Delivering low carbon investment A Working Group 4 Study, December 2009

Transcription

1 Delivering low carbon investment A Working Group 4 Study, December 2009 DISCLAIMER This report is based on discussions within the subgroup and, as such, is intended to represent a broad consensus of the subgroup. This does not imply that each individual sub-group member (or the companies by whom they are employed) subscribes to every element of the text or that the text has been endorsed by the ETG as a whole. Conclusions A sub-group of ETG WG4 was set up to discuss delivery of low carbon investment following discussions within a number of the ETG fora. The group agreed that the ETS cap could deliver the desired environmental outcomes up to There were differing views within the group as to whether the ETS would deliver timely low carbon investment. The group agreed that there was not alignment between the purpose of the EU ETS and proposed Member State policy goals. The majority of members stated that this was particularly apparent in the electricity sector where UK Government stated ambitions to decarbonise the economy, through investment in low carbon technology, will not be solely delivered by the current EU ETS. The Group also noted that sector specific issues should be dealt with by sector specific approaches. Early consultation is required with industry should Government propose to take forward any new policy initiatives to deliver low carbon investment, particularly if proposals affect the EU ETS. Working Group Membership Bryan Bateman (Confederation of Paper Industries) David Cathie (Scottish Power) Daniel Radov (Nera) Denise Smillie (Scottish Power) Edward Craft (Nabarro) Ian McPherson (UK Petroleum Industries Association) Jonathan Grant (Price Waterhouse Coopers) Murray Birt (Confederation of British Industries) Neil Smith (EON UK) Niall Riddell (EDF Energy) (Chair) Penny Tomlinson (RWE npower) Ravi Baga (EDF Energy) Robert Husher (Drax Power) Sarah Owen (Centrica) Tanya Morison (Shell) Tom Bainbridge (Nabarro) (I) Introduction 1 At a WG4 meeting in early October Price Waterhouse Coopers presented a paper on Carbon Tax vs Carbon Trading which prompted some discussion on delivery of low carbon investment. Subsequently WG4 members agreed to convene a sub-group to discuss low carbon investment. 1 December 2009

2 2 There were a variety of differing views within the group as to the effectiveness of the ETS in delivering low carbon investment. Instead, the work of the WG4 subgroup focused on the pros and cons of price support mechanisms to deliver low carbon investment. 3 To achieve this a discussion was held focusing around the following questions: The ETS is designed to deliver a cap. Does it have a role in delivering new long term investment? What does an investor in low carbon require to make a decision? What timescales are required? Phase 3 or Phase 4 or both? What alternative support mechanisms are possible, including looking at a floor price; contracts, government support mechanisms, etc and how would they work in practice? Can they be implemented by the UK alone or only with EU involvement? What are the respective merits of different instruments over the required timescales (specifically do alternative support mechanisms provide any greater regulatory certainty/credibility than setting out the long-term emissions cap/trajectory)? Do alternative support mechanisms need to be integral to the ETS or can they supplementary and what are the implications? 4 The following steps were carried out: a) A sub-group membership was established b) A teleconference workshop was held to discuss the above questions and to develop the pros and cons of the alternative support mechanisms c) Chair produced draft report and circulate to SG for comment d) Sub-group members commented on the paper e) Chair circulated 'fair' version of the draft Report for comment by WG4 f) Chair finalised Report and presented outcomes to WG4 g) The whole process was completed by WG4 meeting in December (II) Summary of discussions 5 A significant majority of the sub-group agreed that the EU ETS could deliver the cap that had been determined by the EU and thus deliver the desired environmental policy outcomes. 6 To deliver this cap organisations have three possible options. They can: a) stop doing what they are doing; b) continue with their activities but reduce emissions of carbon associated with this activity; c) buy carbon credits to allow them to continue their activity with abatement occurring elsewhere in the system. 7 Therefore the problem becomes one of encouraging sufficient investment and in particular participants noted this requirement in relation to evolving UK energy policy. 8 The EU has determined that there will be a 20% cut on GHG emissions by 2020 (30% on conclusion of a successful international agreement). Meanwhile the UK has set carbon budgets requiring a 34% cut by 2020 (42% with a successful agreement). 2 December 2009

