Competitiveness and climate policy: friends or foes? Climate Solutions, Meeting 3 of 3, 11 March 2014 Peter Lilley MP with Carbon Connect and the APPCCG In the week before Chancellor George Osborne announced a freeze to the UK Carbon Price Floor in his Spring Budget, Carbon Connect and the All Party Parliamentary Climate Change Group (APPCCG) held the third meeting in their Climate Solutions Series. The first meeting in the series was held on 27 Nov 2013 Climate policies: global trends and challenges - with Lord Deben as the keynote speaker and a high level supporting panel; while the second meeting was held on 28 Jan 2014, titled Tools for decarbonisation: taxes, markets and regulation. Peter Lilley MP, a member of the Energy and Climate Change Select Committee, chaired the third and final meeting, looking at the impact of carbon reduction on economic and business competitiveness. The meeting was a timely opportunity to discuss how to balance climate action and economic competitiveness and the opportunities and risks of the UK leading on decarbonisation. TAKE AWAY MESSAGES 1. Climate policy can harm competitiveness when there is asymmetric application of policies between nations. The exemption of energy intensive industries from renewable support policies in some, but not all, European nations is an example of where policy has led to competitive distortions. 2. Energy policy and its impact on regional energy prices is one of many relevant factors affecting firm-level competitiveness. However, policy is not the only factor driving differences in regional energy prices and there are other important factors for competitiveness not relating to energy prices, such as labour costs, material costs and access to markets, labour and capital. Nevertheless some goods and services, such as energy and labour, are typically more susceptible to regional differences than others. 3. Competitiveness issues arising from differences between UK/EU climate policy and the rest of the world can lessened by securing a global deal on carbon reductions in 2015, which could help level the playing field for UK firms competing internationally. 4. The short term impact of policies on energy prices should be considered alongside the broader long term benefits. Fossil fuels are likely to become more expensive in the long term as carbon prices rise, and the costs of alternatives are likely to continue falling. 5. Policymakers must also consider the impacts of policies at a macroeconomic level. The costs of some interventions may be offset by gains in new sectors, although these impacts are difficult to quantify. The ability of incumbent losers from policy interventions to lobby Government relative to potentially weaker winners should also be factored into any analysis. Downside risks can be managed by mitigating the effects on badly hit industries, and ensuring policies maximise local benefits where possible. 6. A strong and consistent policy direction is good for investment and economic growth, allowing companies to have the confidence to invest in a particular strategy. Sending mixed policy messages is likely to lead to reduced levels of investment in both old and new industries affected by climate policy.
Michelle Hubert (Head of Energy & Climate Change, CBI) In recent years the debate around climate policy and competitiveness has been framed in an unhelpful way - it is more a yes/if debate rather than a binary yes/no one. Tackling climate change is the right way to go, but only if we put in place the right policies to minimise the economic risks and maximise the opportunities. For example, attracting the 110 billion to overhaul our power sector up to 2020 is a huge investment challenge, the successful delivery of which will require strong and long term policies at various levels. At an EU level it is right to support a strong carbon reduction target for 2030 and the CBI supports the Government s position of pushing for a credible and ambitious target. Specific binding renewables targets should not be set for individual states, however, as it will be more cost effective to set an overall EU carbon target and let states decide themselves how to meet this. Agreeing the EU 2030 package (on climate and energy) will be important in the run up to the 2015 climate negotiations (on a global carbon reduction deal). Long term targets such as these are needed to give businesses long term visibility of policy and confidence for their investment strategies. Many of these policies and the changes that they will bring come with a price tag, however. It is important that we manage these carefully to ensure that the UK remains competitive and is able to maximise the benefits. In our view, demonstrating leadership is also about managing the downside risks. There are two competitiveness challenges facing the UK. The first is the position of the EU compared with the rest of the world. On average, gas prices in the EU are four times those in the US and Russia, and around 12 per cent higher than in China. EU electricity prices are twice the price of those in the US and Russia and 20 per cent higher than in China. The second challenge is within the EU, where compensation schemes for energy intensive industries differ between countries, creating an un-even playing field for businesses competing between member states. A good solution to these issues would be the agreement of a global deal in 2015 to reduce carbon emissions, which will help reduce the difference between nations with strong climate ambitions and those without. The EU should also be focussed on the issue of carbon leakage, and how this impacts climate policies. The UK needs to look at policies that do not disadvantage industry. The CBI hopes to see the compensation scheme (for energy intensive users) extended and more debate of the cumulative costs (on energy bills) of schemes, such as the Renewables Obligation and the CRC, and those which are creating a competitive disadvantage such as the Carbon Price Floor.
