That the Grand Committee do consider the Report of the European Union Committee on the Revision of the EU’s Emissions Trading System (33rd Report, Session 2007–08, HL Paper 197).

I am pleased that we are considering this important report in the relaxed atmosphere of the Moses Room as opposed to the rather formal and sometimes artificial atmosphere of the Chamber.

Debates on EU Committee reports tend to be a little incestuous, with some half-dozen committee members slapping one another on the shoulder and saying what a good job they have done, and the Minister saying, “Hear, hear” from the margins. Therefore, I am particularly pleased to see two non-members of the committee present, the noble Lords, Lord Browne and Lord Giddens. We very much look forward to hearing their contributions.

The report was published some time ago, but I do not think that its relevance has decreased at all since then. If anything, it is perhaps more timely that we have this debate now than at an earlier stage, because the European Council will meet at the end of this week and that will provide an opportunity for EU leaders to give a little more definition and direction to the position that the EU will take up in the Copenhagen negotiations, which is of fundamental importance.

The committee’s report was published just before the December European Council, at which EU leaders reached agreement on a package of measures aimed at implementing their commitment to reduce EU greenhouse gas emissions by 20 per cent below 1990 levels by 2020, and to increase the share of renewable energy in EU energy consumption to 20 per cent by 2020. I suggest that the continual use of the refrain “20-20 by 2020” is not a good and sound basis on which to base policy. It may be nice and catchy, but I do not think it is particularly well justified. That is an aside.

One measure in that package was an overhaul of the EU Emissions Trading Scheme. The committee's report examined the proposed reforms to the scheme. We have already received the Government’s formal response to our report; I thank them for that. It is fair to say that there is precious little between us. There is a large measure of agreement on where we are and where we should be going. I will nudge the Minister from time to time to give us a little more definition and to update us on progress, but there are no major policy differences between us.

We start by asking what the ETS is about. The aim of the emissions trading scheme is to help member states—perhaps “help” ought to be in quotation marks, because I am sure that some of them do not necessarily see it as help—to meet their commitments to reduce greenhouse gas emissions. It does this by putting a price on greenhouse gas emissions. In effect, it is a device that we use to respond to market failure and to the market not costing-in the price of emissions. By introducing a cost price, it makes it cost-effective for firms and industries to reduce their emissions by increasing energy efficiency, adapting new technologies that reduce emissions or switching from carbon-based energy sources to other energy sources. That should provide a real stimulus to bring about a reduction in emissions.

The ETS is a cap and trade scheme, meaning that the authorities place a cap or ceiling on the level of emissions to be permitted and then issue emission allowances or permits that aggregate up to that cap. Those allowances are then traded among participants in the scheme, who must surrender allowances equivalent to their emissions to the authorities at the end of each year. The cap on the overall number of permits is intended to make them scarce and therefore render them valuable. For participants, the incentive to reduce greenhouse gas emissions comes from the prospect of selling unused allowances, thereby making money or from the prospect of having to buy allowances to cover their emissions, thereby losing money. In other words, it puts in place a direct economic incentive.

The theory is that that will stimulate emission reductions where they are cheapest and easiest to deliver, thereby reducing the overall cost to the economy of meeting the reduction targets. However, the history so far in the first phase has not been particularly encouraging. The theory may be fine, but in the first phase of the EU ETS, too many emission permits were issued to participants, resulting in a surplus that wiped out much of their value, and with it much of their power to stimulate emission reductions. Emission permits were also allocated to participants free of charge—that is now seen as a significant error—which in some cases led to windfall profits when companies that had received permits free still went ahead and put up the price of their products or services to reflect the market price of the allowances. That was a perverse policy effect.

We have already moved into the second phase of the ETS, which began last year and will end in 2012. The European Commission has attempted to rectify some of the problems identified in the first phase, but it is too early even now to tell whether those adjustments will be sufficient to ensure that the ETS delivers the right level of emissions reductions cheaply and efficiently. For now, signs are that although there will be a shortage of emissions permits during the current phase, 2008 to 2012, it will be considerably smaller than had been predicted, because one effect of the economic slowdown has been to reduce demand for carbon permits. Indeed, carbon permit prices have plunged from a high of €30 as recently as last summer to a low of €9 last month. It has to be faced that that has a number of serious consequences for the success of the scheme, the danger being that the price is not high enough to bring about the desired change in behaviour. That must be a matter of concern.

A second concern is that a number of Governments, it is fair to say, have already earmarked for spending the money that they anticipated receiving through the auction process, and it looks as though they will have much less to spend on reduction projects than they thought they would have.

The fundamental point is that although we are still at a stage where there must be a number of questions about the efficiency and effectiveness of the ETS, even during phase 2, all our eggs, in terms of emission reductions, are in this one basket—perhaps not all, but many of them. It has become the centrepiece of UK and EU climate change policy, and therefore the environmental and economic stakes in play are immense. A lot rides on the successful implementation of the new phase of the ETS.

If the EU is to meet its target of a 20 per cent cut in greenhouse gas emissions by 2020, the ETS will have to deliver a 21 per cent reduction in emissions in the industrial and energy sectors covered by the scheme. That is a tall order—a real challenge. In order to achieve that, EU companies in those sectors will have to face a carbon price that is sufficiently high to make economically attractive the adoption of policies that bring about a reduction in emissions. As I said earlier, the context will change when the global economy picks up, but at the moment there must be a question mark about the level of the price.

There is the significant problem, usually referred to as “carbon leakage”, that competitors in third countries may not face a carbon price at all, or will face a much lower one. That brings with it the risk that EU companies participating in the ETS may lose business to rivals in third countries or choose to relocate their own operations, leading to no environmental gain at all. The threat of carbon leakage is real. How far has thinking gone in the EU and the Government to tackle the problem of carbon leakage and identify the sectors that are particularly vulnerable to it? That is the downside of risk.

On the upside, the scheme should in principle promote the uptake of emission-reduction opportunities where they are cheapest, thereby reducing the overall cost to the economy. The ETS also has the potential to serve as the nucleus of a global network of emissions trading schemes, which could facilitate international action on climate change. That is the big prize to go for—an international global scheme. The European Commission has proposed that the EU system should be linked to comparable systems in other OECD countries by 2015, and to carbon markets in the more advanced developing economies by 2020. That objective is right, but at this moment it seems ambitious and challenging and I would appreciate any comments the Minister could make on that.

On balance—or, rather, with some degree of enthusiasm—the committee took the view that the threat posed by climate change merits a bold response, and lent its support to the Commission’s proposals to press ahead with the revisions to the ETS. There are difficulties, however, and we have warned that there will be a need for vigilance on a number of fronts if the scheme is to live up to its promise. First, if the ETS is to deliver sizeable emissions reductions, it must put a meaningful price on carbon and other greenhouse gas emissions. That is the central issue. Some of the concessions made during the December negotiations in the European Council, such as reducing the level of auctioning, lowering the threshold beyond which sectors qualify as vulnerable to carbon leakage, and increasing access to external credits—in other words, getting other people to do things to cover your own dirty work—reduce the likelihood that the scheme will produce a strong price signal.

Pulling in the opposite direction are projections showing that the third phase—from 2013 to 2020—of the EU ETS is likely to deliver a substantially higher carbon price than the emissions trading schemes that are being set up in other parts of the world, including a future US scheme. There is a difference. If we are heading towards an international scheme, which is essential, there is a problem with the carbon price that it is anticipated various regional schemes will produce. That will make it much more difficult to link the EU ETS with emissions trading schemes in other countries. In its report, the committee emphasises the importance of such links, and warns that the ETS will be less effective, both economically and environmentally, while it remains an isolated regional initiative. It anticipates that the EU will face stark trade-offs between maintaining the environmental rigour of its scheme, which is important, and extending its reach. Again, there is a need to guard against rhetoric and signing up to a global scheme that may be relatively hollow and may fail to deliver. However, it is a matter of judgment, and it is for the Government and the EU as a whole to see whether a credible global scheme can be put into place.

