HC 61 [incorporating HC 1089-i, Session 2012–13]

Published on 2 December 2013 by authority of the House of Commons London: The Stationery Office Limited

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House of Commons

Environmental Audit Committee

Energy subsidies

Ninth Report of Session 2013–14

Volume I

Volume I: Report, together with formal minutes, oral and written evidence

Additional written evidence is contained in Volume II, available on the Committee website at www.parliament.uk/eacom

Ordered by the House of Commons to be printed 27 November 2013

Environmental Audit Committee The Environmental Audit Committee is appointed by the House of Commons to consider to what extent the policies and programmes of government departments and non-departmental public bodies contribute to environmental protection and sustainable development; to audit their performance against such targets as may be set for them by Her Majesty’s Ministers; and to report thereon to the House.

Current membership Joan Walley MP (Labour, Stoke-on-Trent North) (Chair) Peter Aldous MP (Conservative, Waveney) Neil Carmichael MP (Conservative, Stroud) Martin Caton MP (Labour, Gower) Katy Clark MP (Labour, North Ayrshire and Arran) Chris Evans MP (Labour/Co-operative, Islwyn) Zac Goldsmith MP (Conservative, Richmond Park) Mark Lazarowicz MP (Labour/Co-operative, Edinburgh North and Leith) Caroline Lucas MP (Green, Brighton Pavilion) Caroline Nokes MP (Conservative, Romsey and Southampton North) Dr Matthew Offord MP (Conservative, Hendon) Dan Rogerson MP (Liberal Democrat, North Cornwall) [ex-officio] Mr Mark Spencer MP (Conservative, Sherwood) Dr Alan Whitehead MP (Labour, Southampton, Test) Simon Wright MP (Liberal Democrat, Norwich South)

The following members were also members of the committee during the parliament: Richard Benyon MP (Conservative, Newbury) [ex-officio] Ian Murray MP (Labour, Edinburgh South) Sheryll Murray MP (Conservative, South East Cornwall) Paul Uppal MP (Conservative, Wolverhampton South West)

Powers The constitution and powers are set out in House of Commons Standing Orders, principally in SO No 152A. These are available on the internet via www.parliament.uk.

Publications The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the internet at www.parliament.uk/eacom. A list of Reports of the Committee in the present Parliament is at the back of this volume. The Reports of the Committee, the formal minutes relating to that report, oral evidence taken and some or all written evidence are available in a printed volume.

Committee staff The current staff of the Committee are Simon Fiander (Clerk), Nicholas Beech (Second Clerk), Richard Clarke (Committee Specialist), Andrew Wallace (Senior Committee Assistant), Anna Browning (Committee Assistant), Sayeda Begum (Committee Support Assistant) and Nicholas Davies (Media Officer).

Contacts All correspondence should be addressed to the Clerk of the Environmental Audit Committee, House of Commons, 14 Tothill Street, London SW1H 9NB. The telephone number for general enquiries is 020 7219 6150; the Committee’s email address is eacom@parliament.uk

Energy subsidies 1

Contents

Report Page

Summary 3

1 Introduction 5 Definitions 6 Our inquiry 8

2 The rationale for energy subsidies: Pro-poor policy 10 Lower VAT rates 10 Fuel poverty 11 Prime Minister’s review of energy bills 11

3 The rationale for energy subsidies: supporting infant and low-carbon industries 15

Subsidies, overseas aid and export support 15 Renewables and the need for time limited subsidies 17 New nuclear 19 Contracts for difference and capacity payments 22 Oil and gas 24

Shale gas 25

4 Eliminating harmful and inefficient subsidies 26

Conclusions 29

Recommendations 31

Formal Minutes 33

Witnesses 34

List of printed written evidence 34

List of additional written evidence 35

List of Reports from the Committee during the current Parliament 36

Energy subsidies 3

Summary

Globally, subsidies for fossil fuels exceed $500 billion a year. They are inconsistent with the global effort to tackle climate change, providing incentives for greater use of such fuels and disincentives for energy efficiency. Energy subsidies in the UK are running at about £12bn a year; much directed at fossil fuels. There is no single internationally agreed definition of what constitutes energy subsidy, which has provided a way for the Government to reject—erroneously, in our view—the proposition in some areas that it provides energy subsidies.

In the UK, the Government’s proposed change of definition of ‘fuel poverty’, and the weakening of the legislative commitment to ‘eliminate’ it, will place a greater imperative on the Government to demonstrate that it is committed to making fuel poverty a thing of the past. Unless the Government is prepared to make that commitment and show how it will be delivered, the changes should be stopped.

The Government is undertaking a review to examine the scope for reducing ‘green levies’ in energy bills. While such levies currently account for 9% of bills, in the longer term they will not increase bills. The biggest proportion of such charges is currently already directed at supporting the poorest bill-payers. If the review does find some levy savings in energy bills, perhaps by shifting them to general taxation, the imperative for energy efficiency measures must remain the priority because of the underlying need to tackle climate change by reducing our emissions. In the Autumn Statement, the Government should make clear how any changes to green levies will change the amount that those in fuel poverty will have to pay, by how much and how soon.

The Government uses energy subsidies to support some new technologies, but also some long-established and high-carbon ones. Subsidies for renewables are an essential lever to provide certainty to industry and drive investment in those technologies. The Government should rethink its hostility to a separate continued European target for the deployment of renewables. New nuclear is being subsidised by what the Government prefers to call ‘support mechanisms’ and ‘insurance policies’. The Government’s policy of ‘no public subsidy for new nuclear’ requires it to provide only ‘similar’ support to that provided to other types of energy, but even on that basis the deal for Hinkley Point C is ‘dissimilar’, notably on support for decommissioning and waste.

The Government’s capacity payments regime constitutes a subsidy for gas-fired electricity generation because in practice it will be the only eligible technology, as do field allowances for North Sea oil and gas despite the Government’s assertion otherwise. Fracking does not warrant subsidy through a favourable tax treatment.

The variation in definitions of subsidy allows the Government to resist acknowledging subsidy in many areas, particularly on nuclear energy and the lower rate of VAT on domestic and small business bills. It also allows it to claim that it has no ‘harmful’ or ‘inefficient’ subsidies—those in the firing-line of the UN Rio+20 Summit and the G20—despite fossil fuel consumption contributing to our greenhouse gas emissions.

The Government should use the Autumn Statement as an opportunity to provide a clear

4 Energy subsidies

and comprehensive analysis of energy subsidies in the UK, to present its methodology and calculations, and to show how these figures differ from those produced using the methodologies of the main international institutions. This would bring much needed transparency and provide a basis for an overdue debate on the rationale and justifications for energy subsidies in the UK. The Government should introduce a target to reduce the proportion of energy subsidies that support fossil fuel, rather than low-carbon, consumption.

We do not believe there is any case for treating subsidies to mature energy technologies where there is little likelihood of cost reduction in the future in the same way as technologies that can, over time, compete in the market place without long-term subsidy. We consider that the Government should present a case for subsidy, and hence for the application of EU state aid rules, separately for each energy category.

More fundamentally, the Government needs to demonstrate leadership in increasing the deployment of renewables and in promoting energy efficiency through the careful and targeted use of subsidies and levies, to provide certainty over the longer term for the investment in the technologies on which these will depend.

With overseas aid often globally directed at countries which also have fossil fuel subsidies, and export support going to fossil fuel projects, DfID and UK Export Finance should assess how UK support in these areas correlates with fossil fuel subsidies in support-recipient countries and set out why continued support in each case overrides the need for eliminating fossil fuel subsidies.

Energy subsidies 5

1 Introduction 1. Globally, government subsidies for the use of resources—water, energy, steel and food—run at $1.1 trillion a year.1 The largest part of that figure is accounted for by fossil fuels subsidies. The International Energy Agency (IEA) identified global subsidies to fossil fuel producers alone at $523bn in 2011.2 The OECD estimates that its member countries spend $55–90bn a year on such subsidies.3 The IEA calculate that subsidies for fossil fuels are six times higher than for renewables.4

2. Such fossil fuel subsidies are inconsistent with the global effort to tackle climate change. By encouraging consumption they increase emissions and remove incentives to be more energy efficient. As Shelagh Whitley of the Overseas Development Institute puts it:

If their aim is to avoid dangerous climate change, governments are shooting themselves in both feet. They are subsidising the very activities that are pushing the world towards dangerous climate change, and creating barriers to investment in low-carbon development and subsidy incentives that encourage investment in carbon-intensive energy.5

In 2011 the IEA estimated that completely eliminating fossil fuel subsidies would cut global energy demand by 4%, and emissions by nearly 5%, by 2020. A similar OECD analysis envisaged a 6% reduction in emissions by 2050.6 More recently, the IEA estimated that even a partial withdrawal of fossil fuel subsidies by 2020 could reduce CO2 emissions by 360m tonnes, or 12% of the reduction needed to keep global average temperature rise to the 2oC limit set by the UN Climate Change Convention.7

3. In June 2012, the UN ‘Rio+20’ Earth Summit resolved:

... to phase out harmful and inefficient fossil fuel subsidies that encourage wasteful consumption and undermine sustainable development. We invite others to consider rationalising inefficient fossil fuel subsidies by removing market distortions, including restructuring taxation and phasing out harmful subsidies, where they exist, to reflect their environmental impacts.8

This followed a commitment by the G20 in 2009 (restated in 2012) to:

phase out and rationalise over the medium term inefficient fossil fuel subsidies while providing targeted support for the poorest. Inefficient fossil fuel subsidies encourage

1 ODI, Time to change the game: Fossil fuel subsidies and climate (November 2013)

2 IEA, World energy outlook 2012 (2012)

3 OECD, Inventory of estimated budgetary support and tax expenditures for fossil fuels (2012) (From an analysis of 34 countries (Q48))

4 IEA, Redrawing the energy-climate map (2013)

5 Time to change the game: Fossil fuel subsidies and climate, op cit.

6 IEA, OPEC, OECD & World Bank, An update of the G20 Pittsburgh and Toronto Commitments (2011), Section 1.3

7 Redrawing the energy-climate map, op cit.

8 UN, The Future We Want (June 2012), para 225

6 Energy subsidies

wasteful consumption, reduce our energy security, impede investment in clean energy sources and undermine efforts to deal with the threat of climate change.9

Collectively, the G20 countries accounted for 78% of global carbon emissions from fuel combustion in 2010.10 But of the G20 countries, half (including the UK) claim to have no ‘inefficient’ fossil fuel subsidies (paragraph 66).11 This contrasts with assessments of the extent of fossil fuel subsidies in the UK, without the Rio+20 and G20 differentiation of ‘harmful’ or ‘inefficient’ subsidies, of $6.8bn a year by the OECD and $10.9bn by the IMF.12

Definitions

4. Because there is no single globally agreed definition of energy subsidy,13 we commissioned Dr William Blyth of Oxford Energy Associates to set out the theory and practice of energy subsidies and to review how the various definitions that are available apply to the UK.14

5. He identified a difference between ‘direct’ and ‘indirect’ subsidies. He noted that the subsidies definition used by the World Trade Organisation (“any financial contribution by a government ... that confers a benefit on its recipient”15) focuses mainly on measuring direct subsidies, including the transfer of funds, taxes foregone and government guarantees. Such guarantees transfer risk from producers to government, reducing the cost of capital for the producer which constitutes a tangible reduction in cost. Dr Blyth noted that the OECD, on the other hand, also include as subsidy the impact of “all forms of market price support involving transfers between consumers and producers created as a result of policy such as government interventions on tariffs”, which includes applying tax rates which are lower than those ‘normally’ applied.16 Like the WTO definition, the OECD definition uses the notion of ‘conferring benefit’.17

6. Rather than the OECD’s bottom-up ‘effective rate of assistance’ approach, which relies on identifying different aspects of subsidy in some detail,18 the International Energy Agency uses a ‘price gap’ approach. Its definition covers “any government action that concerns primarily the energy sector that lowers the cost of energy production, raises the price received by energy producers or lowers the price paid by energy consumers”.19 It considers the difference between the subsidy-produced price and the price in the absence

9 G20, Summary of Progress Reports to G-20 Leaders on the Commitment to Rationalize and Phase Out Inefficient

Fossil Fuel Subsidies (2012)

10 Time to change the game: Fossil fuel subsidies and climate, op cit.

11 ibid, Table 1; Summary of Progress Reports to G-20 Leaders on the Commitment to Rationalize and Phase Out Inefficient Fossil Fuel Subsidies, op cit

12 Inventory of estimated budgetary support and tax expenditures for fossil fuels, op cit; IMF, Energy subsidy reform: Lessons and implications (2013); Time to change the game: Fossil fuel subsidies and climate, op cit, Table 1

13 Time to change the game: Fossil fuel subsidies and climate, op cit.

14 Ev 64

15 WTO, Uruguay round agreement: Agreement on subsidies and countervailing measures (1994), Article 1.9 (p44)

16 Ev 64; Inventory of estimated budgetary support and tax expenditures for fossil fuels, op cit.

17 OECD, Analysing energy subsidies in the countries of eastern Europe (2013)

18 Ev 64, para 1.2.2

19 Analysing energy subsidies in the countries of eastern Europe, op cit; IEA, Taxing and Subsidising Energy (2006)

Energy subsidies 7

of subsidy.20 The latter ‘reference price’ requires a judgement about what taxes are ‘normal’, because taxes are essentially negative subsidies. The International Monetary Fund (IMF) have a narrow (‘before tax’) and a broader (‘after tax’) measure, which uses a ‘price gap’ approach to compare the price paid for energy in a country with the international price available.21 The IMF has included reduced VAT rates within its definition of subsidies.22 Under the IEA methodology, however, lower rates of VAT on electricity generation are not treated as being a subsidy, on the basis that the electricity sector is often regarded as an “intermediate energy transformation process rather than a final consumer” and therefore not normally taxed.23

7. The imposition of carbon prices, Dr Blyth told us, acts to correct a market failure. In the OECD model, therefore, they should in theory be considered as “a correction to a sub-optimal prevailing market price signal ... In that sense, the absence of a carbon price in energy markets constitutes a subsidy since in a market without carbon prices, polluters are not paying their full production costs.”24 Renewable UK (one of our witnesses) supported this approach.25 The IEA methodology, however, “excluded environmental externalities from their calculations of subsidies on the basis that carbon pricing is not yet ‘normal’ practice within its member countries”.26 The IMF has actually included as subsidy any lack of taxes designed to internalise the cost of environmental damage, including a $25/tCO2 benchmark for emissions from fossil fuels.27 This shifts the focus of the energy subsidy debate. Since most countries do not tax carbon at this level (if at all), Dr Blyth pointed out that this under-pricing of externalities, combined with tax breaks, “swings the total level of energy subsidies from being dominated by developing country producers (as suggested by the IEA price-gap approach) to being dominated by the major energy users”.28

8. A definition put forward by the Global Subsidies Initiative (who gave evidence to our inquiry), largely based on the WTO’s definition, covers all forms of support—financial or otherwise—provided to consumers or producers. The GSI considers benefits to be a subsidy if they confer a considerable advantage to groups of market participants, even if some other groups may receive equal treatment (e.g. accelerated depreciation allowance is not specific to the oil and gas industry, but the GSI would still consider it a subsidy).29

9. A definition of subsidy is also implicit in EU state aid rules, which identify several tests which all must be met for state aid to be present: that is, whether state resources are being provided, whether they confer an advantage on the recipient which favours certain commercial undertakings or the production of certain goods, and whether that distorts

20 Ev 64, para 1.2.1

21 Energy subsidy reform: Lessons and implications, op cit; Time to change the game: Fossil fuel subsidies and climate, op cit, Section 2.1.3

22 Ev 64

23 ibid

24 Ev 64, paras 1.1.5, 1.2.2 and 2.1

25 Q137

26 Ev 64, para 1.2.1

27 Ev 64, para 1.2.4

28 ibid

29 Analysing energy subsidies in the countries of eastern Europe, op cit

8 Energy subsidies

competition and affects trade.30 Platform, who also gave evidence to our inquiry, take a wider view than most others of what comprises subsidy, by including “diplomatic subsidies and military subsidies” as well as export credit support (paragraph 34).31

10. Some subsidies involve transfers between consumers and producers, or between different types of producers, or between different types of consumers. The UK feed-in tariff for residential solar PV power, for example, provides subsidies to those with solar panels on their roofs which electricity supply companies have to pay, but which they then effectively pass on to all residential electricity customers. The WTO definition of subsidy (paragraph 5) excludes such transfers because they do not involve government money.32 Other subsidies are paid for by government, however. Dr Blyth explained how for such subsidies the benefit is shared between consumers and suppliers—irrespective of whether the subsidy is directed at one rather than the other—depending on the elasticity of demand for that energy.33 The size of the benefit each receives then depends on the change in the quantity of energy produced and consumed, as well as the change in the price, resulting from the subsidising scheme. So, for example, Cold Weather Payments to pensioners in the UK are not subsidy, Dr Blyth told us, because although pensioners receive extra money there is no link to the quantity of energy they consume—they can spend the money on other things.34

11. There is no single internationally agreed definition of what constitutes energy subsidy. Methodologies differ widely, as do the nature of transactions and support mechanisms that might be subsumed in a measurement of subsidy. It is regrettable that this, as we note later in this Report (paragraph 65), has provided a way for the Government to reject—erroneously, in our view—the proposition in some areas that it provides energy subsidies.

Our inquiry

12. Dr William Blyth’s paper described the nature of energy subsidies, from first principles. He explained how ‘perfect markets’ might achieve ‘maximum social welfare’, and thereby how subsidies (like taxes) might represent a distortion from that ideal. But he also noted that perfect markets are in practice difficult to find because competition can be limited, because fixed costs present barriers to market entry, or because ‘externalities’ such as environmental damage (paragraph 7) are not reflected in prices.35 He concluded that “the market model still provides a very important benchmark, but this should not be used as the basis for a dogmatic rejection of interventions that seek to redress some of the more obvious failings”.36 He identifies three main arguments that have been put forward as rationale for subsidies:

30 ibid

31 Q137

32 Analysing energy subsidies in the countries of eastern Europe, op cit

33 Ev 64, Figure 1

34 Ev 64, para 2.2

35 Ev 64, paras 1.1.1 – 1.1.2

36 Ev 64, para 1.1.3

Energy subsidies 9

• to allow ‘infant industries’ and new technologies to be developed and be able to operate economies of scale;

• as part of ‘pro-poor’ policies (the most cited reason for subsidies at a global level); and

• protection from foreign competition.

Shelagh Whitley of the Overseas Development Institute, one of our inquiry witnesses, identified other factors which are often found as the cause for initiating and then failing to curtail fossil fuel subsidies, including the “national patrimony” of fossil fuel producing countries seeking to share the benefit of production across their societies, buffering against price shocks, the power of special interest groups (eg farmers in India), lack of information on the extent of subsidies, and a lack of other available policy levers in countries with weak government institutions.37

13. Against that background, we explore in this Report the rationale for energy subsidies—pro-poor policies in Part 2 and supporting infant and low-carbon industries in Part 3—and the extent to which the UK uses such subsidies. In Part 4 we consider the extent to which UK subsidies are ‘harmful’ or ‘inefficient’ and the extent of transparency in respect of energy subsidies in the UK.

14. In addition to discussing the paper we commissioned from Dr William Blyth of Oxford Energy Associates,38 we took oral evidence from others who have studied the extent of subsidies; representatives of different energy sectors; DfID, UK Export Finance and DECC officials; and the Energy Minister Rt Hon Michael Fallon MP. Our aim has been to produce our Report ahead of the Autumn Statement, which could provide the Government with a timely opportunity for addressing our recommendations.

37 Time to change the game: Fossil fuel subsidies and climate, op cit.

38 Ev 64

10 Energy subsidies

2 The rationale for energy subsidies: Pro-poor policy 15. At a global level, the use of energy subsidies in developing countries is often derived from policies to help protect those countries’ poorest citizens. Subsidies are a readily available policy instrument when such countries have their own domestic energy resources. However, those benefits, when applied as blanket subsidies for all consumers are “inefficient economic and social assistance systems” because, as Peter Wooders of Global Subsidies Initiative told us, “everybody benefits ... particularly people who use more, and that just does not seem to make sense if your target is to protect the poorest. ... The UK VAT exemption has some of those characteristics too”.39 The World Bank calculated in 2008 that in developing countries with fossil fuel subsidies, the poorest 40% received only 15-20% of the benefit.40 Similarly, the IMF found that the poorest 20% of households typically receive less than 7% of the benefit.41

Lower VAT rates

16. The OECD, using its subsidy calculation methodology, identifies the main element of energy subsidy in the UK as a lower-than-normal VAT rate of 5% on energy bills. Domestic and small business use of oil, gas, coal and electricity (whatever the original fuel source) are all charged at 5%. Dr Blyth told us that this practice is unusual, with most European countries taxing energy at the standard rate of VAT.42

17. A March 2013 report from the Joseph Rowntree Foundation43 considered ways in which a carbon taxation regime might be structured to remove what its authors described as the “environmentally perverse subsidies” inherent in the current system. Prof Paul Ekins, one of the authors, discussed the report’s findings with us. One of his revenue-neutral proposals was to raise the rate of VAT on household energy bills to 20%, from a current rate which he saw as a regressive subsidy benefitting high-income households who tend to consume more energy, and using the extra revenue generated by the higher VAT to provide targeted compensation to low-income households through Universal Credit and Pension Credit.

18. The Energy Minister, however, did not agree that the 5% lower rate of VAT on household energy bills represented subsidy, in part because VAT on energy had always been low and had not actually been reduced from the higher standard rate.44 The review of energy bills instigated by the Prime Minister, which we discuss below, would not examine

39 Q61

40 World Bank Independent Evaluation Group, Climate change and the World Bank Group: Phase 1: an evaluation of World Bank win-win energy policy reforms (2008)

41 Time to change the game: Fossil fuel subsidies and climate, op cit.

42 Ev 64, para 2.2

43 Joseph Rowntree Foundation, Designing carbon taxation to protect low-income households (March 2013)

44 Qq241-244

Energy subsidies 11

the scope for using a higher rate of VAT on bills to finance more targeted financial support for the poorest households.45

Fuel poverty

19. The Government centres pro-poor policy in the UK on its measurement of ‘fuel poverty’. This is currently measured in terms of households needing to spend more than 10% of their income on fuel “to maintain an adequate level of warmth”.46 In 2011 DECC calculated that, on that basis, there were 4.5m households (17%) in fuel poverty in the UK, including 3.2m (15%) in England.47

20. In July 2013, DECC published Fuel poverty: A framework for future action, which signalled the Government’s intention to change the definition of ‘fuel poverty’ following the Hills review.48 The new target would be focused “on improving the energy efficiency of the homes of the fuel poor”. Under a new indicator, households will be deemed as fuel poor “if they have above average fuel costs and were they to spend that amount on fuel they would be left with a residual income below the official poverty line”. Under the new measure there were 2.4m households (11%) in fuel poverty in England in 201149 (compared with 3.2m under the old measure). In financial terms, the ‘fuel poverty gap’ of those English households with costs above 10% of their income was £1.05bn, or £438 for each fuel-poor household.50

21. The Government has amended the Energy Bill in the House of Lords to reflect this change of definition, and to change the provisions in the Warm Homes and Energy Conservation Act 2000 to no longer require the “elimination” of fuel poverty by 2016, but instead allow fuel poverty to be “addressed” by a date to be set later by secondary legislation.51 The Energy Minister said that the new measure had the advantage that it did not just address the proportion of income needed for energy bills, but also the level of households’ wealth or poverty: “The new definition allows us to understand much better what the actual depth of fuel poverty is in a particular household rather than simply the extent of it.”52

Prime Minister’s review of energy bills

22. On 23 October, the Prime Minister told the House:

We need to roll back some of the green regulations and charges that are putting up bills. ... What we need to do is recognise that there are four bits to an energy bill: the wholesale prices, which are beyond our control; the costs of transmission and the

45 Q244

46 HC Deb, 28 October 2013, col 366W

47 DECC, Annual report on fuel poverty statistics 2013 (May 2013), Section 2.1

48 DECC, Fuel poverty: A framework for future action (July 2013)

49 DECC, Fuel poverty report: Updated August 2013 (August 2013), Section 2.1

50 ibid; HC Deb, 6 November 2013, col 207W

51 HL Deb 11 July 2013, col GC129

52 Qq239, 240

12 Energy subsidies

grid, which are difficult to change; the profits of the energy companies; and the green regulations. It is those last two that we need to get to grips with. So I can tell the House today that we will be having a proper competition test carried out over the next year to get to the bottom of whether this market can be more competitive. I want more companies, I want better regulation and I want better deals for consumers, but yes, we also need to roll back the green charges that [the Leader of the Opposition] put in place as Energy Secretary.53

The Deputy Prime Minister was reported the next day as saying that the Government “will stress-test all these different levies”, and that a review of environmental policies might involve them being funded in future “from taxes rather than green levies”.54 The Energy and Climate Change Committee took evidence later that month, for its inquiry into energy prices, from the big energy companies, during which the significance of the green levies was discussed.55

23. DECC’s most recent analysis of the component parts of energy bills was published in March 2013. It lists 18 ‘energy and climate change policies’56, which add £112 (9%) to an average dual-fuel bill in 2013.57 Just over half of that was for “energy efficiency and helping the very poorest households” (eg. Energy Company Obligation and Warm Home Discount) and just under half “going towards supporting home grown low carbon sources of energy” (eg. Renewables Obligation, EU Emissions Trading System and Carbon Price Floor payments and Feed-in tariffs).58 Some levies are taxes, such as EU Emissions Trading System and Carbon Price Floor payments, whereas some are subsidies—Renewables Obligation and Feed-in tariffs.59

24. While some of the individual levies are not currently significant, overall they make up, in the Energy Minister’s words, a “sizeable” element in bills,60 and the ‘cost of policies’ in energy bills is forecast to increase.61 However, that is not the complete picture. While DECC expect prices of energy to rise, they also expect bills to be less than they would otherwise be, because some policies are aimed at reducing consumption through greater energy efficiency. DECC calculate that policies will not add significantly to gas prices in 2020 or 2030, and once the impact of energy efficiency policies on consumers is felt their bills will be 13% less (£107 in today’s terms) than they would otherwise be by 2030. For electricity, prices will be 41% higher than they would otherwise be by 2030, but bills 10% higher than they would otherwise be (£67 in today’s terms). Overall, DECC calculate, bills

53 HC Deb 23 October, col 293-4

54 BBC Radio 4, Today programme (24 October 2013)

55 Oral evidence taken before the Energy and Climate Change Committee on 29 October 2013, HC (2013-14) 773

56 DECC, Estimated impact of energy and climate change policies on energy prices and bills (March 2013), Annex B

57 Q220; Estimated impact of energy and climate change policies on energy prices and bills, op cit, Table D1

58 ibid

59 Q227

60 ibid

61 ibid

Energy subsidies 13

will be less than they would otherwise be in 2020 by 11%, or £166, and in 2030 by 3% or £41.62

25. On 21 October 2013, the Committee on Climate Change published a note repeating its earlier analysis of the costs of green policies. It stated:

Energy bills will have to increase by around £10 (1%) to cover costs of low-carbon policies in 2013–14.

Very significant energy bill increases from 2004 to 2012 have been mainly due to increases in the price of gas in international markets, with only a small part of the increase due to low-carbon policies.

Energy bills are expected to increase by around £100 in 2020 due to low-carbon policies. This comprises around £70 related to the Electricity Market Reform and £30 due to the carbon price underpin.

A further £20 increase per household will be required from 2020–2030 to support low-carbon investments. This would be sufficient to meet the proposed target to reduce the carbon-intensity of power generation to 50 gCO2/kWh by 2030. Bills would then be expected to fall from 2030.63

26. The Energy Minister told us that an aim of the review announced by the Prime Minister was to examine “where there are additional levies imposed on top of the bill, these are as fair and as reasonable as necessary”.64 He could not, however, give us an indication of where any change might be made as a result of the review.65

27. Energy subsidies play an important and justified role in alleviating fuel poverty, which remains a significant challenge. The Government’s proposed change of definition of ‘fuel poverty’ and weakening of the legislative commitment—to ‘address’ it rather than ‘eliminate’ it—will place a greater imperative on the Government to demonstrate that it is committed to making fuel poverty a thing of the past. Unless the Government is prepared to make that commitment and show how it will be delivered, the changes to the fuel poverty definition and target, in part being made through amendments to the Energy Bill, should be stopped.

28. The Government is undertaking a review to examine the scope for reducing ‘green levies’ in energy bills. While such levies currently account for 9% of bills, they may not increase bills in the longer term because they will drive energy efficiency. The review cannot significantly assist the poorest bill-payers in the short term simply by scrapping some green levies, because the biggest component of such charges in bills—the Energy Company Obligation and Warm Home Discount—is currently already directed at them (paragraph 23). If the review finds some levy savings in energy bills, perhaps by shifting them to general taxation, the imperative for energy efficiency measures must

62 Estimated impact of energy and climate change policies on energy prices and bills, op cit, Table 3

63 Committee on Climate Change, CCC analysis: low-carbon policies account for only a small part of energy bill increases (21 October 2013)

64 Q217

65 Q227

14 Energy subsidies

remain the priority because of the underlying need to tackle climate change by reducing our emissions.

29. To aid transparency, if the Government introduces its proposed new measure of fuel poverty, it should also continue to publish statistics on the current metric for the remainder of this Parliament, alongside the new figures. In the Autumn Statement, the Government should make clear how any changes to green levies will change the amount that those in fuel poverty will have to pay, by how much and how soon.

Energy subsidies 15

3 The rationale for energy subsidies: supporting infant and low-carbon industries 30. Energy subsidies are often used as a means of promoting ‘infant industries’ (paragraph 12), and in particular renewable energy technologies. In this Part we examine two aspects: the UK’s support for particular energies overseas, and the Government’s support for renewables and other specific industries within the UK.

Subsidies, overseas aid and export support

31. In our 2011 report on Overseas Aid, we criticised DfID support for World Bank aid programmes which supported fossil fuel projects.66 In our current inquiry, DfID informed us that the World Bank’s approach to energy lending is now guided by its July 2013 Toward a Sustainable Energy Future for All: Directions for the World Bank Group’s Energy Sector document, which allows “financial support for greenfield coal power generation projects only in rare circumstances. Considerations such as meeting basic energy needs in countries with no feasible alternatives to coal and a lack of financing for coal power would define such rare cases.”67 The Government’s recent announcement about ending support for coal power plants abroad was couched in similar terms.68

32. The aid programmes of developed counties, sometimes involving renewable energy projects, may provide assistance for countries which are at the same time subsiding fossil fuels. Globally, fossil fuel subsidies are at least five times higher than the $100bn pledged to be made available in climate change finance at the 2009 UN Copenhagen climate change conference.69 Shelagh Whitley of ODI identified five countries (China, Egypt, India, Indonesia and Mexico) which were among both the biggest recipients of climate finance and the biggest providers of fossil fuel subsidies to their consumers.70 DfID told us, however, that the Government does not make the UK aid programme conditional on an absence of fossil fuel subsidies:

There is not a direct correlation between our support for climate finance and whether or not a country has fossil fuel subsidies or not. Having said that, all the programmes that we do support are to do with enhancing access for the poor and are based exclusively on renewables and other forms of non-carbon related energy. ... it is a series of programmes that are about carrot to help countries to work out how best to remove fossil fuel subsidies rather than stick in the sense of seeking to condition aid or support in some way to compel them to do so.

66 Environmental Audit Office, Fifth Report of Session 2010-12, The impact of UK overseas aid on environmental

protection and climate change adaptation and mitigation, HC 710

67 Ev 139, paras 11

68 HC Deb, 21 November 2013, col 56WS

69 Time to change the game: Fossil fuel subsidies and climate, op cit; Q51

70 ODI, At cross-purposes: subsidies and climate-compatible investment (April 2013), page 10

16 Energy subsidies

We make the assessment on the merits of the proposal for support and whether or not that meets the country’s own stated objectives to decarbonise or seek a lower carbon, more climate resilient pathway. We do not ... make a linkage in any specific way to whether or not that country has fossil fuel subsidies.

When applications are made for support through our bilateral programmes and those we support through the World Bank then, yes, we do look at the programme as a whole to see whether or not that makes sense and whether or not it is indicative of a country making a serious attempt to move towards a lower carbon, more climate resilient development pathway. There is not, however, any explicit benchmark or algorithm that takes into account the fossil fuel subsidies or the extent of those which then conditions whether or not we provide that support.71

33. Our witnesses from Global Subsidies Initiative and Overseas Development Institute did not favour overseas aid being blocked when potential recipient countries had fossil fuel subsidies. Some subsidy might be justified where it is targeted at the poorest, rather than as blanket support.72 Shelagh Whitley of ODI wanted greater transparency on where potential overseas aid is going to countries with fossil fuel subsidies, to help reduce cases which “are working full-time against you”.73

34. In our 2011 Overseas Aid report we also criticised UK Export Finance’s lack of support specifically for renewables rather than fossil fuel export projects.74 The OECD and IEA regard export guarantees as subsidies.75 Platform highlighted UKEF’s support for oil and gas contracts in Nigeria, Russia, Urals and Brazil; and diplomatic and military support for Nigeria, Iraq and Russia, which they labelled as subsidy.76 (UKEF provided us with a list of ‘energy’ exports and projects supported over the last 5 years.77) Oil and Gas UK, on the other hand, highlighted that UKEF are a net contributor to the Treasury.78

35. The Energy Minister told us that the Export Investment Guarantees Act 1991 does not allow UK Export Finance to discriminate in its support between different classes or types of export: “It would be unlawful for the Secretary of State simply to declare a blanket ban on certain types of investment. ... I think the objective is the right one, but we are constrained by the existing legislation.”79 David Godfrey, the UK Export Finance chief executive, assured us that a lack of green projects supported by the organisation was not the product of any discrimination on its part. The countries to which such technology is exported, he suggested, do not tend to require export support.80 He highlighted that the OECD

71 Qq 304-306; Ev 139, paras 5 and 9

72 Q68

73 Q64

74 The impact of UK overseas aid on environmental protection and climate change adaptation and mitigation, op cit, paras 70-71

75 Qq70-71

76 Ev 129 ; Q213

77 Ev 132

78 Q214

79 Q307 (See also Ev 132, paras 2 and 4)

80 Qq309-310

Energy subsidies 17

Common Approaches guidance, which the UK follows, requires export projects to be assessed in terms of their social and human rights, but also their environmental, impacts.81 The Government’s 2010 announced prohibition on supporting exports of ‘dirty’ fossil fuel technology82 is defined in terms of meeting World Bank standards.83

36. DfID should make, and publish, an assessment that compares its aid expenditures and the extent of fossil fuel subsidies for each aid-recipient country, and UK Export Finance should similarly provide a comparative analysis of export finance support and fossil fuel subsidies. DfID should then include these analyses in a revision of its Environment Strategy, along with the two departments’ assessment of why continued aid and export support in each case overrides the need for eliminating fossil fuel subsidies in those countries.

Renewables and the need for time limited subsidies

37. The main subsidy for large-scale renewable energy sources in the UK is currently the Renewables Obligation scheme which requires suppliers to provide a certain proportion of their electricity from approved renewable sources. Small scale generators receive a fixed price feed-in tariff for their generation. As a result of the Government’s recent electricity market reform, large scale renewable and non-renewable generation below a certain carbon intensity will instead receive an overall reward for electricity generation based on a contract for difference that will provide variable payments, representing the difference between an agreed ‘strike price’ and an average ‘reference’ price representing what would otherwise be obtained by selling electricity at market rates. If the reference price exceeds the strike’ price, the difference will be repaid by the generator. The strike price and the length of the contract will vary according to the type of energy technology.

38. While such renewables subsidies form part of a move to increase the proportion of energy from renewable sources and contribute to EU and national emissions reductions, the Government is resisting European proposals to increase the renewables targets. In our recent report on carbon budgets, we noted how the EU has agreed to raise its 2020 20% emissions reduction target to 30% if other developed countries and the more advanced developing nations pledged comparable emission reductions.84 As we reported in October 2013,85 the European Commission has been consulting on a 2030 Framework for Climate and Energy Policies, intending to publish at the end of 2013 new targets for 2030.86 The Government wants the EU to adopt a 50% emissions reduction target for 2030 in the context of a global deal, or 40% without a deal, but it did not support a proposal for a separate EU renewable energy target because it believed that that would compromise member states’ flexibility over how they secured a least-cost decarbonisation.87

81 Q307

82 Government, The Coalition: our programme for government (May 2010), p22

83 Q308; Ev 139

84 Environmental Audit Committee, Fifth Report of Session 2013-14, Progress on carbon budgets, HC 60, para 22

85 ibid, para 23

86 European Commission, A 2030 Framework for Climate and Energy Policies (March 2013)

87 Progress on carbon budgets, HC 60, op cit, para 23

18 Energy subsidies

39. Renewable UK believed that until there is a “correct” carbon price, subsidies to many renewable technologies will remain “necessary and indeed desirable”.88 However, different technologies, they told us, needed to be supported for different timescales:

For the time being, subsidies [for Renewables] remain essential, however our members are determined to reduce costs to a point where, in a market underpinned by a strong carbon price, no subsidy is required. However, it is important to understand that the varying technologies will achieve this on different time horizons.89

Subsidies for renewable technologies could potentially become harmful if these where pursued indefinitely and did not change to reflect the dynamics of the market. This is exactly what happened with feed-in-tariff for roof mounted PV systems in 2010 .90

40. Shelagh Whitley of ODI emphasised the importance of building-in processes to limit the duration of all types of subsidies:

What seems to be missing for existing subsidies and how they are structured is around this question of monitoring and reporting and around the question of exit and failure. I do not know ... what are the best ways to put in place sunset clauses, but planning for an exit, planning for flexibility, planning for modification, building that around a system where you have monitoring and reporting so that you can make decisions around milestones seems to make a lot of sense.91

Alan Simpson emphasised that “subsidies should be treated as transitional mechanisms rather than permanent support, addressing market defects and moving the energy market from its current structure towards the energy systems that will replace it.”92

41. DECC calculate ‘levelised costs’ for each energy sector, representing the ratio of the costs of a generic power plant in that sector to the amount of electricity expected to be generated by it.93 DECC expected the levelised costs of onshore and offshore wind and solar PV energy generation to fall, as “reflected in the proposed strike prices for such technologies”, and that “we might expect some projects within these technologies to reach parity with wholesale electricity prices in the latter half of this decade or 2020s.”94 The Energy Minister noted that costs were falling for solar power and that:

we might have to ask why there should be any kind of supported strike price for it after the current levy control framework period. Almost all of [renewables], with the

88 Ev 103, paras 34-35

89 Ev 103, paras 6-7

90 Ev 103, para 35

91 Q58

92 Ev 125, para 1.3

93 HC Deb, 14 October 2013, col 431W; DECC, Electricity generation costs 2013 (July 2013), Annex 1

94 HC Deb, 14 October 2013, col 431W

Energy subsidies 19

exception of biomass and energy from waste, show the prices digressing over the period of the levy control framework.95

42. Renewables energy has an important part to play in delivering the UK’s emissions reduction targets, and allowing the UK to play a full role in tackling climate change. Subsidies for renewables are, in turn, an essential lever to provide certainty to industry and drive investment in those technologies. While the Government has a helpfully positive view on the need to increase the level of emissions reduction ambition in the EU, it should rethink its hostility to a separate continued target for the deployment of renewables. Even without such a continued EU target, however, the Government should be ready to fully use the scope for renewables subsidies to help meet our climate change obligations.

New nuclear

43. On 21 October 2013, the Government announced the parameters of a deal with EDF for the construction and operation of a new nuclear plant at Hinkley Point in Somerset, including the £92.50/KWh contract for difference charge for the electricity it would provide.96

44. Back in February 2013, the Secretary of State for Energy and Climate Change told the House:

... Under [the Electricity Market Reform], ... new nuclear will receive no levy, direct payment or market support for electricity supplied or capacity provided, unless similar support is also made available more widely to other types of generation. By similar, we do not mean the same. Whether similar support is being provided must take account of the material circumstances. It is not a mechanical exercise; it is a matter of sensible judgment. It is obvious that the characteristics of a small onshore wind farm are very different from those of a large offshore wind farm and, indeed, those of a nuclear plant. ... These different characteristics are likely to require differences in the support provided under our electricity market reform.

... It is right that new nuclear power will be entitled to benefit from Energy Bill measures such as contracts for difference and investment contracts. ...

... I do not think that what is needed is a line-by-line comparison of the terms of each contract. That is not what our policy says or requires. In fact, there are likely to be variations in CFD designs between one technology and another, and perhaps also between different projects within the same technology. What is important is that the terms agreed deliver a similar result across technologies and projects, and that they result in a proper allocation of risk. In addition, each contract will need to deliver value for money for the consumer and be compatible with state-aid rules. A contract

95 Q289

96 HC Deb, 21 October 2013, col 23

20 Energy subsidies

with a nuclear developer that does those things would be compatible with our no-subsidy policy.97

Accordingly, DECC and the Treasury told us that:

new nuclear will receive no levy, direct payment or market support for electricity supplied or capacity provided, unless similar support is also made available more widely to other types of generation. New nuclear power will benefit from any general measures that are in place or may be introduced as part of wider reform of the electricity market to encourage investment in low-carbon generation. This is about creating a level playing field for all forms of generation, not subsidising nuclear.98

45. Dr William Blyth had a different view. He told us, before the Hinkley Point announcement, that the contact for difference would constitute a subsidy:

not only because of the raised price compared to market levels, but also because long-term fixed price contracts with reliable counterparties allow companies to borrow money at lower interest rates—a particularly important factor for capital intensive projects like nuclear plant.

It is likely that in the early years of operation, this market price support will constitute a substantial subsidy compared to the cost of the cheapest alternative (i.e. gas-fired plant), but in the long run, the subsidy element is not so clear.99

46. When we questioned the Energy Minister on 30 October about the Hinkley Point deal, he maintained that the project would not represent subsidy as defined by the Government, nor even that it would be subsidised on “similar” terms to the subsidies available to other energy sectors. Instead, the Government would provide the contractor with a “support mechanism”100

These are market based support mechanisms designed to facilitate the earlier introduction of high cost low carbon technologies that the market would not otherwise have been able to finance as quickly as we need them.101

The deal will now be scrutinised by the European Commission for potential state aid implications (paragraph 9).

47. The energy minister told the House on 23 October that:

... The Energy Act 2008 requires operators of new nuclear power stations to have arrangements in place, before construction begins, to meet the full costs of decommissioning and their full share of waste management and disposal costs.102

97 HC Deb, 7 February 2013, cols 488-9

98 Ev 110, paras 93-94

99 Ev 64, para 2.3.3 (Gordon Edge of Renewable UK made a similar point (Q200)).

100 Qq248-249, 252

101 Q249

102 HC Deb 23 Oct 2013, col 200W

Energy subsidies 21

The cost of decommissioning, DECC told us, would not be subsidised by the Government because “the intention is that the decommissioning arrangements will completely fund all the waste that is created by that plant”, for “the lifetime of the plant in terms of operation and decommissioning”—“the entire cost of decommissioning the reactor and dealing with the waste”.103 The Secretary of State told the House that the clean-up fund to pay for eventual decommissioning and a share of the waste management costs would account for around £2 of the strike price.104

48. The Energy Minister also stated on 23 October that:

... The waste contract will, at the outset, set a cap on the level of the waste transfer price ... The cap will be set at a level that reflects the Government's current analysis of risk and uncertainty around waste disposal costs and gives a very high level of confidence that actual cost will not exceed the cap. The Government accepts that, in setting a cap, the residual risk that actual cost might exceed the cap is being borne by the Government. Therefore the Government will charge the operator an appropriate risk fee for this risk transfer.105

Similarly, there will be a £1.2bn cap on the nuclear incident liability which, the Minister told us, was also not a subsidy because the developer will be charged a “risk fee” on “commercial terms” for the Government still having a residual liability. This arrangement, the Minister told us, was an “insurance policy” rather than a subsidy.106

49. The duration of the payments under the contract for difference for Hinkley Point will be 35 years, or 60% of its 60-year expected operating life. That, the Secretary of State told the House, would be “proportionally similar to the length of the [contracts for difference] that are being offered to most renewable technologies”.107 Gordon Edge of Renewable UK had a different view:

Government is taking a much longer term view of the nuclear side than it is for renewables. [Renewables] are being given some foresight at 2020 but they are signing deals for nuclear for 2023 and potentially beyond. So we think that is a bit of a mismatch in terms of commitment to the different sectors and we would like to see much more commitment to our sectors beyond 2020 in order to have parity.108

50. Although the scale and duration of the Hinkley Point project was “qualitatively different”, the Minister told us, overall the support was “similar” to that provided for other energy sectors.109 The Secretary of State said that “the price agreed for the electricity is

103 Qq261-263

104 HC Deb, 21 October 2013, col 24

105 HC Deb, 23 Oct 2013, col 201W

106 Qq255, 256, 271-273

107 HC Deb, 21 October 2013, col 24

108 Q193

109 Qq256, 257

22 Energy subsidies

competitive with the projected costs for other plants commissioning in the 2020s, not just with other low-carbon alternatives, but also with unabated gas”.110

51. The Hinkley Point C deal will be scrutinised by the European Commission for state aid implications. It makes no sense to claim that a subsidy applicable to more than one technology therefore does not constitute a subsidy. It is already clear that new nuclear is being subsidised. The contractor for Hinkley Point will be able to use the guaranteed strike price for the electricity generated to raise capital at lower cost. It is debateable which of the various other Government-termed ‘support mechanisms’ and ‘insurance policies’ also constitute subsidy. Even in terms of the Government’s ‘similarity’ definition of ‘no public subsidy for new nuclear’, there are aspects of support which are not ‘similar’ to that provided for other types of energy, notably on decommissioning and waste.

Contracts for difference and capacity payments

52. The regime established by the electricity market reform envisages a strike price (paragraph 37) and ‘contracts for difference’ for electricity produced by low carbon generators, alongside a ‘capacity market’ to provide guaranteed incentives for the construction of fossil fuel plants to bidders for electricity supply contracts. The Government’s intention for the former is to move to a “technology-neutral competitive process as soon as reasonably practicable”, with ultimately no need to issue contracts for difference: but in the meantime, with technologies at different rates of development, this would be “preceded by a technology differentiated competitive process”.111 The difference between the strike price and the reference price in the proposed electricity market system (paragraph 37) points to an inevitable but variable subsidy—the price the generator receives in excess of the prevailing market price—complicated only by the theoretical possibility that generators may have to pay back that ‘subsidy’ if the reference price exceeds the strike price. Renewable UK were content to acknowledge that the contacts for difference strike prices for renewables were subsidies.112 Dr Blyth told us that for new nuclear whether the strike price represented subsidy would only be established with the passage of time.113 There is no reason to believe, however, that the relationship of the reference price to the strike price over the long life of nuclear contracts for difference will be such that the principle of variable but real subsidy will not also hold as far as nuclear is concerned. The Nuclear Industries Association though saw the arrangements as addressing a market failure, providing “enablers to facilitate the UK’s wider energy policy”.114

53. The first capacity auction will be run in 2014, for delivery in 2018–19.115 Whether the capacity payments regime would constitute subsidy depends on whether they over-compensate producers and whether they are fairly available for all appropriate types of

110 HC Deb, 21 October 2013, col 25

111 Ev 110, para 30

112 Qq155, 160

113 Ev 64, para 2.3.3; Qq24, 47

114 Q157; Ev 102, para 5

115 Ev 110, para 69

Energy subsidies 23

energy. Dr Blyth told us that he would not regard them as a subsidy, but rather as “a pricing mechanism, ... a way of providing payment for services”:116

If the market is competitive—and it is a big if—players in that market will recoup their costs either through the capacity payment or through the energy payment, or a combination of the two. In a competitive market, the combination of the two would cover their short-run marginal cost. ... Whether that works out in practice in a slightly less than competitive market is another issue, but that is not a subsidy issue.117

Gordon Edge of Renewable UK explained how any assessment of whether capacity payments would constitute a subsidy would not be straightforward:

In theory, it ought to be a zero sum game, in that what is paid out in capacity payments ends up lowering the wholesale price of power and therefore it is a recycling of money. I don’t think that is entirely true. There will be some hysteresis in all of that and you will end up with more money going through the capacity mechanism than you save through reduction in wholesale price. But I think it could be seen as a cost of moving to a system where there is a high proportion of high capital cost, low running cost, low carbon generation sources that require a lot of flexibility at the margins in order to cope with their variability or indeed their inflexibility, as nuclear is. So we need to think of it as a system cost. Whether you regard that as a subsidy, I would have to go and think about the philosophy of that.118

The Government expected “the net cost to consumers ... to be lower than the gross cost of the [capacity] auction as the capacity market will result in lower wholesale prices than would have otherwise been the case.”119

54. Where the capacity payment regime more clearly constitutes subsidy is in the restricted availability of the payments essentially to one type of energy. The Energy Minister considered that capacity payments would not be a subsidy because they would “not [be] a support mechanism for any one technology”,120 but he acknowledged that in practice the “majority” of the payments would be for gas-fired power.121 Gordon Edge told us that “the capacity mechanism is too closely designed as a subsidy for new gas-fired plant when it should be thinking much more widely about how we provide flexibility and response to the system as a whole”.122 In practice, of the ‘eligible technologies’ listed in DECC’s October 2013 Electricity Market Reform: Consultation on proposals for implementation,123 it is clear that energy storage participation will be minimal because capacity payments will only be available to non renewable technologies not receiving Renewable Obligation or contract for

116 Q11

117 Q13

118 Q160

119 Ev 110, para 71

120 Q276

121 Qq277-281

122 Q161

123 DECC, Electricity Market Reform: Consultation on proposals for implementation (October 2013), page 152

24 Energy subsidies

difference payments, coal plants will not be able to participate since most existing plants will be required to close from 2016 under the terms of the Large Combustion Plant Directive, and it will not be possible to build new unabated coal plants because of the emissions performance standards set out in the Energy Bill. Demand side reduction measures have been excluded from the 2014 capacity auction, as have interconnectors. The capacity payments regime was another case, the Minister told us, of “an insurance premium” rather than a subsidy.124

55. The capacity payments regime will constitute a subsidy for gas-fired electricity generation because in practice it is the only technology that will be eligible for the payments when the capacity contracts are deliverable in 2018–19.

Oil and gas

56. Using the OECD ‘producer support’ calculation methodology, subsidy includes various tax allowances, such as ‘field allowances’, that can be set against petroleum revenue tax (although not tax allowances which allow exploration costs to be immediately offset against revenues).125 There was some argument, however, about whether the generally higher starting rates of corporation tax and petroleum revenue tax levied specifically on North Sea oil and gas should be taken into account in calculating the net effect of field allowances.

57. Dr Blyth pointed out that all oil and gas producing countries levy taxes or royalties on production, to “gain value from the resources being extracted”.126 The tax system for the North Sea provides a mechanism for the State to “sell” the national asset to the extractive companies.127 The standard rate of petroleum revenue tax therefore “defines the ‘normal’ baseline tax rate for oil production in the UK”.128

58. The Government did not regard field allowances as subsidy:

In the case of oil and gas the Government has introduced field allowances for more challenging categories of field that are economic, but commercially marginal at the high rate of tax. Such fields are relieved of tax of 32% for a certain portion of their income—but they still pay ring fence corporation tax at 30% for this portion, higher than the mainstream corporation tax rate. Field allowances do not reduce the cost of oil to consumers; rather increase what is extracted from the UK continental shelf.129

This oil and gas fiscal regime policy ensures the Government maximises the economic production of oil and gas in the UK, without giving undue support to otherwise uneconomic production. For that reason, field allowances cannot be seen as a subsidy.130

124 Qq282-283

125 Ev 64, para 2.2

126 ibid

127 Q21

128 Ev 64, para 2.2

129 Ev 110, para 10

130 Ev 110, para 113

Energy subsidies 25

The Minister told that “if [North Sea oil and gas companies] are paying a tax higher than other businesses are paying, it cannot be a subsidy. It cannot be both a subsidy and a tax, can it?”131

59. In a similar vein, Oil & Gas UK saw subsidy in terms of “the balance between the taxation collected ... and the amount of value that is transferred from the taxpayer back to these particular elements of the energy sector”.132 Accordingly, “allowances which reduce taxation rates to incentivise activity, and that remain set at such a rate that the effected sector remains a net contributor to the public purse, do not constitute a subsidy.”133 They considered that the higher starting point of tax for oil companies should be taken into account when assessing subsidy. Oil and Gas UK differentiated measures which underwrite the cost of an activity from a tax which is applied on profits “once all costs have already been paid”.134 Platform disagreed. They, like Dr Blyth, emphasised that “these [North Sea] taxes reflect the fact that the fossil fuel companies have been granted a right to exploit a resource that is scarce in the UK, for example, oil and gas reserves. ... These special taxes ... arise due to the special circumstances of natural resource ownership”.135

60. Field allowances for North Sea oil and gas do not fully offset relatively high starting rates of corporation tax and petroleum revenue tax. The allowances nevertheless represent a subsidy because the higher tax rates compensate for the use of state-owned fossil fuel deposits.

Shale gas

61. The Treasury announced tax concessions for shale gas exploration costs in July, reducing the rate from 62% to 30%. There is clearly no rationale for subsidy on the grounds of supporting low-carbon technologies. Shale gas therefore provides a case study for whether subsidies are appropriate for supporting a new industry. The minister told us:

[Fracking] is new to this country. I think it compares much more readily with offshore exploration for oil and gas so the Chancellor is now consulting on a similar form of field allowance. Again, that would not bring it down below the tax rates paid by the rest of British industry.136

As the Energy and Climate Change Committee reported in 2011,137 hydraulic fracturing and horizontal drilling are both techniques that have been present in the UK for many years. They are not new technologies. Fracking is not a technology warranting financial support to become viable and competitive, and on that basis it does not warrant subsidy through a favourable tax treatment.

131 Q285

132 Ev 107

133 ibid (Without mentioning it by name, Oil & Gas UK refer to the effect of the ‘Laffer Curve’; in economics theory, where a tax cut results in more tax revenue because of the increased business activity it triggers.)

134 Q135

135 Q147

136 Q290 (Oil and Gas UK also regarded this as a new industry in the UK context (Q211)).

137 Energy and Climate Change Committee, Shale gas, Fifth Report of Session 2010–12, HC 795

26 Energy subsidies

4 Eliminating harmful and inefficient subsidies 62. In his research for us, Dr Blyth identified the extent of subsidy in the UK and how we compare with other countries. He concluded that “the UK has progressively reduced subsidies to fossil fuels over the past 30 years” but that there are still subsidies for all types of energy. His analysis showed subsidies totalling at least £12.7bn, with the most significant levels being for gas (£3.6bn), nuclear (at least £2.3bn) and renewables (£3.1bn).138 In terms of subsidy relative to the energy output involved, nuclear and renewables are the most subsidised:

• Coal: 20p per MWh

• Oil: 55p per MWh

• Gas: £4 per MWh

• Domestic electricity: £6 per MWh

• Nuclear: at least £33 per MWh

• Renewables: £50 per MWh139

The main elements of these subsidies were the reduced rate of VAT (£6.2bn), renewables (£3bn) and legacy nuclear costs (at least £2.3bn).140 The latter figure is the Government’s net contribution to the Nuclear Decommissioning Authority, but there is uncertainty about the eventual size of the decommissioning liability which could increase this figure.141

63. International comparisons are difficult. Subsidies are defined by reference to the particular tax regime of the country involved, measuring deviations from whatever is deemed ‘normal’ rates of tax in that country.142 Nevertheless, Dr Blyth’s analysis indicated in particular that coal and oil subsidies in the UK are low compared with other countries, and gas subsidies in the UK are higher than other European countries and rising, but less than in Canada and the US.143

64. The Government told us that its policy is to incentivise the energy industry “to bring forward investment where there is a market failure that would act as a barrier to do so in the absence of those incentives.” It also stated that “the Government is open and transparent about where, how, and to what extent it provides support to incentivise the energy sector to help deliver the Government’s objectives, regardless of what that support

138 Ev 64, para 2.7

139 ibid; Q23

140 Ev 64, para 2.7

141 Ev 64, para 2.3.1

142 ibid

143 Ev 64, Figures 10 & 11

Energy subsidies 27

is called.”144 The Government drew distinctions between the methodologies for calculating subsidy applied by different institutions:

The IMF and IEA use versions of a methodology known as the price gap approach, which, similar to the EU definition, compares prices to world market prices. The OECD uses broad measures of Producer and Consumer Support Estimates (PSE & CSE), based on metrics used by the OECD in other sectors, such as agriculture. These measures take account of where lower rates of tax are applied than elsewhere in the economy and so give different results to assessing purely whether fossil fuels are subsidised.145

For G20 purposes, the Government, along with other EU G20 members, defines a fossil fuel subsidy as “any Government measure or programme with the objective or direct consequence of reducing, below world-market prices, including all costs of transport, refining and distribution, the effective cost of fossil fuels paid by final consumers, or of reducing the costs or increasing the revenues of fossil-fuel producing companies.”146

65. It was on the basis of this focus on comparison with world market prices that the Government in several areas rejected the proposition that it provides subsidies. On the reduced rate of VAT on domestic and small business heating fuel and electricity (paragraph 18), for example, the Government highlighted that because it was a tax, it “increases the price above the world-market prices.”147

66. That world-price view of the extent of the Government’s subsidies shapes its approach to the Rio+20 Summit commitment “to phase out harmful and inefficient fossil fuel subsidies that encourage wasteful consumption” and to the G20 commitment couched in similar terms of eliminating ‘inefficient’ and ‘wasteful’ fossil fuel subsidies (paragraph 3). The Government told us that it “does not consider that any of its energy policies are ‘harmful’.”148 The UK government is not alone. An ODI analysis notes that 10 of the G20 countries, including the UK, have reported to the G20 that they have no ‘qualifying emissions’.149

67. The variation in definitions of subsidy allows the Government to resist acknowledging subsidy in many areas, particularly on nuclear energy and the lower rate of VAT on domestic and small business heating fuel and electricity bills, and to claim that it has no ‘harmful’ or ‘inefficient’ subsidies despite fossil fuel consumption contributing to our greenhouse gas emissions. However, the reality is that energy subsidies in the UK are significant, cover all types of energy technology and run to about £12bn a year. Much of this is directed at fossil fuels.

68. The Government must use the Autumn Statement as an opportunity to provide a clear and comprehensive analysis of all energy subsidies in the UK, to present its methodology

144 Ev 110, paras 8 and 12

145 Ev 110, para 111

146 Ev 110, para 112

147 Ev 110, para 90

148 Ev 110, para 13

149 Time to change the game: Fossil fuel subsidies and climate, op cit, Table 1

28 Energy subsidies

and calculations, and to show how these figures differ from those produced using the methodologies of the main international institutions. This would bring much needed transparency and provide a basis for an overdue debate on the rationale and justifications for energy subsidies in the UK. It would also provide an evidence base for developing and refining policies for tackling climate change.

69. We do not believe there is any case for treating subsidies to mature energy technologies where there is little likelihood of cost reduction in the future in the same way as technologies that can, over time, compete in the market place without long-term subsidy. We consider that the Government should present a case for subsidy, and hence for the application of EU state aid rules, separately for each energy category.

70. More fundamentally, the Government needs to demonstrate leadership in increasing the deployment of renewables and in promoting energy efficiency through the careful and targeted use of subsidies and levies, to provide certainty over the longer term for the investment in the technologies that these will depend on. In the Autumn Statement, the Government should make a start on that path by making it clear which minister and which department will be responsible for fully delivering our climate change obligations in a way that avoids maintaining harmful fossil fuel subsidies and protects the fuel poor.

71. The Government has a target to increase the proportion of environmental taxes as a proportion of all taxes, which we examined in 2011.150 In that report we criticised the way that the Government has defined ‘environmental taxes’ and how that excluded fuel duty and other particular taxes which are included in the Eurostat151 definition used by all European countries (including the UK) to report environmental tax revenues. The Government should also use the Autumn Statement to introduce a new target: to reduce the proportion of energy subsidies that support fossil fuel, rather than low-carbon, consumption.

150 Environmental Audit Committee, Budget 2011 and environmental taxes, Sixth Report of Session 2010-12, HC 878

151 ‘Eurostat’ is formally the Statistical Office of the European Communities

Energy subsidies 29

Conclusions

1. There is no single internationally agreed definition of what constitutes energy subsidy. Methodologies differ widely, as do the nature of transactions and support mechanisms that might be subsumed in a measurement of subsidy. It is regrettable that this has provided a way for the Government to reject—erroneously, in our view—the proposition in some areas that it provides energy subsidies. (Paragraph 11)

2. Energy subsidies play an important and justified role in alleviating fuel poverty, which remains a significant challenge. The Government’s proposed change of definition of ‘fuel poverty’ and weakening of the legislative commitment—to ‘address’ it rather than ‘eliminate’ it—will place a greater imperative on the Government to demonstrate that it is committed to making fuel poverty a thing of the past. (Paragraph 27)

3. The Government is undertaking a review to examine the scope for reducing ‘green levies’ in energy bills. While such levies currently account for 9% of bills, they may not increase bills in the longer term because they will drive energy efficiency. The review cannot significantly assist the poorest bill-payers in the short term simply by scrapping some green levies, because the biggest component of such charges in bills—the Energy Company Obligation and Warm Home Discount—is currently already directed at them. (Paragraph 28)

4. Renewables energy has an important part to play in delivering the UK’s emissions reduction targets, and allowing the UK to play a full role in tackling climate change. Subsidies for renewables are, in turn, an essential lever to provide certainty to industry and drive investment in those technologies. (Paragraph 42)

5. The Hinkley Point C deal will be scrutinised by the European Commission for state aid implications. It makes no sense to claim that a subsidy applicable to more than one technology therefore does not constitute a subsidy. It is already clear that new nuclear is being subsidised. The contractor for Hinkley Point will be able to use the guaranteed strike price for the electricity generated to raise capital at lower cost. It is debateable which of the various other Government-termed ‘support mechanisms’ and ‘insurance policies’ also constitute subsidy. Even in terms of the Government’s ‘similarity’ definition of ‘no public subsidy for new nuclear’, there are aspects of support which are not ‘similar’ to that provided for other types of energy, notably on decommissioning and waste. (Paragraph 51)

6. The capacity payments regime will constitute a subsidy for gas-fired electricity generation because in practice it is the only technology that will be eligible for the payments when the capacity contracts are deliverable in 2018–19. (Paragraph 55)

7. Field allowances for North Sea oil and gas do not fully offset relatively high starting rates of corporation tax and petroleum revenue tax. The allowances nevertheless represent a subsidy because the higher tax rates compensate for the use of state-owned fossil fuel deposits. (Paragraph 60)

30 Energy subsidies

8. As the Energy and Climate Change Committee reported in 2011, hydraulic fracturing and horizontal drilling are both techniques that have been present in the UK for many years. They are not new technologies. Fracking is not a technology warranting financial support to become viable and competitive, and on that basis it does not warrant subsidy through a favourable tax treatment. (Paragraph 61)

9. The variation in definitions of subsidy allows the Government to resist acknowledging subsidy in many areas, particularly on nuclear energy and the lower rate of VAT on domestic and small business heating fuel and electricity bills, and to claim that it has no ‘harmful’ or ‘inefficient’ subsidies despite fossil fuel consumption contributing to our greenhouse gas emissions. However, the reality is that energy subsidies in the UK are significant, cover all types of energy technology and run to about £12bn a year. Much of this is directed at fossil fuels. (Paragraph 67)

Energy subsidies 31

Recommendations

10. Unless the Government is prepared to make that commitment [to make fuel poverty a thing of the past] and show how it will be delivered, the changes to the fuel poverty definition and target, in part being made through amendments to the Energy Bill, should be stopped. (Paragraph 27)

11. If the [‘green levies’] review finds some levy savings in energy bills, perhaps by shifting them to general taxation, the imperative for energy efficiency measures must remain the priority because of the underlying need to tackle climate change by reducing our emissions. (Paragraph 28)

12. To aid transparency, if the Government introduces its proposed new measure of fuel poverty, it should also continue to publish statistics on the current metric for the remainder of this Parliament, alongside the new figures. In the Autumn Statement, the Government should make clear how any changes to green levies will change the amount that those in fuel poverty will have to pay, by how much and how soon. (Paragraph 29)

13. DfID should make, and publish, an assessment that compares its aid expenditures and the extent of fossil fuel subsidies for each aid-recipient country, and UK Export Finance should similarly provide a comparative analysis of export finance support and fossil fuel subsidies. DfID should then include these analyses in a revision of its Environment Strategy, along with the two departments’ assessment of why continued aid and export support in each case overrides the need for eliminating fossil fuel subsidies in those countries. (Paragraph 36)

14. While the Government has a helpfully positive view on the need to increase the level of emissions reduction ambition in the EU, it should rethink its hostility to a separate continued target for the deployment of renewables. Even without such a continued EU target, however, the Government should be ready to fully use the scope for renewables subsidies to help meet our climate change obligations. (Paragraph 42)

15. The Government must use the Autumn Statement as an opportunity to provide a clear and comprehensive analysis of all energy subsidies in the UK, to present its methodology and calculations, and to show how these figures differ from those produced using the methodologies of the main international institutions. This would bring much needed transparency and provide a basis for an overdue debate on the rationale and justifications for energy subsidies in the UK. It would also provide an evidence base for developing and refining policies for tackling climate change. (Paragraph 68)

16. We do not believe there is any case for treating subsidies to mature energy technologies where there is little likelihood of cost reduction in the future in the same way as technologies that can, over time, compete in the market place without long-term subsidy. We consider that the Government should present a case for subsidy, and hence for the application of EU state aid rules, separately for each energy category. (Paragraph 69)

32 Energy subsidies

17. More fundamentally, the Government needs to demonstrate leadership in increasing the deployment of renewables and in promoting energy efficiency through the careful and targeted use of subsidies and levies, to provide certainty over the longer term for the investment in the technologies that these will depend on. In the Autumn Statement, the Government should make a start on that path by making it clear which minister and which department will be responsible for fully delivering our climate change obligations in a way that avoids maintaining harmful fossil fuel subsidies and protects the fuel poor. (Paragraph 70)

18. The Government should also use the Autumn Statement to introduce a new target: to reduce the proportion of energy subsidies that support fossil fuel, rather than low-carbon, consumption. (Paragraph 71)

Energy subsidies 33

Formal Minutes

Wednesday 27 November 2013

Members present:

Joan Walley, in the Chair

Peter Aldous Martin Caton Caroline Lucas Dr Matthew Offord

Mr Mark Spencer Dr Alan Whitehead Simon Wright

Draft Report (Energy subsidies), proposed by the Chair, brought up and read.

Ordered, That the Draft Report be read a second time, paragraph by paragraph.

Paragraphs 1 to 71 read and agreed to.

Summary agreed to.

Resolved, That the Report be the Ninth Report of the Committee to the House.

Ordered, That the Chair make the Report to the House.

Ordered, That embargoed copies of the Report be made available, in accordance with the provisions of Standing Order No. 134.

Written evidence was ordered to be reported to the House for printing with the Report, in addition to that ordered to be reported for publishing on 17 April 2013 in the last session of Parliament, and 5 and 26 June, 9 and 17 July, 11 September, 9 October and 11 November.

[Adjourned till Wednesday 4 December 2013 at 9.15 am

34 Energy subsidies

Witnesses

Wednesday 24 April 2013

Dr William Blyth, Oxford Energy Associates. Ev 1

Wednesday 15 May 2013

Peter Wooders, Programme Leader, Global Subsidies Initiative, Shelagh Whitley, Research Fellow, Overseas Development Institute, and Charles Perry, Partner, SecondNature. Ev 11

Wednesday 10 July 2013

Professor Paul Ekins, Professor of Resources and Environmental Policy, and Director, Institute for Sustainable Resources, University College London. Ev 24

Wednesday 23 October 2013

Gordon Edge, Director of Policy, Renewable UK, Keith Parker, Chief Executive, Nuclear Industry Association, David Odling, Energy Policy Manager, Oil & Gas UK, Emma Hughes, Senior Policy Officer, Platform, and Alan Simpson. Ev 32

Wednesday 30 October 2013

Rt Hon Michael Fallon MP, Minister for Energy, Department of Energy and Climate Change, Patrick Erwin, Head, EMI Strategy and Programme Office, Department of Energy and Climate Change, David Godfrey, Chief Executive, UK Export Finance, Helen Dickinson, Deputy Director, Environment and Transport Tax, HM Treasury, and Josceline Wheatley, Acting Head, Climate and Environment Department, Department for International Development. Ev 48

List of printed written evidence

1 Dr William Blyth, Oxford Energy Association Ev 64

2 Nuclear Industry Association Ev 102

3 Renewable UK Ev 103, Ev 141

4 Oil & Gas UK Ev 107

5 Department of Energy and Climate Change and HM Treasury Ev 110

6 Alan Simpson Ev 125

7 Platform Ev 129

8 UK Export Finance Ev 132

9 Overseas Development Institute Ev 136

10 Department for International Development Ev 139

Energy subsidies 35

List of additional written evidence

(published in Volume II on the Committee’s website www.parliament.uk/eacom)

1 Bryan Norris Ev w1

2 Calor Gas Ltd Ev w2

3 Energy Fair Ev w10

4 Dr David Toke Ev w14

5 Renewable Energy Association Ev w19

6 Association for the Conservation of Energy Ev w23

7 Wood Panel Industries Federation (WPIF) Ev w29

8 Friends of the Earth England, Wales and Northern Ireland Ev w30

9 BSW Timber Ev w35

10 EDF Energy Ev w36

11 Vestas Wind Systems Ev w40

12 Fuel Poverty Advisory Group Ev w42

13 Malcolm Grimston Ev w49

14 Energy UK Ev w57

15 United Kingdom Without Incineration Network Ev w59

36 Energy subsidies

List of Reports from the Committee during the current Parliament

The reference number of the Government’s response to each Report is printed in brackets after the HC printing number. Session 2013–14

Session 2012–13

Session 2010–12

First Report Embedding sustainable development across Government, after the Secretary of State’s announcement on the future of the Sustainable Development Commission

HC 504 (HC 877)

Second Report The Green Investment Bank HC 505 (HC 1437)

Third Report Sustainable Development in the Localism Bill HC 799 (HC 1481)

Fourth Report Embedding sustainable development: the Government’s response

HC 877

Fifth Report The impact of UK overseas aid on environmental protection and climate change adaptation and mitigation

HC 710 (HC 1500)

Sixth Report Budget 2011 and environmental taxes HC 878 (HC 1527)

Seventh Report Carbon Budgets HC 1080 (HC 1720)

Eighth Report Preparations for the Rio +20 Summit HC 1026 (HC 1737)

Ninth Report Air Quality a follow up Report HC 1024 (HC 1820)

First Report Embedding sustainable development: an update HC 202 (HC 633)

Second Report Outcomes of the UN Rio+20 Earth Summit HC 200 (HC 633)

Third Report Transport and accessibility to public services HC 201 (HC 632)

Fourth Report Protecting the Arctic: The Government’s response HC 333

Fifth Report Progress on Carbon Budgets HC 60

Sixth Report Biodiversity Offsetting HC 750

Seventh Report Sustainability in BIS HC 613

Eighth Report Codes for Sustainable Homes and the Housing Standards Review

HC 192

First Report The St Martin-in-the-Fields seminar on the Rio+20

agenda

HC 75

Second Report Protecting the Arctic HC 171 (HC 858)

Third Report Wildlife Crime HC 140 (HC 1061)

Fourth Report Autumn Statement 2012: environmental issues HC 328 (HC 1087)

Fifth Report Measuring well-being and sustainable development: Sustainable Development Indicators

HC 667 (HC 139)

Sixth Report Energy Intensive Industries Compensation Scheme HC 669 (Cm 8618)

Seventh Report Pollinators and Pesticides

Energy subsidies 37

Tenth Report Solar Power Feed-in Tariffs (Joint with the Energy and Climate Change Committee)

HC 1605 (HC 1858)

Eleventh Report Sustainable Food HC 879 (HC 567)

Twelfth Report A Green Economy HC 1025 (HC 568)

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Environmental Audit Committee: Evidence Ev 1

Oral evidenceTaken before the Environmental Audit Committee

on Wednesday 24 April 2013

Members present:

Joan Walley (Chair)

Peter AldousNeil CarmichaelMartin CatonKaty ClarkZac Goldsmith

________________

Examination of Witness

Witness: Dr William Blyth, Oxford Energy Associates, gave evidence.

Q1 Chair: What I would like to do this afternoon, DrBlyth, is to give you a warm welcome to our firstsession of this inquiry about energy subsidies. Itwould be fair to say that we regard the research thatwas commissioned, which you provided us with, asthe starting point for what we hope will be an inquirythat will, as we go along, expose further themes thatwe need to be addressing, building on the startingpoint that you have provided us with.Our first question as a Committee to you is that, inthe way that we try to go about understanding theimportance of energy subsidies and their usefulness,what are the main justifications that are put forwardfor having energy subsidies and are those justificationsmore reasonable than others? Is there a pecking orderof justifications for them?Dr Blyth: Thank you. The normal justifications forsubsidies would be the infant-industry argument. Ifyou have an industry that needs protection from fullmarket forces in order to establish itself, maybe bringdown costs and so on, there is an argument forproviding an environment where new technologiescan develop. That is typically one example where youmight provide that kind of market support. The secondarea, typically, would be pro-poor policies, providingsubsidies on products or goods that help alleviatepoverty or allow access to those markets or goods forpoorer consumers. The third area, typically—and thisis not just within energy—would be protection frominternational markets if there is a need for particularcountries—usually it is more relevant in a moredeveloping-country context—to develop domesticmarkets before becoming exposed to widerinternational competition.Thinking about those in the UK context, probably themost relevant in my mind for UK subsidies is still theinfant-industry argument. It is a slightly unfortunateterm because a lot of the technologies that we aretalking about, when we think about the way the energysystem is going and low-carbon energy development,have been around a long time, so they are not reallyinfant, but on the other hand there is a lot of dynamicchange in the energy market. Dealing with the

Caroline LucasDr Matthew OffordMr Mark SpencerDr Alan WhiteheadSimon Wright

dynamics of change and uncertainty, and theunpredictability of the future, is one aspect of theinfant-industry argument that I think does provide abasis on which subsidies can be justified.

