My Lords, during my days as Energy Minister, when I had a keen interest in sustainability and the renewable energy sector in particular, I had the privilege of launching the non-fossil fuel obligation order—the first steps taken by the UK Government into renewables and the challenge of tackling carbon emissions. I have been strongly supportive of the principle of market-driven solutions to reduce carbon emissions ever since. I should declare that until the end of 2019 I was chairman of Hydrodec plc, a company which used proprietary technology to re-refine used transformer oil in Canton, Ohio, securing the first carbon credits for this process and offsetting what would otherwise be new transformer oil refined from virgin crude.
This order is welcome but, as admitted by the Government, it is tight on time. It is laid before the Grand Committee when the energy sector faces the twin challenges of Covid-19 and the end of the Brexit transition period, in a little over two months’ time. It will be welcomed by the market, but it still faces the twin challenges of some lack of clarity and time constraints.
Before moving on to address the specific problems, I thank Linklaters and Pinsent Masons. They have exceptional knowledge and expertise in the sector, and the work their teams have done on this complex subject is invaluable.
As drafted, the order is for a stand-alone domestic emissions trading system—a UK ETS—as the Minister has made clear. By virtue of being stand-alone it will of course be problematic or, at least, introduce complexities for companies with cross-border operations—for example, those that have taken a UK and Ireland approach. It also means that the market for trading allowances is smaller than if it was directly linked with the EU ETS from the outset. This is particularly the case, as it seems from the order that only allowances created under the UK ETS will be capable of being surrendered to meet companies’ obligations under the UK ETS. This means that EUAs would not be capable of being surrendered to meet companies’ obligations. In addition it looks like CERs and emission reduction units under joint implementation—Kyoto units—would not be capable of being used for compliance with the UK ETS, whereas they can under the EU ETS. Would the Minister confirm that this is correct and if so, have the potential impacts of this in terms of effectiveness been considered?
Much is mirror imaged from the EU ETS. Sadly, we will not be part of it, as a number of noble Lords have already said in this Committee. However, in the EU scheme there is a market stability reserve to ensure that no excess or surplus allowances materialise. This is critical to the higher carbon price. I would be grateful if the Minister could explain why there is no similar instrument in this UK ETS. Are the Government taking an approach that does not recognise the wider world markets, and devalues carbon pricing in the UK at a time when Governments are trying to create and support a market where carbon has a robust price? Companies will be keen to know when the first auctions will take place and to have any guidance for this, so that they can prepare, especially given that the first allocation starts in a couple of months’ time. They will want to understand the trading arrangements for allowances and associated documentation. Companies will also be keen to understand how any proposed carbon tax, yet to be consulted on, will interact with the UK ETS.
Although the Government are proposing to broadly mirror the EU ETS, depending on the proposed date of the first auction, there may not be adequate time for companies to prepare after the order is finalised, taking into account the fact that many companies will be operating relevant installations in both the EU and UK at present, and their current strategies in terms of trading and compliance will therefore reflect this. In deciding to take the UK ETS approach, which does
not recognise the wider world markets, are the Government concerned that while the proposed initial cap is 5% below the UK’s notional share of the EU ETS levels from last year, it may not actually reduce emissions sufficiently? UK emissions last year covered by the EU ETS stood at some 129 million tonnes, in contrast to the Government’s proposal for an allowance cap of 156 million tonnes—well above that level. What is the Government’s rationale for this decision?
The companies involved will be keen to gain clarity and to know when the first auctions will take place, and to have detailed guidance on this, so that they can prepare, especially given that the first allocation starts, as I said, in 2021.
It is important to recognise that timing is critical. The cost to emitters and the cost to industry is considerable and, with new regulatory costs and a new compliance system, the more time that industry has to prepare the better. Asking industries at this point to adopt a completely different regulatory system and take on additional compliance costs for energy is a major ask.
I would like to pick up on the point that a number of noble Lords have raised and concentrate the attention of the Committee on the question of a carbon tax, which is still on the table, and ask to be informed of the Government’s current thinking. The concern about a tax route is that a tax is completely divorced from the clear net-zero targets which the carbon pricing mechanism is meant to achieve. I cannot see any coherent read-across strategy between the two, since using the tax route will never guarantee the net-zero commitments of Government. How would it be possible to marry a carbon tax regime to the proposed ETS? You need a staged market-led approach, which cannot be achieved by a carbon tax, but can be reached by an ETS. Perhaps the Minister could also give us her view on the benefits of a carbon tax and whether she agrees with my analysis. How will the Government seek to deliver a policy whereby a carbon tax can be aligned with a net-zero trajectory?
For a long time the tax option was very much a third option: a far fallback position. I hope that remains the case and I would be grateful for the Minister’s views on the subject. It would certainly be a troubling message for the UK to convey at COP 26 if we ended up adopting the carbon tax route. It remains my view that the first item the Prime Minister should discuss with Joe Biden should he be elected President of the United States is the challenge of climate change, the energy transition and the global environment. It would affirm the UK as the trusted friend of the US, as we jointly address the biggest challenge that we face together. It is incumbent on the Government to lead on this issue, work closely with industry and provide timely advice. The order is an important and welcome step in that direction.
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