A third area in which the committee flags up trouble that may lie in store is monitoring and enforcement. From an administrative and audit point of view, emissions trading is hugely complex and cumbersome. The committee warns that without rigorous compliance, the ETS would not only fail to deliver the desired emissions reductions but distort competition among those who do and those who do not play by the rules. The committee was not entirely satisfied that robust enforcement mechanisms that go beyond stricter targets in the future for countries that have failed to meet their targets in the past—I cannot see such countries signing up to targets in the future if they have failed to meet them in the past—are the sort of sanction that carries much real weight.

The committee took the view that the ETS should eventually include as many sectors as possible in order to open up the widest possible range of emissions reduction opportunities. For the foreseeable future, however, the scheme will cover only about half the EU’s greenhouse gas emissions, while sectors such as agriculture and forestry, aviation and shipping, and transport and housing remain excluded. The committee took away the impression that policy on emissions reductions in these excluded sectors is proceeding at a rather more leisurely place. It should therefore be underlined that the ETS alone cannot and will not do all the work. Although we have many eggs in this basket, as I said, the ETS cannot deliver the whole picture. That is an awful lot of mixed metaphors.

In addition to the ETS, flanking measures are required to remove barriers to energy efficiency and to support innovation and the demonstration of low-carbon technologies. That brings us to coal and carbon capture and storage. Particularly urgent is the development of a reliable and commercially viable method of decarbonising coal. Coal is likely to remain a significant, and in some places growing, source of energy, particularly in the developing world.

The committee called for major investment in carbon capture and storage to establish as quickly as possible whether this technology could meet that need and at what extra cost. It supported the European Parliament’s proposal, backed by the UK Government, to use emissions allowances from the new entrants reserve to support such investment. Additional funding for CCS demonstration projects may now be made available as part of the European Commission’s economic stimulus package, but in the UK there is concern that the Government’s timetable for getting a CCS demonstration plant up and running is slipping. I press the Minister for some assurance that progress is being made in that area. At the moment, we are faced with the difficulty that we do not know whether carbon capture and storage is a viable technology or whether it can deliver at a reasonable cost. That is a major concern and worry.

Even if a commercially viable method of decarbonising coal can be found, it will be considerably more expensive than conventional coal-fired power generation. The challenge will be to persuade countries such as China and India, which will continue to be heavily dependent on coal, to deploy such technology at considerable additional cost. In the EU, we have the problem of countries, such as Poland, which are more than 90 per cent dependent on coal in their power sector. A relatively poor country will face a major increase in its power costs if it is to go down the carbon capture and storage route, which in many ways is one of the few avenues open to it.

International negotiations on a treaty to replace the Kyoto Protocol are under way and are expected to culminate at the UN Climate Change Conference in Copenhagen in December. Financial assistance and technology transfer to developing countries will no doubt form part of any eventual bargain. I have written here that the committee’s view was that the “historical responsibility” argument championed by some advanced developing countries is compelling, although quite honestly I think it is a little bit short of compelling; ultimately, it is a distraction.

Developed countries alone cannot fend off the threat posed by climate change. Much of the increase in emissions over the next few decades will come from the developing countries, not the developed countries. In terms of the human and physical capital at risk from the effects of climate change, developing countries are some of the countries that are most exposed to the effects of climate change. It is a great pity that some of those countries’ leaders are still in a state of denial. The rhetoric is not hopeful. Again, we will have to confront that difficulty, and I hope that it can be resolved in the context of Copenhagen.

It is in the interests of the larger emerging countries’ economies to curb their own emissions growth, and we must give them every assistance. The financial assistance which I am sure will be part of the Copenhagen deal that goes to them must be targeted to support reductions in emissions, and must not go down the route of general development aid.

The European Commission has recently published a communication setting out its proposals for the approach that the EU should take in international negotiations building up to Copenhagen. At the European Council on 19 and 20 March, at the end of this week, European leaders are expected to offer their steer on what the EU’s position should be. Naturally, I end with a plea to the Minister that perhaps he could share the views of the Government as they head towards that meeting.

I thank the chairman of Sub-Committee D, the noble Lord, Lord Sewel, for introducing this debate on the committee’s report on the revision of the EU’s emissions trading system. The noble Lord is an excellent chairman. This has been a good report to work on and I believe it has been well received by the Government and the Commission. There is no doubt that global warming poses a great threat to our very existence. With the prediction that the planet may warm by anything from 2 degrees to 6 degrees by the end of this century, it is sensible to take precautionary moves to mitigate that part of the rise over which mankind might have some control by curbing greenhouse gas emissions.

As the noble Lord, Lord Sewel, said, when we started taking evidence for this report last June, the FTSE stood at 5,970 and the oil price was hovering around $145 a barrel. As Members of the Committee will know, that situation has drastically altered. Today, the FTSE is around 3,850 and the oil price is around $46 a barrel. Industrial and manufacturing output has dropped substantially, and unemployment has reached 2 million and is rising fast. It is easy to see therefore that making predictions for a system that will enter into force in 2013 is fraught with difficulties.

However, we started not with a blank sheet of paper, but with the experience of the first two phases of the ETS. The scheme was Europe's response to the Kyoto Protocol, which runs out in 2012, so the third phase of the ETS will be a very important contribution to the next stage of European climate change planning. We have examined the scientific advice, and we have listened carefully to a number of business voices and environmental voices, as well as to Governments. There appears to be agreement that we must tackle this problem now and not leave it to future generations, but it is not clear that the scope of the trading scheme envisaged for 2013 is wide enough to deliver the reductions required to reduce emissions by 20 per cent by 2020 from the 1990 level.

Although the report notes the difficulties of including agriculture and forestry within the ETS because of weaknesses in verification and monitoring, we heard from the New Zealand Government, who seem to have overcome these difficulties. Shipping is another area that should be brought in, but the co-operation of the International Maritime Organisation is needed. Reduction measures in those sectors of the economy that are excluded from the scope of the ETS account for 50 per cent of emissions. They must be brought in before too long to provide a proper cap for the system. As an aside, the Kyoto Protocol has not been ratified by the United States, which accounts for 20 per cent of global manmade greenhouse gas emissions, while other large emitters such as India and China were not included in the protocol.

The first phase of the system allowed nation states to set their own emissions limits to reflect their commitment under the Kyoto treaty and to allocate nearly all the permits free of charge. As the noble Lord, Lord Sewel, said, this has resulted in windfall profits for some industries. However, with the carbon price at about €8 or €9 per tonne last week, it is unlikely to stimulate environmentally efficient investment. Governments will lose out on expected revenues while companies sell unwanted permits in order to maximise their cash positions because of the recession.

We have argued that all the permits, other than those in the sectors liable to carbon leakage, should be auctioned in the third phase, in order to allow the marketplace to find the correct level. There is no doubt that the oil price and the carbon price are related, hence the dramatic fall in the price of the permits. It is considered that permits trading in the range of €35 to €45 would provide the necessary stimulus to encourage green investment decisions. However, the decision taken by the European Council in December 2008 watered down its original proposals, and it has agreed that 70 per cent of permits should be auctioned by 2020 and 100 per cent by 2027.

Although it is tempting to comment on all the recommendations in our report, I shall comment on only one further point which I consider to be important—the use of external credits. In our report, we suggest that external credits in phase 3 should be limited to those available and unused in phase 2. We note in paragraph 225:

“External credits can play an important role in reducing global emissions cost-effectively as long as they do not crowd out developing countries’ own efforts to cut emissions”.