Q2 Chair: You just mentioned change anduncertainty. Would you tie that to the timeline, andhow much is the necessity of having a subsidy for theshort, medium or long term something that features inthe design of subsidies? Where a subsidy was neededinitially, how do you know when it has got to the stagethat it is no longer needed? How do you factor in thelength of time that subsidies may or may not beneeded?Dr Blyth: That is a very good point. That is oneelement of the infant-industry argument: that you donot want something to be an infant for ever. At somepoint you have to bring it to maturity and let itcompete. The economic argument as to why subsidiesare not considered a good thing in the long run is thatthe economics of that is really established inequilibrium economy. If everything was inequilibrium and going to be certain for the future andso on, you would probably scrap all subsidies becauseyou do not need them. Subsidies help you through aprocess of change, but at some point you want to say,“We supported such and such a technology becausewe thought that it was going to reduce costs over acertain period of time.” If you find that it has not doneso, you would need to just bite the bullet and say, “Weare going to remove that,” and hopefully at that stageyou would be identifying other technologies thatwould take their place. But some sort of timeline isvery important.

Q3 Chair: It is interesting that you said that that wasan economic aspect, but ours is a cross-cuttingCommittee, so we are looking at businessDepartments and we are looking at other Departmentsas well. How much is it a matter for otherDepartments who might have some remit for asubsidy either continuing or not continuing in respectof competitiveness, say, or overseas competitiveness?How much is that design of the subsidy a matter forother Government Departments and not just the

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24 April 2013 Dr William Blyth

Government Department that is responsible forfinancing the subsidy?Dr Blyth: Energy costs would be one element, so youwould want to be looking at the competitiveness ofthe energy market as a whole and identifying ways ofreducing or minimising the cost of energy. If you aresubsidising, it implies you are raising the cost, whichmay be true in the short term, but the view is that youare trying to support a transition to something that inthe long run would be cheaper. From that point ofview there is a business competitiveness element tohaving a long-run aim towards a low-cost, low-carboneconomy. Then, obviously, the energy sector is criticalto all of this. How you design an electricity market,for example, and have a fair system for different fuelsources to be able to compete in that market isclearly critical.

Q4 Chair: Do you think that others who might havean interest in that are sufficiently aware that that is aprocedure they perhaps need to be having input to?Dr Blyth: The difficulty with subsidies is that theyimmediately become very politicised. One of thethings I have tried to do in the report is try to be astransparent as possible about what a subsidy is andwhen it is appropriate. Different Departments willprobably have their different stake in which sectorsthey feel most exposed to or have the most interest in.Probably the key areas are for the electricity sector,and that combination between energy and climatechange is the crucial area to be resolved in thetransition to low-carbon energy systems.

Q5 Neil Carmichael: I was going to probe that issueabout new technology. Often it is the most expensivebecause you have to basically invent it, test it out andso on. In particular, if you are not using a fuel butusing the technology itself to generate energy, then ofcourse the bill costs will be enormous. So, subsidiesperhaps can and should be used to enable newtechnology to be developed.Dr Blyth: Yes, I would agree with that. Typically, thebasic economic theory would say you should alwaysdo your cheapest options first, because if you have acheaper option available to you, why would youchoose an expensive option? The problem with thatargument is that it does not take into account thedynamics of how technology costs change over time.If the option you have available to you now is cheap,but there is a risk that it becomes expensive in thefuture, you do not necessarily want to lock intobecoming too dependent on that source. That is theclassic example of where you might want to supportsomething that looks more expensive now, and youcreate a niche for it, and hopefully, if that becomessuccessful, then that niche will grow and perhapsbecome mainstream. But you need a fairly flexibleapproach to that. The way these costs develop overtime are quite uncertain. If it turns out that the low-cost source you have now stays low cost, it may bethat the thing that you thought was going to comedown over time never reaches maturity and nevercompetes with it, in which case you have to keeprevising your approach to how you support that. But

I think exactly in principle that is what you are tryingto achieve with subsidies.

Q6 Zac Goldsmith: Politicians on the whole orGovernments on the whole have not been particularlygood at picking winners, picking the righttechnologies, and most people struggle to imaginewhat the future might look like. In 10 or 20 yearsfrom now, there might be energy sources that none ofus has even really considered that are suddenly veryeconomic. How do you avoid a situation whereGovernments pick winners and then risk creating anaddiction to subsidies for unimpressive technologiesand technologies that will never stand on their ownfeet? How can you have a neutral policy that stillallows these start-ups on to the table?Dr Blyth: Yes, that is a very good point. Sunsetclauses is one element to that—building in, inadvance, an expectation that subsidies are of limitedtime duration—and you can see that in some of thepolicy designs. For example, if you look at Germansupport for solar PV, built into the time frame forthose subsidies is a reducing rate of support over time,and that is tailored to the rate of uptake. So, if thecosts of PV come down very quickly, then the rate ofsupport comes down quickly as well. It is difficult andit does move you away from this idealised worldwhere you can just let the market decide, but whetherthe market is in the right place to take some of thebig strategic decisions over multi-decade time scales,which is potentially what we have to do to society forreducing carbon emissions—

Q7 Zac Goldsmith: Can I come back on that? TheGerman solar example is a good one, and they seemto have made the right decision, but their subsidyregime was based on—There is an odd echo in thisroom.Chair: I know.Zac Goldsmith: Maybe it is just me; I am puttingmyself off. The regime seems to have been based onthe triggers, so every time the unit costs came downfor the subsidy there was a fairly predictable formula,which we have tried to replicate here now, after ourown problems with solar subsidies not that long ago,but what would have happened then had the unit costsnot come down? Had they made the wrong punt, hadsolar not been as successful as it now is, how wouldthat have worked? You could potentially have had asituation in Germany with an unsustainable long-termaddiction, a dependence on a subsidy for a technologythat perhaps did not become more economic. It did,but what would have happened if it had not?Dr Blyth: It is interesting. They have arrived at whatlooks like a very well-tailored policy design, but ithas not been without its mistakes in the early stages.Certainly there have been boom-and-bust cycles—andthere have been boom-and-bust cycles in thiscountry—over solar, which have been repeatedseveral times. You can look at the Czech Republic asan example where it boomed, and it boomed so muchthat they basically had to stop the scheme. Spain is ina similar sort of boat where they have suddenlyrealised that they have run out of public money forjust about anything and so you pull the plug. It is not

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Environmental Audit Committee: Evidence Ev 3

24 April 2013 Dr William Blyth

that difficult for Governments to decide that they arenot going to fund anything any more. It happens allthe time. It is not desirable to do it like that. You wantto do it predictably, because you do not want yoursupply chain for these things to bubble and then crash.Ideally you want to pace it, and that is notstraightforward and Governments are learning how totry to do it.

Q8 Chair: It might be helpful for you to face in tothe Committee; I am reliably advised that if we sit alittle bit too far away from the mic, we do get theecho, so I think the lesson is not to sit too far.Dr Blyth: I see.Zac Goldsmith: We ought to know after three years.Chair: The echo is now getting worse. Can I go backto my previous question and ask you whether or notthe research that you have done has highlighted anyother aspects it would be useful to have in the designof subsidies? You mentioned sunset clauses, but arethere other lessons that have been learned from yourresearch that you would advise us to look at as far asrecommendations and so on?Dr Blyth: In my view, one way to try to avoid thepicking-winners approach in the low-carbon sphereparticularly is neutral technology such as carbonpricing that can support all technologies. All low-carbon technologies benefit from that. At the moment,carbon prices Europe-wide are too low to really beeffective at all, but the UK carbon price floor is quitesignificant, and if the Government sticks to the currentproposal of the rate at which the carbon price floorincreases, it quickly becomes a very significant factor.In a sense, that lifts all boats equally, and you can try,with sunset clauses or planned reductions in the rate ofper unit support, to let those things merge over time.The difficult aspect within all of that is that you alsohave to take into account things like the gas price,which obviously is an international price driven by allsorts of drivers, not least of which is economicgrowth, and what is going to happen to shale gas,either in Europe or North America, and so on. So,there are all sorts of imponderables there that have amajor impact on the cost-effectiveness of different-generation technologies. Those are the sorts of riskthat companies are exposed to, but society as a wholeis also exposed to those risks, and Government, in myview, in some cases does have a role to play inthinking about how society gets exposed to thoserisks.

Q9 Chair: Can you think of any technologies thatwould not require subsidy?Dr Blyth: That would not require subsidy? At themoment, quite clearly, gas-fired generation is the partof the generation sector that has, in a sense, been leftwithout any additional support. Coal is essentiallyruled out unless it has CCS, and CCS will not happenunless there is a subsidy. Nuclear renewables are allsubsidised through the contracts for difference goingforward. Essentially, you have gas as the piece leftover. That is it.

Q10 Dr Whitehead: Capacity payments?Dr Blyth: Capacity payments? Well, they arechanging the rules on how they create the market, soI would say that is a change in the market design.

Q11 Dr Whitehead: Are they classified assubsidies, effectively?Dr Blyth: No, I do not think so; I would not class thatas a subsidy. I would class it as a pricing mechanism.Whether it is a desirable one or not is an issue, but itis a way of providing payment for services. At themoment, they are paid per kilowatt hour and theproposal is to change it to some payment for kilowattsas opposed to kilowatt hours or some combination ofpayment for kilowatt hours plus a payment forkilowatts. So, it is a payment for services.

Q12 Dr Whitehead: For being there, really, as forgas-fired power stations? Isn’t that a subsidy?Dr Blyth: It is a payment—being there is a service inthat sense. The point of the capacity payment is to tryto improve the robustness of the electricity system andhave enough capacity on the system to be able to dealwith peaks and troughs, so being there is a service.That is the principle and I am not necessarilydefending it. I think you could, in principle, have anenergy-only market that would bring forwardsufficient capacity. Current policy is that that is seenas a risky way forward, which is why there is thejustification for capacity payment, but I do not seecapacity payment as a subsidy. It is just analternative market.

Q13 Dr Whitehead: Is it to the extent that you weregoing to be there anyway and you are then gettingpaid for being there?Dr Blyth: Presumably then the market price forkilowatt hours would go down. If the market iscompetitive—and it is a big if—players in that marketwill recoup their costs either through the capacitypayment or through the energy payment, or acombination of the two. In a competitive market, thecombination of the two would cover their short-runmarginal cost. If you are receiving your paymentthrough the capacity mechanism, you would expectthe wholesale energy price to go down to compensate,so you are not adding more. You are not just payingfor it to be there in addition to the energy that theyare selling. Whether that works out in practice in aslightly less than competitive market is another issue,but that is not a subsidy issue. That is, “Are themarkets competitive or not?” which is a differentquestion.Chair: We will move on to measurements anddefinition.

Q14 Caroline Lucas: One of the complications, ofcourse, is that different institutions define subsidiesdifferently. In your paper you describe some of thedifferent approaches taken by WTO, OECD, IMF orwhatever. Does any one of them stand out as being aparticularly coherent and sensible approach todefining what an energy subsidy actually is?Dr Blyth: I think you are right; they are quitedifferent. In my view, what stands out probably is the

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Ev 4 Environmental Audit Committee: Evidence

24 April 2013 Dr William Blyth

OECD methodology, which tries to identify not justconsumer subsidies but also producer subsidies. Theearlier work from the International Energy Agency,which became quite widely known for energy subsidyestimates, mainly identified subsidies as being in thedomain of developing countries where price supportfor products is pretty strong. Governments oftensubsidise energy products, petrol and so on, forconsumers, and that is less prevalent by far indeveloped OECD economies where it is pretty rare tosubsidise consumer energy products. The IEAmethodology tended to say it is not a developed-country problem; it is all a developing-countryproblem. The OECD is taking a more rounded viewand says it is not just consumer subsidies that count;it is subsidies to energy companies, and they need tobe taken into account as well. In my view, that is themost rounded approach. The difficulty with it is youend up referencing everything to what the countrynorms are for taxation of energy products. Despite thelarge amount of work by the OECD that goes intothose studies, it is quite hard to come up with a levelplaying field to compare one country with anotherbecause the definition of subsidies tends to be ratherrelative within an economy.

Q15 Caroline Lucas: That leads on perfectly to thenext question, because some of the institutions likethe OECD, as you say, emphasise that particular taxrates should only be considered as subsidies if they dodiffer from the so-called norm, the normal tax rate inthat country. Is it the case that all of the institutionsthat you have looked at would agree that somethinglike reduced VAT rates for energy should be treatedas a subsidy? Would there be that degree ofcommonality of approach?Dr Blyth: There probably would. In a case like VAT,deviations in VAT rates are usually based on somedeliberate attempt to improve access to that particularproduct. In my view, that counts as a subsidy, andmost organisations would recognise that. Certainly theEU is quite strong on trying to get member countriesto harmonise VAT rates across the economy, apartfrom selected items like children’s clothes and thatkind of thing. On energy, the EU is quite hot onkeeping VAT rates at whatever the going rate is withinthe economy, so they would certainly recognise that,and the new member states have all been required toharmonise energy VAT rates.

Q16 Caroline Lucas: There seems to be a differencein approach between the various institutions in termsof whether externalities like environmental costsshould be part of the subsidy calculation, which isquite a big issue. The IMF thinks that unless carboncosts of at least $25 a tonne of CO2 are being borneby an energy market, the failure to reflect that shouldin itself be deemed to be a subsidy. What do you thinkabout that and what does it tell us, particularly now,when you consider the very low price of carbon withthe ETS in the EU?Dr Blyth: I would certainly agree philosophically withthe idea that lack of or under-pricing of externalitiescounts as a subsidy because, economically speaking,they should be incorporated into economic prices.

Most of the international institutions have recognisedthat, in theory, these things ought to be priced in, butthey have stopped short usually, up until now, ofcalling them a subsidy or calling the lack of carbonprice, effectively, a subsidy. But the IMF has nowbroken ranks with that, and I think that is reallyinteresting politically again.

Q17 Caroline Lucas: Do you support it?Dr Blyth: I do support it, absolutely. I totally supportit. What is interesting is that again it brings thesubsidy debate from it is not an OECD problem,energy subsidies are all out and they are all indeveloping countries. If you include the under-pricingof greenhouse gases in particular, that brings it rightback into the lap of our economies in OECDcountries, and so that is really interesting. In terms ofthe UK, you are looking at somewhere between £5billion and £7 billion worth of subsidy if you werelooking at the additional costing of under-pricing ofgreenhouse gases.

Q18 Caroline Lucas: Between £5 billion and £7billion, did you say?Dr Blyth: Yes. It depends which sectors. I wouldargue that does not include the sectors in the UKcovered by the EU ETS, because they are covered bythe carbon price floor, and the carbon price floor isthere or thereabouts similar to the $25 that they arerecommending. It is the other sectors outside of that.

Q19 Caroline Lucas: Just the last thing: do you getthe sense that other institutions will follow the IMFnow the IMF has broken ranks by includingenvironmental externalities as a subsidy? Do you seethat as something that is going to spread?Dr Blyth: I think they probably will. I can’t see whythe World Bank would not want to apply similar sortsof conclusions to the countries that they are focusingon. In some ways, it is the bravest move for the IMF.So, if they have done it, other organisations wouldfollow. I am not quite sure where the $25 numbercame from. There are so many estimates of what thecorrect price is. It happens to be very similar to thecurrent starting point for the UK carbon price floor,which is possibly an interesting coincidence.

Q20 Peter Aldous: Just at the outset, for the Registerof Members’ Interests, I do have interests in farmlandwhere there are renewable energy projects beingpursued. If we can look at energy subsidies in theUK—so, trying to compare like with like—the firstpoint is, in the calculation of energy subsidies in theUK, do you think it is logical to ignore the high rateof petroleum revenue tax applied to fossil fuel energy?Dr Blyth: The petroleum revenue tax is obviously oneof the ways in which the Government recoups moneyfrom the oil and gas sector. All Governments globally,if they are going to license companies to extract oiland gas that belongs to them as a sovereign state, willcome up with some tax arrangement so that thecompanies have a right to access that oil and gas andto sell it in exchange for tax revenue. In the UK,companies are charged a petroleum revenue tax, alsocorporation tax and various other charges, so that is

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the revenue that comes to Government from the oiland gas companies. That is a tax rather than a subsidy.

Q21 Peter Aldous: But would you agree it is notwhat you would call a normal tax, if there is such athing as “normal”, that is applied to other goods?Dr Blyth: I see what you mean. Yes, I would agreethat is not the way that other companies are taxed.The oil and gas sector, or extractive industries ingeneral, is somewhat different because the state issitting on a resource that belongs to them and thequestion is how they effectively sell that via theenergy companies, whereas mostly other companiesare not sitting on a resource that has value. They haveto create value through the goods and services thatthey produce. Extractive industries are slightlydifferent in structure, and therefore I would argue theydo need a different tax regime.

Q22 Peter Aldous: Just going forward in a similarvein, would you agree that it is logical to exclude fromsubsidy calculation the ability that oil companies haveto set off exploration expenditure against revenuesimmediately, when with capital investment in otherareas of the economy that can’t be done?Dr Blyth: That is different. Again, it is a different taxregime. All I can say in answer to that question isthat the OECD methodology recognises that that is adifferent approach, but they do not consider that thatis a subsidy. I think that is because that is a relativelynormal type of approach used internationally. So,although it is different from the typical way thatcorporations are taxed in the UK, it is not unusualinternationally to operate in that way.

Q23 Peter Aldous: In section 2.7 of your report youpull together the subsidies that you have identified foreach type of energy. In terms of the amount of energyoutput supplied by each type, what is your assessmentof the relative levels of the subsidy? I think what I amsaying is, which types of energy are most intensivelysubsidised in the UK for the winners?Dr Blyth: You are quite right, the table shows the totalvalues of which the largest is gas VAT, but when youlook at the total amount of gas used, the size of thatsubsidy per unit comes out as relatively small. Thetwo largest clearly are nuclear and renewables in thisassessment. I would like to point out and apologisethat the table, as it is presented here, is slightlymisleading because the subsidy level for renewablesin the third column of that table is for 2013, whereasthe energy consumption figure is for 2011. They wereboth the latest available data, but they are not the sameyear, which is unfortunate.Peter Aldous: It is a change in the—Dr Blyth: In the case of most of them, it does notchange very much, but in the case of renewables itchanges a lot because renewables has been growingso quickly.If you divide one by the other, the real figure shouldbe something like £50 per MWh for renewables,which is roughly around the value of the ROCs, therenewables obligation certificates. If you divide oneby the other in the nuclear column, you get something

around £33. So, in answer to the question, the mostsubsidised on a per-unit basis is renewables.

Q24 Peter Aldous: Perhaps we should not speculate,but if we were sitting here in five years’ time, do youthink that would be the same answer?Dr Blyth: I think it probably would, because therenewable rate is—we do not know, is the answer tothe question, because we do not know what thecontract-for-difference strike prices are going to be. Isuspect they will be similar to what they are now anddecline over time, but I still think that they will belarge. The size of the subsidy to nuclear will be verylumpy. It will stay as it is now until the first nuclearpower plant is built, if and when that happens, in theearly 2020s. So, in 10 years’ time you will suddenlyget a spike in the total value of subsidies allocated tonuclear, because that is when the plant will start togenerate and be paid. In 10 years’ time the table mightlook different, but for the time being renewables is thearea that is growing, and, therefore, each time it growsit increases the total size, although the rate of supportto renewables is either steady or possibly decliningslightly.

Q25 Peter Aldous: Finally, is it possible to quantifyany subsidy that is implicit in our public investmentin education and training, which there may be in someenergy-specific areas and in technologies andsciences? I suppose what I am thinking about is,should we regard the teaching of nuclear science inuniversities as a subsidy or not?Dr Blyth: I have not managed to try to get data onbreaking out that. It is difficult. I suppose yes, inprinciple, that would count as a subsidy. I thinkstrategically, if you are thinking whether or not thiscountry needs nuclear and if the answer is yes, theneducation is an extremely important part of that. So,you have to do it, and if you do not have thoseeducation systems in place, you are not supporting theindustry. I suppose the answer to the question is yes,in principle. You should identify every service andaspect of Government service and infrastructure thatgoes into each individual sector and allocate that bysector. I am not sure how possible that is to do.

Q26 Zac Goldsmith: A slightly different question,but also on ancillary subsidies or implied subsidies,is, have you managed to look at the subsidies inherentin our Export Credit Guarantee Department, forexample—which has not recently, but historically,provided favourable loans and has de-riskedinvestments in the fossil fuel sector throughout theworld and is still able to do so now, even though ithas not over the last couple of years, I believe—andalso through our World Bank lending and so on? Isthat part of the calculation?Dr Blyth: I think in principle it is, and one of thereasons it is not in here is because, as you say, theyhave not done any, so as I was looking through—

Q27 Zac Goldsmith: We have through the WorldBank, though, I assume. I would be amazed if we havenot through—

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Dr Blyth: Through the World Bank, yes, and throughthe other development bank institutions, yes.Zac Goldsmith: I am certain we have. I just can’tremember the examples.Dr Blyth: That is right. The development banksthemselves have active energy programmes and theEBRD, for example, will fund coal plant investments.They would argue that they are investing in coal plantto make them more efficient and therefore moreenvironmentally friendly than they would otherwisebe, so you can take your view on that. I suppose thefact is that the involvement of the internationalfinancial institutions does in some sense lubricate thewheels of finance and other sources of finance in thatsense. It is kind of like a subsidy, even though theyare supposed to lend at commercial rates. They wouldargue that they are not subsiding, but facilitating. Thisis where it all gets a bit blurry round the edges, but Ihave not tried to look at the flow of UK moneyspecifically via the IFIs.

Q28 Zac Goldsmith: But from the point of view ofthe inquiry that we are doing now, would it be yourrecommendation that we look closer at some of thosearrangements by the World Bank, Export Credit—Dr Blyth: I suppose it depends what your scope is. Ifyour scope is UK subsidies, then arguably no. Verylittle of that would flow back into decisions made atthe UK economy level, apart from very marginally interms of their impact on global energy markets. Ifyour scope is UK subsidies, I would say that flowaffects developing-country economies.

Q29 Zac Goldsmith: Except not from anenvironmental point of view. There is a growing trendof developed countries exporting their pollution toother countries in any case, whether it is waste oremissions and so on. If you are looking at thecountry’s fossil fuel dependency footprint—I can’tthink of a more elegant way of putting it—then youwould have to look, presumably, at those favourableloans made available directly or indirectly by the UKGovernment, surely.Dr Blyth: I would argue that the Export Guaranteeone is worth looking at, in the sense that it is relativelyeasy to look at it because it is all published and all theprojects are there, and at the moment they are notdoing it. I do not know whether that is a policy not toor whether it is just that nobody has applied for it.I think it is a very reasonable question to look at thepolicy of the IFIs and what they are lending money toand whether the UK, in its broad environmentalpolicy, is either comfortable with that or should beinfluencing that. It is an important issue, but I do notnecessarily see it as linked to the subject, but I am notin charge of your scope, so that would be for yourCommittee to decide.

Q30 Chair: We decided not to restrict this just to UKsubsidies. We will be looking at the whole aspect ofglobal trade and the need to have leadership in termsof global negotiations. It would be very difficult justto restrict it totally to UK, wouldn’t it?

Dr Blyth: Yes. UK subsidies influence decisions inthe UK in terms of what gets built, which affects ouremissions, and then that affects our ability to negotiateinternationally. So, in that sense, I suppose I see thesubsidy question as being what are we doing at homeand—I think your point is right—that that affects whatyou are able to say internationally, but whether thescope of your inquiry should look broadly atinternational subsidies is—

Q31 Caroline Lucas: Very quickly on the relativesubsidies between the different energy sources, wouldyou agree that your figure for nuclear is prettyconservative given that we do not know what thedecommissioning costs are, and they may well behigher than you have factored in, but also on liability?In the main body of your text you point out thatalthough the UK is increasing the cap of liability upto €1.2 billion, Fukushima, for example, is €175billion. Can you just remind us what assumptions youhave built into that figure? If you were to put thatliability figure where it probably should be, the figureof the subsidy would be a bit bigger.Dr Blyth: It would go up in that sense. Yes, I thinkthat is right. I have a question mark in the table againsthow much the NDA budget might be required to bein order to cover decommissioning Sellafield waste inparticular, and other liabilities. So, that is not includedin those numbers that I just quoted comparingrenewables and nuclear.Going forward, I have left out of that table what theforward-looking subsidies are, which is where youreferred to the cap on liabilities for accidents andemergencies and so on being €1.2 billion. That is avery difficult question to try to quantify, which ispartly why I did not come up with a number for whatthose subsidies were. If you start to say Fukushima is€175 billion, it could have been a lot worse. If youhave to evacuate the whole of south-east England,what is the economic damage of that?Caroline Lucas: A lot.Dr Blyth: A lot, exactly. The problem is that the onlyway of quantifying it properly is to try to getcommercial insurance, but you just can’t get it. Thefact that you can’t get commercial insurance on theone hand makes you think, “Crikey, this must bereally high.” On the other, I could argue that theliquidity of the market for insuring againstFukushima-scale accidents is just so thin it is not aproper market. So, is it reasonable to expectcompanies to go and get commercial marketinsurance? Markets are not perfect, and that is aparticular example. I agree that the number is higher,that that is probably a bottom-end estimate, but I amnot going to pin my hat on what the number shouldbe higher than that.Having said that that is a bottom estimate, could I justpoint out that the NDA budget is very visible, it isthere, and that is what the Government puts into theNDA? The NDA becomes quite a complex issue, butwhen you look at the budget for decommissioning ofSellafield, it has not been in EDF’s hands for verylong. It is picking up the back end of a commercialasset, and arguably it should not be responsible for thewhole history of a lifetime of nuclear waste. There is

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a burden of balance between Government and industryin that context. You would have to look at whether theNDA budget was really a subsidy. You would have tolook at the deal done when British Energy was soldto EDF at £12.5 billion and say, “Was that the rightprice for those assets, given the share of responsibilityfor the liabilities that came with it?” You could do awhole study on that, and I am not the right person todo that study.

Q32 Neil Carmichael: So far we have been talkingabout energy generation, but what about distribution?There is a fair bit of subsidy in distribution, notnecessarily in this country now, but in comparison toother countries that still do subsidised distribution.What consideration have you given to that question?Dr Blyth: Distribution? Are you thinking aboutelectricity?

Q33 Neil Carmichael: Of energy, of electricitydistribution systems.Dr Blyth: The electricity distribution system is amonopoly, and it is a protected monopoly in thatsense, so National Grid operates it, but it does operateas a commercial entity, and its costs are covered bythe charges it makes to consumers.

Q34 Neil Carmichael: But in terms of internationalcomparison? Obviously the Central ElectricityGenerating Board and its distribution mechanism wasin the public sector and did get a subsidy. I do notknow the situation in other countries and who shouldbe comparing those, but I would like to.Dr Blyth: The situation varies considerably. I wouldsay Europe-wide there is still some public ownership,but it is not unusual to have a fully-funded privatesector, albeit a regulated monopoly model, operatingin the transmission system. In the US you havedifferent sorts of model, some regulated monopolies,some private-market arrangements, so it does vary. Ithink the UK is probably, in the electricity sectorwhere there is low levels of subsidy internationally, inthe sense that it is fully privatised and it fully coversits own costs, within that regulated model.

Q35 Neil Carmichael: One other area of differenceis, of course, VAT in energy. We have relatively lowVAT levels and lower than our immediate competitorsin Europe. Does that mean they are being a bit unkindto those who are heading into fuel poverty, or are thereother mechanisms they are using to deal with fuelpoverty?Dr Blyth: I think the evidence on the extent to whichthe reduced rate of VAT is targeted to the fuel poorshows it does not target the fuel poor very well. Inother words, all consumers benefit and therefore it isnot very well targeted. I think there are much betterways of spending the money that that effectivelycosts, if you like. If you were to look at the amountof revenue you would get by charging 20% VAT andthink how would you spend that money, giving itequally to all consumers is probably not the way youwould do it.

I think other countries look at individual rebates in amore targeted way. The UK has some interesting anti-fuel-poverty approaches in the ECO, EnergyCompanies Obligation, and those sorts of requirementto invest in housing infrastructure, for example, iscertainly an area that could be strengthened. If youhad a certain number of billions of pounds availableto you to strengthen those programmes, I think thosewould go a long way.

Q36 Neil Carmichael: Of course you could arguethat measures to encourage better insulation and soforth are also an indirect subsidy. How would you, forexample, describe the Green Deal, or at least earliersubsidies for introducing energy use savings?Dr Blyth: A lot of those earlier programmes werefocused on the fuel poor, also vulnerable families,elderly or low-income houses, so the energycompanies were required to go and fit new insulation.I would say that was a subsidy and a good place toput the money. If you can improve the housing stock,that is good not just for the consumers, but for theenergy system and the climate as a whole, so thatseems to be the sensible way to go.

Q37 Dr Whitehead: Could we have some thoughtsabout developing subsidies and, to start with, shalegas? How does that fit into the subsidy pattern, inyour view?Dr Blyth: Essentially the shale gas is going to bealmost like a new sector, a new part of the new gassector, and the Government is going to have to comeup with a tax regime that strikes a balance betweenincentivising companies to do it, if that is the way itneeds to go to develop shale gas. If you tax tooheavily, then companies obviously will not beincentivised to come and try to make a profit out ofdeveloping the resource. If you tax too lightly, thenyou are not making any money out of it as aGovernment and what is the point? You should notjust be giving out this resource for free for companiesto be making a profit out of.I suspect in the early stages of shale gas theproduction profile of those fields is relativelyuncertain. Until you start drilling and fracking you donot know what the flow of gas is likely to be, so thereis quite a lot of learning in the early stages. I suspectthat that will mean relatively light taxation andrelatively little revenue in the early stages. You couldlook at that and say, “Why are you doing that whenyou still have North Sea gas coming in?” You have tobalance the interests of onshore and offshore and tryto create—I think “level playing field” is the wrongterm—at least some sort of fairness while balancingstrategic issues around whether the UK should bedeveloping shale gas strategically over the longerterm. It is a rather fluffy answer to your question. Isuppose in principle you might look at low earlytaxation rates as a subsidy, or you could look at thatand say that is the normal way that countries operatewhen they are trying to attract energy companies intoa new and rather uncertain resource in the country.You have to work your way into that system rathergently and then you potentially increase taxation ratesfrom there if the industry turns out to be successful.

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Q38 Dr Whitehead: Does that come under thegeneral banner of the industry support mechanism,even though the infant industry is in a commodity thatis mature?Dr Blyth: I suppose it does. It is a slightly odd wayround, because the thing with the extractive industriesis you are already sitting on the resource and thequestion is how much you tax companies to come andexploit that resource. The infant industry usually isthe other way round where, as a Government, you aregoing to set a feed-in tariff for renewables, forexample, and you are in charge of the relationshipbetween the consumers and the energy companies. Doyou see what I mean? It is a slightly different wayround. You are mandating payments from theconsumers to the industry in the case of what I wouldcall straight subsidies. In this case, you are trying tocome up with what is the right level of tax. It is smalltaxes, but big taxes as opposed to small subsidies.

Q39 Dr Whitehead: Is that a potential source ofconfusion in terms of how subsidies in general withinthe EU relate to state aid regulations and the extent towhich, for example, the RO is defined as state aid buthas a wayleave on it on the grounds that it isdeveloping a commodity that otherwise would not beavailable?Dr Blyth: I am afraid I can’t answer the specifics ofhow shale gas is going to be viewed in terms of stateaid rules. I think that is something worth pursuing totry to clarify, because you are right: it becomes murkyquite quickly, and it is much easier to think aboutdeveloping a reference level for subsidies in a maturesector. For example, you have the mature gas sector.In 10 years’ time, if and when shale gas is established,you might look at what is the taxation rate for thatcompared to other sectors. It is all settled out, and youcan then compare the different levels and see whetheryou think that is fair or not.At that point, it might start to be sensible to thinkabout the issue in terms of subsidies. At this point,when we are thinking about what is the tax regime forshale gas, I do not think it is sensible to think aboutit in terms of subsidies. It is easier to think about it interms of what is the right strategy for the Governmentto pursue when it is thinking of working out thecorrect tax rate for exploiting those resources.

Q40 Dr Whitehead: Where you have a matureindustry, such as the nuclear industry, and you have apublic statement that there will be no public subsidieson that mature industry, in your understanding of whatis a subsidy, how far away from the direct use of theword does a subsidy have to stand and to what extentdoes that then wrap itself back into EU state aid rules?Dr Blyth: I think you have to contort yourself quitedrastically to say that nuclear is not being subsidisedunder the CFDs, with the caveat we do not know whatthe strike price is yet, because it has not beenannounced, but we think we might know where it isheading.Dr Whitehead: Or the length?Dr Blyth: Or the length—indeed, yes. I should caveatthat statement with the fact we do not know what thenumber is, but it looks as though the numbers being

discussed are higher than market rates, in which casewe should call a spade a spade and call that a subsidy.The question then becomes, “Is that a justifiablesubsidy?” which is the same argument withrenewables. The EU has to then decide, “Okay, this isa state aid. Is it an allowable state aid or not?” I thinkthat is a very healthy discussion.

Q41 Chair: Do you think that will be a discussionthat will be resolved in the European Commission onthe state aid in terms of nuclear?Dr Blyth: The contracts will have to be cleared forstate aid rules in order to be able to proceed, so I amafraid I can’t answer in very much detail as to whatthat process is. I think all you can say is that theGovernment will have to be negotiating now with aview to those rules, that agreement being allowable. Isuspect that it will follow the path of we need this tohappen in order to create conditions under which aviable nuclear programme over the longer term can besustained. If you don’t have one, you can’t have morethan one. Given the lead time on how long thesethings take to build, I presume that is the sort ofargument that will be made as to—

Q42 Dr Whitehead: As far as subsidies areconcerned, bearing in mind we have slightly differentconditions in the UK than in some places in termsof the relationship of the state itself to energy supplycompanies so that the subsidy is going to companiesrather than the subsidy to the state itself for doingsomething in relation to energy, whether or not thatsubsidy is either passed on or borne by the consumeror is putative tax spend or actual tax or consumerobligation, and the same company is undertakingpresent supply as maybe is responsible for developingnew supply—carbon price support, for example,which has been determined not on the basis of aparticular category, but has been determined now—the extension upstream from CCL has beendetermined on the basis of carbon intensity. Is it asubsidy when a supplier avoids a tax as a result of thedefinition that was put into how that tax is extendedand therefore stands much better in relation to that taxthan they previously did and against other suppliers?Dr Blyth: Are we talking about CCL—ClimateChange Levy?Dr Whitehead: CPS is based on carbon intensity andnow does not apply to old nuclear, but does apply to,say, gas or coal, and therefore if you are a private-sector supplier of gas, you will pay CPS. If you are aprivate-sector supplier of existing nuclear, you willnot pay CPS, but you are the same company that isdeveloping that new supply.Dr Blyth: I suppose I see the carbon price system asinternalising the externality, so in that sense I wouldnot say that was a subsidy. It is changing the incentiveas to what you may invest in, and it is creating anincentive to invest in low-carbon sources because, asyou say, if you are using fossil fuels to generateelectricity, you have to pay the carbon price.

Q43 Dr Whitehead: How are subsidies treatedinternationally? In this instance, as a result of adefinition of an extension of a previous arrangement,

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CCL, and its incorporation into claimed carbon floorprice, CPS, people who had been doing what they hadbeen doing suddenly had a differential in terms ofwhat they paid. A company that had for years beenrunning a gas-fired power station paid CPS; acompany that had for years been running a nuclearpower station did not pay CPS; previously they bothdid not pay anything. Does that count as a subsidy,bearing in mind there is no development going on, noincentive for an immature industry and no consumerbenefit thereby? How does that work into the systemthat you have described?Dr Blyth: I think when you change the tax regimegenerally there will be winners and losers, andtypically you would try to smooth those out by havinga transition arrangement to avoid stranded assets. Ifyou, as a company, have set up your investmentsunder one particular framework, you do not then wantthe Government to change the tax regime on you in arather random way to change your income stream inan unpredictable way.I suppose arguably the UK’s ambitions towards lowcarbon from a policy point of view have been ratherwell signposted, so I suppose you could argue thecompanies have had some forewarning, although theyprobably could not predict the details of thosechanges. You might look at that as not being a goodexample of how to transition towards a new taxationregime. I suppose I would struggle to see that as asubsidy issue. Again, it does become a bit fuzzy aboutwhether we are talking about subsidies or changes intaxes.

Q44 Dr Whitehead: This is what I am trying to geta handle on. For example, as it happens there havebeen four extensions given for existing nuclear powerplants to last December, to this December—Dr Blyth: Yes, lifetime extensions.Dr Whitehead: Two of five years, two of seven years,all of which will be covered by the payments underCPS or not. Those will now all be exempt frompayments, whereas previously if someone had wantedto extend the life of a nuclear power plant, they wouldhave been on a level footing with a gas-fired powerstation. There is no new development going on, justan extension of an existing power station.Dr Blyth: I do not see that as a subsidy.

Q45 Dr Whitehead: Forty-four billion pounds?Dr Blyth: In my view, if you are internalising externalcosts of environmental damage, that will create abenefit to the companies who are running plant that isnot creating that damage. That is how I wouldclassify it.

Q46 Dr Whitehead: On more specific renewablesubsidy, bearing in mind that ROCs have translated toCFDs—one of which was about renewables; the otheris about low carbon and not necessarily renewables,and there is a levy control framework for generaldevelopment—how do you regard the role of—On theone hand, you have a development ambition, whichis that there should be a doubling of deployment ofrenewables, particularly offshore, by 2020 on presentdeployment arrangements. That is provided for by a

subsidy, either the ROC or CFD. Then there is thelevy control framework, which limits the amount ofsubsidy that can be paid, and, as you have set out inyour table on page 33 of your report, you indicatethat, bearing in mind cumulation, there should beabout enough room for the present of deployment ofrenewables. So, the subsidy arrangement contradictsthe statement on the ambition of the subsidy.Dr Blyth: Sorry, could you say the last bit again?Dr Whitehead: On the one hand, you are saying thereis going to be a doubling in deployment of renewablesand that is based on a subsidy. The subsidy itself iscapped, and you have shown in your chart that thereis sufficient headroom, bearing in mind cumulation,for deployment at roughly the present rate, whichtherefore is half of the ambition that is set out for2020.Dr Blyth: I see what you mean. I have not done thecalculation of whether that is sufficient. I suspect youmay well be right that there is a conflict between thelevy cap and the level of ambition. I have not donethose numbers myself and I would need to defer toother sources of those calculations, but potentially Ithink you are right. If the cap is not high enough toget you to A or to B then clearly there is a policyconflict that needs to be resolved as to whether thecap has been set high enough. So certainly inprinciple, there is tension between those two issuesand I think that needs to be investigated.

Q47 Chair: I am looking at my colleagues. This hasbeen the first session using the academic research thatthere is here. We have had a very academicpresentation. Before we bring this session to a close,do you have any gut sense yourself in terms of policyrecommendations that you think might arise out of thesubmission that you have given this afternoon?Dr Blyth: Ideally we would want to get to a stagewhere we can discuss these issues without them beingheavily politicised. I suppose that is too much of anask. There are such strong views on all sides aboutnuclear versus renewables and the proponents of eachof those. In my personal view, I think it is clear thatnuclear does receive a subsidy. I also think, given thatthe gas price that we are facing in the 2025 to 2030time frame is so uncertain, while it is clear that thatsubsidy exists against current market conditions, it isnot clear that it will still represent a subsidy over thetime frame for which that plant will be operative. Ifwe think of 2030, it may well be that it has turned outto be quite a good bet. You can see that that hasalready happened in some of the early NFO windcontracts that are currently below market price. Theystarted off as a subsidy, it turns out—what do youclass that as? Does it become a negative subsidybecause they are generating electricity at a fixed pricebelow market rates? You could quite easily seescenarios where the same thing happens for nuclear,so what might be a subsidy today may well not be asubsidy in 15 years’ time.Having said that, I am not going to try to predict foryou that gas prices are going to go up by 2030. Thereare quite plausible scenarios where gas prices godown. I personally feel that when embarking in thatdirection of building—I do not know how many

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24 April 2013 Dr William Blyth

nuclear plants are required to establish it—one or twoor some is not a bad risk and a bad bet to make as aninsurance policy against future gas price risk.

Chair: On that point, I will bring the proceedings toa close, so many thanks once again for coming toappear before us this afternoon and for the research.

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Environmental Audit Committee: Evidence Ev 11

Wednesday 15 May 2013

Members present:

Joan Walley (Chair)

Martin CatonKaty ClarkZac GoldsmithMark LazarowiczCaroline Lucas

________________

Examination of Witnesses

Witnesses: Peter Wooders, Programme Leader, Global Subsidies Initiative, Shelagh Whitley, Research Fellow,Overseas Development Institute, and Charles Perry, Partner, SecondNature, gave evidence.

Q48 Chair: I would like to give a warm welcome toeach of you and thank you for taking the time to comealong to our session on energy subsidies thisafternoon. I know that two of you particularly haveexpertise with respect to fossil fuel subsidies on theglobal stage. It is how we link that in a vertical wayto what is happening in the UK as well. There isrecent interest in this and reports on it, and the newstoday about Shell and BP may be connected in someway with subsidies or pricing. This is to give you anopportunity to give us some idea of the extent of extraglobal emissions that would result directly fromenergy subsidies. I will try to catch the eye of all threeof you and give you an opportunity to respond.Peter Wooders: Thank you very much, madam Chair.Firstly, could I offer my thanks for being invited tothe session today? I think the inquiry is extremelyimportant. To have a leading country like the UK anda G20 member saying how large its own subsidies areand whether they are good public policy or not is veryimportant, both nationally and internationally.On the scale of international subsidies, there are aseries of benchmark publications. The InternationalEnergy Agency, first in 1999, put together an initialestimate of consumer price subsidies—consumersupport in determining lower prices for fossil fuels.That figure is around $500 billion per year across theworld. When we say across the world, they look at 37countries. Those are developing and emergingcountries. They are not looking at the UK within thatlist and they are not looking at most of the developedworld. It is around $500 billion per year.Another very important publication that has been donefor the last couple of years by the OECD is AnInventory of Estimated Budgetary Support and TaxExpenditures for Fossil Fuels. The OECD has lookedat its own membership in 34 countries and worked outhow big subsidies are to consumers and producers forfossil fuels, and their estimates are somewhere around$55 billion to $90 billion per year. Then there is awhole bunch of other studies, including work by myown organisation, Global Subsidies Initiative, thatseek to get extra information, particularly on theproducer side. It is relatively easy to make estimatesof consumer subsidies; it is much harder to makeestimates of producer subsidies. If we think aboutupstreaming oil or gas and there is a tax break for aparticular field allowance or a particular initiative, isthat a subsidy or not? What is the benchmark? There

Caroline NokesDr Matthew OffordMr Mark SpencerDr Alan WhiteheadSimon Wright

are a lot of decisions that have to be made in thatcalculation. The consumer side is very easy. You lookat the price the consumer pays, you relate it to whatit would be if there were a proper free market and youlook at the difference. It is pretty simple.You asked about the scale of emissions. There hasbeen modelling work done. Again, the IEA and theOECD are very strong in this area and their modelstend to show that if subsidies were all withdrawn, allremoved, the world would reduce its globalgreenhouse gas emissions by something in the orderof 5% to 10%. Those are very significant compared toclimate change. This is far from a throwawaycomment.You mentioned the news about Shell and BP and someof the other oil companies this morning. The ultimateaim to remove subsidies is to move to deregulatedmarkets that work very well. In countries that haveprices that are set on an ad hoc basis and are subjectto government interference, it is very hard to reflectwhen the oil price moves that the local price movesas well, and subsidy tends to build up. However, allcountries have an ongoing challenge to make sure thattheir energy markets continue to function well.

Q49 Chair: Thank you. Do you want to add to that?Charles Perry: I am Charles Perry. Hello everybody.It is a great pleasure to be here and I am very pleasedthis inquiry is happening because I am one of thepeople who suggested it. I suggested it initially to theEnergy and Climate Change Select Committee butTim said that they could not fit it in. Then I came tosee Joan and Simon and suggested it here. I am verypleased that it is happening, so I am glad also toparticipate. There is very little that I disagree with inwhat Peter said, even though we only met each othertoday, and I have just had the pleasure of meetingShelagh today as well.I run my own business. It is called SecondNature. Weare a sustainability consultancy, but I used to be at BPso I have a bit of a cross-section of experience. Wedid the whole rebranding with John Browne in2000–2001 to Beyond Petroleum with the Helios.Then I ran the renewable energy division and left in2006 before Tony Hayward became the chiefexecutive. I subsequently ran renewable at GoodEnergy where I was Managing Director.In my experience in energy, both on the fossil fuelside and on the renewable energy side, language is

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very important and definitions are particularlyimportant. There are lots of words that are used oftento confuse people, not intentionally but, for example,the phrase “feed-in tariff” is a very confusing Englishphrase when you first hear it. Some people use a verynarrow definition of fossil fuel subsidies or energysubsidies and others use a much broader one. Peterhas talked about the IEA, OECD and WTO. They alluse a very broad definition, which I do too, but others,for example Her Majesty’s Treasury, use quite anarrow definition in the UK of subsidies, quite a literaldefinition. I am going to throw just a few words out—support, intervention, benefits, concessions, breaks,access, price manipulation, research and development.For me, these are all part of the field of energysubsidies, or energy support if you like. That is thecontext from which I am coming in this discussion.

Q50 Chair: How do you think it might be possibleto get some kind of consensus about a definition ofwhat constitutes a subsidy to include all thosesubsections that you just read out to us?Charles Perry: I would suggest following the quitewell-established definitions of the very crediblesources on the international scale that have alreadywrestled with this. Whether it be the OECD, the WTOor the IEA, there are fairly similar definitions betweenthose three international groups and their definition isvery broad. I will read you the IEA definition rightnow, “Any government action that lowers the cost ofenergy production, raises the price received by theenergy producers or lowers the price paid by theenergy consumers”. That is a very broad definition,which I like. The WTO definition is not dissimilar.However Joan, in particular on your question, in theUK I think it is about a discussion, and I wouldencourage more discussion on this in Government,across Government Departments but also with thepublic and NGOs. I think all of us could be involved.It is a very interesting topic that we need to know ascitizens of Britain. We need transparency on this. Themedia in this country—especially for example theDaily Mail—would like us all to believe that we arepaying a lot more for renewable energy as consumersbut if you compare what we are paying for renewableenergy versus fossil fuels, it is six times more forfossil fuels as a taxpayer than it is for renewables. Itis having that transparency. Another example is that Ihave had conversations with the Treasury and theywould say that a lot of the things that I would argueare subsidies are not subsidies. For example, taxbreaks, field allowances for the North Sea, they wouldargue are not subsidies. It is important to be broad inthis definition if we want to establish transparency.

Q51 Chair: Shelagh Whitley, did you wish to add towhat has just been said about global emissions andhow we can measure them?Shelagh Whitley: Peter quoted the OECD number,which I have as 6% if fossil fuel subsidies areeliminated by 2020, which some people think ispossible. I would agree with that statistic. On linkingUK subsidies to global fossil fuel subsidies, in the

research that I work on, I work with the OverseasDevelopment Institute and we are looking specificallyat climate finance—finance from developed countriesto developing countries that was agreed inCopenhagen. The goal is 100 billion going fromdeveloped to developing countries by 2020.The goal of that money is to address climate change,mitigation and adaptation in developing countries.That finance, when we look at it, is really a drop inthe bucket compared to fossil fuel subsidies, bothdomestically in countries like the UK but also in thesecountries themselves. This has been broadly ignoredin terms of how important it is to understand domesticsubsidies when you are, in a way, putting in place newsubsidies through climate finance. The goal of climatefinance is to incentivise change and the goals aredirectly contrasting with those being achieved throughthese different subsidies.That would be the main link and it is important bothin the climate finance that the UK provides directlybut also what it provides through intermediaries suchas the World Bank, the IFC and other developmentbanks. There are some fairly good statistics as wellabout the scale of fossil fuel subsidies that are beingprovided by those institutions. There are estimates.Again, one of the main challenges of subsidies is thatthe data are not very good. We do not have a lot oftransparent information, so all these are almostsometimes finger in the air estimates, but forinternational financial institutions and nationaldevelopment banks, the estimates, and you can tellby the range, are between 15 billion and 150 billionannually for fossil fuel subsidies and from exportcredit agencies again between 50 and 100 billion. Wedo not have very much robust data but these are theestimates and some of that money will be comingdirectly from the UK in order to support developingcountries. The question is what do we want to besupporting.

Q52 Chair: How important do you think it would befor us to get someone from the IMF—because theyhave just done a recent study—before our Committeeto give evidence about their role in all of this?Shelagh Whitley: I think it would be importantbecause they are engaging other Governments directlyabout how they can address fossil fuel subsidies. Theyare always looking at fiscal policies within countriesso they have a good sense of what is happening onthe ground and the potential for reform. We werespeaking about this outside. The World Bank isbecoming more active in this space so it could beworthwhile having someone from the World Bankcome to speak about the work that they are doing. Iunderstand that there is the potential for a facility tobe set up on this by the World Bank. This was recentlydiscussed at the spring meetings. I think that wouldbe very useful.

Q53 Chair: When we were discussing this before wewere told that there were various justifications forhaving subsidies. We are going to be looking atinequality and affordability later. One of the reasonsthat was suggested to us as a justification for subsidies

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was to protect industry. Do you think there could everbe a justification for a subsidy on that basis?Peter Wooders: I would be very happy to answer thatquestion. The subsidies are given across the energysector to different fuels, to different processes and todifferent users. When we think about the $500 billionper year on fossil fuel subsidies from the IEA, that islow prices for energy consumers who tend to bedrivers of vehicles. The most common source isgasoline (petrol) and diesel use. Some of that is forproductive economic use of transport and so on but alot of it is private transport use. Other subsidies aregoing to electricity, to kerosene, to LPG. Again, someof that is for productive function but a lot of it is not.A lot of it is for heating homes, it is for keepingpeople going within their daily lives, but it is notdirectly related to production. When we look at theenergy side, very few of the actual energy subsidiesare, in effect, making industry more competitive.There are some industries that are heavy users ofenergy but most industry is not. Most industry uses alittle bit. It is a small fraction of their operationalcosts.Where it differs is when we look into renewables.There is a big debate at the moment. Whenever myorganisation, the International Institute for SustainableDevelopment, looks at a scenario for a moresustainable world, it has more renewable electricitygeneration in it. That is clear. So how do we bestencourage that and how do we best incentivise that?There is a temptation for Governments that theywould like, therefore, to have that subsidy or thatsupport to that industry generating jobs and generatingworld class industries and export competitiveindustries in their countries. That is a very legitimateaim. Whether it is legal within all trade agreementsand so on is another question. That is a very importantquestion for the UK and for this Committee to look at.

Q54 Chair: Is it an issue that we should be lookingat in terms of how, through WTO or othermechanisms, this gets resolved?Peter Wooders: I think it is, yes.

Q55 Chair: Do you think that there is a mechanismin place to establish what does constitute it and whatdoes not and whether it should be allowed?Peter Wooders: The WTO has its ASCM, Agreementon Subsidies and Countervailing Measures, which we,the Global Subsidies Initiative, would say is probablythe most useful definition of subsidies there is becauseit is agreed by the entire WTO membership of over150, has been legally tested and so on. However,within that, lots of countries want to support cleanenergy production sectors in the future and it is reallyan industrial policy type question, that everyone istrying to build up their industries.Is that WTO-legal or not? There has been a recentcase just last week with Ontario against Japan, inparticular, where various decisions were made. Wethink it would be very helpful though if the majorcountries within the WTO were to sit down and say,“We all want more renewables here for sustainable

development reasons. We all like to support ourindustries as well. Can we come to some sort ofagreement about what would be fair support and whatwould be unfair support?” Maybe that can go throughthe official rules of the WTO or maybe it needs tohappen in a plurilateral-type way among the mainplayers. The UK is clearly one of those.

Q56 Caroline Lucas: I wanted to see if I could riskputting words in your mouth. You have all been quitepolite about the way in which different subsidies workand the word ringing out hard in my head is that it isjust utterly incoherent. Would you agree that in asense there is a fundamental incoherence betweensubsidies on the one hand that seem to be with oneset of objectives versus subsidies being given by thesame Government, often at the same time, to achievea perfectly alternative objective? Fundamentally whatwe are looking at here is a real lack of coherence, forwant of a better word.Peter Wooders: All subsidies are generally put in atthe beginning for good reasons. Whatever subsidy youlook at, at the beginning there was a need to supportthe public or to stop deforestation or to build up anindustry or whatever it was. The Government had alegitimate aim that it wanted to follow. However, asthat subsidy goes through over time—five, 10, 20more years—it gets captured, in effect. The benefitsgo to those we do not want to see get them. Theclassic would be if we look at the subsidies that aregiven in developing countries to consumers, less than10% goes to the poorest 20%. The other 90% is goingto other people who do not really need it and that thengets defended as a right.However, going back to the definition question aboutsubsidies, there is always a debate about definitionsand which is the right one to use. What we are reallyasking here is, is public policy good or bad. Oftenwhen people use the term “subsidies” it implies badsubsidies, so we say, “There is $500 billion ofsubsidies, they should all be reformed, they are bad”.On the fossil fuel side, on the consumption side, thatis a pretty good rationale because it is not a hard one.Most of the impacts are perverse, are unhelpful. Whenwe look at renewables, it is a different question.Technically they are still subsidies but are they good,are they bad, are they indifferent? There is very littleinformation and analysis about evaluating thosesubsidies and that is what we really need to get to,away from the kind of definition to measurement andthen to evaluation.Charles Perry: It is important to understand thecontext of history here. When the combustion enginewas first developed in the early stages of the IndustrialRevolution, times were very different. It was hugelyexpensive to own your own automobile and there wassupport at the early stages of technology, as thereoften is. When you fast forward to a point where wehave never consumed as much globally as we aredoing today—some people like to talk about usburning 1.5 million years worth of fossilised matterevery year with 7 billion people on the planet—youhave a very different situation. What started off assupport, and of course most of it was nationallyowned way back then, with private enterprise and

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competition and the mass market applicability ofthings like the automobile you get to a point wherenow it does become incoherent—your word,Caroline—because we are trying to use instruments tochange behaviour. If you introduce a Climate ChangeAct because you recognise that things have changedand we are burning too much fossil fuel, then ofcourse you want to use carrots and sticks to changepublic behaviour in line with that change. That is verydifferent from when the automobile was first invented,for example.As evolution happens, one has to use those carrots andsticks to incentivise the right sort of behaviour. Goodclean behaviour is what we want to incentivise, Iimagine. If subsidies are about protecting theconsumer, which indeed they often are, it is aroundwhat sort of policies we need to protect the consumergoing forward. We all know what happened in Nigeriawhen fossil fuel subsidies were removed and priceswere suddenly unaffordable. There were massiveriots. That is the other end of the scale. Iran iscurrently phasing out subsidies too. The USA has gotused to what they call “cheap gas” and certainly weknow that that was not the true cost of that gas at thepump. It was an artificial cost that had been helped bysuccessive Administrations. In the context of history,given that we are trying to solve the massive problemof burning too much fossil fuel, we need to leveragethe right carrots and sticks.Shelagh Whitley: Just to follow on Caroline’squestion, I have published a paper entitled At CrossPurposes. I agree completely but I think that none ofthat is intentional. What you find is that it will bedifferent Ministries with very different sets ofexpertise and very different mandates that are puttingin place the subsidies or incentives, bothinternationally and domestically. If you look at thisbroad definition of subsidies, it includes directfinancial transfers, tax treatment, regulation,infrastructure support and trading and investmentrestrictions. Those are managed by very differentactors and within those different groups you may nothave awareness of the different subsidies that exist,let alone across them. So it requires a certain amountof co-ordination and almost a very high level directionthat is put in place by the Government to say, “Theseare the goals we want to achieve, so which levers orcarrots or sticks do we want to use?” That requiresquite a lot of co-ordination, which I think is one ofthe main challenges. It is not intentional that thesethings are happening at cross purposes.

Q57 Chair: That raises a lot of questions as to whoshould have the responsibility for bringing coherenceto all of that. Do you have any proposals about whatour inquiry could come up with by way ofrecommendations?Charles Perry: Just one point that seems fairlyobvious. We have had some progress, for example, atthe G20 level. The G20 has already agreed to phaseout fossil fuel subsidies and, indeed this was on theagenda of the Rio+20 Summit. I remember talking toCaroline Spelman at the Aldersgate event, before she

went off to the Rio Summit where she was going totake it up. Unfortunately at the last minute this topicgot bumped down the agenda at Rio, but the G20 hasstill committed to phase out fossil fuel subsidies sothere is a recognition that something needs to be done.Then it comes to the UK. To what extent does the UKneed to phase out fossil fuel subsidies and what is thelevel of fossil fuel subsidies in the UK at the moment?One figure, for example in 2010, said it was 3.6 billionin UK fossil fuel subsidies but these figures changeand they are very different, depending on the source.William Blyth did some interesting work and he cameup with some numbers as well. Getting to the bottomof what it means to phase out fossil fuel subsidies forthe UK, what the current level is, what the objectiveis in the next few years and having milestones to makesure that we meet those objectives is vital. I thinksome people feel that we do not have any fossil fuelsubsidies to phase out in the UK unlike in Iran orSaudi Arabia.

Q58 Chair: Presumably there is a case for comingup with a temporary subsidy, whether it is to getfledgling new technologies on stream, or in certaincircumstances to perhaps relieve the worst effects ofwithdrawing the subsidies. Is there a general rule thatapplies to how you might introduce a time limit or aspecific time period that they would apply that hasbuy-in from other countries internationally? Are thereany general rules about that? For example, by way ofUK legislation should we be looking at sunset clausesor things like that? Should there be a beginning andan end to these things?Shelagh Whitley: I have done some work and Irealised that there is a correlation across these. I wasgiving recommendations about how, if you were goingto put in place an incentive for the private sectoraround low-carbon development, you would designsuch an intervention. When I was looking at that Irealised that again these interventions or incentives arejust another word for subsidy. What seems to bemissing for existing subsidies and how they arestructured is around this question of monitoring andreporting and around the question of exit and failure.I do not know—maybe others on the panel do know—what are the best ways to put in place sunset clauses,but planning for an exit, planning for flexibility,planning for modification, building that around asystem where you have monitoring and reporting sothat you can make decisions around milestones seemsto make a lot of sense.We talk about this often when we are talking aboutclean energy because we want to do it in a way thatreflects the mistakes that we have seen so far in tryingto balance the question of long-term signals that theprivate sector needs or investors need with the factthat you do not want to be locked into an incorrectpricing model—allowing for flexibility. I do not thinkanyone knows how to do that perfectly and it wouldbe interesting to hear what others on the panel think,but it is more that you would incorporate monitoring,reporting and milestones and the concept of an exit,and the concept that any subsidy also will involvesome entities that receive that subsidy failing.

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Q59 Chair: I presume you would do thatmonitoring automatically?Shelagh Whitley: Yes.

Q60 Martin Caton: One subsidy that you havealready identified in your answers so far is a blanketsubsidy to consumers that is justified by trying to lookafter the poor. Correct me because I am putting wordsinto your mouth, but I get the impression that none ofyou thinks that that is a good way of going aboutthings. Do you have suggestions about how we tacklefuel poverty without that sort of blanket support?Charles Perry: I think it is the principle of the polluterneeds to pay rather than paying the polluter. If youadopt a principle of the polluter pays, then of courseyou can incentivise those people who are pollutingless and less and you can penalise the people who arepolluting more and more. If that sounds like a goodprinciple, which I think it does, then using the carrotsand the sticks around that principle makes sensebecause then you can help the people who also wantto help solve the problem, which is polluting less. Youreward the people who are polluting less and usingless and you penalise the people who are using toomuch and polluting too much. That happens on aconsumer individual level and also on a company,industrial and commercial level. Then there is alogical follow-through to how you take that from theprinciple.

Q61 Martin Caton: What about the domesticconsumer? Often the very poorest people do not havea choice about what fuel they have. They can’t changethe technology they have in their home because, bydefinition, they are very poor.Shelagh Whitley: I do not know if you want to speakabout developing country examples, but there aredeveloping countries that have restructured fossil fuelsubsidies and instead of using an energy price signalto support the poor—so lowering energy prices—theyare using direct cash transfers. That allows the poorestconsumers to make choices with the money that theyhave. The funds are being given to them to make thosedecisions as opposed to being given to energyproducers so that they can lower their costs. I amguessing Peter might have some more to say on that.Peter Wooders: I would. We have produced aguidebook recently at Global Subsidies Initiativecollating a whole set of international experience onsubsidy reform, which does not tend to be aneconomic problem. It tends to be that the economicsis understood but it is a serious political problem; it isa political economy problem. We categorise subsidiesof the type you described, blanket populationsubsidies, as, “A basic inefficient economic and socialassistance system”. The corollary is that if you canthink of any more efficient economic and socialassistance system, it will perform better than thepricing mechanism because the pricing mechanism isso inefficient everybody benefits from it, particularlypeople who use more, and that just does not seem tomake sense if your target is to protect the poorest. Thesavings are vast on some of these schemes in certaincountries, and I think the UK VAT exemption hassome of those characteristics too. We would advocate

that any sort of different assistance scheme, as longas Government has the credibility and the ability toimplement it, will perform better. It can be a cashtransfer, something through the tax scheme, paymentsinto the other functions of Government, or helpingwith schooling—all sorts of things that work indifferent countries. If any of those can be put in placethey will tend to work better than the pricingmechanism because the subsidies are so large.Charles Perry: I would like to follow on to the themeof this, which is collecting revenue from the bad andusing it to help the good. If you make the polluterpay you collect revenue on that and then you use thatrevenue to help where people need help, from anaffordability point of view but also from a doing theright thing, cleaner behaviour point of view. At themoment, subsidies are extremely costly for the UKGovernment in a situation where our biggest problemis getting the deficit down. These subsidies are hugelycostly. For example, the field allowances for the NorthSea, where we have a boom now in North Sea oil andgas exploration, we are supporting, through taxbreaks, to the tune of £2 billion. A recent study byFriends of the Earth found that for the last five years,since Alistair Darling introduced it and GeorgeOsborne increased it, there is a total of £2 billion forNorth Sea oil and gas exploration in tax breaks wherecompanies exploring are paying a much lower rate oftax as well. They are now paying 30% corporation taxwhere before they were paying much higher 60–80%because North Sea is a national asset. They are gettinghuge support and that is not about supportingefficiency, in my view. That is about supportinginefficiency. How we use our carrots and sticks todrive efficiency and the right behaviour is the criticalchallenge.

Q62 Martin Caton: Looking at the developingworld, if those developing countries are going to beenabled to wean themselves off fossil fuel subsidies,what sort of action is it going to need from thedeveloped world to assist them?Shelagh Whitley: First, and this is what I argued forin my paper, we have pools of money in the form ofclimate finance that are meant to be assisting countrieswith this transformation from, let’s say, brownbusiness as usual growth models to green growthmodels. The first thing that we can do is use some ofthis money to support transparency so that they havea clearer sense of what subsidies are, and there is anability to report on subsidies, which then gives themthe information that they need to make choices aboutthese carrots and sticks.At the moment, this is very much a level playing fieldwhere neither developed nor developing countrieshave a clear sense of the subsidies on the ground, andI guess in the climate space I would extend thisbeyond fossil fuel subsidies. I used data on fossil fuelsubsidies because those are some of the subsidies thatwe have the best data on, but for climate change youhave subsidies to agriculture, you have subsidies to allsorts of different activities that have also a hugeclimate impact. In enabling these Governments tohave a clear sense—a cross-ministerial sense—ofwhat is going on, the carrots and sticks that they are

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currently using and the implications of those, is veryimportant.At the moment, climate finance is already being usedto do that in looking at the expenditure side. Lookingat public expenditure, there is already work aroundthis that is being done in a number of developingcountries. However, for fiscal policies and otherlevers, there is not much work being done, so myargument is that we should start with that and thenyou have the data and information that enableGovernments to make informed choices.

Q63 Mr Spencer: Under the UN climate changenegotiations there has been a big push looking at theamount of cash that is going into developingcountries. To what extent do those subsidies distortand twist the market, and is that preventing privatecompanies investing in those countries? Does it warpthe whole thing so the private sector keeps out of theway?Shelagh Whitley: I would argue yes. What we aredoing right now is using climate finance and othertools, even carbon pricing, in order to reduce risk ininvesting in these situations where the playing field isskewed against investment in clean energy. What weneed to be doing is both. In the short to medium termwe have to have reduced risk to private investorsbecause the playing field is distorted, but you alsoneed to be working on the larger scale for makingmatch-up. Obviously it is different in differentcontexts, but the main problem is that we just do nothave a sense of what instruments are being used andthe impact that they are having. We know the playingfield is not level but we do not know what the maincauses of that are and how we could change them. Weneed to be doing both. In the short term we have tode-risk, but to think we are only going to use thatmoney for de-risking is almost us conceding defeatthat we can’t change the broader policy andinvestment climate of these countries.

Q64 Mr Spencer: Should we put measures in placeto make sure that if you are going to give subsidiesa condition should be the elimination of subsidy forfossil fuels?Shelagh Whitley: I am not sure if you want to go thatfar. It is a possibility. It is what I have just said; it isthis question of transparency. At least you should havethe data available. Maybe you don’t force aGovernment to make a reform but what you want isfor the Government to be able to show you clearly, orto be able to report on, the subsidies that it has inplace so that when you are making a decision to makea subsidy that is a de-risking you are at least doing itin a place where they are not working full-time againstyou, if you see what I mean.Peter Wooders: Governments understand howdifficult fossil fuel subsidies are making their lives.This is for fiscal reasons, for clean energy, investmentreasons; they understand that. To imposeconditionality would possibly just hold back the moveto cleaner energy. However, I support very much whatShelagh is saying, that we must have in mind what isthe shadow price—an economic term. If we are goingto compare properly what should be the energy price

we are comparing to, and that should be theunsubsidised fossil fuel price, asking Governments togo ahead and make that change before we help themwith their investment in renewable energy is probablya step too far. Governments are trying very hard toreform their subsidies. They understand what a bigproblem it is for them.Going back to the previous question, there is a rolefor a lot of players. It is very helpful for the UK withits bilateral aid to support those countries. There is arole for civil society organisations like ours to helpwith the public debate, and then there is a role fororganisations like World Bank and IMF to come inand advise the Government as well, and use theirlevers of access. Moreover, that process to get tosubsidy reform on gasoline in Indonesia, or whateverit may be, can take a couple of years. It has to becareful. You have to build support for reform, look atthe options and so on. I would not advocateconditionality on the clean energy there.Shelagh Whitley: Although support, I guess—there isa process for reform so there could be support thatcould help at different stages of that.

Q65 Mr Spencer: Why do you pick on Indonesia?Where are the worst places on earth where they aretaking the most subsidy, subsidising their fossil fuelsto the highest level?Charles Perry: Iran, Saudi Arabia, Russia China,India, but India, Russia and China are all making realsteps to reduce their subsidies for fossil fuels.

Q66 Mr Spencer: So they are in a poor position butthey are heading in the right direction.Charles Perry: They are trying to.

Q67 Mr Spencer: Is there anybody heading in thewrong direction?Charles Perry: I think we are heading in the wrongdirection because we are incentivising high pollutingbehaviour, which is ironic. It goes back to Caroline’spoint. It doesn’t really make sense.Peter Wooders: An awful lot of developing countryGovernments, when there is an increase in world oil,gas and coal prices, find it very difficult politically topass that full increase on to their consumers. As theworld prices increase, the level of subsidy tends toincrease, and that is really their challenge. They areall motivated to reduce those subsidies but it isdifficult. It is possible but it is difficult.

Q68 Caroline Nokes: From some of your earliercomments I could probably predict the answers tosome of my questions. Can there ever be a case forallowing fossil fuel subsidies in order to encourageeither economic development or to alleviate poverty?Peter Wooders: Yes to both, but the key is to target it.If it is a blanket subsidy through a general pricelowering, lots and lots of people you are not targetingwill benefit from it. Some of the keys are in yourexample; if you look at a country like Saudi Arabia,which has a huge petrochemical industry, they willargue that they will supply oil at a low price for thatindustry in order to build their economy, to make itmore modern, to bring people into the tax system and

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so on, economic development. There is a case for that,but that is not the same as a low price for a privatetransport user to have cheap gas. They are verydifferent, so targeting is the key.Charles Perry: Back to my point about history. For along time Governments around the world havesupported the profitable extraction and production ofcoal, oil and gas since they were first used. That madesense at the time because we had the IndustrialRevolution and that is what economies were built on.Moreover, things have changed and now we have aproblem we did not have at the beginning of theIndustrial Revolution, which is that we are using toomuch of an exhaustible resource and as a result wehave pollution problems that are local, healthproblems as well as international climate changeproblems. It is a valuable finite resource. Oil, gas andcoal are still valuable finite resources, but when theglobal rate of consumption has never been higher andthey are getting harder and harder to exploit, plus theadded costs of pollution, of course you have pricesrising and inflation, and this hurts people.It is a very difficult situation when you are in a viciouscircle and consumers are being hurt by the very thingthat you are trying to reduce. You are trying to reducetheir dependence on an exhaustible resource—fossilfuels—that has become polluting and is no longer asbeneficial as was once seen at the beginning of theIndustrial Revolution and the early phases ofcombustion of vehicles and plants. When as apopulation we have become used to a resource wherewe can get it cheaply at an artificial cost and suddenlyit starts to hurt our wallets—and these are voters weare talking about—you are in a very difficult situationand a vicious circle.How do you break that vicious circle and turn it intoa virtuous circle? This is the challenge we are facingin 2013, which is no small challenge. We have a legalpremise with the Climate Change Act to dosomething, and people generally recognise we needto change behaviour. Moreover, how the Governmentactually helps people to change their behaviour is thepoint of this whole discussion, and that is back tocarrots and sticks in the right way. For example, thephrase “green taxes” to me is a total oxymoron. It isa total contradiction. I cannot understand why peoplecontinue to use this phrase that makes no sense—“green taxes”. If anything it should be “greenincentives” and “pollution taxes”. If you are trying tochange behaviour, don’t tell people “green taxes”.They will run away from doing anything green, ofcourse.

Q69 Caroline Nokes: Do you think we should allowoverseas aid to support fossil fuel energy when it islinked to achieving economic development orpoverty alleviation?Charles Perry: Such as the UK Export CreditsGuarantee $1 billion for Petrobras for offshoreprojects? I definitely think we should not be doingthat.Shelagh Whitley: I would agree. If we are going tobe using overseas development assistance it should betowards achieving the goals of those organisations andthe goals of providing overseas development

assistance, which are poverty alleviation, protection ofthe poor, social protection. If you are also trying toassist in this transformation, specifically how can youuse those resources to support transformation andtransition in those countries?For instance, in Brazil where the UK may besupporting Petrobras through Export Finance, whatyou find is they have also set up a fund where someof the revenue from oil is going to be directed towardsmitigation and adaptation projects. What we shouldbe doing is co-investing alongside those funds andhelping Governments to set up those facilities so thatwhen they discover fossil fuel resources we can helpthem redirect some of those resources back towardstransformation. These are the places where we canengage with the fossil fuel industry. How do youpromote greening of an economy at the same time asexploiting existing resource without single-handedlydriving the economy towards business as usual or abrown path?Peter Wooders: It is a really good question and quitea difficult one. We can start in general with the pointthat electricity is fundamental to development, andusing overseas development assistance and otherinvestments to help countries build up their electricityinfrastructure seems like, in general, a good thing. Ithelps people right at the bottom of the pyramid and ithelps with general economic activity. There is a bigchange when families and communities get electricitycompared to when they did not have it. That is clearand that can be built up in essentially a technology-neutral way. You have a better grid and you can feedwhatever into it.However, in certain countries there is a real problemat the moment, which you would think in some casesfossil fuels could help with. If we look at, forexample, the case of Bangladesh, it is really strugglingto supply enough electricity to its country. It is tryingto generate larger amounts of access so more peopleare on the grid. It is subsidising the price of fossilfuels going into that system at the moment—principally fuel oils of various types and somediesel—and it is racking up huge debts of $1 billion-plus a year, which it is going to struggle to pay back.In that case, better pricing would help but someassistance in building up the electricity system and itsgeneration capacity might be useful there too. It isvery country-specific. It goes back to the same pointagain that everything is about targeting.

Q70 Caroline Nokes: Going back to the ExportCredits Guarantee Department that we have in theUK, if such support were used in other countries toguarantee fossil fuel products would that necessarilyconstitute a subsidy?Peter Wooders: In the broader definition, yes.Shelagh Whitley: Yes. In the subsidy definitions thatare used, at least in my paper and if you look at whatthe OECD and IEA would include, those would beincluded and categorised as subsidies. A guarantee isa very specific type of subsidy and there aremethodologies to estimate the size and value ofguarantees in the subsidy space.

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Q71 Caroline Nokes: Even if the guaranteearrangements were effectively just providinginsurance in a financially neutral way, would you stillregard that as a subsidy?Shelagh Whitley: Yes, it is a specific category ofsubsidy, insurance and guarantees.

