Progress under climate change agreements - but questions remain

Manufacturing industry has again comfortably beaten its energy efficiency targets under climate change agreements (CCAs), according to the Environment Department (DEFRA).1 But in absolute terms, industry's CO2 emissions increased significantly - and DEFRA now admits that it cannot quantify the degree to which CCAs have reduced emissions below business as usual. Meanwhile, the future of CCAs is up for grabs as the Government grapples with complex overlaps between the agreements and the EU emissions trading scheme.

The CCAs are a centrepiece of policies to tackle industry's greenhouse gas emissions. In 2001, an initial 44 sectors - representing more than 5,000 companies and 12,000 sites - signed up to reduce energy use or CO2 emissions, in return for an 80% discount from the climate change levy.

The Government's climate change programme - launched in 2000 and currently under review - expected the CCAs to deliver substantial annual savings of 9.25 million tonnes of CO2 by 2010. Indeed, last year's energy efficiency action plan suggested that the planned review of the CCA targets could increase this figure by more than one-third - and that further savings might come from introducing CCAs in other energy-intensive sectors (ENDS Report 352, pp 45-46 ).

Beyond business as usual?
On the face of it, the CCAs have delivered in spades. In the first milestone period in 2002, industry sectors reported a reduction of 15.8mtCO2 from their various baseline years (ENDS Report 339, pp 23-26 ). The figure was more than three times the cumulative target for the first milestone - and way ahead of the total savings expected for 2010.

As ENDS reported at the time, however, the results appeared less impressive on close inspection. Firstly, several CCAs use baselines going back as far as 1990 - and a fair slice of the reduction had already been achieved long before the agreements were signed. Secondly, most of the saving stemmed from a severe but temporary downturn in the steel industry which, unusually, has a CCA based on absolute energy use rather than energy use expressed relative to output.

Commentators such as the Association for the Conservation of Energy have questioned whether the CCAs really require efficiency improvements beyond "business as usual". The House of Commons Environmental Audit Committee also expressed scepticism over the claimed savings, and called for greater transparency and independent auditing of the results.

Such concerns were reinforced by a recent report for the Treasury by Cambridge Econometrics (ENDS Report 362, pp 3-4 ). This concluded that technological change and relative decline in energy-intensive subsectors of manufacturing "implies that the energy (and therefore carbon) saving and energy efficiency targets would have been met without the CCAs."

Comparing like with like
In late July, DEFRA published the results for 2004, the second milestone period. Sectors under CCAs increased their emissions by 1.4mtCO2 from the first milestone period, mainly because of increased output. Even so, "savings" - or, more accurately, reductions from baselines - of 14.4mtCO2 were reported, and industry again beat targets by a handsome margin.

This time round, however, DEFRA has been much more cautious in presenting the results. An assessment by consultants Future Energy Solutions, which helps to manage the CCAs, stressed that "there have been widespread structural changes in UK industry, changes to products because of market forces and entrants and exits in many sectors" since the targets were set.

FES goes on: "We are not comparing like with like when comparing energy use in base years with energy use in 2002 and 2004. The assumptions of growth and energy prices on which the original business-as-usual forecasts were made are now outdated and of limited relevance."

The candour of the assessment is welcome. But the stark truth is that DEFRA has effectively admitted that it cannot quantify the impact of a flagship climate change policy which represents a tax break worth up to £300 million per year. This information gap leaves officials with a tricky challenge in assessing the scope for further measures to cut industrial CO2 emissions under the review of the climate change programme.

Nevertheless, anecdotal evidence for the benefits of CCAs remains compelling. The consistent message from trade associations is that energy management now has a much higher profile in many companies, a trend which predates the recent rise in energy prices.

"At the beginning of the agreements, this was a very new issue for the dairy sector," says Gareth Stace, environmental manager of trade association Dairy UK. "Now people are sitting up and listening - not just engineers but also general managers. There has been a huge change in attitudes to energy savings."

The Carbon Trust's head of strategy Micheal Rea notes that "companies within CCAs have taken far more action than those outside, even though they face a far lower rate of levy. CCAs appear to have led to a different dynamic, changing how energy is perceived by the management team and particularly finance directors." Some of the main benefits, he suggests, have flowed from the incentive to put in place much improved systems to monitor and manage energy use.

