits, which have pushed the price of carbon down from €30 per tonne at its peak five years ago to around €5 per tonne today. Thomson Reuters Point Carbon (TRPC) reports that the value of traded carbon permits and credits has fallen from £79.7bn in 2011 and £51.4bn in 2012, to £32.3bn in 2013, a decline of 38%. This reflects both the fall in value, and a decrease in the volume of emissions units changing hands, down from 10.7bn in 2012 to 9.2bn in 2013.In the short term this surplus risks undermining the functioning of the carbon market. In the longer term it could affect the ability of the EU ETS to meet emission reduction targets cost-effectively. The Commission has therefore taken the initiative to postpone the auctioning of some allowances, resulting in a ‘back-loading’ of 900 million tonnes of carbon permits that is intended to bolster values near-term. As a longer term measure, in the next trading period from 2021 the Commission proposes to establish a market stability reserve. This reserve is intended to improve the system's resilience to major shocks by automatically adjusting the supply of allowances to be auctioned. It would operate entirely according to pre-defined rules which would leave no discretion to the Commission or Member States in its implementation.A New Entrants Reserve (NER) of EU ETS allowances is a set aside for new operators or existing operators who have significantly increased capacity. These operators must apply to the NER within 12 months of starting normal operation or following start-up of the new or extended activity, and the application will determine the level of free allocation entitlement for the remainder of Phase III to 2020. This adds uncertainty to investment decision-making, as outlined in the case study in Section 7 below.Industry bodies such as the EEF14 have argued that EU ETS, in isolation, restricts growth in carbon efficient countries, inversely incentivising production in countries with no carbon standards and hence has little or no impact on global emissions. It has called on the European Commission to consider the case for moving trade-exposed, energy-intensive sectors to a single trading area under the EU ETS, where the emissions reductions cap is adjusted in line with the emergence of cost-effective abatement technologies, particularly in the continued absence of a global deal on climate change.

4.3 Renewables Obligation

The Renewables Obligation (RO) is currently the main support mechanism for larger scale renewable electricity projects in the UK. It is also arguably15 “the green levy” with the greatest impact today for industry. For example, along with small-scale feed in tariffs it has been estimated to cost steel maker Tata £10.50 per megawatt-hour (year from April 2014) for production in the UK, 14 http://www.eef.org.uk/environmentblog/?tag=/EU+ETS15 Hansard debate, energy intensive industries, 4 December 2013: http://www.publications.parliament.uk/pa/cm201314/cmhansrd/cm131204/halltext/131204h0001.htm

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whereas competitors elsewhere in Europe will either be completely exempt, or have their charges from equivalent schemes capped at €0.50 per megawatt-hour. The RO places an obligation on UK electricity suppliers to source an increasing proportion of the electricity they supply from renewable sources. This figure was initially set at 3% for the period 2002/03 and under current political commitments will rise to 15.4% (6.3% in Northern Ireland) by the period 2015/16. Renewables Obligation Certificates (ROCs) are certificates issued to operators of accredited renewable generating stations for the eligible renewable electricity they generate. Operators can trade ROCs with other parties and ROCs are then ultimately used by suppliers to demonstrate that they have met their obligation.Where suppliers do not present a sufficient number of ROCs to meet their obligation, they must pay an equivalent amount into a buy-out fund. The administration cost of the scheme is recovered from the fund and the rest is distributed back to suppliers in proportion to the number of ROCs they produced in respect of their individual obligation.For the purposes of government financial planning, the long-term value of a ROC is made up of the buyout price, that is the payment avoided by the supplier for presenting ROCs to Ofgem, plus 10%. This is roughly £46 per ROC in 2013/14 prices.The RO will be replaced by Contracts for Difference (CfD) under the Electricity Market Reform (EMR) from 2017 onwards (see Section 4.4.1 below). For the first three years of the EMR, the scheme will operate in parallel with the RO. The RO will remain open to new generation until 31 March 2017, allowing new renewable generation that comes online between 2014 (when CfDs start) and 2017 to choose between the CfD and the RO. After this point, the RO will be closed to new generation. All generation accredited under the RO will receive its full 20 years of support until the scheme closes in 2037.From 2027 the Department of Energy & Climate Change (DECC) will fix the price of the ROC for the remaining 10 years of the RO at its long-term value and buy the ROCs directly from the generators. This will reduce volatility in the final years of the scheme.Suppliers pass the cost of compliance with the RO on to consumers through their energy bills.

4.4 Electricity Market Reform

The Government’s electricity market reforms, featured in the Energy Act, include: A “contract for difference” feed in tariff (CfD) to provide low-carbon electricity generators

with a guaranteed price throughout the period of a long-term contract. A capacity mechanism to ensure sufficient system flexibility is available to maintain

reliable supplies, especially during peak periods, as the amount of variable and inflexible low-carbon generation increases.

A carbon price floor (CPF) to provide a transparent and predictable minimum carbon price for the medium and long term.

These will be supported by: An emissions performance standard (EPS) to limit how much carbon new power plants can

emit per unit of electricity generated. Measures to incentivise Electricity Demand Reduction (EDR). Measures to support market liquidity and access to market for independent renewable

generators.The key policy instruments are described below.

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4.4.1 Contract for Difference Feed in Tariff (CfD)

Contracts for Difference (CfDs) support investment in low carbon electricity generation by providing a stable long-term price for low carbon electricity. The cost of these CfDs is passed through to consumers via their electricity bills.CfDs will support low-carbon generation by giving eligible generators increased price certainty through a long-term contract. A CfD will largely remove exposure to volatile wholesale prices and reduce investment risks. Generators will receive revenue from selling their electricity into the market. In addition, when the market price is below the feed in tariff strike price they will receive a top-up payment, funded by all suppliers, for the additional amount. Conversely if the market price is above the strike price, the generator must pay back the difference: Figure 2.The CfD feed in tariff is tailored to different generation types, with proposed strike prices ranging from £55/MW for landfill gas to £305/MW for wave and tidal stream for the period 2014/15 to 2018/19. For a number of renewable technologies, the strike price will come down over time reflecting the expectation that costs will fall through learning and volume deployment. For the first three years of the EMR, the scheme will operate in parallel to the RO (See section 4.3 above). The proposed CfD strike prices for this period have been set so that they are comparable to the levels of support available under the RO, adjusted to account for the greater revenue certainty and shorter contract length provided by a CfD.

Figure 2: Illustration of the operation of the Feed in Tariff and Contracts for Difference

4.4.2 Capacity Mechanism

The Capacity Mechanism is a response to the risk to future energy security posed by the closure of fossil-fuel based power generation and the addition of increasingly intermittent (wind) or inflexible (nuclear) energy sources on to the system.The Government recognises that the market may not make adequate capacity available without an incentive, given that some power generation plant will need to provide stand-by as opposed to base load electricity. The Capacity Market mechanism is intended to give investors the revenue certainty they need in order to put adequate reliable energy generation capacity in place and protect consumers against the risk of supply shortages. It does this by providing a predictable revenue stream to providers of reliable capacity. In return they must commit to provide capacity when needed or face financial penalties.The Capacity Market will be triggered when National Grid believes that the availability of capacity is less than the government’s reliability standard. National Grid will conduct this analysis four years

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ahead of time and, if there is considered to be a shortfall, an auction will be run to secure the required capacity. This may include demand-side response and storage, as well as generation.The costs of the capacity payments will be recovered from electricity suppliers, who will in turn pass these costs on to their customers.DECC has confirmed that the Government will run the first Capacity Market auction in 2014 for delivery of capacity from the winter of 2018/19, subject to the Energy Bill becoming law and subject also to state aid clearance.

4.4.3 Carbon Price Floor (CPF)

The Carbon Price Floor (CPF) is a UK-specific carbon tax on fossil fuels used to generate electricity. It came into effect on 1 April 2013 and provides a transparent and predictable minimum price for carbon in the medium to long term. The government believes that this will address near term limitations of the EU ETS and incentivise investment in low carbon technologies.Industry bodies such as the EEF are concerned that unilateral measures like the Carbon Price Floor will widen the gap further between costs faced by the UK’s electro-intensive industries and our competitors, unless offsetting measures are provided.The CPF mechanism is deployed through changes to the existing Climate Change Levy (CCL) regime (see Section 4.6 below), by applying carbon price support (CPS) rates of CCL to gas, solid fuels and liquefied petroleum gas (LPG) used in electricity generation. As oil is not subject to CCL, the carbon price floor for oils is being achieved through reform of the fuel duty regimes, and in particular changes to the relief on oil used in electricity generation.The CPF was set at £15.70/tCO2 in 2013. The government proposed that it would follow a straight line to £30/tCO2 in 2020, rising to £70/tCO2 in 2030 (real 2009 prices). The CPS will be determined by the difference between the EU ETS and CPF rates for carbon emissions: Figure 3.Cornwall Energy estimate (based on gas conversion factors and standard efficiencies) that a gas-fired power station will be paying about £1.85/MWh on input fuel in 2013-14, rising to £3.56/MWh in 2014-15 and £6.80/MWh in 2015-16. By 2020-21 with a carbon cost of £30/t, the tax on electricity production from a gas station could reach £10.25/MWh in 2009 prices if (as appears likely) EU ETS carbon prices do not rebound.16,17

The CPF, more than any other EMR policy mechanism, has faced significant criticism for the impact that it is likely to have on the competitiveness and sustainability of UK industry relative to the EU and rest of the world.

16 Cornwall Energy, Energy Spectrum Issue 403, 25 November 201317 A Strategy for Coal in the UK 2013: Managing the transition to meeting a decarbonised energy mix utilising coal with carbon capture and storage. A discussion document from the Coal Forum Working Group, November 2013. Presented to Energy Minister Michael Fallon MP in January 2014.

18


Figure 3: Illustration of the carbon price support mechanism (in real 2009 prices)18

4.5 Small scale Feed in Tariff (FiT)

Feed in Tariffs (FiT) were introduced on 1 April 2010 and replaced UK government grants as the main financial incentive to encourage uptake of small scale (5 megawatts (MW) or less) renewable and low carbon electricity-generating technologies. These include solar electricity (PV), wind turbines, hydroelectricity, anaerobic digesters and micro combined heat and power (CHP). The FIT scheme provides a guaranteed tariff payment on both generation and export of renewable and low carbon electricity. The scheme is open to any businesses, communities and individuals that install small scale renewable and low carbon energy systems and is available through selected licensed electricity suppliers.

4.6 Climate Change Levy (CCL)

The Climate Change Levy (CCL), an environmental tax on energy supplies to industry, was introduced in 2001. It is intended to encourage greater energy efficiency and lower energy use by increasing the effective price of energy. There are two rates of Climate Change Levy; the main rates of CCL and the Carbon Price Support (CPS) rates of CCL as described in Section 4.4.3 above.Exceptions to the regime ease the CCL's impact on energy-intensive business sectors. Since introduction of the CPF, they are eligible for a 90% reduction for electricity and a 65% reduction for gas, LPG, coal and other solid fuel if they sign up to industry-wide Climate Change Agreements which set challenging targets for improving energy efficiency. In the March 2011 Budget, the Chancellor announced that the Climate Change Agreements scheme would be extended until 2023 and the existing 54 participating sectors would continue to be eligible for the scheme and the Levy discount. This extension was intended to provide industry with more certainty to invest in energy efficiency measures with longer payback periods.From April 2014 some mineralogical and metallurgical processes will be able to have a 0% levy rate using an exemption used elsewhere in Europe under the EU Energy Taxation Directive. This was announced by the Chancellor in the 2013 budget.

18 HM Treasury, 2010

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4.7 CRC Energy Efficiency Scheme

The CRC Energy Efficiency Scheme (formerly the Carbon Reduction Commitment) is a mandatory carbon emissions reporting and pricing scheme to cover large energy users in the UK (those using more than 6,000MWh per year of electricity) that are not otherwise covered by Climate Change Agreements or the EU Emissions Trading Scheme.Participants in the CRC need to measure and report their electricity and gas related carbon emissions annually following a specific set of measurement rules, and are required to buy allowances from the Government each year to cover their reported emissions. The price of the allowances was set at £12 per tonne of CO2 for the 2011/12 reporting year.The CRC was converted to a tax in Budget 2011, raising some £950m a year.