Q72 Caroline Lucas: So far most of our discussionin the debate has been about reducing fossil fuelsubsidies in developing countries, but if we used adefinition that was going to include environmentalexternalities that would bring the debate right to ourown doorstep. The first question would be to whatextent should the battle to eliminate fossil fuelsubsidies be waged in the rich world rather than thedeveloping countries, if you use that definition?Charles Perry: One has to innovate the solutions atthe same time as reducing the technologies of the pastthat we have depended on for generations. One has todo them in a complementary way because we aretrying to get people to switch from yesterday’s worldof dependence on fossil fuel consumption and usage.Now that we know about these externalities that havecome round to haunt us, we are trying to get peopleto switch from those to the solutions that we are tryingto innovate, and unless you incentivise the solutionsside of it you just have more and more deficit on theother side. You have a problem that you have nosolutions to guide people towards.It goes back to the other point about $1 billion forPetrobras. Surely Great Britain should be innovatinglow-carbon technologies for export. If we can help notonly British citizens but international citizens reducetheir carbon consumption then that is a good way ofboth helping our economy and their economy, ourcitizens and their citizens. Again it goes back to howwe incentivise the solutions side of the equation usingthe carrot. I have wrestled with this long and hard inmy own energy journey and I honestly believe theonly way to do it is by following the models ofcountries like Norway where you take the revenuefrom taxing the burning of fossil fuels and use thatrevenue to incentivise R&D and the embracing ofcleaner technologies. Norway has done that extremelysuccessfully and I think we could learn a lot fromwhat they have done. There are a lot of parallels withwhat we are good at in our history of innovation andpioneering new technologies. We pioneered the steamengine and the Industrial Revolution. We should beable to pioneer low-carbon technologies for export.Peter Wooders: My organisation is an NGO. We havea global subsidies initiative and we get asked a coupleof questions very commonly. The first one is, are youagainst all subsidies? The second one is, if fossil fuelsubsidies were eliminated would renewables becomecost effective? The answer to the second question isin fiscal terms generally not. There still remains a gapbetween fossil fuel generated electricity andrenewable electricity, but if we include theexternalities, that gap more than disappears. That isthe key construct there, and we think it is extremelyimportant that the issue becomes properlyinternational. If we just focus on fiscal consumersubsidies, it is a developing world issue. If countriesare going to move forward together, it needs to

include producer subsidies and ideas around a cleanenergy and externalities and so on.Subsidy reform remains a national issue. It is not thesame as trade. If I, as a country, reform my subsidiesI tend to benefit. I don’t benefit at your expense andvice versa. It is very much a national issue. However,processes like G20, G8, WTO, UNFCCC, all theseinternational forums, are very important to get thatissue going, and to support those international issuesit is very useful if all the countries have a stake in thedebate and discussion.Shelagh Whitley: I am very new to the subsidyspace—I work mostly on climate policy—but whatyou find is that there is innovation happening in thespace globally, so there will be lessons for developedcountries from developing countries and vice versa. Ina way this is a journey that everyone is taking togetherand there are leaders and laggards in both spaces. Themore you can get common reporting templates,common definitions that are internationallyrecognised, you can also get lesson learning on a levelplaying field across developed and developingcountries.

Q73 Caroline Lucas: To what extent do you thinkit would be a good tool to internalise some of thoseexternalities, if the emissions trading system wereworking properly, which it is not as we know?Building on what you are saying, Charles, would partof that for you be about what you do with theresources, the revenue that you get in?Charles Perry: Yes. I think that is why countries likeAustralia and now China are introducing carbon tax,because essentially they are realising they have to takethis matter into their own hands. We have seen whathappened after 20 years of international negotiations.The carbon price is floundering at $3 per tonne. It isa total joke. In that sort of desperate situation one hasto look at how to make one’s own economycompetitive internationally. In our case it is a veryinteresting situation because now we have had thevote in Brussels and the motion was defeated, soironically the EU ETS is on its last legs and couldcompletely disintegrate at any moment. We have tomake a decision on the carbon floor price in the UK,which is a pillar policy of the Coalition Government.If you look at it through one lens it makes us veryuncompetitive to have a carbon floor price coming inat a ridiculously high rate compared to $3 a tonneacross the way. The Chinese for the word “crisis” istwo characters, danger and opportunity. That is if youfocus on the danger side. If you focus on theopportunity side, you can look back at Norway andsay they have made the polluter pay in order to takethat revenue and pump it into the low-carbon growthside of the equation. Indeed, our low-carbon economyis growing at 4.2% per annum, which is very fast-growing compared to the rest of the economy. Howdoes one use something like the carbon floor price totake revenue from the polluter and incentivise thelow-carbon economy? That is the sort of thing I wouldbe thinking for making Britain a more competitiveeconomy rather than fearing the converse, which isthat we are going to become less competitive.

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I would be taking a longer term view. Many peopleare suffering from short-termitis, where we are justusing carrots and sticks for the short term to try to getthe immediate results we have. There is reconcilingthe short and the long term because the point aboutexternality is that if we leave the cost for futuregenerations, or for the environment or for societydown the track because we have taken those short-term fixes without a view to the longer term solutions,then we are certainly not going to be thanked byfuture generations.Shelagh Whitley: On the carbon market point, Iworked in the carbon markets for five years beforebecoming a researcher and I worked specifically onthe development of CDM projects in developingcountries. I guess that is why I have started to focuson the question of subsidies because we don’t havetime to waste and we don’t have this price signal thatwas incentivising investment in developing countriesin clean energy. What are the other things we can dothat shift price signals so that you can enable thatinvestment? As Peter said, these are decisions that canbe made domestically and we know we won’t have acarbon price in the short to medium term. Potentiallymaybe in the medium term, but we won’t in the shortterm have an international carbon price. What are thethings that we can do now to create the energy priceshift that can incentivise investment? That is why Iam focusing on this, because of that change.

Q74 Dr Whitehead: Before I go on to what I wasgoing to say, can I take the question of floor price alittle further? The floor price in this country wasoriginally devised as a rider on top of the EU ETS; arather clunky rider but a rider nevertheless.Incidentally the floor price is based on a three, fouryear projection of what the forward trading pricemight look like. As the trading price goes down, theresponse in this country has been to put the floor priceup so that the overall price collectively stays the same,but to some extent that has to guess on the collapseof the forward price. The legislation that is goingthrough at the moment effectively institutes asubstitute floor price for ETS so that in the event thatETS happens to revive, the consequence is that thefloor price gets even higher. The overall finalconsequence is that the whole lot gets swept away intothe Treasury. The only effect at that point is that thereis some indirect effect on possible investmentdecisions in terms of comparative advantage.However, there is the possibility of leakage, forexample if you put a gas-fired power station on theother end of an interconnector with that differentiationin price between UK and Europe, say, you stand togain rather a lot of advantage thereby rather thanputting it in the UK.The issue as far as Norway is concerned depends onhypothecation, which then stands out against all of thetheory on how a tax regime works. Are there otherthings that need to change in how that process worksin placing externalities into a tax regime rather betterthan might be suggested by a carbon floor price thatsimply does rather well for Treasury but doesn’t saveany carbon, for example?

Charles Perry: It is a tough one. I am certainly noexpert on policy instruments to do that. Hypothecationis another big word, and I am not sure it needs to beliterally hypothecation in a way. It is a very difficultone in the UK because of the tradition that we have.To try to do something more lateral and creativewould take working across Government Departmentsand looking at the problem from differentperspectives.It reminds me of the work we do for corporates onembedding sustainability. Most corporates are siloed,and when I was in BP it was the same case there. Wehave been working for Tesco, and these corporates arevery siloed and they don’t often talk between the silos.The role of a consultant in that situation is to try tocut across the silos to show the costs and benefits ofa new model. We talk about sustainable businessmodels that are more circular in nature rather thanlinear, which is the old business mantra. When I wasat business school we were taught linear businessmodels not circular business models.I think the current times demand a different way ofthinking and a different approach. In the corporateworld it is the circular model approach, which weknow in the public world as well as the circulareconomy. Likewise, coming back to the issue herebetween Government Departments, what would a newapproach look like that has new benefits in a time ofcrisis? Difficult times demand new, innovative,creative approaches, so it would mean sitting downbetween the Treasury and other GovernmentDepartments and thinking about how this could work,not calling it something like hypothecation because Idon’t think one needs to open that can of worms. Itwould just send people running about in differentdirections.Here one is trying to encourage a collective solutionrather than an individual department solution—thiswhole idea of looking at best practice models andtrying to embrace some of the learnings from Norway,Denmark, Germany and other areas. If Germany’seconomy is so far ahead in many ways on the energyside—they can be seen to be at least 10 years aheadof us—what radical new model should we embrace inorder to mobilise and catch up with them? It issomething like a new approach that is based aroundmaking the polluter pay, taking those revenues fromthe polluter and incentivising in a way that meets allthe objectives of the different GovernmentDepartments.

Q75 Dr Whitehead: Norway, for example,effectively created a sovereign wealth fund thatmediated between the tax take and the—Charles Perry: That is exactly the sort of thing,absolutely.

Q76 Chair: That has been particularly difficult in theUK because of this silo mentality. Do you see anyway in which there could be some kind of a catalystfor getting the kind of collaboration and co-operationyou are referring to that is needed in a time ofausterity and crisis?Charles Perry: Exactly what your Committee is doingright here is, first of all, taking on the challenge of an

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inquiry into an area that a lot of people are not goingto thank you for inquiring into, because it is a verypolitical and pretty difficult area to get to the bottomof—taking on the inquiry and getting engagementfrom other stakeholders into the value of what you aretrying to do. Some people will say you are wastingyour time and you should move on to some other topicand others will say, “This is what we have beenwaiting for for a long time”.As I say, Tim Yeo was very supportive of the fact thatyour Committee had taken it on. He would have likedto, but he said to me that the Energy and ClimateChange Select Committee couldn’t take it on for theforeseeable future. You have taken the step of takingon this inquiry and I will try to get as much supportand engagement in what you learn from this inquiry,both within Whitehall and outside in the corporateworld, because the corporate world is certainly veryinterested in this topic. I spend most of my time inand out of corporates consulting to them and they areextremely interested in this topic.

Q77 Chair: If you had to list the people we shouldbe engaging with to advance this thinking, who wouldyou say should be around this table?Charles Perry: The very first person on my list wouldbe John Browne, formerly BP who is now head ofRiverstone. He has been quite public about this topic.Since he left BP he has been calling for the phasingout of fossil fuel subsidies. I think he is expecting aninvitation from you, to be honest. Lord John Brownewould definitely be one of the first on my list.Vivienne Cox, previously BP, has been veryoutspoken about this as well. She is on the board ofRio Tinto, etc. I think you should ask Vivienne Cox.We have already talked about more public sectorpeople, IEA, IMF, World Bank and so on, but lotsmore in the private sector from both the incumbentside of the equation as well as the emerging side ofthe equation. I think people who run renewable energybusinesses, like Dale Vince from Ecotricity and EddieO’Connor from Mainstream, would be delighted tocome and give evidence, but at the same time someof the big energy and oil and gas company bossesshould be invited to give evidence.

Q78 Dr Whitehead: I have a slight rider on theprevious point. One of the problems of the carbonfloor price, as it presently stands, is because it is orhas been linked—arguably as of next week it will notbe linked—to ETS then it was not particularly ofconcern that the carbon floor price did not actuallysave any carbon. It was because people would offsetallowances elsewhere if you wanted to spend the sameamount of allowances. If you completely de-coupleone from the other, which is effectively what has nowhappened, then that part of the process has beencompletely lost and you are entirely dependent onsupposed parallel mechanisms that react to that floorprice. Then you are in the process of patching uppeople who are disadvantaged by that mechanism,such as giving free money to energy intensiveindustries to deal with the consequence of what youhave done even though you are not saving any carbon.Probably the effect of that is actually you are allowing

more carbon to be produced. Do you see that as animpediment to the particular national route that hasbeen suggested for floor price arrangements, or with acombination of, say, not hypothecation but actuallytax foregone or wealth funds or some such, and thenlinking that to carbon reductions by the consequenceof what it is you are doing with those funds, i.e. youare actually doing something with that incentiveinvestment that really can be calibrated against carbonsaving? Is that the sort of direction you are thinkingabout?Charles Perry: I would say it would be quite awelcome development, ironically, to de-couple thetwo. I think then it gives more independence to howto use the revenues from the carbon floor price inincentivising that sort of technological developmentfor the UK as a benefit. In terms of the UK’scompetitiveness it could be quite a welcomedevelopment to de-couple them.Dr Whitehead: Provided you do something with it.Charles Perry: Exactly. Provided you do something,so quid pro quo. In a sense I think Australia is a veryinteresting model. Don’t forget that Australia was oneof the countries that did not sign up to Kyoto, whowas the laggard under the previous Government onthis, in the same position as the United States saying,“Well, this is going to hurt our economy and we’renot up for being part of Kyoto”, to now with JuliaGillard introducing a carbon tax. Of course that hasbeen a very political thing in Australia but I think itis going to make Australia much more competitivebecause it is going to drive efficiency and it is goingto drive low-carbon technological advancements. Ithink that is the sort of thing that the UK should bedoing.Peter Wooders: I would agree with that very much aswell. You can generate quite a lot of revenue from afloor price, carbon tax, whatever it might be. If welook back to the subsidy analysis, this is about impactanalysis as well; who would be adversely impacted bya high carbon floor price and how much? You findwhen you go through that analysis that it is very fewparticular industries or companies. It tends to be thoseenergy intensive industries. Steel is a big one; oftenbecause of their electricity, aluminium and some ofthe other non-ferrous metals; a bit of cement and notmuch else. You can put in a scheme here with a lotmore revenue coming in. You can use some of thosesavings for general Government revenue, some toreduce taxes on labour, or whatever you might wantto do—a general benefit again—and a bit, if you needto, to help those industries become part of a lower-carbon economy. There seems to be a way forwardthere and I think it is—

Q79 Dr Whitehead: It makes your own economymore energy efficient perhaps?Peter Wooders: Exactly. It will have the impact ofmaking your economy more energy efficient.

Q80 Dr Whitehead: I mean directly doing that ratherthan indirectly, taking the proceeds of a carbon floorprice and using it to make permanent energy savings,for example.

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Peter Wooders: Improving the building stock, as wasdone with many green funds and green growth andso on.Charles Perry: We need, what, £200 billion forenergy infrastructure in the country. Well, there yougo.

Q81 Caroline Lucas: Does it affect the design if youare designing this carbon floor price with more of itsrevenue raising potential as its top line rather than itsreducing carbon? Is that what you are saying?Dr Whitehead: Yes.Caroline Lucas: Then does it affect how you designat all or not? What is the implication of that slightchange of end goal? What does that mean for whatyou are designing?

Q82 Dr Whitehead: If you are simply using it toraise revenue then your considerations at the end ofthe day will be the extent to which the pips squeak somuch in raising your revenue that you can’t put it anyfurther, as opposed to what happens subsequently withthat particular area of income. The position at themoment, as far as I understand, is that the carbon floorprice two years out from now is almost the whole ofwhat was the trajectory upwards towards £30 by 2020,so it has wholly replaced any considerations in ETSbut nothing whatsoever is happening with it. It simplydisappears off into Treasury. There is not any carbonreduction as result of its substitution and that seemsto me the fundamental problem. How do you gear oneup against the other? If you are gearing one againstthe other, does that have a positive effect on the extentto which what you are trying to do, simply by raisingrevenue, is patch up those areas that were adverselyaffected by what you have done in the first place andgive back some of the money you have raised, whichseems to be a wholly negative thing?Peter Wooders: Any price increase will encourageenergy saving and the carbon floor price will supportthat. The other important point is we are looking hereat long-term signals. If we are going to move from ahigher carbon to a lower-carbon economy theninvestors need to know that there is going to be acarbon price or other incentives reaching out for manyyears ahead to encourage them to make thoseinvestments otherwise they will not. Otherwise theywill say, “In five years time I don’t think the EU ETSis going to be around or it is going to have a low priceor whatever. I won’t bother. I’ll stick with what I’mdoing”. We have to create that long-term incentive. Itis very important.

Q83 Chair: If I can go back to my opening question,which was really looking at how much subsidies wereglobally producing carbon emissions, how much is thepoint that you have just made? To what extent is thatfactored into the estimation of what carbon reductionthere would be in investment decisions that are in thepipeline for the future, not just for this year? If youlook at, say, the national investment programme orwhatever it is, it is going to be bringing aboutinvestment now and in five, 10, 20, 30 years’ time,which we are linked into.

Peter Wooders: It is in there but it is in there in amodelling sense. These estimates are based on modelsrather than observed behaviour and models tend to saythat markets work well and that companies will makerational decisions and so on. In the real world, if wehave a carbon price that is going all over the place,for example, then companies will not be soincentivised to make those investments. It issomewhat a theoretical construct but is a goodindicator.Charles Perry: I think it is very difficult to give youan immediate answer, sitting here right now, to yourquestion, Joan. I think it is a very important questionbut I think it takes a bit of analysis and working out,to be honest. There is a potential to look into that andrevisit it because I can’t answer it sitting right hereright now.Peter Wooders: Even if you do look at it in detail, itcomes back to this investment decision. That is thekey thing. In the short term we can make decisionsabout our use of energy, based on the technologiesand the equipment that we have. In the long term wehave the ability to make different investments. Whatwe are trying to do here on the low carbon side is toincentivise people to take those decisions on the lowcarbon side not on the high carbon side.Charles Perry: It reminds me of exactly theconversations that we have in corporations. You arelooking for a win, win, win. What I mean by that isnot a win, win, win across political parties but a winfor the economy, a win for society and a win for theenvironment. That is about building a business case.If it ticks all three boxes then of course you would doit. Why wouldn’t you do it?It is a very interesting situation because the Coalitioncame in promising clarity, confidence and continuityand this is about the framework in which businessesoperate. Then, of course, as a businessman I have seena lot of non-clarity, non-confidence and non-continuity. However, now if you provide somethinglike the carbon floor price in a de-coupled way itessentially becomes what Australia has done, a carbontax, and it gives some clarity to the future forbusinesses to make those investment decisions. I thinkthat clarity is exactly what businesses are looking for.Also Government can take what is currently a veryprecarious situation with the carbon floor price, as aresult of the rebel votes in Brussels, to its advantagefrom a negative to a positive by using the opportunityto take that bold step, not losing a pillar policy—which is what we have all been told the carbon floorprice is—and turning it into everybody’s advantage sothat it becomes a win for the economy, a win forsociety and a win for the environment. I think that isexactly what the carbon floor price, in a de-coupledway as a carbon tax, could actually do.Dr Whitehead: If you don’t just nick the money inthe meantime.Charles Perry: Exactly, which takes federalbehaviour. That comes back to my other triple win aspolitically it would potentially tick all the boxes aswell because everyone is wondering what to do withthis thing called the carbon floor price now that theEU ETS is in a mess.

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Ev 22 Environmental Audit Committee: Evidence

15 May 2013 Peter Wooders, Shelagh Whitley and Charles Perry

Q84 Dr Whitehead: Could I ask you the question Iwas going to ask you and that is what is the likelihood,the possibility, of any effective internationalagreement on eliminating fossil fuel subsidies?Bearing in mind what G20, the Rio+20 Summit hasalready decided—and I want to come on to that in amoment—how do you think that framework worksinto the possibility of any sort of real agreement?Peter Wooders: To answer that question from the2009 perspective, before the G20 made that politicalstatement, the commitment that they were going tophase out, over the medium term, inefficient fossilfuel subsidies that lead to wasteful consumption, thissubsidy issue was hardly on anybody’s radar at all, sothe change in the politics from that has beenenormous. We saw at Rio+20 last year—and we werepart of this—that the civil society got together and wemanaged to get the public to vote it as being the mostimportant thing that the Rio+20 leaders could do. Itdid not mean that they actually did that but it wasvery important.I think it is a slow process but it is one that is buildingmomentum. I was at a meeting the other day of theintergovernmental organisations who were talkingabout co-ordinating their plans going forward for theextra effort that they are going to put into subsidyreform over the next few years. Again, a couple ofyears ago that was not happening. This issue is slowbut it is very much on an upwards profile. Keepingthe issue on the G20 agenda, from our perspective, isincredibly important. I think the leadership for that atthe moment has been largely the United States. TheUK is in a very good position here. The UK is marketfriendly as a rule. The UK understands this issue, hasimportant bilateral aid programmes, is very interestedin low-carbon development and is very interested inrenewable energy. There is a whole set of reasons whythe UK should be at the forefront of this.It will be a step-by-step process within the G20. Itis still the major international forum for this but, forinstance, this year there is a big discussion about peerreviewing the reports that each of the countries mustdo within the G20. Taking those little steps, adding onto them, keeping supporting the process, keeping itgoing, seems to us to be extremely important.Shelagh Whitley: Just to add to that, this idea oftemplate formats for reporting and support fortransparency is something you could get in the nearerterm. So potentially not an agreement on eliminationbut an agreement around definitions and agreementaround reporting approaches would make a significantstep forward.Peter Wooders: We don’t envisage that suddenlycountries will say, “We’re all going to eliminate oursubsidies now and here is the agreement” but they willlearn from each other’s experience, they will pusheach other to some extent, they will be heldaccountable by their electorates to some extent. Itseems to be not necessarily an agreement that willhappen but a jointly supportive set of activities.

Q85 Dr Whitehead: Do you think, however, that thewording that has gone into the declaration so far—the Rio+20 Summit talked about eliminating harmfulsubsidies, inefficient subsidies, wasteful subsidies, all

of which would seem very conditional; people couldargue, “Well, my subsidy is not wasteful and I’ve gota pretty efficient subsidy here and it is not veryharmful”—gives a get-out that overcomes thetrajectory that you might otherwise be thinking about?Peter Wooders: It does. If we are thinking cynicallywe would say people will just use those terms likewasteful consumption, inefficiency and so on, but Ithink there is also a lack of capacity to deal with theissue. If we ask even well-educated and co-ordinatedDepartments, “Could you write down the UK’s fossilfuel subsidies and tell us which are good and whichare bad?” it is very difficult to do. There is a processthat needs to happen there about helping with thedefinition, with the measurement, with the evaluation,sharing how we measure, how we evaluate, what sortof models might we need, what sort of experiencesshould we compare to each other. There is a morepositive agenda here about building the capacity todeal with the issue in all countries.Shelagh Whitley: With that information there is alsothe possibility for civic engagement. We were talkingabout this outside. When you have the informationyou can have a public debate on the topic and theneach country can make the decisions about which areefficient, which are inefficient, which are harmful,which are beneficial, which are the subsidies andincentives that meet the goals that a Government istrying to achieve and which are those that potentiallyundermine them.Peter Wooders: This is where GSI has always comefrom. We would like to be involved in the publicdebate about energy pricing decisions. It is very hardto get into it because a lot of it is technical. A lot ofthe information is not easy to find even in developedcountries. You really have to work at it.

Q86 Chair: So transparency is high on the agenda?Peter Wooders: Absolutely.

Q87 Chair: I think we have just about reached theend of our questions. Finally, you mentioned G20 asbeing very important for getting it on the agenda. Youdid not quite give the same pre-eminence to the post-Rio+20 discussions, particularly on sustainabledevelopment goals and so on, but presumably you seethat as a key process as well.Peter Wooders: We would advocate very much multi-forum, so G20, G8, UNFCCC, WTO, CSD,discussions with the World Bank, IMF, OECD, IEA.Everybody has a role to play here. Let us spread thediscussion about subsidies in all of those; not rely onany of them to actually make an internationalagreement or make an enforceable internationalagreement but all of them can help push this agendaforward.Charles Perry: It is a really important point on thisbecause a lot of them had this on the agenda for thelast few years but not much has happened. Thequestion is which forum is really going to makeprogress, which is going drive the change that weneed. There are lots of get-out clauses, lots of excuses,lots of, “Well, that is not a subsidy”, “Oh, we’re notdoing that”, “It is not classified” and so on, excusesfor not doing things and not tracking the progress to

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15 May 2013 Peter Wooders, Shelagh Whitley and Charles Perry

eliminating them. One thing about the MontrealProtocol was there was a very clear agreement tophasing out CFCs and there was tracking as to thatphasing out. In the same way with the phasing out offossil fuel subsidies, there needs to be a forum that isgoing to take it seriously, it is not going to get bumpedoff the agenda every time and someone is going tomonitor that progress is made.

Chair: That brings us to the end of our session. Eachof you has been really generous with your time. Thankyou for coming along and if you have further thoughtsthat you think will contribute to this inquiry, pleaseby all means let us have them. Thank you very muchindeed.

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Ev 24 Environmental Audit Committee: Evidence

Wednesday 10 July 2013

Members present:

Joan Walley (Chair)

Peter AldousMartin CatonCaroline LucasDr Matthew Offord

________________

Examination of Witness

Witness: Professor Paul Ekins, Professor of Resources and Environmental Policy, and Director, Institute forSustainable Resources, University College London, gave evidence.

Q88 Chair: Professor Ekins, you are no stranger tothis Committee, and it is a pleasure to invite you backagain to give evidence on the paper that you havebeen working on, funded by the Joseph RowntreeFoundation. I think it is something which, in its detail,is very pertinent to our current inquiry on subsidies.To begin with, if you would like to tell us, this full20% rate of VAT on domestic energy bills andtransport fuels—just how that proposal that your paperhas come up with would work in practice and link thatto the whole agenda of fossil subsidies.Professor Ekins: Yes, good morning, and thank youvery much for asking me to come and share this workwith you. You will know that the OECD and otherdefinitions of subsidies include reduced levels oftaxation. In the UK, the lower rate of VAT onhousehold energy—that is gas and electricity—iseffectively the largest subsidy to fossil fuel use; inother words, it is an environmentally harmful subsidy.There is a lot of work on environmentally harmfulsubsidies around the world. It is estimated that theyresult in substantially higher emissions, especially ofcarbon dioxide, and bodies like the OECD and theEuropean Commission recommend that they shouldbe removed. That was the rationale for this piece ofwork.We know that there is political history here in thiscountry. The Conservative Government in the 1990sindeed tried to raise the VAT on household energy tothen 17.5% and was not able politically to do so. Thereason often given for giving such subsidies—and inparticular this subsidy—is that low-incomehouseholds would find it difficult to pay and thereforeenergy bills need to be kept low. Less than 30% ofthe subsidy goes to the three lowest-income decilesbecause higher-income households use rather moreenergy than lower-income households, and thereforeit is the seven higher-decile income groups that getmost of the subsidy. In principle, therefore, it shouldbe possible to raise the rate of VAT to 20% and withjust 30% of the revenues to fully compensate low-income households for the increase in their energybills that would then take place. In practice, it is verydifficult. Work that we carried out in the early2000s—with the best data then available that we couldfind and the benefit system as it then was—suggestedthat it was administratively impossible to find enoughof low-income households really to say that you hadcarried out this comprehensive compensation. You

Mr Mark SpencerDr Alan WhiteheadSimon Wright

had to give very large over-compensation to low-energy using low-income households in order toadequately compensate the low-income high-energy-using households.The single biggest thing that I discovered doing thatwork was that there is enormous variation in energyuse within low-income households. Even the lowestdecile of incomes—that is, the 10% of households thatget lowest incomes—have energy use that varies by afactor of six or more and very often, with somehouseholds within that group, is the same as theenergy use in the top-income deciles. We came backto this issue with this piece of work because more datahad become available. We were using a new modelconstructed by the Centre of Sustainable Energycalled DIMPSA, which had much finer granularity ofhousehold energy use, but I think particularly becauseof the Government’s proposals to move to UniversalCredit as a benefit system, which is much simpler, wewondered whether it would be possible to target low-income households more effectively. We were usingthe IFS (Institute for Fiscal Studies) TAXBEN modelthat had been reconfigured for Universal Credit, andwe did indeed find that it was much easier to targetlow-income households.Our results were that if one spent all the money fromincreasing VAT on these compensation schemes andon tax allowances—we also had the policy to increasethe tax allowance to the Government’s then targetincome tax allowance of £10,000—then only 5% ofhouseholds would lose out, 16% of low-incomehouseholds, so 84% of low-income households wouldbe made better off, some of them substantially betteroff. The bottom three deciles, on average, would be£400 a year better off. This would be, on average, avery significantly progressive—

Q89 Chair: Okay. There is a lot of statistics andfigures in all of this, but I wonder if you could justencapsulate why, in strategic terms, you believe sucha change would be necessary.Professor Ekins: The main argument againstenvironmentally harmful subsidies is that it militatesagainst the efficiency and conservation of whatever itis you are subsidising, in this case fossil energy. If wetake the example of the Green Deal, if VAT onhousehold energy use was at 20%, the number ofinsulation and conservation measures that would passthe Green Deal test, the golden rule, would be verygreatly increased, and therefore households would be

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able to access Green Deal finance for more measures.They would have a higher incentive to access GreenDeal finance and make more efficient use of energy.Indeed, all households would have that greaterincentive.

Q90 Chair: Isn’t part of the issue that the VAT thatis currently applicable at the moment is designed fromthe perspective of addressing fuel poverty, whereaswhat you and your colleagues are looking to do is totry to find a way that would address the issues aboutenergy efficiency and changes towards a shift fromfossil fuels to renewables? That is not a reason for thecurrent subsidy that exists, so, if you like, the wholething is that there is a disengagement between all thedifferent factors that are part of the policy that existsat the moment.Professor Ekins: Indeed. I think the purpose of thispiece of work was largely to say that if one wants toreduce fuel poverty, you would do much better toincrease the rate of VAT to 20% and use the revenuesto give benefit increases to those households onUniversal Credit.

Q91 Chair: Okay, so you think that a change isnecessary from the dual point of view of both fuelpoverty and environmental enhancement?Professor Ekins: I think you would find that thatpolicy had benefits on both those dimensions, yes.

Q92 Chair: I will bring in Caroline Lucas in asecond. Can I add, just in terms of where you thinkpublic understanding is in all of this, given that theexisting arrangements are seen and viewed andperceived by the general public, by and large, as a fuelpoverty issue rather than as an environmental issue?Did your research look at that?Professor Ekins: No, we did not do any work onpublic attitudes. I think that the communication of thepolicy change would have to start with saying that thereduced level of VAT is not a very efficient oreffective way of reducing fuel poverty, that usingthose sums of money—and we are talking aboutnearly £5 billion a year—to target fuel poverty, youcould get a much bigger fuel poverty benefit than weare currently getting because, as I say, more than 70%of it is going to households that are almost certainlynot in fuel poverty.

Q93 Caroline Lucas: I was going to ask whetherthere is a comparison between the effectiveness of thispolicy in terms of the fuel poverty aspect, andobviously there are objectives around perversesubsidies as well, but has there been a comparisonbetween what this would do for fuel poverty versussomething like ring-fencing the carbon floor pricerevenues, for example, the ETS revenues? The NGOshave a big campaign—don’t they?—called the EnergyRevolution Campaign, I think, that would look at ring-fencing the revenue that was raised through a carbonfloor price or the ETS revenues. Do we know whichwould be more effective in terms of the fuel povertyobjective specifically?

Professor Ekins: I am not aware of any work that hasspecifically tried to compare those two policies. Whatthis piece of work was explicitly setting out to do wasto say that if your objective is to reduce fuel povertyand you would also like to reduce emissions, then oneway of doing that more effectively than at presentwould be to increase VAT to 20% and use therevenues in the way that I have described. We stoppedshort in the report of recommending this, because Ihappen to think that there is a better way of usingthose or other revenues to reduce fuel poverty, but thatwas outside the scope of this particular piece of work.I think that—

Q94 Chair: Can I just say, we are not just necessarilyasking you to give evidence to us based on thisparticular piece of work? If you have other—Professor Ekins: Right. It is just that the broader issueof fuel poverty is not entirely linked to the subject ofyour inquiry, which is environmentally harmfulsubsidies or the issue of energy subsidies. This was apiece of work that looked specifically at that subsidy,which is the low VAT rate, and said, “What happensif we remove it? Do we then put more households intofuel poverty?” The answer is, “No, not necessarily,provided you use the revenues effectively.” If youwere to say, “How should we best reduce fuelpoverty?” which you have probably had an inquiryabout, which I will have missed or forgotten, then tome the long-term answer to that is to improve theenergy efficiency of homes. That, as we know, isexpensive. Simply diverting this £5 billion orwhatever into benefits would have an effect onemissions, but we know that the price elasticities arerelatively low and that people would save energy, butperhaps they would not save as much as if you wereto increase those prices gradually and use the moneyfor actual targeted incentives for fuel efficiency.

Q95 Dr Whitehead: Since we are discussing slightlyoutside the scope of your research, I think I know theanswer to this, but when you undertook the researchthis was based presumably on, as it were, a pre-discussed brief on VAT, so you did not look at indeeddifferent methods of attaching flow-through prices toelements that presently are not covered by, say, thepresent carbon floor price and Carbon Price Support.I note, for example, that you have drawn attention tothe fact that gas is not taxed or taxed at 5%, whereaselectricity is 20% and therefore is a perverse incentivein terms of domestic uses, as you have mentioned.However, if you attached a carbon floor price tolandings of gas or risings of gas, that would have thesame effect—would it not?—as to equalise—Professor Ekins: Yes. We looked at two ways ofequalising taxes across household energy use. The firstone, which is what we call the small carbon tax, wasindeed applying a carbon floor price to household gasuse, so that could be done upstream or it could bedone downstream. That is one way, because at themoment the carbon floor price only applies to thefossil inputs into electricity, and this would beextending that to household use of gas because theelectricity companies will pass that carbon floor priceon to the electricity users.

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The second, which we call the large carbon tax, wasincreasing the rate of VAT on both gas and electricitybecause they are both for households currently at 5%.That is the really large sum of money, and that is thenwhat we used to compensate through the UniversalCredit. We did two scenarios—a small carbon tax anda large carbon tax—with those different elements.

Q96 Dr Whitehead: In terms of the large carbon tax,have you calibrated that—and I suspect we mightcome back to this later on—against the very latestactivities of the Chancellor in the budget of changingthe rate of increase of Carbon Price Support to changethe relationship in terms of the overall carbon pricefloor between EU ETS and Carbon Price Support?Professor Ekins: No, we did this work when the onlyannouncements from the Treasury were that theywould aim for a carbon price floor in 2013 of £16 atonne. That was the carbon price that we applied togas, rising to £30 a tonne by 2020.

Q97 Dr Whitehead: So, you have made the overallassumptions of the envelope, but not thedistribution—Professor Ekins: Absolutely, not the distributionbetween the EU ETS price and the other.

Q98 Chair: Just finally from me, in terms of thereport that you have done, what difference do youthink it would make to overall energy consumptionand also to transport emissions, the new arrangementsthat you are exploring?Professor Ekins: Off the top of my head, I cannotremember. It will be a few per cent. It will not beenormous. It will be a few per cent on the basis ofpast elasticities.1 The long-term and the short-termeffect are expected to be quite different, so thattypically the long-term price elasticity of householdenergy uses is two to five times higher than the shortterm. But I think with a measure like the Green Dealand the fact that suddenly all sorts of insulation andconservation measures, which are currently outsidethe golden rule, would come inside the golden rule,one might find that therefore the take-up of GreenDeal measures were substantially higher, but we havenot done that analysis.

Q99 Chair: Okay. Just for the purposes of definition,in terms of who would benefit and in whatcircumstances from the changes that you propose,how do you differentiate between different use ofenergy that different families have, and particularlylooking at the variation between low-income familiesand those who will be on Universal Credit, if you seewhat I mean? There is a difference—isn’t there?—between those who would be likely to receive creditand those who would be looking to reduce theirenergy costs but would not be eligible for UniversalCredit.Professor Ekins: There is. We were able to explorethat in quite a lot of detail because of the granularityof this model of the Centre for Sustainable Energy in1 See supplementary written evidence from Prof Ekins.

Bristol. I said some 16% of low-income households,which is slightly less than 5% of all households,would be worse off. Hardly any of those arehouseholds that are eligible for Universal Credit, sothey are precisely the group that you are talking about.The great majority of those are either people who areincome poor but have substantial assets and thereforethey do not qualify for Universal Credit or they arestudents and they do not qualify for Universal Credit.That is the majority of households that would not bebetter off from this measure.Chair: Okay, we must move on. Dr Offord.

Q100 Dr Offord: You did mention a figurepreviously, but I got a bit lost among the statistics thatyou raised.Professor Ekins: I am sorry.Dr Offord: Would you be able to tell the Committee,for the avoidance of any doubt, how much your taxproposed would actually raise?Professor Ekins: It is just short of £5 billion. This isthe VAT element of it, which is the element I amfocusing on today. That does not include the extensionof the carbon floor price, which I have mentioned toDr Whitehead.

Q101 Dr Offord: Okay. I understand in your reportthat is broadly cost-neutral, then.Professor Ekins: Yes. We recycled all the revenues,both by increasing the personal income tax allowanceand through the Universal Credit increases.

Q102 Dr Offord: I will try to wade my way throughthose. In terms of being cost-neutral, that is obviouslyquite a selling point. Is that in order to receive buy-infrom the public, or is it because you have identifiedthe amount that you believe that poorer and lower-income households need in order to address the issue?Professor Ekins: It was really to do with the projectdesign, if I am to be honest, that it makes a projectlike that neater if you say, “All the revenues arecoming from here, and they are all going there,”because you are not interfering with balances ofpublic spending and the macro-economy and all thatother kind of stuff. You are trying to keep as muchconstant as possible. Obviously, it is a political choice,given that the average increase in income of thelowest three income deciles is just short of £400 ayear. That is a substantial increase in income.Overall, incomes would become much moreprogressive under this measure, and whether that is agood thing or not obviously depends on yourperception of how good progressive income outcomesare. There are some losers, and obviously they are theones who will always cause the political problemswhen the media picks up measures like this. I thinkone would need to be saying two things. One wouldneed to be saying that this was a better way of tacklingfuel poverty than the status quo and that overall thedistribution of income was much better and thatapplied to everyone who is effectively on UniversalCredit.Dr Offord: That is very helpful, thank you.

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Q103 Peter Aldous: Professor Ekins, why would youchannel the redistributed revenue to the UniversalCredit? Do you think that is a good match with thesort of households who will otherwise lose out underthe increase in VAT?Professor Ekins: It is a much better match for low-income households than any other method we couldfind. It is certainly a much better match for low-income households than the previous benefit system.As I said, that was so complicated that if you wereusing the various elements of that benefit system togive compensation, in order to get people who areonly getting one benefit, you inevitably had to give itto people who were already getting compensatedthrough different benefits, so that you ended upspending all the money well before you had managedto compensate these high-energy-using households.We used Universal Credit for administrative reasonsbecause that seems to be what is going to exist andthere is no point advocating a reform of VAT andsaying, “You can compensate low-income householdsin general.” You have to look at what theadministrative means are for compensating low-income households, and the best we have is UniversalCredit, so that is why we chose that.

Q104 Peter Aldous: Do you think there would beany low-income losers under your proposals and, ifso, how would you seek to safeguard them?Professor Ekins: There are low-income losers: some16% of households in the first three income deciles.The majority of those are in the third income decile,so they are not very low-income losers, and they areeffectively people not on Universal Credit. Practicallyany reform in anything is going to lead to some losersand they would be losers, I am afraid, because that iswhat reforms lead to. That is why you get the tyrannyof the status quo, even when you can improve thingson average and overall, because it is quite impossibleto target things so exactly that you get no losers at alland obviously their plight is amplified.

Q105 Peter Aldous: Could there also, by the sametoken, be some people who would benefit from this,the beefed-up Universal Credit, when they previouslywere not paying significant energy bills?Professor Ekins: I think everyone pays some sort ofenergy bills, but 84% of the lowest three incomedeciles do benefit from this measure. As I say, onaverage, they benefit quite a lot, so they are £400 ayear better off on average. So 84% have that averagefigure, whereas the 16% that lose out overall areworse off by about £170 a year.

Q106 Peter Aldous: I think you did touch upon this:did you look at other routes that you could channelthe money effectively to the poorest households andwhy not the Government’s proposal of taking morelow earners out of tax altogether?Professor Ekins: We did raise the personal incometax allowance to £10,000, which was then the targetfor that policy, so we did do that. That was why the

small carbon tax, when we just did that, effectivelythat policy measure swallowed up all the extrarevenue that we got, so there was not any left forUniversal Credit. If you were just to do that, then youwould not be able to compensate low-incomehouseholds for the increased energy costs that theyface.

Q107 Peter Aldous: Just coming back, were thereany other routes that you considered or—Professor Ekins: No, there were not. As I say, in otherwork that I have done for the Joseph RowntreeFoundation that was published about six monthsbefore this piece of work, we did explore mechanismsthat were more explicitly focused on energy efficiencybut made use of the greater targeting that was carriedout between the Department of Work and Pensionsand the energy suppliers for the purposes of the WarmHome Discount. If I was going to craft a full policyproposal in this area, I would be using increases inVAT and channelling the revenues from the increasesin VAT through the Warm Home Discount kind ofmechanism, rather than through the Universal Creditkind of mechanism.

Q108 Peter Aldous: Finally, just taking that pointand going back to what you said at the beginning, thatthe Conservative Government in the 1990s did look atsomething similar but shied away for politicalreasons—this is possibly a question for ourselves—but do you think it would be any different today? Whyare things different, that you might be able to lookat this—Professor Ekins: I remember that time very well andI was very interested in what was being proposed, soI tried to study what was going on. I think the mistakeof the Government of the day was that it highlightedthe revenue-raising potential of the measure, andindeed there was a need in the economy for publicrevenue at that time. The proposals to compensatelow-income households came forward very late in theday. They were not part of the initial package. By thattime, a very substantial head of public opposition tothe measure had been built up.This would clearly be a politically-sensitive proposalif it were to be introduced again. I think it would beessential for the Government to emphasise that this isa better way of tackling fuel poverty than the statusquo and would make a very substantial difference tothe great majority of low-income households and helpthem pay their energy bill, while also givingincentives for non-low income households to saveenergy through mechanisms like the Green Deal. Thatsort of messaging would be very different to themessaging that was carried out in the 1990s and couldbe politically more effective.

Q109 Mr Spencer: Clearly, you have done a lot ofanalysis on different levels of income. I just wonderedif you had considered demographics withinhouseholds and if you had compared households thatcontain children and households that did not contain

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children and compared the amount of energy thatthose households consumed—in my experience,children require a lot of energy—and whether therewould be a positive impact in terms of the amount ofactual Universal Credit or a negative impact becauseof the extra energy costs.Professor Ekins: I am just looking through the reportbecause the answer to your question is yes, becausethis model contains very large numbers of nodes, asthey are called, so that we were able to distinguishbetween household types, “Couples, no children,under 60; couple, no children, over 60; couples withchildren; lone parents; multi-person houses; one adultunder 60; one adult over 60”. That was the householdtypes that we were able to distinguish between andthere were a number of other criteria combined withthose.2

When one digs down into the detail we were able toidentify quite specific kinds of households that, as yourightly say, you would expect to be differentiallyaffected because they have differential energy usebecause each of those types of households is tied to aparticular use of energy. You are getting a quitedifferent cut across the population than if you simplywork in averages, and indeed, that was one of thepurposes of doing that. If you are interested in that,then your researcher might like to have a look at someof the detail of the sorts of households that were goingto be better off—Chair: I think we are more interested in getting theinformation to the Committee as a whole, so weconsider it as part of our inquiry.Professor Ekins: Okay. I am sorry. There is a lot ofdetail there that I could obviously go into, but I doubtthere is time.Chair: I think it is your time constraints that areperhaps greater than ours, but anyway, we must moveon to Caroline Lucas.

Q110 Caroline Lucas: I just want to look at it fromthe perspective of the householders’ energy bill; whatthey see on their energy bill at that point when it getssent to them. Have you calculated how much energybills would rise from the combination of the carbonprice floor and the higher VAT?Professor Ekins: I think we did but, to be honest, thenumbers are not off the top of my head and I wouldneed to look back through the report in order to findthose.3

Q111 Caroline Lucas: One of the sub-themes thatwe have touched on a few times already this morningis about how this gets sold to people in terms of beingcommunicated and indeed sold to Government. Giventhat, at least up until very recently, fuel poverty wasmeasured in terms of the proportion of householdincome that has to be spent on energy, would it nothave the effect, at least on the surface, of appearingto put a lot more people into fuel poverty?

2 See supplementary written evidence from Prof Ekins.3 See supplementary written evidence from Prof Ekins.

Professor Ekins: No. I now have the relevantnumbers. I did not quite understand your question, butI think I now do. As I said before, the 84% of low-income households that benefit from the measure, onaverage, are £400 a year better off. So their energy—

Q112 Caroline Lucas: But it does not appear on theirfuel bill, does it?Professor Ekins: Yes, because VAT would be paid onthe fuel bill, their bill would show the number of kWh,cost of energy plus VAT and that would be the total.Then through their benefits, they would get that £400.

Q113 Caroline Lucas: Maybe I ammisunderstanding, sorry, but when you literally get thefuel bill through the post or on your internet orwhatever, the fuel bill will look higher under thisproposal, even though by the time it has beencompensated by your benefits it is going to bereduced.Professor Ekins: Now I understand.Caroline Lucas: If we still have a way of measuringfuel poverty—and obviously there has been astatement just yesterday from Edward Davey thatchanges this a little bit—but to the extent that untilnow, fuel poverty has been measured by the numberof people who are paying more than 10% on their fuelbills, would it not initially look as if we are puttingmore people into fuel poverty?Professor Ekins: That would depend on how youaccounted for that £400. If effectively you said thatyou were reducing the fuel bills of those people, thenthat would obviously have a much greater impact onfuel poverty than if you simply said you wereincreasing their incomes, because if you are increasingtheir incomes, that has a lower effect on fuel povertythan if you are increasing their fuel bills because ofthe way that fuel poverty used to be defined. I amaware that that definition is likely to change. I do notsee at the moment the actual amount that you wouldincrease the fuel bill by, but it certainly will have beenin the model and in the report.4

Q114 Caroline Lucas: Just in terms ofcommunicating this to the public as a gain—becauseobviously the whole issue of fuel prices is a verydeeply concerning one, and people are concernedabout the Big Six and all the rest of it, so fuel billsare going up and people are concerned—do you thinkthat this proposal could be sold in a way that wouldget public support behind it because they would seethe benefits?Professor Ekins: I hope it could. I am not a politician,and so it is not my skill, but I think that is one of thereasons why, if I was going to design a policy of thiskind, I would probably want to do it through the WarmHome Discount kind of mechanism rather than mostexplicitly through the benefit system, because theWarm Home Discount does explicitly reduce people’sfuel bills. But in order to do that, you would have toget better targeting than exists at the moment betweenthose on Universal Credit and their energy bills.4 ibid

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Obviously, there are all sorts of data protection issues.In order to get the Warm Home Discount targeting,you had to pass an Act through Parliament, so thatDWP and the energy companies were able to sharedata. One of our recommendations in that earlier pieceof work is that that approach should be broadened, sothat it was possible to identify a broader range of low-income households with high fuel bills in this wayand therefore target them directly through their energybills, so that they would then see that this increase inVAT was coming back to them through lower energybills.Caroline Lucas: I think that is very exciting, but thathas not been written up.Professor Ekins: It has been written up as an idea ingeneral in another piece of research that I did with theJoseph Rowntree Foundation with MatthewLockwood, so that exists. What we did not do wascombine the two things in the single project, so thatwe were able to work out the full implications ofthat.5

Q115 Dr Whitehead: Firstly, there has been aconsiderable volume of discussion on themeasurement of fuel poverty relating to the point atwhich, post-rebate, the benefit income is taken intoaccount as the 10% marker or, pre-rebate, the benefitincome is the one that is taken into account. Haveyou looked at that distinction in terms of the effect onfuel poverty?Professor Ekins: No. We were not explicitlyconcerned with calculating the numbers of householdsin fuel poverty as such. We were looking simply at theincome distributions and the energy use within thosedistributions. What we did not do was relate that tothe definition of fuel poverty. At least part of thereason for that was we were aware the definition wasunder review and was about to change.

Q116 Dr Whitehead: You mentioned on the bigcarbon tax scenario, which is the VAT raise, that youwould raise about £5 billion. That would be a constantfeature, I guess?Professor Ekins: That would be annual, yes.

Q117 Dr Whitehead: Yes. If you did the smallcarbon tax route, and you mentioned that you could,for example, include upstream gas into the carbonsupport price, which of course rises or—Professor Ekins: Indeed.Dr Whitehead: Supposedly rises. What would be theresult of that in terms of tax take?Professor Ekins: It is just short of £2 billion.Dr Whitehead: £2 billion, presumably rising withwhatever floor price goes up—Professor Ekins: The year at which—

Q118 Dr Whitehead: £2 billion in what year?Professor Ekins: In 2017, which was the year of ouranalysis, because that was the year in which UniversalCredit was said to be fully operational.

5 See supplementary written evidence from Prof Ekins.

Q119 Dr Whitehead: I take your point that youmentioned you had not looked at the latest effectivedecoupling of carbon floor price on the EU ETS. Thecollective level of Carbon Price Support on gas at thatpoint would be considerably greater than £16 a tonneprobably. Has that changed your—Professor Ekins: No, we assumed that the carbonfloor price on gas would be the one that the Chancellorannounced on electricity, which was starting at £16and going to £30 by 2020.

Q120 Dr Whitehead: That is a composite figure,though, is it not?Professor Ekins: That was a composite figure,because obviously the EU ETS does not apply to gasor the household use of gas. We just used, “On astraight line going to 2017, that is going to be thecarbon floor price that we apply to gas in that year.”

Q121 Dr Whitehead: So you would include in thatthe Carbon Price Support as announced by theChancellor, but you would not add to that, because itis not relevant, EU ETS, although it is relevant tohave all—Professor Ekins: We would simply have a singlenumber that matched the single number that theChancellor said he would be using in 2017, and thesingle number, he said, will include both of theseelements, but we do not distinguish between them.

Q122 Dr Whitehead: Okay. So he has put as anindicative price £14.86, 2016–17?Professor Ekins: Indeed, yes.

Q123 Dr Whitehead: Is that your number, or isthat—Professor Ekins: No, the number is the full carbonfloor price going from £16 to £30.

Q124 Dr Whitehead: Yes, but my point is that thentakes into account a possible variable EU ETS overand above that CPS price. Let us say EU ETSrecovers somewhat.Professor Ekins: Then obviously electricity would bemore expensive, because if the Chancellor sticks tohis announced thing two years in advance—

Q125 Dr Whitehead: But it would not be yourpurpose on the small carbon route to equalise prices?Professor Ekins: On the work that we did, we simplyassumed that the carbon floor price announced by theChancellor would be that that applied to gas.

Q126 Martin Caton: Professor, if not unique, weseem to be very unusual in the European Union inchoosing to try to tackle fuel poverty througheffectively subsidy through VAT. Have other countriesfound ways of tackling fuel poverty, but targeting thatin a much more effective way?Professor Ekins: Yes, fuel poverty was almostexclusively a UK concept. I understand that the ideais now spreading in other countries as affordability of

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energy bills becomes a bigger issue in other countries.Certainly the UK is unique in Northern Europe inhaving a reduced rate of VAT on the household use ofenergy. In Sweden, they not only have a 25% VATrate on the household use of energy, they also havesomething like €100 per tonne carbon tax. Swedenobviously is colder than we are here. The clue to thatis that Sweden has rather better buildings than wehave here in terms of energy efficiency, and indeed ifthey had not, then they would have much higherwinter death rates than we do have, which explainswhy they have them. In a sense, we are the victim ofour temperate climate, which allowed us to build veryenergy-inefficient buildings for so long.For most other countries, this is not an issue that hashad anything like the political purchase that we havefound in this country. The Republic of Ireland is anexception to some extent from that. There is a fuelpoverty debate there. They have just introduced acarbon tax there that does apply to households, andthey have the full VAT rate on household use ofenergy, but that is an issue. Obviously, theaffordability of energy generally is an issue, given thatenergy prices have been rising, quite apart fromanything the Government might like to do in termsof policy.

Q127 Dr Whitehead: One of your proposals is alsoto put a carbon tax on transport fuels at the rateequivalent to the Carbon Price Support.Professor Ekins: Yes.Dr Whitehead: I assume that is on the basis ofcompleteness, for example, at the moment, the carbonprice floor does not affect transport fuels, for ratherstrange reasons.Professor Ekins: We were focusing particularly onaviation, which does not currently have any taxationthere, but yes, it was the idea of saying that currenttax rates on transport fuel are not intended really toreflect external costs there, they are revenue-raising.So if we are going to have a carbon price across theeconomy, then what would happen if you had thesame rate, a quite explicit same rate, on transportfuels?

Q128 Dr Whitehead: That would be on, youmentioned, aviation. There are separate complicationsin terms of how you tax aviation fuel.Professor Ekins: Indeed.

Q129 Dr Whitehead: But presumably that wouldcover road transport?Professor Ekins: Yes.

Q130 Dr Whitehead: That presumably would not becompensatable in terms of rebate on the basis of fuelpoverty for Universal Credit?Professor Ekins: We still used all that revenue tocompensate households through the benefit system.

Q131 Dr Whitehead: You included that when youinvented the benefit system, then?

Professor Ekins: We included that. You obviously getdifferent distributional effects because you have therural/urban divide or differences between rural car useand urban car use. Rural people, for obvious reasons,tend to use their cars more, so, other things beingequal, they would lose out, relatively speaking, fromsuch a change.

Q132 Dr Whitehead: Yes, but I presume then thesame discussions would arise that arose with theimposition of the general fuel escalator when it wasaround in terms of how indeed rural use or heavyvehicle use under particular circumstances might becompensated separately?Professor Ekins: Indeed.

Q133 Mr Spencer: Can I just finally ask, obviouslythere are certain sections of industry that get a doublediscount, like agriculture at the moment gets adiscount on its diesel use? Have you considered theimpact on food prices of some of these increased VATcosts on those types of industries?Professor Ekins: No. This proposal was exclusivelyoriented towards households. Going back to the earlierquestion from Mr Caton about European comparisons,the UK is almost unique in that its environmentaltaxation on industry is higher than its environmentaltaxation on households. Most European countries taxhouseholds environmentally relatively highly, likeSweden and Germany, for example, and haverelatively low environmental taxes on industry, forobvious competitive reasons. We have chosen to do itrather differently, but this piece of work was notlooking at either agriculture or industry generally atall.

Q134 Chair: That is all very interesting. Just finally,you have done this piece of work that, as you havesaid yourself, has a fairly narrow remit, just lookingat one aspect of it. Could you just set out for me howeasy you think it is for a piece of research like this tobe influential in terms of influencing Governmentpolicy for the future, particularly when the wholesubject area that we are looking at is such a cross-cutting issue and the confines of this particularresearch study necessarily is so confined? How do youget the cross-cutting agenda to be a shift of awarenessabout that as far as Government is concerned?Professor Ekins: I think the first objective of theresearch was to start the debate going again. Afterwhat had happened in the 1990s, this was politicallyoff-limits and I knew that even as an academic, if Ieven suggested to someone who was involved in thereal world that you might like to think aboutincreasing VAT on domestic fuel, you were regardedas some kind of weirdo. So, because I believed that itwould be possible to do some analytic work thatshowed that in respect of both the fuel poverty andthe environmental agendas, leaving the economy inthe same place, you could get a better outcome onaverage than at present, I felt it was important to getthat work done, get it in the public domain and getit discussed.

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10 July 2013 Professor Paul Ekins

I do not imagine that one little piece of work is goingto change the political climate overnight, but I thinkthat fuel poverty with rising energy prices continuesto be a concern, and Government will continue to lookat ways of reducing that. It probably will not introducemeasures such as we have discussed here, because themain conclusion that we came to was not that this wasa policy proposal that should simply be rolled out, butthat if you want to reduce environmentally harmfulsubsidies—which is something all Governments saythey do want to do, including the UK Government—and if you want to reduce fuel poverty, then it ispossible to do that through a measure such as this.I think that using things like Warm Home Discount,you could tweak the kinds of proposals that we are

talking about here in order to achieve even betteroutcomes, and perhaps I will be fortunate enough toget the funding to do some research into specifyingthat rather more sophisticated research programme atsome point in the future. But what I think this pieceof research does show is that it is not right to rule outincreases in VAT on the grounds of fuel poverty, thatthere are better ways of reducing fuel poverty than thepresent, which could involve increasing VAT anddoing something different with the revenues.Chair: I think on that point we must leave it. Thankyou once again for coming along and giving up yourtime and presenting your research to us, and alsomaking us aware of the tyranny of the status quo.Thank you very much indeed.

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Ev 32 Environmental Audit Committee: Evidence

Wednesday 23 October 2013

Members present:

Joan Walley (Chair)

Peter AldousZac GoldsmithMark LazarowiczCaroline Lucas

________________

Examination of Witnesses

Witnesses: Gordon Edge, Director of Policy, RenewableUK, Keith Parker, Chief Executive, Nuclear IndustryAssociation, David Odling, Energy Policy Manager, Oil & Gas UK, Emma Hughes, Senior Policy Officer,Platform, and Alan Simpson, gave evidence

Q135 Chair: I would like to give a very warmwelcome to all five witnesses to our EnvironmentalAudit Select Committee session this afternoon. Wehave had previous sessions and we are returning tothis subject of energy subsidies. It might just behelpful for me to say at the outset I realise that wehave five very different witnesses and I am sure eachof you have a huge amount to say on this subject andwe have a Committee that is very focused on this issueas well. We shall do our best to try to finish by 4o’clock at the latest and I will bring in members ofthe Committee as we go through the differentquestions, so I hope that is helpful.Rather than ask each of you to introduce yourselves,because time is short, what I would like to do is justgo straight into the very first question I have for you,which is that the Government tells us that it definesthe fossil fuel subsidy as any measure that reduces thecost of fossil fuels to below world market prices. TheCommittee are very interested to know whether youwould agree with that definition, whether or not youthink there should be a different definition, or indeedwhether or not the Government’s definition isjustified. I do not know how you want to respond,each separately and add or disagree as we go on, andI will try to do it in an inclusive way. Mr Odling, Ithink you were trying to catch my eye first of all.David Odling: Thank you, Madam Chairman. Clearlythere is no universal agreement on the definition of asubsidy and you only have to read the evidencesubmitted to your good selves to recognise that. Fromour point of view, I think the Government’s definitionis a reasonable one, because there is a differencebetween, for example, something that underwrites insome form or another the cost of doing somethingversus, in our case, the tax that is applied on profitsfrom the proceeds of production once all costs havealready been paid. That does not seem to comethrough clearly in some of the evidence that has beensubmitted to you, but maybe that is a subject that wewill develop during the course of the afternoon.

Q136 Chair: Okay. I am going to ask Mr Simpsonto expand or otherwise on that definition.Alan Simpson: I think the Government’sinterpretation is a Queen of Hearts interpretation, thatwords mean whatever you choose them to mean. Iprefer the International Energy Agency definition as asubsidy that either lowers the cost of production and

Dr Matthew OffordMr Mark SpencerDr Alan WhiteheadSimon Wright

raises the profits to the producers or reduces the coststo consumers, and I think that is a more all-embracingone. That ought to include the things foregone, likerents for access to national assets, so the starting pointthat the Government has and the successiveGovernments have had in the UK is not as helpful asthe definition that your Committee have been givenby the Oxford Associates and even less helpful thanthe one taken by the IEA.

Q137 Chair: Any further comments from thewitnesses? Ms Hughes.Emma Hughes: For the Platform, the key thing thatthe Government’s definition is missing is that themajority of fossil fuel subsidies are off-budget and donot appear in national accounts, and therefore it needsto veer towards a far broader definition of fossil fuelsubsidies. In particular, in our submission obviouslywe highlight three things that they miss, the exportcredit, the diplomatic subsidies and the militarysubsidies as well.Gordon Edge: I would expand on that further. Wehave a very wide view of what should be treated assubsidy or support of some kind and that can bequalitative as well as a quantitative monetary value.In particular, we think that the external costs of fossilfuels—and indeed, other energy sources—if they arenot paid, that is a form of subsidy, in our view, andwe should be accounting for those when looking atparticularly fossil fuels but also other forms for whichperhaps externalities are less.

Q138 Chair: Mr Parker, do you wish to contribute tothat specific question?Keith Parker: I would agree with what Gordon saysabout taking account of the external costs particularlyof fossil fuels. In relation to my sector, nuclear, wethink that the Government’s definition is reasonable,that there will no levy direct payment on marketsupport for electricity supplied or capacity providedunless that support is available more widely acrosslow-carbon technologies.

Q139 Chair: So if another sector was getting asimilar support, you would not count that as asubsidy?Keith Parker: No. I think that the Electricity MarketReform proposals are designed to incentiviseinvestment in all low-carbon technologies, including

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nuclear, so we would regard that as an incentive,certainly not a subsidy.

Q140 Dr Whitehead: Forgive me, does that notmean that if I give three out of my four childrensweets, I have not given any of them sweets? Is thatwhat you are saying?Keith Parker: No. What I am saying is that theGovernment has a policy of moving the energy mix,if you like, towards low carbon, particularly theelectricity sector, and therefore in order to achieve thatdesirable outcome and to improve security of supply,they are putting in place policy measures that willincentivise investment in those particulartechnologies, and by implication, disincentivisinginvestment in those technologies that they regard asbeing, if you like, less desirable.

Q141 Caroline Lucas: That is just a slightly separateissue though, isn’t it? I was just hoping that we couldstart the session with all of us being clear about whatwe are talking about here, and however much onemight want to justify the subsidy or not, the fact thatit is being offered to more than one energy sourcedoes not stop it being a subsidy. I think if we couldstart from that starting point at the beginning of thissession, we would all be a lot clearer as we gothrough, because the idea that somehow, as mycolleague says, just because you offer something to arange of other players—and that something that youare offering isn’t the same thing, but we will park thatfor the moment—does not change the nature of whatis being offered. It is a subsidy.Keith Parker: No, I understand. In that case, I wouldagree with Mr Odling that the Government’s definitionof subsidy is reasonable.

Q142 Caroline Lucas: Sorry, the whole language ofthis is so important. Why is it reasonable if you werenodding when I was explaining that it is notreasonable to say something isn’t a subsidy justbecause it is being offered to more than one generatoror type of generator? Why is that reasonable?Keith Parker: Because the whole relationship, if youlike, between the Government and industry and thebasis on which Government would provide support orincentives to industry to go down a particular route Ithink is legitimate activity for Government andtherefore—

Q143 Caroline Lucas: No one is disputing that.Well, they are, but not right this moment. What theyare disputing is whether or not that is a subsidy.Subsidies can be used for good ends or bad ends andwe can discuss whether we think the ends to whichthey are being used are good or bad, but I just wishwe could clarify at the beginning of this session thatjust because you offer something to more than onegenerator does not mean that isn’t a subsidy, goodor bad.Keith Parker: In principle, yes, I would accept thatwhat you are saying is correct, but then—Caroline Lucas: Okay. We will capture that beforeyou—good, thank you.

Q144 Chair: Just in terms of the common definitionthat we are trying to have as our starting point, I amwondering what you might feel is left out of what thatdefinition might be. If you were describing the idealdefinition of what a subsidy would be, are there thingsthat would be included in it—that for the purposes ofour session, Mr Odling started us off on—that are notincluded, if you see what I mean, if that makes sense.The Government’s subsidy definition that we startedoff with, are there items in that, the externalities,which are just not included that should be included?David Odling: It seems there that you are probingtowards the cost of carbon in the energy sector, andof course there is a cost, certainly for heavy industries,which is represented by the European Union’sEmissions Trading Scheme. That cost has not turnedout to be as high as a lot of people would have wishedby now and thinking back five or six years, therecertainly was an expectation in the Commission thatit would be climbing towards €30 a tonne. We are ofcourse down in single figures at the moment, owingto the consequences of the recession more thananything else, which is perhaps not the outcome thatpolicy-makers were expecting, but nonetheless thereis a cost built in there and there is also a cost of allthe other forms of regulation that were applied toindustries. They are not free. They may not have animpost in the form of a tax or a cost of buying anemission allowance or something, but regulation itselfinevitably imposes costs and there is plenty ofregulation around in the energy industries, particularlyin our own: environmental regulation, health andsafety regulation, licensing conditions, you name it,and almost all of them entail costs.Alan Simpson: It would be helpful if the Committeewere firm with us as panellists about a definition thathad to be inclusive of the cost of externalities, becauseotherwise not only do you get caught in convolutedlanguage that reduces meaning to the definition—sadly that is the glaring gap between the Treasury’sresponse to the Committee’s evidence and the positionpaper to begin with—but also that it gets in the wayof taking the next step into questioning what is thepurpose of the subsidies or the intervention measures.In many respects, that is the welcome ground that theCommittee can hopefully take the parliamentarydebate into.

Q145 Chair: Just before we move on from thesubject of definition, is there a current definition,whether it is from the OECD, IMF, WTO that you feelwould serve as providing us that starting point? Isthere a definition that already exists that we couldperhaps adopt or—Gordon Edge: For my part, I don’t think any of theexisting definitions, from where I am sitting, accountfor all the different things that Government do tosupport or retard particular energy industries. I thinkit is important that we have a full accounting,including the legacy institutional support that is outthere for technologies that have been around for amuch longer time than the technologies that Irepresent. That forms a form of subsidy that isdifficult to quantify, but it is definitely a support that

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needs to be set out and accounted for appropriatelywhen you are looking at this whole issue.Chair: We will just move on very briefly to oil andgas and I will bring in Mr Spencer.

Q146 Mr Spencer: Yes, we will drill down into moresoil, shall we say. The Government does not regardfuel allowances as a subsidy: is that right or wrong? Isuppose we will start with Mr Odling.David Odling: We think it is right. I alluded to thereason, and perhaps I can expand on that. First of all,we pay all our costs, so the capital costs of investing,the costs of operation, we are responsible for all those.The taxation that is applied to us is a form of taxationon profits and it comes in several forms. It starts offwith a particular version of corporation tax that ispeculiar to us, and it is called ring-fenced corporationtax. By that, it means that the Treasury draws a circle,a fence around our businesses, the upstream oil andgas exploration and production business, and it taxesthem as independent businesses regardless of whatthat company does elsewhere.For example, if you owned a refinery that lost a pileof money downstream, but you had exploration andproduction upstream that made money, you could notoffset a loss in the downstream refinery from theprofits on the upstream production, and you pay theprofit taxes on the upstream as an independent entity.That rate of ring-fenced corporation tax is 30%, whichis seven percentage points higher than the rest of theeconomy. On top of that, the Treasury levies asupplementary charge of another 32%, which takes thestarting rate up to 62%. On top of that, all the fieldsthat had their development consent before March 1993pay what is called petroleum revenue tax, which is athird form of tax. When you take that into account,those fields pay tax at a rate of 81%, so our startingrate is 62% and our top rate is 81%, which of courseis far, far higher than the rest of the economy.What do field allowances do? Field allowances giverelief from some of that tax for a limited period, orlimited scope in terms of the value of production, andit is done for particularly awkward types of offshorefield where the economics are difficult, where thereare technical difficulties and so on. What that does,the field allowances relieve the supplementary charge,the 32%, for a limited amount of value. Once youhave exhausted that value, you go back up to 62%, soin other words, those fields will start payingcorporation tax at 30%, which is above the normalrate of corporation tax, for a limited period and thenthey go back up to 62%. That is the way the fieldallowances work and if you want chapter and verseon it, our economic report that we published in thesummer, in August, is available and there is a sectionexplaining all of this. I am very happy, MadamChairman, to submit that to the Committee asadditional evidence if that would be helpful.

Q147 Mr Spencer: That would be useful. Do the restof the panel accept that definition or—Emma Hughes: I would not accept it. I would like torespond. So the research submitted to this inquiry byFriends of the Earth showed that the total value to theoil and gas industry over five years of the 28 field

subsidies awarded in 2012/13 was £1.962 billion, andthis is in fact a huge subsidy. As both the OECD andthe WTO recognise, the oil and gas industry areforegoing a payment that would otherwise be due tothe Government, a tax concession, and it is thereforea subsidy. Such field allowances lower the cost ofenergy production by reducing the overall tax payableon those fields, and under any of the broad definitionsof subsidy—around which there is a growingconsensus—they count as a subsidy.The special tax regime for hydrocarbons that DavidOdling spoke about exists in the UK, but it is notlegitimate for Oil & Gas UK to say that this adds toan overall industry tax bill that is particularly high.The reason for this is because these taxes reflect thefact that the fossil fuel companies have been granteda right to exploit a resource that is scarce in the UK,for example, oil and gas reserves. So when comparinghow heavily taxed the energy sector is with othersectors, we need to exclude these special taxesbecause they arise due to the special circumstances ofnatural resource ownership. In the context of this, wewould agree with the Oxford Energy Associates’report, which says that the standard petroleum taxtherefore defines the normal baseline tax rate for oilproduction in the UK.Alan Simpson: I would just add that whether youwant to justify it or not, it comes separate from thequestion of whether you recognise it as a subsidy. Itis a subsidy. If it quacks like a duck, walks like aduck, waddles like a duck, it is a duck. It is a subsidy,and I think it is unhelpful for the Committee to be leddown a path that pretends that some forms ofintervention are not subsidies while others are. It goesback to Alan Whitehead’s point to begin with, thenotion that if you are giving all of your childrensweets and some of them are getting them under thetable, they are not getting sweets. It just takes thedebate or the discussion into areas of nonsense ratherthan what is the value, what are the merits or demeritsof that intervention.

Q148 Mr Spencer: Mr Odling, did you want torespond to any of that or are you—David Odling: If I may. There are several things here.Firstly, we recognise that of course we pay more taxthan others and we do not expect otherwise, becausewe are exploiting a natural resource. We recognisethat, but I would ask the Committee to bear in mindthat various Chancellors over various years, with theagreement of the House of Commons, have approveddifferent rates of taxation on the industry. Forexample, the current Chancellor put our rates oftaxation up significantly in March 2011. Thesupplementary charge had been 20% before then,giving us a starting rate of 50%—30% plus 20%—and he put the supplementary up to 32%.What I am hearing from the evidence of the otherwitnesses suggests that there is no circumstance inwhich altering the supplementary charge downwardsis anything other than a subsidy, but if he can alter itupwards at will with the approval of Parliament,where do you stop? There has to be some point atwhich you say, “That is a fair rate of taxation for theindustry to pay,” but nobody has defined what that

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reasonable rate of taxation should be. What the currentChancellor has done—and the previous Chancellorinitiated the concept of field allowances, by the way—is to provide a variation to take account of thedifferent characteristics of some of the offshore fieldsthat we now face, and in pursuit of the policy thatis agreed by certainly all three main political parties,namely to exploit our offshore oil and gas resourcesto the maximum extent that is economically possiblefor the country. If you leave those oil and gasresources in the ground, you do not have the capitalinvestment, you do not have the jobs, you do not havethe development of new technologies, you do not havethe tax revenues that the production causes and youdo not have the potential exports that the supply chainis very good at creating, based upon the technologiesit has developed. You lose always in that respect, andbearing in mind that we cannot satisfy our own totalneeds of oil and gas any more—we used to be ableto, but that has not been the case for the best part of10 years—all that will do is suck in more imports.

Q149 Mr Spencer: Obviously I have heard theargument made that reducing those tax breaks iscontradicted by the fact that extra revenue comes inbecause of the extra fuel that is sold, but of course youcould then make the argument that your customers arepaying that extra tax, given that you have had thatreduction on those sort of operations. It is tilting thewhole thing the wrong way, in that then the more oilyou sell, the more customers contribute in terms oftax, so it is skewing the whole thing in the wrongdirection. Does that make sense?David Odling: Except that consumption is notsomething that we can vary, because we are sellingour products, oil and gas, at market rates. We are notselling them at something that we can dictate. Theyare at market rates. The consumption side issomething, if I may say so, that is completely differentand the volumes in consumption are completelydifferent. After all, the volume of oil being consumedin all the mature economies of the world is goingdown, progressively down.

Q150 Zac Goldsmith: I just want to get clarity onone thing. The 32% supplemental charge, is that theequivalent of a licence, so almost a rent, to be ableto drill?David Odling: No. We pay licence fees separately.

Q151 Zac Goldsmith: What do they come to andhow does that have a bearing?David Odling: I am sorry, I don’t have that to hand.It is not a huge sum of money compared with the sumsof money from the taxes I have been talking about.

Q152 Zac Goldsmith: But if the 32% supplementarycharge is unique to your sector, which is what youwere saying earlier, then that would imply it is a formof rent. It is the right that you have bought by payingthat supplementary charge to access resources that youotherwise would not be allowed to access, so it is nota tax. It is a rent; it is a charge. Would that be fairor not?

David Odling: That is where I was trying to draw adistinction between something that affects the cost ofoperations—so a licence fee does affect the cost ofoperations because it is a fixed sum of money for thelicence—against all the ones that we have beentalking about, the ring-fenced corporation tax,supplementary charge, petroleum revenue tax, whichare profits taxes.

Q153 Zac Goldsmith: Sorry, I don’t want to getnerdy about this, but a supplementary charge, it doesnot sound to me like a tax. Given that it is unique toyour sector, it sounds to me like a charge. It is a thingyou pay that gives you the right to do what you doand therefore by including it in the overall tax burdenthat you were describing at the beginning, it strikesme as being a bit misleading. I don’t know whether Ihave misunderstood what the charge is or anyonewants to jump in, but that is just—David Odling: That is certainly not the way theTreasury looks at it.

Q154 Chair: What we are trying to do is look at whatit should be, rather than how it is perceived by theTreasury.Mr Simpson, you seem to be nodding. Do you wantto come in on that?Alan Simpson: Yes, I do. I think you just made thepoint that I was going to make, which is thedistinction between the approach by this Committeeand the approach taken by the Treasury, because inparagraph 13 of the Treasury’s response document,they open with the line that says, “We don’t think thatany of any current policies are harmful.” It seems tome on the back of the IPCC report about carbonemissions and the triggers on climate change that thecompelling question about environmental impact says,“Do we want to be encouraging increased extractionof carbon fuels at a time when that is likely to bedriving us into uncontrollable climate disruption?”The impact question is likely to be addressed by thisCommittee in ways I think it never has been by theTreasury. That is a right that I hope you reserve andguard jealously.

Q155 Dr Offord: Under the Electricity MarketReform, the Government is introducing Contracts forDifference and capacity payments. Do what extent doyou see these as energy subsidies?Gordon Edge: They are subsidies. It is pretty simple.There are many reasons why you would do that, butwe should not be shy of calling it a subsidy, becausethat is exactly what it is—and we get accused of beingsubsidy junkies—and they are there for a good reason.We think on the one hand you need to, in the firstinstance, address that market failure that I was talkingbefore about having the externalities unpriced. Untilsuch time as you have a robust price of carbon, youcan justify having specific support for low-carbon,non-carbon forms of energy generation, but inaddition to that, you can also use it as a means oftechnology innovation and bringing technologies tomarket, that you will need, if you are going todecarbonise your economy in total. If you were reliantonly on a carbon price in order to bring forward all

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the technologies you need, you would be paying avery high carbon price in order to get those currentlyvery expensive technologies in the market andeveryone else would be making massive rents. Sotargeted support on, for instance, offshore wind ishelpful in bringing it down the cost curve so it canstart to compete against a robust carbon price, whereasif, as I said, you just rely on the carbon price alone, itwould be too much.