The offset mechanisms created under the Kyoto Protocol are the clean development mechanism and joint implementation. These are methods to allow businesses and Governments in developed countries to fulfil their emission reduction commitments by purchasing carbon credits generated by projects that result in emission reductions elsewhere. Over 1,000 projects have been registered with the CDM executive board. The UK was the primary purchaser of 59 per cent of CDM/JI credits in 2007, largely for onward transmissions. The EU will have to monitor this trade very carefully to make sure that the emissions target set for the various member states is not fulfilled more than their allocation by external credits.

The European Council meeting in December had to balance the scientific evidence and the agreed targets for emission reduction against the political climate of a deepening recession. That is what politicians do; and, of course, the result was a bit of a fudge, with brave words about commitment and then the announcement of a compromise deal. There is auctioning phased in over a much longer period, with extra time-limited derogations and the continuation of free permits in several sectors. The threshold for small emitters was raised from 10,000 tonnes to 25,000 tonnes. Generous concessions were made on the extent to which national targets on CO₂ reduction could be made by CDMs. The energy trading system is a tax on industry, which will be passed on to consumers by higher prices, especially in the energy field. With demand for industrial products falling fast, businesses will have to think very carefully about energy-efficient investments, but without that investment we run the risk of missing our national target and the EU its commitment to the international protocols.

I thank the noble Lord, Lord Sewel, both for his excellent introduction to the debate and for his chairmanship of the committee, of which I was a member.

The noble Lord, Lord Sewel, described the emissions trading scheme as hugely complex and cumbersome. Yet, in essence, it is actually a very simple scheme. Once—this in itself is something of a question—you can measure carbon emissions among large carbon emitters, you place a cap and, in principle, the tighter you screw that cap, the greater the demand for permits and the higher the price. As the price rises, so this encourages those who can easily make savings in emissions to do so, thus providing an incentive to energy efficiency and innovation. The cap puts on the pressure to reduce emissions while the trading allows this pressure to be absorbed flexibly by those who can most easily change their ways.

This hands-off market mechanism has a lot of attractions for government because it is neutral—it is the market that is effecting the changes—and it has indeed been the Government’s favoured way of cutting carbon emissions not only within the EU as a whole but specifically for the UK. A series of White Papers has come out. In the 2006 White Paper, the Government described the EU Emissions Trading Scheme as the cornerstone of the Government’s policy framework to tackle climate change. It is the main policy that we have picked up in this country for tackling climate change. The energy policy White Paper of May 2007 said:

“The best way to encourage a change in investment patterns towards a low-carbon economy, and the most cost-effective way of reducing global emissions, is to establish a price for carbon … Trading mechanisms such as the EU ETS and the CDM”—

the clean development mechanism—

“allow cost-effective sharing of the burden of reducing carbon emissions”.

Phase 1 of the EU scheme ran from January 2005 to December 2007—three years in all—and in many respects was a success, although I know that the noble Lord, Lord Sewel, has picked up some of the other aspects of it. It embraced more than 11,000 firms, and covered all major power stations and industrial installations in 25 countries, which together are responsible for some 45 per cent of carbon dioxide emissions in the EU, with the vast majority of these installations reporting their independently verified CO₂ emissions and surrendering the appropriate number of allowances to cover them to the required deadlines. In addition, an active market for emission permits was established, with the City of London as its headquarters.

Nevertheless, phase 1 failed miserably to achieve its main aim: the reduction of carbon emissions. Allocations to emit carbon, which were agreed by national Governments for each member state under a national allocation plan, were much too generous, and as a consequence the market price of carbon collapsed before the end of the three-year period. That provided no incentive to any installation to cut emissions. Instead, it put large profits—both noble Lords mentioned this—into the pockets of utilities that had raised prices to consumers in anticipation of increased costs.

Phase 1 has generally been regarded as a learning phase. Phase 2 came into play on 1 January 2008 and is for five years, lasting until 31 December 2012. It has promised to make good many of the deficiencies of phase 1. The Commission has set a much tighter cap—6.5 per cent below 2005 levels—to meet our Kyoto targets, and has vetted the national allocation processes to prevent overgenerous allocations. Only 90 per cent of the allocations were awarded free of charge; the remaining 10 per cent are to be auctioned. More plants and installations were brought into the scheme and include the aviation sector, which is to come in on 1 January 2012.

As the noble Lord, Lord Sewel, said, with only one year’s trading to date it is much too early to judge how far the new scheme will succeed. However, it is noteworthy that, as in phase 1, the price of emissions permits has fallen. On this occasion, the blame is very much with the recession; the noble Viscount, Lord Ullswater, mentioned the degree to which the price of permits has fallen.

Our report, as the noble Lord, Lord Sewel, said, is not about phase 1 or phase 2, but actually about phase 3, which is to start in 2013 and run through to 2020. The Commission’s proposal for phase 3, which it produced last spring, was successfully negotiated through the Council in December, with final clearance due later this week. Again, the proposals take into account the lessons learnt from phase 1. Instead of a series of national caps, there is to be a single EU cap which would hold, and the aim would be to cut emissions by some 21 per cent. A number of new industries such as petrochemicals and aluminium are to be brought in, and a much larger proportion of emissions licences will be auctioned. As the noble Viscount, Lord Ullswater, mentioned, the committee would also opt for a larger proportion. However, under the concessions made in the December talks we see that in fact a number of Governments have caved in, so it looks as though it will be smaller rather than larger. Where permits are given away rather than auctioned, it is in effect a subsidy for the utilities and firms concerned. New regulations on monitoring and verification are to be introduced, and the degree to which external credits can be used to offset domestic emissions under ETS obligations will be restricted.

Our report examined the proposals put forward by the Commission last summer and in general endorsed the stronger stance, particularly the notion of a tighter overall cap—a 30 per cent rather than 20 per cent reduction—provided that a broader agreement was reached in Copenhagen around climate change. If the ETS is to work, it is sensible to extend its coverage to areas such as transport and shipping. Agriculture and forestry, as the noble Viscount, Lord Ullswater, mentioned, were the subjects of an interesting teleconference with the New Zealanders on their approach to these measures. However, I do not agree that they are coping with it all, and indeed it struck me that they still have much to learn. We are also particularly keen to see auctioning extended and the free allocation of permits limited to those industries that are likely to relocate out of the EU—those that comprise the so-called carbon leakage.

We are and have been much in accord with the UK Government in all this, as their response to our report implies. However, we part company on two issues. First, we have argued that where allowances are auctioned, part of the revenue should be ring-fenced for policies that promote low-carbon technologies. The noble Lord, Lord Sewel, mentioned the importance we place on promoting carbon capture and storage. The Commission asked that a proportion of these funds be put at its disposal, but we agree with the Government that that is not a good idea. However, the money should be directed as a matter of urgency into R&D in the UK. We also parted company over the use of clean development mechanisms and similar schemes for offsetting carbon. While understanding the general argument that a reduction in carbon usage is just as useful whether it derives from an advanced country such as the UK or from a developing country such as Nigeria, it nevertheless sends all the wrong messages. If we are to meet the tough carbon reduction targets necessary to prevent global warming, all countries have to make the shift towards low-carbon technologies, with the developed countries leading the way.

In this respect, I think that the agreement on these issues concluded last December in Brussels was extremely disappointing, caving in as it did to much too great an extent to national and industrial interests on so many points where a tough stance was needed—the commitment to the 30 per cent target is still very tenuous; limiting the number of new industries to be brought into the fold was not clear; there was a caving in on the auctioning of allowances and allowing free allocations to a lot of the major players; and there was agreement that up to two-thirds of emissions reductions could be outsourced to third-world countries.