4.8 Levy Control Framework

In 2011, in recognition of the need to monitor and control the considerable cost of energy investments funded by households and businesses through their electricity bills, the Government introduced the Levy Control Framework (LCF). The LCF sets a ceiling on the overall cost of DECC’s levy-funded policies, including the Renewables Obligation (RO), small scale Feed in Tariffs (FiTs), and Contracts for Difference (CfDs). The LCF spending cap was set at £2 billion in 2011-12 and is set to rise to £7.6 billion in 2020-21 (in 2011-12 prices). In future, the Capacity Market will also be included in the LCF. However, expenditure will not begin until 2018, and when there is greater certainty on the size of the levy it will be given its own, separate budget, which we assume will be additional to the above.It is important to note that the LCF does not include levies applied to business, other than through electricity bills. As such, it does not encompass the costs of the EU ETS, CPS, CCL and CRC Energy Efficiency Scheme.

4.9 Carbon Leakage

Carbon Leakage describes the situation where for reasons of cost related to climate policies, businesses offshore jobs and production to other countries which have lesser or no constraints on greenhouse gas emissions. This can lead to an increase in total global emissions, if manufacturing processes are less efficient and there are increases in transportation of goods.This has been recognised by the EU in relation to the EU ETS for those industry sectors deemed most at risk because they are unable to pass on EU ETS-related cost increases to their customers without significant loss of market share.The EU ETS introduced two mechanisms to mitigate the risk of carbon leakage:

Sectors deemed to be at significant risk of carbon leakage receive 100% free allocation of allowances up to the sector’s benchmark (see Section 4.2); and

Member States are allowed to compensate sectors at significant risk of carbon leakage, provided schemes are designed within a framework set by the European Commission.

According to the ETS Directive (Article 10a), a sector or sub-sector is deemed to be exposed to a significant risk of carbon leakage if:

The extent to which the sum of direct and indirect additional costs induced by the implementation of the directive would lead to an increase of production cost, calculated as a proportion of the Gross Value Added, of at least 5%; and

The trade intensity (imports and exports) of the sector with countries outside the EU is above 10%.

And also if: The sum of direct and indirect additional costs is at least 30%; or The non-EU trade intensity is above 30%.

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The sectors and sub-sectors which are deemed to be exposed to a significant risk of carbon leakage figure in an official list, established by the European Commission after agreement by the Member States and the European Parliament. The EU ETS Directive allows for a review of sectors at risk every five years, with the possibility of adding sectors to the list on annual, ad hoc basis. The first carbon leakage list was adopted by the Commission at the end of 2009 and amended in 2011 and 201219. The next substantive review of sectors will conclude in 2014.In compliance with the second EU mechanism to address carbon leakage, the UK government is currently developing support packages for those UK industries impacted by both the EU ETS and EMR. These are described in Section 4.10 below.The TUC is concerned that the definition of sectors at risk may be too narrow, in particular given differences within sectors and sub-sectors across the EU. There is also concern that the existing and proposed compensation measures are inadequate, in particular given the uncertainty and risk introduced by energy and environmental policy into long-term capital investment decision making in the UK. These issues are explored in the Case Studies in Sections 6 to 9.

4.10 UK government support for heavy energy users

Government policies aimed at reducing carbon emissions rely both on enhancing industrial energy efficiency and pricing carbon emissions. In practice, this approach risks reducing the capacity of industry to invest, and if applied unilaterally, distorts international competition, causes carbon leakage and compromises the sustainability of UK businesses.In response to representations from industry and trade unions, in the Autumn Statement in 2011, the Chancellor announced the government’s intention to implement measures to reduce the impact of policies on the cost of electricity for the most electricity-intensive industries. A commitment of £250 million was given for the period 2013-2015 to offset the impact of rising electricity prices, including:

Up to £100 million in compensation for impacts from the Carbon Price Floor pass-through. £110 million compensation for indirect impacts of the EU ETS on electricity prices, in line

with European Commission state aid guidelines. £40 million uplift on relief from the Climate Change Levy (from 65% to 90%) from April

2013.In Budget 2013, this package was boosted by a further £150 and extended to 2016.In October 2012, DECC and BIS launched a consultation into their proposals for the eligibility and design of two energy intensive industries compensation schemes to counteract the impact on electricity prices of both the EU ETS and Carbon Floor Price. The consultation closed in December 2012, and following state aid clearance, the government’s response and the design of the compensation scheme for the EU ETS were published in May 2013 (see Section 4.10.1 below). Details for the Carbon Price Floor compensation scheme, which remains subject to state aid approval from the European Commission, have yet to be published.In November 2012, further exemptions were announced to offset the additional costs arising under Electricity Market Reform. Specifically, the Government announced its intention to exempt energy intensive industries from the full costs of Contracts for Difference, subject to consultation and state aid approval. The aim is to bring this exemption into force at the same time that EMR is implemented. Although the value of these exemptions has yet to be specified, the Committee on Climate Change estimates that they will amount to around £350 million a year for electricity-intensive industries in 2020.

4.10.1 Compensation for the indirect costs of EU ETS

The European Commission has provided framework guidance to European Member States, setting out which sectors and sub-sectors are eligible for compensation for the indirect costs of EU ETS20. The UK government has applied these criteria to its compensation package. Consultations have

19 http://ec.europa.eu/clima/policies/ets/cap/leakage/index_en.htm20 http://ec.europa.eu/clima/policies/ets/cap/leakage/index_en.htm

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taken place with unions and industry through the government’s Energy Intensive Industries Task Group. Within eligible sectors, businesses will need to demonstrate that their indirect carbon cost (the combined cost of EU ETS and CPS in 2020) will amount to 5% or more of their Gross Value Added (GVA). Following the Commission guidelines, aid intensity must not exceed 80% of the eligible cost increase in 2013, 2014 and 2015. In addition, the UK Government has set an overall budget limit for the scheme. If there is a significant risk of budget overspend, the level of aid intensity may be reduced below these EU guideline figures. Up to December 2013, the ETS compensation scheme had paid out £18 million to 29 companies in the energy intensive industries sector including Tata Steel, Celsa Steel and chemical firm Ineos Chlor Vinyls, in the energy intensive industries sector.21

4.10.2 Compensation for the costs of CPF

The Carbon Price Floor (carbon tax) will raise £600m in 2013-14, rising to £1.2bn by 2015 and beyond. Details of the compensation scheme, which remains subject to state aid approval from the European Commission, have yet to be published. However in the consultation process, the government proposed adopting the same criteria for determining eligibility as used for the EU ETS compensation scheme. The Government has indicated that it might extend eligibility to sectors not on the EU approved list, provided that companies are able to provide ‘firm evidence’ that the EU ETS and CPF-related costs amount to 5% or more of their GVA, and that their products are ‘significantly traded within or beyond Europe or that imports would become more economically viable as a result of increased carbon costs’. The approvals on this extended list would have to be cleared with the European Commission as consistent with State Aid.

4.10.3 Compensation for the costs of CfDs

A consultation into the eligibility for exemption from the pass-through costs of CfDs closed in August 2013. The government’s response to this consultation and the design of the CfD compensation scheme has yet to be published. However, the Government has proposed using the same eligibility criteria as those proposed for the EU ETS and CPF compensation schemes. As such, eligible businesses would need to operate in specified sectors and be able to demonstrate that carbon costs will amount to 5% of GVA.In order to comply with EU rules on state aid, any exemption would also have to involve an energy efficiency benchmark, require all beneficiaries to have signed Climate Change Agreements or pay at least 20% of the costs they are being exempted from. The Government prefers the latter option since it would have fewer administrative costs than an energy efficiency benchmark, and most energy intensive companies have already entered into Climate Change Agreements in order to benefit from an exemption under the climate change levy. Its preference would therefore be to exempt eligible industries from 80% of the costs of CfDs, although it does put forward an option for a lesser level of exemption for some companies. All options would see other consumers pay more to cover the redistributed costs of the exemption.The consultation also considers options that would exempt a wider range of businesses than those eligible for compensation under the EU ETS compliance scheme. One option it suggests is to extend the "5% test" to include CfD costs, as well as the costs of complying with the EU ETS and Carbon Price Support mechanism. It also proposes extending the partial exemption to more 'medium electricity-intensive' companies which are not covered by EU ETS compensation support, a move which, the consultation claims, would "deal with the potential of a 'cliff edge' to a degree". Another suggestion contained in the consultation is the option of 'tapering' relief, which would give a wider range of industries varying rates of exemption relative to their costs. However, according to the consultation, both alternatives carry more of a risk of "compensating companies for their costs without affecting their behaviour/investment considerations" compared with the Government's preferred option. A tapering relief may also mean more administrative complexity and make EU state aid approval less likely.

21 Hansard December 2013: http://www.publications.parliament.uk/pa/cm201314/cmhansrd/cm131204/halltext/131204h0001.htm

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5 Steel sector case study

5.1 Introduction

The steel case study examines the impact of policies on the competitiveness of Celsa UK relative to its counterparts within the Celsa Group. Celsa UK, an electric arc furnace steelmaker, is the largest producer of steel reinforcement in the UK. It is part of the Celsa Group, Europe’s largest producer of long steel products with operations also in Spain, Poland, France and Norway.There are two primary processes used in the production of steel: basic oxygen steelmaking (BOS) in which iron ore, carbon (coke) and limestone are used to produce iron which is subsequently refined, strengthened and moulded to create steel; and electric arc furnace (EAF) steelmaking in which scrap steel is recycled into new steel.The EAF process is far less resource intensive and more energy efficient than the BOS process (see Figure 4). It consumes only one third of the energy and releases only one sixth of the CO2 emissions of basic oxygen steelmaking.

Figure 4: Process materials consumption in BOS and EAF processes

In the UK market, the volumes of virgin steel produced from blast furnaces and recycled steel sourced from scrap metal are approximately the same, underscoring the significance of recycled steel. While being highly energy efficient in comparative terms, the EAF process is nevertheless electro-intensive and so highly sensitive to electricity price.The world’s steel industry is dominated by global players such as ArcelorMittal (Luxembourg), Nippon Steel & Sumitomo Metal (Japan), Hebei Iron and Steel (China) and Tata of India (formerly Corus in the UK). In the UK there are three integrated BOS sites at Scunthorpe and Port Talbot (Tata Steel), and Teesside (SSI). The Teesside site is currently mothballed, but its new owners are planning to restart shortly following an investment programme. The UK steel industry also has five EAF steelmaking sites which are located at Sheffield (Sheffield Forgemasters and Outokumpu), Rotherham (Tata Steel), Cardiff (Celsa Steel) and Sheerness (Thamesteel – currently in administration). There is a further mothballed furnace at Newport (Mir Steel).All steelmakers in the UK other than Sheffield Forgemasters are foreign owned and part of larger steel groups. As such, they are subject to international competition within their parent companies for operational and capital investment.Downstream of the steel production process, there are steel re-rolling businesses located mainly in the West Midlands, South Wales, North East, Scunthorpe and Sheerness, and tube making in Corby,

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the North East, West Midlands and South Wales. Wire and other cold drawing operations are largely independent of the steelmakers and are generally located in Yorkshire, the West Midlands and North Wales. Approximately 20,000 people are employed in direct steel production with many more in downstream operations, and the sector contributed £1.9 billion to the UK balance of trade in 201222.World steel production is presently at the highest level ever recorded, largely driven by rapidly increasing demand in China. At 1,510 million tonnes, output of crude steel in 2012 was 12% higher than that achieved pre-recession in 2007 (Figure 5).

Figure 5: Global crude steel production 1997 – 2012

In contrast, in 2012 UK steel output fell to 9.8M tonnes, one of the lowest annual outputs since 1934. 2012 output was 32 % less than in 2007 (Figure 6). In part this reflects the general economic downturn within Europe and the UK. However, it is also believed to reflect energy and environmental policy which is adversely impacting upon UK steel producers relative to their European and international counterparts.