3 9 The DECC Low Carbon Transition Plan (to deliver these budgets) and the analysis from the Committee on Climate Change suggest that decarbonisation of the electricity sector is a key component to delivering these targets. However this analysis also indicates that to achieve the UK s longer term targets for an 80% cut in emissions by 2050 this decarbonisation needs to occur soon. This long term price horizon is beyond that of the current EU ETS. 10 However the sub-group differed in opinions over whether the ETS would deliver timely low carbon investment in their sectors. Broadly there were two views: a) the ETS is currently delivering investment in the sector concerned and will continue to do so as the market evolves and the cap and trajectory change; b) the ETS will not deliver low carbon investment for a variety of reasons including the way in which the price was formed and investor uncertainty in the future. Arguments for the ETS delivering low carbon investment 11 Proponents of the former highlighted previous work completed by the ETG Response by companies to carbon policy initiatives. This report showed that some sectors had completed work on the basis of Governments approaches to reducing carbon (the UK ETS, Climate Change Levy, EU ETS and the Carbon Reduction Commitment). 12 Some participants noted that the Government s publicly stated ambitions to deliver a low carbon economy and to reduce our dependence on higher carbon technologies should be sufficient to provide confidence that schemes to deliver a carbon price, like the EU ETS, will stimulate investment in low carbon technologies. Governments are also making investments to accelerate the development of some low carbon technologies to the point that they may be supported by a viable carbon price. 13 When considering long term investments the investor s perception of likely future prices is more important than current price. A tightening cap (to 30%) depending on the results of decisions in Copenhagen later this year and the delivery of caps and trajectories through to 2030 or 2040 were cited as further reasons to raise investors expectations of the carbon price and drive investment across Europe. Arguments against the ETS delivering low carbon investment 14 However opponents of this view presented a different argument highlighting the need for the UK to act now. a) they stated that the marginal EU ETS price is currently being set by lower abatement cost initiatives (such as coal to gas fuel switching in the electricity sector), which will not on their own deliver the required long-term cuts; b) the CCC and the Government are calling for substantial decarbonisation of the UK electricity sector by 2030; c) the UK currently has an opportunity to replace many of its electricity generation assets. These assets (like many under the ETS) have long lifetimes and thus there is a risk of carbon lock-in (should particular plant be built); and therefore d) the shift to low carbon electricity generation needs to occur now. 15 This argument implies that the speed at which certain low-carbon generation assets might be built is more heavily influenced by the current opportunity to 3 December 2009

4 replace assets rather than by the trajectory of reductions implied by the EU ETS cap. Group consensus 16 Interfering with the ETS through a European wide change (such as a cap or floor mechanism) would take significant time and effort to agree and deliver. It could also lead to problems in relation to an international agreement to link carbon trading schemes. 17 The main concern of participants related to the gap between UK stated ambition and that of the EU ETS. As a European wide policy tool the ETS does not address Member State specific issues. Should a MS wish to address a specific policy issue either for strategic reasons or as a result of a time limited opportunity (such as for large scale asset replacement) as in the UK then MS specific approaches may be required. 18 Participants also noted that sector specific problems should be addressed by sector specific measures. Interfering with an EU wide scheme that covers multiple sectors may not be appropriate and could lead to unwanted outcomes. One concern highlighted was that of the competitiveness of some industrial sectors if they are required to pay a higher CO 2 price in the UK than in other MS s (or if a high EU-wide carbon price makes them less competitive in the global market place). The Phase III ETS Directive was designed to deliver greater harmonisation across Europe. Interfering with the scheme may undermine this. 19 The group agreed that amendments to the EU ETS would only be effective if delivered across all participating Member States. However, in order to address UK ambition, UK specific approaches may be required. The decarbonisation of the UK economy at the rates proposed by the Carbon Budgets and The UK Low Carbon Transition Plan was highlighted as the main example of this. Efficient delivery 20 Efficiency of the EU ETS was considered by different sub-group members to mean different things. 21 Some parties argued that the principal purpose of the EU ETS was to deliver the reducing cap agreed by the Member States through the EU. The market should allow for price discovery to signal what abatement is needed to meet the cap. The current arrangement under the EU ETS framework was argued by some to be delivering efficient abatement investment in the short term and that any changes to the current EU ETS would reduce this efficiency. Some organisations are investing on this basis currently (it was noted that the paper industry had invested 150m in biomass power stations on the basis of an uncertain future, alternative subsidies and not on the basis of carbon price). 22 It was also argued that in order to achieve the most efficient pathway to reductions in emissions in the longer term that action would be required now in order to incentivise some of the higher cost changes to infrastructure that would be required to avoid lock in to high carbon technologies and to decarbonise the economy into the future. The EU ETS does not currently extend to these longer timescales. Some considered that the growing international consensus by governments on the need to address climate change provided investors with some confidence that there would be a carbon price beyond the next phase of the ETS.. 4 December 2009