Q156 Caroline Lucas: I only want to interpret whatyou were saying just there. To that extent, is theconcept of transition an important one in terms of howyou are seeing the role of subsidies, in other words,that a subsidy would be alive for the period duringwhich it enables a transition to take place, in this casebringing renewables to a market price, but it is notsomething that then goes on for another 40 years?Gordon Edge: Absolutely. There is nothing we wouldlike more than to be able to compete directly in amarket supported only by robust carbon pricing,without direct support. The amount of potshots thatget taken at our industry because we have this supportare so large that we would like to be away from it assoon as possible.

Q157 Dr Offord: The Electricity Market Reformwill eventually introduce a carbon price floor, but inthe meantime, with a very low carbon price from theEU Emissions Trading Scheme, should we regard allfossil fuels as being subsidised because they do notcover the cost of their full emissions?Gordon Edge: I have explained that I think that isentirely correct.Dr Offord: Does anyone have a contrary view tothat?Keith Parker: I agree, but I would say that theElectricity Market Reform, as I said at the outset, isan incentive to encourage investment in those low-carbon technologies. Within the Government’sdefinition, they do not regard that as a subsidy, andthat is not something that the nuclear sector, forexample, has sought, but it wants that level playingfield, the ability to be able to compete and to bringforward that investment, which under current marketconditions would not otherwise come forward, so it isa mechanism to reform the market to bring forwardthat investment. So it is addressing a market failure,as Gordon Edge has said.Dr Offord: Okay, thank you. I think that is prettyclear.Alan Simpson: Qualitatively though, it is alsoimportant to acknowledge not only are they a subsidy,but that the Committee and Parliament needs to askwhether they are a subsidy that takes the UK towardsan energy future or an energy past, and I think thatthat is the biggest question mark about the scale offinancial undertakings by the public in one form oranother that will be built into the current Energy Billand whether it is money down the drain.Emma Hughes: Just to add to that, I would say theEmissions Trading Scheme is setting up the wrongincentives for the transformation of the energy system.A marginally higher carbon price may at best, I guess,incentivise a short-term switch from coal to gas-fired

power production, but this incrementalism serves tofurther lock us into dependence on fossil fuels ratherthan transforming to a low-carbon economy, which iswhat we need.Gordon Edge: If I could just follow up a little bit onthat one, having a price for carbon begs the questionof how big should that price be. If you were beingkind of a purist environmental economist, you wouldsay, “Well, let’s price that. Let’s go out and find someevidence and find a level of damage that that pollutioncauses” and then you price it in through a tax.Virtually impossible to do that with carbon. I haveseen varying estimates of what price should bebrought back to the electricity sector for that and itranges right up to things like $2,000 a kWh and itgoes down to a few cents. It is impossible to set asingle price that prices in the damage cost of thatcarbon. The best you can do is to set a robust targetfor where you think carbon needs to be, really enforceit, and that should give you a proxy for that level, butI think it also needs to be underpinned by a minimumlevel. My personal view would be that you have areserve price in the ETS auctioning that means thatthe price of the carbon unit would not go below acertain level, and that would underpin the investmentsin low carbon that you need.Alan Simpson: It is very easy for the Committee orParliament to get waylaid by the technical detail ofproposals that come forward in legislation, but the onething that I would just try to remind the Committeeabout—and I recognise that many of you will not beold enough to remember this—the UK had somehorrendous smogs in the 1950s and early 1960s, andthe way that Parliament dealt with them at that pointwas not to say, “We all need to be issued with personaltradeable breathing quotas,” or, “There isn’t asufficiently robust market price for soot.” TheGovernment of the day, then the ConservativeGovernment, introduced legislation that set minimumstandards and it said, “There is a three-year transitionperiod and all of industry will be required to produceagainst the following emission standards.” There wasa hue and cry from industry, saying ‘the UK will be awasteland; no one will produce here’. Actually, threeyears later, by and large, we had the same production.That was driven by a very clear setting of atransitional phase towards a higher set of standardsand I think that is a successful lesson to rememberwhen Parliament is being presented with highlycomplicated mechanisms that will do pretty muchthe opposite.

Q158 Chair: A transformational effect in Stoke-on-Trent. Mr Edge and then I will bring in Mark Spencer.Gordon Edge: I would caution that there is more thanone way to skin the cat here. There are successfulexamples of using emissions trading very well.Sulphur dioxide in the States, utilities had to bedragged kicking and screaming to it, but thendiscovered that they could do it at minimal cost andit turned out to be the lowest-cost way of bringingdown sulphur emissions from power generation in theStates, they could trade it and it was successful. So itcan be done. It depends whether you are targeting theright sectors. The thing about the EU ETS, it is

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focused on large emitters, the people who can tradeand there is no reason philosophically why it shouldbe by other sectors of the economy, the non-tradedsectors, where you impose regulations and standards.That is absolutely fine and may be exactly theappropriate way.

Q159 Mr Spencer: Just to go back, you seem to besuggesting that because some renewable technologiesreduce carbon footprint, they are good subsidies, ifyou like. I just wondered then if you would agree thatsupporting carbon capture and storage for coal-firedpower, is that a good subsidy or a bad one?Gordon Edge: Setting a robust carbon price isappropriate across the board for everyone. Then youhave an additional slice of policy on top of thatsaying, “Do we want to do this for good industrialreasons?” and you may well want to do that for carboncapture and storage. I do not hold a candle for carboncapture and storage. I support the wind, wave and tidalstream industries and I think they are entirely justifiedfor that, but that is entirely a policy choice. Do weuse additional targeted support to bring forward thesetechnologies in a time-limited way for other goodreasons, which is part of our carbon reduction policy?

Q160 Dr Whitehead: Just for Alan Simpson’sbenefit, incidentally, my mum sent me to school inthese dreadful smogs. You couldn’t see three feet infront of you. You would not believe it looking at me,but this is true.The Energy Bill indeed put forward a series ofContracts for Difference—which I think we haveagreed are a subsidy—in order to, among other things,drive down the carbon content of energy by subsidinggreener energy production. However, the Bill alsodoes an interesting thing, which is that as a result ofnon-low carbon energy investment possibly takingplace because an underwriting has been provided forlow-carbon energy, the Bill introduces capacitypayments in order to ensure that those bodies thatmight otherwise be investing in, for example, gas-firedpower stations are able to do so, despite the fact thata price has been put on their power additionally, whichit has not been for nuclear and wind and other formsof renewables. Is that a subsidy or is that a marketinstrument? How do you see the introduction ofcapacity payments for non-low carbon energyproducers? Incidentally, not providing power, beingavailable to provide power, as such.Gordon Edge: In theory, it ought to be a zero sumgame, in that what is paid out in capacity paymentsends up lowering the wholesale price of power andtherefore it is a recycling of money. I don’t think thatis entirely true. There will be some hysteresis in all ofthat and you will end up with more money goingthrough the capacity mechanism than you savethrough reduction in wholesale price. But I think itcould be seen as a cost of moving to a system wherethere is a high proportion of high capital cost, lowrunning cost, low carbon generation sources thatrequire a lot of flexibility at the margins in order tocope with their variability or indeed their inflexibility,as nuclear is. So we need to think of it as a system

cost. Whether you regard that as a subsidy, I wouldhave to go and think about the philosophy of that.Keith Parker: I agree that it is, if you like, aninsurance policy against the transition towards thelow-carbon mix, because there are characteristics ofthe low-carbon technologies that could potentiallyhave an impact on energy security, so having capacitypayments is a way of ensuring that the lights do stayon, that the power is available when it is needed. Thatrequires flexible plant that can be ramped up quickly,but investors are not going to invest in that sort ofplant unless they have some guarantee that they aregoing to have a return on their investment, particularlyif it is lying idle for quite a substantial amount of time.David Odling: But it also illustrates vividly the riskswhen you start to intervene, because one interventionbegets another and begets and on you go, andcertainly if you go back to the European EmissionsTrading Scheme, one of the things that the industry asa whole across Europe, not just here in the UK, hasbeen saying to the Commission when it starts toconsider what happens after 2020—because at themoment, we only have knowledge of what goes on upto 2020, which is not that far away in investmentterms—“Please, please, if you are going for a targetfor 2030, go for simplicity. Don’t let us have multipletargets that cross one another, which interact withanother. Please, please try to keep the landscape assimple as possible.” I fear that in this country, we arecreating so many different policy instruments that weare in danger of getting lost in some of the fog that itcreates. Where does it all stop? How do you get backto what Gordon has rightly said is the ultimate aim,which is to have no subsidies at all and haveeverything compete so the best wins?

Q161 Chair: On that point, Mr Simpson.Alan Simpson: It is a subsidy, and the danger is thatit will turn out to be a very expensive subsidy. If youlook at the impacts of the first round of capacitypayments and contracts awarded in the United States,80% of them went to high-carbon energy production,because it was the cheapest to put in place, but it wasthe most environmentally damaging. It is important toask whether we want to have those unintendedconsequences of making a situation worse by a systemof subsidies that puts in place that safety net. I havesuggested that we ought to consider othermechanisms, one of which should be legal duty, and Isay that because, technically at least, in the bankingsector you could not get a licence to operate unlessyou held reserve requirements in order to meet theliquidity needs and expectations of your customers.Whether they are sufficient is a matter of currentdebate, but that is a requirement.If you look at any other sector of manufacturing, theyalways have their own reserve capacity and no oneoperates to 100% capacity, so that if you haveadditional demand coming through, you have yourown ability to respond to that and you make it acondition of market access. I think that Parliamentneeds to think carefully about whether it has torespond to each demand from the energy sector that itcan only do things if the public in one form or anotherpays them more money to do it.

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Gordon Edge: I think you can mitigate that riskthrough careful design of a capacity mechanism tomake sure that other non-polluting forms of balancingand flexibility, storage, demand-side response areproperly and adequately brought into the system. I amnot completely convinced. I don’t follow the capacitymechanism as closely as I do the CfD—I simply don’thave time—but my understanding is the capacitymechanism is too closely designed as a subsidy fornew gas-fired plant when it should be thinking muchmore widely about how we provide that flexibility andresponse to the system as a whole.I would also want to add just a little bit about theindustry wanting simplicity. It is dangerous when itcomes to simplicity of it becoming simplistic. Onlyhaving one focus on carbon and just carbon price Ithink is having a single blunt club and you would notgo around playing a round of golf with one club. Weneed not to be scared of complexity, because this is acomplex and difficult process, which therefore wemay need to have multiple mechanisms andinstruments to do various different bits of.Dr Whitehead: I was just reflecting on the questionof you might say strategic reserve against capacitypayments and the extent to which, Gordon, youranalogy of clubs, you have one club to get you out ofthe problem that another club has put you into andwhether that constitutes a viable set of golf clubsunder those circumstances. Sorry, that is not aquestion, I guess.Chair: For those of us who do not play golf. Do wemove on to nuclear? Yes, let me move on to nuclearsubsidy.

Q162 Dr Whitehead: We have opened on thisdiscussion already in terms of the question of thestatement that new nuclear will have no publicsubsidy, but I think recognising that the debate hasmoved on from that new nuclear will have no publicsubsidy to new nuclear will only have public subsidyif other forms of energy have some form of publicsubsidy as well, and then perhaps the question of theextent to that those are—indeed, as I think we haveaccepted—nevertheless a subsidy. But then thepurpose of the subsidy and how that then reflects onnew nuclear, and indeed the nuclear industry as awhole, and indeed taking perhaps a slightly widerdefinition of subsidies, the question of Governmentunderwriting for the Nuclear DecommissioningAuthority, the question of the capping of insuranceliabilities, the question of indeed underwriting otherelements of risk, what does the panel see as thelandscape of subsidies therefore as far as nuclear isconcerned and new nuclear is concerned in particular,and how closely do you think that stands up to thegeneral view that new nuclear will have no publicsubsidy? How far are we pushing the definition, dowe think, and with what purpose?Keith Parker: I return to my initial point, that theGovernment has a policy to move the energy sectorand electricity-generating sector towards a low-carbonone. Nuclear is seen as a low-carbon technology;indeed it is. They want to incentivise in that particulartechnology, along with renewables, and carboncapture and storage, which have the characteristics of

having high upfront capital costs, but then relativelylow and predictable operating costs with the benefitof low-carbon emissions. So that is the objectivebehind the Electricity Market Reform, which is thereto encourage that investment to come forward. As wehave seen from announcements on Monday of thisweek, the investment is very likely to come forwardand a number of other companies, other than—

Q163 Chair: Sorry, you said “very likely”?Keith Parker: Yes. It is not the final deal, but it is asignificant step towards that. EDF Energy still have tomake their final investment decision, which could beseveral months off, so it is—

Q164 Chair: Sorry, I was just seeking someclarification on that from your own perspective.Keith Parker: Yes, so I am not saying this is definite.There are still some steps to be taken, but on the backof the Government’s objectives for nuclear, as part ofthe overall energy mix, a number of investors havecome forward not seeking subsidy, but on the basisof the framework that the Government has created toencourage investment, which is not just aboutElectricity Market Reform, but it is also aboutstreamlining planning and licensing procedures, forexample. It is creating the right sort of environmentin which those policy objectives can be achieved. Iknow there has been a lot of debate around the policystatement, that there will be no public subsidy tonuclear unless it is available for other forms of low-carbon technology and we accept that definition of nopublic subsidy for nuclear.

Q165 Dr Whitehead: But insurance risks, assistancewith decommissioning and short-term disposal risk-taking and long-term decommissioning underwritingare not available to any other technology.Keith Parker: On the decommissioning and wastemanagement, we have to distinguish between thelegacy liabilities that are being managed by theNuclear Decommissioning Authority, that thoseliabilities were in fact created in the public sector inthe early days of nuclear development, including theoperation of the Magnox stations, all of which bar oneare now decommissioned, and the Government hasaccepted that it is appropriate for those liabilities tobe funded and dealt with by the public sector. Whenit comes to the new nuclear build, the developers andoperators will be obliged to pay into a fund, whichhas to be agreed by the Secretary of State, a FundedDecommissioning Programme, which will guaranteethat the money will be available to cover all of thedecommissioning costs of each of the stations and afair share of the waste management costs. Given thatthese are very long-term commitments on wastemanagement, the Government will come to somearrangement about taking title to the waste that iscreated by the new build developers. That is, if youlike, a very different picture from that which appliedin the early days of nuclear technology. The operatorswill be obliged to cover those costs and they will notbe passed on to the taxpayer.

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Q166 Dr Whitehead: The question of liability of theinsurance and various other things that seem to have,frankly, dogged the industry over a period of time, ie,the extent to which the industry is able to insure itselfand the extent to which therefore the Governmentundertakes a role as the insurer of last resort, again,which in terms of the Energy Bill with theintroduction of counterparties to arrangements,appears to have a specifically opposite direction. Isthat something that you feel is sort of a riding subsidyor does it have other purposes, in your view?Keith Parker: I think it recognises what you said, thatultimately the Government is the insurer of last resort,whether it is for nuclear or any other industrial sector,if there were to be a major accident. I think theinternational agreements and treaties that the UK havesigned up, what it does is formalise that arrangement,that recognition that if there were to be a significantor large-scale nuclear accident, then the operator, whohas strict liability under the treaties, would not be ableto cover all of the claims to compensate victims ofthat accident. I suppose that is a recognition, as I say,that there will be a sort of cap on the operator’sliability, which is being increased, incidentally, underthe revision of the treaties, and then if the claims orcompensation exceed that, then the Government willstep in, but that would be the case in any other majoraccident. But I suppose what it does do is put theemphasis very much on ensuring that major accidentsof that kind do not occur, so it is safety, securitywithin the operating system, which is something thatwe have done very well in this country, a very goodtrack record on safety.Chair: Just before we move on, I know that both ZacGoldsmith and Caroline Lucas want to come in onthis point before we move on.

Q167 Zac Goldsmith: Thank you, Chair. I wanted topress that point, because the liability issue that youhave been discussed is not something that will berelevant to any of the other renewable energies, as Iunderstand it. That is therefore a de-risking exerciseby Government, effectively putting the risk on thetaxpayer, so there is an element of indirect subsidythere. There would have to be. I don’t see any otherinterpretation of that. You were talking about wastemanagement earlier and the pot into which theoperators are going to have to be making annualdeposits, but I think from what you said that that is notdesigned to cover all waste management costs goingforward, but a serious proportion of them. That issomething that would not apply to any of the otherrenewable technologies. In terms of security, I do notknow what the deal is with the Government—I amnot sure if it has been announced—but nuclear powerplants require more day-to-day security than any otherform of energy around the world. I think it is uniquein its need for personnel, security and so on, and I amguessing that a significant proportion of that will alsobe taken up by the state or the taxpayer. These areassistances provided by the state at the cost of thetaxpayer and it just seems bizarre to me. Perhaps youwould, but it would be odd to me if you wouldn’t, ifyou were unable to regard those supports as a formof subsidy.

Keith Parker: In relation to safety and security, theoperator has to pay for that, so the securityarrangements at specific nuclear sites are paid for bythe operators.

Q168 Zac Goldsmith: Okay, and on wastemanagement?Chair: But that would be much less than the full costof insuring the facility, wouldn’t it? The operator willnot necessarily be paying the full costs, so there is, ifyou like, a hidden subsidy insofar as—Zac Goldsmith: There is a cap. In the event ofsomething awful happening, there is a limit to howmuch the nuclear operator would have to contribute.The rest, anything in excess of that, would land on theshoulders of the taxpayer and I cannot think of anyother form of energy generation, any other type oftechnology in the energy market that would requirethat kind of cap. The same applies and the questionextends to the waste management, just taking you upon the point you made, that those are surely at leastindirect subsidies provided by the Government toyour sector.Keith Parker: They are a recognition of the nature ofthe technology, if you like, that if there were, Godforbid, to be a major nuclear accident in this country,then it is low probability, but high consequences.

Q169 Zac Goldsmith: No, I obviously understandthat if there was an appalling accident, it couldpotentially, if there was unlimited liability, bankruptthe company. We could argue about whether or notthe Government is right to limit the amount that theoperators would have to provide, but my question toyou is does that constitute a subsidy? Whether it isright or wrong, does that constitute a subsidy, giventhat that support is not being offered to all other formsof energy?Keith Parker: I think, as the point was made, otherforms of energy perhaps do not have that risk if therewere to be an accident on that scale, so it is—

Q170 Zac Goldsmith: That perhaps is an argumentin favour of those other forms of energy, but my pointstill comes back to whether or not, by your definition,the definition you used right at the start of this session,I would suggest that that does constitute a subsidy,and the same would apply to the waste managementissue. If I understood you correctly, you were sayingthat you think the operators are obliged to provide asignificant proportion in order to cover future costs,but not all. I don’t know what that proportion is interms of percentages. I am not sure if that figureexists, but that is another even more direct form ofsubsidy, surely. This is a mess that has been createdthat our grandchildren perhaps are going to have topay, in the same way that we are paying for themistakes over the last decades. As I understand it,69% of the DECC budget—I am not sure, and it ishard to imagine this is true—is devoted to clearing upa mess that the sector you represent has created forus. It seems to me that we are building into thisagreement preparation for exactly the same thing tohappen, perhaps not quite 69%, in the years to come.

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If that is not a subsidy, what is a subsidy? It takes usback to the first part of our discussion.Keith Parker: I think if you are setting a limit on thethird-party nuclear liability and the operators have tosecure insurance for this and there is an activeinternational insurance market that covers this sort ofrisk, it is justifiable, I think, in the public interest toensure that the risk is appropriately managed.

Q171 Zac Goldsmith: But is it a subsidy, an indirectsubsidy? Whether it is justifiable or not, we will havethat discussion another time, but it is a support that isavailable to the nuclear sector and not the others.Keith Parker: It is support that is available, indeed,but I think Mr Simpson’s point was that you have tolook at the purpose of the intervention and the meritsof the intervention and I think it is to manage the risksof a major accident in an appropriate way.

Q172 Zac Goldsmith: Just before we move on, theissue of waste management then. That seems to beeven more direct, if my understanding is correct.Keith Parker: The Government policy objective is tohave a geological disposal facility for the high-levelwaste. When that is available, the operators of the newnuclear plant will, through negotiation—and I do nothave a figure or proportion of how much they wouldhave to contribute—about the appropriate level offunds that need to be put aside for the wastemanagement as well as the decommissioning cost.

Q173 Zac Goldsmith: Can I ask you, can you thinkof any other example of an energy technology wherethe waste generated by that technology is picked uppartially by the taxpayer? Can you think of any?Keith Parker: I think if you look at the waste that isgenerated by a fossil fuel plant, for example, it is notcovered at all, whereas the nuclear industry doescontain its waste, it manages its waste from the timeit is produced until its final disposal. That externalityis not covered for other technologies, and youmentioned that there—

Q174 Zac Goldsmith: About half an hour ago, youagreed that that was a subsidy. By not pricing carboninto the market as an externality, by not internalisingthat externality, that was, according to you—not longago—a subsidy, so what is different then about thissubsidy that we are talking about now, this otherexternality which the taxpayer has to pick up?Keith Parker: What I said was that the carbon floorprice is a means of trying to price to that externality,but it has not been available and certainly was notavailable when the fossil fuel plant was and still ispumping out its own waste into the atmosphere.Chair: Before I turn back to Dr Whitehead, I knowCaroline Lucas wished to come in.

Q175 Caroline Lucas: Only simply to say that forthe last 10 or 15 minutes, we have been piling up allthe different levels of extra support that nuclear getsbecause of particular risks associated with it andtherefore the particular costs that are associated withnuclear energy as opposed to other forms of energy.When the Government unveiled this new deal with

EDF and China earlier in the week, it did so sayingthat this was necessary because it was going to reduceconsumer bills over the long term. If that is taken asthe Government’s objective of this deal, then can yousee better ways of using measures or subsidies thatwould be more effective in reducing the cost ofenergy, if that is what the Government is trying to do,than a form of energy that you have just describedyourself, which requires so many layers, so manyunknown layers too, because we do not quite knowhow much we are going to be paying for cleaning upthe waste. We are talking about a share but that shareis not defined. There’s a cap. The cap is not defined.We don’t know how much the taxpayer will have tostep in when it comes to liability either so you haveall of these layers of many unknown extra sets of costsand yet we are being sold this on the grounds that itis going to reduce costs to the consumer in the long-term. Do you, firstly, think that stacks up and,secondly if you were to be designing a system to usesubsidies more effectively with that end goal, wouldyou end up with something that looks like this?Keith Parker: I don’t agree. Caps, for example, arenot defined under the Paris Brussels Conventions.There will be an increase in the nuclear liability onthe operator from £140 million up to €1,200 million,so there is quite a significant increase—

Q176 Caroline Lucas: We don’t know the cap forthe waste management though. That is for theinsurance liability. I understand there is a cap as wellon the share that the industry will share with thetaxpayer when it comes to waste management. Do weknow what that is? I have not seen a figure on that.Keith Parker: No, but I think that the estimates thatthe operators have made of the decommissioning ofwaste management costs are quite a small proportionof the overall costs of nuclear so building up the fundto be able to cover those costs in the future should notbe a difficult task during the 60-year operating life ofa station. I think the benefits, and we have alreadyalluded to this, is that once operating, a nuclear plant,as similar with renewables, has relatively low andpredictable operating costs that, over the 60-yearperiod of nuclear operations, should translate intolower prices for consumers as part of the fix.

Q177 Caroline Lucas: Would you say that would belower than, for example, using support mechanismsfor renewables? You think that supporting nuclear isgoing to be more cost effective than supportingrenewables?Keith Parker: I think what we need to have a moresustainable cost effective energy system is to have amix and the mix should predominantly be low carbon.I think with nuclear, with its sort of base load qualitiestogether with renewables, which are more variable intheir output, it will ensure that we do have that moresustainable and cost effective mix into the future.

Q178 Chair: Mr Edge, did you want to commenton that?Gordon Edge: No, I am staying well out of this one.Chair: Mr Simpson?

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Alan Simpson: Yes. I just wonder what we are allinhaling in taking part in this sort of discussion. Icannot understand why anyone in their right mindwould want to subsidise old energy rather than new. Icannot understand why there is not a fairly radicaldegression rate that is built in to any form of marketsupport here. I also question whether it meets any ofthe UK’s objectives, certainly about delivering energysecurity within the current decade and also aboutenergy affordability in the decades that follow. So inrelation to Caroline Lucas’s question about, are therebetter ways of using the £80 billion of lifetime priceguarantees, the £14–15 billion loan guarantees forconstruction, the answer for me is absolutely and youonly have to look at other parts of Europe to see howthat is already happening.The first, in a negative context, is that this is a hugeinvestment, a huge public contribution towardsyesterday’s energy thinking. At the end of the FirstWorld War France did not want to be vulnerable inthe way that is was in the First World War so it took30% of its defence budget and threw it into buildingthe Maginot Line. It was a fantastic investment thatwould have been really relevant to the First WorldWar and utterly irrelevant to the Second World Warand CfDs for nuclear are the Maginot Line of energythinking for the 21st century.If the Committee members just take their ownpersonal experience of phone systems. Some of usgrew up when the telephone was the landline and asthe lifeline now everyone carries a mobile phonearound in their pocket and the telecommunications aremuch more versatile, they are quicker, lighter,brighter. Energy systems in the 21st century will bethe same and that is the problem that nuclear has hadin Europe because the impact of renewables into theEuropean energy grid, where they have priority accessfor renewables, has really dramatically dropped thecost of wholesale prices for electricity, sometimesgoing into negative prices where producers have beenpaying up to €100 per megawatt to put electricity intothe system.Chair: I would quite like to just keep it just on thesubsidy if you can, if you could just relate it to thesubsidy.Alan Simpson: If you are talking about the use of £14billion of loan guarantees or £80 billion of revenuepayments the UK would get much better value inbuilding another couple of BritNed interconnectors totake advantage, in the next couple of years, of existingelectricity surpluses. That is, if there is a crisis, whatwe are going to need to have access to. For two ofthose you could get them done at £500 million eachand within 18 months to construct, which was the lastexperience. So in the short-term there are muchcheaper and more sustainable solutions. In the longerterm flexibilities of energy thinking is where the restof the world is heading. The danger of this is that itis a huge subsidy that will be heading in the otherdirection.

Q179 Mr Spencer: Just briefly to pick up on yourcomment about what is new technology and what isold technology. Obviously we were milling wheat andpumping water with wind in the 18th century. We did

not do too badly there until the 1940s. I don’t know.What is the new technology?Alan Simpson: It is the energy source that is on themost rapidly rising cost curve and if you look at theperformance of construction of nuclear power in anEuropean or a north European context they are all wayover budget and way over time and are beingovertaken in the other direction by technology’s newertechnologies whose cost curves are falling rapidlywith the scale of deployments and also deliveringhuge boosts to innovation across other parts of Europeand we are not likely to see any of that. The dangeris we may even find the migration of other productionto other parts of Europe where it is just cheaper toproduce.

Q180 Dr Whitehead: My final bit on this bit, andincidentally I do observe that there are no capacitypayments available for interconnectors right now—but a minor point.The EU state aid regulations, which the new nucleardeal will need to negotiate. Interestingly the previousregime, prior to CfDs, ie renewables obligation, wasdeemed effectively by a competition commission inthe EU as state aid but was given a wayleaveeffectively on the grounds that it was a state aid thatwould bring about a non state aided form of energysupply.I understand part of the issue of the EU looking atstate aid will be the role of CfDs, which cover bothrenewables and low carbon but not renewable functionof nuclear in the context of what was previously thearrangement on what would have been a wayleave forstate aid. Do you anticipate any issues with the stateaid examination that new nuclear will receive or doyou think that the way that it has been pitchedpreviously may well apply to new nuclear in roughlythe way it did previously?Keith Parker: You are right. The CfD agreement thatwas announced earlier this week will have to beassessed by another state aid authority so all I can say,and I am not an expert on state aid, is that what theSecretary of State said the other day that they areconfident that there will not be an issue over this andthat there will be approval, ultimately given, for this.I said to the Chair earlier that that is another step thatneeds to be taken before the final investment decisioncan be—

Q181 Chair: What discussions have you had withBrussels in respect to the state aid issue? You seem toimply it is a matter for the Secretary of State.Keith Parker: Well, because it is a Government issue.It is for the Government to make the case to theCommission.

Q182 Chair: Sure, but I am asking you whatnegotiations you have had.Keith Parker: I haven’t had any personally.Chair: In your industry.Keith Parker: No, our association has not had anydirect discussions with—Chair: Indirect?

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Keith Parker: No, nor indirect. The Nuclear IndustryAssociation has not been involved in that discussionat all.Alan Simpson: What we do know is thatCommissioner Oettinger wanted to include newnuclear within the legitimate state aid provisions ofthe current draft and that that has been thrown out. Sowe do not know what the exact wording of the finalframework draft will be but we do know at this stagethat is the decision that has been made. I think the UKmay well wish to appeal but I think there is going tobe a real struggle in getting this through and we needto take account of not what the EU has said in positiveterms but we need to understand what they havealready thrown out.Gordon Edge: Yes, I just wanted to point out thatthere is a kind of plan B on this that DECC cansegregate out the renewables and the nuclear bit if itappears that the nuclear stuff may derail the passingof the EMR package as a whole. It may well be thatthe nuclear one, which is going to be treated, as AlanSimpson was saying, differently to the renewables partof this because of the way the new state aid guidelinesis coming forward. It may be that the nuclear parttakes quite a bit longer to analyse.There is also one other point I wanted to make interms of one of the ways where the Commission mightbe looking at this, as to whether it is okay, is thecomparability across the deal that is on the table fornuclear as it is for renewables. We have not seen thefull detail of what is agreed for Hinkley C. What Ihave seen in the press release leads me to believe theremay be some key differences around change in lawprovisions and risk reduction. We do not know howlong the target commissioning window around thatdate has been set for this project. For renewables, it isgoing to be one year, after that you start losing yourterm of your CfD if you have not finished it by then.We do not know how long the window is going to befor Hinkley C and we do not know the terms of theguarantee that is being talked about with Treasury. SoI think we need to look at the detail of that deal andgo, “Well, is it really comparable to what is being puton the table for renewables as well?” I would be verykeen for it to be comparable but it would be verydifficult to work out sometimes what it is.

Q183 Dr Whitehead: Are you saying that things likeinvestment instruments, which bring about a CfD, canbe lost if a window is not adhered to in terms of thatapplication?Gordon Edge: The system that DECC is setting upfor the contract for difference says, “You have a targetcommission date.” That is where a targetcommissioning window comes in.

Q184 Chair: So what will the date be?Gordon Edge: For Hinkley C they said it was 2023.Now, if the project does not start within the windowaround that date then the contract is automaticallystarted and the clock starts ticking, in this case 35years, in the renewables case 15 years. So how longthat window is, is going to be a key parameter in therisks involved in the construction.

Q185 Dr Whitehead: Do you simply lose the end ofyour CfD period or do you lose the investmentinstrument advantage that has been gained by gettingCfDs in advance of you using them?Gordon Edge: You lose time of support. If you arenot fully generating by the time the end of the targetcommissioning window—

Q186 Dr Whitehead: So you lose support at the endof your contract?Gordon Edge: No, it eats into the front of the contractuntil such time as you start and that contract would bedeemed to be—

Q187 Dr Whitehead: Sure. You don’t get theunderwriting if you are not generating but if you haveobtained an investment instrument, which isessentially a subsidy because it leads to CfDs—Gordon Edge: You will get a shorter term of it if youcommission after the end of the targetcommissioning window.Keith Parker: The fact that the CfD only takes effectonce you start generating is an incentive to meet thattarget because then you start earning money on theinvestment.

Q188 Dr Whitehead: If, say, you did not generatefor four years—let us say you had an investmentinstrument that said, “This instrument will becometenable in 2023,” for example, but you did not startgenerating until 2027, would you then hold thatinvestment instrument in a cupboard in the meantimeand the only effect at that point would be you woulddegrade a certain part of the end of that instrument,or would someone come up to you at some stage andsay, “Well, hang on a minute, you are hanging on tothis investment instrument and no one else can getinto the market because you have it and therefore weare going to take it away”?Gordon Edge: There will be a right to terminate thatinstrument at what is known as the longstop date,which will be a certain period after the end of thetarget commissioning window. For renewables it’s oneyear or two years. We have no idea what that periodis for the Hinkley C CfDKeith Parker: I cannot enlighten you on that date.

Q189 Mark Lazarowicz: A question for Mr Edge.What impact do you think the CfD arrangements forHinkley C will have on the renewables industryparticularly if they are replicated with similaragreements with other power stations in the future?Gordon Edge: It depends how big the budget underthe levy control framework is. All the money—thereis a zero sum game for that, what is paid to nuclear isless for anything else. So it really depends when andby how much Government sets a budget for beyond2020. As things stand even though the Hinkley projectis meant to start in 2023 it still has to be accountedfor within the budget that leads up to 2020 because atthe moment we cannot assume that Treasury willallow any growth in that budget after 2020 andtherefore you sterilise, and my back of the envelopesays about £1 billion a year, round number, from that

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£7.6 billion that Government has set aside up to 2020per year to pay for low carbon generation.

Q190 Dr Whitehead: Forgive me, that £7.6 billionincludes accumulation from previous years.Gordon Edge: Absolutely. It is in that year the supportis allowed.

Q191 Dr Whitehead: So sterilising £1 billion issterilising all the new entrances and—Gordon Edge: It could do if they fail to set furtherbudget beyond that.

Q192 Chair: That is a function of the definition ofsubsidy to cover both renewables and nuclear in order,presumably, to make the case for both from theGovernment’s perspective?Gordon Edge: It caps the amount that Governmentis going to pay out for low carbon generation as awhole, yes.Keith Parker: My understanding of Hinkley Point C,because it falls outside the current levy controlframework, is not coming out of that—Gordon Edge: I have had it from the Treasury’smouth myself that they will not do that until such timeas they increase the budget post 2020 and there is noguarantee they are going to do that.

Q193 Mark Lazarowicz: That is obviously a pointwe can pursue with a Minister in a future session.That is just one plant at Hinkley C. If there are morethen presumably there will be other effects on the totalavailable for low carbon energies.Gordon Edge: I think it would become increasinglyuntenable for Government to say that comes out ofthe £7.6 billion in 2020 when we are talking abouttarget commissioning dates that will be 2025, 2027.It starts looking increasingly ridiculous so there willbecome a point where the cognitive dissidence in thisbreaks and they have to say, “Okay, we will beincreasing the budget beyond 2020. We won’t tell youby how much now but just work on that assumption.”They will have to have, eventually, if they are signingloads more deals that far in advance.One thing I would say though is this is an indicationthat Government is taking a much longer term viewof the nuclear side than it is for renewables. We arebeing given some foresight at 2020 but they aresigning deals for nuclear for 2023 and potentiallybeyond. So we think that is a bit of a mismatch interms of commitment to the different sectors and onethat we would like to see much more commitment toour sectors beyond 2020 in order to have parity.Alan Simpson: Can I just say this is a uniquely Britishapproach to the way we are trying to delivery energytransformation? Since leaving Parliament I have takenvarious groups, including politicians, to look at whatis happening in Germany in terms of their energytransformation programme. When the Treasuryresponse document recognises that pretty mucheverywhere else in Europe has moved towards a feed-in in tariff framework, which does not count as asubsidy. It does not count against public expenditureand that there is a European court ruling that supportsthat and yet the UK Treasury insists that it has to be

put in a levy control framework and it has to countagainst public expenditure. When confronted with thescale that Germany, in particular, is using it differentlyUK politicians have tended to say to their equivalentsin Germany, “But how come there are different rulesthat are being made for Germany that do not apply tous?” and the answer that they get is, “Because Britain,by and large, just will not take yes for an answer.”The question, can we do this without it countingagainst public expenditure is an unequivocal, yes. Itdoes not have to come within a levy controlframework and it can be entirely a self-financingmechanism within the energy sector accounting.That was the original intention in the 2008 Act thatwe put through, which then got hijacked into a fixedbudget framework in the settlement in 2010 aboutpublic expenditure and we have not escaped from that.On Gordon’s points about this, we will continue to seethat whole transformation agenda locked into a fixedbudget with a diminishing slice of those resourcesbeing available for genuine energy transformation.

Q194 Chair: Okay. I presume that is a matter for usto take up with the Treasury Minister. Just before weleave nuclear can I just ask Mr Parker one quickquestion in terms of subsidy? In the instance, forexample, construction costs of new nuclear carry takelonger to build than what is anticipated, and that iscovered by Government guarantee, if the costs dooverrun will that be something that we will berequired to pay back or will it be received by thecompanies concerned as a grant? In that circumstance,will that then count as a subsidy?Keith Parker: EDF have made it clear, and this cameout in the press conference on Monday, they will takethe construction risk entirely.

Q195 Chair: The Government will not?Keith Parker: No, the developer takes theconstruction risk. The interest—

Q196 Chair: Even if it overruns?Keith Parker: Yes.

Q197 Chair: There is no Government finance tocover that?Keith Parker: There is an infrastructure guarantee thatis available to EDF, which would be available—

Q198 Chair: So is that part of the subsidy?Keith Parker: It would be available if the investorswere to default on the debt financed at—

Q199 Chair: Would you count that as a subsidy?Keith Parker: Again I go back to the point that theinfrastructure guarantee is available acrosstechnologies and going back to the definition of “nopublic subsidy for nuclear” it was unless supportmeasures are available across technologies. Soyesterday, for example, there was infrastructureguarantees announced for a range of renewabletechnology. Drax has received an infrastructureguarantee for the transformation of that station tobiofuels. So within that definition that the Governmenthas set down, no, I would not regard it as a subsidy.

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Q200 Chair: Does anybody else wish to comment?Gordon Edge: I would, in the same way that I wouldregard the CfD as a subsidy. It is a form of supportand we need to be clear about that. I think it is anentirely justified support and one that uses theGovernment’s balance sheet in order to bring downcosts and I think that is entirely good but it is also thecase that Hinkley C will be taking about a quarter ofthe entire budget for this programme, which may be alittle strong weighting for one project.

Q201 Chair: So it is the scale of it that you wouldhave a concern about?Gordon Edge: I think it is disproportionate to put thatlevel of the budget into one project.Chair: We must move on.Alan Simpson: I might just like to look at the Draxdeal because within the sector there are some concernsabout just how much of an underwriting Drax hasbeen given and what rate of return they are makingon this in order to, firstly continue to burn coal at alarge scale and not in an abated way and, secondlyalso to use biofuels at a greater scale than the UKproduces so that the environmental impact of this issomewhat open to question.Chair: We must move on

Q202 Peter Aldous: At the outset I will just declarean interest; I do have interests in family farms whererenewable energy policy is being pursued.Traditionally there are three justifications put forwardfor energy subsidies, to protect and support infantindustries, to come forward with pro-poor policies andto protect industry from foreign competition. In youropinion, which should carry any weight? I might justadd to that and say, perhaps, that the situation doeschange over time.David Odling: Maybe I can come in here? We haveno difficult with infant technologies getting support.Just about all forms of new technology in some wayor another have benefitted and that is fine. Of coursethe question is, when does that support run out andwhen do they have to stand on their own two feet?Our view is very simple, as soon as possible and quitea lot of it, of course, comes out of academia and thatkind of thing so inevitably has a hefty part of publicmoney behind it in any event but some of it is industrysponsored as well so there is a bit of both in there.Beyond that we believe in market pricing, andlistening to all the evidence that has just gone throughover the last 20 minutes, in some sense it isastonishing to my ears because the price of ourproducts are determined in the market and we live bythe risks of those. We think technologies need to standon their own feet as quickly as reasonably possible.Emma Hughes: I think from our point of view we arenot against subsidies per se. What we are against isharmful subsidies. Subsidies have a useful role to playas a tool to transform a market and that is where Ithink subsidies can be really useful. I think as wellwhat would be called the pro-poor subsidies also havesome use and I think better targeted consumersubsidies could be useful for alleviating the very realproblem of fuel poverty. The problem at the momentis that we have incoherent subsidy system, which

means there is a roadblock to stopping the markettransformation that we need towards a low carbonmarket and that is because of this incoherencebetween the amount of subsidies that go intorenewables and fossil fuels.Alan Simpson: I agree with Emma, and I would justsay that in addition to the three points that you listedI would add a fourth, which is, do they deliver anopen sustainable and accountable energy market? Thedifficulty is that what we have at the moment is thatthey fail most of those tests. That there are muchbetter ways of doing things and some of our Europeanpartners are very good at leading the way on that. Iknow in my submission I pointed out that Germany,over the last 20 years, has delivered an average of27% GDP growth and a 24% reduction in greenhousegas emissions. They are also delivering 400megawatts of energy savings per month in theirapproach as to how to raise the energy efficiency oftheir build environments and that is really pro-poor ata time when people’s energy bills are running awaybeyond their pockets. So it is not that those principlesare wrong, it is just that we have got some really lousymechanisms for pursuing them.Gordon Edge: I would certainly support the idea thatthere is a fourth leg, which is dealing in marketfailures, particularly environmental. Coming back tothe point about supporting industries, I think one ofthe problems we have is that misalignment betweenthe environmental market failure support and theindustrial strategies. We are finding a mismatchbetween what DECC is trying to do through EMRand in 2020 for offshore wind and the very welcomeoffshore wind industrial strategy that was led by BISand DECC were involved. We do not feel that theyare working together along the same lines and wewould very much welcome that those two were mademore coherent.David Odling: Just to add, if I may, on the questionon pro-poor. That is social policy, which obviously isa central part of Government’s activity and certainlywe see it as more aligned towards social policy to dealwith those specific groups of people.

Q203 Peter Aldous: So that should be funded out ofgeneral taxation?David Odling: It is at the moment and to encourageenergy efficiency in the homes that are ill served,particularly if they are heated by electricity, which isfar and away the most expensive form of heating thereis at the moment, which is what should be done. It isa social policy in our view.

Q204 Peter Aldous: Where subsidies are used tosupport infant industries and new technologies, andyou did touch upon this, Mr Odling, how long shouldthey last? You said as soon as possible. Does anyoneelse have any views on that?Alan Simpson: Again, for me the most usefultemplate and where most of the learning has beendone on this is in Germany. They have a differentmatrix for different technologies. They have a built-inpresumption about the rate of efficiency gain per yearand they have a target of installations that they wouldthen say, “If you exceed the three gigawatts of

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renewables per year then the degression rate increasesby 3% per gigawatt,” and they have a regularindependent review process so that in terms ofrunaway success of the growth of maturity of thattechnology, which can be accounted for within theprocess.Other elements of the new technologies will notmature at the same rate or on the same scale so thatthe review process has a longer tail to it. Maybe forthose who play golf that is where having a set of golfclubs rather than a single one makes sense but the keyfor me is that they have set very ambitious targetsand the expectation of degression rates combined withregular independent reviews, which can be as regularas quarterly.David Odling: Can I just come in there? This ideathat Germany is the paragon of all virtues I just findslightly difficult to swallow. Certainly from ourindustrial contacts both here in Germany and inPoland there are all sorts of shortcomings that I hearabout, not least the total cost of what is being done,so I just think there is a little bit of a twist in thebalance here.

Q205 Chair: Sure, when we are talking about costswe are trying to understand what the costs are on alevel playing field, are we not, which is why we aretrying to get to the heart of what does or does notamount to a subsidy?David Odling: Indeed. There are some very bignumbers in Germany on that front and it is affectingnot just Germany but it is affecting its neighbouringstates as well. You talk to the Poles and they are notat all happy some of the time. I am just trying toshift this—

Q206 Chair: Sure, but given that this a SelectCommittee that looks in a cross-cutting way acrossdifferent Government Departments, on this issueabout ensuring the supply of energy, the issue aboutsecuring energy efficiency, there is also the issueabout the carbon limits, and the real issue is how touse the subsidy for a good purpose that will balanceall of these three things.David Odling: I understand and agree with thatentirely, and we address that in our economic report.

Q207 Chair: Other European companies may have adifferent understanding of how much carbon may beconsumed for example, which would put a completelydifferent slant on it.David Odling: Yes, I was just trying to get away fromthis view that Germany is perfection.Chair: I am sure if you want to give evidence on—David Odling: I don’t believe it is. That was the pointI was making.Chair: Perhaps we will leave that there. Mr Aldous,have you finished?

Q208 Peter Aldous: No, I have a couple morequestions. Do the panel think there are anytechnologies that have been subsidised too long or,turning the question around the other way, are theretechnologies that have not been subsidised longenough?

Chair: Who wants to go?Alan Simpson: I think pretty much the entirety of ourexisting energy sector has, as its fuel source base,been over-subsidised for overlong. In terms of newtechnologies I think that we have yet to really takeseriously the national grid assessment of four or fiveyears ago where they said that if we are serious aboutbiomethane from waste we could deliver up to 49%of our domestic gas needs by 2020 but it would be ona much more decentralised production and distributionbasis than we currently have.The experiments in Newcastle in relation togeothermal—we have only begun to paddle in those,and I suspect that is one of the technologies with alonger tail to it. We also have not looked at othertransformational issues, for instance, citizens havingthe right to reduce their energy bills by socialising theownership of the local grid, because we have done alot on energy production but not on the distribution.In large parts of the United States now, and other partsof Europe, people are looking at decentralisedgeneration and decentralised distribution and sellingthemselves non-consumption in a market that hastraditionally only ever understood more consumption.So those are the spaces that I think, as a society, wereally have not begun to examine properly.Emma Hughes: You won’t be surprised to hear that Ithink the oil and gas industry have been subsidised fartoo long. In 2009 at the G20 the governmentscommitted to phasing out fossil fuel subsidies andthere has yet to be any clear decisive action to showthat happening and that is supposed to happen by2020. The IEA called dirty energy subsidies, “Theappendicitis of the global energy system that must beremoved for a healthy energy economy”, and thereneeds to be urgent action for that to happen.

Q209 Peter Aldous: Mr Odling, do you want tocome back?David Odling: Yes. I think we have to be careful. Iunderstand perfectly where you are quoting from butyou are talking worldwide there. I am assuming weare talking about the United Kingdom.

Q210 Chair: We are talking about the UnitedKingdom but clearly our policies do have animplication for wider international policies. I thinksometimes it is very difficult to separate out what isinternational, national and local but please do goahead with your comments.David Odling: Yes, subsidies in some countries arevery widespread for fuels. It is no secret that somefuels are extremely cheap in some parts of the worldbut not here. Western Europe or the EU generally isnot a place that offers the fat subsidies that are beingreferred to, but some parts of the world, yes they are.Some countries, of course, are finding themunsustainable, the Indians for example, theIndonesians, so yes, but that does not apply here.Emma Hughes: Just to come back to that and talkspecifically about the UK the OECD found that theUK Government support for the fossil fuel industryhad increased by £500 million to £4.3 billion between2010 and 2011 and this does not include some of the

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indirect subsidies that we spoke about in oursubmissions.Chair: We are going to have to draw our questions—

Q211 Peter Aldous: I have one quite importantquestion. There is one technology we have not spokenabout today, shale gas. Could you perhaps view thatas an infant industry in this country and on that basiscould you provide it with subsidies? Over to you,ladies and gentlemen.David Odling: I will start if you like.Chair: We need quick answers because—David Odling: It is clearly an industry that, in thiscountry, is in its very early stages so we don’t yetknow whether it can work economically and so on. Ithas to be done satisfactorily from an environmentalpoint of view, which we have to take as a given. Wewill not know for some time until we have drilledsome wells and discovered the data of what is goingon down there. The only way we are going to learn isto drill wells and the more wells we drill the moredata we will get, the more we will be able tounderstand what the genuine possibilities are but Idon’t think anybody is looking for a subsidy per se.In other words they are not looking to have their costshelped in one way or another. They are paying for thecosts themselves, which is what this industry does.Emma Hughes: Shale gas should not qualify for asubsidy both because it is unsustainable; it is a highcarbon technology but also because it is unlikely tosubstantially transform the energy market. If that iswhat we are looking for subsidies to do shale gas isnot a technology that is going to do that. Justyesterday the Government’s former chief adviser, SirDavid King, said that the UK would need 3,000 shalewells per year to make a real difference to energysupply. This raises serious doubts about thetechnology’s ability to transform the energy marketbecause that just will not be publicly acceptable.Chair: We may return to this in a moment. I am justvery conscious I need to bring Caroline Lucas inbefore 4 o’clock.Caroline Lucas: Don’t worry, it is music to my ears.Chair: All right, so who wants to comment on thatresponse?

Q212 Peter Aldous: I think it would be a mistake toassume that shale gas here would have the same sortof transformational impact that it has done in theStates and certainly it would be a mistake to divert usaway from the direction of travel that we have alreadyembarked on, towards low carbon energy mix on theassumption that shale gas is going to changeeverything.Alan Simpson: On this Keith and I are absolutely atone, shale gas is not sustainable. It is not economic.It is not going to reduce people’s energy bills, and ifmy reading of things is correct I am not sure thatpoliticians will find themselves electable on a pro-shale platform.The key thing that I would direct the Committee’sattention to is that earlier this year Exxon ended theirtrial drillings in Poland. Their chief geologist basicallyturned around to a conference in Berlin and said,“Look, the problem here is not politics, it is not cost,

it is the fact that some so-and-so a million years or soago scrunched Europe and it is the geology that stuffsus. In the States we have big flat tectonic plates andlots of space and no one gives a stuff about releases.We can get it out cheaply. In Europe we cannot and ithas an 85% depletion rate in two years and withoutsubsidy it is a nightmare to try to get your moneyback.” That is even before you get to this scale ofdrilling that would have to take place in the UK andthe transport movements and the discharges on landfrom the fracking fluids and the uncontrolled releases.It not an answer to anyone’s energy crisis and it willonly make the crisis worse.

Q213 Dr Offord: That was—Chair: Okay. Caroline, we will let you ask yourquestion.Caroline Lucas: Yes, it is a question of platformessentially. You say that the support that the UKexport finance provides for energy projects abroadshould be considered as a subsidy and I wondered ifyou could tell us what the basis is for that.Emma Hughes: Yes, sure. So the UK offer billions ofpounds of public money every year as both credit linesand insurance for UK companies who are exportingoverseas and this includes guarantees for fossil fuelprojects. We reference in our submission a range ofthese projects including £1 billion credit line for ultradeep drilling by Brazil’s state company, Petrobas. Ifyou look at both OECD and IEA definitions of whatthey include as a subsidy, export credit guaranteeswould clearly be included and categorised as this.Guarantee is a very specific type of subsidy and thereare methodologies available to estimate the size andthe value of guarantees as subsidies.Another point is that the UK have not implementedthe coalition agreement not to use export finance tosupport dirty fossil fuels. This has been shown bothby the loans for deep sea drilling to Petrobas but alsoto coalmining in Russia.

Q214 Chair: Thank you. Does anyone else want tocomment on that?David Odling: It is interesting that according to theevidence submitted by the UKEF they are a netcontributor to the Treasury, so you could say they areinvesting public money to make money for the publicpurse. I think the second point perhaps worth saying,certainly as far as exports of oil and gas, goods andservices are concerned from this country where wehave a substantial business amounting to about £7billion per year, in most international trade if you areinvolved in projects you will not get export ordersunless there is some form of guarantee offered. It justwill not happen. It is not something that is new. It isnot something that we are uniquely subject to. It issomething that all countries are involved in. So this isnot just a fossil fuel question, this is a much widerinternational trade question.Gordon Edge: In some ways I would echo that in thatwe, in the wind industry, see it from the other side inthat the export credit agencies of particularly Denmarkand Germany, UKF and Hermes, play a very big partin financing wind projects around the world andindeed in the UK on the basis of products of their

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23 October 2013 Gordon Edge, Keith Parker, David Odling, Emma Hughes and Alan Simpson

countries’ industries being used in those projects. SoI do not think there is anything evil about export creditguarantees and finance but you can use it for particulartechnologies over others.Keith Parker: We support the principle of havingexport credit available. One of the ambitions that theGovernment has in relation to the new nuclearprogramme is that it will help to revive the UK’snuclear supply chain and give it opportunities to workin overseas markets where nuclear is also beingdeveloped. I think the availability of credit would beimportant in enabling that to happen.Alan Simpson: I just think that the question is, whatdo you get out of it? For me the real value of thisinquiry from the Committee is that it allows a properfocus, which never happened in the entirety of mytime in Parliament, on where the UK wants to be in10 years’ time and 20 years’ time. That is the periodwhen energy markets will be transformed on the samescale that telecommunications have been transformed.The question is whether the current mechanisms allowus to be players in that or laggards.

Q215 Chair: Do we have any further questions?Caroline Lucas: Only to say that, it is not exactly aquestion sorry, but I think this brings us back kind offull circle, does it not, in the sense that we are talkingless about the mechanisms and more about theobjectives of the mechanisms? I was only going toquickly ask if there were time, but maybe there is not,to ask Emma Hughes about her views of thesubmission from the UK Export Finance Organisationbecause just from my quick scanning they arecompletely upfront about what they are giving themoney for, is things like oil and gas exploration inBrazil, Nigeria, petrochemicals in Saudi Arabia andthe question then comes back to what extent is thatdelivering the transformation in our energy system, Iguess that we have been saying that we want?

Emma Hughes: Just to come back on that I think thatis exactly right. It is not delivering the transformationthat we need. There are very good reasons that thecoalition committed to not using export credit tocontinue financing fossil fuel projects. I think also tocomment on her submission, another big problem withexport credit is the lack of assessment of projects thatthey are guaranteeing. UKEF have only conductedimpact assessments on six of the 26 loans for energyprojects that they list in their submission and thisincludes a lack of assessment on both environmentaland human rights issues. The reason for this isbecause the OECD common approach is, whichUKEF reference in their submission, “This does notrequire any impact assessment if the support is aproject bond rather than an export credit, if the loanis for less than two years or if the loan is for less thanSDR 10 million.” So what this means is that many ofthe projects are not being properly assessed and thatis why many of the problems that we reference withthe loans that they have given, in our submission,occur.

Q216 Chair: Who would you say would have theresponsibility for doing that assessment?Emma Hughes: I think that the UK Government hasthe responsibility to make sure that those loans areproperly being assessed. In particular I would put thatin the remit of BIS.Chair: With BIS?Emma Hughes: Yes.Chair: Anyone wish to add anything at all? In thatcase I think we have come full circle. I think we havecovered a lot of ground from five very expertwitnesses. So I thank you all very much indeed andwe shall continue with our inquiry. I am sure you willread our recommendations with some interest so thankyou all very much indeed.

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Ev 48 Environmental Audit Committee: Evidence

Wednesday 30 October 2013

Members present:

Joan Whalley (Chair)

Peter AldousNeil CarmichaelMartin CatonKaty ClarkZac Goldsmith

________________

Examination of Witnesses

Witnesses: Rt Hon Michael Fallon MP, Minister for Energy, Department of Energy and Climate Change,Patrick Erwin, Head, EMI Strategy and Programme Office, Department of Energy and Climate Change, DavidGodfrey, Chief Executive, UK Export Finance, Helen Dickinson, Deputy Director, Environment and TransportTax, HM Treasury, and Josceline Wheatley, Acting Head, Climate and Environment Department, Departmentfor International Development, gave evidence.

Q217 Chair: I would like to start by giving a warmwelcome to the combination of witnesses that we havebefore us. I particularly thank you, Minister, forcoming along with your colleagues and officers fromother Departments. We have been looking at thewhole issue of subsidy over the last few months. Forthose of us who were in Prime Minister’s questiontime earlier, the debate is very much a current andtimely one.Can I start by trying to understand where theGovernment is now in respect of the way the debateabout energy and energy prices is linked to the greenregulations and where we are, given the PrimeMinister’s announcement that we need to roll backsome of the green regulations and charges that areputting up bills, and the fact that now there is goingto be a review? I wonder if, first of all, Minister, youcould perhaps give some clarification about the reviewthat is under way and where we stand on this.Michael Fallon: Thank you very much and thank youfor the invitation this afternoon. Yes, I am very happyto clarify this. As a Coalition Government we areconstantly watching to see how we can reduce thepressure on the budgets of hardworking families. Youwill recall that we, much earlier, froze council tax.You will recall that we continue to freeze fuel dutyand given the recent increases in wholesale prices andthe quite dramatic increases we have seen from somesuppliers I think it is only right that we look, too, atthe total fuel bills being paid by our constituents, sowe are looking very hard at that. It is not simply aquestion of the so-called green regulations, which Ithink you referred to them to as. We are looking atthese bills across the board to ensure that there issufficient competition in this market to ensure thatnetwork costs are no higher than they need to be andthat where there are additional levies imposed on topof the bill these are as fair and as reasonable asnecessary.

Q218 Chair: So where does that leave the greenestGovernment ever agenda?Michael Fallon: The what?Chair: The greenest Government ever agenda.Michael Fallon: We have green obligations, ofcourse. We have legal obligations to the European

Mark LazarowiczCaroline LucasDr Matthew OffordMr Mark SpencerDr Alan Whitehead

Union. We have other international obligations but wealso have to ensure a securer energy supply for ourpeople in the United Kingdom, which means morehome grown energy, and we have to make sure thatwe keep the bills affordable. So we have to do allthree things at the same time.

Q219 Chair: So do you have any idea how muchmoney you would be shaving off energy bills as aresult of the process that has started? Could you giveus some idea of the timetable for the process as well?Michael Fallon: So far as the amount is concernedwe have not set a target of what we have to get offbills. I have simply drawn your attention to the verysteep increases that we have seen and any responsibleGovernment obviously wants to see what it can do tokeep those in check or to mitigate them. So there isnot a specific target but certainly we want to bringhelp, not least, to those who need it most and we havea number of schemes for doing that. We want to makesure they are working properly.So far as the time scale is concerned we are lookingvery hard at all this at this moment and the Secretaryof State hopes to make his annual energy statement toParliament very shortly and there may be some detailthere. Of course we then have in front of us the nextfiscal event, which is the autumn statement.

Q220 Chair: Could you set out for the Committeethe proportion of the bills that relate to the greenagenda in terms of the information that was providedby the Climate Change Committee?Michael Fallon: The total is around 9%. I can readout the actual figures if somebody has them to hand.Yes, the total is around 9%, which is takingGovernment policies in the round, both energypolicies and—Chair: Is that what relates to the gas bills? Is it the9% that relates to the gas bills?Michael Fallon: No, to the overall fuel bill, the dualfuel bill, and that is made up of 5% contributingtowards energy efficiency and helping the verypoorest households and 4% going towards supportinghome grown low carbon sources of energy. You mightclassify both of those as green.

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30 October 2013 Rt Hon Michael Fallon MP, Patrick Erwin, David Godfrey, Helen Dickinsonand Josceline Wheatley

Q221 Chair: How do you square that with thestatements that we have had from the Deputy PrimeMinister suggesting that the review that you are aboutto undertake may result in the money being movedover to Her Majesty’s Treasury? How is this going tobe funded, the green incentives that are needed for thedecarbonisation agenda?Michael Fallon: We have not come to anyconclusions. We are looking very hard at each of theseindividual components but we certainly have not cometo conclusions. Now, one option being canvassed, andnot just by the Deputy Prime Minister, I have seen itcanvassed more widely, is that you move some ofthese levies over towards general taxation but that isonly one option.

Q222 Chair: Okay. Has that been discussed insidethe Treasury?Michael Fallon: If I may, I do not think we ought todraw individual officials into this. I am here to answerfor the Government as a whole. We are looking ateach of these levies and all the various optionsassociated with them.

Q223 Chair: I just think it would be very helpful tohear from the official in the Treasury how this processof cost cutting on the green agenda is being taken upat the stage when the review is being planned.Michael Fallon: I hope you will not mind if I resistthat because I am here to speak for the Governmentas a whole.

Q224 Chair: May I ask what the officials from theother Departments are here to speak for, if they arenot able to speak?Michael Fallon: I gather you wanted some specialistevidence on the taxation of North Sea oil and youwanted some specialist evidence on the treatment ofsubsidies in relation to UK export finance.

Q225 Chair: We are concerned about subsidies as awhole, so clearly if there is going to be a change tothe bills, if they are not going to be met through theconsumer by the energy companies then the questionarises, as indeed the Deputy Minister said, as to howthis extra expenditure for the green commitments thathave been given—and we have signed up to legallyas part of the Climate Change Acts—is going to befound from alternative sources. That is what I hadrather hoped that maybe the official from the Treasurycould help with.Michael Fallon: I think that is premature. We havenot reached any conclusions.

Q226 Chair: With all respect I am not asking forconclusions. I am asking for the process wherebythese are going to be discussed jointly and withDEFRA involved but also with DECC and with theTreasury because there are serious issues, are therenot, if we are not going to be able to meet the greencommitments?Michael Fallon: These are serious issues but they arediscussed collectively within the normal process of

Government and that involves a number ofGovernment Departments including my own.Chair: Okay. So I take there is no response from theofficials on that.

Q227 Dr Whitehead: On the most recently declaredaverage dual fuel bill, I think it was suggested lastweek that £112 of that bill would be made up of whatare generally regarded as green or energy efficiencylevies or incentives, such as eco renewableobligations, carbon floor price, FITs, warm homediscounts and smart meter rollout. Some of those arewhat you might call underwriting subsidies in theperhaps more straightforward sense, for example onrenewable energy through the renewables obligation.Others, such as carbon floor price, are essentially atax that goes straight to Treasury. Others are assistancefor energy efficiency or indeed for fuel poverty orelderly people’s warm homes.In terms of the review that is being undertaken do youhave any preference for those that might be at theforefront of the review that would be more likely tobe reviewed in terms of the policy commitments thatthe Government has? On the basis of that, what wouldyou see are the main questions to be asked about howthose changes might be successfully completed, forexample, bearing in mind that carbon floor price is inthe Red Book over the next three or four years with avery steep rising cost per tonne? Have you made anycalculation as to how that might be replaced in theRed Book for future Treasury management purposes?Michael Fallon: Well, we are looking at all thesethings now and I am not taking any particular one ofthem as a preference or priority. The point really isthree-fold. They are now 9% of the bill. You mightregard that as very little but of course the dual bill hasincreased, wholesale prices have increased, so it isnow a sizeable element, £112, as you have pointedout, of the bill so that is a large sum.Secondly, of course, it is a sum that is forecast toincrease. These levies, as you know, better thananybody, Dr Whitehead, are due to increase over thenext two or three years and grow even more. Thirdly,I think it would not be right to exempt these greenlevies from the other pressures that we are exerting onthe retailers and on the transmission and networkcosts. It would not be right to say, “You cannotpossibly look at these.” So we are looking at all ofthem. Now, adjusting any of them is not easy.Adjusting any of them has implications. Adjusting thecarbon price floor has implications for the Revenueand indeed others have implications across the levycontrol framework and so on. So there is no easy winhere but I do not think we can start by taking any oneof them completely off the table. We have to have agood hard look at each of them.

Q228 Dr Whitehead: Indeed. I was not suggestingthat, nor do I gather from what has been suggested sofar about a review, any will be taken off the table. Iwas concerned to find out what the particularprinciples of an investigation might look like in termsof what is at the centre of the table and what istowards the edge of the table, particularly in terms of

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30 October 2013 Rt Hon Michael Fallon MP, Patrick Erwin, David Godfrey, Helen Dickinsonand Josceline Wheatley

the knock-on consequences of certain moves oncertain levies as opposed to others. I wonder whetherat this stage any such principles have been drawn up,or whether there is a very general review under way.As far as Treasury is concerned, for example, I wouldhave thought that, if certain levies are being movedinto general taxation, which would be a substantialcost to Treasury, or certain levies are being taken off,which would be a substantial cost to Treasury becauseof the lack of income coming in, it would be centrallyinvolved in, perhaps, discussing with DECC what theconsequences of that might be, for example, in termsof whether DECC might make up the difference fromits own budget or whether Treasury would take it outof more general funds. Therefore, I thought that mightconcentrate the discussion on how those levy changesmight be spearheaded. I wonder whether you have hadany such thoughts and whether you have had anydiscussion with the Treasury along those lines.Michael Fallon: If only DECC had the kind of budgetthat might help to sustain the kind of changes that arebeing discussed. We do not in DECC. We have a tinybudget and the vast majority goes on nucleardecommissioning costs.The difficulty with laying down any sort ofoverarching principles for the review is all of theseare slightly different, some of them are over timeperiods, some of them apply to the most vulnerableand nobody would want to see that kind of supportwithdrawn for the people we really want to help themost. Others of them are much more general and haveapplications to industry and, of course, to the Revenueas well. So it is quite difficult to lay down a generalprinciple for the review. All I can say, I am afraid, andI keep repeating this, is that we are looking very hardat all of them.

Q229 Chair: I will bring in Zac Goldsmith but justbefore I do, is there not a danger that the wholecommitment the Government has to the agreed agendaand to decarbonisation targets is just going to unravelas a result of the Prime Minister’s review?Michael Fallon: No, I do not accept that. We havelegislation almost through Parliament now, in its finalstages in the other place. We have a significant degreeof interest after publishing the draft strike prices fromthe low carbon and renewables industry. A healthynumber of applications have now been submittedunder the FID enabling process and last week wefinally signed heads of terms with EDF to have a newgeneration low carbon nuclear plant built, so I do notthink there is any danger—Chair: We will move on to nuclear in a moment.Michael Fallon: There is no danger to our agendaand I think I am right in saying in the last quarterrenewables contributed some 15% of our electricity.

Q230 Chair: You would accept that the parts of thebill that are there to encourage investment in greencommitments is as a result of the need to get theenergy companies themselves to reduce the amount ofcarbon that they use.Michael Fallon: Certainly.

Q231 Chair: You would. Can you then clarifywhether the review that the Prime Minister has set upwill come before or after the Government’s responseto the Fourth Carbon Budget Review?Michael Fallon: As I indicated we are looking hardat these things at the moment. We will have the annualenergy statement to Parliament by the EnergySecretary, I hope, later this week. The next fiscal eventafter that is the autumn statement and I cannot go intoany further detail on the timetable other than that.

Q232 Chair: But does that not leave an awfulamount of uncertainty about the current situation?Michael Fallon: No, I do not accept that. The autumnstatement is on 4 December, which is only five weeksaway, and we are seeing more and more investorcertainty now as we put the legislation in place. Wehave published a lot of the draft secondary legislationwith a big consultation document about four weeksago. The draft strike prices are out there and the testis, is there interest in the FID enabling process, theinvestments that come forward between the ROCs andthe new contracts for difference? Yes, there is.

Q233 Zac Goldsmith: You have described this 9%figure. More than half relates to energy efficiency,which is about reducing the cost of living. Theremaining 4%, I am guessing, is largely non-negotiable in the sense that at least part of the 4% ismade up of many contractual obligations theGovernment already has in relation to the feed-in tariffand so on. So the question would be, is there not achance, a risk, the Prime Minister and the Leader ofthe Opposition are inflating or exaggerating theopportunities of reducing people’s bills in the contextof these green measures and should they not belooking elsewhere?Michael Fallon: Some of these items are relativelysmall. I think you are right to point that out, althoughthey are scheduled to increase over the next two orthree years. So I think it is worth looking at them. Butthat is not all we are doing, we are looking very hardat the wholesale costs of energy and how that is beingpassed through into prices. That was the subject ofintense scrutiny in another committee yesterday. Weare looking very hard at the transmission costs. Weare looking too at the network distribution costs. Weare looking at all the pieces that go together to makeup this bill. I simply do not think it would be right toisolate this 9% and say we could not look hard at thatas well.

Q234 Zac Goldsmith: Would you not accept thatthere is at least a risk? From the point of view ofpeople looking in at Parliament, politics, and thisdiscussion that we are all having in relation to energybills, it does appear that the big six energy companieshave managed to completely set the agenda so that allof us are looking at what is, in real terms, a lesssignificant part of the bill—the green measures, muchof which are non-negotiable, because these are dealsthat have already been done—as opposed to lookingat the structures and the mechanics that have led tothese enormous monopolies being able to engage in

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Environmental Audit Committee: Evidence Ev 51

30 October 2013 Rt Hon Michael Fallon MP, Patrick Erwin, David Godfrey, Helen Dickinsonand Josceline Wheatley

what many people regard to be bullying behaviour. Itseems to be that we have allowed them to set theagenda and both the Prime Minister and the Leader ofthe Opposition have just rolled over and engaged onthe narrative set by those energy companies. Youwould agree there is risk of that, would you not?Michael Fallon: I do not think they should be allowedto get away with that. I agree with you. They shouldnot be allowed to get away with that. The spotlightthat is now being placed on the big six is encouragingpeople to dig deeper into their costs, whether they arepassing through these wholesale costs in the way thatthey say they are. You will know the Energy Secretaryhas written to each of them demanding much greatertransparency in the way that they discharge theirvarious obligations, like the ECO. I expect theregulator, too, to be asking tougher questions of thebig six.The current interest in the big six and the dramaticprice increases they have announced has also focusedattention on the issue of competition and has, perhaps,highlighted what many of our constituents might nothave realised, that there are 15 smaller companies outthere. Therefore, it has concentrated minds on whatwe need to do to encourage more transparency,simplification of tariffs and ease of switching. I expectthe Secretary of State to say more about that in hisannual energy statement.

Q235 Dr Whitehead: On the question of the recentagreement that was reached on nuclear power withEDF, was there any discussion at that point of theeffects that removing or reviewing the carbon floorprice might have on the several billion pounds a yearthat EDF receive, because of their particular portfolioof generation, as effectively a subsidy, through the factthat while their existing nuclear power is traded withgas as a market maker they do not pay the carbonfloor price? Therefore, they make £12-£13 a kilowatthour through that mechanism. If the carbon floor pricewere to be reviewed they would lose a fortune andthat might be a bit of a problem in terms of how theymight see their arrangement to build a new nuclearpower station. Have you discussed that with them?Michael Fallon: No. I am not aware of linkage likethat.

Q236 Chair: Who would have been the person tohave discussed that with them?Michael Fallon: Well, you are alleging it has beendiscussed. I am saying to you I am not aware it wasdiscussed. It certainly was not discussed at anynegotiation I was a party to.

Q237 Dr Whitehead: Would it be your intention todiscuss that in the context of this review that is beingundertaken, depending what is on the—Michael Fallon: No. You are making a very earlyassumption that we are going to adjust the carbonprice floor.

Q238 Dr Whitehead: Presumably if it is on the tablethen someone ought to know what the consequencesof it being on the table are?

Michael Fallon: We are looking at all of these variouslevies. We have not come to any conclusions. It is ata very early stage. Certainly, in the negotiations withEDF that was not a matter that I am aware wasdiscussed at any time.

Q239 Martin Caton: During this inquiry one thingwe have looked at is the extent that subsidies havebeen used to help those in fuel poverty. In July EdDavey said that the Government was changing thedefinition of fuel poverty. Has this resulted in youthinking of ways of making energy cheaper forpoorer households?Michael Fallon: Yes. I think the new definition—andwe have taken the power to do this now in the EnergyBill—will be helpful in enabling us to focus on whois in need of most help rather than the householditself, which might be very drafty and poorly energyefficient but might well belong to somebodyreasonably wealthy. I think we have a more sensibledefinition now. Without necessarily changing theamount spent it will make sure it is better targeted.

Q240 Martin Caton: The current definition talksabout how much disposable income goes on energybills. That appears to fit with the Prime Minister’scurrent review to reduce bills, doesn’t it?Michael Fallon: I am sorry I am not with you there.Let me just check the definition.Martin Caton: I understand the definition to be howmuch disposable income goes on energy bills. I amjust suggesting that fits quite neatly with the PrimeMinister’s current review with the aim of reducingbills.Michael Fallon: No. The new definition allows us tounderstand much better what the actual depth of fuelpoverty is in a particular household rather than simplythe extent of it. It will give us, rather than a fluctuatingpopulation of people moving above and below theline, a much more stable population that we can reallyfocus our attention on. So I think it is a much moreuseful way of looking at it.

Q241 Martin Caton: All right, which leads me on towhat I next wanted to talk about. According to theOECD and IMF the 5% reduced rate of VAT onenergy bills is a subsidy, albeit not very well focusedon the poor, which is what you were implying justthen. Is the Treasury looking at replacing that subsidywith better targeted fiscal measures?Michael Fallon: Well, I do not accept that it is asubsidy. VAT, by definition, is a tax, so it cannot be asubsidy. It increases the cost of—Martin Caton: The OECD and the IMF beg to differwith you.Michael Fallon: I do not agree with the OECD andthe IMF on that. By definition a tax increases the costto consumers, it cannot be a subsidy.

Q242 Martin Caton: All other VAT is 20% and onenergy it is 5%. VAT on energy in Europe is at that20% rate. So we are different and it effectivelyreduces the price for British consumers. The problem

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Ev 52 Environmental Audit Committee: Evidence

30 October 2013 Rt Hon Michael Fallon MP, Patrick Erwin, David Godfrey, Helen Dickinsonand Josceline Wheatley

is it reduces the price for all British consumers notjust the fuel poor that you want to target better.Michael Fallon: Member states make their decisionsabout the level of VAT they apply. You are not quiteright on that. Other countries do have lower rates forcertain types of fuel but this was not a reduction from20% to 5%. You will recall that purchase tax itself—sorry, you will not recall, it was before your time. Iam so sorry. Purchase tax, the origin of VAT, did notapply to fuel. Purchase tax applied to things that wereregarded as luxuries rather than essentials so we neverhad tax applied to fuel of this kind. It was theGovernment in 1994, I forget what Government,which decided to end zero rating and move up to 8%and that then was reduced in 1997 to 5%. So we neverhad VAT at 20% so I cannot accept it is any kindof subsidy.

Q243 Martin Caton: Okay. It really doesn’t matter.Effectively it means energy prices are cheaper forconsumers in this country.You are probably aware that some academics havesuggested that if you were quite ambitious in tacklingVAT, even though it is politically sensitive—we doappreciate that—then you could far better target moreresources to the very worst off. Is that even beingconsidered and is not the Prime Minister’s review anopportunity to go for more ambitious thinking toensure that those people do benefit?Michael Fallon: I saw that submitted in evidence toyou but I am afraid I can’t agree with it. IncreasingVAT would increase bills for everybody. I think itwould make it more difficult to get at the underlyingprice increases but it would be regressive. It would hitall poorer households harder and I don’t think that isthe answer.