Figure 6: UK crude steel production 1991 – 2012

22 http://www.eef.org.uk/uksteel/About-the-industry/Steel-facts/Output-UK.htm

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This case study looks specifically at the impact of policies on the competitiveness of Celsa UK relative to its counterparts within the Celsa Group. Celsa UK is the largest producer of steel reinforcement in the UK. It is part of the Celsa Group, Europe’s largest producer of long steel products with operations in Spain, Poland, France, Norway and the UK.The energy prices paid by the largest energy intensive companies are generally not public domain. However, Celsa has shared insights from their operations. These show that the Celsa UK plant is one of the most energy and labour efficient in Europe. However, as a result of UK energy and environmental policy, it also faces the highest electricity prices within the Celsa Group. This is undermining the long-term prospects of this highly efficient, low carbon business.The ultimate conclusions and recommendations arising from this case study complement those from the other case studies and are reflected in Section 9 of this report.

5.2 Overview of Celsa UK

Celsa, later to become Celsa Group, was established in Spain in 1967. It started out as a small reinforcing bar re-rolling mill, but has gradually grown to become a vertically integrated business and Europe’s largest producer of long steel products. The group has total annual sales of over €4,500m, some 6,000 employees, and an output of around nine million tonnes of steel per year. There are eight companies in the Group. These operate seven EAF steel mills in Spain, Poland, France, Norway and the UK (Cardiff), which consume over ten million tonnes of scrap every year. Acquired in 2003, Celsa UK is the largest producer of steel reinforcement in the UK and one of the largest producers of other long steel products. Celsa Group invested £90m in state of the art melt shop facilities in Cardiff in 2006, making it one of the most efficient in the group. Celsa UK facilities also include a rolling reinforcing products and wire rod facility, and a plant for rolling merchant bar and light sections. Celsa UK produces around 1.2M tonnes of finished products annually, mostly for the British and Irish markets. The company supplies products for some of the largest civil engineering infrastructure projects in the UK. It serves the construction sector with reinforcing bar and high yield coil, mesh, wire rod and ‘merchant bars’ (angles, flats, rounds and channels).Approximately 700 people are employed directly at the Cardiff melt shop, and a further 1,000 in other parts of the UK. The company estimates that its UK operations generate a further 6,300 jobs indirectly.23

5.3 Celsa UK, electricity prices and the competitiveness challenge

CELSA UK operates one of the most efficient EAF facilities in Europe. It emits 270 kg CO2/tonne of steel produced (2012), against a benchmark of 285 kg CO2/tonne for the best 10% of EAF steelmakers in Europe (Figure 7). The EAF process operated by Celsa UK in Cardiff is so energy efficient it presents few opportunities for reducing carbon emissions or the company’s £50m annual electricity bill. Despite operating a world class, energy efficient facility, Celsa UK has incurred operating losses over the period from 2008 to date. There is growing concern that one of the most efficient steel plants in Celsa Group’s European portfolio is exposed to carbon leakage as a result of UK climate change policies and tariffs.

23 Celsa UK

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Figure 7: Celsa UK direct and indirect CO2 emissions

A key challenge in Celsa UK’s drive to remain competitive and improve net margins is the structure of its cost base. Approximately 70% of the company’s costs and 100% of its products are internationally traded commodities. Both scrap steel feedstock and final products offer little room to negotiate on price. Of the remaining transformation costs, approximately a third, or £50m, is accounted for by electricity costs. This leaves Celsa UK controlling no more than 20% of its cost base, in the form of labour and other costs (Figure 8).

Figure 8: Breakdown of Celsa UK’s operating costs

While production levels have been maintained, labour costs have been reduced by over 25% against a 2008 baseline (Figure 9). Wages have been either reduced or maintained and employee numbers reduced such that Celsa UK now has amongst the lowest labour costs within the Celsa Group on a Euro/tonne output basis (Figure 10). As the wider economy begins to pick up, Celsa UK now faces recruitment, retention and skills challenges in a competitive labour market where certain key skills are highly sought after. It is becoming increasingly difficult to afford the market price for these skills, given the lack of flexibility within the company’s cost structure.

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Figure 9: Labour and electricity cost trends 2008 - 2013

Figure 10: Celsa UK labour costs benchmarked against Celsa Group

At the same time, energy costs have continued to rise in the UK, ahead of the rest of Europe. Despite leading within Europe in terms of energy efficiency, Celsa UK faces the highest energy costs within the group on a Euro/tonne output basis (Figure 11).

Figure 11: Celsa UK energy costs benchmarked against Celsa Group

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The cost of energy for very large EII users is not generally transparent. Celsa have shared their view on European prices based on their experience (Table 2). In their estimate, electricity prices faced by the largest EIIs in the UK will be twice that of equivalent operations in Germany in 2014. Furthermore, the planned policy mechanisms are anticipated to increase unit energy costs by 60% over 2010 prices by 2020, although there is uncertainty about the scale and duration of support measures (Table 3).

Table 2: Celsa estimation of 2014 electricity costs for energy intensive industries in selected countries in the European Economic Area24

2013 PositionRenewables obligation currently £8.66/MWhFeed-in tariff £2.12/MWhEU-ETS cost pass through from generators £0/MWhCarbon Price Floor additional pass through £2.69/MWhIncrease over 2010 prices £8.6M ≡ 24.8 % increase2020 PositionRenewables obligation £10.00/MWhFeed-in tariff £3.00/MWhEU-ETS cost pass through from generators £19/MWhCarbon Price Floor additional pass through £6.38/MWhIncrease over 2010 prices £21M ≡ 60 % increase2030 PositionAssumed in line with DECC estimate TBCTable 3: Direct and Indirect Energy Tariff Costs

241 Renewable energy support schemes2 Availability and utilisation revenues comprised (up to €400/MWh in Germany)3 85 % x 0.76 teCO2 /MWh x €5/te CO2 (€500M in Germany and £125M in the UK from 2013 on4 €1 = £0.81095 ARENH (historical nuclear energy) is considered in this table (tariff accepted by the EU). Alternatively, there is a lower

regulated tariff to expire end 2015 (Tariff Vert C – EIP)?6 In France, ARENH regulated price has been considered (€42/MWh) minus back-selling surplus estimated at €1/MWh)7 Virtual imports for 2010 – 2015 were based on German (no direct connection) and French prices. An allocation of 60 % has

been taken into account and a payment of €4.5/MWh for Terna’s operations: 60 % @ €40/MWh (Germany/France) + 40 % @ €65/MWh (Italy)

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5.4 Conclusions

Mr Tajani, the European Industry Commissioner, recently warned that Europe’s energy and environmental policies risked undermining industrial competitiveness. He told The Daily Telegraph during the Ambrosetti forum of global policy-makers at Lake Como that ‘we face a systemic industrial massacre’ as America's shale revolution cuts US natural gas prices by 80%. He went on to say that ‘I am in favour of a green agenda, but we can't sacrifice Europe's industry for climate goals that are not realistic, and are not being enforced worldwide’25. The Celsa UK experience suggests that this view can be amplified in relation to the UK relative to the rest of Europe too.Celsa UK has been operating at a loss for some time, despite significant efforts to improve process efficiencies and reduce costs. Celsa UK operates one of Europe’s most modern and efficient steel production facilities. It invested £90m in 2006 in a new electric arc furnace which achieves world-class emissions and production standards. Carbon emissions associated with the UK facility are not only lower than blast furnace steel producers, but also other electric arc furnace facilities employed in Celsa Group’s production portfolio.Celsa UK has also driven down other operating costs in recent years to reduce overheads and improve margins. Labour costs are now among the lowest within Celsa Group’s European business. The company has little control over recycled steel costs because scrap metal is a commodity which is traded in a global market. The reasons for Celsa UK’s poor commercial performance are attributable mainly to wholesale electricity prices which are among the highest in Europe, and considerably higher than Celsa’s other sites operating the same process. Planned unilateral UK climate changes policies and tariffs, such as CPF and CfD are expected to exacerbate this situation.This case study shows that UK energy and environmental policy is adding significant cost to UK steel manufacture relative to both EU counterparts and international competition. This is distorting the economics of supply against UK companies and is encouraging carbon leakage.

25 http://www.telegraph.co.uk/finance/financialcrisis/10295045/Brussels-fears-European-industrial-massacre-sparked-by-energy-costs.html

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6 Heavy clay ceramics sector case study

6.1 Introduction

The ceramics sector is a cornerstone of the UK construction industry, with the ‘heavy clay’ sub-sector producing facing bricks, engineering bricks, pavers, clay roof tiles and clay drainage pipes for use in housing, urban development and infrastructure projects. The sector is highly energy intensive, accounting for approximately 4000 GWh of gas consumption and 600 GWh26 of electricity consumption annually. Many UK-based heavy clay businesses are part of multinational companies, characterised by headquarters located in other parts of the European Union and multiple sites producing similar product ranges.Our case studies include:

Ibstock, the UK’s largest brick producer, with a company history dating back to the late 19th Century. It employs just under 1,500 people and produces a broad range of heavy ceramic products – primarily facing bricks and special shapes - from 19 UK sites.

Marley Eternit, part of the Etex Group, with 105 companies operating 123 factories in 45 countries around the world. The Group is headquartered in Belgium. In the UK, Marley Eternit produces clay roof tiles at Keele, Staffordshire.

While the ceramics sector as a whole generally uses more gas than electricity (all heavy clay kilns are gas-fired, for example) some ceramics companies are among the most electro-intensive in the UK. Refractory and technical ceramics manufacturers operate electric arc and induction furnaces at temperatures above 2,000oC. Several of these highly electro-intensive manufacturers have already relocated overseas, with electricity costs being cited as one of the reasons for closing down UK-based operations. Carbon leakage is therefore already occurring within the ceramics sector, albeit in very specific product areas.Heavy clay producers have been severely affected by the economic downturn since 2008, and many plants have been either permanently closed or mothballed. There were 93 operational heavy clay sites in the UK in 2008; at end of 2013 only 63 remained with three sites mothballed and 25 permanently closed.27 In the last year there has been an upturn in the housing market, driven in part by increasing market confidence and the Government’s Help to Buy scheme. Although heavy clay manufacturers have responded promptly to increases in demand for bricks and clay tile products from house builders, at present there is still under-capacity in the market and output remains at just 60-70% of pre-recession volumes. This under-capacity is being redressed by sourcing more materials from overseas markets, not only from other parts of the EU but also new geographies such as Turkey and the Indian sub-continent, and there is clear evidence that some of these competitors established a foothold in the UK market during the recession.The ceramics sector operates to long investment cycles. As a result, highly uncompetitive UK energy prices (for electricity, sometimes twice that of European competitors) and UK-specific escalator tariffs on electricity bills, gas supply security and price volatility risks, accompanied by support mechanisms with time horizons which extend no further than the current Treasury spending review period, pose serious risks to business planning processes. In addition a more flexible regulatory and R&D funding environment in other EU countries, such as the Netherlands, Germany and France, are driving strategic investment decisions offshore.At a time when the heavy ceramics sector should be responding favourably to a recovering UK housing market, direct and indirect energy tax burdens and below-capacity production, coupled with increasing trade intensity, are giving rise to the threat of carbon leakage, with the potential for this sub-sector to start following its electro-intensive counterparts out of the UK.

26 BCC CCA database (2010-11)27 BCC Climate Change Agreement sites 2008-2013

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6.2 Trends in European and UK markets

The ceramics sector makes a positive contribution to the trade balance of the EU. Cerame-Unie estimates28 that around 25% of EU production is sold outside the EU with, for example, total exports in 2011 of €7.2 bn and imports of just €3.5 bn. This trend is continuing with 2011 exports increasing by 7.3% and imports decreasing by 5.9% compared to 2010. Cerame-Unie nevertheless highlights increasing trade intensity as an area of concern in its 2050 Roadmap. This is evidenced by the status of the ceramics sector within the EU ETS.Having originally been omitted from carbon leakage status during round 1 of the EU ETS, there is now increasing consensus that brick and clay tile companies are indeed exposed to carbon leakage. Following the 2010 EU ETS review, and using a ‘qualitative assessment’, the NACE code sector (2640) ‘Manufacture of bricks, tiles and constructions products, in baked clay’ formally qualified as ‘exposed to significant risk of carbon leakage’, a decision which was ratified in November 2011 by the European Commission29. This decision made reference to, among other things, challenging market conditions, ‘in particular increasing trend in imports from low cost manufacturing countries, increased international competitive pressure, …and only modest profit margins for the years evaluated compared to the additional CO2 cost, which limit the capacity of installations to invest and reduce emissions.’

