WG5/6 Sub-Working EU Emissions Trading Scheme - Auctioning Proceeds Introduction of Paper Under the current EU Emissions Trading Directive, Member States are required to submit a National Allocation Plan (NAP) outlining the number of allowances they propose to allocate for free and by auction. In Phase II, the UK s NAP includes the provision for the auctioning or sale of 7% of the UK s EU ETS emissions cap which is around 85million allowances over the five year phase. At current Phase 2 prices, the auctioning of these EU Allowances (EUAs) would result in around 0.3 billion 1 per annum of revenue. In Phase 3, the Commission and the UK Government plan to increase the level of auctioning which will result in an increase in revenue from the sale of EUAs. It is anticipated that the auctioning of EUAs in UK would result in around 4 billion 2 per annum of revenue. This is comparable to Defra s own department operating budget of 3.5 billion per annum in 2007-2008. One of the key issues for government going forward is what happens to the revenues from the sale of EUAs. The proposed amendments to the EU ETS Directive provides non-binding guidance that a minimum of 20% of the auctioning proceeds should be used to reduce greenhouse gas emissions, for adaptation, research and development, for renewables, for CCS, to avoid deforestation and facilitate adaptation in developing countries, for addressing social aspects such as possible increases in electricity prices in lower and middle incomes and to cover administrative expenses of the management of the Community scheme. Hypothecation is unpopular amongst Finance Ministries and the EU Council of Finance Ministers published a statement on 6 February 2008 setting out their opposition to hypothecation of auction proceeds. UK Government is strongly opposed to hypothecation. Treasury have not established a budget line for revenues and are concerned around the unpredictable and perceived volatile nature of the revenue stream. 1 EUA price @ 27 November 2007of 23.50 /tco2 with 2% annual inflation and exchange rate of 1.4 /. 2 Based on 23 January proposed amendments to EU ETS Directive, assumes 60% of UK allowances are auctioned in 2013, moving towards 100% by 2020 (for the purpose of this calculation). ETG Sub-Working Group Auctioning Proceeds 11/04/2008 Page 1 of 8
UK Government should also recognise the use of revenue has the potential to introduce distortive effects in the EU carbon market, in intra-eu markets and in how EU industry competes in global markets. Scope of the paper This paper examines the options for the use of the revenues from the auction or sale of EUAs during Phase 2 and Phase 3. It assesses the key advantages and disadvantages for 5 different options for the use of auctioning proceeds. It does not cover the level of auctioning going forward or the design / structure of the auctions. Options The key advantages and disadvantages for 5 different options for the use of auctioning proceeds are outline in the below table. Only option 1 and 5 creates direct financial return to participants. 1. Use of auction revenues for participants Participants can be defined in a number of ways - sector participants, UK individual participants, ETS participants in the UK or broader. Use of auction revenues for participants can be defined using a number of different methods in line with actual emissions, in line with actual allowances purchased, in line with actual emission reductions from a baseline etc. Discussion in this report reflects to a general definition. This could be an area for future work. 2. Use of auction revenues for climate change mitigation projects or schemes national or international schemes. 3. Use of auction revenues for climate change adaptation projects or schemes - national or international schemes. 4. General Revenue - All revenue is kept by Government for purposes other climate change mitigation, adaptation and returned directly to the participants. 5. Revenue neutral - All revenue is kept by Government but is used to reduce other taxes on businesses and/or individuals. ETG Sub-Working Group Auctioning Proceeds 11/04/2008 Page 2 of 8
Auctioning Proceed Options Advantages Disadvantages Comments OPTION 1 Recycled to participants where the auction revenue is recycled directly back to auction participants. Discussion in this section reflects to a general definition. OPTION 2 Use of auctioning revenue for climate change mitigation projects or schemes (within or outside the EU ETS traded sector) e.g. renewable energy projects, abatement technologies Potential to mitigate or reduce distortive effects of auctioning, e.g. Mitigate financial and competitive impact on energy intensive industries impacted by climate change policy Aligns EUETS with other UK initiatives e.g. CCL and CRC Could be designed to reward good behaviour Funds are used for carbon abatement and environmental benefits Funds are used to accelerate the deployment of emerging low / zero carbon technologies Increased public perception of value since demonstrates linkage to climate change mitigation Target/Mitigate financial impact on abatement in energy intensive industries Potential to introduce distortive effects in the EU carbon market, in intra-eu markets or in how EU manufacturers compete in global markets. Recycling auction revenues could raise state aid issues Potentially administratively complex and expensive Reduces effectiveness of carbon price signal and thus reduces industry engagement with carbon reduction objective If Government does not undertake its spending review of these funds, as a consequence this may not be the most effective use of funds. Potential to introduce ETS distortions (as with recycling to participants) Potential delays full internalisation of carbon into full product lifecycle by effectively subsidising carbon reduction costs associated Sector impacts will be different. Trans-European issues will be different. In extremis, does auctioning with 100% recycling to participants simplify to perfect allocation according to need, but not drive abatement? Example could be funding both direct emissions reduction efforts (e.g. in non-traded sectors) or indirect emissions reduction (e.g. by supporting development of innovative but currently noncommercial, technologies such as CCS) This could be applied to national or international schemes. ETG Sub-Working Group Auctioning Proceeds 11/04/2008 Page 3 of 8