5 23 Some industries that are required to make more capital intensive investment decisions are not investing currently. These industries consider that the price signal for these investments is currently not providing these investors with confidence. Renewables are noted as an exception to this on the basis that a separate incentive scheme exists. 24 It was, however, noted that there were exceptions to this. Where a new technology was to be incentivised (such as CCS) additional support would be required until such time as the technology is demonstrated after which it should be sufficient allow the carbon price in the EU ETS alone to deliver CCS through the EU ETS. In the alternative, where a technology required long term price support and it was the subject of a particular Government objective then it to would require targeted price support (e.g. some renewable technologies). 25 The group agreed that any additional support mechanism should not provide windfall profits to any sector and also broadly agreed that, under certain approaches, support could fall away as the carbon price rose. 26 The risk return structure of investment in industries was discussed. It was noted that many industries face uncertainty over certain commodity prices (in particular the oil industry). However the particular range of uncertainties with the carbon market was highlighted as the carbon market is solely the product of regulation. Specific measures to support low carbon investment 27 The following section summarises the measures to incentivise low carbon investment that were discussed. It should be noted that a number of comments were made that could be interpreted as pros or cons depending on the parties viewpoint. Floor price 28 The introduction of a floor price was noted to be a separate activity from a reserve price. It was also noted that any reserve price (should there be one) could never be below the floor price. A floor price would require that no transaction for allowances could take place below a certain price. This may require Government/EU to buy back unlimited volumes of allowances at the floor price in the event of a collapse of the market. 29 This option would have to be implemented at an EU level. The price would need to be set by the EU with Member State agreement and the mechanism would require a Directive and State Aid clearance. The price mechanism could be set by EU Regulation. Whilst the price mechanism could be subject to change (impacting on investor certainty), this risk of price change is somewhat mitigated by the time required to pass EU legislative instruments necessary to effect such change. 30 It was noted that this option basically moves risk around market participants and through necessitating Government financial support, would likely smear the cost more broadly across society. A situation could occur where the market price drops below the floor price. Should a market participant (potentially a distressed seller) wish to sell allowances (possible for a variety of reasons) then someone will need to pay the floor price. The buyer of last resort would be the Government and the risk would pass to the taxpayer. 5 December 2009

6 31 Where Government/the EU buys back allowances it could elect to cancel these and thus this would lead to a tightening of the cap and an upward pressure on the market price of carbon. However this outcome also leads to less certainty in the market as the cap changes. 32 The major cons for this option included a) a requirement that Government/the EU would have to buy back allowances from distressed sellers (constituting a form of State Aid) should there be a downturn in the market 1. It was noted that Government would also be selling allowances so would likely still be a net winner; b) there is a possibility that a floor price in the EU ETS would make linking of this scheme to others that had no/ or a different floor price difficult; c) consumers will ultimately have to pay and this mechanism would become publicly unacceptable if the consumer is required to pay the higher costs (through smearing); d) additional costs to some sectors in the EU ETS would increase the possibility of leakage; e) interference with market fundamentals. 33 The most important pros of this option are a) it provides certainty of carbon price which for some investors may support investment in low carbon infrastructure assets; b) this could provide a transitional measure en route to an EU wide carbon tax - floor price effectively representing a set value paid for emissions of CO 2. (The pros and cons of carbon taxes are discussed below.) Reserve Price 34 A reserve price could be used in conjunction with a floor price or alone and could be set at an EU or a Member state level. Consideration in this section is given to the properties of a reserve price alone. 35 A reserve price could be fixed or floating. A fixed reserve price could be set and then inflated at a set rate. A floating reserve price could be set in relation to the prevailing prices in the secondary market (such as the one used, but not implemented, by the UK Government in its most recent auctions). Only a clearly stated reserve price would provide long-term certainty for investors. 36 Political risk surrounds this figure, particularly if it is set at MS level rather than EU level. A reserve price set at MS level would be less efficient at delivering investment confidence than one set at EU level and could undermine the efforts made in the ETS Phase III Directive to harmonise approaches across the EU. 37 The most significant pro for the reserve price is that there is no longer an obligation on Government to buy back significant volumes of allowances. 38 Similar to the floor price a reserve price could change the cap should Government hold back allowances and cancel them thus tightening the cap. 1 It is unlikely that a Government would agree to any such arrangement without strict controls on the maximum exposure of the public balance of payments. Treasury would not allow for the risk of a potential uncapped liability. 6 December 2009