Relative improvements
Further evidence for the effectiveness of the CCAs comes from Future Energy Solutions' analysis of the results for the second milestone.

For sectors with "relative" targets, the consultants worked out the performance if output in the base year had been the same as in the target period. The results give an indication of the reduction in emissions attributable to improved efficiency - although the report warns that changing membership of the CCAs mean that the 2002 and 2004 results "are not always readily comparable".

Overall, industry has achieved a significant improvement in "relative" savings between 2002 and 2004 - with the main contributions coming from the aluminium, chemicals, cement and paper sectors. However, relative performance - and by implication energy efficiency - deteriorated in a dozen of the 42 sectors, most of them smaller players such as non-ferrous metals, foundries, dairies and leather.

Future Energy Solutions argues that UK industry is under competitive pressure to move to more value-added products, which tend to be more energy-intensive. "This has led to difficulties in some CCAs with relative targets, where the absolute consumption has fallen, but the relative consumption has increased." Another factor is that relative targets can be harder to hit in declining markets because baseload energy use is spread across a smaller output.

For example, some subsectors of the ceramics industry have seen a significant deterioration in their energy efficiency. In the fletton brick industry, output has roughly halved since the CCAs were drawn up. In the refractories sector, volume production has shifted overseas and UK manufacturers have focused their efforts on specialist, high value products.

Steel in the spotlight
Despite DEFRA's efforts to improve the presentation of the CCA results, interpreting the detailed picture remains a tricky task for the uninitiated. Results for several sectors appear counter-intuitive, at least at first glance.

One complication is the special status of the steel industry, which accounts for roughly a quarter of all primary energy in the CCA sectors. The sector beat its first milestone target by a massive amount because of plant shutdowns and poor trading conditions. This led DEFRA to tighten the sector's targets for 2002 and 2004 considerably - although the industry still beat them by 1.7 and 1.5mtCO2, respectively.

The steel industry's fortunes have now recovered, and output is expected to continue rising to 2010. Corus says that its output in 2004 was 19.5% up on 2002, but its energy use was just 9.4% higher. It puts the improvement in energy efficiency down to restructuring, with production being concentrated on fewer sites and the closure of steelmaking facilities at Stocksbridge, together with an aggressive cost-cutting programme.

Of the 42 sectors still under CCAs, 21 met their targets outright at sector level. In a further 17 sectors, all the facilities had their climate change levy discounts renewed once DEFRA had drilled down to examine individual compliance. Some 2% of the 10,300 facilities either left the agreements or were not recertified.

However, individual companies were able to make use of emissions trading or other complex "risk management" tools to help meet their targets. Trading was overwhelmingly the most common tool - used by one-quarter of companies.

There have been concerns that the glut of allowances from direct participants in the UK emissions trading scheme and over-achievement in the first CCA milestone could neuter the incentive for continued efficiency improvements under CCAs. DEFRA's figures suggest that this has not happened - at least, as yet.

In total, allowances for 0.9mtCO2 were bought on the market in order to meet 2004 targets - up from 0.58mtCO2 in the first milestone. But this figure was still dwarfed by the over-achievement of 6mtCO2. Much of the over-achievement in 2002 and 2004 has been "ring-fenced" for possible future use - though so far only some 1.2mtCO2 has been verified to make it available for sale.

Overall, Future Energy Solutions says "there is no evidence that large numbers of operators used the trading mechanism as an alternative to implementing their own energy efficiency measures." Indeed, many companies seem to have had a cultural aversion to the trading option. Moreover, the relatively high allowance price of £3.5-4/tCO2 - sustained by poor market liquidity despite the massive oversupply - also made relying on bought allowances less attractive.

Looking ahead
As well as overseeing compliance with the second milestone, DEFRA has been busy on three other fronts:

  • Review of CCA targets:
    CCA targets for 2006-10 were always scheduled to be reviewed in 2004. But the stakes were raised by the massive over-compliance in the first milestone, and the decision to use the revised targets as the basis for allocation under the EU emissions trading scheme (EUETS).

    DEFRA's "opening negotiating position" was that targets should be tightened by 5%, or by the over-achievement in 2002 if this was greater. But it settled for considerably less in the 22 sectors which overlap with the EUETS (ENDS Report 361, p 41 ) - one of the reasons why the Government was drawn into a messy scrap with Brussels over the UK's allocation.