Auctioning Proceed Options Advantages Disadvantages Comments Directly drives emission reductions in support of Climate Change Bill targets Funds could be used to invest in JI/CDM projects or purchase these project credits to assist in meeting national climate change targets with targeted abatement activities Auctioning proceeds are uncertain and scheme / project planning requires level of certainty. Does not mitigate financial impact on participants unable to achieve cost pass through OPTION 3 Use of auctioning revenue for climate change adaptation projects or schemes e.g. flood defences. OPTION 4 General Revenue assumes goes into the consolidated fund. Could provide long term benefits in addressing physical impacts of climate change Increased public perception on the need to manage impacts of climate change and for mitigation Does not create additional distortive effects within the EU or carbon market Does not address or assist in tackling the cause of climate change i.e. is not mitigation Could detract from emissions reduction and mitigation activities Auctioning proceeds are uncertain and scheme / project planning requires level of certainty If Government does not undertake its spending review of these funds, as a consequence this may not be the most effective use of funds. Revenues may not be allocated to the mitigation or adaptation of climate change Removes investment capital from cause of climate change which limits potential for abatement. This could be applied to national or international schemes. ETG Sub-Working Group Auctioning Proceeds 11/04/2008 Page 4 of 8
Auctioning Proceed Options Advantages Disadvantages Comments There is however an opportunity to link to schemes which is addressed in option 2 & 3. OPTION 5 Revenue neutral all revenue goes into the consolidated fund but taxes are reduced elsewhere in the economy. This is linked to Option 4, but is explicit in requiring a revenue neutral approach Undergoes Government spending review process and assessment which aims to provide best value for money in public expenditure. Simple Simple in concept May be more palatable for business community and society as a whole By reducing the tax burden on lower carbon businesses and/or individuals Government sends a clear, positive signal for the longterm and reducing emissions. Lack of transparency of how revenues are use could be discrete Government and be seen as tax and spend approach Difficult to measure in reality; not easily transparent Industry concern that Government may not be able to sustain this approach over time, cf. revenue from the CCL reducing employers NICs Could be seen as a re-calibration to influence behaviour. Possibly the least distortional approach at the macro-economic level if there is a concomitant, broad-based reduction in taxes on employment or capital. ETG Sub-Working Group Auctioning Proceeds 11/04/2008 Page 5 of 8
Case Studies Below are two examples of how existing environmental scheme where revenues are recycled. Case Study 1 - Recycling of the Climate Change Levy The Levy was intended to be broadly revenue neutral to the Treasury at a macro level, and so was matched with a 0.3 percentage point cut in employers National Insurance Contributions. The below table from the National Audit Report (p14) shows that the Levy has consistently yielded less than the rebate on employer National Insurance Contributions. However when examined at a micro / sector level the levy revenue recycling is not neutral. In some energy intensive sectors the cost of the levy far outweighs the benefit of the NIC rebate. This highlights a potential danger of not recycling the tax/levy/auction revenue by a mechanism which is related to the way it is collected. In the case of the CCL the NICs rebate is not related to energy intensity, rather it is related to the number of employees. Case Study 2 - NFFO/SRO Surplus under Sustainable Energy Act 2003 Under the Sustainable Energy Act 2003, the Fossil Fuel Levy Surplus (held by Ofgem) can be directed into the Consolidated Fund (under instruction from the Secretary of State) and if so directed must be used to promote the use of energy from renewable sources, subject to the specified cap ( 60m). This money has been used in the past to support the funding of Round 1 offshore grants. ETG Sub-Working Group Auctioning Proceeds 11/04/2008 Page 6 of 8
The Fossil Fuel Levy is currently set at zero. The levy was originally set at 10%, and most of the money raised was used to subsidise nuclear power but a small amount was also used to support payments under the NFFO/SRO order contracts for the first wave of renewable generation projects. As of the end of 1998 there was no further subsidy to the nuclear industry. Although the levy is now set at zero, the surplus continues to grow because there is a positive differential between the prices achieved in the NFPA auctions for SRO/NFFO contacts and the payments due to be made to renewable generators under the SRO/NFFO contracts. In 2007/8 the SRO/NFFO surplus amounted to 181m. Initiative/Regulation Recycling of Revenues from Selected Environmental policy initiatives Take (Yield from Revenue Recycling Key Characteristic Comments policy) pa Tax No Direct linkage Revenue neutral Climate Change Levy 744m (2005/6) 1,275m NIC cut of 0.3% * Enhanced Capital Allowances 50m Carbon Trust and renewables Funding Landfill Tax 900m (2007/8) Up to 6.6% of landfill tax ( 135m) liability can be offset by contributing to approved environmental projects NIC cut of 0.2% * Aggregates levy 400m NIC cut of 0.1% * 35m pa into sustainability fund CRC ~ 440m Revenue net of costs recycled to participants. NFFO/SRO surplus 500m (total to date) SEA provided that 60m be paid to the Treasury, who have since diverted a further 150m. Tax No Direct Linkage Tax No Direct linkage Broadly Revenue neutral Market based Recycling mechanism linked to abatement. Treated as crown revenue Includes provisions to mitigate impact on Energy intensive industries through 80% rebate Designed to encourage recycling and reduce landfill. Intended to reduce demand for Aggregates. Positive NPV for participants. Revenues will depend on auction price, initially fixed. Revenues derived from sale of legacy NFFO project ROC s and CCL exemptions. ETG Sub-Working Group Auctioning Proceeds 11/04/2008 Page 7 of 8
Renewable Obligation Buyout Fund Recycling of Revenues from Selected Environmental policy initiatives 140m Buyout fund revenues held by Ofgem are recycled to suppliers annually pro rata based on ROC s surrendered, Obligation based Direct linkage Recycled 750m ROC collected by suppliers from consumers is entirely recycled to project developers. * Despite these reductions, NIC rates have actually increased from 11.7% in 2002 to 12.8% currently. ETG Sub-Working Group Auctioning Proceeds 11/04/2008 Page 8 of 8