Q244 Martin Caton: If you are looking at the samepiece of evidence that I am talking about, the wholepoint was the extra VAT income was then provided tohelp those very poor and they would be the only onesthat were better off as a result of the change. All I amsuggesting is that we should be thinking outside thebox and that the Prime Minister’s review gives us anopportunity to do that.Michael Fallon: It does give us the opportunity tothink very widely and to think outside the box but Iam afraid, Mr Caton, it is not one of the things thatwe are considering at the moment. I think it would betoo complicated. Even if you raised all this extramoney by imposing it as an extra tax on people whomight not be very poor but are not that well off, Idon’t think you would be able to target the help anymore efficiently than the schemes that we have at themoment so we are not considering that.Martin Caton: At least we have identified one optionyou are not considering. Thank you.Michael Fallon: You have.

Q245 Chair: Just before we leave fuel poverty, theGovernment has obviously removed the commitmentto remove fuel poverty by 2016. What weight will theGovernment be giving to those in fuel poverty as partof this review?

Michael Fallon: We have taken power in the EnergyBill to change the target to make it better identify amore stable population of those who are in greatestneed. We certainly do not want, as we look at these—if you want a principle behind this review—to weakenthe position of the most vulnerable, those who needthe most help with their bills and who need the mosthelp in terms of improving their energy efficiency.That is not the point of the review.

Q246 Chair: Given what the Deputy Prime Ministersaid about the likelihood of the Treasury having tofund more, and given that it was going to be takenaway from individual bills, does that mean, as far asthe support for those in fuel poverty is concerned—one of the first things that the Government did was toend the Warm Front Scheme and get rid of thetaxpayer funded subsidy for those in fuel poverty—that the Government may be looking at a taxpayerfunded scheme to deal with fuel poverty?Michael Fallon: The Warm Front Scheme, and youmay not know, was not working very well. OurAffordable Warmth Scheme is working far better andis helping more households. But the aim of this reviewis not to weaken the position of those who need themost help. We have not yet taken any decision aboutwhether any of these particular levies should bemoved across to general taxation. That is only oneoption that one Minister referred to.Chair: The Deputy Prime Minister?Michael Fallon: Indeed.

Q247 Caroline Lucas: I wanted to move to nuclearand we had the famous Coalition agreement that therewould be no public subsidy for nuclear. Do you acceptthat you have used a bit of a sleight of hand byredefining that original commitment because no publicsubsidy means no public subsidy, presumably, and yetwhat we are now told it means is no subsidy unless itis being made in a similar way to other energysources?Michael Fallon: That is what was said to Parliamentback in October 2010. There would be no levy ordirect payment or market support for new nuclear thatwas not available in a similar way to any other lowcarbon type of new technology.

Q248 Caroline Lucas: I am an English graduate andone thing that really annoys me is when peopleredefine words. A subsidy does not cease to be asubsidy just because it is offered to more than onesource, does it? It is still a subsidy whether or not youoffer it just to nuclear or to nuclear and a range ofother low carbon sources. It is still a subsidyrelatively speaking.Michael Fallon: I do not define it as a subsidy. If youare trying to get somebody else to put up £16 billionworth of money to build a nuclear station and toaccept all of the construction risk in doing it, youobviously have to offer them some degree of reservedaccess to the grid at the beginning of the operatinglife of the asset when they start supplying electricityto it. So there is a support mechanism for nuclear just

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Environmental Audit Committee: Evidence Ev 53

30 October 2013 Rt Hon Michael Fallon MP, Patrick Erwin, David Godfrey, Helen Dickinsonand Josceline Wheatley

as there is for off-shore wind or on-shore wind orbiomass or anything else.

Q249 Caroline Lucas: Exactly. I do not have anyproblem in saying that renewables are subsidised. Iwould be happy to say renewables are subsidised andI think we can justify that because renewables aregoing to be subsidised for a relatively short time andthey are a new technology. If we can all agree thatrenewables are subsidised could we then also, please,all agree that nuclear is subsidised and we candisagree as to whether or not it is a good thing or abad thing, but I just would like the Government, onrecord, to accept that nuclear is subsidised.Michael Fallon: I am going to disappoint youslightly.Caroline Lucas: I thought you might.Michael Fallon: These are support mechanisms. Ithink it is important that support mechanism shouldbe open and transparent. They should be, as far aspossible, market based and competitive. They shouldbe available to all, and I think you and I agree, highcost new forms of low carbon technology that cannotbe supported by the market. They should be timelimited, I think you and I agree on that, and wherepossible they should degress in terms of price support.Finally, they should be good value for money for thetaxpayer. They should be underpinned by a robustimpact assessment and evaluated afterwards bythorough monitoring and so on but I would not callthem subsidies. These are market based supportmechanisms designed to facilitate the earlierintroduction of high cost low carbon technologies thatthe market would not otherwise have been able tofinance as quickly as we need them.

Q250 Caroline Lucas: Okay. We will not agree onthat but maybe we could agree on one thing, you saidthat subsidies should be open and transparent.Michael Fallon: Yes.Caroline Lucas: If we were looking at the subsidiesaround dealing with the nuclear waste, in other wordsdecommissioning, then in what way is that open andtransparent? There is a rather wonderful phrase yousaid in response to a parliamentary question whereyou said, “Nuclear should pay their full share of wastemanagement and disposal costs.” What is a full share?A share, how much is the share? Is it 40%, 50%?Michael Fallon: This is the first time we have everhad a nuclear station built where we have made thedeveloper build in a waste decommissioning cost rightfrom the start.

Q251 Caroline Lucas: That is a different question,with respect. You were saying that subsidies shouldbe open and transparent.Michael Fallon: Yes.Caroline Lucas: One of the subsidies is the fact thatnuclear will not be giving its full amount towards thewaste, there is going to be a full share. So, in theinterests of openness and transparency, can you tell uswhat a full share is? What percentage of it, is it?Michael Fallon: I do not have the exact figure. Wedid specify the decision at the time when we

announced the heads of term. I think it gave the exactamount that had to be paid right from the start of theoperation of the asset.

Q252 Caroline Lucas: Because it is also capped ofcourse. Even if you can’t give me that figure, and Iwould be delighted if you can—Michael Fallon: We will get you the figure.Caroline Lucas: It is also the case that there is a cap.Beyond that you accept that the taxpayer would haveto pick up the rest. So that does not feel very fair interms of a difference that is being made for nuclear.It is not the same for renewables.Michael Fallon: What we have said in a statement toParliament is the support mechanism for nuclear hasto be made available in a similar way for other lowcarbon technologies. Of course they do not havenuclear waste to deal with. So to that extent nuclearis slightly different. All of these new technologies areslightly different, one from the other. They all comewith different associated costs, whether you aretalking about insurance or waste or whatever.

Q253 Caroline Lucas: Nuclear is hardly a newtechnology. You would agree with me about that.Michael Fallon: I would not entirely. This is the thirdgeneration nuclear technology. I think it is new in thatsense and those are the terms that we will bepresenting the support mechanism to the Commissionfor state aid clearance. This is a new form of nuclear.

Q254 Caroline Lucas: Firstly, I think it is a secondgeneration but, secondly the very fact that you haveto go to the EU to get state aid clearance surely meansit is a subsidy. If it is not a subsidy you do not needto do it.Michael Fallon: A great deal of the supportmechanisms that we are designing as part ofelectricity market reform have to go through clearanceprocedures in Brussels, which is true of the capacitymarket, it is true of some of the other terms that weare offering. I do not think nuclear is particularlyexceptional in that. The Commission, itself, will wantto scrutinise the terms of this particular deal to makesure that the support mechanism is thoroughly fairand justified.

Q255 Caroline Lucas: In terms of other hiddensubsidies—I know you are still getting me the figurefor the full share and the cap—there is the issue ofliability as well, because the Government now hasincreased its overall support of liability or the overallrequirement of nuclear to pay its liability up to £1.2billion. Again, if you look at something like the costsof Fukushima, we are talking about orders ofmagnitude higher than that. So, again, would you notsee that as being a subsidy to nuclear, the fact thatuniquely among technologies there is nothing similarabout it? Uniquely to nuclear we have the risk of anextraordinarily high amount of money that thetaxpayer could have to find.Michael Fallon: Again we have been completelyopen and transparent about that. The current limit on

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Ev 54 Environmental Audit Committee: Evidence

30 October 2013 Rt Hon Michael Fallon MP, Patrick Erwin, David Godfrey, Helen Dickinsonand Josceline Wheatley

nuclear liability is £140 million. We have increased itin this instance to £1,200 million, £1.2 billion.Caroline Lucas: I appreciate that and I said thatmyself. My question though is, do you accept that inthe event of a serious accident we will be looking athaving to pay an awful lot more than that and thatwould be uniquely the case in nuclear in terms of theamount of extra money we would need to be payingand, therefore, another form of subsidy is going tonuclear that is not going to wind farms or solarpanels?Michael Fallon: Financial cover for unlimitedliability is simply not available on the commercialmarket either for nuclear or indeed for buildings in theCity of London insuring themselves against terrorism.There are certain sorts of cover.Caroline Lucas: We are not comparing like with like,though, are we?Michael Fallon: There are certain forms of cover thatsimply are not commercially available. What we havedone is significantly increase the liability limit butbeyond that the State has to step in and of course thedeveloper will be charged a fee for that.

Q256 Caroline Lucas: It is very convenient to makea comparison outside of the energy question and talkabout buildings in London. But if we are looking atthe support that the Government is giving to theenergy sector in particular then I do not understandwhy you can’t accept that the support that you arehaving to give to nuclear is qualitatively differentfrom the support you are giving to the other energysources because, uniquely, nuclear cannot findcommercially available insurance on the market.Michael Fallon: Clearly there are quantitativedifferences. We are dealing with much larger amountswhen it comes to liability. We are dealing with a muchlonger construction period. We are dealing with amuch longer lifetime of the operating asset. Thesestations will run for 55–60 years and quantitativelythis is of a different order of magnitude to say thelargest wind farm that might have a life of only 20years. That is why the previous Secretary of State wasvery careful to use the word “similar”. It cannot beexactly the same kind of support as is available tobiomass, wave power or tidal. These are differenttechnologies.

Q257 Caroline Lucas: It just seems to me that yourDepartment has an extraordinary elasticity in itsdefinitions. First of all around subsidy, we have nowstretched the meaning of subsidy to mean somethingmuch broader than most people would understand ofthe word subsidy. I fear we are in danger now of doingexactly the same when it comes to the word “similar”because what we have been talking about for the last10 minutes is a range of ways that nuclear isextremely dissimilar from other energy sources. Youcan see that not only in the sweeteners that I have justbeen describing but also if you compare the actuallength of the contract that is offered under CfDs, the35 years that nuclear gets, the much smaller amountthat, for example, solar would get and yet figures fromthe solar industry itself show that it is going to be far

more competitive. It will be beating nuclear on strikeprice alone by 2018. That is five years before evenHinkley C is due to be completed. If you looked atsolar versus nuclear the idea that somehow those CfDsare being offered in a similar fashion does not add up.Michael Fallon: Let me deal, first of all, with thisissue of contract length. We are offering the supportprice for 35 years out of the potential operating life ofaround 60 years. The support being offered to off-shore wind, for example, is for 15 years undercontracts for difference for a turbine that might onlylast for 20 years. It is a much greater proportion ofthe operating life of the asset than it is for nuclear. SoI think what we are offering for nuclear is a prettygood deal and I know you do not agree with that.On the issue of the definition I would slightly takeissue with you. I think the evidence you have had asa committee shows it is very difficult to come to anagreed definition of the word “subsidy”. I do not thinkthis is a difficulty that DECC is causing you. I havenoticed that there is not quite agreement out there onhow you define a subsidy in the way that you wouldlike to do so.

Q258 Caroline Lucas: I would just make the pointthat in terms of your saying that wind, for example, isgetting a good deal and nuclear is paying a reasonableamount, I think there is a confusion in terms of whatthe working life of some of these renewable sourcesare because often it is about 60% of the working lifeof nuclear or 60% of the working life of a renewablesource and that is somehow similar. There is a lot offeedback that suggests that what you are comparingwhen it comes to the renewables is their so-calledwarranted life, in other words the life that they areinsured for, which does not mean their overall life. Acar might have a warranty for five years, it does notmean on year six it stops working and so just becausewind turbine or solar panels have a certain warrantedlife does not mean that that is a significant way ofjudging their life.Michael Fallon: We will see. As I understand it after15 to 20 years there is quite a lot of the turbine thatmay need replacing but there you are. It is veryimportant though to get on the table that the strikeprice that is being offered for nuclear is only for aproportion of its operating life. It is not for the wholeoperating life.Caroline Lucas: I think we are just disagreeing aboutthe length of operating life.Chair: Moving on.

Q259 Caroline Lucas: Sorry. Very quickly, couldyou give a figure that would have represented asubsidy in your mind in the Hinkley case? If 35 yearsat £92 is not a subsidy what would have been?Michael Fallon: What would be a subsidy?Caroline Lucas: Yes, what amount of money for thestrike price? What could you ever have said was asubsidy?Michael Fallon: That is not how we started thenegotiation. We think this is a reasonable strike pricetaking into account a whole range of factors, theextent that all of the construction risk, all of the cost

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Environmental Audit Committee: Evidence Ev 55

30 October 2013 Rt Hon Michael Fallon MP, Patrick Erwin, David Godfrey, Helen Dickinsonand Josceline Wheatley

of it—if the build time is beyond schedule, if the costsrise—is borne by EDF and its consortium. These areconsiderable costs involved that have to be raised inthe market. I think it is a reasonable price given thosetwo factors and there are many others as well.Caroline Lucas: The last question before the end—Chair: Just before your last question, Zac and thenAlan Whitehead.

Q260 Zac Goldsmith: I just wanted to press a pointthat Caroline Lucas made in relation to the waste. Ido not know whether you are still looking for thefigures or whether you are going to come back to uslater with those figures.Michael Fallon: Either.Zac Goldsmith: It would be useful to know whatpercentage of the anticipated waste bill is going to bepicked up by the taxpayer, what percentage would beleft for the industry itself and what that means in termsof the actual bill. How much are we likely to bepaying to clear up?Secondly, I am struggling with the definition ofsubsidy as well. I can’t understand how it is possible,if one of the inevitable consequences of nuclear poweris nuclear waste, that a chunk of that bill is going tobe picked up by the taxpayer. That is an externalitythat the industry ought to be internalising by now. Itis a mature industry.I am interested to know how you can possiblymaintain that that is not a subsidy—it just seems tobe, by any definition, by any understanding of thedefinition of a subsidy. The taxpayer will be pickingup a cost that the companies, themselves, ought to betaking on board.Michael Fallon: I think we ought to get back to youon the exact figure because this is the same questionthat I have been asked as to exactly what the share is.

Q261 Zac Goldsmith: You do maintain that that isnot a subsidy? That if the taxpayer picks up the wastebill or a proportion of it that is not a subsidy.Michael Fallon: Mr Erwin may have found the figure.Chair: Are you allowed to speak?Patrick Erwin: I think there is a misunderstanding.When we talk about a fair share of decommissioningcosts, we are talking about total decommissioningcosts across the portfolio of nuclear assets in the UK.Most of the nuclear waste, most the nuclear bars comefrom the historical research programme and the earlyreactors in the 1950s and 1960s. In terms of newplants, the intention is that the decommissioningarrangements will completely fund all the waste thatis created by that plant—so its proportion, its fairshare of the costs of, for example, a deep geologicaldisposal facility and there are mechanisms by whichthat funded decommissioning programme goes up anddown to make sure that it covers the full wasteliability over the lifetime of the plant and that is not35 years. It is the lifetime of the plant.

Q262 Zac Goldsmith: After the plant isdecommissioned as well or not?Patrick Erwin: Lifetime of the plant in terms ofoperation and decommissioning.

Q263 Zac Goldsmith: It is not possible that thetaxpayer will have to pay for any of the clean-up ofthe new generation nuclear power plants? It will allbe paid for by the industry. Is that an absolute?Patrick Erwin: The intent is a fundeddecommissioning programme that covers the cost ofdecommissioning in its entirety.Chair: It is very difficult to hear.Patrick Erwin: Sorry. The funded decommissioningprogramme is designed to cover the entire cost ofdecommissioning the reactor and dealing with thewaste.Michael Fallon: So there was a misunderstandingthere about the word “fair”.Chair: I would urge you to use the microphone so weall can hear very clearly in future.

Q264 Dr Whitehead: A 35 year contract at £89strike price, possibly rising to £92.5 if no morenuclear power stations are built is an interestinginversion in terms of how much you get for not doingsomething, as opposed to how much you get for doingsomething but perhaps we will pass that one by.Is that going to be regulated by means of a variedinvestment instrument as set out in the Energy Bill?Michael Fallon: The answer to that is yes.

Q265 Dr Whitehead: The varied investmentinstrument in the legislation enables variations to takeplace in that agreement if an agreement to do it isentered into at the time that the investment instrumentis signed but only has to be reported after the variationhas taken place. Has any such agreement been reachedas far as the strike price is concerned?Michael Fallon: No. We have not signed aninvestment contract with EDF.Dr Whitehead: No. I mean has any agreement to dothat been agreed, i.e. an investment instrument thatwill have those provisions within it?Michael Fallon: No, we have agreed heads of terms.We have agreed the basis on which an investmentcontract will be signed but that has to await passageof the legislation to Royal Assent and it also has towait approval from the Commission in Brussels. Sowe are not at the point of signing an investmentcontract. We have already given an indication as tothe circumstances in which the contract could bevaried and the number of events you will probablylook at, like curtailment and change of the law riskand risks to changes of business rates and so on.

Q266 Dr Whitehead: Bearing in mind that the variedinvestment instrument does not require anyone to saywhat the terms of the variation were when thevariation was agreed other than report at the point ofvariation that that agreement has been implemented,are you able to say, today, the strike price that hasbeen announced is really going to be the strike priceover the entire term of the contract or will there be adifferent strike price depending on the variedinstrument?Michael Fallon: No. It is the agreement betweenourselves and EDF and its partners, this will be thestrike price, but we have set out in the agreement the

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30 October 2013 Rt Hon Michael Fallon MP, Patrick Erwin, David Godfrey, Helen Dickinsonand Josceline Wheatley

circumstances that it can vary up or down. Not leastif there is a gain on a construction, we are going toshare half of the gain. If there is pain on theconstruction, it slips behind budget by a couple ofyears, they have to take all of that.

Q267 Chair: Can I just interrupt you there and justask for clarification on that because my understandingis that if there is a delay with the construction thosecosts could be met by the taxpayer?Michael Fallon: No. If there is a delay in theconstruction that is a matter for the developer. Thedeveloper has to take all of the pain involved in that.If construction is delayed for something completelyout of the developer’s control, supposing we had, Godforbid, the return of a malevolent or anti-nuclearGovernment that suddenly decided to haltconstruction that is not something that can be laid atthe door of the development. There are a range ofcircumstances that are outside the control of thedeveloper.

Q268 Dr Whitehead: What I was trying to clarify isif there is a delay in construction or a number of otherfactors then within a varied investment contractarrangements can be made within the terms of thecontract to vary the subsequent strike price, forexample, over a period to reflect that delay or thosecircumstances. Indeed some of them were set out inthe Secretary of State’s statement. Are you able to saythat other than those things that have been set out inthe Secretary of State’s statement nothing would be ina varied contract that would enable that price to bevaried if circumstances arose that were not in whatthe Secretary of State had said in his statement aboutthe circumstances that could lead to a variation?Michael Fallon: That is our intention.

Q269 Chair: Just before I come back to CarolineLucas, can I ask for clarification because I understandthat the National Audit Office is intending to look atthe arrangements? I am not quite sure the stage thenegotiations have reached. Is it your intention that thisNAO review will be completed prior to anyfinalisation of the agreements? On the uncertaintiesthat Dr Whitehead has just referred to, would youexpect that all of those would be scrutinised with fulltransparency by the NAO before any final decision isreached? Parliament has not had an opportunity tolook at the detail of all of this because it has beensubject to commercial confidentiality.Michael Fallon: I understand that and this came upduring the passage of the Energy Bill. They went atsome length into this to try to reassure Parliamentexactly what we would make available and publishedto Parliament and how we would define what wasbeing withheld from Parliament for reasons ofcommercial sensitivity. There was an argument in thecommittee or at report stage about this and I think weaccepted an amendment making this clearer. It maywell have been Dr Whitehead’s amendment.Chair: Given that the NAO is now going to belooking at this, which is a change—

Michael Fallon: On the timetable, yes. I am notresponsible for the NAO’s timetable. I am not quiteclear what that is.

Q270 Chair: Would you expect that review to havebeen completed before you finally sign off any ofthese arrangements that have just been referred to byDr Whitehead?Michael Fallon: I really do not know their timetablefor doing this. We are not likely to sign an investmentcontract for this project before next summer. I am notsure how long an NAO review normally takes;perhaps somebody can help us on that.Patrick Erwin: My understanding is the NAO reviewis about to start and is likely to be carried on inparallel but report probably afterwards. If that isdifferent we will come back to you.I should say this is probably the most transparentapproach we have ever taken to this kind of contract.It is much more transparent than say a PFI contract oranything like that. We are really trying to do it asopenly and transparently as we can within the confinesof trying to do a commercial deal.

Q271 Caroline Lucas: Just the very last bit onnuclear. I do just want to come back to what Mr Erwinsaid earlier because I think there has been a bit ofconfusion, and I apologise if it is partly from me, butthere were two things we were talking about in termsof whether or not the taxpayer would have anyresponsibility, one was on decommissioning and theother was on waste management. I think, Mr Erwin,you have clarified that on the decommissioning thereis no risk of the taxpayer having to step in and fundany of that because the nuclear plants themselves, thenuclear companies, have said that they will do that.On the waste management there is a cap and,therefore, I just want acknowledgement on that andacceptance from you that that is the case. Indeed, Ihave some text in front of me again from an answerfrom a parliamentary question that says, “The wastecontract will, at the outset, set a cap on the level ofwaste transfer price. The cap will be set at a level thatreflects the Government’s current analysis of risk anduncertainty. The Government accepts that in setting acap, the residual risk that actual cost might exceed thecap is being borne by the Government.” So that beingthe case can we agree that that is a subsidy?Patrick Erwin: We are charging for that cap so weare taking a risk fee for that cap.Caroline Lucas: Yes, but it is not the full amount. Tothe extent that—Patrick Erwin: The fact that we are providing, if youlike, that insurance, that is costed into thedecommissioning process. It is not a certainty; we areinsuring them against that cap.

Q272 Caroline Lucas: Yes, you are insuring themagainst that cap but if the cost of waste disposalexceeded the cap the difference between the amountthey were insured for and the full cost would still bepaid by the taxpayer, would it not?Patrick Erwin: That is a very small risk and—

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Caroline Lucas: I do not care how big the risk is. Icare about the principle of whether or not it is asubsidy.Chair: Is it or is it not?Patrick Erwin: We would not describe it as a subsidy.We describe it as a—Caroline Lucas: A what, sorry?Patrick Erwin: It is an agreement we have made oncommercial terms and charged a fee for.

Q273 Caroline Lucas: Maybe I am just missingsomething here, but surely we have just establishedthat the Government has accepted that in setting a cap,the residual risk that actual costs might exceed the capis being borne by the Government. The Governmentin this case means the taxpayer. It means us.Patrick Erwin: Yes, but we are not providing thatservice for free, we are charging a fee for it.Caroline Lucas: No, you are charging for it but therewill still be an amount of money to be paid over andabove that were this cap to be exceeded, surely?Patrick Erwin: That is the nature of such a product.Caroline Lucas: Quite. It is a subsidy.Michael Fallon: It is an insurance policy.Chair: Sorry, what was that, insurance—Michael Fallon: It is an insurance policy.Chair: An insurance policy.Michael Fallon: Yes. They pay us for that.

Q274 Chair: Right, I think that is perhaps as far aswe are going to get to on when is a subsidy aninsurance policy.Just before we finally move on from nuclear, in termsof state aid and discussions that you have been havingin Europe, have you been leading in terms ofdiscussions in the European Union from a point ofview of making the same arguments about this notbeing a subsidy and therefore not subject to state aid?Michael Fallon: Yes, we have pre-notified the likelyterms of this agreement, the shape of this agreement,and we formally notified it, I think, to the Commissionon the day of the announcement to Parliament. It issomething we have been discussing with state aidofficials from DG Comp over the last few months andwe are not the only nuclear member state. There arearound a dozen other member states that have thebenefit of nuclear power so I hope this will proceedsmoothly through the approval process.

Q275 Chair: Given that you think it will proceedsmoothly through the approval process, does thatmean that the Commission has already expressed aview to you as to what they see as a definition ofsubsidy?Michael Fallon: No. I must be very clear on this. TheCommission has not expressed any view at all. Wepre-notify the likely terms and then we formally notifythe project as a whole and it is then for theCommission and its lawyers and advisers to come toa view on it and that is almost a quasi-judicial processso they have not expressed any view.Chair: We have a fair amount of ground still to cover.We will move on to capacity payments.

Q276 Dr Whitehead: You mentioned a little whileago that an instrument that is available to more thanone form of generation, which involved money beingcollected to provide underwriting for those forms ofgeneration, would not be a subsidy provided it wasavailable to more than one form of generation. Howdo capacity payments fit into that definition?Michael Fallon: Capacity payments are a form ofensuring that we have some kind of reserve when thesystem is at its tightest. This is not a supportmechanism for any one technology. This is ensuringthat there is sufficient supply four years out. We aredesigning the first auction next year to be run fordelivery in 2018 to make sure in the medium term thatthere is sufficient supply. I do not think you candirectly compare it to the strike prices that we areputting out for the various technologies.

Q277 Dr Whitehead: You can only get it if you area gas fired power station, can’t you?Michael Fallon: I think we have set out the variousdefinitions of which technologies apply for it. I do notthink that is quite right that it is only gas.Dr Whitehead: Coal?Michael Fallon: Coal under certain circumstancesyes.Dr Whitehead: Abated.Michael Fallon: Sorry?Dr Whitehead: Abated.Michael Fallon: If it is abated, yes.Dr Whitehead: But there will not be any abated coalin 2018.Michael Fallon: That is not a matter for me.

Q278 Dr Whitehead: In practice only gas firedpower stations can access capacity payments.Michael Fallon: I am not sure that is right. There maywell be other technologies that could apply.Chair: I am sorry, I really cannot hear if you couldspeak up.Patrick Erwin: The generation not receiving the ROor CfDs will be able to bid into this.

Q279 Dr Whitehead: What might they be?Patrick Erwin: That will be gas. It will be coal plants.Dr Whitehead: We have agreed there are not any ofthem.Patrick Erwin: No, abated and unabated.Dr Whitehead: Unabated?Patrick Erwin: Indeed, and they will have to compete.The point here is that we are buying very differentthings here. With capacity payments we are not—

Q280 Dr Whitehead: But will they not be closeddown under the large plant directive?Patrick Erwin: Some will be, yes, and with thecurrent price floor without capacity payment manymight not be economic but with the capacity paymentwe allow ourselves the ability to keep generation ofvarious kinds on the system.Dr Whitehead: Forgive me but coal fired powerstations under the large plant directive that cannotadhere to that will be closed down by 2017.

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Patrick Erwin: Variously depending on variousaspects.

Q281 Dr Whitehead: There will not be any abatedcoal fired power stations. Biomass might have accessto CfDs and therefore would not be eligible forcapacity payments. Nuclear, we just heard, wouldhave CfDs and would not be eligible for capacitypayments so what is left?Patrick Erwin: There is demand side response.Michael Fallon: Storage.Dr Whitehead: Yes. Taken out of the auction as aseparate part of it? It is not in the auction the first timeround. For the capacity auction only gas fired powerstations will actually take part in it, is that not right?Michael Fallon: No, I don’t think that is right.Patrick Erwin: No, some unabated coal plant will beeligible. Not all coal plant will come off the system inthis decade.Michael Fallon: But if the answer you are lookingfor is will a majority of it be gas, yes, of course gaswill play a very large part.Dr Whitehead: The overwhelming majority.Michael Fallon: We will see.Dr Whitehead: About 99%.Michael Fallon: Gas will certainly play a very bigpart in the capacity market. That is the answer you arelooking for.

Q282 Dr Whitehead: In what way therefore is thatnot a subsidy?Michael Fallon: It is an insurance premium to makesure there is reserve capacity to call on when thesystem is at its tightest and I think it is a very sensiblething. A number of other countries are looking at it.Dr Whitehead: I am not disputing whether it is a verysensible thing or not, I am just questioning whether itis a subsidy, or whether it is an underwriting of fossilfuel generation.Michael Fallon: No.

Q283 Dr Whitehead: The way the capacitymechanism works is through an auction, you gain asum of money for being ready to provide capacityand demonstrating that you are ready to do so. So thereadiness to do so is underwritten and one kind ofplant overwhelmingly gets that underwriting. Doesthat not look a bit like a subsidy?Michael Fallon: No, as you will find if you fail todeliver it. It is an insurance premium we are payingas a country to make sure there is sufficient energycapacity. There is a reserve there available when thesystem is at its tightest. I think that is prudent.Dr Whitehead: Maybe so but that is not my question.Michael Fallon: That is my answer.Chair: I think that is as far as we can go with this. Iwill move on to Dr Offord.

Q284 Dr Offord: Why doesn’t the Department countfield allowances for North Sea oil and gas operationsas subsidies?Michael Fallon: I am sorry, I missed the first part.

Dr Offord: Why doesn’t your Department considerfield allowances for North Sea gas and oil operationsas subsidies?Michael Fallon: North Sea oil is taxed at a far higherrate than most commercial activity. Overall they arepaying some, as you know, 81% on the older fields,62% on the new fields and even with the allowancesthey are still paying 30%, whereas corporation tax forevery other form of commercial activity this year is23% and falling to 21% and 20% in the next couple ofyears. North Sea oil is still much more heavily taxed.

Q285 Dr Offord: I understood, particularly fromyour submission to this inquiry, that you seem tosuggest that field allowances should not be regardedas subsidies because they increase the volume of oiland gas extracted by what you would consider asuncommercial fields and making them viable.Michael Fallon: If they are paying a tax higher thanother businesses are paying it cannot be a subsidy. Itcannot be both a subsidy and a tax, can it?

Q286 Dr Offord: No. Okay, on your logicparticularly would you not also regard feed-in tariffsas the same?Michael Fallon: As what, sorry?Dr Offord: Feed-in tariffs.Michael Fallon: As what?Dr Offord: As the same as North Sea oil and gasoperations.Michael Fallon: No, no, no. There are allowances fora whole range of industrial and commercial activities.There are first year allowances that apply to a wholenumber of things, to energy saving investments, towater efficient investments, to gas refuelling and soon, and you will recall the Chancellor increased theannual investment allowance for two years from£25,000 to £250,00 for almost any form of industrialactivity. I do not think there is anything particularlyspecial about industrial allowances but the tax thatNorth Sea pays is greater than any other industrialactivity so I do not think that can be a subsidy.Dr Offord: Okay, I am happy to leave it there.

Q287 Martin Caton: As I understand it, this is trueof other countries that have oil and gas resources, allof which use taxation, because those oil and gasresources are regarded as the property of the state andin fact use that taxation mechanism to charge for thoseresources. That is why it is a higher level of taxationbecause it is the price for the product.Michael Fallon: You have heard what I have said.Chair: You do not wish to comment further on that?Martin Caton: I have heard what other people havesaid as well.

Q288 Peter Aldous: At the outset I will just drawattention to the register of Members’ interests—I haveinterests in farmland where renewable energy schemesare being pursued. Minister, the Government providedifferent subsidy regimes for different types ofrenewable technologies. How is it worked out in eachcase how long those subsidy regimes should last?

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Michael Fallon: We have set out the main features ofthe contract for difference. You will be aware of thatand it is a 15 year term. We have then set out for thenext five years, taking us up to 2019, which isbudgeting for the whole of the next Parliament, howthe levy control framework will operate for each ofthe different technologies. We have done that inconsultation with the different industries and we havepublished those in draft. We have been consulting onthem all summer. That consultation has just closed andwe are now assessing the final strike price we shouldfix, I hope, before Christmas.

Q289 Peter Aldous: Have you identified anyparticular renewable technologies that might notlonger need subsidies as they get established and getmore competitive?Michael Fallon: It is looking that way with solar. Thecosts are coming down all the time. It is becomingcheaper and cheaper so we might have to ask whythere should be any kind of supported strike price forit after the current levy control framework period.Almost all of them, with the exception of biomass andenergy from waste, show the prices degressing overthe period of the levy control framework. They are allcoming down and that was one of the principles I haveset out in my definition of a support mechanism at thebeginning. Where possible the prices should degressand should be time limited.

Q290 Peter Aldous: On fracking in the States, it is awell tried technology. Is there a need in this country,do you think, for there to be a special tax treatmentfor it?Michael Fallon: It is new to this country. I think itcompares much more readily with offshoreexploration for oil and gas so the Chancellor is nowconsulting on a similar form of field allowance.Again, that would not bring it down below the taxrates paid by the rest of British industry.

Q291 Zac Goldsmith: A small add on to thatquestion. I understand that there will be moves by theGovernment to make it easier for communities that donot want wind turbines to prevent that fromhappening, and probably rightly so. Will the sameapply to potential fracking installations incommunities and, if not, why not?Michael Fallon: We have said for wind turbines weare now requiring developers to consult withcommunities in advance before even putting in aplanning application. We have asked the planninginspectors to attach more weight to factors that areimportant for local communities, like the visualimpact and whether or not there are already existingwind turbines in the same locality. We have certainlytilted the balance, if you like, to ensure that windturbines are only sited where they are appropriate andwhere they are supported by the local community.When it comes to hosting shale, the principle elementof the decision is again, of course, local. Althoughthere is a licence from my Department for thecompany, a licence bloc in which they are operating,and although they have to have permits from the

Environment Agency if they want to drill or explore,and to have authorisation from the Health and SafetyExecutive and finally a consent from my Department,the key decision in that whole process is they have tohave planning permission locally. That has to beobtained from the minerals authority, in most casesthe county council. The community at that stage hasthe ability to decide whether the application isappropriate for their area. Obviously there are variousfactors they will want to take into account.

Q292 Zac Goldsmith: You do not anticipatesituations where fracking takes place in communitieswhere a clear majority oppose fracking in that area?Michael Fallon: If the local authority is opposed to itthen it will not be granted planning permission. Thatis first and foremost a decision for them.

Q293 Chair: Did you say exactly the same regime?Michael Fallon: It is not exactly the same regime.Chair: What would be the difference?Michael Fallon: We are not formally requiring thedevelopers to pre-consult but they have already agreedto do that—they would be pretty silly not to—andthey are already doing it. They are already involvingthe community long before they submit a planningapplication and I do not think we have put that yetformally into the guidance. There may be one or twominor differences like this. The answer is to consultthe community early, to provide as much informationas possible to reassure people as to exactly what theenvironmental impacts are likely to be and that thesite they are choosing is the most appropriate in thatarea for getting down to the shale that they want toextract.

Q294 Caroline Lucas: Just on that, I thought that Iremembered that the planning guidance to localauthorities is that they cannot base their decision onviews of climate change or other energy sources thatthey might prefer to see rather than fracking. Whenyou say that it will only go ahead if it has localauthority support, is that not a bit disingenuous?Michael Fallon: No, it is for the planning authorityto decide whether to grant the application.Caroline Lucas: But the grounds on which it doesthat are very constrained in the case of fracking. Theycannot decide that they do not want it on the groundsthat they think it is going to be a threat to climatechange.Michael Fallon: No, what we have said forrenewables, for onshore wind, and that will apply Ithink also to drilling for shale, is that they cannotallow environmental or energy policy considerationsto trump their local decision. They must take theapplication into account on its merits and look at themerits of the case. They cannot simply be told by thedevelopers, “The country needs more renewables soyou have to pass my application”.

Q295 Caroline Lucas: Can they decide that they donot want to pass the application because they thinkthat fracking is going to pose an unacceptable threatin terms of climate change?

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Michael Fallon: No, they have to look at it on itsmerits. It has to be balanced.Caroline Lucas: That is the point. Please can we justhave a straight answer on this?Michael Fallon: I am giving you a straight answer.Caroline Lucas: It is not a straight answer.Michael Fallon: It is.Caroline Lucas: I need you to confirm myunderstanding, which is that if a council’s primaryreason for not wanting the fracking site to go ahead isbecause it is concerned about the impact on climatechange it is not allowed to use that as a ground foropposing that planning application.Michael Fallon: It could not use it as the soleground, no.

Q296 Caroline Lucas: Your earlier answer to mycolleague is not entirely true because you said itwould not go ahead if local authorities did not want itto. It could indeed go ahead even if local authoritiesdid not want it to if the reason the local authority didnot want it to was because of the risk of climatechange.Michael Fallon: It is for the local authority todetermine the planning application.Caroline Lucas: Under certain criteria.Michael Fallon: They have to make the decision.

Q297 Chair: It is the grounds on which they reachthat decision that matters, is it not?Michael Fallon: Yes, and I am saying it has to bebalanced just as they cannot be forced by thedeveloper to accept an application on the grounds thatit aids the Government’s national energy objectives,nor can they turn it down on the grounds that theyhave their own energy policy.

Q298 Caroline Lucas: No, but the point was youresponded to my colleague by saying that the frackingwill not go ahead if the local authority does not wantit to. All I want you to acknowledge is that that is notthe full case. It depends why the local authority doesnot want it. If the reasons that the local authority doesnot want it happen to fall within the terms with whichthey are allowed to object, fine, but because of theway in which the planning guidance has been drawnup, if their principal and sole reason is that climatechange is the biggest threat that we face and frackingis going to simply exacerbate it, we do not want it,they cannot refuse it on those grounds.Michael Fallon: If that is the sole reason, no, theycannot.Chair: Okay, we have clarification on that. DrWhitehead wanted to come in.

Q299 Dr Whitehead: On an answer you provided tomy colleague a moment ago you agreed that thesubsidy for renewable energy through CfDs, becauseit was degressing over a period of time, would cometo an end at a certain point, but it was a subsidy.Michael Fallon: No, it is a strike price. That is whatis degressing over time.Dr Whitehead: Sorry, so there is no subsidy forrenewables either?

Michael Fallon: We are going over ground we havealready, I think, trodden on quite heavily. This is asupport mechanism, a market based supportmechanism that involves a strike rate that has beenmade available for the very early stage of theintroduction of a new technology.

Q300 Dr Whitehead: Sure, yes, and that is identicalto the renewables obligation really, is it not?Michael Fallon: It is similar. The contracts aredifferent from renewable obligations.Dr Whitehead: Yes, I accept the difference in the waythey work but they work with renewables in exactlythe same way in as much as they provide anunderwriting which degresses over a period of timeand may then disappear.Michael Fallon: There are some importantdifferences. They begin earlier in the process, forexample. They can be negotiated at the point at whichyou obtain planning permission and consent to latchon to the grid rather than at the point ofcommissioning. There are important differencesbetween the contract for difference and the oldrenewables.

Q301 Dr Whitehead: Yes, but the renewablesobligation essentially is an underwriting that degressesover a period of time and then maybe disappears.Indeed as I recall, that went before the EUCommission and competition directorate and wasagreed to be a subsidy, but was given away leave onthe grounds that it was degressing and therefore wouldlead to the introduction of new technology that mightultimately be beneficial. Therefore, no action wastaken by the EU at the time of RO coming in on thegrounds that it was a subsidy, even though it wasagreed that it was. At the moment that sameCompetition Commission will be looking at CfDs asfar as nuclear is concerned, which of course are nowjumbled in with CfDs for renewables, on the groundsthat it might conceivably be state aid. Indeed wevisited Brussels a little while ago and we talked tosome Competition Commissioners who said that thatwas exactly what they were going to be looking atnuclear on the grounds of. If those Commissioners atthat point suggested that indeed CfDs for nuclear didlook like a subsidy, wouldn’t that undermine the CfDsfor renewables in terms of anything that hadpreviously been agreed about those being a subsidybut would have away leave because they wereintroducing a new technology that would come tomaturity?Michael Fallon: If you are asking me would there bea read across from an unfavourable decision on theHinkley notification to the rest of strike prices I amnot sure about that and I have not speculated on that.I am not sure there would be an immediate read acrossbut we are not expecting an unfavourable decision.We should be arguing the case.

Q302 Dr Whitehead: I appreciate obviously onewould not go into all this very detailed work whileexpecting an unfavourable decision from the EUCompetition Commissioners. Bearing in mind that

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they have already looked at something that looksremarkably like CfDs and have said it is a subsidy—but they have certain derogations from it on thegrounds that it is a subsidy that may bring about anoverall benefit on the grounds of the maturity of thatnew technology—is that not a worry that you mighthave in terms of how the Commission might then lookat the immediate successor to the RO in its applicationto both nuclear and renewables over a period? Theymight say both are subsidies or they might not seeeither as subsidies.Michael Fallon: I think we are able to show theCommission that most of the strike prices do degressover time. They do facilitate the arrival of atechnology that can stand on its own two feet. Someof them degress quite sharply.Chair: I think we must move on to other issues. I willturn to Mr Lazarowicz.

Q303 Mark Lazarowicz: Yes, thank you, Chair.Before we do go on I wonder if I could ask just brieflyone question which follows up from the answers thatyou gave to Caroline Lucas? You understand,Minister, given my constituency, I do not haveintricate detailed knowledge of planning legislation inEngland. When you said that local authorities couldrefuse an application for fracking I presume it doesthat on the basis that it considers it is out of theplanning guidelines but that refusal can still beappealed to the planning inspectorate like any otherplanning application. Is that the case?Michael Fallon: Absolutely.Mark Lazarowicz: Therefore the local authority doesnot have the ultimate say. It will be the subject ofmore planning authorities.Michael Fallon: No, the point I was making to MrGoldsmith was that in the first instance the maindecision is not made by Ministers. It is a matter forthe minerals authority in each area and it is veryimportant to put that on record. Both the developersand those who oppose the search for shale do havethat reassurance that the principal decision is taken inthe first instance by a local authority.

Q304 Mark Lazarowicz: I appreciate that. I wantedto clarify the position of the RO for potential appealand refusal and we have now had that clarification.My principal questions relate to issues concerningDfID and also UK Export Finance. I do not knowwhether you want to answer it yourself, Minister, orto refer to your officials as we go along. In relationfirst of all to DfID, early in our inquiry we heard aboutthe sometimes significant level of fossil fuel subsidiesthat applied in developing countries and the concernobviously therefore rises that on the one hand we asthe UK will be providing climate finance to reduceemissions to certain developing countries while at thesame time those developing countries may bepursuing policies that promote fossil fuel use ratherthan reduce it. Is there any linkage in the decisionsyou make about climate finance to assessment—Michael Fallon: About what?Mark Lazarowicz: Is there any linkage to thedecisions we make about climate finance through

DfID to an assessment of the fossil fuel subsidiesavailable within those developing countries that arereceiving the assistance?Michael Fallon: No.Mark Lazarowicz: Not assistance from the UK,assistance within their own policy framework.Michael Fallon: No, I understand the question and letme say first of all we have a very strong presumptionin the aid we give against investing in coal fired powerstations in developing countries. Now you do have tolook at this on a case by case basis. Some of the verypoorest countries do want to continue with coal and Idon’t think it is possible to have an absolute blanketrefusal to help under those circumstances. On thespecific issue of climate finance perhaps I could allowone of the hitherto silent officials to answer.Chair: I was just wondering if they might be given avoice. Mr Wheatley, do you wish to comment?Michael Fallon: Their chance to shine.Josceline Wheatley: The Minister has covered theground there. There is not a direct correlation betweenour support for climate finance and whether or not acountry has fossil fuel subsidies or not. Having saidthat, all the programmes that we do support are todo with enhancing access for the poor and are basedexclusively on renewables and other forms ofnon-carbon related energy. We also support WorldBank programmes, which are to help developingcountries work out how to deal with the social andeconomic consequences of coming back from fossilfuel subsidies. If you like, it is a series of programmesthat are about carrot to help countries to work out howbest to remove fossil fuel subsidies rather than stickin the sense of seeking to condition aid or support insome way to compel them to do so.

Q305 Mark Lazarowicz: But just to be clear—and Iaccept what you are saying about it is an approach ofcarrot rather than stick—do we make an assessmentof their policies domestically with regard to fossil fuelsubsidies when we consider whether we agree to giveclimate finance? It will be odd to have a situation ofgiving countries climate finance to reduce emissionswhen, for all we know, they are pursuing policies thatare drastically increasing emissions. Surely we needto have some linkage in our decision making processthere.Chair: The Minister or Mr Wheatley?Josceline Wheatley: We make the assessment on themerits of the proposal for support and whether or notthat meets the country’s own stated objectives todecarbonise or seek a lower carbon, more climateresilient pathway. We do not, as I have said, make alinkage in any specific way to whether or not thatcountry has fossil fuel subsidies.

Q306 Mark Lazarowicz: This is not just atheoretical question because the evidence that we havesuggests that there were some countries, which wewere significantly supporting with climate finance,which did have substantial programmes of fossil fuelsubsidies. It does seem there should at least be anassessment. We should know what we are doing in adomestic fossil fuel subsidy policy when we are

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30 October 2013 Rt Hon Michael Fallon MP, Patrick Erwin, David Godfrey, Helen Dickinsonand Josceline Wheatley

making decisions about climate finance. Is that not areasonable suggestion that we should at leastinvestigate and assess that wider energy framework inthat country? Isn’t that reasonable?Josceline Wheatley: As I say when applications aremade for support through our bilateral programmesand those we support through the World Bank then,yes, we do look at the programme as a whole to seewhether or not that makes sense and whether or not itis indicative of a country making a serious attempt tomove towards a lower carbon, more climate resilientdevelopment pathway. There is not, however, anyexplicit benchmark or algorithm that takes intoaccount the fossil fuel subsidies or the extent of thosewhich then conditions whether or not we providethat support.

Q307 Mark Lazarowicz: Okay, I understand theposition. Can I ask then about UK Export Finance,which is obviously a different departmentalresponsibility? May I quote briefly from the CoalitionAgreement? It made a commitment and I quote, “Wewill ensure the ECGD”, as it then was, “becomes achampion for British companies that develop andexport innovative green technologies around the worldinstead of supporting dirty fossil fuel production.”That seems a little unclear whether that means allfossil fuel production is dirty or just that some fossilfuel production is dirty and we do not support it. Thatis quite important to what I am going to ask.UK Export Finance’s submission to the committeegave us a list of what energy projects are supportedand without going through the list in detail it is prettyclear the vast majority of the projects are ones forfossil fuel energy technologies. At first sight I canonly see a hydroelectric plant that presumably couldbe regarded as a low carbon technology. I may havemissed one or two but I think the general position isclear. How far is that commitment given in theCoalition Agreement being put into practice in thepolicies and support given by UK Export Finance?Michael Fallon: The policy has to be constrained inthe end by the law. The Export Investment GuaranteesAct of 1991 does not allow UK Export Finance todiscriminate in this kind of support between differentclasses or types of export. That is the legal position.It would therefore be unlawful for the Secretary ofState simply to declare a blanket ban on certain typesof investment. We are constrained there. I think theobjective is the right one but we are constrained bythe existing legislation.David Godfrey: Could I perhaps just add that we are,of course, governed and guided by the OECDCommon Approaches for looking at projects and haveto identify and define those projects in terms of theirenvironmental, social, human rights impact. Those arecategorised A, high impact; B, medium and C, and aspart of that we would have to look at obviously theenvironmental impact that such a project would have.If it failed to meet those standards we would not beallowed or enabled to proceed with that programme.Those environmental assessments are public,particularly in the case of projects that are identifiedas category A, both before and after decision.

Q308 Mark Lazarowicz: Does that mean UK ExportFinance can refuse to support projects that would beregarded as supporting dirty fossil fuel production andis that what you do?David Godfrey: If it failed to meet internationalstandards as implemented by the World Bank, yes.

Q309 Zac Goldsmith: Just very quickly on theinnovative green technologies that Export Credits hasbeen supporting the export of, can you give us a roughidea or even a better than a rough idea of how manysuch projects have received support from theGovernment? What sort of percentage of the overallsupport package has been geared towards greentechnologies? Are there any obvious examples ofsuccess?Michael Fallon: We can get you that.David Godfrey: I would say it is low at this point intime. The Department has been very involved throughthe fora that exist in international ECAs on amultilateral basis attempting to improve the credit thatcan be given to renewables and green energyprogrammes, for instance extending credit and terms,but within the UK the take up of such availabilities,such programmes has been very low.

Q310 Zac Goldsmith: Yes, early on in the CoalitionGovernment’s life I asked the same question and therewere not any examples at all—this is probably sixmonths into the new Government—of innovativegreen technologies that have been supported throughthis agency. It would be really interesting to know,maybe in due course, what projects have beensupported, how much support they are getting and ifnot a lot, as you have just implied, why do you thinkthat is? Are we struggling to find them? Are they notcoming forward or is there no open for business signat the Department?David Godfrey: It is certainly not that there is no openfor business sign at the Department. We work veryclosely with the Renewables Association. As I say wehave been instrumental in trying to pushmultinationals for better terms for green projects. Ithink to some extent it is the state of the UK industry.It is where they are exporting to in terms of notrequiring state support to do that. I think there are awhole range of reasons why UK Export Finance hasnot provided a large amount of support to the industry,but I can assure you it is not because we are in anyway discriminating. As the Minister said, our statuterequires us to be even-handed in the support that wegive and we certainly participate in fora that wouldpromulgate those types of projects.Zac Goldsmith: Thank you.

Q311 Mark Lazarowicz: If I can come back there,Mr Goldsmith’s question has helpfully allowed me toopen up the attachment to the equity evidence, whichwas in quite small print. I just noticed, for example,just above the support for a hydro electric powerstation, which was supported to the tune of £38,000,we can see support for a petrochemical complex inSaudi Arabia where the support was £375 million. Itdoes suggest that while we might have an open mind

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30 October 2013 Rt Hon Michael Fallon MP, Patrick Erwin, David Godfrey, Helen Dickinsonand Josceline Wheatley

to different technologies there is not much, as MrGoldsmith said, innovative green finance beingsupported by UK Export Finance. Perhaps when youprovide the additional evidence, Minister, you couldhighlight those projects which you regard assupporting that objective of giving support toinnovative green finance. That would be helpful.Michael Fallon: We will certainly do that and we willupdate the position which I hope is improving. I thinkyou have heard some of the reasons why it may nothave improved as much as you would have liked.

Q312 Chair: We are almost at the end. In view ofthe Government’s support for the G20 in 2009 andsimilarly last year’s Rio+20 declaration, just how theGovernment can support the outcomes of those whenthe Treasury and the DECC submission to ourcommittee tells us that the Government does notconsider that any of its energy policies are harmful.Isn’t there an inconsistency there?Michael Fallon: No, we certainly support the G20commitment to rationalise and phase out thosesubsidies to fossil fuel in countries that are inefficientand simply encourage wasteful consumption. We seeclear benefits to the British economy from thathappening for our own domestic energy security andfor our own budgetary stability it helps us too.

Q313 Chair: Does that trump everything, thesecurity and the economy?Michael Fallon: Security of energy supply trumpsalmost everything I can think of. The most importantduty as an Energy Minister is to make sure that ourconstituents’ lights stay on and they do have access tothe power that they need. That is important. Secondly,it is important they do so with bills that are affordableand, thirdly, of course, we are committed to meet our

European and international obligations. There arethree priorities there but if you ask me to rank themthe first, of course, is absolutely security of supply.

Q314 Chair: Could I just finally ask how DfID aretaking forward the ongoing discussions in respect ofthe outcomes from Rio+20 and how that links in topolicies at home and the agreements that were madeat Rio?Michael Fallon: Sure. Who would like to take that?Josceline Wheatley: We support the UN SecretaryGeneral’s SE for All undertaking, which was reflectedin the high level panel outcome, which in turn is goingto be considered by the open working group. So thereis a good deal of discussion internationally still to behad about how that outcome will be reflected and whatthe energy commitments will be. The Department isnow and will remain actively engaged in that processup to the conclusion of it in 2015. More details onthat I am afraid I would have to come back to youin writing.Chair: It might be helpful if you were to perhapsprovide that in writing from DfID. The issue for ourCommittee is whether the UK needs to take action toeliminate fossil fuel subsidies at home. It is withinthat context of how we take forward the sustainabledevelopment goals, which are now part of theMillennium development goals, following the highlevel panel at the UN. Unless any of my colleagueshave any further questions—I do not think that theyhave, you will be pleased to know—I must bring thesession to a close. We will be looking at this wholeissue of what we thought was subsidy but appears tobe support mechanisms and insurance premiums inthat order. Can I thank you and colleagues from otherDepartments for attending our sessions? Thank youvery much indeed.

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Written evidence

Written evidence commissioned by the Committee from Dr William Blyth, Oxford Energy Associates

Acknowledgements

This report has benefited from inputs and suggestions from a number of colleagues, and the author wouldlike to thank in particular Antony Froggatt, Doug Koplow, Richard Tol, Morgan Bazilian, and Ulrik Stridbaek.Any outstanding errors and omissions remain the author’s.

ENERGY SUBSIDIES IN THE UK

1. Background

This report provides an overview of energy subsidies in the UK, starting with an overview of the basiceconomics, then identifying the scale of subsidies in the UK, and finally comparing the UK position withother countries.

The scope of the report is limited to a review of published sources, and it is not possible to say that such anapproach captures all subsidies. Although a considerable amount of information has been published, suchefforts nevertheless feel somewhat piecemeal. Some subsidies are hidden and hard to quantify, so the figuresidentified here probably represent a lower limit. For example, cross-subsidies relating to payments for electricitysystem balancing and maintaining security of supply in the face of risks of unexpected outages for differentplant would ideally be included, but they are notoriously difficult to quantify and allocate, and are beyond thescope of this report. In other cases, the definition of subsidies is very dependent on the particulars of a country’stax base, making international comparisons difficult.

Ideally, a thorough study on energy subsidies would track, for each branch of the energy system, total incomearising through energy taxes, and net off all public payments made for infrastructure, services (includingregulatory functions, system balancing etc.) as well as the direct subsidies provided through price supportmechanisms.

At an economy-wide level, simple generic comparisons can be made on this basis. Tax revenues from energyin the UK amount to around £28 billion annually, the vast majority (97%) of which comes from road fueltaxes. Tax income for transport of around £27 billion considerably outweighs the total government transportbudget of around £20 billion1. Road transport fuel has long been used to provide net revenues to treasury.

Outside of the transport sector, the other energy sectors on the other hand are much more lightly taxed (asshown in Figure 5). The consumer tax base for energy products in the UK generates revenues (excluding VATand carbon taxes) of around £1 billion (Figure 5). This compares with subsidies identified in this report totallingaround £10 billion, which is around 0.8% of the market value of energy (~£120 billion excluding road transportfuel). Even considering that this is a lower bound estimate, in aggregate, energy subsidies and taxes aretherefore rather low compared to market value. Nevertheless, they form an important part of the revenue streamfor many different types of energy investment, and for this reason, subsidies have an important strategicinfluence on the development and choice of energy technology used in the UK.

1.1 Subsidies from First Principles

Subsidies have become synonymous with bad economic practice because of the distortionary effects theyhave on producer and consumer behaviour. This leads to a working assumption in policy-making that subsidiesgenerally reduce economic efficiency, and that removal of subsidies should therefore lead to an overall welfaregain, albeit with winners and losers along the way. The creation of winners and losers means that there areoften strong interests on all sides about the appropriateness and scale of different types of subsidy.

This section attempts to take out some of the heat and inject some light into the debate by exploring theunderpinnings of these basic assumptions in more detail in order to clarify the theoretical basis from whichdifferent points of view are argued. It will be shown that there are indeed unresolved theoretical issues overwhich reasonable people might reasonably disagree. Energy subsidies are part of a country’s adaptation touncertain and dynamic futures, and decisions will need to be based as much on political judgment as on “hard”economic evidence.

1.1.1 Perfect markets as a benchmark for assessing subsidies

Subsidies are usually measured in terms of the deviation they create in terms of the prices and quantities ofgoods exchanged from the “ideal” equilibrium market price. In order to understand why, it is worth revisitingsome basic economic principles.

Arguments in favour of free markets usually proceeds along two different routes (Sander 2009). The first isthe libertarian defence of the principle of free markets which argues that letting people engage in voluntaryexchanges respects their freedom. As Amartya Sen compellingly points out in his review of the role of markets1 http://www.ukpublicspending.co.uk

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in economic development, “To be generically against markets would be almost as odd as being genericallyagainst conversations between people…”(Sen 2001). Sen’s argument is that free exchange between people ispart of the natural order of the human experience, and therefore in general is a desirable mechanism to promote,although he recognises that there are many instances where the power balance between people is such thatexchange is not truly free, and protections need to be put in place.

The second main defence of free markets is made in terms of economic efficiency. In 1906, Vilfredo Paretoshowed that social welfare is maximised by an allocation of resources that meets with unanimous approval. APareto efficient allocation means that it is impossible to reassign resources so as to make any individual betteroff without making at least one other individual worse off. (Arrow and Debreu 1954) then showed that acompetitive market economy would lead to an equilibrium position which would satisfy this condition ofoptimal social welfare (the so-called first fundamental theorem of welfare economics). The Arrow-Debreuproof requires perfect and complete markets in all transactions in order for the optimal equilibrium position tobe reached.

Pareto efficiency does not however guarantee political desirability. There are many different possibleequilibrium positions in which individuals are allocated a different level of initial wealth, but which could stillbe considered overall welfare maximising. This leads to the second fundamental theorem of welfare economics,which states that any of these efficient equilibrium solutions can be achieved by a perfect market as long as itis accompanied by a (politically decided) lump-sum redistribution of resources.

This is the basis of the rather convenient general claim of economics to be able to separate issues ofefficiency (ie maximising overall social welfare, the typical domain of economists) from issues of equity (iethe distribution of wealth, the typical domain of politicians).

Based on the idea that perfect markets achieve maximum social welfare, it then follows simply that anydistortion of these markets (including taxes, subsidies etc.) must therefore reduce social welfare, incurring anoverall cost to society. This viewpoint reaches its peak in the Chicago school and the economic outlook ofMilton Friedman. The rationale for these beliefs rests on the assertion that the real world comes sufficientlyclose to the idealised world enshrined in the first fundamental theorem that its tenets can be applied to real-world policy making. Whilst most economists would recognise that although the markets may not be optimallyefficient, government interventions are not either, and politicised interventions will often have unintendedconsequences, making unambiguous social welfare improvements difficult to achieve. However, as we will seein the next section, there are opponents of this school who question the applicability of the two fundamentaltheorems to the real world.

1.1.2 Critique of perfect market assumptions

The history of the two fundamental theorems of welfare economics is not as solid as one might suppose(Blaug 2007). The assumption of perfect market conditions is a severe constraint on the applicability of thefirst theorem. Meanwhile the applicability of the second theorem is severely limited by the fact that it ispractically impossible to achieve perfect lump-sum transfers that do not influence marginal behaviour ofproducers and consumers (calling into question the ability to separate issues of efficiency and equity).

In quantitative terms, the most significant challenge to the perfect market view is given by the general theoryof second best (Lipsey and Lancaster 1956). This shows that although social welfare is maximised under perfectmarket conditions, if there are some market imperfections already in the system that cannot be addressed, thereis no guarantee that “correcting” other market imperfections will necessarily improve efficiency or welfare.Lipsey demonstrates with a simple example of a market with three commodities. It is assumed that onecommodity has a tax imposed that cannot be removed, and a second commodity has no tax imposed. Thesocially optimal tax on the third commodity ranges from positive (tax), zero, or negative (subsidy) dependingon the degree to which the commodities act as substitutes or complements2 for each other.

The general theory of second best does not contradict the first fundamental theorem of welfare economics,but it does potentially limit the latter’s applicability to real-world policy decisions, depending on one’s viewof the degree to which market imperfections in the real world prevail. Many economic theorists andpractitioners still work on the assumption that the perfect market assumption is good enough that the firstfundamental theorem still applies to real-world situations.

However, there are also many reasons to suppose that market imperfections are ubiquitous in the real world,and that assumptions of general equilibrium may be a poor guide to policy decisions. As Lipsey noted in alater paper (Lipsey 2007), many real-world sources of economic imperfection prevail which are not createdby policy:

1. Markets are rarely competitive enough to make prices equal to marginal costs. Pricing is ofteninfluenced by other factors such as economies of scale, barriers to entry of new firms, and productdifferentiation (eg brand value).

2 Substitutes can be used in place of each other, whereas complements require the other commodity to be in place before it canbe consumed.

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2. When products are differentiated, fixed costs such as establishing distribution networks, productdevelopment costs and marketing costs create non-convexities that break the requirement ofgeneral equilibrium.

3. There are many cases of missing markets, where commodity exchanges required to achieve generalequilibrium are not available, and many markets (eg labour markets) often deviate from perfectmarket assumptions due to incomplete and asymmetric information.

4. Externalities (both positive and negative) are associated with many economic activities, and it isoften hard to create compensating market mechanisms to internalise these costs or benefits.

In addition to these “static” market imperfections, there is also the question of how economies should respondto dynamically changing and uncertain future conditions. Equilibrium economics assumes that conditions canbe optimised in terms of economic efficiency given knowledge of all current and future states of the inputvariables. In practice, the future is uncertain, and firms undertake innovation activities in order to adapt tothese uncertain changes.

It has been argued (Blaug 2007) that even if one were to take the first fundamental theorem as a validguideline for achieving static efficiency, there is no theoretical basis to suppose that achieving static efficiencywill guarantee achievement of dynamic efficiency. Whilst competitive pressures can no-doubt help to channelsuch innovation in socially useful ways, the conditions for innovation to respond to dynamic and uncertainfutures are generally far from those usually considered under static equilibrium. Indeed, Schumpeter’sconception of “creative destruction” (Schumpeter 1942) is a determinedly non-equilibrium view of howcompetition leads to dynamic progress. Indeed, a branch of operations research (Abernathy 1979, Adler, Benneret al. 2009) has grown up around a micro-economics view of how this might play out at the firm level. Thissuggests that firms may experience a tension between aiming for static efficiency (optimising processes basedon historical learning about what has worked in the past), vs. a focus on learning and innovation to respond tonew challenges in the future.

1.1.3 Consequences for policy decision-making on subsidies

The upshot of the theoretical literature is not that markets are an inappropriate model. On the contrary, inLipsey’s (2007) words there is a “long line of appreciative theorising running from Adam Smith to MiltonFriedman and Thomas Schelling and many others…” behind the key propositions that:

“(1) the market system coordinates economic activity better than any known alternative—not optimally,just better, and 2) markets do this relatively efficiently by producing prices that are influenced (butnot solely determined) by relative scarcities”

In other words, the market model still provides a very important benchmark, but this should not be used asthe basis for a dogmatic rejection of interventions that seek either to redress some of the more obvious failings,or to help build in robustness to dynamic pressures. Lipsey recommends basing “advice on a combination offormal models, appreciative theorising, empirical knowledge, and a large dose of judgement”.

In the case of energy subsidies, arguments in favour of some intervention include:

1. Infant industries. In cases where new technologies are being introduced which are not yet competitivewith mainstream technologies, but could be expected to be so in the future, there is a dynamicefficiency argument for creating protected niche markets to allow these to develop appropriateeconomies of scale and learning by doing cost reductions in the supply chains for these industries.These arguments are typically used in connection with subsidies for renewable energy, and to someextent are again being invoked in the case of third generation nuclear energy. In practice, infantindustry arguments are often used inappropriately as a lobbying tool by industry players who wishto carve out a specific subsidy that will benefit them. In general, the infant industry argument canonly be justified for a certain length of time before those industries should be expected to standon their own feet. In the long run, subsidy-dependence is likely to breed inefficiency and lackof competitiveness.

2. Pro-poor policies. Some sections of society may simply be too poor to access the supposedly “free”market, or they may not be able to afford sufficient fuel to maintain a basic level of energy services.In these circumstances, subsidies are often introduced to reduce prices for reasons of equity and topromote overall economic development or standards of living across the whole population. Suchsubsidies are perhaps the most prevalent stated reason for subsidies on fossil fuels at the global level.On the other hand, there is evidence that many of these subsidies are not well targeted towardspoorer consumers, but actually create proportionally higher benefits for richer sections of society.

3. Protection from foreign competition. Subsidies to protect domestic industry from foreign competitionhave been rife throughout the history of economic development, but are coming increasingly undercontrol as a result of free trade agreements such as WTO and the EU single market. Nevertheless,protection of jobs is still an important political driver for subsidies in contexts where there is aperception that foreign competitors in some way have an unfair advantage. This is particularlyrelevant in dynamic contexts (such as emerging economies are experiencing) or where such subsidiesare taken as a precaution against explicit anti-competitive behaviour by external trade partners.However, in a long-run equilibrium context, such domestic subsidies will tend to lead to higher

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domestic prices for the protected goods, leading to inefficiencies that leave the country worse of interms of jobs and the economy.

The common factor behind all these arguments for subsidies is that they are very context-specific, and theyusually relate to a situation that is temporary or dynamic by nature. Whilst the general theory of second bestsuggests that it is difficult, or perhaps even impossible to judge what exact conditions are required to achievea social optimum in terms of static efficiency across the whole economy, there are grounds for consideringpositive interventions based on more parochial considerations of costs and benefits in relation to potential“corrections” of dynamic effects in the particular sector being considered.

In general, subsidies introduced to address these temporary conditions should therefore be designed with asunset clause. This allows them to be phased out in line with the timescale over which the dynamic effects areexpected to be addressed in order to avoid fostering inefficient subsidy-dependence. though there are manyexamples of provisions with sunsets being continually extended, and legacy subsidies that do not get debated.Super-majorities for overturning sunset clauses is one way around this. If the factors that the subsidies areintended to correct for are not expected to be temporary by nature, then subsidies are unlikely to be a suitableresponse. For example, if a foreign supply of cheap energy becomes available (and is expected to remainavailable over a long period of time), then it is likely to be more efficient for a country to adapt to this newsituation rather than trying to protect domestic sources for long periods of time. Clearly however, adaptationalso raises its own set of costs that need to be factored into this consideration.

1.1.4 Source of economic inefficiencies of subsidies

Putting aside for the moment concerns raised by the general theory of second best, it is useful to review thetheoretical basis for how subsidies introduce economic inefficiency and loss compared to a perfect marketcontext, because this often provides the basis for most major studies of energy subsidies.

In order to calculate the total economic cost of a subsidy, the cost to government of paying the subsidyneeds to be weighed against the economic benefits that accrue to producers and consumers. This is illustratedin Figure 1. The effect of a subsidy is not only to change prices, but also the quantity of goods exchanged.This is because of the elasticity of demand, whereby consumers will tend to increase demand if prices reduce.Subsidies paid to a producer will in general alter market prices leading to benefits to both consumers andproducers, although the total costs of the subsidy outweigh these total economic benefits. Based on the area ofthe triangle DWL in the final diagram, the total economic loss (or deadweight loss DWL) is approximately QSwhere S is the size of the per unit subsidy. The size of the overall economic loss is therefore strongly dependenton the slope (elasticity) of the demand curve.

It should be noted that very similar considerations apply to taxes (since subsidies are effectively just anegative tax). Taxes also result in a deadweight loss to the economy (although an exception is where feestermed as “taxes” are really user fees to recover the government cost of goods or services linked to a specificfuel: the absence of such fees would actually constitute a subsidy). In principle, subsidies are no more inefficientthan taxes, except insofar as they need to be funded, and may therefore have budget implications for overalltax burden.

This simple graphical representation needs to be treated with care, as it assumes that the initial equilibriumpoint is somehow optimal. In practice, there may be various externalities that are not included in such arepresentation. For example, in considering the quantity of fuel purchased in the context of fuel poverty, thefree market equilibrium point may well represent a sub-optimal consumption level, leading for example tohealth problems for elderly consumers not able to heat their houses sufficiently in winter. In such cases, theoptimal level of consumption may indeed be higher than the simple crossing point of supply and demandcurves would indicate. This is not to say that subsidising energy (especially for all consumers) is necessarilythe most appropriate measure to take, only to point out that simple analyses of equilibrium points in the marketneed to be considered carefully to see what may be missing.

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Figure 1

SUBSIDIES ALTER BOTH PRICES AND QUANTITIES LEADING TO DEADWEIGHT LOSS

1. In a ‘free’ market, supply and demand balance at an equilibrium price Pe and quan�ty Qe the crossing point of the supply and demand curves.

2. If a subsidy is given to suppliers, they are willing to supply any given quan�ty at a lower price, since they will recoup the produc�on costs via the subsidy. This leads to a downward shi� in the supply curve indicated by the dashed line.

3. Supply and demand now reach a new equilibrium at a lower price to the consumer Pc who as a result will tend to consume a greater amount of the good increasing the quan�ty by ΔQ.

4. The supplier receives price Ps which is the price the consumer pays (Pc) plus the size of the subsidy.

5. Both consumers and suppliers therefore benefit from the subsidy, since the consumers pay a lower price, whilst the suppliers receive an increased price.

6. The total benefit (£) to consumers of the lower price is the change in price (£/unit) mul�plied by the quan�ty (number of units). This is the consumer surplus shaded in red. Likewise, the benefit to producers is the producer surplusshaded in blue.

7. In theory, the benefit of the subsidy is always shared between producers and consumers, irrespec�ve of who the subsidy is paid to.

8. The total cost of the subsidy to government is the size of the subsidy mul�plied by the total quan�ty of the good supplied (yellow rectangle).

9. The yellow rectangle is larger than the producer and consumer surpluses. This means that the cost to government is higher than the overall economic benefits. The difference is the triangle marked DWL known as deadweight loss. This measures the overall efficiency losses arising from subsidies in comparison with the ‘free’ market equilibrium.

Price

Quan�ty

Demand

Qe

Pe

ΔQ

SupplySize of subsidy (per unit)

Pc

Size of subsidy (per unit)

Ps

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1.1.5 Types of subsidy

Subsidies can come in many different forms. Direct subsidies are the easiest to measure as they usuallyprovide some form of direct payment either to the producer or consumer of a particular good in order toinfluence the price and/or quantity of goods exchanged. Examples of direct energy subsidies include feed-intariffs for renewable energy, where additional payments are made to suppliers over-and-above the paymentsthey receive from consumers for the electricity provided. Another example is where governments set energyprices for consumers below the cost of supply, usually implying the need to compensate producers forassociated losses through some other budgetary mechanism. This is the source of the majority of energysubsidies measured in non-OECD countries.

However, the net can be cast much more widely than these direct subsidies. What constitutes an economicapproach to defining a subsidy is itself the subject of much debate among economists and those responsiblefor measuring subsidies. As noted by (Donohue 2008):

“Broadly speaking, subsidies can be seen in one of two ways: subsidies are given by governments orsubsidies are given by society. Almost all subsidy definitions available in the literature could be seen asgenerally conforming to one of these perspectives on subsidies. … An economic approach might be todefine subsidies as transfers that distort the allocation of economic resources which would be a society-wide approach to defining subsidies. A more government-oriented approach might be to define subsidiessimply as financial payments from governments to firms or consumers. … The distinction betweensubsidies derived from government action, versus social subsidies, is profound, and includes manypossibilities for refinement.”

Because of its remit, the definition of subsidies used in the WTO is fairly focused on the more directgovernment-oriented approach. Article 1 of the WTO’s Agreement on Subsidies and Countervailing Measuresdefines a subsidy as involving a financial contribution by a government or any public body within the territoryof a Member … or price support in the sense of Article XVI of GATT 1994 that confers a benefit. Among thefinancial contributions covered by the definition are:

(i) direct transfers of funds (eg grants, loans, and equity infusion), potential direct transfers of funds orliabilities (eg loan guarantees);

(ii) the foregoing or non-collection of government revenue that would otherwise be due (eg fiscalincentives such as tax credits); and

(iii) goods or services (other than general infrastructure) provided by a government in kind, or goodspurchased from companies in a way that confers a benefit to that company (eg, by paying a pricethat is higher than the market price).

The definition also covers situations in which a government makes payments to a funding mechanism, orentrusts or directs a private body to carry out one or more of the type of functions illustrated in (i) to (iii)above which would normally be vested in the government and the practice, in no real sense, differs frompractices normally followed by governments.

However, energy economists concerned about the wider set of economic distortions in the energy sectoroften cast the net wider than this and would also include other types of regulation that influence market pricesand quantities. For example, the OECD’s definition used in its “producer support estimate” (PSE) indicatoralso includes all forms of market price support involving transfers between consumers and producers createdas a result of policy such as government interventions on tariffs. The OECD’s “consumer support estimate”(CSE) includes any additional policy-induced transfers that affect consumption. The OECD’s framework isdiscussed in more detail in the following section.

Another issue to consider is the treatment of externalities (ie costs which are incurred in other parts of theeconomy that are not directly party to the transaction between producers and consumers). In the energy sector,the most obvious example includes environmental impacts of energy use. Most local pollutants are comingunder a regime of increasingly stringent controls, so that it is reasonable to say that these external costs havelargely been internalised.

One of the problems of internalising the climate change externality is the difficulty of estimating the scaleof the damage, and therefore identifying a suitable level for the carbon price. Carbon emissions in principleare internalised through the EU-ETS for the sectors covered, although there are concerns that the carbon priceis inadequate. The UK government has taken the position that carbon prices ought to follow a trajectory in linewith the costs of meeting a long-term carbon reduction trajectory appropriate to staying within a 2 degreewarming limit. This has led to a long-term carbon price forecast which was used to inform its carbon pricefloor which applies to UK emitters covered by the EU-ETS. This guarantees that carbon prices for UK powergenerators will not fall below a level that the UK deems is a reasonable approximation of the external costs ofcarbon emissions.