    Negotiations with the remaining 20 sectors are nearly complete. However, it is certain that the review will fall considerably short of delivering the 3.3mtCO2 of additional savings which were originally promised.

    There are also concerns that DEFRA may have been too soft in its tightening of the targets. In 2004, at least 10 sectors - including the chemicals, lime and vehicle manufacturing industries - were already ahead of their new, tighter targets for 2010.

    Nick Sturgeon of the Chemical Industries Association argues that the sector's over-performance in 2004 was "exceptional because it was a peak year for some cyclical sectors like petrochemicals." DEFRA agrees that there is a good explanation for most of the sectors which have already beaten their new 2010 targets - but it is possible that it may seek to revisit targets for a couple.

    There is one more formal opportunity to revisit the targets: a review in 2008 will reconsider the target for 2010, the final milestone year.

  • Interface with EUETS:
    The arrival of the EU trading scheme adds another layer of complexity to the CCA framework.

    Some 500 installations under the EUETS - nearly half of the total in the UK - are also covered by CCAs. Of these, 330 (mostly smaller) installations have won a temporary opt-out from the first phase of the EUETS (ENDS Report 365, pp 41-42 ) - though all must take part in the second phase from 2008.

    The Government has little time to resolve tricky issues around the overlap between the two policies, as it has to submit its allocation plan for the second phase to the European Commission by the end of June 2006.

    The EUETS and CCAs cover similar territory - but the EUETS includes process CO2 emissions, excludes electricity use and many wider combustion sources, and sets absolute caps rather than output-related targets. Monitoring and reporting requirements also differ.

    At one stage, the Government considered taking EUETS emissions out of the ongoing CCA targets. However, this was rejected because of complexity and the risk that energy management on large sites would no longer be viewed in an integrated way. But keeping the two schemes running in parallel has introduced its own complexities - and the Department of Trade and Industry is understood to be pushing for a rethink.

    There are many different views over how to tackle the muddle. Corus says that "whilst managing two different systems is complicated and challenging, we would prefer the two to continue to run in parallel."

    In contrast, David Morgan of the Confederation of Paper Industries says "We'd love to have a system where the monitoring and reporting requirements were reduced. If there were some way that the 80% discount from the climate change levy could be tied to EUETS participation, letting CCAs fall by the wayside, we'd be very interested." The CIA's Nick Sturgeon agrees that "the simple answer is to abolish the levy for all big sources covered by the EUETS."

    However, smaller emitters are keen to remain under the CCAs. Gareth Stace of Dairy UK says that "the EUETS should not catch us - the 20MW threshold for combustion plant is far too low, and the verification and subsistence fees alone far outweigh any benefits."

    Kevin Farrell, chief executive of the British Ceramics Confederation, says "it would be madness" to keep the EUETS and CCAs running in parallel. He calls for the thresholds for EUETS participation to be raised, pointing out that the 100-150 ceramics installations account for only 2% of emissions covered by the EUETS.

    However, DEFRA is concerned that scrapping the CCAs for sectors under the EUETS would leave no policy in place to address wider emissions from manufacturing sites - or to encourage efficient use of electricity. Some industry bodies claim that this does not matter, as electricity generation is already subject to an EUETS cap. However, DEFRA argues that to deliver the same impact on end user efficiency as the CCAs, electricity prices would need to double or treble.

    Michael Rea of the Carbon Trust is also cautious - saying that CCAs should only be abandoned "when it is clear that problems surrounding weak allocation and prices in the EUETS have been resolved - which might not be until 2010 or later."

  • Extending CCAs to new sectors: In the 2004 Budget, the Chancellor announced plans to extend eligibility for CCAs to sectors which met a specific energy-intensity threshold and, for moderately energy-intensive industries, a test of their exposure to international competition (ENDS Report 355, p 9 ).

    Progress has been slow. DEFRA has completed negotiations with the horticulture industry, which is keen to join a CCA because its 50% exemption from the climate change levy expires next March. It is awaiting final approval from the European Commission.

    However, proposed agreements with four other sectors - industrial gases, kaolin and ball clay, calcium carbonate and heat treatment - have fallen foul of state aid problems. The Commission has objected to the eligibility criterion concerning exposure to international markets. Even if it is possible to resolve the issue without going back to square one in the negotiations, clearance is likely to take many months.

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