As outlined in Section 4.2, businesses which are exposed to significant risk of carbon leakage receive approximately 95% of EU benchmark allowances for free. For those not deemed at risk of carbon leakage, this figure is 82%, falling to 25% in 2020. Retention of ‘carbon leakage’ status in the 2014 review for the period 2015-2019 is therefore critical to the heavy clay sector as its loss would incur heavy penalties.At a UK level, domestic demand for heavy clay products has been met by domestic production, and trade intensity has historically been relatively low. However, Figure 12 and Figure 1330 indicate that, over the three year period 2011-2013, the level of clay tile and brick imports rose significantly, despite the housing market only picking up towards the end of that period. Even during the recession, therefore, some of the domestic demand for bricks and tiles was being met by imports at the same time as UK plants were closing or being mothballed.

28 Cerame-Unie, Brussels (Undated) Paving the way to 2050 the ceramic industry roadmap http://www.cerameunie.eu/en/news/european-ceramic-industry-launches-2050-roadmap-paving-the-way-to-a-better-future accessed January 201429 Commission Decision of 11 November 2011 amending Decisions 2010/2/EU and 2011/278/EU as regards the sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage30 https://www.uktradeinfo.com

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http://www.cerameunie.eu/en/news/european-ceramic-industry-launches-2050-roadmap-paving-the-way-to-a-better-future


Figure 12: Total imports of bricks by volume

Figure 13: Total imports of roof tiles by volume

The underlying trade data shows that brick imports reached more than 14% of total sales, whilst tile imports rose by 53% between 2011 and 2012, and then a further 11% over the corresponding period in 2013. Between January and October 2013, 38,813 tonnes of clay tiles were imported, with a value of £10.7 m, although it is interesting to note that the value of imports did not rise as significantly as the quantity of product, suggesting that pricing was being demand side driven.The principal European countries driving carbon leakage from the UK include France, The Netherlands and Germany, with Poland and Denmark also acting as significant exporters of clay roof tiles to the UK. However, notably, in the context of carbon leakage beyond the EU, trade routes from Turkey, China, India, Pakistan and even Sri Lanka and Vietnam appear to be getting established for brick and or roof tile products.

6.3 Responding to recovery in the housing market and construction sector

Levels of house building across the UK increased gradually during 2013, with the private sector leading the way and much of the demand driven by the Government’s Help to Buy scheme. The NHBC reports31 that the number of homes built in the UK in 2013 (133,670) was the highest since the start of the economic downturn, and a 28% increase on 2012. Significantly, the figures still fall short by almost a factor of two on the number of new houses considered necessary to accommodate an increasing population. Even in 2007, prior to the economic downturn, the annual figure was just 200,000 homes, suggesting that considerable latent demand for new housing stock will remain for some time.The positive turnaround in construction and house building activity has given rise to unusual market distortions. A recent industry survey32 conducted by the Construction Products Association, (CPA) for example, highlights that:

Manufacturers are reporting a short-term supply problem caused by historically low stock levels of building materials, particularly bricks and blocks.

These short-term supply constraints are compensated for by the fact that there is sufficient manufacturing capacity in the UK to cope with market expansion of all materials.

31 Reported in the Daily Telegraph online 30 January 2014 http://www.telegraph.co.uk/property/propertynews/10608718/New-homes-boom-helps-to-build-the-recovery.html accessed January 201432 Construction Products Association Qualitative Analysis of UK Construction Manufacturing Capacity 26 September 2013

32

http://www.telegraph.co.uk/property/propertynews/10608718/New-homes-boom-helps-to-build-the-recovery.html

http://www.telegraph.co.uk/property/propertynews/10608718/New-homes-boom-helps-to-build-the-recovery.html


Capacity increases across the building products industry will need to be accompanied by investment security in the supply chain.

Manufacturers will need to pass on costs to secure the margins required to justify continued investment in UK production capacity.

Confidence in long-term investments will be dependent on the sustainability of demand-side factors and market volumes, regulatory certainty, and energy security.

The CPA report suggests that, as house building starts to pick up pace, manufacturers have raised production of bricks and other construction materials, whilst using imports as a temporary buffer. Brick production in November 2013 was 27% higher than a year earlier according to the latest statistics from the Department for Business,33 and major brick producers have worked over the winter period for the first time in five years. At the same time, imports of bricks in Q3 of 2013 were 39% higher than a year earlier.34

It is clear that, in the longer term, a balance between sufficient production capacity and a sustainable demand for bricks is needed to reduce reliance on imports and avoid the closures and mothballing seen over the last five years. 6.4 The impacts of climate change tariffs and support mechanisms

As a result of their energy intensive nature, heavy clay ceramics companies are subject to substantial direct and indirect costs associated with both EU and UK climate change policies and electricity market tariffs. More than 1,000 ceramic installations are subject to the EU ETS, representing >10% of the number of industrial installations covered by the scheme, but only 0.5% of the scheme’s CO2 emissions. This is because 75% of ETS installations in Cerame-Unie’s membership are classed as ‘small emitters’ (i.e. production >75 te/day and emissions <25,000 te CO2/year)35. Since 2013, there has been an EU ETS small emitter scheme in the UK, to help minimise administrative costs. A number of the tariffs paid by British ceramics producers, such as CCL, CfD and CPF apply only to the UK. In some heavy clay companies fixed, pass through and carbon-related energy tariffs already account for around 30% of operating costs, and in some cases this proportion has doubled since 2006. By 2020 it is anticipated that these costs may account for approximately 55% of total OPEX. As seen in the steel case study (see Section 5), market distortions are arising between British producers and their overseas counterparts operating within the same parent company, since opportunities to drive down energy consumption costs are constrained by the existing use of best in class technologies at many facilities.

6.4.1 EU ETS

The allocation of carbon under EU ETS is based upon industry benchmarks, with the benchmark for bricks being considered highly ambitious. CO2 emissions arise, not only from energy consumption, but also from embedded mineral carbon in the clay feedstock which is released as process emissions. The carbon content of natural clays is highly variable around the UK. In fact, the content in the local Etruria marl serving the Ibstock and Marley sites in this study is very low, but even the most energy efficient heavy clay factory will give rise to higher, unavoidable process CO2 emissions if the mineral carbon content in the feedstock is high. (This provides an interesting comparison with the cement and lime sectors profiled in Section 6, where process-related CO2 emissions are highly significant but nevertheless generally consistent amongst different producers in the EU.)There is no means to abate the carbon content occurring naturally in clays. The benchmark in the ETS Directive is based on the average of the top 10% of the lowest emissions processes in overall carbon emissions terms. However, closer inspection of , derived from studies36 by the European Bricks and Tiles Federation (TBE), reveals that the natural geographical variations in clay types does indeed give rise to variations in overall specific CO2 emission rates, and in turn influences the 33 www.theguardian.com/business/2014/jan/10/brick-shortage-threatens-construction-sector-recovery accessed January 201434 The Guardian (2014) op. cit.35 Ceram-Unie, Brussels (Undated) Paving the way to 2050 the ceramic industry roadmap http://www.cerameunie.eu/en/news/european-ceramic-industry-launches-2050-roadmap-paving-the-way-to-a-better-future accessed January 201436 TBE 2010 benchmarking exercise

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http://www.cerameunie.eu/en/news/european-ceramic-industry-launches-2050-roadmap-paving-the-way-to-a-better-future

http://www.theguardian.com/business/2014/jan/10/brick-shortage-threatens-construction-sector-recovery


relative ranking of ceramics producers, inevitably creating market distortions. In some cases the least fuel-efficient enterprises have favourable specific emissions rates because of their low levels of process CO2.

Figure 14: Specific process- and energy-related CO2 emissions rates for facing bricks

The UK EU ETS support mechanism, completely bypasses the ceramics sector, since the sector is generally not electro-intensive as defined by the EU37: electro-intensive installations account for about 40% of the electricity used in the ceramics sector, and consume about 10% of the total energy used, and comprise less than 10 % of the installations38. Although some ceramics firms are the most electro-intensive in Europe, about 85% of energy demand across the ceramics sector as a whole is supplied by gas. These highly vulnerable installations are therefore denied access to a key part of the EU ETS and Carbon Price Floor support package (see Section 4.4.3).

6.4.2 UK support mechanismsCCL and CCA

The Climate Change Levy (CCL) is an environmental tax on energy supplies to industry which was introduced in 2001. As described in Section 4.10, the Chancellor announced in last year’s Budget (2013) that the Treasury proposes to introduce 100% relief from the costs of the Climate Change Levy from April 2014 for mineralogical and metallurgical processes. This Exemption was applied under the EU Energy Taxation Directive and is in force in a number of other Member States. The BCC considers that the tax relief will not be significant in proportional terms, saving only about 2% of energy costs for its members, but acknowledged the importance of the concession in terms of Government recognition of the cumulative burden of electricity taxes faced by the sector, and the need for a more level playing field with the rest of Europe. Electricity Market Reform: CfD and CPF

UK Government proposals to provide Contract for Difference support mechanisms to ceramics sector businesses are very limited in scope (see Sections 4.10.2 and 4.10.3). With regards to CPF compensation, the Government is currently pursuing a two stage approach, with those companies on the annex II ‘EU ETS electro-intensive sectors list’ benefitting first, and other sectors later if at all. As a result, the UK Government is taking the case of a handful of UK electro-intensive ceramic

37 annex II of the ETS State Aid Guidelines (Commission Communication 2012/C 158/04 of 5.6.2012) http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2012:158:0004:0022:EN:PDF 38 BCC, CCA data for 2012

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http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2012:158:0004:0022:EN:PDF


manufacturers to the European Commission to apply for Carbon Price Floor compensation, but none of these are in the heavy clay sector. At a European level, the Commission has recently released a proposal for consultation regarding state aid39. A key eligibility criterion in the proposal (which references the EU ETS Annex 2 indirect compensation list) is that “the costs of funding renewable energy support lead to a substantial increase in production costs, calculated as a proportion of the gross value added amounting to at least 5%. The ceramics industry believes that GVA is completely inappropriate as a denominator since electricity taxes are effectively being measured as a percentage of the wages bill. In recession, and for barely profitable firms, this discriminates very heavily against companies and sectors that are more labour-intensive. Given the emerging guidelines, there are thus major concerns over whether the most electro-intensive UK installations in ceramics, clay, minerals, glass etc. will receive any compensation at all under the proposed schemes for CfD and CPF, and the outlook for the heavy clay sector is even more uncertain. Figure 15 summarises the current status of support measures for ceramics businesses in the UK, and indicates the market distortions being introduced, not only within the sector, but across the energy intensive industries.