The imposition of carbon prices acts to correct a market failure, so carbon prices should be considered as acorrection to suboptimal prevailing market price signal. In that sense, the absence of a carbon price in energymarkets constitutes a subsidy since in a market without carbon prices, polluters are not paying their fullproduction costs. Whilst this is the most intellectually robust way to consider externalities, it is clearlypolitically sensitive, as the attempt by the EU to impose EU-ETS carbon prices on external airlines has shown

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(despite the rock-bottom carbon prices). Political constraints are largest for commodity producers competingwith parties outside of the jurisdiction of the policy. However, potential solutions (eg, pooling airline carbonfees to finance upgrades within the industry rather than disbursing to national treasuries) may be one wayaround the conflicts. Multi-lateral agreements would also work in principle, but are struggling to make progressin practice.

A class of subsidy which is alluded to in the WTO definition, but which are difficult to measure is theprovision of various forms of guarantee by government on behalf of private companies making investments inthe energy sector. These guarantees can take a number of forms, loan guarantees for upfront capital investment,or guarantees associated with long-term liabilities such as nuclear waste or long-term CO2 storage. In caseswhere there is partial or full government ownership of the energy companies, such guarantees are implicit, andeven harder to measure. Rates of return on capital may be much lower than commercial rates, and difficult toidentify in financial reports. Such guarantees transfer risk from private companies to public tax-payers. Theserisks may or may not materialise as real costs to the economy, but nevertheless, the transfer of risk to thepublic domain allows companies to borrow at lower costs of capital than would be the case if the risks werefully costed within the boundaries of the loan decision, and should therefore strictly be counted as a subsidy.Methods for quantifying the financial magnitude of such risk transfers are discussed in (Lucas 2010)).

1.2 Methodologies Used in Major International Studies of Subsidies

This section reviews some of the different methodologies used to measure subsidies in major internationalstudies.

1.2.1 Price-Gap Approach

The most widely used method to measure subsidies is the “price-gap” approach, developed in detail by the(IEA 1999) in their landmark publication on energy subsidies. This approach follows the same logic as thatportrayed in Figure 1. The first step is to measure the price gap based on the difference between end-use pricesto consumers, and a reference price that is taken to be the “efficient” price that would prevail in the absenceof subsidies. The second step is to calculate the impact of the price gap on consumption, based on estimatesof the elasticity of demand. This quantity effect is then used (as described previously) to estimate the scale ofwelfare losses associated with the subsidy.

Conceptually, the price gap approach is straight-forward, but a number of complexities arise in calculatingboth the consumer and reference prices. As noted in (IEA 1999), methodological issues arising in thecalculation of consumer prices include:

— Appropriate currency units (local, international at market rates, international at purchasing powerparity).

— Inclusion of energy-specific taxes, fees, levies and surcharges, as well as all rebates and reductionsrequires detailed data.

— Appropriate treatment of general taxes such as VAT.

— Accounting for situations where there is a physical constraint to the supply of energy, so thatconsumption levels are only partially influenced by price.

The reference price indicates the opportunity cost of consumption of one unit of energy, its true economicvalue. It corresponds either to the border price for internationally traded energy products or to the costs ofproduction for non-traded ones, both adjusted for transport and distribution costs. For some energy goods,especially those that are internationally traded, the reference price is fairly easy to identify. Even where thesemarkets vary regionally, there are relatively well-established traded prices in most parts of the world for oil,gas and coal, and the border prices (for both energy exporters and importers) is the relevant reference pointagainst which the prices of domestic energy consumption can be compared. Nevertheless, care is required totake account of all internal transportation costs and to ensure that adjustments are made to account fordifferences for example in fuel quality between domestic sources and international markets.

Treatment of VAT needs careful handling, since it is often a general part of a country’s tax structure, socould be considered a “normal” cost which should be included in the reference price. This would allow taxexemptions to show up as subsidies in the price gap calculation. On the other hand, the electricity sector oftenbears no general taxation, since it is an intermediate energy transformation process rather than a final consumer,so the IEA methodology treats zero VAT rates as the normal reference point.

To date, the IEA methodology has also excluded environmental externalities from their calculations ofsubsidies on the basis that carbon pricing is not (yet) “normal” practice within its member countries, althoughthey recognise that in principle carbon prices etc. should at least theoretically be part of the reference price.

The limitations of the price gap approach are summed up by the IEA as follows:

“The price-gap approach captures the effects of subsidies on economic efficiency to the extent that theylower the end-use price of the good in question. Other forms of subsidies, especially those, like importtariffs, which are designed to support domestic production, would raise final consumption prices.

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When more than one subsidy applies to the same good, a frequent occurrence, the price gap measuresonly the net price effect of all the different subsidies together. In reality, however, the effects on economicefficiency of coincident subsidies are not netted out, but add up. For instance, the combined applicationof a subsidy to capital costs and an import tariff might well leave end-use prices close to the referenceprice. In this case, the price-gap approach would yield little or no insight, but double efficiency losses dooccur. So work based on price differentials cannot measure all efficiency losses associated withgovernment policies.

Trade effects, the reduction of imports or the additional availability of exportable fuels, are particularlyaffected by this analytical limitation. Depending on the specific forms of the subsidies, their removalmight have much greater impacts than simply closing or narrowing the price-gap. Removing a capitalsubsidy and an import tariff might change prices little, but it would have very strong trade implications.

Depending on the form in which the subsidies are administered, taxes can also offset their impact onprices, at least to some degree. For example, if subsidies lead to lower capital costs for power generation,a tax on electricity would offset the increased consumption due to lower prices. Energy taxes, however,would not offset the efficiency losses induced by an inefficient factor mix, such as a bias towards capital-intensive forms of energy production bolstered by a capital cost subsidy.”

1.2.2 OECD “Effective Rate of Assistance” Approach

One of the key limitations of the price gap approach is that it does not adequately address support to energyproducers (Koplow 2009). The OECD calculates subsidies using a more bottom-up assessment of the scale ofgovernment budget transfers involved to energy consumers and producers arising from the major subsidiesidentified. This requires in-depth analysis of the policy framework for each individual energy sector. Table 1.1shows the potential range of different types of subsidy that need to be considered under such an approach,using the coal industry as an example (IEA, OPEC et al. 2010).

Table 1.1

OECD CATEGORISATION OF SUBSIDIES WITH EXAMPLES (OECD 2012)

Consumer Support Producer Support

Unit cost of consumption

Household or enterprise income

Outputreturns

Enterprise income

Cost of intermediate inputs

Costs of production factors

msinahceM refsnarT

Direct transfer of funds

Unitsubsidy

Government subsidizedlifelineelectricityrate

Output bountyor deficiencypayment

Operating grant

Input-pricesubsidy

Capital grantlinked toacquisitionof land

Transfer of risk to government

Price-triggeredsubsidy

Means-testedcold-weathergrant

Governmentbuffer stock

Third-party liabilitylimit for producers

Provision ofsecurity (e.g.military protectionof supply lines)

Assumption ofoccupationalhealth andaccident liabilities

Tax revenue foregone

VAT or excise taxconcessionon fuel

Tax deductionrelated toenergypurchases thatexceed givenshare of income

Productiontax credit

Reduced rateof income tax

Reduction inexcise taxon input

Investmenttax credit

Other government revenue foregone

Under-pricing ofaccess to anatural resourceharvested byfinal consumer

Under-pricing ofa governmentgood or service

Under-pricing ofaccess togovernmentlandor naturalresources

Induced transfers

Regulated price;cross subsidy

Mandated lifelineelectricityrate

Import tariff orexport subsidy

Monopolyconcession

Monopsonyconcession;export restriction

Land-usecontrol

The OECD method involves making a producer support estimate (PSE), a consumer support estimate (CSE),and general services support estimate (GSSE) that support both consumers and producers.

Producer support estimate (PSE). Support provided to producers by governments may be delivered througha wide range of mechanisms: increasing the output price (Market Price Support); providing cash directly (acheque from the government); reducing the riskiness of investing in fixed capital (eg, loan guarantee;investment insurance); foregoing a payment that would otherwise be due to the government (eg, a taxconcession) or reimbursing a tax or charge (eg, as for fuel taxes in some countries); reducing the price of aninput (eg, electricity for mining) or of a value-adding factor (eg, a wage subsidy); providing a service in kind

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(eg, police protection of a pipeline) for free or at a price less than the producer would pay on the open market;investing in knowledge-creating activities (eg, research and development; education and training of specialists).

Consumer support estimate (CSE) includes price transfers to or from consumers. The normal case, especiallyin countries that are net exporters of fossil fuels, is that transfers are made to consumers through administeredpricing. These transfers may exist alongside other subsidies in cash or in kind (including vouchers) linked tothe consumption of a particular energy product. When consumers pay more than the reference price for a fuel,such as because of an import tariff, market transfers can be considered the inverse of transfers associated withmarket price support for the production of commodities that are consumed domestically; these are called pricetransfers from consumers. Sometimes, when domestic prices are above international prices, budgetary transfersmay be provided to first consumers of energy products where these are provided specifically to offset the higherprices resulting from market price support.

General services support estimate (GSSE). Unlike the PSE and CSE, GSSE transfers do not directly affectproducer revenue or expenditure by consumers, although they may affect production or consumption of energyproducts in the longer term. This includes for example, research and development, inspection services,infrastructure specific to the energy sector being considered, and marketing & promotion.

The OECD method then involves quantifying the budget transfers associated with each source of subsidy ineach of these three categories, and then summing them up together. Care is needed to avoid double counting,so that any transfers made from producers to consumers as a result of producer support measures passedthrough to consumers is netted off the calculation. See (OECD 2010) for a detailed review of the methodology.

1.2.3 World Bank

The World Bank recently undertook a review of energy subsidies globally (WorldBank 2010), with a focuson consumer subsidies for fossil fuels in developing countries. The study is not aimed so much at quantifyingsubsidies as understanding their role in different country contexts, and identifying conditions under whichsubsidy reform might be possible and effective. The Bank notes that such subsidies are often regressive, withthe benefits flowing mostly to richer sections of society. Key findings of the review are:

— Gasoline, diesel, and LPG subsidies are weakly targeted to the poor, particularly in low incomecountries.

— Kerosene subsidies may be targeted to the poor through their direct effects, but the leakage tobetter off households, commercial establishments, and the transport sector arising from the ease ofadulterating diesel fuel with kerosene means that the subsidies’ pro poor benefits may be limited.

— Electricity subsidies resulting from excessive losses or failure to collect bills do not have economicjustification and should be actively reduced.

— Electricity subsidies through generalized under-pricing are likely to be regressive, and much bettertargeting may be achieved through a careful design of the tariff structure. Volume differentiatedtariffs appear to perform much better in this respect than increasing block tariffs.

— Subsidies to connection charges for electricity can be designed to be strongly progressive, but theirsubstantial cost per household requires an investigation into the lowest cost method of supply aswell as comparative assessment of other options to help the poor.

— Cross subsidies for tariffs and for connection charges between different classes of users can be animportant instrument, but are of limited use where overall connection rates are very low.

— Social safety nets can provide a more effective way of reaching the poor while controlling publicexpenditure. However, they require a strong administration.

— Because energy subsidies can result in a large fiscal burden, all subsidy schemes should consider theinclusion of natural phase-out provisions. This can help to reduce the expectation of a permanentsubsidy that can be very difficult to combat at the time a government feels the need to reduce thefiscal burden. However, some subsidy schemes may be designed to be permanent, such as crosssubsidies between different groups of consumers (such as urban households cross-subsidizing ruralhouseholds for whom costs of electricity supply can be markedly higher).

— Transparency is important. Proper accounting and public awareness of which groups benefit fromsubsidies, by how much, and the cost is essential to evaluate g through sector as the main beneficialyof subsidies [Figure 5]ch of counting lower VAT on energy as a subsidy, identifies the overnmentpolicies.

— Subsidies to support a switch from fossil fuels to renewable energy need to be carefully planned andto consider the inclusion of natural phase out provisions.

1.2.4 IMF

The IMF has also recently completed a major study of energy subsidies (IMF 2013) across both advancedeconomies and developing countries. Whilst the study recognises the importance of both consumer andproducer subsidies, the evaluation of subsidies focusses mainly on consumer subsidies for fossil fuels. However,unlike the World Bank study, the IMF study considers post-tax subsidies—eg tax breaks such as reduced

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VAT—consistent with the definitions used by the OECD. Whilst pre-tax subsidies are mostly focussed indeveloping countries (especially oil-producing states in the Middle-East and North Africa), post-tax subsidiesare more widespread in advanced economies.

Remarkably, the IMF also introduces another strand to their analysis by including in their definition ofsubsidies the lack of taxes to address the externalities. They include environmental damages, as well asestimates of transport externalities, but probably the most significant element is the inclusion of a $25/tCO2

benchmark for CO2 emissions from fossil fuels to cover climate change damages.

Using this basis of accounting transforms the focus of the energy subsidy debate. Since most countries donot tax carbon at this level (if at all), the combination of counting tax breaks as well as under-pricing ofexternalities swings the total level of energy subsidies from being dominated by developing country producers(as suggested by IEA price-gap approach) to being dominated by the major energy users.

On the IMF’s accounting basis, of the global total, pre-tax subsidies account for about one-quarter, and taxsubsidies account for about three-quarters (see Figure 2). The advanced economies account for about 40 percentof the global total. The top three subsidizers across the world, in absolute terms, are the United States ($502billion), China ($279 billion), and Russia ($116 billion).

The study also undertook 22 case studies to assess experiences of energy subsidy reform (IMF 2013). Thecase studies show that subsidy reform requires careful handling. The case studies show examples of bothsuccessful and unsuccessful episodes of subsidy reform over the past two decades in a wide range of countrycontexts, but focussing mainly on developing and emerging economies.

Figure 2

IMF ESTIMATES OF GLOBAL ENERGY SUBSIDIES INCLUDING TAX ADJUSTMENTS ANDUNDER-PRICING OF EXTERNALITIES

0 500 1000 1500 2000

Pre-tax subsidy Externalities VAT

0 5 10 15 20 25 30 35 40

Percent ofG

DP

Total subsidy, billionsU

.S. dollars

Percent of

government revenues

World

Sub-Saharan Africa

MENA

LAC

E.D.Asia

CEE-CIS

Advanced

WorldSub-Saharan Africa

MENALAC

E.D.AsiaCEE-CIS

Advanced

WorldSub-Saharan Africa

MENALAC

E.D.AsiaCEE-CIS

Advanced

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S.S.Africa

Adv.

CEE-CIS

E.D.Asia

LAC

MENA

Total post-tax subsidies$1.90 billion Percent of total subsidies1

Petroleum products$879 billion

Coal$539 billion

Natural gas$299 billion

Electricity$179 billion

The IMF study also gives a country-level breakdown of these subsidies, and the countries classified as“advanced” in the IMF analysis is shown in Figure 3. According to the IMF definition, the UK falls into thelower half of the distribution, with energy subsidies totalling around 0.45% of GDP.

Figure 3

SUBSIDY LEVELS IN “ADVANCED” ECONOMIES AS DEFINED IN IMF STUDY

0

0.5

1

1.5

2

2.5

3

3.5

4

atlaM

dnalreztiw

SdnalecIya

wroN

nedew

SecnarFkra

mneD

lagutroP

muigleB

ylatId nalniFairtsuAniap

SmodgniK detin

UdnalerIsdnalrehte

Neceer

Gsurpy

Cyna

mreG

lear sInapaJainevolScilbupe

R kavolS

RAS gnoK gnoH

eropagniSaero

Kada na

Ccilbupe

R hcezC

ailar tsuAdnalaeZ

weN

nawiaT

ainotsEsetat

S detinU

gruobmexuL

PD

G fo %

Coal

gas

electricity

Petroleum

However, it should be noted that these figures focus mainly on consumer subsidies, and underestimateproducer subsidies. In particular, subsidies for nuclear energy and renewable energy are not included explicitlyin these figures. These are addressed further in Sections 2 and 3.

1.2.5 Global Subsidies Initiative

The Global Subsidies Initiative of the International Institute for Sustainable Development has been workingfor a number of years towards increasing the level of transparency over the definition and measurement ofsubsidies, and has produced a manual aimed at promoting best practice in this regard (GSI 2010). The studygoes beyond energy subsidies, looking at the environmental impact of all subsidies including the naturalresources, minerals and agricultural sectors.

One issue the GSI has focussed on quite strongly is the underestimates that occur when only consumersupport measures and price-gap approaches are used. As noted above, these approaches tends to suggest thatsubsidies are a developing country issue, whereas including producer support measures tends to show a muchgreater spread globally, but they require considerably more in-depth analysis in order to evaluate the extent ofsubsidies. To date, the GSI has produced the following quantitative studies in the area of producer subsidesfocussing particularly on upstream oil and gas sectors:

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— Government support for upstream oil and gas in Norway (GSI 2012). The study identified ninesubsidies that are offered to the oil and gas sector, totalling around $4 billion per year in 2009,although these are expected to be declining over time. By far the largest component of subsidy isprovided via a faster rate of capital depreciation for tax purposes compared to other industriesin Norway.

— Tax and Royalty-related subsidies to oil extraction in high cost fields: Brazil, Canada, Mexico, UKand US (GSI 2010). Given the importance of high-cost fields in setting global oil prices, the role ofsubsidies here has considerable international importance. The report indicates that all five countriesconsidered provide some preferential treatment to smaller marginal fields, though quantification ofthese was not possible.

— Government support for upstream oil in three Canadian provinces (GSI 2010). This report identifiesannual subsidies in the region of $2.8 billion, approximately $2 billion of which were allocated toAlberta, and evenly split between Federal and State sources. Most of the subsidies identified seek toincrease exploration and development activity, (59% of total subsidies $1.68 billion). These subsidiestypically reduce capital expenditures through accelerated write-offs, tax credits, royalty reductionsor allowances. Subsidies to support exploration, drilling, operations and research and technologycomprised the remaining share of subsidies in about equal proportion.

— Government support for upstream oil and gas in Indonesia (GSI 2010). For the areas that could bequantified, subsidies totalled around $1.8 billion annually, the largest component (86%) of whicharises from the Domestic Market Obligation which obliges producers to sell a certain share oftheir production to the government-owned oil company Pertamina at below market rates. Given theinvolvement of the state at various levels in the industry, the total level of subsidies is likely to besignificantly higher. The report identifies several areas where subsidies potentially exist, but couldnot be quantified without further research.

2. Extent of Energy Subsidies in the UK

2.1 Energy Mix in the UK—Historical and Future Trends

The energy mix in the UK and beyond is in a state of transition due to multiple drivers includingtechnological developments in oil & gas sector, environmental constraints on carbon and other emissions,energy security concerns including international reactions to the Fukushima disaster.

The UK mix has shifted dramatically since the early 1970s from being dominated by coal and oil, to havinga much larger share of gas. There are many different projections of the fuel mix going forward, but all of themshow that further change in the UK is inevitable. Figure 4 shows DECC’s projections with a continued declinein coal use, and expanded contribution from renewable sources. The share of a fuel in the energy mix is animportant element in determining the overall size of subsidies paid to each energy source.

Figure 4

PRIMARY ENERGY MIX IN THE UK

250

200

150

100

50

0

Mto

e

1970

1980

1990

2000

2010

2020

2030

Source: DECC, Digest of UK Energy Statistics and Updated Energy Projections, October 2012

Electricity (not imports)

Nuclear

Renewables and waste

Natural Gas

Oil

Coal and other solids

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In terms of downstream energy consumption, analysis of the tax base shows that like many countries, theUK raises the great majority of its energy taxes from transport fuels (OECD 2013) as shown. The shaded barsin the figure correspond to total tax revenue, excluding ad valorum taxes such as VAT. The most intellectuallyrobust way to assess whether or not such taxes represent net revenues or net subsidies would be to take grossrevenues, and subtract the degree of government expenditure for example on infrastructure or other servicesrequired to support that energy service. Such detailed assessments are beyond the scope of this study, and tendalso to be excluded from assessments such as those carried out by the OECD, which takes each country’s taxcode as a “norm” from which to assess subsidies.

Figure 5

THE CONSUMER TAX BASE FOR ENERGY PRODUCTS IN THE UK (EXCLUDES VAT)

2.2 Fossil Fuel Subsidies

The UK has progressively reduced subsidies to fossil fuels over the past 30 years in line with EU and OECDguidelines. There are no end-user price controls, with all prices being set by the market. The following analysisis based on the recent OECD calculations of energy subsidies for its member countries (OECD 2012).

Producer support

The main type of producer subsidy remaining in the UK is in the oil and gas sector and relates to taxallowances to partially offset the petroleum revenue tax (PRT). The PRT is the main tax levied at 50% of grossprofits on oil and gas production in the UK. All oil and gas producing countries levy some kind of tax orroyalties on production which is how they gain value from the resources being extracted. There is no commoninternational standard for the rate of such taxes and levies, the level is set by each country. The standard PRTtherefore defines the “normal” baseline tax rate for oil production in the UK.

Various allowances which partially offset the PRT are available to companies which act as subsidies. Theseinclude a new-field allowance that was introduced in 2009 for small, ultrahigh-pressure and high-temperatureoil fields, and ultra-heavy oil fields. As noted in Section 1.2.5, such subsidies for high-cost fields are notuncommon (GSI 2010). This allowance was subsequently extended by the government to cover remote deep-water gas fields (March 2010), very deep fields with sizeable reserves (March 2012), and certain large shallow-water gas fields (July 2012). Other measures to support certain types of production include Promote licences,which allow small and start-up companies to obtain a production license first and secure the necessary operatingcapacity and financial resources later through reduced rent for the first two years. These PRT allowances addedup to £159m in 2011 for oil, and £121m for gas.

The OECD considers that in the context of the UK tax system design, the ability of oil and gas companiesto write off exploration and production expenditures immediately does not constitute a subsidy.

Producer support for coal-mining sector has been removed since 2006, with only inherited liabilities relatingto previous public ownership estimated by the OECD at a level of £4m in 2011. This includes management ofabandoned mines and treatment of mine-water discharges.

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Looking ahead, shale gas is a potentially important new area of energy resource development in the UK.HM Treasury is currently consulting with industry on a fair tax regime for this new development (DECC2012). The definition of a “fair” tax in this context will have to take into account whether special tax treatmentis required for the sector given its different pattern of capital investment and other differences compared toconventional oil and gas fields. Given the normative nature of subsidies in the energy sector, a decision onwhether or not any special treatment given to shale gas vis-à-vis conventional sources would have to take intoaccount similar considerations. In the US which has the greatest experience of shale gas development, emergingsubsidy issues include the adequacy of bonds used by oil and gas producing states to assure funding forreclamation of drilling sites, cover regulatory costs and offset public infrastructure costs. Road damage fromuse of heavy trucks on secondary roads, and payments for cleanup of fracking water are also emerging as costswhich will need to be accounted for.

Consumer support

By far the largest subsidy for fossil fuels in the UK relates to the lower VAT rate of 5% for domestic energysupplies (compared to 20% for the economy as a whole). Since VAT is a general economy-wide tax, anyreduction from the general national rate is considered by the OECD to be a subsidy. Domestic energy supplieshave always been taxed at a lower rate in the UK, since being raised from zero to 5% in 1994, but this practiceis unusual, as most countries tax energy at the prevailing rate of VAT (see Section 3.1).

In 2011, this tax was worth £81m for coal, £380m for oil and £3,510m for gas.

There are very few measures other than tax exemptions or reductions that support energy consumption inthe United Kingdom. Schemes such as winter fuel payments for the elderly or cold-weather payments do notdepend on the price of fuels and are provided in-cash to eligible households. Most of the remaining measurestarget consumption technologies such as low-carbon vehicles and hydrogen refuelling equipment rather thanenergy use per se.

Discounts to the climate change levy CCL (an end-user energy tax) are offered for eligible energy intensiveusers in return for committing to a climate change agreement to reduce energy consumption (see Section 2.6.2).

Missing Data

The OECD study points to a number of areas where data was not available to calculate subsidy levels forfossil fuels. These include:

Ring-Fence The Ring-Fence Expenditure Supplement (RFES) was introduced in January 2006 toExpenditure replace the former Exploration Expenditure Supplement (EES). In its current version, itSupplement provides oil and natural-gas companies with a yearly 10% increase in the value of

unclaimed deductions for expenses related to exploration and appraisal for a period of upto six years.

Field Allowance This new allowance was first introduced in 2009 and later extended to encourage thedevelopment of small or technically-challenging fields. Before 2012, qualifying fields hadto be small in size, feature ultra-high pressure or temperature, possess ultra-heavy oilreserves, or be remote deep-water gas fields. In 2012, it was then announced that newfield allowances would also be extended to very deep fields with sizeable reserves, andlarge shallow-water gas fields. This extension is expected to generate revenue losses ofabout GBP 20 million per year (HM Treasury, 2012). The field allowance providescompanies with a partial exemption from the Supplementary Charge. Relief is calculatedat the level of the field but is provided at the company-level. Unclaimed allowances canbe carried forward.

Mineral The Mineral Extraction Allowance (MEA) was introduced in 1986 to provide miningExtraction companies (including coal, oil, and natural-gas producers) with faster rates ofAllowance depreciation for qualifying capitalised expenditures. The latter include the acquisition of

mineral rights or deposits and expenditures connected to access to the reserves.Prescribed rates vary with the type of expenditure to which the provision applies.Analysis of this provision is, however, complicated by the interaction of the MEA withthe general tax regime that applies to oil and gas extraction. These caveats do not applyto coal though. Although this provision applies to the mining sector as a whole, datafrom the OECD’s STAN database indicate that mining of fossil fuels accounts for nearly90% of total gross output for the mining and quarrying sector (as defined in the standardISIC Rev.3 sector classification).

Abandonment This provision allows capital expenditures connected to the abandonment of fields andCosts mines to be deducted in full in the year in which they are incurred. Deductions are

coupled with a carry-back provision which makes it possible for companies to use lossesarising from decommissioning costs against profits earned in earlier years. This maytherefore result in tax refunds. Although this provision applies to the mining sector as awhole, data from the OECD’s STAN database indicate that mining of fossil fuelsaccounts for nearly 90% of total gross output for the mining and quarrying sector (asdefined in the standard ISIC Rev.3 sector classification).

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2.3 Nuclear Subsidies

Nuclear plants provided 62.7 TWh or 17.8% of the UK’s electricity in 2011 (down from a maximum of26.9% in 1997), coming from ten nuclear power stations with a combined capacity of 11 gigawatts (GW). Thelargest nuclear operator is EDF Energy, a wholly owned subsidiary of Electricité de France (EDF), whichpurchased British Energy Group plc in January 2009. It runs eight nuclear power stations, seven of which areadvanced gas-cooled reactors (AGRs) and the remaining one is a pressurised water reactor (PWR) at SizewellB. Two plants operated by Magnox Ltd. run Magnox gas-cooled reactors. The Nuclear DecommissioningAuthority (NDA) owns several closed Magnox stations.

The UK reactor fleet is comparatively old. Up to 7.4 GW of existing nuclear capacity were scheduled forclosure by 2019. However, the AGR reactors are being awarded life extensions, which is likely to delay closure,currently for around 7 years. The other reactor is the 1200 MW PWR at Sizewell B whose scheduled lifetimeis to 2035 (IEA 2012).

2.3.1 Historical liabilities

The NDA has responsibility for radioactive waste management and decommissioning, and for nuclear legacysites. It is a non-departmental public body created in 2005 that employs about 200 people. NDA owns formernuclear sites and the associated civil nuclear liabilities and assets of the public sector, including all the formersites and reactors of British Nuclear Fuels Limited (BNFL) and the UK Atomic Energy Authority (UKAEA).Its responsibilities include decommissioning and clean-up of these installations and sites, as well as theimplementation of the UK nuclear waste policy. It is currently working on an annual budget of around £3billion, of which £2.3 billion comes from the UK government, and the remainder from commercial operations.Total public liabilities for NDA’s sites on a total discounted lifetime cost basis are around £50 billion. Asshown in the breakdown in Table 2.1, by far the largest of these is £32 billion for Sellafield (net of remainingoperating revenues).

However, as pointed out by the National Audit Office (NAO 2012), these cost estimates, although improving,are still quite uncertain. They note:

“The [NDA’s] undiscounted provision for the lifetime cost of the clean-up of Sellafield up to 2120increased from £46.6 billion as at March 2009 (in 2011–12 prices) to £67.5 billion as at March 2012. The[NDA] expects that the lifetime cost will continue to rise, as uncertainties in the lifetime plan areaddressed, then plateau, and finally decline as Sellafield Limited manages the decommissioning processbetter.”

Some of the financing of the NDA comes from the Nuclear Liabilities Investment Portfolio (NLIP), a fundof about £4 billion that was separately identified in BNFL’s accounts before privatisation, but which stayed inpublic hands. Arguably therefore, some of NDA’s budget comes from the industry rather than from government,but in the bigger scheme of things, this is only sufficient to pay for two years or less of NDA’s expenditure,so for the large part NDA can be considered to be publicly funded (Thomas 2004).

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Table 2.1

PUBLIC LIABILITIES FOR RETIRED NUCLEAR PLANT3

2011–12 Estimated Discounted Lifetime Plan (£m)Total

OperationsDecomm & Costs** Net

Clean-up Running Commercial Running GovernmentCosts* Cost Revenue Cost Funding

Site Licence D = (B-Company Site A B C C) E = (A+D)

Magnox Limited Magnox Support 690 0 690Berkeley 659 0 659Bradwell 506 0 506Chapelcross 749 0 749Dungeness A 647 0 647Hinkley Point A 699 0 699Hunterston A 667 0 667Oldbury 1,008 0 1,008Sizewell A 778 0 778Trawsfynydd 611 0 611Wylfa 1,045 80 80 1,125

Research Sites Harwell andRestoration WinfrithLimited 1,122 0 1,122Dounreay Site DounreayRestorationLimited 1,904 0 1,904Sellafield Sellafield (includingLimited Calder Hall and

Windscale) 36,601 3,571 8,040 -4,469 32,132Capenhurst 647 0 647

LLWR Limited LLWR 253 533 598 -65 188Springfields SpringfieldsFuels Limited 384 0 384Sub-Total 48,970 4,184 8,638 -4,454 44,516

Electricity Sales 90 246 -156 -156Geological DisposalFacility 3,840 3,840NDA CentralLiabilities & Group 83 1,447 1,550 -103 -20

Total 59,893 5,721 10,434 -4,713 48,180

2.3.2 Waste and decommissioning for future plant

Waste liabilities for future plant are even more uncertain than historical liabilities. The government’s positionis that any new nuclear plant must cover the costs of future waste and decommissioning out of their currentoperating costs without any public subsidy. This requires companies to put aside funds each year which canaccumulate over the operating lifetime of the plant to pay for these back-end costs. However, long term disposaloptions will not start to become operational until after 2050, and until then, costs remain speculative.

The problem with costs being so uncertain is that it creates a barrier to investment because of the potentialfor liabilities to be higher than originally expected. In order to help companies manage this risk, the governmenttherefore has proposed to introduce a fixed payment mechanism, the so-called “waste transfer price” (DECC2011):

“In order to provide Operators with certainty over the maximum amount they will be expected to pay forwaste disposal the Government will, at the outset, set a Cap on the level of the Waste Transfer Price. TheCap will be set at a level where the Government has a very high level of confidence that the actual costwill not exceed the Cap. However the Government accepts that, in setting a Cap, the residual risk that theactual cost might exceed the Cap is being borne by the Government. Therefore the Government willcharge an appropriate Risk Fee for this risk transfer. Hence for clarity, the Waste Transfer Price willinclude two separate risk allowances:

— The Risk Premium is the premium over and above expected costs that will be included in the WasteTransfer Price to reflect the risk being assumed by the Government, when the Waste Transfer Price isset at the end of the Deferral Period, that actual costs might be higher than the Waste Transfer Price.

3 Source: NDA available at http://www.nda.gov.uk/sites/financials/index.cfm accessed March 2013

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Ev 80 Environmental Audit Committee: Evidence

— The Risk Fee is an additional element included in the Waste Transfer Price to reflect the smallresidual risk being assumed by the Government, when the Cap is set at the outset, that actual costsmight be higher than the Cap.”

The offer by government of a cap on liabilities could be considered a subsidy because it acts like an insurancepolicy. On the other hand, the government is aiming to charge for this transfer of risk via the risk fee, whichin principle cancels out the subsidy. It is very hard to determine an appropriate “market price” for this risk,since it would be almost impossible to obtain an insurance against such open-ended risks.

As an illustration of the potential scale of subsidy, DECC have published an indicative waste disposalliability based on cost estimates for the disposal of intermediate level waste of £14.5k/m3. Based on thisestimate, the illustrative cap would be £48.4k/m3. However, estimates of the NDA’s true marginal cost forwaste disposal is put at £67/m3 which suggests a significant risk that future liabilities may end up beingtransferred to the public purse. Estimates of the potential total value (undiscounted) of this subsidy have beenestimated at between £400m to £1,500m depending on the lifetime of the nuclear plant between 40–60 years(Greenpeace 2011). The Birmingham Policy Commission (Birmingham 2012) puts the waste transfer fee pricecap into context, estimating that it is worth at most 1.5–2% of the revenue from sales of electricity, and quotesDECC estimates that the likelihood of the cap being exceeded is less than 1%.

The true scale of these risks come down to an assessment of how realistic these estimates of these liabilitiesare. In principle, the government could try to sell a portion of the ultimate liability on the secondary marketto reality test pricing assumptions against market value, although the liquidity of such markets is likely tobe questionable.

2.3.3 General operating conditions for new nuclear

Despite Ministerial announcements as recently as October 2010 that there would be no public subsidies fornew nuclear plant, it is apparent that several subsidies will in fact be in place, some explicit, some implicit,driven in large part by the rapid escalation in the estimates of capital costs for building new nuclear plant (forestimates of how costs have changed over the past 10 years, see (Schneider, Froggatt et al. 2012).

The most transparent will be the price support for producers under the feed-in tariff to be introduced as partof recent electricity market reforms. The tariff is still being negotiated between the government and EdF, forplanned new build at Hinkley Point in Somerset. The price that the company receives for its electricity will befixed by a contract for difference, which requires consumers to top up payments over and above the marketprice up to the agreed level. Once the strike price has been announced for Hinkley Point, the extent of thesubsidy will become more apparent.

These arrangements constitute a subsidy not only because of the raised price compared to market levels, butalso because long-term fixed price contracts with reliable counterparties allow companies to borrow money atlower interest rates—a particularly important factor for capital intensive projects like nuclear plant. Theduration of the contracts is therefore very important element of the subsidy, and is also still under negotiation,but there has been some speculation that contract periods of up to 40 years are being discussed4.

It is likely that in the early years of operation, this market price support will constitute a substantial subsidycompared to the cost of the cheapest alternative (ie gas-fired plant), but in the long run, the subsidy element isnot so clear. Given a 40 year time horizon, gas prices are extremely uncertain, and nuclear may turn out to becheaper, especially taking into account the costs of removing CO2 from gas-fired generation. On the otherhand, nuclear will be competing with renewable energy sources, for which costs have been coming downrapidly over recent years. From a strategic energy security perspective, governments may consider that thesemacro-economic uncertainties are beyond the scope of private companies to cope with via normal marketmechanisms.

Other types of subsidy are less transparent. The nuclear industry operates in a somewhat protectedcommercial environment because of the fact that each plant is too big to fail. This means that it is necessaryfor national governments to underwrite most of the commercial risks of nuclear power, as evidenced by theway the UK government had to bail out British Energy in 2005 at a cost of about £5 billion. This demonstratesthe general point that, ultimately, national governments have no choice but to underwrite the commercial risksof nuclear power. The state aid for the rescue and restructuring of British Energy and BNFL were allowed bythe EC in 2004 and 2006 respectively5. In November 2009, British Energy was sold to EDF Energy for £12billion, the proceeds of which were put into the nuclear liabilities fund. An issue for the government to manageis how to accrue sufficient interest on these funds to cover future liabilities given the current low return onsecure investments such as treasury bonds. A related issue is how government funds should be accounted forwhen considering the cost of capital for infrastructure projects such as waste disposal. One line of argumentsuggests that government cost of capital is an inappropriate measure of the real costs, since it tends to maskthe effects of risk (Lucas 2012).

4 http://www.guardian.co.uk/environment/2013/feb/18/nuclear-power-ministers-reactor5 The case reference documents are in the state aid register: http://ec.europa.eu/competition/state_aid/register/

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The same goes for limits to company liabilities associated with major incidents such as nuclear accidents,terrorist threats and so on. Despite the low probabilities of such events occurring (at least on a plant-by-plantbasis), the excessively high level of the maximum liability incurred means that companies are unable to obtainprivate insurance against such risks6. The value of such implicit subsidies are very difficult to assess.Estimates depend crucially on assessments of the likelihood of such events occurring. This tends to be a verysubjective issue, and difficult to obtain impartial analysis. Despite the difficulty of quantifying these implicitsubsidies, it is clear that without them, private investment in new nuclear power plant would not go ahead.

The UK government intends to increase the cap on liabilities to €1.2 billion from its present level of £140million as part of its implementation of an international treaty on nuclear third party liability—the Paris andBrussels Conventions, to which the UK and most of the other EU countries are signatories (DECC 2012). Thisincreases substantially the range of low-level incidents that companies will have to cover themselves. It isclearly substantially short of a full-scale disaster of the order of magnitude of Fukushima, for which the clean-up costs alone have been estimated at €175 billion, not including the wider economic damages incurred(EnergyFair 2012). Significantly higher liabilities in the private sector are not unprecedented (eg BP hasallocated $41 billion to settle claims resulting from the Gulf of Mexico disaster). Such large sums are probablybeyond the ability of relatively smaller utility companies to handle, but the fact remains that there is anincentive for companies to understate their ability to secure private insurance for such risks in order to gaingovernment protection, and ways should be sought for these risks to be internalised as far as possible withinthe general costs of production.

2.4 Renewables

2.4.1 Current subsidy arrangements

Renewables Obligation

The main subsidy to large-scale renewable energy sources in the UK is currently the Renewable Obligation(RO) scheme which requires suppliers to provide a certain proportion of their electricity from approvedrenewable sources. Generators of renewable energy are issued with a renewable obligation certificate (ROC)for each MWh of power generated. Some sources of renewable energy are credited with more than one ROCper MWh, and some less in order to balance out investment incentives with respect to technology costs7. Forexample, onshore wind receives 0.9 ROCs per MWh, whilst offshore wind receives 2 ROCs per MWh (fallingto 1.5 from 2014–15 onwards). These certificates are tradable. Suppliers buy sufficient ROCs to be compliantwith their obligations. This creates a market for ROCs, so that their price is a transparent observable value.

Any suppliers who do not hold enough ROCs pay a “buy-out” price. These penalty fees are paid into acentral fund, out of which is taken the administration costs of the scheme, and the remainder is redistributedback to suppliers in proportion to their degrees of compliance with the RO. This recycling of the buy-out fundeffectively increases the value of holding ROCs, and adds to their market price.

The value of holding excess ROCs is zero, since they cannot be banked for use in future periods, so to stopthe market price of ROCs falling to zero, the government sets the RO at a level above what is expected to bedelivered, so as to achieve “headroom”, ensuring a positive payment into the buy-out fund.

The current obligation level for suppliers for April 2012 to 31 March 2013 is 0.158 ROCs for each MWhthey supply to customers in England and Wales. The obligation level for April 2013 to 31 March 2014 is 0.206ROCs for each MWh supplied. This figure is calculated by DECC8 based on the list of potential new buildexpected to generate in 2013–14 sourced from the Renewable Energy Planning Database (REPD), the NationalGrid’s Transmission Entry Capacity (TEC) Report, Ofgem’s preliminary ROC Register, and, the UK WindEnergy Database.

ROCs (millions)

Potential ROCs from existing stations 39.7Potential ROCs for new build 16.2Total expected ROCs 55.9Total (with 10% headroom) 61.5

Suppliers can pass on the costs of purchasing ROCs to their customers. The market price is currently around£42 per ROC (and has traded in a fairly narrow band between £40–50 over the duration of the market asshown in Figure 5). This puts the total value of the RO subsidy at (55.9m x £42) at around £2.4 billion for2013–14. In addition to receiving the ROC price, renewable generators also receive payments for generatinglevy exemption certificates (LECs). The value of a LEC is tied to the charge made on energy users under theclimate change levy (CCL). Electricity is currently subject to the CCL at a rate of £5.09/MWh, which6 See discussion in Der Spiegel http://www.spiegel.de/wirtschaft/soziales/0,1518,761826,00.html#ref=nldt or here for an English

translation: http://tinyurl.com/d7yz48k7 https://www.gov.uk/calculating-renewable-obligation-certificates-rocs8 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/65530/6527-calculating-renewables-obligation-

2013–14.pdf

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Ev 82 Environmental Audit Committee: Evidence

effectively sets the traded price of LECs. For the last full year for which data is available (2010/11), the numberof LECs issued was 29.8m. This puts the value of this subsidy at £152m.

Figure 5

MARKET (AUCTION) PRICE FOR ROCS HAVE BEEN QUITE STABLE OVER THE PAST 3 YEARS

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NFFO

Prior to the introduction of the renewable obligation, market support for renewables was via the non-fossilfuel obligation (NFFO). These were long term contracts priced by auction giving a fixed price per kWh fordifferent bands of renewable technology. Based on the volumes and prevailing auction prices of the NFFO, thevalue of these remaining contracts are shown in Table 2.2, totalling around £400m. However, unlike ROCs,these payments are not additional to the value of the electricity, but instead they include the value of electricitygenerated. For NFFO 4 and NFFO 5 rounds, the fixed payments made under the long-term contracts is actuallyless than the wholesale price of electricity. Therefore, these contracts no longer act as a subsidy for the NFFOgenerators. NFFO generators are not eligible for producing LECs.

Table 2.2

VALUE OF CONTRACTS REMAINING UNDER NFFO ARRANGEMENTS

Total Total value of Approx.contracted NFFO market value Approx.

capacity Average price payments of electricity value ofperiod (MW) 06/07 (p/kWh) (£m) (£m) subsidy (£m)

NFFO 3 01 Apr1995–28 Aug2013 627 6.15 128 99 29

NFFO 4 01 May1997–30 Dec2016 843 4.51 132 138 -6

NFFO 5 01 Dec1998–29 Nov2018 1177 3.40 137 195 -58

TOTAL 2,647 396 432 -36

Feed-in Tariffs

For small-scale renewables, the RO system has been deemed too complex, so to provide a simpler and morecertain revenue stream, a feed-in tariff (FiT) was introduced for plant installed up to 5MW. This provides afixed additional revenue stream over and above the value of electricity generated for each kWh of electricitygenerated. By far the largest beneficiary of the scheme since it was first introduced in 2010 has been rooftopsolar PV, accounting for about 90% of installed capacity under the scheme (Ofgem 2012). The tariff for April2010—March 2011 was set to 41.3 p/kWh for systems up to 4kW retrofitted to rooftops. Tariffs are fixed inreal terms for 25 years, adjusted for inflation annually at RPI. In addition, householders receive an additionaltariff for any exported electricity, acting as an incentive to run the household efficiently.

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The tariff was due to remain unchanged for the first two years, and then drop by 8% to 37.8p/kWh in thethird year (UK 2010). In fact, demand for the tariff was so strong, that government decided to drop the tariffrate much more quickly to 21p/kWh for schemes after March 2012. The latest arrangements for setting solarPV tariffs require Ofgem to set quarterly tariff rates which can be adjusted to take account of the volume ofuptake of the subsidy (UK 2012). The tariffs for other renewable technologies are set annually by Ofgem. Thelatest rates for small scale rooftop solar are as follows9:

Table 2.3

CHANGE IN TARIFF RATES FOR ROOFTOP SOLAR PV <4KW10

FIT Year 12010–11 (for Mar May

projects up to 2012— Aug 2012— Nov 2012— Feb 2013— 2013—JulMar 2012) Aug 2012 Nov 2012 Feb 2013 May 2013 2013

FiT p/kWh 45.40 21.00 16.00 15.44 15.44 15.44Export tariff p/kWh 3.2 3.2 4.5 4.5 4.64 4.64

Total subsidy payments made under the FiT scheme are summarised in Figure 6. The amount of installedcapacity dropped significantly in 2012 Q2 compared to previous periods after the tariff was reduced, but havepicked up again since then. The total payments made under the scheme are cumulative, since any new projectsadd to the payments made against capacity that has already been installed in previous periods. Total annualpayments in 2012 will therefore amount to more than £500m for the FiT scheme.

Figure 6

PAYMENTS MADE UNDER THE FIT TO DATE11

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2.4.2 Future Investments—implications of electricity market reform

As a result of the recent energy market reforms, all support for renewables will now be moved to a feed-intariff support mechanism. The arrangement for small (<5MW) systems remains as before. Large-scalerenewable projects that would previously have been supported under the RO will instead receive a fixed pricebased on a contract-for-difference (CfD) payment mechanism which tops up payments to generators over andabove the amount they receive for selling electricity at market rates. The tariff rates will vary according to thetype of technology.

The tariffs to be received for renewables have not been yet been finalised, but it seems likely that they willbe broadly comparable with the support levels received under the previous RO scheme. An indication of thetotal value of the subsidy is provided by the levy control framework, which sets a total limit on the value ofpayments that can be made via “levy-funded” spending (ie increases to consumer energy bills to pay for lowcarbon energy sources). This is currently £2.35 billion, rising to £3.56 billion by FY 2014/15 (DECC 2011),and in the pre-budget report in November 2012, it was agreed to set the figure for 2020 at £7.6 billion per9 From http://www.ofgem.gov.uk/Sustainability/Environment/fits/tariff-tables/Pages/index.aspx10 Properties with an energy performance rated D or below receive a lower tariff. Developers installing solar PV on more than 25

properties also receive a lower tariff.11 Data from http://www.ofgem.gov.uk/Sustainability/Environment/fits/Newsletter/Pages/Newsletter.aspx

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Ev 84 Environmental Audit Committee: Evidence

year12. Figure 7 indicates that the limit on levy spending specified in the levy control framework providessome headroom compared to spending to date and projected spending over the next year on FiTs and ROCs,the two main sources of levy spending. The projected rise to 2020 appears sufficient to allow for a continuationof the expansion of renewable energy at its current rate.

Figure 7

VALUE OF CURRENT SUBSIDIES TO RENEWABLES AND THE SPENDING CONSTRAINT UNDERTHE LEVY CONTROL FRAMEWORK OUT TO 2020

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2.5 Electricity

VAT rates for electricity for domestic use is charged at a reduced rate of 5%. This acts as a subsidy comparedwith the general rate of VAT of 20%, leading to a higher than optimal rate of electricity usage. Because thisapplies to final use, it does not distort the choice of fuel used in the generation of electricity, since generatorsreceive the ex-VAT value.

The ex-VAT value of electricity sold to the domestic sector is approximately £14.8 billion per year. Thevalue of a 15% discount on VAT is therefore of the order of £2.2 billion per year.

Some of the distortions created by this subsidy are offset by a reduction in the VAT rate for energy savingequipment as listed below13.

Table 2.4

REDUCED VAT RATES ON ENERGY SAVING GOODS

The installed goods VAT rate

Air source heat pumps 5%Boilers—wood fuelled 5%Central heating and hot water controls 5%Draught stripping 5%Ground source heat pumps 5%Insulation 5%Micro combined heat and power units 5%Solar panels 5%Water and wind turbines 5%

Nevertheless, the lower rate of VAT for electricity and gas are a significant distortion to the tax code.Removing such subsidies is however difficult. As noted in a set of case studies on environmentally harmfulsubsidies in the EU (Valsecchi, ten Brink et al. 2009):

12 Press release: https://www.gov.uk/government/news/government-agreement-on-energy-policy-sends-clear-durable-signal-to-investors

13 http://www.hmrc.gov.uk/vat/forms-rates/rates/goods-services.htm

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“The traditional argument to tax “necessities” at a reduced VAT rate (or not to tax them at all) is that low-income households tend to spend a relatively large part of their income on these goods and services, sothat taxing them at the standard rate would have a regressive distributional impact. In reality however,only a small part of the subsidy reaches the intended recipients (low-income households). High-incomehouseholds receive most of the benefits, as the income elasticity of demand for energy is positive. Theoriginal social motive for the subsidy has largely disappeared, as the share of energy in householdexpenditure has decreased dramatically, also among low-income households. A more cost effectivealternative would be to provide direct income support or tax relief for low-income households.

There have been previous attempts to remove this subsidy including an attempt in 1995 which failedbecause of the expected distributional impact. In particular the fact that it would hit elderly people thehardest, led to the abandonment of the proposed increase of VAT to the standard level. A possiblecompensation measure that could be used to palliate the impact of removal would be to reinforce existingschemes to assist low-income households with investments in energy saving.”

2.6 General

2.6.1 Government funded energy R&D

The UK spends about £7.5 per capita per year on energy-related R&D (IEA 2012), which is approximatelyequal to the median amount for IEA countries. R&D expenditure has increased rapidly in recent years followinga period of decline over the previous decade. Total expenditure in the UK including R&D and demonstrationprojects in 2010 was over £500m, representing a very significant increase (76%) increase since 2009. Thefigure for 2011 dropped back to around £300m, but the trend over the past 5 years is still significantly higherthan over the previous decade. The breakdown of expenditure between different energy sources is shown inFigure 8.

Figure 8

UK GOVERNMENT ENERGY R&D EXPENDITURES

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Research on energy efficiency and renewables in particular have increased rapidly, with nuclear energy andcarbon capture and storage for fossil fuels also having experienced a resurgence over recent years.

2.6.2 Climate Change Levy Exemptions and Discounts

The climate change levy is a tax applied to business energy users (including industrial, public, commercialand agricultural users). It applies to electricity, gas and solid fuels for heating, lighting and process use. Thepurpose of the tax is to work towards the principle that the polluter pays for the climate change externalitiesof the energy use, and because the tax is applied rather generically across the economy, exemptions from theCCL should therefore be considered a subsidy.

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Exemptions from the climate change levy are available for:

— Small businesses (eg <1000 kWh per month)

— Supply from good-quality CHP schemes

— Supply of electricity from renewables

— Inputs for own-use electricity generation

— Non-fuel use (eg chemical feed-stocks)

In addition, a discount of 65% is available to energy-intensive users who sign up to a climate changeagreement (CCA) to meet an energy reduction target. Based on the author’s estimate, and assuming that CCAscover a large proportion of industrial energy consumption, the discount is worth around £500m in avoided tax.

In some sense, this could be seen as a subsidy, since these companies face a lower tax rate than the normfor business in the UK. On the other hand, DECC estimates that the energy savings achieved under the CCAsare at least as great if not greater than the energy savings that would have occurred if the companies involvedwere subject to the full energy costs associated with the CCL. Therefore, tying the CCL discounts to CCAsactually reduces energy demand rather than increasing energy demand as would normally be the case for astraight subsidy. If a definition of subsidies is used which only counts situations where there is a resultingincrease in energy consumption, then CCL discounts tied to CCA energy reductions would not be considereda source of subsidy.

2.6.3 Enhanced Capital Allowances

The Enhanced Capital Allowance (ECA) scheme enables businesses to claim a 100% first year capitalallowance on investments in certain energy saving equipment, against the taxable profits of the period ofinvestment. Capital allowances enable businesses to write off the capital cost of purchasing new plant ormachinery (eg boilers, motors), against their taxable profits. The general rate of capital allowances is 18% ayear on a reducing balance basis, so 100% capital allowance in one year represents a considerable benefit interms of 1st year cash flow, and also reduces overall tax payments. It is estimated that the cost to treasury ofthe ECA tax breaks is round about £100m per year14.

2.7 Summary of UK Subsidies

The values assigned to different forms of subsidy are, as described in the introduction section, dependent ona definition of what constitutes “normal” taxation practice, which is not necessarily comparable across fueltypes. Table 2.5 pulls together the various estimates made in the text should therefore be used with caution.Nevertheless, it is useful to see where the estimates of significant levels of subsidy lie, and where there arestill significant gaps in the data that is readily available.

14 Personal communication with Carbon Trust.

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Table 2.5

SUMMARY OF UK ENERGY SUBSIDIES

Primary EnergyDemand15 Annual Value

Energy type (GWh) of Subsidy £m Source of subsidy Comments

Oil 975,792 159 PRT Producer support380 VAT Consumer support

Gas 906,489 121 PRT Producer support3,510 VAT Consumer support

Oil & Gas ? Additional Producer supportexemptions fromcharges andaccelerated taxallowances

Coal 385,174 4 Mining liabilities Producer support81 VAT 5% Consumer support

Nuclear (incl 68,980 ~2300 Gov’t input to NDA roducer supporthistorical annual budgetliabilities)

? Possible increases inbudget required todeal with legacywaste

Current 34,409 2400 ROCs Producer supportRenewables

152 LECs500 FiTs

Electricity 364,897 2200 VAT reduction Consumer supportEnergy R&D 300 All sectors General servicesCCL discounts 500 For energy intensive Consumer support

industry (but offset by CCAs)ECAs 100 For en. efficiency Consumer support

3. International Comparison

3.1 Fossil Fuels

The most thorough assessment of fossil fuel subsidies in comparable countries to the UK is provided in theOECD report “Inventory of Estimated Budgetary Support and Tax Expenditures for Fossil Fuels” (OECD2012). The data is provided in local currency units, and has been converted here to US$ for comparison.However, a health warning is required when making these comparisons between countries. As noted in theintroduction to this report, subsidies are defined in comparison to the particular tax regime, measuringdeviations from whatever is deemed “normal” in that country. Since the tax regimes vary considerably, thereis no single consistent measure for subsidies in this case that ensures that they are being compared on a like-for-like basis. The OECD caveat to these figures reads:

“Tax expenditures for any given country are measured with reference to a benchmark tax treatment thatis generally specific to that country. Consequently, the estimates … are not necessarily comparable withestimates for other countries. In addition, because of the potential interaction between them, the summationof individual measures for a specific country may be problematic.”

With that caveat in mind, the figures are presented here in two ways. Firstly, in total expenditure terms aspresented in the OECD report but converted to a common currency unit. Secondly, the total subsidy levels aredivided through by the total primary energy supply of each fuel type in that country in order to adjust for thesize of the country when making the comparison. Subsidies are distinguished between Producer Supportmeasures, Consumer Support measures and General Services.

Data is not shown here for all the countries covered in the OECD report, but the focus is on larger countries,and those that are more comparable with the UK.

15 Figures for fossil fuels relate to total primary energy demand in the UK in 2011. For nuclear, renewables and electricity, thefigures relate to total production in 2011.

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Figure 9

TOTAL SUBSIDY LEVELS FOR FOSSIL FUELS (US$M)

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In common with many other OECD countries, UK subsidies for coal are small by international standards.Coal subsidies mostly take the form of producer support measures in countries that still have significant levelsof production (Germany, Poland, Spain, US), although not all producer countries have such subsidies (egAustralia). In general, there is a declining profile over time for these subsidies as they are gradually phasedout, and as a result of a declining share for coal in most countries.

In the oil sector, producer support measures are a smaller fraction of total subsidies, and concentrated mostlyin Australia, Canada and US. In most countries, oil subsidies are provided to consumers, and take the form ofvarious tax credits, exemptions, refunds and discounts for specific end-use of oil products. These are toodiverse to list in detail here, but a full explanation of the subsidies defined for each country is provided in theOECD report.

For gas, producer support is limited mainly to Canada and the US, and relatively little subsidies of any sortin most OECD countries. The UK has a relatively high level of subsidy for gas which is mostly the VAT taxbreak for domestic consumers. The UK is unusual in Europe in this respect in providing a sales-tax break fornatural gas, although In the US, state-level exemptions of energy from sales taxes levied on other goods andservices are common.

In order to adjust these subsidy comparisons for the size of the country, the figures are compared with thetotal primary energy consumption of each fuel in the relevant year. The charts are shown in Figure 10 in unitsof US$/MWh. It should be noted that under this measure, the subsidy expenditure is divided by the total fueluse for the country concerned. This will tend to underestimate the value of the producer subsidies to individualcompanies for the particular applications for which they apply.

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Figure 10

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Relative to its overall consumption levels for each fuel, the UK appears to have low subsidies by internationalstandards for coal and oil. For gas, UK subsidies are relatively high by international standards, but othercountries such as Austria (tax break for energy intensive users), Czech Republic (energy tax exemptions) andCanada and Norway (producer support) also have a relatively higher degree of subsidy under this measure.Nevertheless, in general, subsidies across most OECD countries are lower for gas than they are for coal and oil.

3.2 Renewables

In principle, renewable energy subsidies focus on explicit price support mechanisms which should be moretransparent to trace than subsidies for other fuel sources. In practice, there is quite a complex pattern of differentsupport rates for different sizes and vintages of plant, and the legislation in each country tends to changefrequently. As a result, there seems to be little literature available providing a like-for-like comparison ofsubsidies between countries. Two data sources have been used to construct a comparison, the EU energy portal(Portal) and a study for the European Renewable Energies Federation (Fouquet 2012).

Some countries’ schemes are based on a feed-in tariff that represents the total payment to renewablegenerators per MWh produced. Other schemes are based on a “premium” over and above the wholesaleelectricity price. In these cases, an estimate has to be made of the market price for electricity in order to reachthe total payment to make a like-for-like comparison. The UK situation is similar to the premium tariff in thesense that renewable generators receive income from electricity plus an additional amount for the renewableenergy certificates (ROCs + LECs) shows values that are inclusive of electricity prices, and therefore do notrepresent the subsidy, but rather the subsidy + market value. Because of the difficulty of comparing acrosscountries, a relatively smaller sample is presented here.

In some cases, there appears to be a discrepancy between the different data sources, leading to a range ofestimates—these cases are noted with an asterisk. In other cases, the range relates to different tariffs applyingto different sizes of plant, or for different vintages (ie year of installation). For example, in the UK case theranges apply to different tariff rates applied to different dates of installation as described in the notes belowthe charts.

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Ev 92 Environmental Audit Committee: Evidence

Figure 11

RANGES OF SUBSIDIES FOR RENEWABLES IN SELECTED EU COUNTRIES

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(1) Lower limit is the reduced banding rate for offshore wind of 1.5 ROC per MWh. Upper limit is currentrate of 2 ROC per MWh.

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(3) Lower limit is for biomass co-firing, upper limit is for dedicated energy crops or biomass with CHP.

Onshore wind tariffs lie within a relatively narrow band (with the exception of Italy), reflecting the maturestate of the technology. The UK lies at the upper end of this range, but is broadly comparable with otherEuropean countries. By comparison, offshore wind tariffs vary considerably. The lowest figures appear to befor Denmark, based on data from the EREF report which constitutes the lower bound of the range. On theother hand, the tariff rate arrived at by auction for the recent Anholt offshore wind farm was around €140/

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Ev 94 Environmental Audit Committee: Evidence

MWh, which is comparable with the lower end of the UK range (€134/MWh) which applies to the lowerbanding rate for projects built after 2014. In general, it therefore appears that under current RO bandingarrangements, the price for offshore wind including subsidies and market prices is either comparable orrelatively low compared to other major European countries.

Solar tariffs also vary considerably between countries, and generally have a wide range even for individualcountries. This largely represents the fact that tariffs are under frequent review, and are generally coming downquite quickly. Many countries have a degression rate for subsidy levels, and these are often tied to the rate ofuptake (notably in Germany). This means that different plant will receive very different rates depending onwhen it was installed. The range for the UK represents the difference between the current (lower) rates and thehigher rates that pertained prior to March 2012. Broadly speaking, the new lower rates in the UK lie at thelower end of the range of European tariff levels, whereas the rates prior to March 2012 were at the upper end.

Support levels for Biomass in the UK are broadly comparable to those in the rest of Europe, although directcomparison is more complex than this chart would suggest because the wide range of applications of biomassand different sources of biomass tend to attract different rates, and there is no harmonisation of these categoriesacross different countries.

3.3 Nuclear

International comparisons of national-level nuclear subsidies for new plant are difficult to obtain, partlybecause nuclear subsidies are more obscure, and partly because of the scarcity of new build operations. Thenew plant at Flamanville in France is being undertaken by EdF, a majority state-owned company, so costoverruns presumably are picked up ultimately by the state, and therefore constitute a subsidy, but independentfigures are difficult to obtain. The Olkiluoto 3 plant in Finland is being built under market conditions, but it isnot yet clear who will ultimately pick up the tab for cost overruns.

Estimates of funding arrangements for decommissioning and waste are available through EU comparisonsof state aid, although it is not clear that such comparisons are truly on a like-for-like basis. The EU is involvedin nuclear support at the national level in a number of ways, some direct, some indirect. In terms of directsupport, during the accession negotiations, the Lithuanian, Slovakian and Bulgarian Governments committedthemselves as part of their Accession Treaties to close their Soviet-design reactors. This was a central issue inthe negotiations with all three countries, and an important part of the whole package of rights andresponsibilities. To help them meet this commitment, substantial Community assistance in addition to thatprovided under the former PHARE programme were agreed. The overall financial support for the threeprogrammes totals some € 2.5 billion. This covered the support for Bulgaria until 2009 and covers Lithuaniaand Slovakia until 2013. The EU is also involved more indirectly through its influence on state aid decisionsmade by Member States.

The significant liabilities for decommissioning and waste disposal built up during the lifetime of a nuclearreactor are supposed to be covered by the EU’s Polluter Pays Principle. To comply with this principle, plantoperators should build up a supply of finance to cover these liabilities over the productive life of the plant.This principle is only partially complied with across the EU.

The European Commission has recently (March 2013) released a staff working paper which sets out thelevel of support provided by Member States to fund nuclear decommissioning activities (EU 2013), from whichdata is summarised in Table 3.1. Member State governments are involved in these decommissioning funds ina number of different ways. Most directly, where nuclear power plants are under public ownership, thegovernment will be directly responsible for the decommissioning and waste costs. Often these liabilities willbe met out of current budgets rather than building up ring-fenced reserves. In other cases, governments havemade commitments to meet some of the liabilities on behalf of the companies that own the plant. In Germany,the financial provisions for decommissioning are provided by the owners of the plant, conforming to thepolluter pays principle. Nevertheless, the tax treatment of these funds does constitute a subsidy, although nota state aid, a decision arising from a test in the European courts. With €30 billion of decommissioning fundsset aside, the German government is forgoing income tax revenues on the order of €4.5 billion16. This estimateis confirmed by a DIW study (Diekmann and Horn 2007) which valued this subsidy at €5.6 billion.

16 Based on an assumed application of Germany’s flat rate corporate tax level of 15%.

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Table 3.1

COMPARISON OF NUCLEAR DECOMMISSIONING COST ESTIMATES ACROSS THE EU

Total estimated Provisionsdecommissioning accumulated by end % of required % of operational

costs 2009 funds accumulated lifetime expired[€ million] [€ million]

Belgium 3,453 2,002 64% 63%Bulgaria Special caseCzech Republic 1,280 251 20% 46%Germany 11,672 2,529 22% 100%Denmark 98 98 100% 100%Finland 519 506 97% 62%France 77,048 36,781 48% variousHungary 4,030 116 3% 51%Lithuania 2,400 153 0% 100%Netherlands ConfidentialRomania 598 13 2% 28%Sweden 8,548 4,459 52% 63%Slovenia 1,155 145 13% 68%Slovakia 1,955 931 48% 62%UK 42,405 83%

For a review of energy subsidies to the nuclear industry (past and present) in the US, see (UCS 2011). Thisquantifies subsidies for investor-owned utilities (IOUs) and publicly-owned utilities (POUs), suggesting thatfor existing plant, legacy subsidies amount to around 140% of market prices, whilst ongoing cost subsidiesamount to between 13–100% of market prices. For new plant the study concludes that subsidies amount tobetween 70–200% of market price (Figure 11).

Figure 11

ESTIMATES OF SUBSIDY LEVELS FOR NUCLEAR PLANT IN THE US ¢/KWH (SOURCE: (UCS2011)

A) Existing plant

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B) New plant

3.4 European-level Support for Energy

The EU’s influence on energy issues has increased in recent years and culminated with the adoption of theTreaty of Lisbon and within that the inclusion of energy as an area of joint competence between the EU andMember States.

The total value of energy consumption in the EU is around €1.2 trillion per year. The EU has both a directand indirect impact on this price through its legislation. However, the financial implications of these impactsare relatively small, compared to total energy expenditure. Of the two, the direct impacts of EU legislation isaround 1% of the total expenditure, whereas the indirect affect is around 5%.

Direct Impact: The EU institutions can make available finance, either in the form of loans or grants, for thedevelopment and piloting of new energy technologies or for energy infrastructure, in particular for the gas andelectricity grids, transport infrastructure and the energy efficiency of infrastructure in general. The types ofprojects being funded by the EU are dependent on a number of factors, for example the sector specific supportmechanisms for nuclear and to a lesser extent coal exist as a direct result of the establishment of the EURATOMand Coal and Steel Treaties, over fifty years ago. However, a larger share of the finance is determined bycurrent policies, in particular as the EU strives to meet the 20:20:20 targets.

Indirect Impact: The EU, through it legislation or rulings, also has an indirect impact on the subsidies andsupport schemes in Member States. This is most financially significant in the area of State Aid rulings, whichdetermine the extent to which Member States can assist their industries, and in setting the framework for theuse of market mechanisms such as feed in tariffs for renewable energy. Feed in tariffs do not require directpublic financial support, but will often lead to additional financial assistance for a technology or technologiesfrom within the market.

Figure 12 shows the degree to which the EU institutions have control and/or influence on energy subsidiesand ultimately energy pricing within the borders of the European Union.

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Figure 12

INFLUENCE OF EU INSTITUTIONS ON ENERGY SUBSIDIES IN EUROPE

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There are a number of mechanisms in which the EU directly funds, either through loans or grants, thedevelopment of the energy sector within and outside the EU. However, there is no single process which decidesthe engagement of the EU institutions. This creates both a complexity and potentially a lack of consistency inthe projects and infrastructure funded.

The main loans are granted through the European Investment Bank which, in terms of the volumes of financethat it disperses, is the largest International Financial Institution in the world (see Figure 13)

Figure 13

EUROPEAN INVESTMENT BANK ENERGY LENDING 2006–2009 (€ MILLION)

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Source: EIB 201017

17 EIB (2010): Projects financed data-base, accessed June 2010 http://www.eib.org/projects/loans/index.htm

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More recently, EIB has consolidated lending around renewable energy, and gas and electricity infrastructureprojects. In 2012, there were no loans to coal plant, and one loan for the expansion of uranium enrichmentfacilities in Almelo, Netherlands (Figure 14).

Figure 14

EIB LENDING IN 201318 (€m)

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The other major direct area of influence is the EU’s structural funds, which through the European Fund forRegional Development (EFRD), the European Social Fund (ESF) and the Cohesion Fund can make availableover €300 billion to promote growth and jobs leading to the convergence for the least-developed MemberStates and regions. In the energy sector this includes financial assistance to meet EU objectives, such as energyefficiency targets, but also the greater integration of the energy networks, though the trans European energyand transport networks programmes. The EU also seeks to directly influence the development and deploymentof new technologies, through its long established research programme or through demonstration funding, suchas in the European Recovery or the Energy Intelligent Europe Plans.

Figure 15

EXPENDITURE ON ENERGY INFRASTRUCTURE 2000–6 IN THE EUROPEAN REGIONALDEVELOPMENT FUND (€ MILLION)

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18 EIB (2013): Projects financed data-base, accessed Mar 2013 http://www.eib.org/projects/loans/index.htm19 European Commission (2002): Staff Working Paper Inventory Of Public Aid Granted To Different Energy Sources. , December

2002, page 121. It must be noted that the figure used for renewables is less than that quoted in the same report on page 50,which estimates the renewables expenditure during this period to be €487 million.

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The Structural and Cohesion Funds are used widely in the EU to harmonise the economic and socialconditions in different regions. Europe’s poorer regions receive most of the support, but all European regionsare eligible for funding under the policy’s various funds and programmes. The Structural Funds are made upof the European Regional Development Fund (ERDF) and the European Social Fund (ESF). Together with theCommon Agricultural Policy, the Structural Funds and the Cohesion Fund make up the great bulk of EUfunding, and the majority of total EU spending. New objectives have been defined for the current programmes,which run from 1 January 2007 to 31 December 2013. The overall budget for this period is €347 billion: €201billion for the European Regional Development Fund, €76 billion for the European Social Fund, and €70billion for the Cohesion Fund.

In July 2004 the European Commission adopted its legislative proposals on the reform of the cohesion policyfor the budgetary period, 2007–13. Within this and through the Cohesion Fund, a specific budget for investmentin both energy efficiency and renewable energy was established.20 The anticipated budgets are seen below andshow how much the shift has taken place to support the development of renewable energy and energy efficiency.

Table 3.2 summarises the major direct expenditure by the EU for energy, including transport issues. As canbe seen transport expenditure dominates the major EU sources of funding, the structural funds and the loansfrom the EIB. The transport sector receives eight times more funding from structural funds than energy andthree times more from the EIB. The transport sector in fact receives nearly one quarter of all structural funds.

Table 3.2

SUMMARY OF DIRECT EU INFLUENCE ON ENERGY EXPENDITURE AND PRICING (SOURCE:EUROPEAN COMMISSION21)

Type of Total AnnualTechnology support Programme Dates (€million) (€million)

GrantsEnergy

Structural andNetworks Grant Cohesion funds 2007–13 675 112

Structural andRenewables Grant Cohesion funds 2007–13 4,761 793

Structural andEnergy Efficiency Grant Cohesion funds 2007–13 4,272 712

Structural andOther Grant Cohesion funds 2007–13 1,101 183

TransportStructural and

Road Grant Cohesion funds 2007–13 41,000 5,850Structural and

Rail Grant Cohesion funds 2007–13 23,600 3,370Structural and

Urban transport Grant Cohesion funds 2007–13 8,100 1,160Ports and inland Structural andwaterways Grant Cohesion funds 2007–13 4,100 590

Structural andMulti-mode transport Grant Cohesion funds 2007–13 3,300 470

Structural andAirports Grant Cohesion funds 2007–13 1,900 270

Networks Grant Recovery Plan 2009–11 2,365 1,182Offshore Wind Grant Recovery Plan 2009–11 565 282Coal—CCS Grant Recovery Plan 2009–11 1,050 525

1952—Coal Grant ECSC 2002 13,000 260

2003–06 60 15Energy Intelligent

Energy Efficiency Grant Europe 2008 10 10Renewables Grant EIE 2008 11 11Transport Grant EIE 2008 13 13

20 European Commission (2007): Cohesion policy: the 2007 watershed: Inforegio, Fact Sheet 2004: European Union RegionalPolicy.

21 European Commission (2007): Cohesion Policy 2007–13: Energy, DG Employment, Social Affairs and Equal Opportunity, DGRegional Policy. http://ec.europa.eu/regional_policy/themes/statistics/2007_energy.pdf

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Type of Total AnnualTechnology support Programme Dates (€million) (€million)

FrameworkProgrammes

Nuclear R&D 4–7 1994–2013 8,701 457Framework

All non-nuclear Programmesenergy R&D 4–7 1994–2013 5,959 313

Framework ProgrammeTransport R&D 7 2007–14 4,100 585

LoansENERGYGas Loan EIB 2006–09 6,981 1,745Oil Loan EIB 2006–09 626 156Renewables Loan EIB 2006–09 6,837 1,709Nuclear Loan EIB 2006–09 886 221Coal Loan EIB 2006–09 1,060 265Nuclear Loan Euratom loans 1977–2009 3,420 N/ATRANSPORTRoad Loan EIB 2006–09 21,416 5,354Rail Loan EIB 2006–09 11,576 2,894Sea Loan EIB 2006–09 4,509 1,127Air Loan EIB 2006–09 5,782 1,145

3.5 Energy R&D

A comparison of government R&D expenditure on energy is provided by (IEA 2012). As noted in Section2.6.1, funding for energy research in the UK increased dramatically between the mid-2000’s and 2010. indicatesa similar trend (though not so extreme) in many IEA countries as interest in energy issues and concerns overenergy security and the rise in energy prices rose over this period. R&D expenditure in the UK shifted frombeing amongst the lowest of IEA countries (measure relative to GDP), to being the median level of expenditure.

Figure 16

GOVERNMENT R&D BUDGETS ACROSS IEA COUNTRIES

0.9

0.8

0.7

0.6

0.5

0.4

0.3

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0.1

0

per 1 000 units of GDP

Por

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Hun

gary

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in

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land

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Cze

ch R

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lic

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y

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2005-07average

2010

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Abernathy, W. J. (1979). “The productivity dilemma.” Business Horizons 22(6): 86–87.

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Adler, P. S., M. Benner, D. Brunner, J. MacDuffie, E. Osono, B. Staats, H. Takeuchi, M. Tushman and S.Winter (2009). “Perspectives on the Productivity Dilemma.” Journal of Operations Management 27(2): 99–113.

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Birmingham (2012). THE FUTURE OF NUCLEAR ENERGY IN THE UK Birmingham Policy Commission,University of Birmingham.

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DECC (2011). Control Framework for DECC Levy-Funded Spending: Questions and Answers.https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/48244/3290-control-fwork-decc-levyfunded-spending.pdf.

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DECC (2012). Nuclear third party liabilities to be increased sevenfold.

Diekmann, J. and M. Horn (2007). Fachgespräch zur Bestandsaufnahme und methodischen Bewertungvorliegender Ansätze zur Quantifizierung der Förderung erneuerbarer Energien im Vergleich zur Förderung derAtomenergie in Deutschland Available online at: http://www.erneuerbare-energien.de/inhalt/39617 Availableonline at: http://www.erneuerbare-energien.de/inhalt/39617, Auftrag des BMU.

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Fouquet, D. (2012). Prices for Renewable Energies in Europe: Report 2011–2012 European RenewableEnergies Federation.

Greenpeace (2011). Subsidy Assessment of Waste Transfer Pricing for Disposal of Spent Fuel from NewNuclear Power Stations

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GSI (2010). Fossil Fuels—At What Cost? Government Support for Upstream Oil and Gas Activities inIndonesia. Geneva, Switzerland, International Institute for Sustainable Development.

GSI (2010). Subsidy Estimation: A survey of current practice Geneva Switzerland, International Institute forSustainable Development.

