Economic Instruments


EIUG recognises that there is a role for a variety of economic instruments in providing incentives to manage demand for energy and capture the externalities attributed to emissions of greenhouse gases. Such measures may be essential if the UK is to achieve its Kyoto commitments.EIUG believes that a rational system of economic measures would reflect the fact that a tonne of carbon dioxide attributable to industrial activity has the same environmental impact as a tonne attributable to transport or domestic activity.

A disproportionate emphasis on industrial emissions is neither environmentally appropriate not economically efficient.EIUG believes that the design of economic instruments introduced to help achieve environmental goals should take into account the need to preserve international competitiveness, both within the EU and beyond. A global solution is clearly required to deal with global emissions. We note the non-participation of USA and Australia in the Kyoto process, the continuing uncertainty over Russian ratification, and the absence of any meaningful constraints on emissions in developing countries.Comments on specific measures:

Climate Change Levy

EIUG believes it is wrong in principle to have introduced a downstream energy tax applying only to business consumption. It is illogical for a tax to apply to electricity from sources that are not associated with greenhouse gas emissions, such as nuclear, given the ostensible aim of addressing climate change concerns. Climate Change Agreements have successfully allowed many energy-intensive sectors to mitigate the damage that would otherwise have been caused by application of the tax at the full rate.

The ability for other sectors to enter such agreements should not therefore be artificially limited. If the government believes that sectors within such agreements have done more than those outside to improve energy efficiency, as recent statements suggest, the case is made for widening the eligibility criteria. EIUG believes that with the advent of compulsory EU-wide emissions trading, CCL should be phased out to avoid double taxation. In the meantime, EIUG welcomes the exemption from CCL for good quality CHP.

Renewables Obligation

EIUG believes government should not specify the generation mix and that to do so is fundamentally at odds with a market based energy policy. To require suppliers to contract a target level of electricity from national renewable sources is a clear restriction of trade within what should be a single, liberalised, European energy market. It would be more efficient (and environmentally productive) for renewable generation to be sited where the market judges the long run cost of generation to be lowest, not to satisfy a geographic distribution based on essentially arbitrary national targets. A system of tradeable European renewables certificates would help alleviate this problem.

The RO reduces the incentive for renewable generators to compete with one another, removes altogether the incentive to compete with conventional generation, and provides a perverse incentive to ensure market share remains below government targets. The level of subsidy resulting from the penalty charge levied on suppliers (which enables renewable electricity to be sold at around three times the current market price) is unsustainable.The cost of subsidising uneconomic renewable generation has a disproportionate impact on energy-intensive users.

We note that other EU states such as Germany are addressing this problem. We also note that many other measures (such as industrial CHP) provide more cost effective emissions reductions than subsidy-dependent renewables. EIUG believes that such case as there is for retaining the RO will be significantly weakened once the EU emissions trading scheme is active.

Emissions Trading

EIUG recognises that there are advantages in emissions trading being the primary instrument used to ensure that the UK’s international commitments on emissions are realised at least cost. However, serious concerns remain about the nature of the proposed European scheme and its likely impact on the competitiveness of energy-intensive sectors competing in international markets.It is often asserted that the EU will benefit from a ‘first mover advantage’ as a result of its experiment with Emissions Trading and that competing economic blocs will adopt similar measures in due course. EIUG notes the marked reluctance of fast growing economies elsewhere, especially but not only in the developing world, to consider being bound by absolute emissions caps for fear of the economic consequences. EIUG is therefore sceptical about the extent to which a European style cap and trade regime will be adopted internationally.

The development of the EU scheme should take this reality into account in the event that such scepticism proves well founded.EIUG believes that the UK national cap, within an EU system, should logically be established with reference to the UK’s international commitments. To set the national cap at a lower level, in order to achieve a more ambitious emissions reductions, would distort competition within the EU in the affected sectors, and worsen the competitive position internationally. In addition, affected UK sectors that have already reduced emissions would have lower quantities of tradable credits than otherwise, reducing potential income from the scheme. EIUG believes that the government should be cautious in deciding on the level of the UK emissions cap, and fully consider the extent of the disbenefit to the UK economy.

The allocation of initial emission rights (within the national cap) should reflect the need to reward and not disadvantage sectors that have made improvements in energy and/or carbon efficiency in recent years, such as those within CCAs. The initial allocation should be grandfathered, i.e. not subject to auction, to minimise the shock of adaptation to the new regime. The extent to which caps are tightened or the option to increase the extent of auctioning of emissions rights is exercised in future must be moderated in light of the international position.EIUG accepts that some emissions rights will need to be retained for allocation new entrants, especially in generation.

EIUG believes that particular consideration should be given to the balance of emissions allocated between manufacturing industries (who compete in international markets beyond the EU) and the generators (who do not) and that it would be perverse if allocation was done on a basis that resulted in windfall gains for fossil fuel intensive generators.EIUG believes the EU trading scheme should not artificially limit the extent of international trading in emissions credits, nor the opportunity to make use of flexibility mechanisms such as Joint Implementation and the Clean Development Mechanism. These important features, central to the Kyoto trading concept, will help carbon reductions to be achieved at lowest cost. If use of these mechanisms is restricted, the cost of carbon will be unnecessarily high.