Ceramics Sub-sector

EU ETS indirect compensation on

electricity

Carbon Price Floor

EMR / CFD

Renewables Obligation

Small Scale FITs

CCL*

Electro-intensive ceramics

X @ @ I

Heavy clay and rest of ceramics sector

X X @ @ I

X Sector excluded

Presently highly unlikely due to exclusion from EU ETS indirect compensation list and challenges with draft State Aid Guidelines – but industry welcomes that UK Government taking case forward

I Sector included@ No proposals to compensate any sector

Sector contributing to other EII sectors’ exemptions*CCL Not a component of the package of measures for EIIsFigure 15: Support packages for EU and UK Climate Change and Energy Taxes

6.5 Specific challenges facing the UK heavy clay sub-sector – two case studies

6.5.1 Ibstock

Ibstock is the UK’s largest brick producer, with a company history dating back to the late 19th Century. It employs just under 1,500 people and produces a broad range of heavy ceramic products – primarily facing bricks and special shapes - from 19 UK sites. Increasingly, more innovative products have been developed for the construction market to reflect modern day building requirements. One example is an external wall insulation system clad with clay products used for the renovation and upgrading of existing domestic and commercial building stock. Ibstock’s multinational parent company, CRH Group, is headquartered in Ireland. Ibstock Brick’s Chesterton site, one of the two heavy clay businesses referred to in this case study, opened a new facility in 2013. It features the latest kiln and brick-making technology, and is among the most energy-efficient of its type in the world. Ibstock’s £20M investment represents, along with Marley Eternit’s investment at Keele (see below) are the largest capital expenditure in the UK’s ceramic

39 http://ec.europa.eu/competition/consultations/2013_state_aid_environment/draft_guidelines_en.pdf

35


industry for many years. The Chesterton site has the capacity to produce 70 million bricks per year. Production at all of Ibstock’s factories has been severely affected by the economic downturn and the concomitant decline in the construction sector. In 2007 2.5 billion bricks were produced by UK brick manufacturers and this virtually halved to 1.3 billion in 2010. By 2013 the market had risen but only back to 1.6 billion40. This resulted in 25 factories permanently closed – almost all brick producers – out of the 93 UK heavy clay factories that had been operational in early 2008.From an energy consumption (and carbon emissions perspective), the low production levels have impacted on specific energy consumption and costs for the company. Specific energy consumption varies considerably according to production rates – heavy clay producers must continue to operate continuous tunnel kilns at sub-optimal efficiency levels to retain sufficient capacity for when market conditions recover, and avoid costly damage to the refractory components in the kilns. Energy costs at Ibstock during this period have virtually doubled due to a combination of commodity cost rises and significant increases in climate related taxes and efficiency schemes. The company anticipates that the costs associated with climate related taxes and efficiency schemes will triple over the next seven years.

6.5.2 Marley Eternit

Marley Eternit is part of the Etex Group, with 105 companies operating 123 factories in 45 countries around the world. The Group is headquartered in Belgium and has approximately 18,000 employees (9,900 in Europe) and €3.168 billion in revenue. In the UK, Marley Eternit produces clay roof tiles at Keele in Staffordshire. The most recent K3 production unit on the site is a modern (commissioned in 2006) and highly energy efficient facility. At present, however, the facility is running at only 60% of potential capacity, and as shown in Figure 16, annual production levels are variable and have not recovered to pre-recession levels. Investment in this new plant resulted in closure of a production facility in Cannock.

Figure 16 Annual production levels at Marley Eternit, Keele

Historically, Marley’s energy cost ratios between gas and electricity were approximately 2:1, reflecting the energy intensity of the gas-fired kiln. Specific energy consumption is more controllable than that reported by Ibstock, mainly due to the greater flexibility afforded by the five tunnel kilns, and gas consumption has declined from 1,800 kWh/tonne to 1,400 kWh/tonne as a result of the investment in the new plant and improved energy efficiency. However, electricity costs are rising, not only as a result of direct and indirect taxes and tariffs and increasing wholesale prices, but also as a consequence of fuel switching from gas to electricity, driven by the desire for greater plant efficiency and environmental performance. For example, the Keele K3 plant is highly automated along the production lines both prior to and following firing of the clay products.

40 https://www.gov.uk/government/collections/building-materials-and-components-monthly-statistics-2012 (2007 data available in 2012 excel spreadsheet)

36

https://www.gov.uk/government/collections/building-materials-and-components-monthly-statistics-2012%20%20(2007

https://www.gov.uk/government/collections/building-materials-and-components-monthly-statistics-2012%20%20(2007


Variable speed drives, kiln motors and conveyor motors all serve to drive down costs but are nevertheless still significant electricity consumers.As with Ibstock, large capital investment decisions are taken by Marley’s parent company outside the UK and new capital projects have increased the company’s roof tile production in competing jurisdictions. For example, in 2012 a new clay roof tile factory was opened in Koscian, Poland, not only to supply the domestic market, but also to export to other European countries. Trade intensity is increasing in the UK, with tiles being imported from as far away as Turkey for the first time in recent years.

6.5.3 Cost escalation and security of energy supply

The heavy ceramics sector is not generally considered to be electro-intensive, but electricity supplies currently account for 30% of energy costs for both Ibstock and Marley. An underlying aim of energy and environmental policy mechanisms is to encourage and incentivise energy intensive sectors in their transition to a low carbon economy. An implicit assumption within this regime is that businesses will invest in low carbon technologies because they will see a return on investment, within acceptable payback periods, relative to both the costs of carbon taxes, and the continuing use of older, more energy-intensive technologies. Figure 16 and Figure 17 illustrate, however, that even following investment in state of the art facilities, energy price escalation over time can skew returns on investment.

Figure 16: Marley energy costs as a proportion of total production costs

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Figure 17: Energy price escalation and specific energy consumption at Marley

Looking in greater detail at how electricity bills might develop, and in particular the effects of ‘non-baseload’ charges, Figure 19 illustrates how non-baseload charges (fixed, pass through and green taxes) at Ibstock are rising from 25 % (2007 figures) to over 45% in 2013 to over 60 % (2020 estimate). Baseload charges include EU ETS indirect pass through charges in this example, but it is notable that the baseload costs do not include provision for Contract for Difference, potential extra charges for ESOS pilot pass through or charges likely to be incurred by likely extra measures by National Grid to promote a demand side responses in winter.

Figure 18: Increases in non-baseload charges at Ibstock as a % of total electricity bill

To compound uncompetitive electricity prices, UK heavy ceramics producers face potentially significant security challenges for gas supplies. Although the gas price is currently steady, rules governing procedures in the event of chronic shortage state that many manufacturers relying on gas for production can have their supplies terminated at very short (four hours) notice. At the moment, sites are exempted from shutdown only if the potential damage to factory equipment from gas supply interruption is more than £50 million. All UK heavy clay businesses, including Ibstock and Marley, fall below this threshold, but nevertheless face potentially serious damage to their tunnel kilns should gas supplies be cut.

6.6 Conclusions

The European ceramics sector is now considered to be at risk of carbon leakage through market distortions arising from trade barriers and unfavourable climate change and carbon taxation policies. These EU-level business challenges are exacerbated in the UK by unilateral direct and indirect energy costs, placing UK producers at a competitive disadvantage to European counterparts. The UK ceramics sector has very limited access to current government support mechanisms. The heavy clay sub-sector will not receive any CPF relief (and therefore, by inference) through CfD support mechanisms.

38


For those handful of highly electro intensive ceramics companies (for example in the technical ceramics and refractories sectors) which may receive CPF (and CfD) compensation, the duration and scope of the UK support package is an issue. For example, the compensation for CPF and EU ETS indirect costs are only proposed at present for the current spending review period, whereas the taxes will continue well beyond this. Investment cycles in the sector are far longer than Treasury spending review periods and manufacturers therefore need to be able to plan on a long term basis. Indeed, several of the highly electro-intensive factories have already relocated outside the UK, some to Germany and France, with electricity costs being cited as a major influencing factor.41 Energy efficiency measures are the most obvious way to reduce fuel emissions. However, the operational life of a kiln can be over 30 years, and payback periods on major capital spend are not commercially sustainable. It is not practicable to routinely upgrade kilns before the end of their operational life and replace them with more energy-efficient models. Even when substantial new investments have been made in new state of the art kilns and production facilities, as is the case at Ibstock Brick and Marley Eternit, and where these facilities are using the lowest process emissions clay in the UK, this has not been sufficient to overcome the market distortions arising from energy costs and EU and unilateral UK tariffs.Heavy clay producers have been severely affected by the economic downturn since 2008, and many plants have either been permanently closed or mothballed. There has, however, been an upturn in the housing market over the last year, driven partly by increasing market confidence and the Government’s Help to Buy scheme. Although heavy clay manufacturers have responded promptly to increases in demand for bricks and clay tile products from housebuilders, at present there is still under-capacity in the market and output remains at just 60-70% of pre-recession volumes. This under-capacity is being redressed by sourcing more materials from overseas markets, not only from other parts of the EU but also new geographies such as Turkey and the Indian sub-continent. For the first time in its history, and at a time when there are signs of recovery from a deep recession in the construction industry, there are real indications that imports of bricks and clay roof tiles have gained and may be continuing to gain ground rapidly in the UK market.The key to remaining competitive and keeping jobs in the UK is investment, but investment decisions are being delayed and compromised. The UK is increasingly being viewed by overseas owners as an unfavourable place to invest. There need to be real incentives to invest, based on reliable, predictable and long-term tariff forecasts.

41 BCC pers. comm. December 2012, but also presented in written submissions to the EAC and the Chancellor

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7 Mineral products sector case study

7.1 Executive summary

The mineral products industry is large and important to the UK economy. It accounts for over £4 billion of gross value added (GVA) each year and employs 70,000 people, with a further 2.5 million people employed in consuming sectors42. Employment is geographically spread through every part of the UK, including rural areas where the industry creates demand for skilled labour and trades.Within the mineral products industry, cement and lime manufacturers are the most energy intensive and the focus for this case study. An unusual feature of the cement and lime sectors is that a high proportion of carbon dioxide emissions are governed by the chemistry of the industrial processes involved. In the absence of new technologies like carbon capture and storage, this limits the opportunities to reduce overall carbon emissions. Nevertheless the UK cement industry has achieved reductions of 55% since 1990, largely through investment in efficient plant, industrial rationalisation, and the replacement of fossil fuels with waste derived biomass fuels. The lime industry, in which 53% to 75% of emissions are defined by the chemistry of the process, has delivered abatement of combustion emissions by 15% since 2005.Opportunities to drive further emissions abatement in cement and lime production are limited by available technologies and require significant government intervention in support of technology development and commercialisation. The Mineral Products Association (MPA) has defined emissions reduction scenarios for the UK cement industry of between 62% and 81% relative to 1990; however an 81% reduction is dependent upon carbon capture and storage technology being commercially available and deployed at scale. Both scenarios also require significant investment in alternative waste derived fuels, including biomass, and low carbon clinker.Both cement and lime sectors have been badly hit by the recent economic downturn. In 2012, for example, total cement production in Europe fell by 40% when compared to pre-crisis levels, and the return on capital employed is well below the cost of capital for the industry43. In common with the steel and heavy clay ceramics sectors profiled in previous case studies, there are now concerns that the viability of these sectors in the UK will be undermined by financial burdens arising from evolving UK energy and environmental policy, over and above EU obligations. There is emerging evidence of carbon leakage and significant loss of value from the cement and lime sectors, at the very time that there are signs of a recovery in the UK construction industry. Cement and lime sectors are both capital intensive, with long investment time horizons. Energy policies not only have an impact on the day-to-day operational finances of these businesses, but also influence capital investment decision making. Policy uncertainty creates risk, which in turn is reflected in higher hurdle rates for investment. This case study looks specifically at the impact of policies and proposed relief on the climate for investment in mineral products sectors. It finds that, rather than encouraging a transition to low carbon technologies, the uncertain policy framework, unilateral burdens on UK producers, and unrealistically short timeframes for support packages, are having a corrosive impact on the investment climate and long term viability of these businesses in the UK. In particular, they are stifling innovation and making offshoring of new investment a more attractive proposition to multi-national parent companies.The ultimate conclusions and recommendations arising from this case study complement those from the other case studies and are reflected in Section 9 of this report.