GSI (2010). Tax and Royalty-Related Subsidies to Oil Extraction from High-Cost Fields: A Study of Brazil,Canada, Mexico, United Kingdom and the United States. Geneva, Switzerland, International Institute forSustainable Development.

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Koplow, D. (2009). Measuring energy subsidies using the price-gap approach: what does it leave out?,International Institute for Sustainable Development.

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Sander, M., J. (2009). Justice. London, Penquin Books.

Schneider, M., A. Froggatt and J. Hazemann (2012 ). World Nuclear Status Report. Paris, London.

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Thomas, S. (2004). The UK Nuclear Decommissioning Authority, Public Services International Research Unit

UCS (2011). NUCLEAR POWER: Still Not Viable without Subsidies Union of Concerned Scientists.

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UK (2012). The Feed-in Tariffs (Specified Maximum Capacity and Functions) (Amendment No. 2) Order 2012No. 1393. http://www.legislation.gov.uk/uksi/2012/1393/pdfs/uksi_20121393_en.pdf, UK GovernmentStatutory Instruments.

Valsecchi, C., P. ten Brink, S. Bassi, S. Withana, M. Lewis, A. Best, F. Oosterhuis, C. Dias Soares, H. Rogers-Ganter and T. Kaphengst (2009). Environmentally Harmful Subsidies: Identification and Assessment Finalreport for the European Commission’s DG Environment, November 2009

WorldBank (2010). Subsidies in the Energy Sector: An Overview Background Paper for the World Bank GroupEnergy Sector Strategy. Washington, World Bank.

17 April 2013

Written evidence submitted by the Nuclear Industry Association

1. The Nuclear Industry Association (NIA) welcomes this opportunity to respond to the Environmental AuditCommittee’s inquiry.

2. NIA is the trade association and information and representative body for the civil nuclear industry in theUK. It represents around 270 companies operating in all aspects of the nuclear fuel cycle, including the currentand prospective operators of the nuclear power stations, the international designers and vendors of nuclearpower stations, and those engaged in decommissioning, waste management and nuclear liabilities management.Members also include nuclear equipment suppliers, engineering and construction firms, nuclear researchorganisations, and legal, financial and consultancy companies.

3. As the trade association for the nuclear industry the NIA does not have the expertise to provide detailedresponses to the five specific questions posed by the Committee, which are essentially a matter for Government.We would however like to make some higher level points relating to the financing of new nuclear plants.

4. As the Oxford Energy Associates (OEA) report to the Committee emphasises the energy subsidies issueis complex. There are diverse views on how they should be defined, and both wider and narrower parametershave been used. In the UK the Government’s approach has been to use a narrower definition for subsidies tothe electricity industry, which has had the benefit of providing a clear picture of specific support measuresincluding their impact on the energy economy.

5. Against this background, and our reading of the OEA report, we believe the Government’s ElectricityMarket Reform proposals are not a key issue for the Committee. We would regard their provisions—including

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the CfD arrangements and the carbon floor price—not as subsidies but as enablers to facilitate the UK’s widerenergy policy.

6. The UK’s current nuclear power stations have been making a major contribution to the UK’s energysupplies over many years, operating in a competitive market and without subsidy. However, with much of ournuclear and coal fired capacity closing over the next few years, the UK needs credible plans to replace thatcapacity and to decarbonise the power sector if it is to meet its energy security and climate change targets. TheEMR proposals are designed to provide investors with the certainty they need to proceed with the low carbonplant—both nuclear, renewables and potentially CCS—needed to achieve this.

7. Whilst nuclear and low carbon generation generally have lower operating costs than fossil generation,their higher up front capital costs mean they are difficult to finance in the current market. The EMR proposalsare therefore addressing a market failure. Without such action the UK would be locked into a high carbonenergy scenario.

8. In this context the Oxford Energy Associates report comments that subsidies have become synonymouswith bad economic practice, and are generally assumed to reduce economic efficiency. The EMR proposalswill not have this effect. In the case of nuclear the introduction of new plant will provide long term pricestability for consumers, protecting them from high or volatile fossil fuel prices. The Government view is thatelectricity bills after the implementation of EMR are expected on average to be lower than they would havebeen in the period up to 2030. Moreover the Climate Change Committee recently concluded that delayinginvestment in low carbon technologies to the 2030s would be likely to drive up costs—by up to £100 billionin some scenarios.

9. To sum up, the EMR proposals are carefully designed to create a level playing field for all low carbongeneration technologies at minimum cost to consumers. The NIA believes this will not only help the UKmeet its energy security and carbon reduction objectives, but will also protect the consumer from long termprice increases.

10. Finally, in relation to the UK’s historic liabilities, we would note that the Nuclear DecommissioningAuthority was set up in 2005 to decommission and clean-up these sites. Whilst the cost of this work is beingfunded from the NDA’s commercial operations and the UK Government, we would suggest this should properlybe regarded not as a subsidy but the cost of dealing with a public sector liability from the historic nuclearresearch and development and public sector operation of the Magnox power station fleet.

13 June 2013

Written evidence submitted by RenewableUK

1. Government needs to reassess how energy subsidies are defined and make sure that subsidies for allenergy technologies that take place throughout their life-cycle are reported transparently.

2. Further consultation is needed on how to implement this process but also to clearly define subsidiesand how these will we measured. This is particularly important for subsidies that are complex or difficultto monetise.

3. Despite efforts of the Government to reduce the environmental subsidies to fossil technologies throughthe Carbon Floor Price and Climate Change Levy, these are only small steps in the right direction and supportfor Renewable Energy Technologies remains justified, In fact, they appear to be the most cost effective approachto meet decarbonisation objectives.

4. In order to avoid conflicting policies and therefore a possibly inefficient use of public finance, Governmentneeds to ensure that industrial policies are aligned with industry subsidies while making sure that these policiesdo not contradict each other. Subsidies to the fossil fuel industry are therefore counterproductive to ourdecarbonisation efforts.

Introduction

5. RenewableUK is the UK’s leading trade association in the field of renewable energy, representing over650 companies in the wind, wave and tidal stream sectors. Together, these technologies will provide the bulkof the renewable electricity we will need to meet targets in 2020 and through to 2050, and should be the motorsof new industrial growth, providing thousands of new jobs and significant export revenue.

6. We believe that the technologies that we represent are, to varying degrees, still developing industries butall offer large-scale, cost-effective low carbon options for the longer term.

7. For the time being, subsidies therefore remain essential, however our members are determined to reducecosts to a point where, in a market underpinned by a strong carbon price, no subsidy is required. However, itis important to understand that the varying technologies will achieve this on different time horizons.

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8. This time horizon is directly correlated to Government policy, from subsidies to the long term certitudethat accompany these. The recent CCC report22 highlights the “clear benefit in committing to invest in low-carbon generation over the next two decades”.

Renewable Energy

9. The technologies that RenewableUK champions could need a total of about £50 billion of additional, sofar uncommitted investment up to 2020. The result of this and previous investment would be approximately13GW of onshore wind, 18GW of offshore wind and 200MW of marine renewables, in total generating about25% of this country’s power. We would also have world-leading industries in offshore wind and marine, whichwould be starting to earn significant export revenues from about 2020 onwards.

10. Direct support for these technologies is necessary to secure this investment, which is vital to stimulateour economy at this challenging time. This support is justified due to the explicit and implicit support thatother technologies have received or continue to receive, and in order to promote new energy technology options.

11. The greatest challenge faced in securing this financing is risk mitigation. Direct support in the form ofthe Renewables Obligation has provided us with exactly this. Onshore wind is now a mainstream generationtechnology, with costs approaching those of new-entrant gas generation. Now that some scale is being achievedin Offshore Wind, we believe that we are on the way down the learning curve and RenewableUK is workinghard with its members on cost reduction strategies to accelerate this process.

Whether the Government has identified the extent of energy subsidies, and measured them

12. The challenge of defining and identifying subsidies is complex and requires careful consideration. Webelieve that only informed policy decisions will yield the sustainable future that we need, and thus we needtransparent and clear reporting for all subsidies, for all technologies/energy sources and at all levels (extraction,production, transmission and consumer).

13. These subsidies should be reported online in an easily and freely accessible forum, and reporting shouldbe a carried out using a common metric. It is important that all Government activity and policy that providescompetitive advantage to one technology over another be identified, even if the impact is difficult to quantify.For instance, Government guarantees can represent a risk to the public, yet the quantification of such risks iscomplex, with no clear standard in existence. Such measures may be justified or classed as not harmful, but itis important that they be reported alongside direct subsidy in order to give a complete picture of support thatis given. Definition of the reporting system should be subject to further public consultation.

14. Failure to achieve such transparency on all subsidies creates an unfair burden on renewable technologiesfor which subsidies are direct and transparent. This also has the benefit of allowing clear internationalcomparisons of “true” technology costs, and thus helping to expose and eliminate distortions in cross-bordertrade.

How well any identification of subsidies by the Government matches up to best practice methodologies inhow energy subsidies are defined and scoped

15. The current Government definition of a “subsidy” (in the context of electricity) appears to be a “levy,direct payment or market support for electricity supplied”. This fails to account for a number of subsidies thatexist, particularly in fuel extraction and is ambiguous on what implicit subsidies are measured, if at all, andhow this is done.

16. In our view, in the energy industry, a subsidy is either the use of public money, regulation or institutionalframeworks to protect or promote a specific industrial sector or technology. The definition of a subsidy shouldcover the whole life-cycle of a technology and its fuel from production all the way to end-use and wastedisposal. This should also include soft measures, such as guarantees provided by Government in order toreduce investor risk. Implicit subsidies such as public health and environmental externalities should also beincluded, though valuing such externalities can be challenging.

17. Consideration must also be given to understanding historical subsidies for fossil fuel and nuclear power.This is an important part of a decision maker’s tool kit, as it would provide further clarity on the cost ofbringing new technologies to market.

18. A more complex indirect subsidy that has not yet been properly identified and costed is institutionalrigidity. The current regulatory framework in the energy industry favours traditional generation technologiesover innovative and renewable technologies, through history and familiarity. While this situation will slowlychange as these new technologies become mainstream, industry codes and practices still impose inappropriatebarriers that can add to cost. Even if these cannot be quantified, acknowledging their existence will facilitatethe process of resolving these issues.22 “Next steps on Electricity Market Reform—securing the benefits of low-carbon investment”, Committee on Climate Change,

May 2013http://www.theccc.org.uk/wp-content/uploads/2013/05/1720_EMR_report_web.pdf

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19. Early research and development is the only area where we believe technology specific accounting ofsubsidies is not helpful. Strict categorisation of innovative technologies, including disruptive technologies, isrestrictive. Early R&D needs flexibility to explore multiple pathways at all times and will inevitably lead tosome failures which cannot be allocated to any specific technology. Support of R&D is essential and shouldbe encouraged as widely as possible.

Externalities—Carbon costs

20. RenewableUK considers that externalities, or market failures, should be priced. In the absence of pricingthis constitutes a subsidy. As such we are supportive of the Carbon Floor Price and Climate Change Levywhich are reflections of the polluter pays principle and are steps towards removing legacy subsidies to thefossil fuel industry.

21. In principle, this is an example of how the Government has successfully identified and started to amenda market distorting subsidy, however, the definition of the “right price” for carbon is contentious. While intheory it should be decoupled from economic drivers, becoming a sole reflection of the cost to the environmentand society of carbon emissions, in practice this is a complex issue for which we do not yet have a practicablesolution. A price which is sufficiently high and stable enough to stimulate investment in low-carbon alternativeswill likely have to serve as a proxy for the true external cost of carbon emissions.

Reduced VAT

22. As long as the VAT tax break is a blanket tax break across all technologies, and thus does not confer acompetitive advantage to any, RenewableUK is agnostic to how the Government deals with this.

The scale of subsidies in the UK, including comparison with other countries

23. After review of the evidence, RenewableUK generally agrees with the comparisons made, although moredetail needs to be provided. For example, how each country deals with the cost of grid reinforcement or thespecific use of a technology, such as roof mounted PV or large scale PV, can have a distorting impact onneeded level of public money invested. Unlike the UK’s support system for Offshore Wind, under Germany’sfeed-in-tariff generators do not pay grid use-of-system costs. Other variables such as the duration of supportalso change.

24. With that caveat, we feel that international comparison is a useful benchmark to assess theappropriateness of the level of subsidies in the UK. Currently these seem to indicate that our levels of supportfor Renewable Energies are within the range of support in comparative countries, which gives a level onconfidence that the UK is providing an appropriate level. However we must caution that technology specificsupport must take account of local circumstances, whether these are environmental, economic, social andregulatory.

25. In the context of a competitive investment market, and once local circumstances have been accountedfor, we must be careful about reducing levels of subsidies in the UK below our European counterparts. This isparticularly true with technologies that are in the early stages of development and for which it is in oureconomy’s interest to attract the supply chains for these industries. Subsidies should therefore be in line withour industrial strategies. For instance, the opportunity to secure a large part of the offshore wind farmmanufacturing and service industry should prompt “higher than average” subsidy.

26. In this context, it is worth highlighting the recent study from the CCC which demonstrates the benefitsof having long term ambitious targets as a further driver for the development of technology supply chains inthe UK, not just subsidies.23 Again, this should be looked at through the lens of our industrial strategy.

Whether the Government has any plans or targets to reduce or eliminate “harmful” subsidies

27. The clear definition of Government support is essential to identify “harmful” subsidies. In our opinionthese are subsidies that are harmful to the environment, do not work towards the long term sustainability ofthe UK and harm the poor. In the energy sector this means that subsidies need to be directed to technologiesthat will decarbonise our electricity sector at the least cost to consumers, whilst maintaining security of supply.In the energy industry, we cannot decouple the concept of a “harmful” subsidy from the technology that subsidyis aimed at.

28. The “On Picking Winners” report from Imperial College London24 clearly highlights that:

— Disruptive innovation to the energy generation stock cannot be achieved through stepped increasesin carbon pricing alone.

23 “Next steps on Electricity Market Reform—securing the benefits of low-carbon investment”, Committee on Climate Change,May 2013http://www.theccc.org.uk/wp-content/uploads/2013/05/1720_EMR_report_web.pdf

24 “On Picking Winners”, Imperial College London, Oct 2012http://assets.wwf.org.uk/downloads/on_picking_winners_oct_2012.pdf

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— Direct subsidies are necessary to foster this shift, and in-fact, appear to be a more cost effectivesolution as it attracts investment with a lower cost of capital (ie lower risk premium). Additionally,action now helps foster growth and associated cost reductions.

— This rule no longer stands true if, and only if, the carbon price is put to a realistic level (the targetseems to suggest this would be around £74/tCO2) immediately with long term certainty that this willnot be removed or reduced. This would appear to be politically impossible, given that it is likely tobe painted as a regressive tax, and undesirable (transition period needed, carbon leakage withoutglobal agreement, etc.).

29. Currently it is not obvious that Government is working towards the common goal of removing harmfulsubsidies. Under the premise of “Security of Supply”, subsidies to the fossil fuel sector are the highestespecially when we take stock of the un-priced externalities and rigidity of institutional frameworks. Continuedsubsidies to these industries are difficult to reverse, however, this should be a medium term goal with cleartargets for 2020. New subsidies that will lead to legacy investments in fossil fuel extraction and use must beavoided at all costs.

30. The UK gas market is coupled to the global gas market and subject to WTO rules. Domestic productionof gas will therefore have limited impact on the price paid by UK consumers, which will be dependent on theglobal demand/supply balance. Subsidy to this sector is thus unlikely to provide significant security of supplyand economic benefits to UK. Additionally, the timeline for the development of this industry in the UK createsvery limited additional industrial opportunities for UK businesses; we have missed the boat.

31. Further support to the fossil fuel industry therefore demonstrates limited economic benefits, limiteddecarbonisation benefits and limited security of supply benefits. Additionally, further investment in shale gaswould require subsequent infrastructure investment creating lock-in that seriously threatens our currentinvestments in low-carbon and renewable technologies.

32. Finally, in a systems context, the “golden age of gas” is likely to lead to an international “dash for gas”.This will lead to a global boom in demand for gas, with a consequent risk of an “overshoot”. If growth ofdemand outstrips supply, in a competitive market this will prompt higher fuel prices. We believe that countrieslocked-in to gas generation will be exposed to increasingly volatile and high prices.

Progress in reducing such harmful subsidies, and how current energy policies and DECC’s “EnergyPathways” for the mix of energy sources will influence the magnitude of any subsidies

33. Progress in the removal of harmful environmental subsidies is a slow and painful process. The CarbonFloor Price and Climate Change Levy are indications of the build-up of momentum in this area which wewelcome, however it is obvious that there is a lot of division on these matters which is threatening the longterm political support for these initiatives.

34. As the deployment of renewable technologies increases confidence that these technologies can provideus with a secure and economically viable energy supply, the removal of subsidies to harmful industries willbecome more acceptable. We are confident that a correct (high) carbon price in the future is achievable,however until such a point is reached, direct subsidies to many renewable technologies will remain necessaryand indeed desirable.

35. It is also worth noting that subsidies for Renewable Technologies could potentially become harmful ifthese where pursued indefinitely and did not change to reflect the dynamics of the market. This is exactly whathappened with feed-in-tariff for roof mounted PV systems in 2010 that did not reflect the dramatic fall in thecost of PV resulting in excessively large pay-outs to owner/developers. This is a clear policy failure that hastarnished the generally well developed support policies for Renewable Technologies. Regular RO band reviewsand the planed CfD strike price reviews are essential in guaranteeing that the industry does not benefit undulyfrom public support.

36. Our members are also committed to the purpose of the long term Government support strategy, costreduction. RenewableUK works closely with its members to foster opportunities for cost reduction and thereport of the Offshore Wind Cost Reduction Task Force25 highlights the industry’s commitment to achievingGovernment’s £100/MWh cost target by 2020; providing that the support system is not weakened. The longterm goal is to reduce costs to a point where, in a market underpinned by a strong carbon price, no subsidyis required.

Conclusion

37. RenewableUK and our membership will strongly welcome and support any Government initiative thatseeks to provide transparency on the level of subsidies received by all energy technologies and their fuelsources. We feel very strongly that subsidies to renewable technologies are the clearest and most transparentin the whole energy sector and that this should not be the exception but the rule. Only by achieving full25 Offshore Wind Cost Reduction Task Force Report, RenewableUK, June 2012

http://www.renewableuk.com/en/publications/reports.cfm/Offshore-Wind-Cost-Reduction-Task-Force-Report

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transparency throughout the energy sector’s whole life-cycle will policy makers and the public be empoweredto make informed decisions.

38. The investment horizon in the energy sector spans decades, creating lock-in, and therefore the definitionof “harmful” subsidies cannot be decoupled from our long term decarbonisation targets to 2050. Doing sowould be counterproductive and therefore against the public interest. A consistent strategy for the fossil fuelindustry would therefore only focus on assisting it to transition towards renewable technologies.

39. Finally, subsidies should also be in line with our industrial strategies in order to maximise the benefitsto our economy and job creation potential. As such their level also needs to be defined within the globalcontext. For solar PV or Onshore Wind, the relocation of manufacturing jobs from abroad to the UK will behard to achieve. This does not warrant “above normal” subsidy levels, however, as leader in the newer OffshoreWind Industry, which has a growing supply chain, there is real potential for a large UK based supply chain todevelop, providing consequent export opportunities, which warrants “above normal” subsidy levels.

14 June 2013

Written evidence submitted by Oil & Gas UK

Introduction

Oil & Gas UK is the leading representative body for the UK offshore oil and gas industry. It is a not-for-profit organisation, established in April 2007 but with a pedigree stretching back over 40 years.

Membership, which currently exceeds 350, is open to all companies active in the UK continental shelf, fromsuper majors to large contractor businesses and from independent oil companies to SMEs working in thesupply chain.

Our aim is to strengthen the long-term health of the offshore oil and gas industry in the UK by workingclosely with companies across the sector, governments and all other stakeholders to address the issues thataffect our member’s businesses.

Oil & Gas UK welcomes the opportunity to respond to the Environmental Audit Commission’s call forevidence in relation to the inquiry “Energy subsidies in the UK”.

As part of our submission, we have also responded to the written evidence commissioned by the Committeefrom Dr William Blyth of Oxford Energy Associates entitled “Energy Subsidies in the UK”.

Summary

— Oil & Gas UK strongly advocates that the Committee adopts an approach which explores the balancebetween the taxation collected from individual energy sectors against the amount of value that istransferred from the taxpayer back to these particular elements of the energy sector.

— Subsidies are methods of value transfer, from the taxpayer to an individual economic sector, to theextent that that sector benefits a net gain from the taxpayer relative to the tax contribution.

— Allowances which reduce taxation rates to incentivise activity, and that remain set at such a ratethat the effected sector remains a net contributor to the public purse, do not constitute a subsidy.

— Tax allowances that are available for a small number of oil and gas related activities never bringthe overall tax rate to a point lower than that which is applied to businesses generally—and neverto a point whereby the sector is a net benefactor from the UK taxpayer.

Establishing a Definition of “Subsidy”

Central to the Environmental Audit Committee’s inquiry, and perhaps the most challenging aspect, will bedefining what does and what does not constitute a subsidy. The issue of definition has been the subject ofsubstantial recent debate and, as reflected in Dr Blyth’s paper, is an area of significant complexity.

However, in the context of the Committee’s inquiry, Oil & Gas UK strongly recommends that thisinterpretation excludes benefits from general public spending (eg, the employment of state educated staff oruse of infrastructure such as the road network) which are available and exploited, to a greater or lesser extent,by all businesses operating in the UK.

Oil & Gas UK strongly advocates that the Committee adopts an approach which explores the balancebetween levels of taxation collected from individual energy sectors against the amount of value that istransferred from the taxpayer back to these particular elements of the energy sector. It is our belief that toapproach this inquiry in this way will allow the Committee to most reasonably, accurately and meaningfullyassess the degree by which some areas of the energy sector are subsidised.

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What is a subsidy?

Subsidies are methods of value transfer, from the taxpayer to an individual economic sector, to the extentthat that sector benefits a net gain from the taxpayer relative to the tax contribution. This can be achievedeither through direct value transfer of capital or by indirect means where the burden of taxation is outweighedby Government spend, or regulation is artificially lessened, on a sector as a whole.

What is not a subsidy?

Allowances which reduce taxation rates to incentivise activity, and that remain set at such a rate that theeffected sector remains a net contributor to the public purse, do not constitute a subsidy. This is particularlytrue when an allowance is used to incentivise activity which leads to an increase in the tax revenue generateddestined for the Exchequer.

In this regard our views are aligned with comments recently made by the Secretary of State for Energy, theRt. Hon Edward Davey MP, during the recent press launch of Sir Ian Wood’s review into “the economicbenefits of offshore oil and gas production”, when he said:

“Let’s be absolutely clear, the Treasury only agrees to allowances [for the oil and gas sector] if itknows it is going to benefit from the overall tax take going up as a result. I think an important partof the dialogue has been to ensure that fields that wouldn’t have been recovered or wouldn’t haveimproved their recovery rates, those have now come on and actually the taxpayers are netbeneficiaries.”

In the case of the offshore oil and gas sector, where the starting point for tax rates is very high in comparisonwith those imposed on other sectors, the tax allowances that are available for a small number of activitiesnever bring the overall tax rate to a point lower than that which is applied in the UK to business generally—and never to a point whereby the sector is a net benefactor from the taxpayer.

If this argument was to be applied to, for example, income tax rates, the logical conclusion would be todescribe those paying the basic rate of income tax as being subsidised.

Why reliefs in the UK’s oil and gas tax regime do not constitute a subsidy

As discussed above, there is often a tendency to assume that any tax allowances which lessens the burdenof tax for particular activities (especially when these activities are sector specific, rather than, for example,general research and development) constitutes a subsidy. However, Oil & Gas UK would like to take thisopportunity to draw the Committee’s attention to the special tax regime which operates for hydrocarbonextraction in the UK, which we have outlined below.

The theory of taxing mineral extraction

The taxation of mineral extraction differs from the corporate taxation regime applied to most other sectors.Reflecting the uniqueness of this activity and in acknowledging that reserves are national assets, the offshoreoil and gas industry is subjected to “economic rent”.

The taxation of economic rent is characterised by higher than normal tax rates, reliefs for capital investmentand the isolation of these activities from any other commercial operations in which companies may be engaged.By putting these tax rates into isolation, also known as “ring-fencing”, it restricts the opportunity for companiesto offset losses arising from non-mineral extraction activities in order to reduce taxable profits from the oil andgas production business, making tax avoidance activities extraordinarily difficult. Indeed, HMRC themselvestreat the sector as a whole as low risk due to the strength of the tax code in this area.

The UK oil and gas fiscal regime

In the UK, businesses involved in oil and gas production are subject to three different taxes on their profits(alongside other indirect liabilities such as VAT, NICs etc.). These taxes are outlined below:

— Ring fence corporation tax (RFCT)—levied on a company’s total taxable profits, computed in thesame way as normal corporation tax, but for the offshore sector, the rate is 30% (7% higher thanthe current “main” corporation tax of 23%)

— Supplementary charge (SC)—levied on a company’s total taxable profits, computed in a similar wayto normal corporation tax, but finance costs are not deductible. The current supplementary chargerate is 32%.

— Petroleum Revenue Tax (PRT)—levied on the adjusted profits for the field, rather than the company.Only fields which received their original production consent before March 1993 are liable to PRTand it is only paid by the most profitable, productive fields in the UK. The current PRT rate is 50%.

In practice, this means that the marginal tax rate applied to fields which are subject to PRT is 81% (50% +(50% * (30% + 32%)) on all production income. The tax rate applied to fields not paying PRT is 62% (30%+ 32%).

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Oil Allowance

To encourage the recovery of technically or commercially challenging assets that would otherwise remainundeveloped, some fields which received their original production consent before March 1993 are granted an“Oil Allowance”. This provides fields that would usually be liable to PRT a certain allocation of hydrocarbonsthat can be recovered before PRT is payable. Whilst the profits from production covered by Oil Allowance isnot taxable to PRT, it still bears RFCT and SC at the usual rate of 62% (30% + 32%).

Field Allowance

A number of new fields which meet certain physical criteria benefit from a “Field Allowance”. This allowsa certain amount of production income that can be generated by the field to be free of the SupplementaryCharge. Field Allowances cannot be used to reduce a company’s liability to RFCT.

Field Allowances have been designed to reduce the marginal rate of tax for companies who want to developsmall or technically challenging fields which are less profitable. Without this incentive the fields would remaincommercially unviable and, as a result, remain undeveloped. Even if a field’s total production income wascovered by a Field Allowance, a company would remain liable for RFCT, charged at a higher rate than therate that corporation tax is applied to businesses generally.

Thus, ensuring that development of these small and/or difficult fields takes place, aggregate tax revenuesfrom the sector will be increased in due course.

“Energy Subsidies in the UK”—Dr William Blyth

Oil & Gas UK also wanted to take the opportunity to respond to the report commissioned by the Committeeand written by Dr William Blyth.

UKCS tax regime

We read Dr Blyth’s report with great interest. We felt it would be helpful to clarify some of the detailexplored in the sections relating to the UK’s oil and gas sector and in particular to highlight omissions relatingto the tax regime that is applied to this industry.

Dr Blyth’s report fails to acknowledge that companies which recover oil and gas from the region of waterssurrounding the United Kingdom, otherwise known as the UK Continental Shelf (UKCS) are subject to threedifferent taxes, as discussed above. As a result, there are factual errors in some of Dr Blyth assertions whichsuggest that one of the taxes paid across the UKCS, ie the Supplementary Charge, levied at 32% on allupstream profits, has been omitted.

“Baseline” tax rates

We dispute, in the strongest possible terms, the assertion given in the report that:

“The standard PRT therefore defines the “normal” baseline tax rate for oil production in the UK.”26

We disagree that the top rate of tax should be considered the baseline against which other tax rates aremeasured and with the view that allowances applied to this rate should be considered to be subsidies.

As we have discussed above, even if the most generous tax allowances are applied, the overall value transferremains to the net benefit of the Exchequer and exceeds the tax rates applied to any other business sectoroperating in the UK. Indeed, as PRT is only payable on fields which received their original production consentbefore March 1993 this definition of the “baseline” at PRT is further flawed.

Allowances against PRT

Dr Blyth then claims that:

“Various allowances which partially offset the PRT are available to companies which act as subsidies.These include a new-field allowance that was introduced in 2009 for small, ultrahigh-pressure andhigh-temperature oil fields, and ultra-heavy oil fields.”27

Field Allowances are not a relief against PRT, but against the Supplementary Charge. As we explore above,allowances are necessary in the context of taxing natural resources to ensure that marginal fields are sufficientlycommercially viable to be developed. Indeed, elsewhere in his report Dr Blyth acknowledges that suchmeasures for high-cost fields are not uncommon in tax regimes for oil and gas producing countries.

Promote Licenses

Dr Blyth’s paper also asserts that the licensing regime imposed on the oil and gas sector should be considereda subsidy, stating that:26 Dr William Blyth, Energy Subsidies in the UK, page 20.27 ibid

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“Other measures to support certain types of production include Promote licences, which allow smalland start-up companies to obtain a production license first and secure the necessary operatingcapacity and financial resources later through reduced rent for the first two years.”28

Oil & Gas UK considers it strange that an area of the oil and gas licensing regime, administered throughDECC, is deemed to have a fiscal benefit and therefore is considered, by Dr Blyth at least, to represent asubsidy. In actual fact the Promote licenses are a way of encouraging more diverse range of companies tooperate in the UKCS, with reduced licensing fees, but for shorter term license periods. There are no negativefiscal consequences of the licensing regime a company is operating under.

The use of Promote Licenses is intended to boost activity by encouraging the development of smaller,economically and technically challenging prospects. They are designed to maximise the recovery of remainingoil and gas resources and reflect that barrels left in the ground earn the Treasury zero tax revenues.

Further, the development of challenging assets creates jobs, promotes skills development, benefits the UK’ssignificant the supply chain industry and inspires technological innovations—all of which contributeeconomically through domestic activity in the UK and globally as exports.

This was recently acknowledged in the UK Oil and Gas Industrial Strategy produced by the Department forBusiness, Innovation and Skills, which stated:

“…through the recent extensions to the field allowance regime, the Government has demonstrated itis committed to a fiscal regime that encourages investment and innovation in the UKCS, whilstensuring a fair return for taxpayers.”29

The Strategy goes on to assert that:

“…changes to field allowances for new fields…have seen a number of major developments proceed...Since introducing the brownfield allowance, uptake has been strong. Significant field life extensionhas been realised.”30

Conclusion

Oil & Gas UK is encouraged by the Environmental Audit Committee’s inquiry and feel that the debatesurrounding how to define what is and what is not a subsidy, and how subsidies are applied, is one that wouldbenefit from greater clarity.

We are confident that the Committee will find our evidence of relevance to this inquiry and would welcomethe opportunity to provide further information should the Committee feel that it would be beneficial.

17 June 2013

Written evidence submitted by the Department of Energy and Climate Change andHM Treasury

Introduction

1. This is the Government’s evidence to the Environmental Audit Committee inquiry into energy subsidies,covering UK government support for energy, following a call for evidence on 24 April 2013. This evidence isa joint response from the Department of Energy and Climate Change (DECC) and HM Treasury (HMT).

Background

2. Currently there is no universally accepted definition of a subsidy. The Organisation for Economic Co-operation and Development (OECD) describes it as an “elusive concept”.31 The spectrum of what could beincluded in a definition is extremely broad. The narrowest possible definition of subsidy refers to directbudgetary payments by a governmental body to producers or consumers.32 The widest definitions extend tomost or all areas of government activity, encompassing the time government officials act for or on behalf of aparticular group or industry.

3. Neither extreme would provide the basis for sensible engagement on how, and to what extent theGovernment incentivises a particular sector to deliver Government objectives.

4. The International Energy Agency (IEA), OECD, the World Trade Organisation (WTO) and others haveall undertaken work to look at subsidies, and have endeavoured to provide definitions. However, thesedefinitions have been proposed for specific purposes and studies.28 Dr William Blyth, Energy Subsidies in the UK, page 2029 Department for Business, Innovation and Skills’ UK Oil and Gas Industrial Strategy, page 2930 Department for Business, Innovation and Skills’ UK Oil and Gas Industrial Strategy, page 3031 Overview of key methods used to identify and quantify environmentally harmful Subsidies with a focus on the energy sector page

1432 ibid page 6

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5. The Government has worked with international organisations on a number of these studies into subsidies.Agreeing working definitions of subsidies has been important to progress these areas of inquiry which seek toprovide recommendations and advice for governments to reduce the incentives for fossil fuels and encouragelow-carbon alternatives.

6. The Government looks at the support it provides more generally, allowing it to consider development,deployment and management of a clear and coherent package of support to enable the Government to deliverits energy objectives.

7. The UK faces a huge investment challenge to ensure security of supply, and keep energy bills affordablewhile meeting targets for economy-wide decarbonisation. To meet our energy objectives, the Government needsto diversify the mix of energy, increasing and accelerating the use of low-carbon energy in the UK.

8. The Government’s policy therefore is to incentivise the energy industry to bring forward investment wherethere is a market failure that would act as a barrier to do so in the absence of those incentives. For example,while new mechanisms were introduced to enable renewable generation to compete in the market this leftexposure to power price risk. For investors in technologies such as offshore wind, which face substantial initialinvestments but very low running costs, this can be problematic. Additionally, support available for low-carbongeneration was not considered within a long-term funding envelope, meaning that investors have not hadcertainty and consumers have not been protected.

9. The Government has taken decisive action to address these issues and provide a sustainable, long-termbasis for investment in electricity. It is determined to ensure that electricity supplies are secure, produce feweremissions, and above all are affordable for consumers. It has:

— introduced legislation to provide new support for low-carbon electricity generation through Contractsfor Difference (CfDs) which will provide investors in technologies such as wind for the first timewith stable, predictable revenues and protect them from the risks associated with wholesale volatility;

— implemented the levy control framework and set a long-term funding envelope for support availablefor investment in low-carbon generation, to up to £7.6 billion (in 2012 prices) in 2020–21; thisprovides unprecedented certainty, stretching well beyond existing spending plans;

— created incentives for low-carbon investment further by implementing the Carbon Price Floor;

— invested in low-carbon infrastructure projects through the Green Investment Bank (GIB) which seeksto leverage additional private finance through its lending and aims to multiply the £3 billion lentthrough its original capitalisation; and

— recognised the need to accelerate delivery of schemes in the shorter term. Therefore the Governmentis using the strength of its balance sheet to provide the £40 billion UK Guarantees facility forinfrastructure projects.33

10. Energy taxes on businesses are designed to support wider energy policy in addition to raising revenueand cover both upstream and downstream activities. The main taxes are the oil and gas tax regime, the CarbonPrice Floor (CPF), the Climate Change Levy (CCL) and the Carbon Reduction Commitment (CRC), all ofwhich have different objectives. In the case of oil and gas the Government has introduced field allowances formore challenging categories of field that are economic, but commercially marginal at the high rate of tax. Suchfields are relieved of tax of 32% for a certain portion of their income—but they still pay ring fence corporationtax at 30% for this portion, higher than the mainstream corporation tax rate. Field allowances do not reducethe cost of oil to consumers; rather increase what is extracted from the UK continental shelf.

11. In the case of the CPF, EU emissions trading scheme, CCL and CRC, the Government does providesupport for certain industries or sectors which would be disproportionately impacted or as a transition measureto prevent carbon leakage. It is important the Government provides this kind of support to ensure our taxsystem remains competitive whilst managing the transition to a low-carbon economy.

12. The Government is open and transparent about where, how, and to what extent it provides support toincentivise the energy sector to help deliver the Government’s objectives, regardless of what that supportis called.

13. The Government does not consider that any of its energy policies are “harmful”. Furthermore, energypolicy (as with other Government policy) is subject to an initial impact assessment and subsequent monitoring,evaluation and review. This ensures that the Government can provide confidence and certainty while ensuringthat the policy advances the Government’s objectives in a coherent way that provides best value for money. Italso ensures that detrimental consequences can be quickly and effectively addressed.

33 Details and conditions are on the .gov website: https://www.gov.uk/government/news/government-uses-fiscal-credibility-to-unveil-new-infrastructure-investment-and-exports-plan

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Extent and Measurement of Support for Energy in the UK

Overall budget control

14. As confirmed in the UK Renewable Energy Roadmap Update 201234 and in Electricity Market Reform:Delivering UK Investment published on 27 June 2013,35 the amount of market support to be available forlow-carbon electricity investment (under the LCF) up to 2020–21 has now been agreed. This will be set at upto £7.6 billion (real 2011–12 prices) in 2020, and will help diversify the UK’s energy mix by increasing theamount of electricity coming from renewables from 11% today to around 30% by 2020, as well as supportingnew nuclear power and carbon capture and storage.36

Departmental spending limits

15. Non-levy funded support must be provided from within agreed departmental spending limits as set byHM Treasury. Government Departments providing support to the energy sector follow government-wideguidelines on project and financial management, with projects subject to monitoring to ensure spending deliversvalue for money for taxpayers, and to prevent overspending.

The Levy Control Framework

16. The LCF places limits on the aggregate amount levied from consumers by energy suppliers to implementGovernment policy. In effect, it specifies the budget available to levy-funded policies and helps protect energyconsumers from excessive levies on their energy bills.

17. Table 1 shows the annual caps to levies raised for electricity policy agreed under the LCF as announcedon 27 June 2013. These caps are upper limits on the levies raised to fund electricity policies such as theRenewables Obligation (RO), Feed-in Tariffs (FITs) and CfDs, but would apply equally to any future levy-funded electricity policy.

18. These caps do not apply to non-electricity policies that are levy-funded, such as the WarmHome Discount.

Table 1

UPPER LIMITS TO ELECTRICITY POLICY LEVIES UNDER THE LEVY CONTROL FRAMEWORK

2015–16 2016–17 2017–18 2018–19 2019–20 2020–21

£ billion (2011/12 prices) 4.30 4.90 5.60 6.45 7.00 7.60

Impact on energy Bills

19. The Government is committed to being open and transparent about the impacts of energy and climatechange policies on households and businesses. In March 2013, the Government published the EstimatedImpacts of Energy and Climate Change Policies on Energy Prices and Bills 2012.37 This document assessesthe impact of energy and climate change policies on gas and electricity prices and bills and updates analysispublished in November 2011.38 It shows that the cost of energy and climate change policies account foraround nine% of household energy bills in 2013.

Support for Low-Carbon Energy

Renewables Obligation

20. The RO is currently the main financial mechanism by which the Government incentivises the deploymentof large-scale renewable electricity generation in the UK.

21. The RO places an obligation on UK electricity suppliers to source a specified proportion of electricitythey supply to customers from renewable sources, or pay a penalty.39 This proportion is set each year and hasincreased annually since the RO was introduced in 2002. The size of the Obligation in 2013–14 is 61.5 millionRenewables Obligation Certificates (ROCs) with the suppliers Obligation for England and Wales set at 0.206ROCs per megawatt hour (MWh) of electricity supplied.

22. Ofgem issue ROCs to renewable electricity generators for every MWh of eligible renewable electricitythey generate. Generators sell their ROCs to suppliers or traders which allows them to receive a premium inaddition to the price of their electricity. Suppliers present ROCs to Ofgem to demonstrate their compliance34 UK Renewable Energy Roadmap Update 201235 Electricity Market Reform: Delivering UK Investment, Annex A36 UK Renewable Energy Roadmap Update 2012, page 437 See Annex E for web address38 Estimated impacts of energy and climate change policies on energy prices and bills39 The RO works on the basis of three complementary Obligations—one covering England and Wales, and one each for Scotland

and Northern Ireland. Scotland and Northern Ireland may set their own bands, and there are some minor differences in supportlevels between the three Obligations to reflect national circumstances.

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with the Obligation. Suppliers failing to present enough ROCs to meet their obligation in full have to pay apenalty known as the buy-out price. This is set at £42.02 per ROC for 2013–14 (linked to RPI) and providesa floor price for a ROC.

23. In April 2009 the RO was moved from a mechanism which offered a single level of support for allrenewable technologies to one where support levels vary by technology according to a number of factors,including their costs and level of deployment.

24. The Government has stated that the RO will close in 2037. DECC intend to close the scheme to newgeneration in March 2017 and this will be put in secondary legislation. A generating station accredited underthe RO will continue to receive its full lifetime of support (20 years) until the scheme closes in 2037.Introduction of Electricity Market Reform and CfDs will provide support for large-scale renewable electricitygeneration beyond 2017.40

25. While it is for suppliers to decide whether to pass the cost of ROCs to consumers through their electricitybills, the Government assumes that they do for cost control purposes. The total cost that can be levied onconsumers is controlled within agreed limits by the LCF.

Table 2

THE BUDGET FOR THE RO UNDER THE LEVY CONTROL FRAMEWORK WITHIN THE SPENDINGREVIEW PERIOD

Year 11–12 12–13 13–14 14–15

Levy Budget (£ million)* 1,750 2,156 2,556 3,114

*2011/12 prices, discounted

26. The total RO annual support costs are expected to rise from around £1.4 billion in 2011–12 to up to£3.5 billion at the peak in 2016–17 (undiscounted , 2011–12 prices).41

Contracts for Difference

27. CfDs support low-carbon generation by ensuring that generators will receive a fixed price level for theelectricity they produce known as the “strike price”.42 Generators will receive revenue from selling theirelectricity into the market as usual. However, when the market reference price is below the strike price theywill also receive a top-up payment from suppliers for the additional amount. Importantly, if the reference priceis above the strike price, the generator must pay back the difference.

28. The CfD was identified as the support mechanism for low-carbon generation as it offered the best balanceof results across the four key criteria chosen: cost-effectiveness, coherence with the rest of the ElectricityMarket Reform package, durability and practicality.43

29. CfDs for renewables will initially be awarded on a first come first served basis before moving toallocation rounds. This will support a move to a more competitive allocation and price-setting system later inthe decade. The allocation and price-setting processes for carbon capture and storage (CCS) and nuclear projectsthat will apply after the final investment decision (FID) enabling window and outside the CCSCommercialisation competitions is being developed. The Government expects to publish further informationin the summer. The level of support for different renewables technologies will be set administratively in thefirst instance.

30. The Government’s ultimate aim is to move to a technology-neutral competitive process as soon asreasonably practicable. Realistically as technologies are at different stages of development this ultimatetechnology neutral process is likely to be preceded by a technology differentiated competitive process. Thistechnology differentiated process may be introduced as early as 2017. The Government’s ambition is to moveto the next phase, in which there will be technology-neutral auctions, in the 2020s before ultimately reachinga phase where there is no longer a need to issue CfDs due to the existence of a competitive market whichdelivers low-carbon electricity without the need for Government support.

Value of CfDs

31. While it is for suppliers to decide how to pass the cost of the CfD on to consumers through theirelectricity bills, the Government assumes that they will do so for budgetary and cost control purposes. Thetotal cost that can be levied on consumers through the CfD is therefore controlled within agreed limits bythe LCF.40 During the transition period between the introduction of CfDs in 2014 and RO closure in 2017, operators will have a one-off

choice of scheme between the RO and CfDs for support for new generating stations and for new additional capacity of over 5MW.

41 See also the Final Impact Assessment on proposals for the levels of banded support under the renewables Obligation for theperiod 2013–17 and the Renewables Obligation Order 2012. July 2012.

42 Electricity Market Reform: Delivering UK Investment.43 Further information is available in the EMR impact assessment.

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32. The budget for the CfD under the LCF within the Spending Review period is still to be determined, andas a cap has been set for total spend, will depend on spending on the RO and small scale FITs.

Feed-in Tariffs scheme

33. The FITs scheme was introduced on 1 April 2010, under powers in the Energy Act 2008 to encouragedeployment of small-scale, low-carbon electricity generation. The technologies supported under FITs are: solarphoto voltaic (PV), wind, hydro, anaerobic digestion and micro (less than 2kW) combined heat and power.FITs provide a fixed payment to these small scale generators (per MWh produced).

34. DECC has just completed the first Comprehensive Review of the scheme. This sought to improve valuefor money and reduce tariffs in light of falling costs. The reforms introduced a system called degression whichreduces tariffs over time to ensure the scheme delivers increased value for money.

35. Funding for FITs is delivered through a levy on electricity bills and controlled within agreed limits bythe LCF. Suppliers are at liberty to determine how to pass through the cost of the scheme to their consumers.

Value of FITs

Table 3

FEED-IN TARIFFS SPEND, £ MILLION, 2011–12 PRICES, UNDISCOUNTED44

2011– 2012– 2013– 2014– 2015– 2016– 2017– 2018– 2019– 2020–FinancialYear 12 13 14 15 16 17 18 19 20 21

Total 155 477 596 729 849 955 1051 1,126 1,179 1,224

Heat

Renewable Heat Incentive

36. The purpose of the Renewable Heat Incentive (RHI) scheme is to encourage and support heat users tomove away from using fossil fuels for heating and to contribute to the UK’s renewable energy and emissionsreduction targets by making it more financially appealing to install renewable heating systems.

37. Renewable heat technologies are currently more expensive than traditional, fossil-fuelled technologies.The RHI provides financial support in the form of a payment per unit (kilowatt hour) of heat produced.

38. The Government launched the non-domestic RHI in November 2011. The scheme provides tariff-basedfinancial support to commercial, industrial, public, not-for-profit and community generators of renewable heatfor a 20-year period. The Government consulted on its proposals for the domestic RHI last autumn, and isintending to introduce the scheme in spring 2014.

39. The RHI Scheme is subject to a degression-based mechanism which is designed to respond quickly toemerging budget risks (for example, from unexpectedly high levels of deployment) by decreasing tariffsgradually over time; whilst also enabling continued growth towards the heat portion of the 2020 renewablestargets.45

Costs

40. The RHI is funded directly from Government spending and has been assigned annual budgets for thefour years of this Spending Review period.

Table 4

RHI ANNUAL BUDGETS FOR THE 2011–12 TO 14–15 SPENDING REVIEW PERIOD46

Financial year 2011–12 2012–13 2013–14 2014–15 Total

Budget (£m) 56 133 251 424 864

41. This includes budget for the Renewable Heat Premium Payment (RHPP) in 2011–12 and a spend of upto £25 million for the second phase of the RHPP (expected to be spent primarily in 2012–13 but with flexibilityfor some spend in 2013–14).

42. The recently agreed Spending Review settlement for 2015–16 is £430 million, which allows the RHIspend to significantly increase from levels currently being observed.47

44 Modelling from FITs Comprehensive Review Government Responses.45 “The UK is legally committed to delivering 15% of its energy demand from renewable sources by 2020 contributing to our

energy security and decarbonisation objectives.” UK Renewable Energy Roadmap Update 2012, paragraph 1.1.46 The Renewable Heat Incentive: consultation on interim cost control.47 As of 30 April DECC estimates that expenditure committed to the RHI from applications received to date is just under £50m

for the next 12 months.

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Renewable Heat Premium Payment

43. The RHPP scheme was introduced to provide a one-off payment for householders to install renewableheating systems as a short term measure before the introduction of the domestic RHI.

44. The scheme provides vouchers which can be redeemed against the cost of installing renewable heatingtechnologies, and is mainly targeted at those living off the gas grid, where most money on bills and carboncan be saved.

Fuel Poverty and Energy Efficiency

Addressing fuel poverty

45. Government is committed to doing all that is reasonably practicable to end fuel poverty in England by2016, and to helping low income and vulnerable households heat their homes more affordably. The supportprovided comprises:

— The Warm Front scheme provided help to low income vulnerable households to improve the thermalefficiency of their homes. It is expected that around 35,000 households will be assisted fromapplications received in 2012–13.48

— The Warm Home Discount scheme provides rebates on electricity bills to a range of low income andvulnerable customers. Around £283 million is expected to have been spent by suppliers providingrebates and other support in 2012–13.49

— The Energy Company Obligation runs alongside the Green Deal (see paragraph 47 below) providingsupport to low income and vulnerable households to improve the thermal efficiency of their homes.The Affordable Warmth and Carbon Saving Communities Obligations together should generateexpenditure in home thermal efficiency improvements worth around £540 million and supportingaround 230,000 households per year.

— The Department for Work and Pensions (DWP) automatic Cold Weather Payments are targeted atthe elderly, disabled and those with young children. During the 2012–13 Cold Weather Paymentseason,50 5.8 million payments (worth £25 a week) were made to 3,290,800 recipients at a cost ofover £146.1 million. DWP also offer automatic annual Winter Fuel Payments of £200 for householdswith someone who has reached women’s state pension age and is under 80 and £300 for householdswith someone aged 80 or over. In winter 2011–1251 it helped over 12.6 million older people in over9 million households with their fuel bills at an estimated cost of £2.1 billion.

Energy efficiency and energy demand reduction

46. The Government has also introduced measures designed to improve energy efficiency and reduceenergy demand:

— The Green Deal lets consumers pay for some of the cost of energy-saving property improvements,like insulation, over time through savings on their energy bills. Repayments will be no more thanwhat a typical household should save in energy costs52.

— Smart Meters: The roll-out of smart gas and electricity meters is expected to deliver significanteconomic benefits, placing consumers in control of their energy use, and more widely to improvethe consumer experience and engagement with the energy market.53

— Businesses can benefit from 100% first-year capital allowances for energy saving-technologies,54

commonly called enhanced capital allowances or ECAs, which were introduced in 2001 to help theUK meet its target for reducing greenhouse gases.55 These allowances reduce the effective cost ofthe machinery for the investor. They do not, however, significantly affect the unit price paid forenergy consumed.

48 The scheme closed to new applications on 19 January 2013, at which time the Energy Company Obligation was alreadyoperational.

49 Final spending will be confirmed in Ofgem’s annual report in October 2013.50 1st November 2012 to 31st March 2013.51 The latest period for which figures are available.52 For further information, see the Green Deal impact assessment and the Green Deal consultation.53 Energy suppliers are obliged, through conditions in their licences, to take all reasonable steps to install smart gas and electricity

meters for their customers by the end of 2020. Energy suppliers will continue to be responsible for the costs of metering, asthey are today. Similarly, under current arrangements consumers pay for the cost of their metering and meter maintenancethrough their energy bills, and this will be the same for smart metering.

54 Eligible equipment, and the criteria they have to meet, is published in an “Energy Technology List”. The criteria are reviewedannually by DECC.

55 The Government aims to reduce the UK’s greenhouse gas emissions by at least 80% (from the 1990 baseline) by 2050(https://www.gov.uk/government/policies/reducing-the-uk-s-greenhouse-gas-emissions-by-80-by-2050).

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Low-carbon Capital Investment and Research & Development

Carbon capture and storage

47. The Government is also supporting CCS, which will allow the use of existing fossil fuel supplies morecleanly by capturing carbon dioxide from fossil fuel power stations (or large industrial sources), transportingit via pipelines and then storing it safely offshore in deep underground structures.

48. Through its CCS Commercialisation Programme, the Government hopes to support up to two CCSprojects with the funding available. These projects have potential to support large supply chains with significantUK content, through the capital support the Government is providing, as well as the further approximately £1.9billion being invested by the winning projects themselves.

49. The Government has allocated £1billion of capital support through its CCS CommercialisationProgramme, although the final level of support for each project will be confirmed depending on the outcomeof the on-going competition.

50. This support is provided in the form of capital funding by the Government.

Research and Development Funding for CCS

51. The UK has a four-year (2011–2015) £125 million cross-Government CCS research, development andinnovation programme. Funding comes from the DECC, the Technology Strategy Board, the EnergyTechnologies Institute and the Research Councils.

52. CCS research, development and innovation will play an important role in reducing the costs of CCS.This is necessary to help bridge the gap to commercial scale demonstration, enable wider scale deployment, aswell as developing the supply chain to maintain the industry.

Funding for research and development

53. The Government provides support for research and development, covering early stage research to pre-commercial deployment with over £1 billion committed over the current Spending Review period.

54. The funding is distributed through a number of organisations. The key sources of funding are detailedin Annex D.

55. In addition, businesses in low-carbon sectors are encouraged to apply for grants and/or loans fromthe £2.4 billion Regional Growth Fund (RGF) and the £125 million Advanced Manufacturing Supply ChainInitiative (AMSCI).

Carbon Pricing

Energy intensive industry compensation

56. HM Treasury’s 2011 Autumn Statement announced a £250 million package of measures to help electricityintensive industries adjust to the low-carbon transformation while remaining competitive.56 It included:

— £40 million to increase the rate of CCA relief for electricity to 90%;

— £110 million to provide compensation for the indirect costs of EU ETS; and

— £100 million to provide compensation for the indirect costs of the CPF.

57. The 2013 Budget announced that the Government will continue to provide support to energy-intensiveindustries to compensate for the indirect cost of the CPF in 2015–16. Further details will be announced at thenext spending round. However, support is intended to be transitional while other countries catch up in pricingthe costs of carbon emissions.

Climate Change Agreements

58. CCAs allow eligible energy-intensive businesses to receive up to a 65% discount from the CCL57 inreturn for meeting energy efficiency or carbon-saving targets. The discount for electricity will increase to 90%from April 2013.

59. Currently, 51 industrial sectors participate in CCAs which cover some 9,900 facilities or sites,58 and in2011–12, CCL discount awarded by the scheme was £165 million.59 Budget 2011 announced that the schemewould be extended for all currently eligible sectors until 2023.60

56 2011 Autumn Statement, paragraphs 1.105.57 Climate Change Levy—introduction.58 Climate Change Agreements Scheme (Environment Agency Website).59 http://www.hmrc.gov.uk/statistics/expenditures/table1–5.pdf60 Budget 2011, page 33.

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European Union Emissions Trading System (EU ETS) Free Allowances and Commercial Support

60. Although auctioning is the default method for allocating emission allowances to companies participatingin the EU ETS in Phase III (2013–2020), industry will continue to receive a share of allowances for free until2027 under the revised EU ETS Directive. This is a transitional measure for industrial installations to lessenthe risk of a “shock” introduction to the carbon price signal. In 2013 those sectors not deemed to be atsignificant risk of carbon leakage will receive free allowances to cover emissions from 80% of theirbenchmarked baseline output, decreasing linearly each year to 30% in 2020 and 0% in 2027.

61. In addition, Directive 2003/87/EC sets out two mechanisms to address the risk of carbon leakage:61

— sectors deemed at significant risk of carbon leakage will receive 100% of their EU allowances needfor free (based on their average production (eg in tonnes of product) over a baseline period), up toa product benchmark based on the average of the 10% most efficient installations in the EU (termedfree allocation); and

— from January 2013, Member States may choose to compensate sectors at risk of carbon leakage asa result of indirect costs (ie through EU ETS related increases in electricity prices), based on revisionsto the State Aid guidelines.

Table 5

LEVELS OF SUPPORT UNDER THE EU ETS FOR UK INDUSTRY

Measure Value of mechanism Number of installations

Free allocation on a declining trajectory for Around £210 million* Around 430 installations**sectors not deemed to be at significant riskof carbon leakage.Free allocation on a non-declining trajectory Around £4 billion* Around 400 installations**for sectors deemed to be at significant riskof carbon leakage.Compensation for those sectors at significant £110 million† 15 sectors‡

risk of indirect carbon leakage due to theEU ETS.

*Based on the UK’s draft National Implementation Measures (NIMs), DECC’s short-term traded carbon valuespublished in October 2012 and expressed in real 2012 prices.

** Based on current draft of the UK’s National Implementation Measures (NIMs).†Over January 2013—March 2015‡No. of companies will be known in July 2013, once the scheme is operational

Carbon Price Floor and Climate Change Levy

62. Putting a price on carbon emissions is at the heart of the Government’s strategy for enabling the UK toreduce emissions over the long term. The CPF firmly establishes the “polluter pays principle”. Liability will bedirectly linked to the environmental damage caused by different types of fossil fuel-based electricity generation.

63. The Carbon Price Support (CPS) rates announced in Budget 2013, of £18.08, are in-line with thepreviously announced price CPF. It is important to maintain the commitment to this floor to provide thecertainty that investors need to invest now in our ageing electricity infrastructure.

64. Similarly, the CCL encourages businesses to reduce their energy consumption. The CCL is a tax onenergy supplies (electricity, natural gas, liquid petroleum gas and coal) to UK business and the public sector.

65. Supplies of electricity from renewable sources (eg wind, hydro, wave, waste) are exempt from the CCL.Renewable electricity is exempt from the CCL via a system of levy exemption certificates. These ensurethat the amount of renewable electricity supplied to businesses matches up with the amount of renewableelectricity generated.

66. Electricity produced from renewable sources is exempt in support of the CCL’s objective, which is toencourage energy efficiency and reduce emissions of carbon dioxide from the energy used by business and thepublic sector.

Combined Heat and Power

67. Combined Heat and Power (CHP) captures and utilises the heat that is a by-product of the electricitygeneration process and can be more efficient and reduce carbon emissions by up to 30% compared to separategeneration of heat and power, via a boiler and power station, using the same fuel.61 Carbon leakage is the prospect of an increase in global greenhouse gas emissions when a company shifts production outside a

country because they cannot pass on the cost increases induced by climate change policies to their customers without significantloss of market share.

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68. Input fuels used to generate “good quality” heat in fossil fuel CHP plants are exempt under the CPF.This reflects the fact that heat generation will not ordinarily be subject to the CPF. Small scale generators, of2 MW capacity and less, will also be excluded from the CPF. Taken together, this puts CHP electricitygeneration on a level playing field with alternatives. Fossil fuel CHP remains incentivised through the taxsystem, as fuel used in “good quality” CHP is exempt from CCL, unlike separate boilers producing heat whichwill still be liable to the CCL.62

Capacity Market

69. The Government is legislating through the Energy Bill to introduce a Capacity Market to ensure that wecan maintain reliable electricity supplies. The first capacity auction will be run in 2014, for delivery in 2018–19,subject to state aid approval.63

70. A Capacity Market works by providing upfront payments to all providers of capacity (includinggeneration and demand side, and with some exceptions, for example plant receiving the a CfD), in return forwhich they must commit to be delivering energy when needed or face financial penalties. Capacity agreementswill be allocated through a competitive auction, four years ahead of delivery. The costs of the upfront capacitypayments will fall to energy suppliers (and therefore consumers), but the Capacity Market will have adampening effect on wholesale electricity prices that will largely offset the upfront costs.

71. Consumers already pay the costs of capacity through the wholesale electricity price; the Capacity Marketsimply means that the costs of capacity are instead made through a separate revenue stream. The costs of theCapacity Market are not included in the agreed £7.6 billion LCF. However, the costs of the Capacity Marketwill be included within updated LCF totals for purposes of reporting to Parliament. The level of supportprovided will depend on the clearing price of the auction and the amount of capacity contracted, but as notedabove, the net cost to consumers is expected to be lower than the gross cost of the auction as the CapacityMarket will result in lower wholesale prices than would have otherwise been the case.

Other Support

Support for energy used in transport

Renewable Transport Fuel Obligation

72. The Renewable Transport Fuel Obligation (RTFO) requires transport fuel suppliers to supply biofuel inproportion to fossil fuel. Typically more expensive than the displaced fossil fuel the obligation represents acash transfer from fuel suppliers to biofuel producers and their supply chains (eg farmers, waste cookingoil collectors) rather than direct government support. RTFO costs are assumed to be passed through to endfuel consumers.

73. Some NGOs (and others) consider biofuel support harmful on grounds of environmental sustainability,social sustainability and food price impacts.

74. The total cost to suppliers subject to the obligation is estimated to be £387 million in 2013–14. However,the RTFO value is determined by the market reflecting biofuel and fossil fuel prices at any given point in time.

Low Emission Vehicles

75. The Office for Low Emission Vehicles is a cross Government, industry endorsed, team combining policyand funding streams to support the early market for electric and other ultra-low emission vehicles (ULEVs).

76. Buyers of ULEVs are able to benefit from a consumer incentive grant if purchasing an eligible newvehicle. This is worth 25% up to £5,000 towards the value of a car and 20% up to £8,000 towards the valueof a van. Grants are also available for the installation of recharging points in homes, stations and the publicsector estate.

77. Whilst these measures are Government funded they are not classified as support for energy, rather theysupport the cost of the vehicles powered by the energy, not the electricity on which they run.

National Concessionary Fuel Scheme

78. Under the 1994 Coal Industry Act HMG inherited responsibility for certain employee related benefitsstemming from the nationalised coal period (1947–1994). Amongst these is the National Concessionary FuelScheme whereby certain former employees of British Coal are entitled to either the supply of solid fuel (coal)or cash in lieu.

79. The entitlement to receive concessionary coal is linked to the beneficiaries original contract ofemployment and DECC is not able to vary that arrangement on a unilateral basis. Any change has to be with62 Renewable CHP is one of the technologies eligible for support under the Renewables Obligation or the Renewable Heat

Incentive. Government consulted on a CHP specific RHI tariff in 2012 to replace the additional support for renewable CHP(over power-only plant) currently in the RO banding. A Government response is pending.

63 Electricity Market Reform: Capacity Market proposals.

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the consent of the individual concerned. Any wholesale change to the coal services would require legislationand would give rise to human rights implications. Currently DECC has no plans to seek such a legislativechange.

80. The majority of the beneficiaries are now in receipt of cash in lieu (around 57,000 currently) but DECCstill supplies coal to around 11,000 former employees or their widows. The fuel element of the service isestimated to cost DECC around £16.5 million in 2013–14 and the cash in lieu arrangements around £35 million.The amounts of coal supplied are all set out within agreements negotiated between the former British Coal andthe mining trade unions.

81. This scheme directly reduces the price paid by a specific group of consumers for energy they receiveunder specified circumstances.

International comparisons

82. The energy challenge in each country is different. Governments must choose the appropriate supportmechanisms, and support them to the appropriate levels depending on their respective energy needs. The UKhas an ambitious target to halve emissions from 1990 levels by 2027.64 By comparison, Japan has a 30%target between 2003 and 2030 and Sweden a 20% target between 2008 and 2020.

83. In addition, the UK has a legally binding target to produce 15% of its energy needs from renewables by2020. Whilst this target is lower than those for other European countries it is nonetheless very ambitious. TheUK must secure a factor of ten increase in renewable energy over the period, compared with an average factorof two increase across Europe—all while increasing demand means additional deployment is needed just to“stand still”.

84. State Aid guidelines on compensation for those sectors at significant risk of indirect carbon leakage dueto the EU ETS were adopted by the European Commission in late 2012. Compensation is voluntary. Only oneMember State other than the UK has announced a compensation scheme so far—Germany has €500 millionper year. The approach for free allocation is harmonised across all EU member States.

85. It is extremely difficult to directly compare the support for renewable energy between different Europeancountries as regulatory issues, taxation, base load cost of energy and many others factors can all play a role.According to the Status Review of Renewable and Energy Efficiency Support Schemes in Europe conducted bythe Council of European Energy regulators, in 2011, the UK had a low level of subsidy per MWh whencompared to other member states.65

86. Most European and OECD countries have some form of Feed-in Tariff. Spend varies widely, Germanyand other well established schemes have spent many billions on support over the past decade. Other countriesare only now starting to offer this type of support (notably China).

87. The Global Carbon Capture and Storage Institute (GCCSi) estimate that worldwide up to $40 billionhas been committed by Governments to support CCS projects. Governments around the world have provideddifferent levels of financial incentives to support the deployment of CCS. It is difficult to directly comparesupport levels, as projects in different countries face different market conditions and regulatory and policyframeworks. In addition to direct financial support in the forms of grants, subsidies can be in other forms. Forexample, in the US, federal and state support for CCS have included investment tax credits and loan guaranteesto help offset the higher capital and operating costs of CCS projects.

88. Estimates of levels of funding specifically for carbon capture and storage R&D in other countries arenot easily available. However, there is information on publication rankings (a good measure of research activity)and specific initiatives in other countries.

89. A Capacity Market is a type of “capacity mechanism”. Capacity mechanisms are a common feature ofliberalised energy markets, and indeed when the England and Wales electricity market was first liberalisedthere was a capacity mechanism in place. France is developing a Capacity Market similar to the one we arelegislating for, and there are similar mechanisms already operating in a number of worldwide markets, includingin the US and Europe.

Annexes

Annex A

REDUCED (5%) VAT RATE ON DOMESTIC HEATING AND POWER

90. A reduced rate of VAT applies to domestic and small business heating fuel and electricity. This is a tax,not a subsidy, and increases the price above the world-market prices. Non-fossil fuel heating would also becovered under the 5% VAT rate.64 The Government will review the fourth Carbon Budget, covering the years 2023–2027, in 2014. If at that point our domestic

commitments place us on a different emissions trajectory than the ETS trajectory agreed by the EU, we will, as appropriate,revise up our budget to align it with the actual EU trajectory.

65 Status Review of Renewable and Energy Efficiency Support Schemes in Europe.

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Annex B

NUCLEAR POWER

91. The UK Government believes that nuclear energy has a vital role to play in the energy mix and iscommitted to removing unnecessary obstacles to investment in new nuclear power.

92. The Office for Nuclear Development (OND) is part of the Energy Markets and Infrastructure (EMI)group within DECC, and has a key role in helping to ensure that the UK has access to clean, safe, and securesupplies of competitively priced energy.

New Nuclear Power

93. It is the Government’s policy that there will be no public subsidy for new nuclear power, as defined ina written statement made to Parliament in October 2010,66 and in a debate in Parliament in February 2013.67

This means that new nuclear will receive no levy, direct payment or market support for electricity supplied orcapacity provided, unless similar support is also made available more widely to other types of generation.

94. New nuclear power will benefit from any general measures that are in place or may be introduced aspart of wider reform of the electricity market to encourage investment in low-carbon generation. This is aboutcreating a level playing field for all forms of generation, not subsidising nuclear.

95. It will be for private sector energy companies to construct, operate and decommission nuclear powerstations. It will be for the Government and the independent regulators to ensure appropriate levels of safety,security and environmental regulation.

Nuclear Waste and Decommissioning

Legacy waste and decommissioning

96. In terms of financing the legacy waste and decommissioning of old and existing nuclear power stationsand facilities, the UK policy operates under cover of and in accordance with European Commission decisionson the restructuring of British Energy (BE) and Nuclear Decommissioning Authority (NDA)/British NuclearFuel Limited (BNFL).

97. Responsibility for decommissioning, cleaning up and dealing with the waste from the public sector, civilnuclear legacy sites has been given to the NDA, created in 2005. The NDA’s mission is fully funded by thepublic sector, through a mixture of direct grant and commercial income from the few facilities in the estatethat are still operational. This will decline over time as the remaining operational nuclear plants close and enterdecommissioning. Closure of the operational commercial plants was one of the conditions attached to state aidapproval, with which we remain in compliance.

98. The European Commission approved the grant of state aid to the restructuring of British Energy plc(BE) in October 2004 (decision 2005/407/EC) on the basis that it was satisfied that the new structure of BritishEnergy would ensure that aid was exclusively used for the decommissioning of BE’s nuclear power plants andthe discharge of its nuclear liabilities, for example for radioactive waste and spent fuel. Under restructuringagreements scrutinised by the Commission at the time of its original decision, the Nuclear Liabilities Fund(NLF)—a company limited by shares and owned by an independent trust—was made responsible for meetingthose decommissioning costs.

99. In January 2009, BE was purchased by EDF. At the time of sale, the UK Government committed toensuring through the sale process that the conditions for State Aid imposed by the Commission on BE at thetime of restructuring would continue to be met. Accordingly, EDF are subject to the BE restructuringagreements. As a consequence EDF must submit their decommissioning plans and any applications for NLFpayments to the UK’s NDA for prior approval. In providing their approval, the NDA are charged with ensuringthat EDF’s plans and applications meet the terms of the restructuring agreements including that such fundingis directed only to that work deemed qualifying under those agreements.

100. The NLF’s liabilities as stated in the 2011–12 DECC accounts are £5.1 billion whilst its assets are £8.7billion. The liabilities are extremely long-dated, stretching more than 100 years into the future on current plans.And there are a number of uncertainties regarding decommissioning costs, including the applied discount rate,station lifetimes, regulatory changes, inflation and the rate of investment return. Given these uncertainties it isvery difficult to predict whether the fund will be sufficient to cover the liabilities. If they do not, theGovernment has undertaken to meet any shortfall.

101. Any money paid out by the NLF to EDS conform to the conditions imposed by the Commission at thetime of British Energy’s restructuring in October 2004, and does not constitute a subsidy or state aid. Neitheris the Government’s undertaking to meet any NLF shortfall, should that be necessary. As is the case with NLF66 https://www.gov.uk/government/news/written-ministerial-statement-on-energy-policy-the-rt-hon-chris-huhne-mp-18-october-

201067 Hansard, 7 Feb 2013 : Debate from Column 485, http://www.publications.parliament.uk/pa/cm201213/cmhansrd/cm130207/

debtext/130207–0003.htm

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payments to EDF, the Government would only meet costs that fall within the conditions imposed by theCommission at the time of British Energy’s restructuring in October 2004.

Decommissioning and waste from new nuclear power stations

102. Geological disposal is the way in which higher activity radioactive waste will be managed in the longterm. The Government expects to dispose of spent fuel and intermediate level waste (ILW) from new nuclearpower stations in the same geological disposal facility that will be constructed for the disposal of legacy waste.

103. Before construction of a new nuclear power station begins the Government expects to enter into acontract with the operator regarding the terms on which the Government will take title to and liability for theoperator’s waste. This “Waste Transfer Contract” will in particular set out how the price that will be chargedfor this waste transfer will be determined (the “Waste Transfer Price”).

104. In December 2011 the Government published details of how the Waste Transfer Price is to bedetermined. This stated that the Government’s objective is to ensure the safe disposal of ILW and spent fuelfrom new nuclear power stations without cost to the taxpayer and to facilitate investment through providingcost certainty.

105. This arrangement involves the transfer of liabilities and risks from the operator to Government, but thewaste transfer pricing methodology sets out how this will be done in a way that does not involve any subsidyto new nuclear power. As set out in the written Ministerial Statement of October 2010, the Government doesnot consider that taking title to radioactive waste, including spent fuel, for a fixed price is a subsidy to newnuclear power, provided that the price properly reflects any financial risks or liabilities assumed by the state.

Limitation of Liabilities

106. The UK is a Contracting Party to the Paris Convention on nuclear third party liability and the BrusselsSupplementary Convention. The Conventions establish an internationally agreed framework for compensatingvictims in the event of a nuclear accident and are implemented in the UK by the Nuclear Installations Act1965. This regime seeks to ensure access to adequate and fair compensation for victims by requiring operatorsto take on more onerous obligations than they would under the ordinary law, so that they are bound to paycompensation irrespective of whether they are at fault and are required to put in place insurance or otherfinancial security to cover their liabilities. This is consistent with the no public subsidy policy.

107. As part of the regime, a limit is set on operator third party nuclear liability. Government believes thisis justifiable in the public interest and is the right way of ensuring that risk is appropriately managed, and that,overall, any potential cost or risk to the Government can be justified by the corresponding benefits of the Paris/Brussels regime. The UK currently limits operators’ liability at £140 million per incident but this will rise to€1.2 billion once we have implemented the revisions that were made to the Conventions. The UK is alsobound, with other Brussels signatory states, to contribute to a fund that will compensate victims both in theUK and other convention countries should a serious nuclear incident happen.

108. Government is working with other parties to the Paris/Brussels regime to amend and update the existingscheme and published a consultation on the changes in 2011. These amendments impose a more stringentregime for operators than the current one. As mentioned in the summary of responses to the consultation,68

Government has always acknowledged that a catastrophic accident at a nuclear plant could far exceed theability of the operator to pay and that Government, as with other natural or man-made disasters, may have tostep in. The most effective way of guarding against large accidents is to have a robust regulatory regime toensure the risk of a significant incident is kept extremely small. In so doing, the nuclear industry is alreadypaying to protect society for a very low probability but high consequence accident through meeting the exactingregulatory requirements.

Annex C

OIL AND GAS FISCAL REGIME

109. The tax regime which applies to exploration for, and production of, oil and gas in the UK and on theUK Continental Shelf (UKCS) currently comprises three elements:

— Ring fence corporation tax—this is calculated in the same way as standard corporation tax, but thering fence prevents taxable profits from oil and gas extraction being reduced by losses from otheractivities or by excessive interest payments. The current rate of tax on ring fence profits, which isset separately from the rate of mainstream corporation tax, is 30%.

— Supplementary charge—this is an additional charge, currently at a rate of 32% on a company’s ringfence profits (increased from 20% from March 2011).

— Petroleum revenue tax (PRT)—this is a field based tax charged on profits arising from oil and gasproduction from individual oil and gas fields which were given development consent before March1993. The current rate of PRT is 50%. PRT is deductible as an expense in computing profitschargeable to ring fence corporation tax and supplementary charge.

68 https://www.gov.uk/government/consultations/compensating-victims-of-nuclear-accidents

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110. Oil and gas produced in the UK is therefore subject to a tax on profits of 62% for new fields and 81%for older fields. This ensures the taxpayer benefits from highly profitable fields. The Government has introducedfield allowances for more challenging categories of field that are economic, but commercially marginal at thehigh rate of tax. Such fields are relieved of tax at 32% for a certain portion of their income—but they still payring fence corporation tax at 30% for this portion, higher than the mainstream corporation tax rate. Fieldallowances do not reduce the cost of oil to consumers.

111. International organisations such as the International Energy Agency (IEA), Organisation for EconomicCo-operation and Development (OECD) and International Monetary Fund (IMF) use a variety of differentmethodologies to assess support to fossil fuels. The IMF and IEA use versions of a methodology known as theprice gap approach, which, similar to the EU definition, compares prices to world market prices. The OECDuses broad measures of Producer and Consumer Support Estimates (PSE & CSE), based on metrics used bythe OECD in other sectors, such as agriculture. These measures take account of where lower rates of tax areapplied than elsewhere in the economy and so give different results to assessing purely whether fossil fuelsare subsidised.

112. For the purposes of G20 work on inefficient fossil fuel subsidies, the UK, along with other EU G20members, defines a fossil fuel subsidy as any Government measure or programme with the objective or directconsequence of reducing, below world-market prices, including all costs of transport, refining and distribution,the effective cost of fossil fuels paid by final consumers, or of reducing the costs or increasing the revenues offossil-fuel producing companies.