Danielle Lane (Head of Regulatory & Stakeholder Affairs, Dong Energy) Competitiveness is a key issue that impacts on the energy sector within which Dong Energy operates. The company has made a strong commitment to decarbonisation, with interests in offshore wind, gas and biomass power generation. The company is aiming to reduce the carbon intensity of its electricity supply from 443 g CO2/kWh in 2012 to 260g CO2/kWh in 2020. This will be achieved by converting coal power stations to biomass and increasing operational ownership of offshore wind farms. The company s strategy demonstrates that businesses can take a leadership role in decarbonising our economy. It is often asked whether the UK can afford to decarbonise its economy, a question that has been asked with more urgency since the economic downturn. A key issue to consider is how to reform energy supply, and make this compatible with wider economic competitiveness. It is important to remember that the answer may not simply be what is cheapest today. Evidence suggests that investment in low carbon technologies will provide savings in the long term, as the costs of high carbon alternatives rise due to carbon pricing. There are also other benefits, such as a diversified energy mix, which can help reduce the risks of being over reliant on limited energy sources. Over the next decade, the UK will need to overhaul much of its power sector infrastructure. The very long lifespan of energy infrastructure means that this is a big opportunity to make investments that will provide benefits in the longer term. We must therefore think carefully about the types of investments that we make today, and ensure that these are aligned with longer term trends and ambitions. The higher cost of low carbon technologies in the short term, however, is a significant issue. It is crucial that we harness ongoing deployment to bring these costs down as rapidly as possible. A clear target has been set by the offshore wind industry and Government to rapidly reduce the costs of this technology. Dong is confident that these reductions can be achieved, and the company has set itself the even greater ambition of reducing the cost of projects reaching a final investment decision in 2020 to 100 per megawatt hour (compared to around 160 today). This will be achieved by working more closely with suppliers, investing in research and development and by moving to larger turbines. Firms that realise that sustainable energy is the way forward set an example to others, helping to breed confidence in new sectors. The UK should embrace long term changes now in order to maximise the benefits of transition.
Tim Morris (Head of Government Relations, Tata Steel) Tata produce nine million tonnes of steel per year in and employs 18,000 people in the UK directly. Around two to three times that number of people are supported through the company s supply chain, which is entirely located outside of London and the South East. The company exports around half its annual UK production. The balance between competitiveness and climate policy is absolutely crucial to the future of our industry. The industry is unavoidably high energy and carbon dioxide emitting, and exists in a highly global and competitive market, not just in terms of selling steel but also for securing investment. Climate policy brings both benefits and challenges. It can be an important driver of demand, for example by stimulating new markets for steel such as wind energy. Tata also supplies steel to Nissan for the manufacture of their electric vehicles. Unfortunately, these benefits are currently outweighed by the challenges. The company has recently announced that 120 jobs (a quarter of the workforce) are under threat at a factory in South Wales that makes steel for electrical motors and components. The factory produces a high-tech product and faces stiff competition from rivals in Japan and Korea. Energy is the factory s largest cost, and its electricity costs are between 50 and 60 per cent higher than those of competitors in Germany, a difference that cannot simply be overcome through improved productivity or innovation. Currently, all parts of the UK business must overcome the hurdle that gas and electricity costs (for large firms) in the UK are higher than in other parts of Europe and the rest of the world. It is unlikely that even a lot of innovation, productivity and close customer relationships can overcome such a cost disadvantage. The Government has a role to play in terms of setting policies to minimise the current gap between energy prices here and elsewhere. Our UK activities are not only competing for business, but also for investment from the company management overseas who have a wide range of options about where to invest. A level playing field needs to be created in Europe, for example by addressing the effect that the Renewables Obligation has on electricity prices of UK businesses compared to firms in Germany that are exempted from such levies. A global agreement on carbon reductions is also needed. If there was a truly level global playing field, British business would win, as on average our firms are more energy and environmentally efficient than elsewhere in the world. A global deal would be an advantage to economies such as ours. Government support for innovation and R&D is also crucial. Tata has developed the world s first low carbon pilot-scale blast furnace in the Netherlands. It will take several hundreds of millions of pounds to scale this up, but there is no legitimate business case to do so at present without a policy intervention to help capture the benefits. More thought must also be given to the links between competitiveness and climate policy in the UK s emerging industrial policy.