I can only agree with a letter written to the Guardian by the Green MEP, Caroline Lucas, who was a member of the European Parliament’s team working on the package. She wrote:

“EU leaders ended up with such a dramatically weakened agreement, devoid of any serious ambition ... A 20 per cent emissions reduction target by 2020 is far too little too late and, scandalously, around two-thirds of the emissions reduction could be outsourced to developing countries. This is scientifically unsound and ethically wrong. It means the EU can cherry-pick the cheapest climate mitigation potential in developing countries in order to prolong our own unsustainable model”.

I have for some time been something of a sceptic about the European Emissions Trading Scheme. I worried that it was too clever by half to work effectively, another of those schemes dreamt up by economists that get distorted in practice and never work out as planned. I confess that the probing that we undertook as a committee for the report somewhat reassured me. For all its limitations, it seemed to be beginning to get a carbon market off the ground and to provide a model that could be extended to link with others—a link that would be so important if President Obama manages to get a similar scheme off the ground in the United States.

Although my scepticism is somewhat abated, it is important to put the ETS into perspective. Its record is, as we say in the final chapter of our report, unproven. In particular, the UK Government need to beware of putting too many of their eggs in that one basket. Few dispute today the gravity of the climate change agenda. All the data coming out of last week's science meeting in Copenhagen emphasise how important it is. It is important that the Government back the scheme as wholeheartedly as they can, but other policies on that agenda that promote energy efficiency and encourage the uptake of low-carbon technologies also play a part in the strategy. As I have said before, the public mood is now receptive to the climate change message and the public are looking to the Government to provide the lead. Hiding behind the seeming neutrality of market mechanisms is not necessarily the most effective way to show that leadership.

I venture with some trepidation into this incestuous debate, but I start by congratulating the committee on the excellence of its report. I do not want to question its excellence, but I want to comment on the wider context of the ETS. It is worth remembering its background. The European Commission originally wanted a carbon tax. Carbon markets have their origin in the US, where they were used with some success to control emissions of sulphur dioxide. The EU switched to carbon trading in the face of opposition to EU-wide taxes, and I fear that this country was one of those opposing such a tax.

The Commission originally proposed to auction credits. The noble Baroness mentioned economists. Some American economists invented the notion of carbon trading. It is worth remembering that they insisted that auctioning the credit was crucial for the success of the scheme. What happened in the European Union in the run-up to phase 1 was that lobbying from business and some nations sunk the proposal to auction credits.

That is one, but not the only, reason for the conclusion drawn by the noble Baroness, Lady Sharp, which I also draw, that phase 1 of the ETS was a failure. As is mentioned in the report, the Commission likes to call it a learning experience. Putting it bluntly, one has to say that it is a failure. We have some data on its consequences for lowering emissions. Some studies indicate that emissions were something like 5 per cent lower than they would otherwise have been if the scheme had not come into operation. That figure is almost certainly empty. It is more apparent than real, because it probably comes from the fact that originally member states produced tactical exaggerations of their emissions in the build-up to the scheme. We know that they did that; it is quite well documented.

I am pleased to see, in a phrase that was also quoted by the noble Baroness, Lady Sharp, that the committee says that,

“its record—in delivering emissions reductions cheaply and efficiently—is as yet unproven”.

I hope, with the committee, that the scheme in its new form will meet with success, but it is plainly an open question at the moment. The noble Baroness, Lady Sharp, also said that it is worth asking why Governments like emissions trading schemes. In principle at least, they are quite popular with Governments. The reason is basically the one to which the noble Baroness alluded; all will be resolved by the magic of markets, and it does not seem like a tax even though it is a tax, so it has a certain intuitive political appeal.

The ETS in its new form, just like in its previous forms, must be situated in the context of a diversity of other policies and strategies that Governments have to follow. To me, that is a really crucial point, and I should like to make three sets of observations about it.

First, we must be careful not to measure success in terms of turnover. I have seen this so much in studying the literature on this over the past year. In 2007, the World Bank estimated the size of the global carbon market at $64 billion a year. Yet plainly that is irrelevant. What counts is how far it has actually reduced emissions. The report has a very good section on monitoring and standards, but it mostly covers monitoring the standards involved in the actual operation of the scheme itself. It is crucial that we monitor outcomes, but this is not discussed in the report. We must try to work out how far such schemes on the ground actually reduce the proportion of CO₂ or greenhouse gases going into the atmosphere. I assure noble Lords that we have only very partial data on this at the moment. Most of those who favour carbon trading talk in terms of the sheer volume of trading that is generated. Whatever other benefits that might bring, it does not show us anything about the case under consideration.

Secondly, as noted on page 18 of the report, carbon pricing on its own will not deliver new technologies, although it could provide something of a stimulus to them. As for low-carbon technologies and limiting emissions, we need one or more significant technological breakthroughs.

I note what the committee says on CCS. The committee is discussing it in the context of the emissions scheme. As noble Lords quite rightly said, it is problematic. We do not really know how effective it will be in the longer term, no matter how much money is pumped into it. I feel very strongly that, alongside the ETS, Governments need to reverse their attitude towards technological innovation. I remember the noble Lord, Lord Browne, speaking eloquently about this in a debate that we had in your Lordships’ House about climate change. Governments should talk less about costs and emphasise competitive advantage instead. They should stop talking only of problems and start talking of opportunities.

I note that President Obama has been dragged into duty in this discussion. He wishes to set up a trading scheme for the United States, but there is a massive contrast between his approach to climate change and innovation and that of the European Union, which—and I say this as a strong pro-European—is still a typically bureaucratic, complicated concern with regulation above all. President Obama’s approach has an inspirational quality to it. He says, “Look, we’re on the cusp of a new economy. Let’s invest in it and promote innovation. Let’s see if government can help businesses to secure a competitive edge”. There is probably a gestalt switch in business and technology whereby the companies that are environmentally progressive will be more competitive in the marketplace, and a strong reversal of emphasis is needed to go along with carbon trading and the other target and regulation-bound commitments to which the Government have signed up.

Thirdly, no matter how successful or otherwise the European trading system might be, it will not take away the need for a robust fiscal policy, and the Government should not shirk from that. We know that fiscal policy must take the form of a mixture of penalties and incentives. We know, not least because of work done in BP and the inspiration of the noble Lord, Lord Browne, that however the carbon cap is set, it is not going to be enough to guarantee adequate pricing for most low-carbon technologies. We know that we will need further taxation-based platforms for those technologies to get off the ground, because they are not competitively priced against existing fossil fuel technologies.

We also know that we need an overall fiscal order on climate change. I have been studying all the major EU countries that are signed up to the ETS in this respect, and I have found that hardly any of them have made an overall fiscal audit. By that I mean not only introducing carbon-based taxes but auditing existing subsidies for fossil-fuel businesses. I do not know how far the Government have got in making such an audit, but I would like to see them at the leading edge of the European countries in so doing.

My conclusion is that the report should be situated in a wider context, which has to involve diversity of policy. Wherever one looks in climate change—I say this having now spent a couple of years immersed in the literature of it all—there are strongly problematic elements. I support the principle of a more rigorous European trading scheme for carbon trading. I also support the principle of the internationalisation of that scheme, but that second objective is a long way off.

At the moment, my conclusion will be similar to that of the noble Baroness, Lady Sharp, in that there is a strong component of faith in the ETS at the moment. It can therefore be no more than one set of policies in the context of a whole series of other robust policies that have to be instituted elsewhere.

I, too, served on Sub-Committee D and was involved in the report. I say without any embarrassment that I found it an immensely complicated area, even if others seem to find it basic.

If an emissions trading scheme were to work effectively day to day worldwide, it would be a step forward for mankind that was almost on a par with the introduction of paper money and banks 250 years ago.

Look where that got us.

That is the point; that introduction involved a whole new way of thinking about wealth and prosperity as well as—for most of the time, anyway—being a major boost to the world economy. A worldwide carbon trading scheme would also involve a whole new way of thinking, and the idealists hope that it will represent a major new economy and increased prosperity as well as saving the world. They are idealists, after all. They might eventually be right, but at the moment the Stern review describes the economics of climate change as,

“the greatest market failure the world has seen”.