113. This oil and gas fiscal regime policy ensures the Government maximises the economic production ofoil and gas in the UK, without giving undue support to otherwise uneconomic production. For that reason,field allowances cannot be seen as a subsidy.

114. Any profits from shale gas production would be subject to the same ring fence regime, and would havea marginal 62% tax rate. Given that the industry is at an early stage of development, the Government hasannounced that it will introduce a shale gas allowance to help unlock investment. This allowance will operatein a similar way to existing field allowances—relieving a portion of a company’s income from thesupplementary charge. Companies will continue to pay ring fence corporation tax on this portion. The use ofallowances to encourage investment in the North Sea has demonstrated the effectiveness of a targeted allowancein stimulating investment and production that would not otherwise have gone ahead.69

115. The Government will publish a consultation document on proposals for the shale gas allowance toensure that the final structure is appropriately targeted while maintaining a fair return for the Exchequer.

Annex D

RESEARCH AND DEVELOPMENT FUNDING

Research councils

116. The Engineering and Physical Sciences Research Council (EPSRC) is the main UK Government agencyfor funding research and training in engineering and the physical sciences and leads the Research Councils UKEnergy programme, worth over £500 million over the period 2011–15, bringing strategy to UK energy researchin support of Government targets.

Technology Strategy Board

117. The Technology Strategy Board (TSB) tackles barriers to early stage technology development, andsupports business-led innovation. It works across business, academia and government—supporting innovativeprojects, reducing risk, creating partnerships, and promoting collaboration, knowledge exchange and openinnovation.70 It has a budget of around £1 billion over four years, which includes over £200 million ofGovernment funding over the current spending review period for low-carbon innovation.

118. In addition to sponsoring the Energy Technology Institute, some examples of TSB investments between2007 and 2012:

— £25.5 million in offshore renewables, including co-funding of £5.5 million from Scottish Enterprise,Natural Environment Research Council and Regional Development Agencies (RDAs) with acommitment to invest a further £10 million core funding per annum to the Offshore RenewablesCatapult centre;

— £29.5 million in fuel cells and hydrogen, including £7 million co-funding from DECC;

— £19.5 million in carbon abatement technologies, including £9 million from DECC and RDAs;

— £17 million in civil nuclear, including £8million from the Nuclear Decommissioning Authority,DECC and EPSRC; and

— £11.9 million in grid balancing, management and infrastructure and £6 million in oil and gas.71

69 https://www.gov.uk/government/news/government-action-to-stimulate-shale-gas-investment70 https://www.innovateuk.org/our-strategy71 https://www.innovateuk.org/energy;jsessionid=C26C4293A0FBB9CE038F294E0329B9AF.3

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DECC innovation funding

119. DECC has made up to £150 million of funding available to cover the 2010 Spending Review period.The spending focus has been on those technologies and programmes where there are clear market failures andwhere intervention will have greatest impact on meeting our climate change and energy objectives.

120. Funding decisions are subject to the Technology Innovation Needs Assessments (TINAs). TINAs aimto identify and value the main innovation needs of specific low-carbon technology families to inform theprioritisation of public sector investment in low-carbon innovation.72

121. The TINAs apply a consistent methodology across a diverse range of technologies, and a comparisonof relative values across the different TINAs is as important as the examination of absolute values within eachTINA. Once priority areas for funding have been decided, suitable projects are selected. They include projectsto reduce the cost of offshore wind, marine innovation, work to reduce the costs of next generation of CCS,work on energy storage, energy efficiency and work on future nuclear R&D. Each project that is funded hasan evaluation plan in order to see how much it did achieve against its original aims and to learn lessons thatcan be used or shared.

Energy Technologies Institute

122. The Energy Technologies Institute (ETI) will receive up to £120 million of public funding and up to£120 million of private funding over the 2011–15 Spending Review period.

123. The ETI’s goals are to accelerate the development, demonstration and eventual commercial deploymentof a focused portfolio of energy technologies, which will increase energy efficiency, reduce greenhouse gasemissions and help achieve energy and climate change goals.73

Waste & Resources Action Programme (WRAP)

124. WRAP’s Business Plan 2011–15 promotes “working in partnership towards a world without waste”.WRAP’s focus is now on preventing waste being created in the first place. However, where waste isunavoidable, WRAPs expertise can help make sure the material is recycled to maximum value, or used tocreate energy.

Ofgem—Low-carbon Networks Fund

125. As part of the electricity distribution price control arrangements that run from 1 April 2010 to 31 March2015, Ofgem established the Low-carbon Networks (LCN) Fund. The LCN Fund allows up to £500 millionsupport to projects sponsored by the distribution network operators (DNOs) to try out new technology, operatingand commercial arrangements. The objective of the projects is to help all DNOs understand what they need todo to provide security of supply at value for money as Great Britain (GB) moves to a low-carbon economy.

126. Projects awarded funding involve the DNOs partnering with suppliers, generators, technology providersand other parties to explore how networks can facilitate the take up of low-carbon and energy saving initiativessuch as electric vehicles, heat pumps, micro and local generation and demand side management, as well asinvestigating the opportunities that smart meter roll out provide to network companies. As such the Fundshould also provide valuable learning for the wider energy industry and other parties.

OLEV (DfT)

127. Ultra-low emission vehicle technology is developing fast. The Government is committed to acceleratingthe pace of change in this area and contributes to the funding of a range of innovative research and developmentactivities. The Office for Low Emission Vehicles (OLEV) is focused on identifying and supporting emergingtechnologies in the field of ultra-low emission vehicles.74

128. The Government’s programme of research and development for low-carbon vehicle technologies isdelivered through the Technology Strategy Board’s Low-Carbon Vehicles Innovation Platform (LCVIP). Thisplatform was launched in 2007 and is funded by the Department for Transport, Department for Business,Innovation and Skills, the TSB and the EPSRC.

Reviewing funding of Research and Development

129. The Low-carbon Innovation Co-ordination Group (LCICG) was re-invigorated following DECC’sleadership of a pan Government review of the innovation landscape and improving its delivery. It bringstogether the UK’s major public-sector funding and delivery bodies that are supporting low-carbon innovationin the UK. The Group aims to maximise the impact of UK public sector funding for low-carbon technology,in order to:

— deliver affordable, secure, sustainable energy for the UK;72 More detail available at: https://www.gov.uk/innovation-funding-for-low-carbon-technologies-opportunities-for-bidders73 http://eti.co.uk/index.php/technology_strategy74 https://www.gov.uk/ultra-low-emission-vehicle-research-and-development

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Ev 124 Environmental Audit Committee: Evidence

— deliver UK economic growth; and

— develop the UK’s capabilities, knowledge and skills.

130. It is developing a common evidence base, using the TINA work done for DECC and is developing ajoint strategy to ensure focus on those areas where of most impact, and to ensure strong coordination ofmembers work.

Annex E

URLS FOR DOCUMENTS REFERENCED IN THIS EVIDENCE

To note—URLs were correct on 27 June 2013

Document Title/Reference URL

Overview of key methods used to identify http://www.oecd.org/env/outreach/EAP(2012)2_NP_and quantify environmentally harmful Subsidies%20report_ENG.pdfSubsidies with a focus on the energysectorUK Renewable Energy Roadmap Update https://www.gov.uk/government/uploads/system/uploads/2012 attachment_data/file/80246/11–02–13_UK_Renewable_Energy_

Roadmap_Update_FINAL_DRAFT.pdfInvesting in Britain’s Future https://www.gov.uk/government/uploads/system/uploads/

attachment_data/file/209279/PU1524_IUK_new_template.pdfElectricity Market Reform: Delivering UK https://www.gov.uk/government/publications/electricity-market-Investment reform-delivering-uk-investmentEstimated impacts of energy and climate https://www.gov.uk/government/uploads/system/uploads/change policies on energy prices and bills attachment_data/file/172923/130326_-_Price_and_Bill_Impacts_2012. Report_Final.pdfEstimated impacts of energy and climate https://www.gov.uk/government/publications/assessment-of-the-change policies on energy prices and bills impact-of-energy-and-climate-change-policies-on-prices-and-billsFinal Impact Assessment on proposals for https://www.gov.uk/government/uploads/system/uploads/the levels of banded support under the attachment_data/file/66181/Renewables_Obligation_renewables Obligation for the period consultation_-_impact_assessment.pdf2013–17 and the Renewables ObligationOrder 2012EMR Impact Assessment https://www.gov.uk/government/uploads/system/uploads/

attachment_data/file/42637/1042-ia-electricity-market-reform.pdfUK Renewable Energy Roadmap Update https://www.gov.uk/government/uploads/system/uploads/2012 attachment_data/file/80246/11–02–13_UK_Renewable_Energy_

Roadmap_Update_FINAL_DRAFT.pdfThe Renewable Heat Incentive: https://www.gov.uk/government/uploads/system/uploads/consultation on interim cost control attachment_data/file/42906/4729-rhi-consultation-interim-cost-

control.pdf2011 Autumn Statement http://webarchive.nationalarchives.gov.uk/20130129110402/

http://www.hm-treasury.gov.uk/as2011_documents.htmClimate Change Levy—introduction http://customs.hmrc.gov.uk/channelsPortalWebApp/

channelsPortalWebApp.portal?_nfpb=true&_pageLabel=pageExcise_InfoGuides&propertyType=document&id=HMCE_CL_001174

Climate Change Agreements Scheme http://www.environment-agency.gov.uk/business/topics/pollution/(Environment Agency Website) 136236.aspxBudget 2011 http://webarchive.nationalarchives.gov.uk/20130129110402/

http://cdn.hm-treasury.gov.uk/2011budget_complete.pdfElectricity Market Reform: Capacity https://www.gov.uk/government/publications/electricity-market-Market proposals reform-capacity-market-proposalsStatus Review of Renewable and Energy http://www.energy-regulators.eu/portal/page/portal/EER_HOME/Efficiency Support Schemes in Europe EER_PUBLICATIONS/CEER_PAPERS/Electricity/Tab2/C12

-SDE-33–03_RES%20SR_3-Dec-2012_Rev19-Feb-2013.pdfGreen Deal Impact Assessment https://www.gov.uk/government/uploads/system/uploads/

attachment_data/file/43000/3603-green-deal-eco-ia.pdfGreen Deal Consultation https://www.gov.uk/government/consultations/the-green-deal-

and-energy-company-obligationBudget 2013 https://www.gov.uk/government/publications/budget-2013-

documents

4 July 2013

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Environmental Audit Committee: Evidence Ev 125

Supplementary written evidence submitted by Professor Paul Ekins

Effect of Modeled Environmental Taxation on Household Bills (Re Q110 asked by CarolineLucas MP)

Increasing the rate of VAT to 20%:

For an average dual-fuel bill of £1,000, the bill would increase by £150.

For an average dual-fuel bill of £1,500, the bill would increase by £225.

Extending the carbon floor price to the household use of gas:

Dividing the tax revenue equally between 25 million households, average increase in bills would bearound £75.

Extending the carbon floor price to all transport fuels:

Dividing the tax revenue equally between the (roughly) 70% of UK households that own cars,average increase in bills would be £150.

So, effect of “large carbon tax with no transport” on household bills would be around £300 p.a. for ahousehold with a dual-fuel bill of £1,500.

So, effect of “large carbon tax with transport” on household bills would be around £450 p.a. for an averagecar-owning household with a dual-fuel bill of £1,500.

Effect of Modeled Environmental Taxation on Carbon Eemission (Re Q98 asked by JoanWalley MP)

This was not calculated by the research, but may be roughly calculated as follows:

If the taxes cause an increase in household bills of 20%, and if the short-term price elasticity ofenergy demand is -0.2, then the taxes might be expected to cause an immediate reduction inhousehold energy emissions of 4%. This might be expected to rise to up to 12% in the long term(more than five–10 years).

Effects of Modeled Environmental Taxation on Different Types of Household (Re Q109 askedby Mark Spencer MP)

In the evidence given a number of different household compositions that were differentiated in the modelingwere cited. In addition to these, the modeling also differentiated between households on the basis of: receiptof Universal Credit; tenure; sex and age of household representative person; number of adults and children;category of dwelling (type of building); gas supply (see JRF1 Report, Box 3, p.45).

References

The evidence derived from two reports produced with funding from the Joseph Rowntree Foundation (JRF):

JRF1: Browne, J, Dresner, S, Ekins, P, Hamilton, I, Preston, I and White, V 2013 “Designing carbontaxation to protect low-income households”, March, JRF, York, http://www.jrf.org.uk/sites/files/jrf/carbon-taxation-income-summary.pdf

JRF2: Ekins, P and Lockwood, M 2011 “Tackling fuel poverty during the transition to a low-carbon economy”, October, JRF, York, http://www.jrf.org.uk/publications/tackling-fuel-poverty-low-carbon-economy

15 July 2013

Written evidence submitted by Alan Simpson

1. Summary of Conclusions and Recommendations

1.1 The overarching conclusion of this submission is that Britain gets poor value from the elaborate web ofenergy market subsidies it operates; subsidising the past rather than the future, old technologies rather thannew, the unsustainable rather than the sustainable, and a closed cartel in preference to a more open energydemocracy. The current subsidy framework acts as a roadblock to market transformation, rather than a pathwayto it.

1.2 Energy market subsidies should be measured against their ability to transform rather than maintain. Allenergy market subsidies (including tax exemptions and credits) are market distorting. This is neither a vice nora virtue. What matters is their contribution to market transformation.

1.3 Subsidies should be treated as transitional mechanisms rather than permanent support; addressing marketdefects and moving the energy market from its current structure towards the energy systems that will replace it.

1.4 Transformational subsidy policies should therefore

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— be targeted towards new technologies rather than established ones;

— have built-in “degression” rates, offering diminishing rates of support, towards full market viability,

— prioritise renewable over non-renewable energy systems;

— require all technologies to cover their own environmental clean-up costs;

— be consistent with government carbon reduction targets;

— maintain social cohesion and resilience; and

— deliver a more open, democratic and sustainable UK energy system.

1.5 The current UK approach to energy market subsidies does not constitute any such markettransformation strategy.

2. Background

2.1 The issue of energy market subsidies is certainly political, but it is not ideological. Every governmenton the planet uses energy market subsidies. Parties of all political hues are locked into energy market subsidies.Even the most ardent champions of deregulated, competitive markets like to make exemptions for their ownchosen dependencies.

2.2 Confusion only arises when less-than-honest distinctions are drawn between visible and concealedsubsidies; between the use of public spending (of taxes raised) and revenues forgone (in exemptions/credits/accelerated capital depreciation rates, etc). Whatever strategies are pursued, the public ultimately pays. Thecritical questions revolve around whether the public (society/the planet) gains or loses from the chosenintervention strategies.

2.3 To take a balanced view of the way in which current subsidies impact on overall UK energy policy, theCommittee needs to examine energy market subsidies in their broadest context; including both visible and lessvisible support mechanisms, and incorporating a wider appraisal of their economic and environmental impact;something the Treasury appears constitutionally unable to do.

3 Methodologies

3.1 To be fair to government, there is no international consensus about what constitutes an energy subsidy,let alone any meaningful distinction between what is market distorting and what is market transforming.

3.2 International attempts—by the Institute for Sustainable Development (2010), the World Bank (2010), theOECD (2012), and the IMF (2013)—to evaluate the impact and trade-distorting effects of different subsidyregimes all flounder upon the lack of an agreed view on how direct and indirect subsidies should be judged,let alone measured.

3.3 The OECD study did, however, set out a useful framework (below) of the conventional elements thatconstitute consumer and producer subsidies. Although limited by a narrow concept of energy (separated fromits broader impact on the economy and the environment), it does at least recognise the complexity of bothproducer and consumer subsidies that are wrapped into existing market support mechanisms—

3.4 The value of this table [OECD (2010) Measuring Support to Energy, in Oxford Energy Associatessubmission, Table 1.1 [not reproduced here] ]is that it acknowledges that energy market subsidies run far widerthan just “price support” measures going directly to the public (ie as Winter Fuel Payments or reduced VATrates on fuel).

3.5 Parliament has just voted to create a separate welfare state for new nuclear power, guaranteeing it amarket and price for the next 35–40 years. It will be a subsidy (in all probability to a single monopoly supplier)that exceeds all other energy subsidies. It also comes on top of the annual taxpayer contribution of £2.3 billionfor nuclear waste disposal, the £5 billion bailout of British Energy in 2005, and government underwriting ofinsurance liabilities (in excess of £1.2 billion) for any nuclear accident. These are barely recognised in thecurrent “subsidy” debate.

3.6 Whilst Japan is beginning to calculate the full depth and duration of such costs, no similar comparisonis being made with the long term costs and consequences of existing UK nuclear subsidies. Contracts forDifference (CfDs) and New Investment Instruments, in the current Energy Bill, will add further subsidies tothe only energy sector on a spiralling “construction cost” curve.

3.7 Whilst the Stern Report made a stab at evaluation of environmental damage, its greater message wasabout the urgent need to address the market failure (of increasing carbon emissions) in existing UK energypolicies and subsidy regimes. It was a message Britain quickly chose to ignore.

3.8 Some of the new incentives the Treasury seems determined to offer to the extraction of “unconventional”gas deposits (Fracking) would turn Stern’s alarm bells into sirens.

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4 Current Breakdown of UK Energy Subsidies

4.1 The Committee has already been given a reasonable outline of current UK energy market subsidies byOxford Energy Associates [Oxford Energy Associates submission, Table 2.5 [not reproduced here] ].

4.2 Even though this breakdown does not address the full OECD checklist of intervention measures, it isclear that the Government puts over £15 billion of annual subsidies into its energy sector, over 80% of whichgo to old, dirty, non-renewable energy sources. The Committee might like to consider the adequacy of thecurrent subsidy framework against the following criteria:

(a) Does it promote innovation and lower energy production costs? The only parts of the energy marketwith rapidly falling unit costs of production are in the renewables sector (particularly solar). Thereis no evidence of UK subsidies to non-renewable energy delivering lower energy-production costs.The recent fall in global coal prices has had little to do with UK support mechanisms. It derivedmainly from US prices being (temporarily) driven down by cheap gas, and from a European race touse up coal quotas before the 2016 Large Combustion Plant Directive comes into effect.

(b) Does it reduce dependency on taxpayer support? Again, with the exception of renewables, most oftoday’s intervention mechanisms invite long-term (and often increasing) public subsidy. There is, forexample, evidence that despite huge existing gas subsidies, power companies are already preparingto “game” the market for further support. In October 2012, Ofgem’s “Electricity CapacityAssessment” noted that:

“Some of the most difficult issues to form a firm view on are whether new gas fired generationwill be built over the next four years, whether gas power stations (CCGTs) that have been takenout of operation (“mothballed”) will return, and how interconnectors will flow at times ofpeak demand.”

(Ofgem, Electricity Capacity Assessment, 2012, p8)

(i) Energy companies claim that mothballing of existing plant (and of new planning permits) hasbeen necessary because gas prices are too low (?!). Many suspect that, in an artificiallyconstructed UK “supply crisis” in 2014–15, utilities will seek new government subsidies tobring this plant back into operation. The channel for doing so will be payments under theCapacity Mechanism of the Energy Bill.

(ii) DECC’s own Impact Assessment calculated that the Capacity Mechanism would cost£2.5billion a year in standby contracts. Experience in the USA is that some 70% of these contractswent to fossil fuel generators, with only 3% going to measures that looked at demand reductionrather than increased consumption.

(iii) Additional inducements to fossil fuel generators would be a classic example of parliament againbeing “suckered” into over-generous subsidy payments to corporate energy interests. Tougherregulatory requirements, a Strategic Reserve provision, (or the prospect of prison sentences)might be more effective ways of “keeping the lights on”.

(c) Has it reduced carbon emissions in the energy sector? The energy efficiency and Climate ChangeAgreement measures in the table (above) have certainly helped reduce UK carbon emissions, as hasthe support given to renewable energies:

(i) Though not recognised in the table, the former Warm Front programme directly helped reducecarbon emissions from large parts of the UK housing stock.

(ii) The nuclear waste subsidy is a legacy issue not a carbon reduction one. And fossil fuel subsidiesall unambiguously promote carbon emissions.

(iii) In carbon reduction terms, the UK subsidy framework looks to be largely regressive.

140

120

100

80

60

Change in %

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

GDP per capits(1991 = 100)

GHG emissions inCO2 - equivalent(1991 = 100)

GDP+27%

GHG-24%

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(iv) The Committee may wish to compare UK performance with the record of greenhouse gasemissions reductions in Germany over the last decade -

(d) Have the UK subsidies produced a more open and competitive energy market? No. UK energymarket concentration has increased over the last decade.

(e) Is there a consistent approach to environmental “clean up” obligations? No. Nuclear receives amassive annual subsidy for its waste management. It also receives insurance support and long termprice guarantees given to no other energy source. It is unclear whether the government will subsidisedecommissioning costs relating to North Sea oil wells. No such subsidies are offered to renewables.

(f) Does the subsidy framework promote innovation and market transformation? Tomorrow’s energy“systems” will be smarter, more integrated and more decentralised than the one we have today. Theywill also be based on using less energy rather than more. UK subsidies have concentrated onincreasing energy production/consumption rather than reducing the need for it.

(i) The only genuinely transformative element in the subsidy framework is to be found in theFeed-in-Tariff (FITs) payments for renewable energy. This is also the main area in whichgenuine innovation and competition has been taking place. It says a lot about the UK that it isalso the one aspect of the energy market in which the government actively constrains growth.

(ii) Whilst other EU states are seeing renewables deployment at rates of over 5GW p.a.—and withinnovation rates and unit cost reductions on the same scale—the UK has opted for a fixedbudget, low growth approach, missing out on most of the innovation gains being enjoyedelsewhere.

(iii) It is worth noting that the UK opted to structure FITs in a way that forces it to be counted as apublic subsidy. The European Court previously ruled that FITs can operate as a free-standingelement within energy sector accounting ... with no public subsidy whatsoever. The effect ofthis is to allow renewables to play a much bigger role in market transformation across the EUthan is allowed in the UK.

(iv) This is a good example of UK subsidies being used to limit transformational change ratherthan drive it.

5 Redressing the Balance

5.1 All subsidy measures are market distorting or transforming. That is their purpose.

5.2 The most worrying aspect of UK energy market subsidies is just how regressive they are. Whilst highcarbon, non-renewable energy sources absorb the bulk of subsidies (often uncapped), demand reductionmeasures are to be driven by loans. Moreover, the subsidy framework reinforces market concentration ratherthan dilutes it.

5.3 The UK does not have an open, competitive energy market. The “market” is, in effect, an energy cartel,dominated by the Big 6 power companies, regulated around short-term price considerations, and underpinnedby an elaborate (and expensive) system of corporate welfare. All attempts to broaden the ownership of energyproduction or distribution are fiercely resisted by the same interests. UK energy market subsidies underpin thisclosed energy cartel.

5.4 Yet, if you were to believe the press coverage, the UK debate about energy market subsidies is whethertaxpayers/bill-payers will sink beneath an “unaffordable” burden of annual (£0.5 billion) Feed-in-Tariffpayments for renewable energy.

5.5 None of this works in Britain’s long term interests. If the Committee is to set itself a benchmark forprogressive recommendations arising from this Inquiry, then clarity, transparency, sustainability andconsistency will be a far more valuable elements than “continuity”, in a UK approach to energy marketinterventions.

5.6 It isn’t just that throwing subsidies at fossil fuel, non-renewable energy sources is expensive, inefficientand climate damaging. These are yesterdays energy sources, reliant on yesterday’s energy thinking. It is aworld only losers will try to live in. This is why the a shift into transformational subsidies (outlined in para1.4) is the key to a more secure UK energy future.

14 June 2013

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Environmental Audit Committee: Evidence Ev 129

Written evidence submitted by Platform

Summary

1. Any discussion of fossil fuel subsidies in the UK context should recognise that the majority of subsidiesare off-budget—that is, transfers to energy producers and consumers that do not appear in national accounts asgovernment expenditure.

2. The government should widen its definition of energy subsidies to fit with that given by the InternationalEnergy Agency, which describes subsidies as “any government action that concerns primarily the energy sectorthat lowers the cost of energy production, raises the price received by energy producers or lowers the pricepaid by consumers.”

3. Platform has identified three main types of off-budget subsidy that need to be quantified and curtailed:Export Credit, Diplomatic and Military.

4. To effectively tackle our dependence on fossil fuels, it is crucial to bring to light and end the existing,wide-ranging government subsidies for fossil fuel companies, whether direct or off-budget.

Background

1. Platform is a London-based research organisation that has monitored the social, economic, environmentaland human rights impacts of the British oil and gas industry for over fifteen years. Our work is regularlypublished and cited by governments, academia, media and corporations. We are consulted for expertise byhuman rights defenders, parliamentarians and journalists. We have in-depth knowledge on British oil companiesoperating in Nigeria, Iraq, the Caspian and North Africa.

Factual Information

1. This committee is interested in the scale of energy subsidies in the UK and whether the government hasplans to reduce “harmful” subsidies.

2. Currently the government is heavily supporting fossil fuels with energy subsidies and is increasing ratherthan decreasing this support. The IMF state that current energy subsidies “distort resource allocation byencouraging excessive energy consumption, artificially promoting capital-intensive industries, reducingincentives for investment in renewable energy, and accelerating the depletion of natural resources”.75

3. The government is offering tax discounts for new fossil fuel exploration (from the North Sea and, furtherin the future, Shale Gas).

4. New research by Friends of the Earth revelled that the UK oil and gas industry received tax breaks worth£1.952 billion over five years during the financial year 2012–13.76

5. In addition there are several types of “off-budget” subsidy provided by the British state that providesignificant support for fossil fuel companies.

Defining Subsidies

1. This paper also discusses the first and second questions of the inquiry (1) whether the Government hasidentified the extent of energy subsidies, and measured them and (ii) how well any identification of subsidiesby the Government matches up to best practice methodologies in how energy subsidies are defined and scoped.

2. The International Energy Agency (IEA) defines subsidies as “any government action that concernsprimarily the energy sector that lowers the cost of energy production, raises the price received by energyproducers or lowers the price paid by consumers.”77

3. The OECD also offer a broad definition of a subsidy: “Governments support energy production in anumber of ways, including by: intervening in markets in a way that affects costs or prices; transferring fundsto recipients directly; assuming part of their risk; selectively reducing, rebating or removing the taxes theywould otherwise have to pay; and undercharging for the use of government-supplied goods or assets…thescope of ‘support’ is deliberately … broader than some conceptions of subsidy.”78

4. The IMF states that “although energy subsidies do not always appear on the budget, they must ultimatelybe paid b someone.”79

5. However, the UK government only identifies and measures direct energy subsidies rather than consideringthe other services provided for free by the UK state to British oil companies. The majority of fossil fuel75 http://www.imf.org/external/np/pp/eng/2013/012813.pdf76 Friends of The Earth Fossil fuel subsidies additional information, David Powell77 IEA, Economic Analysis Division, “Carrots and Sticks: Taxing and Subsidising Energy”, 17/1/06 http://www.iea.org/papers/

2006/oil_subsidies.pdf78 OECD, An OECD-wide inventory of support to fossil-fuel production or use, 2012 http://www.oecd.org/site/tadffss/

PolicyBrief2013.pdf79 http://www.imf.org/external/np/pp/eng/2013/012813.pdf

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Ev 130 Environmental Audit Committee: Evidence

subsidies are off-budget—that is, transfers to energy producers and consumers that do not appear in nationalaccounts as government expenditure.

6. Platform has identified three main types of off-budget subsidy that need to be quantified and curtailed:

7. Export credit. The UK government underwrites (takes on the financial risk of) overseas oil and gasprojects through UK Export Finance. In June 2012, the UKEF submitted a proposal to the Azeri State OilCompany to underwrite a new oil & gas refining and petrochemicals complex.80

8. Diplomatic. The FCO maintained a consulate in Basra largely to support UK oil companies, with threediplomats on staff and a £6.5 million budget. High-profile UK political figures appear on request of oilcompanies for deal signing, such as Huhne attending the signing ceremony during BPs first attempt to brokera deal with Rosneft.

9. Military. The UK Government spent £12 million on military aid to Nigeria, at least in part due to Shell’slobbying effort.81

Export Credit Subsidies

1. UK Export Finance (UKEF), previously known as the Export Credits Guarantee Department (ECGD),offers billions of pounds of public money every year as credit lines and insurance for UK companiesexporting overseas.

2. This subsidy has been provided to oil and gas companies, despite Coalition commitments to end“investment in dirty fossil-fuel energy production”.

3. ECGD, and now UKEF’s, decision-making has been controversial. Crucial information regardingdangerous impacts is repeatedly—and sometimes consciously—ignored.

4. Offers for credit lines for particular projects are often made first, with the various potential UK exportersonly identified later.

5. UKEF has no climate change policy for its projects, nor does it have an emissions reduction target. Tothis day, UKEF continues to provide financial support to some of the most controversial fossil fuel projects.

Particularly problematic subsidies provided by the ECGD/UKEF include:

6. KBR—Bonny LNG—Nigeria. UKEF decided to finance a UK subsidiary of Halliburton, despite specificallegations of the company’s corruption in relation to the Bonny LNG project being common knowledge. Afterinternational investigations started into the bribery, minutes of meetings between UKEF and Halliburton showUKEF failing to ask Halliburton for crucial details of the allegations, telling the company that it did not wishto “delve into the finer details” of the consortium’s arrangements. The Halliburton subsidiary eventually pleadguilty in both the USA and UK.82

7. Shell—Sakhalin II—Russia. Shell’s drilling, pipelines and LNG plant in Arctic conditions on theSakhalin Island in Russia threatened indigenous populations and highly endangered populations of whales.Nonetheless, UKEF gave a secret but legally-binding commitment to support the project in March 2004 worth£1 billion, before an adequate EIA had been completed and before UKEF’s own assessments were complete.83

The application to UKEF was only withdrawn because of a judicial review over its illegality.

8. BP—Baku-Tbilisi-Ceyhan Pipeline—Azerbaijan/Georgia/Turkey. UKEF chose to support this projectto the tune of at least £81.7 million, despite a multitude of reported and documented infringements on citizens’rights. There were over a hundred violations of World Bank standards,84 emergency powers were invoked toacquire land in Turkey, and the UK government itself ruled that BP had violated international rules by failingto investigate complaints of intimidation by state security forces in Turkey.85

9. Petrobras—ultra-deep drilling—Atlantic Ocean. In 2011–12, UKEF agreed a $1 billion credit line tosupport Brazil’s state-owned oil company Petrobras conduct ultra-deep drilling in the pre-salt oil deposits inthe Atlantic Ocean.86 This drilling is more complicated and dangerous than the deep Gulf of Mexico waterswhere BP’s Deepwater Horizon disaster took place.

10. Other fossil fuel subsidies provided by the UKEF in the last two years include: £65 million for apetrochemical plant in Saudi Arabia, £22 million to a Norwegian offshore oil contractor, £6 million for apetrochemical plant in Azerbaijan and £6 million for a gas plant in Nigeria.87

80 http://platformlondon.org/2012/06/25/rbs-ecgd-offer-billions-in-public-money-to-expand-caspian-fossil-fuel-infrastructure81 http://platformlondon.org/wp-content/uploads/2012/07/MoD-Military-training-Amunwa-Response-22.pdf82 The Next Gulf: Rowell, Marriott, Stockman, Constable and Robinson Ltd. 2005 chapter 6.83 http://www.thecornerhouse.org.uk/resource/wwf-files-court-proceedings-against-government-department84 http://www.baku.org.uk/eia_review.htm85 http://www.thecornerhouse.org.uk/resource/bp-violating-human-rights-rules-says-uk-government86 http://www.ukexportfinance.gov.uk/assets/ecgd/files/publications/plans-and-reports/ann-reps/uk-export-finance-annual-report-

and-accounts-2011–12.pdf87 http://www.ukexportfinance.gov.uk/assets/ecgd/files/publications/plans-and-reports/ann-reps/uk-export-finance-annual-report-

and-accounts-2011–12.pdf

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11. Lisa Nandy MP, chair of a parliamentary inquiry into UKEF said: “It is a cause of real concern that,despite the coalition commitment to end all export finance for dirty fossil fuels, particularly the risky Atlanticoil drilling, UKEF still funds so many fossil-fuel-related projects and has so far failed to support a single greenenergy project.”

Diplomatic Subsidies

1. The British government supports the interests of oil companies operating overseas through variousdepartments including the Department for International Development, the Foreign and Commonwealth Office(FCO), the Department for Business, Innovation & Skills and UK Trade & Investment (UKTI).

2. It is David Cameron’s stated policy that diplomats should prioritise promoting “UK-based” businessinterests88 and, alongside arms companies, fossil fuels receive the largest share of this support.

3. Day-to-day phone calls and intelligence gathering on behalf of BP and Shell are a key activity of UKembassies abroad, involving commercial attachés, secretaries for energy and ambassadors.

4. These costs add up—until October 2012, the FCO was maintaining a consulate with three diplomats inBasra largely to meet the needs and demands of BP and Shell. At over £2 million per diplomat per year, the£6.5 million annual budget was significant.89

5. Ongoing lobbying is backed up by high-profile ministerial handshakes and official trade missions.

6. Close state backing for oil companies is exerted especially when oil companies are forcing their way intonew countries—whether that is Tony Blair’s support for BP and Shell in breaking into Libya in the 2000s, theheavy lobbying on behalf of Western oil interests in occupied Iraq after the invasion, or during the samecompanies’ entry into newly independent states of the Former Soviet Union in the 1990s.

Other examples of diplomatic support include:

7. A meeting in February 2013 between the UK Prime Minister, David Cameron and Nigeria’s PresidentGoodluck Jonathan. In this meeting they discussed “how to ensure the Nigerian Petroleum Bill encouragedmaximum investment from other countries in Nigeria’s energy sector.”90

8. Eighteen months of meetings between Anne Pringle, British ambassador in Moscow, and BP as thecompany was making its first attempt to broker a deal with Russian oil company Rosneft. This culminated inChris Huhne, Energy Secretary, attending the signing ceremony which was later ruled to breach a shareholderagreement.91

9. Foreign Secretary William Hague lobbying “strongly” on behalf of Tullow oil over a dispute over thecompany’s £175 million unpaid tax bill.92

10. These are just some examples but they point to a system of continuous, systematic diplomatic supportfor a handful of fossil fuel companies.

Military Subsidies

1. The UK Government provides fossil fuel companies with military subsidies to secure key overseas oiland gas infrastructure and transport routes.

2. For example, figures released under the Freedom of Information Act show that the UK spent close to £12million in military aid in Nigeria since it revived ties with the regime in 2001. Spending has risen consistentlyover the last decade.93

3. The UK has established a permanent naval facility in Lagos to train the Nigerian military to secure theDelta’s oil fields in British loaned boats.94

4. Such subsidies are often brought about as a result of corporate lobbying. For example, UK Governmentdocuments from 2006 reveal that Shell lobbied the UK and US Governments to increase military aid to securetheir oil fields in the Niger Delta.95 Military aid was subsequently increased over the next four years.96

5. Similarly, the provision of UK frigates to the NATO and EU flotillas patrolling the waters off Somaliaenforces the passage of tankers through the Gulf of Aden. In 2010, Jan Kopernicki, President of the British88 BBC News, David Cameron focuses on foreign trade policy, published 22.07.2010 http://www.bbc.co.uk/news/uk-politics-

1072228389 Petroleum Economist, Update: ExxonMobil “to quit West Qurna-1”, 18.10.2012, http://www.petroleum-economist.com/Article/

3105120/UPDATE-ExxonMobil-to-quit-West-Qurna-1.html90 http://www.number10.gov.uk/news/statement-on-president-goodluck-jonathan-meeting-with-prime-minister/91 http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/8410043/Foreign-Office-backed-BP-in-Rosneft-talks.html92 http://www.telegraph.co.uk/news/politics/william-hague/8314345/William-Hague-lobbied-strongly-for-oil-companies-run-by-

Tory-donors.html93 http://platformlondon.org/wp-content/uploads/2012/07/MoD-Military-training-Amunwa-Response-22.pdf94 http://www.publications.parliament.uk/pa/ld201213/ldhansrd/text/121101w0001.htm#1211012600024495 http://platformlondon.org/wp-content/uploads/2012/07/0475-Redacted-note-of-meeting-23-Feb-2004–1-BA-rcd-Sept-13.pdf96 http://platformlondon.org/wp-content/uploads/2012/07/MoD-Military-training-Amunwa-Response-22.pdf

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Ev 132 Environmental Audit Committee: Evidence

Chamber of Shipping and also Vice-President of Shell’s shipping arm, was lobbying hard for the UK to increaseNavy spending and bring forward the acquisition of a new generation of warships, to support the private oiltankers moving through this “vital strategic artery”.97

6. The UK government does not appear to have made any demands for accountability in the Nigerian armedforces in return for military aid.98 Instead the UK has frequently turned a blind eye to Nigeria’s excessive useof force.

7. For example, on 1 December 2010, Government forces reportedly attacked a town in Delta State calledAyakoromo because there may have been a militant camp near or in the town. The number of dead is stilldisputed. One report claims that 100 were killed, mostly children, the elderly and women. The Red Cross saysthat it was barred from entering after the raids. There has been no official inquiry into the tragedy.99

8. Though Nigerian troops have failed to resolve the Delta conflict, the UK actively supported themilitarisation of the area and the wider Gulf of Guinea.

Recommendations

1. When measuring the extent of fossil fuel subsidies it is critical that the government include and addressoff-budget subsidies rather than only looking at direct subsidies like tax breaks.

2. In particular export credit, diplomatic, military support should be included in definitions of fossil fuelsubsidies. It is only by including these areas that a meaningful assessment of fossil fuel subsides can be made.

3. The government should offer a quantitative and qualitative assessment of these subsides and the resultsof this analysis should be publicly available.

4. Having established the level of fossil fuel subsidies, measures should be taken to rapidly reduce them.

5. The money saved from curtailing fossil fuel subsidies should instead be used to support the developmentof sustainable, renewable and safe energy technologies.

13 June 2013

Written evidence submitted by UK Export Finance

Role of UKEF

1. UKEF (formally the Export Credits Guarantee Department) is the United Kingdom’s official Export CreditAgency. Its principal statutory100 purpose is to support exports. It does so mainly by providing insurance toexporters and guarantees to banks (in respect of export credit loans they make available to finance exports)that protect them against the risk of overseas buyers/borrowers not paying UK exporters, or repaying loans tobanks, in respect of supplies made. In consequence, there is a risk transfer from the private to the public sectorwhereby the Exchequer ie the taxpayer, assumes contingent financial liabilities; if and when claims are madeagainst the insurance policies and guarantees that are issued, caused by the buyer/borrower defaulting onpayment, the Exchequer must provide cash resources to meet those liabilities.

2. In fulfilling its role, UKEF complements the private market: it does not compete against it and, therefore,acts an insurer, guarantor and lender101 of last resort. As a consequence, it is asked to support exports that theprivate market will not support. Thus, UKEF responds to demand but does not seek to create it. UKEF cansupport the export of goods and services from all industrial and service sectors; it does not discriminate theprovision of its support between different sectors which would otherwise be contrary to its Act.

UKEF’s Operating Policies

3. UKEF must operate under the consent of HM Treasury which requires it to meet minimum credit riskstandards, price to risk, recover its operating costs and achieve particular financial objectives.

4. UKEF also operates under international agreements that regulate the activities of Export Credit Agencies.These include:

(i) the World Trade Organisation (WTO)—the Agreement on Subsidies and Countervailing Measures(ASCM) which prohibits governments from providing export credit guarantees or insuranceprogrammes at premium rates which are inadequate to cover the long term operating costs and lossesof their programmes;

97 Combating Somali Piracy: The EU’s Naval Operation Atalanta, House of Lords Select Committee on European Union, April2010

98 http://www.hrw.org/sites/default/files/related_material/nigeria_2012.pdf99 http://www.thisdaylive.com/articles/ayakoromo-attack-the-truth-and-fiction/72425100 The Export and Investments Guarantee Act 1991 as amended.101 UKEF is introducing a direct lending scheme in September 2013.

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Environmental Audit Committee: Evidence Ev 133

(ii) the Organisation for Economic Co-operation and Development (OECD) which has established agentleman’s agreement102—the OECD Arrangement on Officially Supported Export Credit (theOECD Arrangement)103—to help create a level playing field in the provision of export credits andprevent trade distortions and minimise export subsidies. The OECD Arrangement establishes themost generous export credit terms and conditions that may be supported; it places limitations on theterms and conditions of officially supported export credits eg minimum interest rates, risk fees andmaximum loan repayment terms.

(iii) The EU—the EU Medium and Long Term Harmonisation Directive which incorporates the OECDArrangement and the Short Term Communication which regulates the provision of credit insuranceby the governments of Member States for exports supplied to EU and OECD markets on short termsof credit ie up to 2 years.

Financial Performance

5. Over the past decade and longer, UKEF has met all the financial objectives set for it by HM Treasury. Ithas been a net contributor of funds to the Exchequer, partly because of the low incidence of claims againstissued insurance policies and guarantees, over that period. UKEF publicly discloses its financial performancethrough the publication of its Annual Report and Accounts104.

6. It should be noted that until March 2011 UKEF operated a Fixed Rate Export Finance Scheme (FREF)105.The FREF scheme enabled export credit loans to be made to overseas borrowers at fixed rates of interest (therate was informed by prevailing OECD rules). However, as such loans were funded by the banks at floatingrates of interest, it was necessary to establish interest equalisation arrangements so that when floating rates(plus a margin payable to the banks) exceeded the fixed rates, the banks received a subvention (subsidy) fromthe Exchequer equal to the difference between the two rates. Conversely, when floating rates (plus a marginpayable to the banks) were below the fixed rates, the banks paid the difference to the Exchequer. In practice,floating rates generally exceeded fixed rates, resulting in significant cash outflows from the Exchequer. Thelevel of subvention peaked in the 1980s and declined substantially by the 2000s as the OECD reformed itsrules on minimum interest rates, UKEF sought to limit exposure to interest rate movements through purchasinginterest rate swaps and by tightening the terms of the FREF scheme.

Environmental, Social and Human Rights (ESHR)

7. UKEF adheres to the OECD Common Approaches for Officially Supported Export Credits andEnvironmental and Social Due Diligence (OECD Common Approaches). This agreement establishes the basisupon which member Export Credit Agencies should address the potential ESHR impacts of the projects (towhich exports are being supplied) they are asked to support. It requires projects to meet international standards,principally those of the World Bank Group ie the World Bank Safeguard Policies and the International FinanceCorporation (IFC) Performance Standards. Projects UKEF has supported which fell within the ambit of theOECD Common Approaches and required ESHR review have been benchmarked against the IFCPerformance Standards.

Coalition Government Commitment

8. The Coalition Government included in its programme for government106 the following commitment: “wewill ensure that UK Trade and Investment and the Export Credits Guarantee Department become championsfor British companies that develop and export innovative green technologies round the world, instead ofsupporting dirty fossil-fuel production”. The Secretary of State for Business, Innovation and Skills explainedin a Ministerial Statement in July 2012 how the Government would implement the commitment. The statementis reproduced at Appendix A.

Energy Exports Supported

9. At Appendix B is a list of “energy” exports/projects supported107 by UKEF over the past 5 years. Thelist includes exports supported under UKEF’s Short-Term products108 and those supported by way of exportcredit loans guaranteed by UKEF including the ESHR categorisation of those which fell within the ambit ofthe OECD Common Approaches.102 Incorporated into EU law.103 Sometimes known at “The OECD Consensus”.104 See https://www.gov.uk/government/organisations/uk-export-finance/series/uk-export-finance-annual-reports-and-accounts105 Following a Public Consultation the FREF scheme was closed that year—see webarchive.nationalarchives.gov.uk/

20130302040301/http://ukexportfinance.gov.uk/Consultations106 “The Coalition: our programme for Government”.107 Energy exports/projects has been widely interpreted to include exports directly or indirectly related to energy extraction,

production, generation and distribution. UKEF publishes details of exports supported in its Annual Report and Accounts.108 The Short-Term products were introduced in 2011 following a decision to support exports sold on short terms of credit, usually

up to 1 year, where exporters could not obtain support from the private market (UKEF had privatised its support for this classof exports in 1991). Such exports/products fall outside the scope of the OECD Common Approaches.

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Ev 134 Environmental Audit Committee: Evidence

APPENDIX A

WRITTEN MINISTERIAL STATEMENT

Dr Vince Cable, The Secretary of State for Business, Innovation and Skills, Department for Business,Innovation and Skills

UKTI and ECGD Support for Green Technologies

17 July 2012

The 2010 Coalition Programme for Government contained a commitment that:

“We will ensure that UK Trade and Investment and the Export Credits Guarantee Department becomechampions for British companies that develop and export innovative green technologies round the world,instead of supporting investment in dirty fossil-fuel production.”

UKTI set out in its strategy “Britain Open for Business” how it would promote low carbon exports; thisincludes a Green Export Campaign that aims to build the UK’s reputation in the green and low carbon sectorand to promote this capability overseas. UKTI is embedding this campaign into trade work in all marketswhere there is a clear opportunity to do so.

The Export Credits Guarantee Department (ECGD), operating as UK Export Finance, has been engagingwith companies and trade bodies based in the UK which are involved in the development and export of greentechnology exports. The purpose has been to ensure companies are aware of the support that is available tothem from ECGD if they require credit insurance, export working capital finance, contract bond support or iftheir buyers require export credit loan finance. Through engagement with overseas project sponsors ECGD hasalso promoted the availability of export credit finance to help to influence them to purchase supplies fromcompanies based in the UK.

This work by UKTI and ECGD is intended to assist UK exporters of low carbon technologies and supportthem in taking advantage of international opportunities.

As to support for dirty fossil-fuel energy production, “dirty” should be taken as referring to projects whichproduce pollution in excess of international environmental standards. The standards which ECGD applies arethose set out by the OECD in the OECD Council Recommendation on Common Approaches on OfficiallySupported Export Credits and Environmental and Social Due Diligence and are usually those of the WorldBank Group. ECGD will normally refuse support for exports to projects that do not meet those standards.

The UK will seek to promote the strengthening of the relevant World Bank Group international standards toinclude limits on emissions of greenhouse gases.

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Ev 136 Environmental Audit Committee: Evidence

Written evidence submitted by the Overseas Development Institute

1. Summary and Recommendations

1.1 The Government should include both international and domestic initiatives in its review and measurementof energy subsidies. This should include support provided directly by UK departments (DFID, DECC, DEFRA,CDC, and UKEF), through development finance institutions, and other intermediaries.

1.2 As there is currently no single Government department responsible for reviewing and reporting energysubsidies, the Environmental Audit Committee (EAC) should identify a single department or inter-departmentalcommittee to lead in measurement and reporting of UK domestic and international subsidies.

1.3 As a first step the Government should apply the framework suggested to this inquiry by Alan Simpson109

to all current development finance support to energy projects:

— Does it promote innovation and lower energy production costs?

— Does it reduce dependency on taxpayer support?

— Has it reduced carbon emissions in the energy sector?

— Does it produce a more open and competitive energy market?

— Is there a consistent approach to environmental “clean up” obligations?

— Does it promote innovation and market transformation?

1.4 Under its commitment to supporting low-carbon growth and adaptation in developing countries, theGovernment should seek to identify and quantify “harmful” subsidies provided in the form of developmentfinance. This includes support to fossil fuel energy projects.

1.5 In the context of G20 commitments on phasing out inefficient subsidies, there have been calls to set upan international body on fossil fuel subsidies110. The UK has the opportunity to lead by example in trackingits own subsidies, and to call for international cooperation in defining, monitoring and tracking inefficient orhigh carbon subsidies.

1.6 Where “harmful” or inefficient subsidies are identified these should be rationalized, and resources usedto promote low carbon energy development both in the UK and internationally. This can include supportingdeveloping countries with subsidy review and reform.111

1.7 As subsidies have a significant impact on private investment in low carbon energy, this inquiry and itsresulting actions should inform the Committee’s parallel inquiry on Green Finance.112

1.8 As subsidies are a significant and growing element of UK development cooperation, this inquiry and itsresulting actions should be linked to the current inquiry by the International Development Committee on theFuture of UK Development Cooperation.113

2. Overseas Development Institute—Background

2.1 The Overseas Development Institute (ODI) is a leading independent think tank on internationaldevelopment and humanitarian issues. Our mission is to inspire and inform policy and practice which lead tothe reduction of poverty, the alleviation of suffering and the achievement of sustainable livelihoods. We do thisby combining high-quality applied research, practical policy advice and policy-focused dissemination anddebate. We work with partners in the public and private sectors, in both developing and developed countries.

(i) Has the Government identified the extent of energy subsidies and measured them?

3. The Government has not considered potential subsidies that may be involved in the energy projects andprograms that it supports in developing countries. In turn, these potential subsidies do not appear to havebeen quantified.

3.1 The International Monetary Fund (IMF)114 uses the following definition for energy subsidies:

Energy subsidies comprise both consumer and producer subsidies. Consumer subsidies arise when theprices paid by consumers, including both firms (intermediate consumption) and households (finalconsumption), are below a benchmark price, while producer subsidies arise when prices received bysuppliers are above this benchmark.

3.2 Development finance and other international support to energy projects in developing countries, impactsboth prices paid by consumers and revenues received by suppliers in those countries.109 http://data.parliament.uk/writtenevidence/WrittenEvidence.svc/EvidencePdf/1048110 http://www.iisd.org/gsi/sites/default/files/g20lib_oilchange_2012_phasingoutffs.pdf111 http://www.odi.org.uk/sites/odi.org.uk/files/odi-assets/publications-opinion-files/8335.pdf112 http://www.parliament.uk/business/committees/committees-a-z/commons-select/environmental-audit-committee/inquiries/

parliament-2010/green-finance/113 http://www.parliament.uk/business/committees/committees-a-z/commons-select/international-development-committee/news/

new-inquiry-the-future-of-uk-development-/114 http://www.imf.org/external/np/pp/eng/2013/012813.pdf

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Environmental Audit Committee: Evidence Ev 137

3.3 The submission to this inquiry by HM Treasury and the Department for Energy and Climate Change(DECC)115, did not include any reference to the UK’s support to energy projects in developing countries. Iunderstand that the Department for International Development and UK Export Finance are to provideseparate submissions.

3.4 Though not considered explicitly within the inquiry’s questions, or in the report prepared for this inquiryby Oxford Energy Associates116, the role of development finance in energy subsidies was raised:

3.4.1 by Zac Goldsmith during the oral evidence117 provided by William Blyth;

3.4.2 during the oral evidence118 that I provided along with Peter Wooders of the Global SubsidiesInitiative (GSI) and Charles Perry of SecondNature; and

3.4.3 by Platform in its written submission119.

(ii) How well does the Government match up to best practice methodologies in how energy subsidies aredefined and scoped?

4. As it applies to development finance, the Government does not appear to match up to best practicemethodologies in how energy subsidies are defined and scoped.

4.1 As noted, the submission by HM Treasury and the Department for Energy and Climate Change (DECC)to this inquiry120, did not include the UK’s support for energy projects in developing countries.

4.2 However, the Department for International Development (DFID), the Department for Energy and ClimateChange (DECC), the Department for Environment, Food and Rural Affairs (DEFRA), UK Export Finance(UKEF), and CDC (the UK’s development finance institution) currently provide financial and technical supportfor energy sector activities in developing countries.

4.3 These Government departments (and investors of UK tax revenues) provide support to energy projectseither directly or through Development Finance Institutions (DFIs). There is a need to strengthen reportingsystems, to allow a better understanding of whether this support results in 121 “harmful” or “inefficient”subsidies.

4.4 Estimates of fossil fuel support from International Financial Institutions (IFIs) and National DevelopmentBanks (NDBs) range from $15 to $150 billion annually.122

4.5 Export Credit Agencies (ECAs) are bilateral organisations that provide financial services to support theoverseas trade and investment activities of private domestic companies. While exact figures on ECA supportfor fossil-fuel projects are difficult to obtain, ECA financing often dwarfs official development assistance and,historically, a large portion of projects have been fossil-fuel related. International estimates of fossil fuel supportfrom ECA’s ranges from $50 to $100 billion annually.123 As with IFIs, it is unlikely that all of this financingactually qualifies as a subsidy, but again, lack of disclosure prevents a more thorough analysis.124

4.6 An ODI review of Oil Change International’s “Shift the Subsidies” database identified that between 2008and 2011 the majority of IFI125 energy project support was to fossil fuel projects. Over 75% of energy projectsupport from IFIs to India, South Africa, Saudi Arabia, Indonesia, Brazil, Thailand, Kazakhstan, Egypt,Venezuela, Uzbekistan, Algeria, and Nigeria was to fossil fuel projects. These are 12 of the top developingcountry emitters.

(iii) What is the scale of subsidies in the UK, including comparison with other countries?

5. The UK provides significant support to energy projects in developing countries through IFIs and UKEF.Additional research would be required to compare this support to that provided by other countries.

5.1 A basic analysis by ODI of UK finance126 to energy projects through IFIs127 identified more than USD3 billion (or GBP 2 billion) in support between 2008 and 2011. Support to fossil fuel projects128 through IFIswas twice as large as support for clean energy projects129.130

115 http://data.parliament.uk/writtenevidence/WrittenEvidence.svc/EvidencePdf/1114116 http://data.parliament.uk/writtenevidence/WrittenEvidence.svc/EvidencePdf/700117 http://www.publications.parliament.uk/pa/cm201213/cmselect/cmenvaud/c1089-i/c108901.htm118 http://www.publications.parliament.uk/pa/cm201314/cmselect/cmenvaud/c61-i/c6101.htm119 http://data.parliament.uk/writtenevidence/WrittenEvidence.svc/EvidencePdf/1038120 http://data.parliament.uk/writtenevidence/WrittenEvidence.svc/EvidencePdf/1114121 http://www.odi.org.uk/publications/6760-uks-private-climate-finance-support-mobilising-private-sector-engagement-climate-

compatible-development122 http://www.boell.org/downloads/LowHangingfruit.pdf123 http://www.boell.org/downloads/LowHangingfruit.pdf124 http://www.odi.org.uk/sites/odi.org.uk/files/odi-assets/publications-opinion-files/8335.pdf125 Including the WB Group, AfDB, ADB, IADB, and EBRD.126 Based on capital subscriptions127 Including the WB Group, AfDB, ADB, IADB, and EBRD.128 Fossil fuel projects include: Oil, Oil & Gas, Natural Gas, Coal, and T&D Fossil129 Clean energy projects include: Solar, Wind, Demand Side EE, Geothermal, RE General, T&D-Efficiency, T&D-Clean, Policy

Loan-Clean, Hydro Small, Efficiency General, and Clean-Financing.130 http://shiftthesubsidies.org/

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Ev 138 Environmental Audit Committee: Evidence

5.2 An initial review by ODI of UKEF support indicates a wide range of support to energy projects, andenergy intensive industries and sectors in developing countries:

In June 2013—UK Export Finance announced that it will guarantee $700 million of finance for UK exportsto a petrochemical facility in Saudi Arabia.131

In November 2011 -UK Export Finance is guaranteeing a $1 billion line of credit for Petroleo BrasileiroSociedade Anonima (Petrobras) to finance UK exports for Petrobras’ investment programme. The line of creditis to expand Petrobras’ oil exploration and production facilities off the east coast of Brazil.132

2011–12 UKEF133 issued guarantees for civil aerospace business amounting to £1,832 million (out of £2.3billion), generating premium of £65.6 million and supporting the delivery of 132 aircraft in total. The aircraftwere delivered to 32 airlines and operating lessors. Where the aircraft were fitted with aero-engines suppliedby Rolls-Royce, ECGD support exceeded 30% of the financing cost of the aircraft.

The most important markets for UKEF were Azerbaijan, Bahrain, Brazil, Dubai, New Zealand, Norway,Russia and Saudi Arabia. The export contracts supported were for a diverse range of sectors including mining,flight simulators, packaging, wall coverings, petrochemical engineering, logistics, automotive supplies, cleanair equipment, cardboard packaging plant, buses, natural gas delivery systems, remote operating vehicles,plasma furnaces, air traffic control equipment, construction, automated tolling, telecommunications, defencevehicles, training services, industrial catalysts, water treatment plant, steel manufacture and processing andpipe manufacturing.

5.3 Information on support by CDC134 and other Government departments for energy projects is notdisclosed in a transparent manner (even taking into considerations of commercial confidentiality).

(iv) and (v)—Does the Government have any plans or targets to reduce or eliminate “harmful” subsidies;and what has been the progress in reducing such harmful subsidies?

6. The Government currently states that it does not provide “harmful” subsidies. Therefore it is impossible toassess if the Government has plans or targets to reduce or eliminate “harmful” subsidies; nor its progress inreducing such “harmful” subsidies.However, the Government has a commitment to supporting low-carbon growth and adaptation in developingcountries, under which the Government should seek to identify and eliminate “harmful” subsidies provided inthe form of development finance. This includes support to fossil fuel energy projects.

6.1 The submission by HM Treasury and the Department for Energy and Climate Change (DECC) to thisinquiry135, states that the UK does not have any “harmful” energy policies, but does not address the broaderquestion of “harmful” subsidies:

The Government does not consider that any of its energy policies are “harmful”. Furthermore, energypolicy (as with other Government policy) is subject to an initial impact assessment and subsequentmonitoring, evaluation and review. This ensures that the Government can provide confidence and certaintywhile ensuring that the policy advances the Government’s objectives in a coherent way that provides bestvalue for money. It also ensures that detrimental consequences can be quickly and effectively addressed.

6.2 The HM Treasury/DECC submission to this inquiry136 defines fossil fuel subsidies as follows:

For the purposes of G20 work on inefficient fossil fuel subsidies, the UK, along with other EU G20members, defines a fossil fuel subsidy as any Government measure or programme with the objective ordirect consequence of reducing, below world-market prices, including all costs of transport, refining anddistribution, the effective cost of fossil fuels paid by final consumers, or of reducing the costs or increasingthe revenues of fossil-fuel producing companies.

6.3 The UK’s 2012 submission137 to the G-20 on the Commitment to Rationalize and Phase Out InefficientFossil Fuel Subsidies states that the “UK has no inefficient fossil subsidies”.

6.4 However, a basic review by ODI of IMF data138 on energy subsidies in the G20 countries indicated thatthe UK ranked 14th (out of 20) in terms of the scale of its support for fossil fuels (including petroleum products,natural gas, and coal). This was equivalent to almost USD 11 billion (GBP 7 billion) in 2011. The IMF doesnot indicate if these subsidies are inefficient or “harmful”, however, its calculations of UK energy subsidiestakes into account inadequate pricing of externalities, including carbon.

6.5 While the Government does not have targets to track or reduce “harmful” subsidies either providedthrough Official Development Assistance (ODA) or other forms of development finance, international support131 https://www.gov.uk/government/news/massive-boost-to-british-industry-in-biggest-ever-petrochemical-project132 https://www.gov.uk/government/news/business-gets-1-billion-uk-government-support-for-exports-to-brazil133 https://www.gov.uk/government/publications/annual-report-and-accounts-2011-to-2012—7134 http://www.odi.org.uk/publications/6760-uks-private-climate-finance-support-mobilising-private-sector-engagement-climate-

compatible-development135 http://data.parliament.uk/writtenevidence/WrittenEvidence.svc/EvidencePdf/1114136 http://data.parliament.uk/writtenevidence/WrittenEvidence.svc/EvidencePdf/1114137 http://www.g20mexico.org/images/stories/canalfinan/deliverables/energy_markets/Fossil_Fuel_Subsidies.pdf138 http://www.imf.org/external/np/pp/eng/2013/012813.pdf

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for high carbon technologies and approaches may not be consistent with the Government’s clear objective tosupport low carbon climate resilient development.139

From HM Treasury’s Spending Round 2013:

The Government will maintain its effort on urgent action to tackle climate change by supporting low-carbon growth and adaptation in developing countries. The UK’s pool of money for climate changeprojects in developing countries will be increased to £969 million, funded by DFID, the Department ofEnergy and Climate Change (DECC) and the Department for Environment, Food and Rural Affairs(DEFRA).

The Government remains committed to supporting those people across the world whose economies aremost in need of development. This is in the UK’s national interest. Tackling global issues such as economicdevelopment, effective governance, climate change, conflict and fragile states provides good value formoney.

13 September 2013

Written evidence submitted by the Department for International Development

Introduction

1. This is the Government’s evidence to the Environmental Audit Committee inquiry into Energy Subsidiesin the UK. The Committee has asked for information on DFID’s approach to fossil fuel subsidies and energyprogrammes overseas. It also includes an update on the coverage of these issues in the Committee’s June 2011report on Overseas Aid.

Fossil Fuel Subsidies

2. The Government recognises the potentially negative impact that fossil fuel subsidies can have on the mostvulnerable in a country, as well as the impacts on energy use and government incomes. The Government alsorecognises the political and social issues associated with attempting to remove fossil fuel subsidies. We supportrecent work being undertaken by the World Bank, the IMF and others to consider appropriate methods toprovide greater support to country governments around fossil fuel subsidy reform, and to put in placeappropriate safety nets so that the poorest and most vulnerable people are not disproportionately affected.

3. For example, through the Arab Partnership Economic Facility (APEF) DFID is funding a range ofprogrammes, including:

— Via the World Bank MENA multi-donor trust fund, knowledge-sharing between Middle East andNorth African countries and others that have reformed subsidies, on how to move towards reformingsubsidies in a sustainable manner. This also involves specific advisory services to Egypt on reformingsubsidies and the use of smart cards for improved subsidy targeting.

— Through the World Bank, technical assistance in Egypt aiming to build capacity around fuel subsidyreform, as well as identifying the poverty impacts of reform and concrete measures that could beimplemented to allow the energy sector to remain financially viable.

— Through the World Bank in Tunisia, strengthening capacity to implement reforms to socialprotection—including fuel subsidies—and improve targeting to the most vulnerable in society.

4. The government also supports discussions at the G20 to rationalise and phase out inefficient fossil fuelsubsidies that encourage wasteful consumption over the medium term, while providing targeted support forthe poorest.

5. The Government does not differentiate its aid to countries based on their level of fossil fuel subsidies.Instead, through the International Climate Fund DFID and DECC have a range of programmes aimed atreducing demand for and dependence on fossil fuels through the development of cost effective on- and off-grid renewable energy production and improved energy efficiency, thus helping to foster more sustainable andequitable economic growth. Examples include:

— GetFit, Uganda—providing top up grants and policy risk guarantees for small scale hydropower,bagasse (sugar and rice residue to energy) and solar power. The UK is providing up to £20 millionand will demonstrate how an effective regulatory regime and cost-reflective tariffs can bring ininvestment in renewables. With other donors, this will result in at least 15 new power plants beingbuilt by 2015/16, increasing Uganda’s power supply by 30% and enabling it to put its twice-as-costly emergency heavy fuel oil plants on standby, saving the Ugandan government electricity billc. $2.6bn over 15 years.

139 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/209036/spending-round-2013-complete.pdf

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Ev 140 Environmental Audit Committee: Evidence

— Green Africa Power (GAP)—providing a long term debt-equity instrument via the PrivateInfrastructure Development Group (PIDG) for larger renewable power plants. The UK will invest£98 million to demonstrate the long-term viability of renewable energy in Africa to attract privatedevelopers and investors and to encourage future projects. It will deliver c. 270MW of new renewableenergy generation capacity.

6. The UK (DFID and DECC) has also provided £385m to the Clean Technology Fund (CTF) from theEnvironmental Trust Fund (ETF) and £225m from the International Climate Fund (ICF) since 2009 to bringabout scaled-up increases in investment in renewable energy generation, energy efficiency and low carbontransport in developing countries.

7. The CTF comprises a portfolio of over 100 projects. While many of these projects are in the design phase,33 projects have been approved and, as a whole with other project funding, are expected to deliver reducedCO2 emissions of 594 MTCO2e over their lifetime; secure $19.2bn in co-financing from governments, MDBs,and the private sector; deliver 6.4GW of additional installed renewable energy capacity (from 13 projects); anddeliver annual energy savings of 4,492 GWh (from 3 projects).

8. DFID also supports the equitable and transparent development of extractives industries to ensure thegreatest benefit for host countries. DFID programmes aim to support economic development and transparentand equitable access to the market, but do not subsidise prices. Examples include:

— Extractives Sector Support programme in Afghanistan—which aims to support the AfghanGovernment to develop its natural resources for the benefit of the Afghan people.

— Extractives Industries Transparency Initiative (EITI) Support Programme—which aims to promotetransparency of payments from oil, gas and mining companies to host country governments.

UK Government Approach to Investment in Coal-Fired Power Stations in Developing Countries

9. The Government has a strong presumption against investing in coal-fired power stations in developingcountries given that their emissions contribute significantly to climate change, and have a negative impact onlocal air quality. However, our position has been to recognise that for the poorest countries—where there is noviable alternative—it is possible that coal may be appropriate. We would need to consider these on a case-by-case basis, and at present there are no specific proposals being put forward for new coal-fired power stationsin such countries. We continue to keep this position under review.

The World Bank’s Energy Portfolio and Approach to Energy Lending

10. The World Bank has not invested in greenfield coal projects since 2010, when it contributed to thefinancing of the Medupi plant in South Africa. Over the last five years it has only invested $106m in coalpower station retrofits or upgrades. Over the past five years (2009–2013), the World Bank invested $3,481min fossil fuel projects, $9,569m in renewable energy projects and a further $6,391m on energy efficiency.

11. The World Bank’s approach to energy lending is now guided by its “Toward a Sustainable Energy Futurefor All: Directions for the World Bank Group’s Energy Sector” document. This document was approved bythe Board in July 2013. Its approach is aligned with the UN Secretary General’s Sustainable Energy for Allinitiative, looking to support increased access to energy, renewable energy generation and rates of energyefficiency. With regard to coal lending it states:

“The WBG will provide financial support for greenfield coal power generation projects only in rarecircumstances. Considerations such as meeting basic energy needs in countries with no feasible alternativesto coal and a lack of financing for coal power would define such rare cases. The “Criteria for ScreeningCoal Projects under the Strategic Framework for Development and Climate Change” will apply to allgreenfield coal power projects undertaken in such exceptional circumstances.”

12. DFID’s current engagement with the World Bank on its energy lending has two main components to it.These are:

(a) On-going dialogue and sharing of views with the World Bank’s energy anchor to give them sightof our intentions and to influence its future energy lending away from fossil fuels and towardsrenewable energy.

(b) Support to the Energy Sector Management Assistance Programme (ESMAP), which helps contributeto the development of World Bank energy practices through its research and think-tank functions.DFID is currently providing ESMAP with £20 million funding over 4 years.

13. The UK’s delegation in Washington takes a keen interest in projects that come to the board that have aclimate change element or are relevant to climate change more broadly. Through our Executive Directors,DFID is also engaged with the other multilateral development banks regarding their evolving energy strategies,providing input as appropriate.

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Approach to Access to Energy in Poor Countries

14. DFID supports the expansion of energy access in energy poor countries through a series of multilateraland bilateral programmes which increase generation, transmission, distribution, fuel and appliance access.These programmes address a range of barriers and include leveraged support to capital investments, capacitydevelopment and policy reform. The majority of our relevant support in this area is delivered through the ICFwith relevant programmes including the Results-Based Financing (RBF) for Low Carbon Energy Access projectwhich aims to provide energy access to 2.5 million consumers in predominantly low income countries viaincentivised investments in off-grid energy products and services, including solar lighting and clean cook-stoves.

15. DFID’s programmes targeting energy access and the increased supply of reliable and affordable on-gridenergy focus exclusively on renewable energy and energy efficiency technologies. Through our contributionsto the Energy Sector Management Assistance Programme (ESMAP) at the World Bank we are supportingenhanced mapping of renewable energy potential to support expansion of renewable energy sectors. Throughour support to the Scaling-Up Renewable Energy Programme (SREP), one of the Climate Investment Funds(CIFs), we are directly supporting the scale up of renewable energy in predominantly low income energy poorcountries, with almost 800MW of new renewable energy capacity approved through countries’ InvestmentPlans.

16. DFID also provides support to small local initiatives managed by civil society organisations both throughdirect support to NGOs via the Programme Partnership Agreements (PPA), as well as funding to specificprogrammes managed by, or with the participation of, civil society organisations. For example, internationalNGO, Practical Action supported community-based energy access to 220,000 people in the last financial yearunder its PPA with DFID. DFID India’s support to the national NGO TERI has delivered local access to energyvia solar lighting and improved cookstoves to 300,000 people in the past 2 years.

17. The UK is supportive of the UN Secretary General’s Sustainable Energy for All (SE4ALL) initiativewhich has proposed 3 global targets for 2030:

— universal energy access (including electricity access and clean cooking);

— a doubling of renewable energy; and

— a doubling of the rate of improvement in energy efficiency.

18. DFID has provided financial support to the initiative, which has enabled the target indicators for SE4ALLto be defined, and the establishment of the Global Tracking Framework to track progress against each of thetargets. The SE4ALL targets were incorporated in the High Level Panel Report on the Post-2015 developmentagenda which the Prime Minister co-chaired. DFID does not have an internal target for the UK contribution tothis goal, if it were to be adopted. We do track our impact on this issue through the DFID Results Frameworkindicator on the number of people with improved access to clean energy as a result of DFID funding. TheDFID Annual Report and Accounts 2012–13 shows that as at the end of 2012/13, DFID programmes hadprovided off-grid access to clean energy for over 1.1 million people.

13 September 2013

Further written evidence submitted by Renewable UK

Background

The 2010 Spending Reviewi set the LCF cap for the current spending round, rising to £2.6bn in 2015:

2010–11 2011–12 2012–13 2013–14 2014–15

£0.70bn £1.10bn £1.50bn £2.00bn £2.60bn

The December 2012 Levy Control Framework settlement approved expansion of the LCF spending envelopefrom £2.6bn at the end of this period to £7.6bn in 2020 (real 2012 prices) ‘specifically for electricity policiesin order to inform decisions on Electricity Market Reform and to provide investors in the sector with greatercertainty on future levels of Support’.

An annualised breakdown of the LCF budget was publishedii in July 2012 alongside the draft ElectricityMarket Reform Delivery Plan, set out in the table below. The figures are specifically for electricity policiesand include budgets for the Feed-in Tariff policy and legacy spending on the Renewables Obligation.

2015–16 2016–17 2017–18 2018–19 2019–20 2020–21

£4.30bn £4.90bn £5.60bn £6.45bn £7.00bn £7.60bn

Of the £7.6bn, £3.5bn is expected be absorbed by legacy spending from the Renewables Obligation and£1.2bn by the small-scale Feed-In Tariffiii, leaving only about £3bn to support new low carbon developmentsthrough the Contract for Difference (CfD). The Government has not committed to increasing the Levy cap post2020–21. Without such indications from Government, all developers of renewable and low carbon energy must

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Ev 142 Environmental Audit Committee: Evidence

operate under the assumption that the £7.6bn is a finite limit and allocation of CfDs that start after 2020–21will need to be accounted for within that cap. Given the zero-sum nature of this game, post-2020 allocationwill prevent deployment of projects before that time, unless Government makes an early move to set anincreased budget for the period after 2020.

Accounting for New Nuclear

On the 21 of October 2013 DECC announcediv that it had reached agreement with EDF on the CfD termsfor Hinkley Point C. The strike price agreed with EDF is £92.50/MWh, reducing to £89.50 should the companymove forward with its investment in new reactors at its Sizewell site. While it was announced that the CfDlength would be 35 years, the rest of the key CfD terms are not expected to be published until 2014.

While Hinkley Point will commission in 2023, outside of the current LCF period, in the absence of anyGovernment undertaking on post 2021 uplift in the LCF, developers must operate on the assumption thatwhatever sums are envisaged to be paid under the Hinkley CfD will be ring-fenced within the £7.6bn 2015–21Levy cap. While it is difficult to estimate the precise level of Levy funding that will be required to meet theHinkley Point CfD obligations without knowing the key terms of the contract or the wholesale electricity pricein 2023 and beyond, we believe a figure in the region of £1bn/year or approximately one third of the CfDbudget allowance, is a reasonable estimate at this stage.

Long Term Delivery of Renewable Energy

RenewableUK is confident that there is sufficient wind project capacity being developed that can be broughtforward by 2020 to ensure that our renewable targets for that date are met. We are also confident that an LCFlimit of £7.6bn would allow enough of that capacity to access support. However, if significant amounts of thisbudget are ‘sterilised’ by having to be earmarked for projects delivering after 2020, the ability of the renewableindustry to meet these and other objectives is threatened. In particular, there may be insufficient room withinthe LCF envelope to deliver enough offshore wind capacity to ensure that a robust supply chain is establishedand cost reduction objectives are met, squandering the first mover advantage that the UK currently holds inthis technology, squandering the first mover advantage that the UK currently holds in this technology.

It may be possible to account for both the CfD for Hinkley Point C and achieve the UK’s 2020 ambitionsfor renewable energy. However, without undertakings from Government to increase the LCF post 2020, shouldfurther CfD terms be agreed for new nuclear plant coming online in the mid to late 2020s, the ability of theLCF to enable development at scale of renewables be severely undermined. It would be advantageous forGovernment to commit early to increasing the LCF budget post-2020, and making clear that the Hinkley PointC CfD and any further nuclear plant would be financed from that budgetary increase.

Moreover, we note that the financial commitment to deploying new nuclear plant—not only at Hinkley butalso potentially at other sites—outside of the current LCF period is not a commitment that has been extendedto renewable generators. While renewable deployment is underpinned by 2020 renewable energy targets, thereis a distinct lack of a strong policy driver for further significant deployment of renewables. Indeed, theGovernment is opposing European Commission proposals to extend renewable energy targets to 2030 and hasdeferred setting a 2030 decarbonisation target until after the next election—both of which would enhanceindustry confidence in the post 2020 UK renewables market.

References

i HMT, Spending Review https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/203826/Spending_review_2010.pdf

ii DECC, LCF Update https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/223654/emr_consultation_annex_d.pdf

iii FoI request 12/1550, https://www.gov.uk/government/publications/12–1550-levy-control-framework-spending-estimates

iv https://www.gov.uk/government/news/initial-agreement-reached-on-new-nuclear-power-station-at-hinkley

28 October 2013

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