Dimitri Zenghelis (Principle Research Fellow, Grantham Research Institute, LSE) Competitiveness is a crucial issue in the climate debate. The asymmetric application of climate policies can impose additional costs on energy intensive sectors, whose output may fall. The aim of policy is of course to reduce emissions, but domestic emissions may fall by more than the optimum as firms are tempted to relocate abroad. The displacement of emissions can lead to an unnecessary distortion to global production patterns and even an increase in overall emissions if production in these countries is more carbon intensive. The first step to tackling this threat is to examine how asymmetric the application of climate policy has been and is likely to be. To some extent, the UK and other North European economies are ahead of the rest of the world, but they are relatively similar to their European neighbours who constitute their primary trading partners. It is also important to consider whether such policy differentials will persist? Future fossil fuel prices are also relevant, with rising demand in emerging markets creating uncertainties around their costs relative to alternatives such as renewables, which may end up providing cheaper energy. The evidence from the UK and elsewhere suggests that there has not been a huge amount of industrial relocation as a result of climate policy. It should be noted that there have not been very large differentials to examine, with policies such as the EU Emissions Trading System suffering from poor implementation. Moreover, energy is a small component of costs for most companies in the UK (typically less than one per cent) although energy accounts for more than five per cent of total operating costs for a small number. In addition, some sectors such as metals, steel, paper, ceramics and some chemicals are both carbon intensive and exposed to international trade and therefore unable to pass costs through to consumers threatening margins. Nevertheless, even for these sectors labour and material costs, as well as access to skilled labour, technologies and large and stable consumer markets are more important determinants of profits and location decisions. This is why these industries trade profitably even in high cost economies such as Germany. Competitiveness at the whole economy level is a slightly different concept. At this level of analysis, opportunities derive from the response of the economy to long run changes in comparative advantages which determine the most profitable allocation of resources. This means that impacts on non-energy intensive sectors, such as new employment arising from renewables, must also be included. Although renewable energy is a growing sector of the economy, it is small relative to the established incumbents, and consequently has lower lobbying power. It is therefore important to factor in the asymmetry between the potential winners and the losers as a result of policy interventions. It is also important that policies be designed to prevent the growth of new rent-seeking activities and lobbies, and policies should therefore be designed to be as market oriented, nondiscriminatory and transparent as possible. At the economy level, countries tend to perform better if they are open to trade and embrace structural change. The UK has historically performed well against these criteria, being an open, outward-facing economy shy of protectionism. The climate policy framework should be similarly open to change and have measures to compensate potential losers, rather than sending mixed or muddled policy signals which can lead to reduced investment and a higher cost of capital in both the old and the new industries.
Neil Schofield (Head of Sustainable Development, Worcester Bosch) Worcester Bosch makes heat (via gas boilers), which is an essential but forgotten part of the energy mix - gas provides around 70 per cent of the UK s heat and there are around 26 million homes with gas boilers. There has been too much focus on electricity policy within energy policy debates over the last few years. Our business tends to be driven by lower level policy, such as regulations and codes. One of the biggest impacts on our business occurred in 2004 when a very simple change to building regulations forced consumers to switch to condensing boilers. This policy has actually been one of the most successful at reducing carbon emissions. Since then, many policies have withered away such as the delayed Zero Carbon Homes standard or the Consequential Improvements requirement that was scrapped. The ambition of the current policy, the Energy Companies Obligation (ECO), has been significantly reduced. Last year the company sold 160,000 boilers through the scheme. We expect this to reduce significantly next year. This is inconsistent with the fact that the UK has some of the poorest quality housing stock in the developed world. The Renewable Heat Incentive, to encourage domestic consumers to install renewable heat technologies has been delayed since 2011, significantly slowing the deployment of these technologies. Bosch is owned by a charitable foundation, and is interested in long term growth. Investment decisions require long term clarity, which the current UK policy framework for heat has not been able to provide. We are often asked when we will stop producing gas boilers our current guess is somewhere around 2030/35. But we do not yet see what it is, policy or otherwise, that will drive such a massive change in our heating sector. The company would like to invest for the future but is currently unable to do so because the policy framework is so unclear and subject to constant change.