We have a long way to go, and therein lies the problem; how do we get from here to there, particularly now that we are in a worldwide recession and, as has been alluded to, the carbon price has fallen as low as €8 a tonne? It is, however, a road that we have to take. I need only repeat the Stern review mantra that the sooner we take action, the less it will cost us in the long run.

Furthermore, we do not need only an EU ETS; we must end up with a worldwide scheme. The EU is responsible for only 14 per cent of the world's CO₂ emissions, so a 20 per cent cut on the EU stage would represent only a 3 per cent cut in global emissions. We need a worldwide scheme, and eventually we need to think of a carbon economy that affects not only all businesses but all people. Having said that, my two messages for today are: first, “softly, softly, catchee monkey”; and, secondly, let us try to create a climate of certainty over a long period so that businesses and individuals know where and how to invest over a 20-year period.

On the softly, softly front, let me first deal with carbon leakage: that is, there is no point in making an EU industry uncompetitive by slapping carbon costs on to it when the production would merely move to the third world and have no such restraints. The cement and aluminium industries are good examples here. However, we can freeze the present free emission allowances for these businesses and state firmly that these free allowances are going to be gradually reduced between 2013 and 2020. This would give those industries a soft landing in this new economy but with the certainty of a route map for the future.

Again on the softly, softly front, I support the CBI belief that the de minimis threshold for a company to fall into the scheme should be raised from the original EU proposal of 10,000 tonnes of CO₂ per annum. The CBI went for a minimum of 50,000 tonnes, claiming that while it would remove 70 per cent of business emitters from the scheme, it would actually remove only 5 per cent of emissions. Speaking as someone who has spent much of his political life supporting SMEs, especially small rural businesses, I support this message. The EU and the UK Government have now chosen a threshold of 25,000 tonnes, but I have not seen any statistics on the effect of that figure. All I will say is that it is a dangerous time for the survival of small and medium-sized businesses, and in the UK at any rate they are already going to be affected by the climate change agreement scheme and the carbon reduction commitment.

We have to bear in mind in all of this that everyone and every industry will soon be forced to pay higher electricity costs as a result of this scheme. The electricity generating industries will pay for 100 per cent of their allowances from the start of the scheme: thus we will all be affected, come what may, including those industries that are protected by the carbon leakage safety net. In this context, aluminium is a very high electricity usage industry and its world competitive position will be affected in a small way from day one.

As an aside—this has been mentioned by most speakers in connection with the electricity generating industry—if non-renewable generators can apply carbon capture technology to their power stations, they too will get free allowances. This is essential, and an effective system of CCS would probably be the most important breakthrough for the whole world—not least in China and India—if it could be made a cost-effective reality. However, as time goes on, I am becoming less and less hopeful of the likelihood of it becoming the norm or even happening at all on any meaningful scale in the near future. I hope that I am wrong and that the exhortations of the noble Lord, Lord Giddens, will have some effect.

My softly, softly approach actually goes slightly further than the proposed EU scheme because I believe that every industry, including agriculture and forestry, ought to be included in the long-term plan. I have to declare an interest as a farmer, although no doubt what I am saying will not be very popular with my fellow farmers. New Zealand, which was referred to, has included its agricultural industry in its scheme but says that its agriculture will continue to have free allowances until 2030. However, it is getting its agricultural industry to assess its emissions in kilograms per hectare and thus to establish a baseline for future use. The same ought to apply in the EU. Even if every farm were made to calculate only its current emissions, that would be a first step. Benchmarks would then come into being, thought processes would happen, solutions would be identified, and, eventually, as with all SMEs and microbusinesses—indeed, as with all industries—they too would fall into the net of an ever-developing ETS. Softly, softly, catchee monkey.

As for my second point on certainty, the main thrust must be proper auditing and controls. As our chairman said, this must not be a voluntary scheme. It is crucial that the EU enforces the application of the scheme equally in every member state. Without that, it is, frankly, inoperable. We also need certainty as soon as possible on a range of other issues: for instance, in the areas I have already touched on, such as carbon leakage and the de minimis threshold. We need a long-term but well planned market structure of 20 to 30 years for this to work effectively.

Another complicated area is that of the emissions-saving projects outside Europe to which other speakers have referred, such as CDMs and the like. The extent to which these could be used to offset domestic obligations will be uncertain until after the Copenhagen conference. That uncertainty must be resolved as soon as possible, as immediate investment worldwide in new carbon-saving processes is vital now for both economic and environmental reasons. My own view—I accept that I am slightly at odds with our report—is that we should be as flexible as we dare over worldwide schemes and access to international credits, without upsetting the discipline of the internal marketplace. That may be a contradiction, but the point I made earlier was that unless this develops into a worldwide scheme, it will not serve much purpose for saving the world.

The rules on CDMs must, however, be clear and be rigorously policed. In the past, neither has been the case, and as a result clean investment in third-world countries has fallen into disrepute, which in the long run will be bad news for the future of our planet. Again, the need for underlying certainty through proper enforcement to encourage sound long-term investment is my main point.

My final point is about research, which the noble Lord, Lord Giddens, mentioned. We desperately need money for aggressive R&D in this area. It is to be hoped that imposing costs on larger industries will mean that they develop cleaner technologies that might trickle down to smaller businesses. As the noble Lord has said, however, the Government must do their bit on behalf of taxpayers and consumers, who will ultimately have to pay for all the downside risks. The CBI told us that in publicly funded energy R&D we spend about one-third of the EU average as a proportion of GDP. The Government appear to recognise that this is an important area, and they must put their money where their mouth is.

As a member of the committee, I, too, thank our chairman for the skilful way that he led us in this inquiry. I also thank our Clerk, Julia Labeta, our committee specialist, Alistair Dillon, and our specialist adviser, Alyssa Gilbert, for all the assistance they have given us with this complex inquiry.

I want to tender an apology to the chairman, the Committee and the House for overlooking that I should have declared in our report that I am an adviser to Accenture plc. I make this declaration in the House’s Register of Members’ Interests, of course, and so far as I can see it is not really relevant in this instance, but, as a number of newspapers seem to have taken to adding two and two together and reaching five, since I did not mention it I ought to make sure that my oversight does not lead to any unfounded and inaccurate allegations. I can declare it only as an irrelevant interest.

I turn to the meat of the debate. We have heard a remarkable survey not only of what we dealt with in the report but beyond it. This is a fast-moving topic, and indeed since we reported we have seen the details of the compromise reached on the terms of the system that is to run from 2013 through to 2020, and for some aspects of it on to 2027. Some of those details have fallen short of what we recommended, but positive steps have also been announced as part of the package. I refer particularly to the support that has been offered to help stimulate the much needed development of carbon capture. Here I underwrite the plea of the chairman of the committee that the Government need to get a move on in this area if they are to avoid continuing and increasing criticism from several quarters for failing to take the appropriate decisions speedily enough.

The world economy has continued to decline dramatically since we reported last autumn, and as a consequence of the downturn in business, carbon dioxide emissions have also dropped. That is a good thing, and not many people would argue against it. However, as others have mentioned, a worrying consequence is that we have also witnessed a collapse in the price of traded carbon, which is seen as a cornerstone of the EU’s climate and energy policy. Some have argued that the system might fail, contending that we are over-reliant on market forces and that policy-makers are ignoring the risks attached to a low price for carbon: something that could become the norm.

I would be grateful if the Minister could tell us what adjustments and alternatives might be available to the Government and the EU if circumstances demand changes to the system. Some advocate that we need a minimum and a cap within the price to ensure some stability for businesses in Europe so that they can see where they are going and decide whether they can sign up, but the present circumstances are so uncertain that all the hopes and ambitions that Europe might have will fail to be delivered unless we see a swift upturn in the world economy and thus in Europe.