7.2 The UK mineral products industry, energy use and emissions

The mineral products industry, comprising aggregates, asphalt, cement, precast concrete, ready-mixed concrete, mortar, dimension stone, silica sand and industrial and agricultural lime, is a key enabling sector for the UK economy as a whole, and in particular for construction. It accounts for 42 Mineral Products Association43 http://www.4-traders.com/news/CEMBUREAU--calls-for-cement-sector-to-maintain-carbon-leakage-status--17434318/ accessed December 2013

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over £4 billion of gross value added (GVA) each year and employs 70,000 people, with a further 2.5 million people employed in consuming sectors44.Cement and lime are the most energy intensive mineral product sectors, and the focus for this case study. In the cement sector, electricity costs equate to more than 24% of business GVA (in real 2007 prices), and total energy costs for approximately 38%. In the lime sector, these numbers are 15% and 72% respectively.These industries have taken significant steps to reduce energy use and emissions. The UK cement sector has replaced part of its traditional fuel sources with biomass and waste, with alternative fuels accounting for approximately 40% of its fuel requirements in 2012. In addition, direct emissions of CO2 have been reduced from 924 kg/tonne of cement in 1998 to 730 kg/tonne of cement in 2012 and, since 1990, absolute emissions reductions of 55% have been achieved, largely as a result of investment in more efficient plant, industry rationalisation, and replacing fossil fuels with waste derived biomass fuels. This achievement is all the more remarkable given that 60% of carbon emissions associated with cement manufacturing arise from the chemistry of the process itself. That is, carbon dioxide is released as a natural by-product from the chemical alteration of the limestone feedstock. In the lime sector this value rises to 80%. It is important to note that these entirely unavoidable carbon emissions contribute to the carbon footprint of the industry which in turn is used in the calculation of, for example, obligations under the European Emissions Trading Scheme (EU ETS) and the Climate Change Levy (CCL).Consultations with the MPA suggest that opportunities to drive further emissions abatement in cement and lime production are extremely limited without significant government intervention in support of technology development and commercialisation. In 2009, the International Energy Agency (IEA) and the WBCSD together developed a cement industry technology roadmap. It outlines existing and potential technologies, and how they may help the industry halve CO2 emissions.45 Based on this, the MPA has defined emissions reduction scenarios for the UK of between 62% and 81% by 2050 relative to 1990. An 81% reduction is, however, dependent upon carbon capture and storage technology being commercially available to the cement industry and deployed at scale. Both scenarios also require significant investment in alternative waste derived fuels, including biomass fuels, and low carbon clinker.

7.3 Energy and environmental policies and their impact on operational costs

Both the cement and lime sectors have been badly hit by the recent economic downturn. In 2012, for example, total cement production in Europe fell by 40% when compared to pre-crisis levels, and the return on capital employed remains well below the cost of capital for the industry.46 In common with the steel and ceramics sectors profiled in previous case studies, there are now concerns that the viability of these sectors in the UK is being undermined by energy and environmental policy which will result in carbon leakage and significant loss of value.The MPA recently published its assessment of the cumulative impact of the energy and environmental policy mechanisms, described in Section 4, on its members47. This showed that these measures add costs equivalent to 15% of the GVA of the cement industry today. Costs are likely to increase from a current €51m to more than €250m in 2020, equivalent to 73% of GVA, in particular if EU ETS CO2 carbon leakage status is lost. See Figure 19 below.

44 Mineral Products Association45 Cement technology roadmap 2009 carbon emissions reductions up to 2050; IEA46 http://www.4-traders.com/news/CEMBUREAU--calls-for-cement-sector-to-maintain-carbon-leakage-status--17434318/ accessed December 201347 Minerals Products Association (Undated) The Cumulative Impact of Environmental and Planning related Taxation & Regulation. A preliminary and indicative assessment from the Mineral Products sector.

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Figure 19: Cumulative Burden of Policies on the UK Cement Sector

The equivalent figures for the lime sector are shown in Figure 20. The cumulative cost of energy and environmental policy mechanisms are estimated to be €8.4m today, equivalent to 19% of sector GVA, and are forecast to rise to approximately €50m in 2020, equivalent to 117% of GVA48.

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Figure 20: Cumulative Burden of Policies on the UK Lime Sector

48 Mineral Products Association

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A key issue for the cement and lime sectors is their vulnerability to carbon leakage and, as the UK transitions to a low carbon economy, the competitiveness of UK manufacturing needs to be maintained against countries which do not carry the same cost of carbon. The Commission 2030 package has included announcements to the effect that carbon leakage status will be retained but it is not yet certain. The Commission has until the end of 2014 to finalise its position. Even if cement and lime stay on the list, the risk appears again in 2019 when it is reviewed once more.

7.4 Proposed government support packages49

The indirect costs of the EU ETS are those costs faced by electricity generators and passed through to their customers in electricity prices (see Section 4). In the cement sector in 2013, these costs are estimated to be €11.6m, rising to €19.4m in 2020 in the UK, whilst the indirect cost of EU ETS to the lime sector in 2013 is estimated at €1.1m rising to €1.9m in 2020. However, as a consequence of the sector eligibility test being conducted at EU level, neither sector eligible to receive compensation for the indirect costs of EU ETS. At UK level both sectors would be eligible, indicating the very high impact of these indirect costs on UK-based companies.The indirect cost of Carbon Price Support (CPS) to the cement sector is estimated at €4.3m in 2013, €8.4m in 2014 and continuing to rise steeply to €21.7m in 2020. The MPA has submitted data to the Department of Business Innovation and Skills (BIS) showing that both sectors exceed the 5% GVA cost impact threshold for sectors eligible to receive compensation for CPS. BIS determined that the evidence submitted by the cement sector was sufficient to apply to the European Commission for EU state aid approval for compensation. However, there is no certainty that EU state aid approval will be granted.If deemed eligible for CPS compensation, the cement sector will receive €0 compensation in 2013 (unless the rules are changed on backdating compensation) and at most €7.4m in 2014 depending on whether the compensation scheme has to be tied to the requirements of compensation for indirect EU ETS. These requirements could include reducing the compensation by an electricity efficiency benchmark. The compensation is currently only available until the end of the current spending review period i.e. until April 2015. Therefore it is possible that no compensation will be received from 2015 onwards. If the cement sector receives relief from the CPF then it should also be eligible for exemption from costs arising from Contracts for Difference (CfD), with an estimated maximum value to cement of €4.1m in 2014 and €8.2m annually from 2014 onwards if the full cost is compensated.The indirect cost of EU ETS to the lime sector in 2013 is estimated at €1.1m rising to €1.9m in 2020. The indirect cost of CPS to the lime sector is estimated at €427K in 2013, €825K in 2014 and rising steeply to €2.1m in 2020. Similarly, if the lime sector is eligible for CPS financial support it will receive €0 compensation in 2013 (unless the rules are changed on backdating compensation) and €993K in 2014, with nothing guaranteed beyond April 2015.Should the lime sector be eligible for CPS support then it should also be eligible for exemption from the costs of CfD. This has an estimated maximum value to lime of €404K in 2014 and then €809k from 2014 onwards if the full cost is compensated.It should be noted that the focus of these support packages is directed primarily towards electricity consumption. Both the cement and lime sectors are electro-intensive as well as energy intensive due to the significant energy required to grind and move hard and heavy materials.

7.5 Mineral products sectors and carbon leakage

There is broad consensus that the cement and lime industries are particularly exposed to carbon leakage, as indicated in Figure 21 below. The cement industry qualified as a sector exposed to carbon leakage under the EU ETS risk review undertaken in 2009. Industry analysis suggests that these risks have since increased50.

49 All numbers provided by the Mineral Products Association50 http://www.cembureau.eu/cement-industry-exposed-carbon-leakage-regardless-assessment-method-used-and-relevant-product-level accessed December 2013

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Figure 21: Sub-sectors potentially exposed under unilateral CO2 pricing51

Cement manufacturing involves the production of clinker in high temperature kilns. This is then ground with other minerals to produce the powder that we know as cement. Clinker and cement are both subject to international competition with approximately 13% of British cement consumption supplied by imports in 2012. A study undertaken by the Boston Consulting Group for CEMBUREAU in 2008 examined the sensitivity of clinker production to overseas imports, taking into account the effects of carbon pricing and inland transport costs from the main UK ports. It found that 100% of clinker production in the UK is at risk if the CO2 price rises to €24/tonne (see Figure 22).

Figure 22: Isolines of cement clinker production at risk for different CO2 prices52

The lime sector, which is exposed to greater trade intensity than the cement sector, is subject to additional risks in its supply chain. The primary consuming sectors for lime include other energy intensive industries such as iron and steel, glass, paper, pharmaceutical and chemicals which are themselves facing financial pressures from the regulatory and policy framework.51 Climate Strategies (2008). Differentiation and Dynamics of the EU ETS: Industrial Competitiveness Impacts by J.C. Hourcade, D. Demailly, K. Neuhoff and M. Sato52 Assessment of the impact of the 2013-2020 ETS proposal on the European Cement Industry, Boston Consulting Group, November 2008

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Any loss of UK manufacture to other jurisdictions will almost inevitably result in an increase in emissions, given the increase in transport that would be associated with lime imports, and the fact that there is little scope to reduce emissions from the manufacturing process itself.

7.6 Energy and environmental policies and their impact on investment

An underlying aim of energy and environmental policy mechanisms is to encourage and incentivise energy intensive sectors in their transition to a low carbon economy. An implicit assumption within this regime is that businesses will invest in low carbon technologies because they will see a return on investment within acceptable payback periods relative to the direct and indirect costs of carbon taxes and the continuing use of energy-intensive technologies.There is however a dis-connect between the known short lifetime of policy and support mechanisms and the long term investment periods of major capital projects. The cement and lime sectors both comprise capital-intensive businesses with multi-decade investment cycles. Portland cement kilns have a typical lifespan of 35-40 years and are generally sited near to quarries with 50-60 years-worth of limestone. Lime kilns are similarly long-lived. As an example, in 2004 Tarmac invested £110 million in a new kiln at its Tunstead site at Buxton which replaced a kiln that was installed in 1965. Estimated costs for a second kiln at the Tunstead site are in the region of £200m53.Capital and energy intensive industries, such as cement and lime, need a stable legal and policy framework and consistent support mechanisms upon which to make long-term, large scale capital investment decisions. Evolving EU and UK energy and environmental policies create uncertainty and risk, as shown in Figure 23, which in turn is reflected in higher hurdle rates for investment. These uncertainties add to the risk faced by UK investors relative to their EU and international counterparts, and are additive to the normal commercial and technical risk associated with a new capital investment.Any business considering investment in Europe today will face the following EU ETS policy-related uncertainties and risks:

An increasing over-supply of ETS allowances and credits, combined with low market demand following the global economic downturn, have prompted the EU to propose amendments to the timetable governing the release of new allowances during Phase III of the ETS. In particular, there are proposals to ‘back-load’, or delay, the scheduled auctioning of new allowances into the Phase III market.

Back-loading will partly address the anticipated imbalance between supply and demand in the Phase III market. It will not, however, be sufficient to recalibrate the estimated structural surplus of 2 billion Phase II allowances which will continue to distort the market. Further Phase III structural changes have been discussed, as has increasing the EU emissions reduction target in 2020. In January 2014, the introduction of a Market Stability Reserve was announced from 2021 onwards in order to address this challenge in the longer term (see Section 4).

Any business considering investment in new or substantially expanded capacity faces further risk related to the environmental permitting regime and the ETS New Entrants Reserve. The latter point is highly significant because allowances under the New Entrants Reserve cannot be applied for until a new plant is commissioned. If there are allowances left, the number received is based on the first 90 days of operation. Under the current arrangements for new entrant allowances, failure to achieve optimal operating capacity during the first few months of commissioning, even if these problems are ultimately resolved a short time after the 90 day threshold, will result in a lower allowance allocation. This could make the newest most carbon efficient plant uncompetitive in the market.

The list of sectors eligible for carbon leakage status is under regular 5-year review and an updated list will be published in 2014. The Commission announced in January 2014 that the carbon leakage review would be based on the same criteria (including a carbon price of €30) that were previously used in the 2009 review. This makes it more likely that both cement and lime will remain on the list of sectors vulnerable to carbon leakage but beyond 2020 there is no guaranteed protection from carbon leakage.

53 Derby County Council Planning application 2011

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New plant cannot rely on the decommissioning of old plant or industry rationalisation. Plants are required to run at 50% of their activity level in order to receive 100% of their allowance allocation. This promotes the continued use of less efficient plant, and there is no rule for moving production to more efficient plant.

Beyond 2020 the political landscape is very uncertain; there could be major structural reforms to the EU ETS in Phase IV and there is no sign of an international agreement which could level the playing field with competitors outside the EU.