7 Holding back allowances until they rise above the reserve price and cancelling allowances are two different issues. The cancellation of allowances will have a greater market impact and would require agreement at an EU level. Safety valve 39 Participants noted that, in the case of both the floor price option and the reserve price options mentioned above, that there was potential for Government (or the EU) to hold back and cancel allowances. Consequentially, it was noted that, should the market overheat and the price rise to a certain value, the option to sell allowances back onto the market could exist. 40 This is not a cap on the price whereby more allowances beyond the emissions cap are created, but merely a mechanism to re-introduce allowances that had previously not been sold to prevent unnecessarily high price spikes. 41 A safety valve alone will not work (no allowances have been cancelled/retired ). However a safety valve could operate in conjunction with a reserve or floor price. No additional low carbon investor confidence is provided by the safety valve alone. Carbon tax 42 A carbon tax could be applied to all goods and services or just to large emitters. This could be applied upstream (on fuels) or downstream (on users) and this could be additional to the EU ETS or could be used to set a pseudo-floor price. The group questioned what the best way to apply a carbon tax would be and to whom. 43 Even if it should be applied to non-eu ETS sectors some carbon leakage and competiveness concerns would still be likely to arise both with regards to competition within the EU and in respect of trade with countries outside the EU. There would need to be a way of protecting industries through tax relief, leading to the same or even greater complexity as experienced with the EU ETS. 44 A carbon tax at an EU level would be particularly difficult to achieve (although as highlighted earlier a carbon price floor may be one way to achieve this for the traded sector). It was noted that a form of carbon tax already exists in the UK in the form of the Climate Change Levy (CCL) (although the approach to some low carbon technologies is questionable and there are a number of exclusions from the CCL such as the domestic sector.) The Climate Change Agreements (CCA s) were noted as a way in which to protect industry from some of the effects of this levy. 45 Although carbon taxation does not itself act as a market floor price, it can be used to enhance a differential in pricing between low carbon and high carbon energy commodities or activities and, if priced appropriately, would have similar effects as a floor price. A carbon tax could provide a direct floor price (through linking to the EU ETS) or an indirect incentive depending on the details of how it was applied. 46 It was recognised that whilst a tax may simplify some things for larger organisations it may not necessarily encourage investment at a domestic level (should this be part of the policy objective). A tax set at the right level would 7 December 2009

8 encourage long term investment in low carbon technologies. However the challenge of addressing specific Member State needs would still remain. 47 Should a carbon tax be set at a Member State (or EU) level for the ETS sector then it would not achieve any additional carbon reductions but would impose an additional cost on the industry taxed in that Member State. 48 It was noted that one of the cons with a carbon tax was the political risk that the tax level could be changed at any time. Cap and Trajectory 49 A change to the cap or the trajectory of the EU ETS could occur in Phase 3 (as a result of Copenhagen discussions) or decisions could be made regarding the cap or trajectory for Phase 4 of the EU ETS. 50 A significant con would be that a change in cap during a phase may signal to investors that there could be subsequent changes to the cap thus reducing investor certainty. This scenario is somewhat mitigated by the timescales under which the EU makes decisions. Changing the cap needs to be clearly signalled such as the EU s intention to change the Phase III cap as a result of an international agreement. 51 Some participants noted that a change to cap or trajectory would not change the current perceived inefficiencies of the EU ETS. Although there may be some changes to the price it was noted that if there was a change to the cap or trajectory this would be more about environmental outcomes and not about price change. In addition it was noted that changes would be needed to correct for the longer timescales over which some investors need to make decisions, beyond those that the EU ETS currently accounts for. 52 Little certainty on price is provided to investors through the use of this approach however certainty on the cap would be provided. 53 Participants noted that if a change in price (in order to support low carbon investment) was required then changing the cap alone may not necessarily achieve this and alternative mechanisms may be more appropriate. (III) Conclusions The group agreed that the ETS cap could deliver the desired environmental outcomes up to There were differing views within the group as to whether the ETS would deliver timely low carbon investment. The group agreed that there was not alignment between the purpose of the EU ETS and proposed Member State policy goals. The majority of members stated that this was particularly apparent in the electricity sector where UK Government stated ambitions to decarbonise the economy, through investment in low carbon technology, will not be solely delivered by the current EU ETS. The Group also noted that sector specific issues should be dealt with by sector specific approaches. Early consultation is required with industry should Government propose to take forward any new policy initiatives to deliver low carbon investment 8 December 2009