I start from the premise, which the noble Viscount, Lord Slim, put so ably in his groundbreaking report, that the scientific evidence for global warming is now overwhelming. The benefits of early action considerably outweigh the costs. I know that this is not the universal view of noble Lords, but I share the mainstream opinion that global warming is an urgent and escalating problem. I welcome the EU’s commitment to set clear targets to try to reduce carbon emissions.

Evidence of the scale of the challenge continues to grow. The reports of the Copenhagen climate change gathering held just over a week ago were quite frightening, as the noble Baroness, Lady Sharp, indicated. The noble Lord, Lord Stern, was there, again calling for action, as he did at the World Economic Forum meeting in Davos. I am an avid reader of his contributions to the various international gatherings that he attends. I was particularly interested in what he said about Britain’s banking industry and how it is likely to become one of the nation’s key assets in dealing with climate change. He suggested that Britain’s banks and financial institutions would be an essential element in building the low-carbon infrastructure that the country will need if it is to achieve its emissions reduction targets. He said:

“Banking could do very well as Britain moves to a low carbon economy. There will be lots of business opportunities and Britain’s bankers are particularly strong in this area. They have been very creative over all kinds of issues and they could do it again in the financing of green initiatives”.

I do not know whether he was speaking with his tongue in his cheek or being truly green, but he prompted me to refer to that part of our report where, last October, we took evidence from a number of bankers, analysts and researchers. We were anxious to get an insight into how the carbon market was developing in monetary terms in its volume, its value and where it was anticipated it would go in the light of the Commission’s proposals, particularly for the third phase from 2013-20.

I will not go into all the detail. Different views have been expressed about whether the first phase has been a success. Certainly, the bankers’ view was that the money had grown very quickly in the relatively short space of time that the new system had been operating. Admittedly it has declined since then because of the downturn in the world economy, but their figures showed that it was growing at a phenomenal pace. We need to get back to growth to see whether the carbon price can initiate the changes we are looking for. Will the Minister ensure that we are up to speed with the financial regulation? On page 71 of the oral evidence, at Question 334 which I raised, the Minister will see that we expressed concerns about how the system was operating and how it was being regulated. While I take into account the views expressed by my noble friend Lord Giddens about overregulation, in some areas we need proper regulation.

In the evidence, it is interesting to note that the bankers and the analysts expressed doubts about the ability of the FSA in this area. One witness said:

“What is lacking is the financial regulation. The FSA does not care all that much about the carbon market just yet”.

This is a market worth not just up to $60 billion, but estimated—not the final figure—for 2008 to be worth more than $100 billion within the space of three years. The witness continued:

“The bigger gap is in financial regulation. If we want carbon to be an asset class in the same way as other commodities are assets, then before long we have to get serious about the financial regulation of that asset class”.

In fairness we did not take any evidence from the FSA, which may have quite a different view on this. I would welcome the Minister’s comments and his assurance that this issue is being examined and that we will not run into problems in the same way we have in other areas with our banks over recent months.

This report highlights both the challenges and the opportunities of emissions trading as part of a strategy to reduce carbon production. Like others, I believe that ultimately the solutions will have to be found on a global level. Given the problem we have with the price of carbon and where it is going, can the Minister indicate how much elbow room and opportunity there will be for European Governments at the forthcoming Copenhagen conference to actually have the money needed to incentivise the BRICs to get involved with us and the other developing countries to participate in a global climate agreement? Without the money being there and the incentive being open to them, I suspect that, while we may have our scheme operating in Europe—warts and all—it will not be worth anything if we cannot pull in the rest of the world. We have to be in a position to incentivise them to join us.

Before I start, I should like to disclose interests. I am a managing director of a company called Riverstone Holdings, which manages private investments in energy. I am also chairman of Accenture’s energy advisory board and I am on the advisory boards of the following: Deutsche Bank’s climate advisory board; Sustainable Forest Management; and Valiance, a European infrastructure investor. I believe that that should cover all the bases.

I very much support the conclusions of the report, and I congratulate the noble Lord, Lord Sewel, and the sub-committee on constructing it. I also very much support emissions trading schemes generally. In theory, the EU ETS is about the efficiency of resource allocation in the EU, getting resources to the right places. But that is in theory. I also agree that as many sectors and as many parts of those sectors need to be included in the scheme as possible. In the light of those comments, let me make four points.

The potential emissions reductions that come from forest and land management need somehow to be included. Many scenarios show that if we take the period just to 2020, a period that we can probably understand quite well, up to half of the required emissions reductions could be achieved by better forest management and land husbandry. So, first, somehow that must be included.

Secondly, to scale this globally there must be a link to the clean development mechanism or, more precisely, to whatever succeeds the present clean development mechanism, which is a project-based system. Given some concerns about governance, we hope to go to a programme-based system, one that can be administered more easily with the appropriate governance.

The reason that that is important is that if we look at what needs to be done by 2020, two-thirds of the required emission reductions are likely to be achieved in the developing world, and the cost of achieving them will be one-third of the total, so it is very important to link a CDM mechanism to the EU ETS. The scale of expenditure in total is about $100 billion, which exactly corresponds to all overseas development assistance last year. Carbon finance flows need to be at about that scale, and much of that could be achieved by a revised CDM mechanism.

Thirdly, there are plenty of exceptions in the scheme, so the EU ETS will not be a pure indicator of the price of carbon needed to reduce the amount of carbon dioxide to an acceptable level. Experience to date has shown that it will also create a carbon price that is too volatile for long-term planning. In my practical experience, the carbon price established by the trading system is unlikely to be used to determine whether a project will go ahead or not. It simply will not be used in that way, because most decision-makers will not know where to place it. We therefore need different systems to create stability of estimation, some certainty and consistency, and to do that in a transparent way. Until the system develops fully, we cannot regard it as the only mechanism to price carbon. We need it relevantly to operate alongside regulations, incentives and taxes designed to price in the carbon externality in a practical and stable way.

We also need to understand that whatever we do and whatever we think about the EU Emissions Trading Scheme, it probably applies to longer term stable investments. It does not help in determining how much research has to be done or what should be done in innovation. Nor will it inspire innovation. All these things need to be done by making choices and taking decisions.

I agree with the noble Lord, Lord Giddens. These systems and mechanisms of trading, incentives, taxes and regulations are in many ways designed to create a level playing field between many energy sources. In order to understand that level playing field, we need to examine the existing energy sources and ask ourselves what explicit, or otherwise implied, subsidies are applied to these sources. That is the result of a fiscal audit, which he has suggested.

Most people look at the things being talked about with regard to climate change and energy and ask a simple question: does this change the way our economy will work? Will it change the whole way we think about not just energy or climate change, but everything—not just separate and apart, but integrated with what we do? The question we have to ask is whether that will happen with this scheme, or whether it will be used as a crutch to avoid looking at the whole system that operates our economy.

I also thank the noble Lord, Lord Sewel, for this report. I agree with him that we should try to make this session rather less formal than maybe it would be in the Chamber, although I notice that we have not had any Committee-style interruptions or interjections yet—not that I am inviting them over the next 10 minutes.

Reading through the ETS report took me back to my young management days when I was an energetic manager in industry. I was a member of the Bristol Junior Chamber of Commerce and we took part annually in a competition based on a business game. This was back in the 1970s, when computers did not exist in the form that they do now. We would be given a scenario. We decided a number of management actions, which we would fill in on a form and send off. They would be fed through a computer, along with forms from our competing junior chambers, and it worked out what would happen. When we came back the following week we found out what the results of our management had been, and then we made our next step. That reminds me of the EU ETS, except that we do not have a one-week gap—we operate on gaps of five years and seven years—but it is just as much in the fog of what else is going on. It is even more on the cutting edge of experimentation. But, instead of talking about junior managers and a theoretical company, we are talking about the future of the planet, its atmosphere and the major pollutant that we are trying to control, and about changing the habits of the whole of industry globally. That is the challenge.