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Figure 23: Policy uncertainly and risk faced by UK capital investment

UK cement and lime producers are further impacted by uncertainty surrounding the eligibility criteria, scale and durability of UK-specific policies and support packages. For example:

The details of the Carbon Price Floor compensation scheme, which remains subject to state aid approval from the European Commission, have yet to be published. However in the consultation process, the government has proposed adopting the same criteria for determining eligibility as used for the EU ETS compensation scheme. The Government has agreed to apply to the Commission for state aid approval to extend eligibility to sectors not on the EU approved list. In order to be included in this extended list, sectors and companies must provide ‘firm evidence’ that the EU ETS and CPS-related costs amount to 5% or more of their GVA, and that their products are ‘significantly traded within or beyond Europe or that imports would become more economically viable as a result of increased carbon costs’. These eligibility criteria are already giving rise to disagreements between producers and regulators, for example in relation to the calculation of GVA, and there is no guarantee the Commission will grant state aid approval to this extended list of sectors, which includes the cement sector.

Similarly, in relation to eligibility criteria for exemption from CfDs tariffs, the Government has proposed using the same eligibility criteria as those proposed for the EU ETS and CPS

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compensation schemes. As such, eligible businesses would need to operate in specified sectors and be able to demonstrate that cost impact will amount to 5% of gross value added (GVA).

The impact of policy measures are judged separately according to the Commission’s guidelines so the cumulative impacts of unilateral UK policies are not considered.

In order to comply with EU rules on state aid, UK support packages would have to involve, amongst other things, either an energy efficiency benchmark, a requirement for all beneficiaries to have signed Climate Change type agreements, or payment of at least 20 % of the costs they are being exempted from.

Once these compensation schemes are defined, their persistence beyond 2015 are not guaranteed.

The Chancellor of the Exchequer made a recent welcome commitment to preserving CCL reduction rates for CCA members to 2023, in specific recognition of the long time-horizons for investment.

7.7 Conclusions

UK energy and environmental policy is adding significant cost to cement and lime manufacture relative to both EU counterparts and international competition. This is distorting the economics of supply against UK companies and is encouraging carbon leakage.These operational costs, and uncertainty surrounding energy and environmental policies are also having an adverse impact on capital investment decisions in the UK. While some of this policy uncertainty is shared with other EU cement and lime manufacturers, additional UK-specific regulatory and tax burdens are compounding this problem in the UK.Far from encouraging investment in new energy-efficient plant and promoting a transition to a low carbon economy, there is mounting evidence to suggest that the cumulative effects of the UK’s energy policy framework are having a corrosive impact on the investment climate and long term viability of cement and lime sectors in the UK. Specifically, they are stifling investment and innovation, exposing businesses to increased trade intensity from overseas geographies, and accelerating carbon leakage.According to Dr Martyn Kenny54, Sustainability Director at Lafarge Tarmac, “Cement and lime manufacture are capital intensive operations with long pay back periods. Lafarge Tarmac’s investors must choose between investing in UK manufacturing of importing. When assessing investment risk and return, EU and UK policy uncertainty and uncompetitive energy prices can drive energy intensive manufacturing investment out of the UK, impacting on the UK Government’s growth ambitions and UK jobs.”Proposed EU ETS, CPS and CfD support packages and their eligibility are still to be fully defined. However, based on what is known, they will be inadequate in scale or duration to overcome the adverse impact of policy measures on both operational costs and on the propensity to invest in the UK relative to other jurisdictionsThese conclusions complement those from the other case studies and the resulting recommendations are reflected in Section 9 of this report.

54 Statement from Dr Kenny to authors of this report.

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8 Paper sector case study

8.1 Introduction

Half of all paper making sites now make use of Combined Heat and Power (CHP) units on site, the focus of this case study in the paper industry. CHP offers the potential for significant emissions abatement. Around 6% of the UK’s power needs are currently met by industrial CHP installations resulting in 15 million tonnes of carbon emissions abatement per year. Vast untapped potential remains. In a recent study for DECC, Ricardo-AEA calculated that just a third of cost effective CHP opportunities have been exploited.Yet investment in CHP has stalled, in part due to unfavourable market price differentials between gas and electricity, and in part due to energy and environmental policy changes. .This case study at Northwood and WEPA examines these policy changes, which include the removal of CHP climate change levy exemption certificates (LECs), and the introduction of CPS costs on the fuel used to generate electricity in CHP plant. Their impact is illustrated by a specific example from the paper industry.Northwood and WEPA, the UK’s third largest manufacturer of private label, toilet tissue and kitchen towel. It operates a modern paper mill and converting operations at Bridgend in South Wales, heat and powered in part by a CHP plantThe conclusions and recommendations from this case study complement those from the other case studies and are reflected in Section 9 of this report.

8.2 The CHP opportunity

Combined heat and power (CHP) offers the potential for significant emissions abatement, in particular on large industrial sites that consume substantial quantities of heat. CHP plant integrate the production of usable heat and electricity, into one single, highly efficient process, so reducing fuel use and emissions by up to 30%55. In 2011, the TUC and EIUG commissioned a report from the Centre for Low Carbon Futures56 that explored the low carbon technology solutions needed to deliver emissions abatement and secure energy intensive industries in the UK. This found that increased use of CHP was critical to realising reduced carbon emissions objectives, along with the use of biofuels and carbon capture and storage (CCS).Approximately 6% of the UK’s power needs are currently met by industrial CHP installations, resulting in 15 million tonnes of carbon emissions abatement per year57, and a reduction in gas imports of about 2%, providing a net balance of payments benefit of £165m.58 39% of UK CHP is used in refining and 29 % in chemicals industries.59 CHP is also used in other heat intensive sectors, including paper, ceramics and food and drink. At least 33% of chemicals, 50% of paper, 10% of food and drink, and 80% of refining companies utilise CHP. In total, there are approximately 130,000 people employed on sites using CHP. CHP can be sizeable. As an example, the Immingham CHP plant, supplying two refineries in Humberside with heat, steam and power, was expanded in late 2009 to reach the same electricity generating capacity as the UK's flagship nuclear power station, Sizewell B.Vast untapped potential remains. In a recent study for DECC, Ricardo-AEA calculated the technical potential of CHP at 29.4GWe in 2012 rising to 31.8GWe in 2020 and 33.8GWe in 203060. The current capacity of approximately 6.1GWe represents 21% of technical potential. The same study

55 The Future of heating: Meeting the challenge, DECC, March 201356 Technology Innovation for Energy Intensive Industry in the UK, July 201157 DUKES, DECC, June 201358 CHPA analysis59 Digest of UK Energy Statistics (DUKES), DECC, June 201360 Projections of CHP capacity and use to 2030, Ricardo-AEA /R/ED56126 Issue Number 1.2 Date 20/03/2013

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found that the cost effective potential, based on a discount rate of 15% pre-tax over 10 years, was 18.1GWe (57% of technical potential) in 2020, rising to 20.1GWe (60% of technical potential) in 2030.Investment in CHP in recent years has slowed, and growth projections to 2030 are modest (see Table 4 below). In part this reflects unfavourable market price differentials between gas and electricity, in which it is more economical to import electricity from the grid than invest in CHP. However, it also reflects changes in policy as outlined below.Capacity, GW 2010 2015 2020 2025 2030 October 2012 projection 6.1 8.1 8.6 - - September 2013 projection 6.0 7.7 8.4 9.2 8.8 Table 4: Updated projection of installed capacity of renewables and gas CHP61

8.3 Energy and environmental policy and CHP

For most major industrial users, CHP represents the single biggest investment needed to realise a step-change improvement in energy efficiency. However, the balance of cost and risk is weighed against investment.CHP plant are capital intensive (approximately £1 million per MW rising to £1.4m for plant below 50MW in size), requiring lengthy periods of investment return (typically 15 to 20 years). The economics are defined by the cost of the principal combustion fuel, primarily gas, relative to the value of heat and electricity generated. The price volatility of the primary combustion fuel and that of the produced electricity impacts directly on the viability of the project. There is also a need to factor in significant maintenance costs. A turbine typically requires refurbishment after 32,000 hours of operation. These costs alone amount to approximately 30% of the initial CHP plant cost. In addition, new CHP plant are often located in areas where the electricity grid is constrained, so increasing project costs and complexity.Industrial CHP plant are typically designed to meet a heat demand, with excess electricity sold to the grid. The electricity market interaction is a secondary activity for CHP operators and is viewed as inherently risky. Where a third party develops the CHP plant for an industrial user, not only does the developer need to secure long-term power purchase agreements (PPAs), but it also needs to ensure that it has long-term heat supply contracts in place with credit-worthy customers. As a result, CHP is typically required to deliver higher investment return rates than conventional combined cycle gas turbines (CCGTs) in order to secure financing.Whilst CHP is more efficient that conventional heat and power generation, incentives are generally needed in order to overcome these practical barriers to deploymentCHP is seen by most analysts as important to realising near term industrial emissions abatement objectives. Until recently, the government sought to encourage investment in CHP for both carbon emissions abatement and diversification of electricity supply purposes.However, in Budget 2011 the Government announced plans to remove CHP Levy Exemption Certificates (LECs) from the market, thus removing from April 2013 a key financial incentive to invest in industrial CHP. The Treasury’s rationale was that the LECs were complex to administer and costly to the taxpayer. The government indicated its intention to revisit CHP incentives for existing plant, but has yet to do so. The imposition of the CPF in April 2013 has further eroded the economic rationale for CHP. According to the CHPA, taxes faced by industrial CHP plant have risen by £158 million in 2013.62 This increase is up to three times greater than the increase for conventional gas power stations. This is a consequence of the fact that the CPS is based on total fuel consumed in the power station to produce electricity and, as a CHP plant uses extra fuel to deliver the same amount of power as a

61 Updated energy and emissions projections 2013, DECC, September 2013 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/239937/uep_2013.pdf62 Less waste, more jobs and growth; CHPA, 2013 http://www.chpa.co.uk/

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CCGT, it faces a higher tax burden. The tax burden for CHP plant is also expected to grow, with industrial sites using CHP seeing £262 million in tax by 2015. These changes not only erode the incentive to invest in CHP, but impose charges on existing plant, so undermining investor confidence. E.ON UK director of strategy and regulation, Sara Vaughan, has gone on record to say that “[LEC removal] is a huge issue … It is giving us a financial penalty on an investment that we have already made. That sort of thing does not give you much encouragement to take further investments.” CHPA are able to cite a number of further examples of the detrimental effect of these policies, including instances where the introduction of CPS and removal of LEC have led to non-profitable operations and proposals to shut plant.