As many Members of the Committee have said, this is the key item in the climate change toolbox in Europe and the developed world. It accounts for some 50 per cent of carbon generally, so it has to work. We do not have much of an alternative. We have various regulations and incentives, such as renewable energy targets. But, at the end of the day, if this mechanism, which we have been investing in for some eight years or so, does not work, we have a problem overall.

The mechanism is market-based. The noble Lord, Lord Giddens, is right; the irony of this to me was always that this mechanism was almost demanded by an American Administration—at the fag-end of the Clinton era, I seem to remember—and taken on by the EU. Then the US did not even put the Kyoto Protocol through Congress to be ratified. Therefore, we have a cap system that needs to decline between 2008 and 2020 by 21 per cent. Why has this become such an important item in the toolbox? It is one that we like to think can work but, as I believe the noble Lord, Lord Giddens, said, it is an easy way forward for the Government, and I do not say that pejoratively. It does not constitute an overt tax, even though it will affect prices, and, even better, it provides an income stream, so you win both ways: you are not only seen as not taxing the public but you have a significant income stream, to which I shall return in a minute.

On the negative side, the problems were well outlined by my noble friend Lady Sharp. For example, we have oversupply in the first phase. In the second phase there will still be a problem of free issue, which means price variability. When a business is short of cash, it looks at its assets. If assets have been allocated to it for which it has not had to pay and which have a market value—even though IRRs are low at the moment, their present value is worth a lot more than their future value—it sells them and so the whole market moves down, although I know that it has bounced up slightly. With regard to the problem of flooding clean development mechanism units, the Commission has tried very strongly to restrict this although we are already committed to moving them forward from phase 2 into phase 3. Once they are there we are stuck with them, but the quality of incoming units could devalue the clean development mechanism EUAs.

The good news is that the mechanics of the system have worked well. Verification is one of the most positive aspects of the EU ETS. I am not aware that anyone has questioned the monitoring of individual plants’ emissions, whereas claims of cheating are rife in more or less everything else to do with the European Union. The verification procedures are good because they relate mainly to large-scale installations or energy users. It would be preferable to address other sectors such as farming, agriculture or land management but problems around verification and having confidence in the scheme immediately arise. You have to have balance in that regard. On phase 3, I very much welcome the European Commission’s stronger management regarding the issuing of EUAs and its efforts to curb the inflationary aspects of clean development mechanisms. A further positive aspect is that the new-entrant reserves are also being reduced—down to 5 per cent, I think. Even then, they are allowed to be allocated only on a best-technology basis. However, if we had complete auctioning, new-entrant reserves would not be required. They exist only because we allow free allocations in the first place.

Aviation will come into the scheme in 2012. It is a pity that we have to wait until 2012 for that but it is only three years away. However, there is no mention of shipping coming in, although the report says that it should be included where that is possible. That would be a good step. The calculations around aviation and shipping may be difficult but the emissions are reasonably easy to verify.

On carbon leakage and the whole area of auctioning, we cannot get away from the fact that to get a proper carbon price to make the system really work we have to auction a very large proportion of the total. The Commission does not expect total free allocation to end until 2027, and the figure should be about 70 per cent by 2020.

Again, we would not have had the fall in carbon price that we have had over the past month if we had had auctioning and people had to pay. You would not buy until there was a need, so you would not have the vast offloading of an asset, particularly when there is no co-ordination between member states as to when those annual allocations are let out. We are not sure whether the carbon price is going to come down again, because we are not clear when Poland is going to fully allocate the rest of its 2008 allocation, let alone its 2009 allocation. That is a major issue.

I welcome the fact that we are moving out from just carbon dioxide into other greenhouse gases—nitrous oxide and perfluorocarbons. That is good, and I also welcome the de minimis rule. As the report says very well, we have to make sure that we do not have the situation that we had with car taxation where, if there is a big step up in costs, everyone designs a car to be below that level, so that everyone gets away with the taxation. There are a number of good things there.

What concerns me greatly—I reflect many of the comments made by my noble friend Lady Sharp—is that we are heavily reliant on this one mechanism. If this does not work, the whole climate change strategy falls over in one step. We enter this debate and leave it knowing that it has to work. It includes only 40 per cent to 50 per cent of emissions. The next step down, which the UK Government are trying, the carbon reduction commitment, is only another 5 per cent or 10 per cent. Even beyond that, there is a long way to go.

I absolutely agree with the noble Lord, Lord Browne, that every business that I have talked to, even large-scale ones, does not really take notice of the fact of the carbon price. No one really puts that into the spreadsheet or the investment appraisal, because it is so difficult to put it in, considering whether it will be there in the long term and what the price will be. Until that starts happening—that is the litmus test in the boardrooms of this country and of Europe—the system has failed.

The report talks about the rest of the world, which is clearly pretty important, as the European Union is now only responsible for about 15 per cent of emissions. It is wrong to look at the developing world, particularly China, and say that now the largest polluter has to change its mind. I believe that China realises the challenges, but it also understands that it has to solve the huge rural poverty in its own nation. That is the only way that China can move forward. The will is there. We should never forget that although its production of carbon may have gone up quite substantially—now it is up to 27 per cent or 30 per cent of global emissions—a major proportion of that increase is to feed our consumption in Europe and North America. Its answer to us is, “You have put carbon into the atmosphere in the past, but now a large proportion of the carbon that we are putting into the atmosphere is for you to consume as you want to as western consumers”.

This scheme has to succeed. We are overcommitted. The market mechanism is right, if we can make it work. We have to apply it as it needs to be applied. That means a large proportion of auctioning of permits early on. I regret to say that we have to be very cautious about the number of clean development mechanism units that we allow into our own scheme. Philosophically, I absolutely believe that a tonne of carbon saved elsewhere is equal; it does not matter where it is. The problem is that in verification of those schemes, you devalue the gold standard in Europe. Because this scheme has to work, there has to be another way to make technical efficiency in the developing world work better. I do not say that I have the right answer to that, but we risk undermining the scheme.

I should like to ask the Minister how the Government will use the £8 billion that they will get per annum by 2020. It is a nice revenue to have, and I would like to think that it will go into this area. The British Government have gone through two rounds of auctioning. What lessons came out of that that they would like to share with Europe and the Commission? How can we get carbon capture and storage to go at a much faster pace? I think we have already lost that one for 2020. Carbon price stabilisation was referred to by the noble Lord, Lord Browne. The noble Lord, Lord Turner, in a committee of the other place, talked about the possibility of floor pricing. Are the Government looking at that? Even if we meet all our EU ETS targets on carbon savings and reduce them by 80 per cent by 2050, what will our carbon consumption be by 2050 compared with in 1990?

I thank the noble Lord, Lord Sewel, for his excellent introduction and the members of the European Union Committee on the revision of the European Union’s emissions trading system. I thank in particular those who have spoken today, including my noble friend Lord Ullswater. He said that it is fairly incestuous that members should turn up and speak because they have been on a European Union Committee, but I am very happy to be here today. I spent the first six years of my time in this House serving on European Union committees, which was a very good apprenticeship for the Front Bench. It teaches you patience, if nothing else.

My party warmly endorses this report, which is mainly in line with the Conservatives’ publicly stated position. We fully support the EU ETS and agree that the scope needs to be enlarged to progressively cover more economic activity. There have been some excellent questions. Every day, I learn something more about this subject. I was obviously delighted to listen to the noble Lord, Lord Browne of Madingley, who brings such experience to our debates on this subject.