8.4 The UK paper industry and CHP: Northwood and WEPA

The UK paper industry has suffered a steep decline. Between 2000 and 2010, half of the UK’s paper mills closed, with the loss of thousands of jobs. Production fell by over a third and the UK now imports twice as much paper as it produces.63

This decline has been halted in recent years, in part due to the construction of two new paper mills and in part due to significant investment in energy efficiency, including CHP. Between 1990 and 2010 UK paper industry energy use was reduced by 34% per tonne of product and total emissions by 42%, equivalent to 1.6m tonnes of carbon per annum. These efficiencies come, in part, from investment in new plant. However, larger and more complex mills have also invested significant sums of money in generating their own heat and electricity in CHP plant. Half of all paper making sites now make use of CHP. Together they account for 7% of the total UK installed CHP electrical capacity. An increasing number of mills also make use of waste materials to fuel their CHP plant. Northwood and WEPA is the UK’s third largest manufacturer of private label, toilet tissue and kitchen towel. It operates a modern paper mill and converting operations at Bridgend in South Wales, heat and powered in part by a CHP plant.The CHP plant, installed in 1995, was originally owned and operated by an independent developer, RWE Cogen. It consisted of two gas turbines and two waste gas recovery boilers to generate steam. Georgia Pacific, the previous owner of the Bridgend paper mill, purchased the plant from RWE Cogen in July 2009, and it is now in the ownership of Northwood and WEPA. The turbines have operated for a majority of the time since installation in 1995.In 2001, the then Chancellor introduced CCL exemption for Good Quality CHP. Good quality CHP refers to CHP generation that is energy efficient, as determined by the CHP Quality Assurance programme (CHPQA).Subsequent interpretation of the EU Cogeneration Directive in 2004, altered the basis on which good quality CHP was defined in the UK, in order that CHPQA could comply with the higher efficiency and increased heat bias specified in the Directive. In effect this moved the goal posts and penalised companies such as Northwood and WEPA that had taken the brave step of installing CHP, by altering the level of CCL exemption.In common with most CHP plant of equivalent age, the Northwood and WEPA plant is now deemed to fall slightly below the 100% Good Quality CHP threshold. As such, the company pays CCL on a small proportion of fuel used.Until recently, all electricity produced by CHP plant was exempt from CCL. The removal of LECs in 2013 meant that power sold to utilities, as opposed to being used in direct operations, is subject to CCL. The Northwood and WEPA plant, in common with most industrial CHP is heat led. Were it not for their ability to balance electricity supply and demand within the mill, this would result in additional costs. Most other CHP operations are less fortunate than Northwood and WEPA in this regard.The introduction of CPS for fuel used to generate electricity in CHP plant has added significant further burden to Northwood and WEPA’s energy costs in 2014. These policy changes and their

63 Confederation of paper industries (CPI)

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impacts are illustrated in Figure 24 below, with the arrows shown in orange reflecting inputs or outputs subject to CCL or CPS. The combined effect of these policy changes substantially impacts upon existing CHP plant but more importantly, undermines reinvestment economics in the CHP plant. Furthermore, regular and sizeable policy changes that impact upon investment returns add risk and discourage investment in new CHP capacity, similar to that outlined in the case study in Section 7.

Good Quality CHP

Fuel

Fuel

Electricity

Heat

Heat

TFI - QFI

QFI

TPO

Good Quality CHP

Fuel Electricity

Fuel Electricity

Heat

Heat

TFI - QFI

QFI

TPO - QPO

QPO

Good Quality CHP

Fuel Electricity

FuelElectricity

Heat

Heat

TFI - QFI

QFI/E

TPO - QPO

QPO

Previous Arrangement:• Fuel for Good Quality CHP (QFI) exempt

from CCL• Remaining fuel input (TFI-QFI) is subject to

CCL• Power output exempt from CCL (QPO)

Removal of LECs:• Fuel for Good Quality CHP (QFI) exempt

from CCL• Remaining fuel input (TFI-QFI) is subject to

CCL• Qualifying power (QPO) for directly

supplied electricity exempt from CCL• Power supplied to electricity utility subject

to CCL (TPO-QPO)

I ntroduction of CPF:• Fuel used for Heat element of Good Quality

CHP (QFI/H) exempt from CCL and CPS• Fuel used for Electricity element of Good

Quality CHP (QFI/E) subject to CPS• Remaining fuel input (TFI-QFI) is subject to

CCL and CPS• Qualifying power (QPO) for directly

supplied electricity exempt from CCL• Power supplied to electricity utility subject

to CCL (TPO-QPO)

Fuel

QFI/H

Key:QFI: Quality CHP fuel inputQFI/H: Quality CHP fuel input for heatQFI/E: Quality CHP fuel input for electricity

Input or output subject to CCL or CPS

TFI: Total fuel inputQPO: Directly supplied power outputTPO: Total power output

Figure 24: Recent policy impacts on CHP plants

8.5 Conclusions and recommendations

The Confederation of Paper Industries, in common with other energy intensive industry affiliated organisations, has expressed significant concern that the cumulative effect of energy and

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environmental policy measures, including the removal of CHP LECs and CPF, is undermining the sector and that it will result in another period of significant decline and ‘offshoring of emissions64.CHP offers a significant opportunity to enhance UK industrial energy efficiency, reduce emissions, and diversify electricity generation capacity. Recent policy changes have undermined new investment prospects and disadvantaged existing installations.DECC has acknowledged the need for a new policy mechanism if gas CHP is to realise its potential, and the CHPA is working with the government in this area. Options include promoting CHP through investment grants or heat incentives. However, this support will be limited to new CHP capacity. A more immediate intervention is needed on behalf of existing generators to compensate for the loss of LECs.The CHPA has proposed exempting CHP from the CPS costs that it incurs on fuel used to generate electricity. Their analysis, produced for HM Treasury, shows that relief on fuel used to generate electricity from CPS begins to return the LEC value to CHP operators. This is illustrated in internal rates of return (IRR) of the three real-world case studies given in Source: CHPA..

Project Elec. Export Relief from CPS BenefitZero 100% 100%

60MWe Combined 45% 11% 15.8% 4.8% 10MWe Simple 10% 10.3% 16.8% 6.5% +100MWe Combined 33% 8.3% 16.4% 8.1% Source: CHPA.

Table 5: Impact of relief from CPS on fuel used to make electricity on project IRR65

The manufacturer’s organisation, EEF, and numerous other industry bodies including the CBI, CIA, FDF, PIA, and CPI have all called on the government to make investment in CHP more attractive, and in particular to provide relief from the CPS on fuel used to make electricity. The TUC and EIUG endorse this recommendation.These conclusions and recommendations complement those from the other case studies and are reflected in Section 9 of this report.

64 http://www.paper.org.uk/aboutcpi/communication/mps/MPs%20Briefing%20January%202014.pdf65 CHPA analysis

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9 Walking the Carbon tightrope: conclusions and recommendations9.1 Conclusions

Energy intensive industries are the bedrock of the UK manufacturing sector. They are vital to our successful transition to a low carbon economy, providing some 160,000 jobs directly and four times this number in their supply chains. However, they face extraordinary pressures in coping with the cumulative impact of climate change and energy policies. Our case studies suggest that energy intensive industries are walking a tightrope from a high to a low carbon economy. Government policy should, we argue, enable the transition rather than add to its perils.This report has examined through four detailed industry case studies the current impact of government policies. Significant changes in policy direction are required to support these vital industries to secure their just transition in a low carbon economy.The TUC is committed to the realisation of a low carbon economy, securing our industrial base and to the creation of new low carbon industries. However, it believes that this cannot be achieved without sustaining energy-efficient EIIs in the UK.The hard evidence from these four case studies suggests that well-intentioned energy and environmental policies, and inadequate support packages, are adding significant cost to UK manufacture relative to both EU counterparts and international competition. This is distorting the economics of supply against UK companies:

Steelmaker Celsa has shared insights from their European operations that show that its UK plant is one of the most energy and labour efficient in Europe, but that it faces the highest electricity prices within the Group, in part due to the Carbon Price Floor and Renewables Obligation. This is undermining the long-term prospects of this highly efficient, low carbon business and adding unnecessary pressure to reduce labour costs. Details of energy prices paid by the largest energy intensive companies are generally not in the public domain.

The most electro-intensive ceramics companies have already relocated away from the UK due to high electricity costs. Recent trade data suggests that heavy clay sectors, such as clay roof tiles and bricks, which have previously been less exposed to carbon leakage are now seeing significant increases in imports.

The mineral products cement and lime sectors, in common with steel, heavy clay ceramics and most other EIIs, are capital intensive operating on long investment cycles. There is evidence that policy uncertainty and support mechanisms that extend no further that the current Treasury spending review period in 2015 are adding risk and discouraging investment.

Uncertainty, unilateral burdens on UK producers, and unrealistically short term relief packages are corroding the investment climate and long term viability of these businesses. In particular, they are stifling innovation and making offshoring of new investment a more attractive proposition to multi-national parent companies.

Support packages are inadequate in scope. As an example, although some ceramics firms are the most electro-intensive in Europe, about 85% of energy demand across the ceramics sector as a whole is supplied by gas. As eligibility for support is currently defined at a sector-wide level, these highly vulnerable installations are denied access to key parts of the EU ETS and Carbon Price Floor support packages. Furthermore, using policy impacts as a proportion of Gross Value Added (GVA) in order to determine eligibility for support, discriminates very heavily against companies and sectors that are more labour-intensive, creating further unintended distortions.

Policy changes on CHP have undermined incentives to deploy an effective and proven means of industrial carbon emissions abatement.

9.2 Recommendations

Government policy should, we argue, enable the low carbon transition rather than add to its perils.

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Government, industry, Trades Unions and trade associations are aligned in terms of overall objectives of delivering a low carbon future that is affordable to both industrial and domestic consumers. However the challenge is putting this into practice, in ‘walking the carbon tightrope’ between creating the right environment to encourage investment in decarbonising energy supply, and sustaining energy intensive industries in the UK. Both are needed in order to deliver our low carbon future.The UK’s heavy energy industries are generally mature, making use of similar manufacturing processes and technologies across all countries. The primary routes to emissions reductions include investing in the most up-to-date plant, deploying cross-sector emissions abatement solutions such as Combined Heat and Power and carbon capture and storage (CCS) technology, and minimising unnecessary transport of goods. The responsible approach is therefore to ensure that UK heavy industries:

Remain in the UK and do not succumb to leakage of jobs, investment and emissions. Deploy the most carbon-efficient processes available to them. Invest in innovation to reduce the environmental impact of their activities. Have available proven and commercially viable cross-sector solutions such as CHP and

CCS. Retain and develop highly skilled, well paid jobs in the UK.

Most EIIs supply commoditised products to internationally competitive and price-sensitive markets, and are highly capital-intensive, dependent upon long term fiscal and regulatory stability in order to attract investment. Many are multi-national concerns, with inter-company competition for capital and operational investment. Given the above, Government policies need to:

Ensure that energy prices faced by all levels of UK industry, and in particular EIIs, are no higher than competitor nations in Europe and the rest of the World at all times

Shift policy from penalising energy intensive industries to encouraging investment in energy efficiency

Deliver a long-term stable environment that encourages industry to invest in new plant, innovation and emissions abatement, just as the Government is endeavouring to do for nuclear and renewable energy sectors. Government policy should respect the fact that investment cycles for EII can be several decades in length

Facilitate the development and encourage deployment of cross-sector carbon emissions abatement solutions such as CHP and CCS.

Given the insights gained from these case studies, we believe that there is a need for a fundamental re-think of Government policies. Current policies are having perverse and unintended consequence of undermining investment in UK industry and having a long term corrosive impact on competitiveness, so favouring imports and manufacturing in other jurisdictions, with the resultant carbon leakage.The evidence from these case studies would support near-term measures to limit the adverse impact of energy and environmental policies on EIIs, whilst longer-term measures are considered. To enable the transition of heavy industry to a low carbon future, we would recommend that the government should:

Freeze the CPF at its current level. The near doubling of CPS rates in 2014 and in 2015 is unaffordable, and in the absence of State Aid approval for a long-term durable compensation package, risks causing significant damage to the competitiveness of UK electro-intensive industries. If state aid approval cannot be secured, CPF should be abandoned

Extend and widen the scope of proposed compensation packages for electro-intensive installations. Eligibility for compensation should be determined at a company, rather than a sector-wide level; and the duration of these measures should reflect the length of the policy impacts that they are intended to mitigate and the investment cycles of the industries concerned

Consult with industry on relief from the Renewables Obligation (RO), the main support mechanism for larger scale renewable electricity projects in the UK, which also has a

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considerable impact on industries’ costs. Subject to this, extend the scope of proposed compensation packages to include RO costs.

Exempt CHP from the CPS costs that it incurs on fuel used to generate electricity. Given the need for significant investment in electricity generation, and the proven efficiency benefits of CHP, industrial CHP should be encouraged. Exempting CHP from CPS will compensate for the recent removal of LECs.

Reduce complexity and risk by simplifying rationalising UK policies, including CPF, RO, CFD FITs, CRC, and CCL into a single policy mechanism and support package.

Create a well-funded programme to support industrial energy efficiency and low carbon solutions, with incentives for investment. The current reliance on driving energy efficiency and carbon reduction through higher energy prices risks carbon leakage if undertaken unilaterally in the UK.

Create a high level Energy Intensive Industries Council, with representation from industry, trade unions and government, tasked with developing comprehensive long-term industrial strategy to secure jobs, growth and the low carbon transition.

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Walking the carbon tightrope

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