I, too, would like to ask some questions. I will try to keep them brief because we have been here a long time. We have all had a very nice time, but I am sure that the Minister is ready to deal with us all. In reference to the EU ETS, the committee states that,

“the fledgling scheme has yet to demonstrate that it can deliver the substantial greenhouse gas emission reductions that will form the yardstick of its success”.

Does the Minister agree with this assessment, and what changes does he advocate implementing to make real inroads into reducing greenhouse gas emissions and prove the worth of the scheme? It is evident from the committee’s report that it anticipates the European Union eventually facing stark trade-offs between maintaining the environmental integrity of the ETS and extending its reach. Therefore, it would be good to know what discussions the Minister has had with his European Union counterparts over this potential trade-off. What measures does he think he can put in place to ensure that the ETS reaches its full potential without jeopardising its integrity?

Provision has already been made for the inclusion of aviation in the ETS from 2012. However, no such provision has been made for shipping. As we heard from the noble Lord, Lord Teverson, and my noble friend Lord Ullswater, the committee’s report highlights that action needs to be taken on shipping, and its inclusion should be delayed until no longer than 2013 for the largest emitters in this sector. Does the Minister agree, and will the Government make a similar provision to include shipping in future UK carbon budgets?

On allowances, one of the major flaws of the pilot phase in 2005-07 of the EU ETS, as we have heard, was the overallocation of free permits. In the second phase, the number of free permits was reduced by 5 per cent and the auctioning of allowances increased. The proposal for the next phase is to put in place 100 per cent auctioning for the power and CCS sectors by 2013, as we have heard today. The committee seemed to be of the opinion that while a shift towards full auctioning is a positive step, derogation should be permitted to those with particularly fossil-fuel-intensive energy sectors, and we wonder if the Minister is in alliance with that view.

The committee agreed with the UK Government that it would be inappropriate for the European Union to prescribe how auctioning revenues were spent. That said, the committee stipulates that member states should invest considerable funds in climate-change-related measures. What is being done to ensure investment in and the protection of certain sectors, such as carbon capture and carbon storage?

Again, I congratulate the noble Lord, Lord Sewel, and the members of the committee on such a good, solid report. It included plenty of analysis of the future options of the ETS and the need for reform for the next phase. We agree with the way ahead, but it will need strict policing, auditing and those mechanisms. We have heard twice today about the fiscal audit that will be necessary. That is true, but having served my time on the European Union Select Committees, chaired the National Consumer Council for six or seven years and spent a lot of time in the EU working with the member states, I know, although it is difficult to accept, that how we behave is not necessarily how all the other members are going to behave.

This subject is particularly complicated. It is not familiar to people, and it is not delivered in a language that they can understand. We are therefore in danger of alienating them from these discussions. Those who know Kipling’s poem “Norman and Saxon” will know how important to the British people are the words “fair dealing”. Fair dealing is something the British people understand and stand by; they will put up with pretty well anything else. The worry with the European Union, certainly for enforcement, is always that this is not a level playing field. If we are going to build confidence in saving our world, and if we are going to take our people with us, we should encourage more of these reports to be written in a language that can be taken up by the press in such a way that the general public are not frightened or confused but can actually understand what we are saying.

It is a pleasure to respond to the committee’s excellent report. I commend my noble friend and members of the committee on it. I agree with him that the Government’s response shows that there is not much between us; we all broadly share the same philosophy, and many of the questions that noble Lords have raised are the very issues that the Government are grappling with in our negotiations in Europe and internationally.

This has been a good debate. I share my noble friend’s enjoyment of taking part in debates in the Moses Room. Indeed, as a refugee from the Marine and Coastal Access Bill, I wish that we could debate in the Moses Room day after day after day.

I agree with my noble friend Lord Sewel that, although the report was written in the lead-up to the negotiations for the agreement reached in December last year, the substantive comments have been as apposite to the situation today and in the lead-up to Copenhagen as they were before Christmas. The report is as relevant as when it was first produced. The noble Baroness, Lady Sharp, said that at its heart, emissions trading is simple. Indeed it is, but the reality is that it is a very complex procedure. The noble Baroness, Lady Wilcox, and I share a strong feeling that the language used by Governments and NGOs in the whole arena of climate change seems designed to create a barrier between the experts and the public. Over the next few years, as people begin to understand what climate change really means and what we have to do to combat it, we will have to sort out the language. Who understands what the words “mitigation and adaptation” mean? The trading scheme itself is very difficult for anyone unless they do what noble Lords on the committee have done, which is to spend many hours and days learning to understand it. This is a major challenge if we are to win public support for the changes that need to be made.

Let us be frank. The reason it has proved to be so difficult to negotiate a really effective emissions trading scheme in Europe is because of the fears felt by Governments about the impact of going for a tight scheme on their industries, jobs and the public. While collectively I think we can regard ourselves as inside the climate change tent, in the lead-up to Copenhagen we need to think carefully about how we will manage communications and take the public with us. If we cannot do that, we are not going to pass the test set for us by the noble Lord, Lord Teverson, of promoting the critical importance of making this system work.

The noble Lord, Lord Teverson, said that the ETS is the major tool in our armoury, so we have to make it work. However, noble Lords suggested that phase 1 had been a failure. My noble friend Lord Giddens and the noble Baronesses, Lady Sharp and Lady Wilcox, also made that point. It is clear that the market was overallocated and, in the euphemism of Europe, the 2005-07 phase of the ETS was also intended as a “learning period” prior to the Kyoto commitment. Perhaps that is the softly-softly approach described by the noble Lord, Lord Cameron. We are where we are, and the really important issue is whether we have learnt the lessons taught by the difficulties encountered in phase 1 to translate, at least in terms of practice, into phase 2 and, it is hoped, into the outcome of phase 3.

In phase 2 the Government will auction 7 per cent of allowances, one of the highest levels of auctioning in the EU. We have held one auction so far, and from now on we will be auctioning every two months. Perhaps I may write to the noble Lord, Lord Teverson, and other members of the Committee because I have extensive details of how the first auction went. It was oversubscribed, which gives us confidence for the future integrity of the system. As I say, I have some interesting information about it that I am happy to circulate.

That takes us to phase 3. It is a fact that we were able to conclude an agreement in December. Although noble Lords have expressed disappointment with some aspects of it, it was by no means assured that we would even reach an agreement. At many moments it appeared to be touch and go, which explains some of the compromises that have had to be made. We cannot run away from that. The noble Viscount, Lord Ullswater, talked about the current economic climate, and he was absolutely right to do so. But the state of the economic climate was used by many countries in the negotiations to argue that the downturn justified postponing action on climate change until stability returns. To accept that argument would be an utter disaster. Although there is some disappointment about certain aspects of what was agreed in December, the fact is that an agreement was reached.

That agreement puts us in a much better position for phase 3 than we are in for the current phase. We see a more rigorous approach to setting the cap on emissions; it is set at a much more ambitious level, and there is a large increase in auctioning. Several noble Lords commented on auctioning. I have every sympathy with the points raised, but the fact is that at least 60 per cent of EU ETS allowances will be auctioned by 2020. In phase 2, by our reckoning, only about 3 per cent of allowances are being auctioned across the EU. Our goal for the EU ETS is for 100 per cent auctioning in the long term. We share the committee’s goal on that, but I cannot underestimate the difficulties that we have had in negotiating the auctioning level that has been agreed. We must carry on arguing on that.

The noble Lord, Lord Teverson, is right about free allocation: it will not end until 2027 in the revised directive, but will be revised after Copenhagen, assuming that we are successful. We must ensure that any free allocations are fully justified.

Aviation will be included in the EU ETS from 2012, but not shipping. I understand that if nothing is agreed internationally on shipping at Copenhagen, the European Commission will put forward a proposal by 2011 on the inclusion of shipping in the EU ETS, because clearly it is very important that that should happen.

What about the non-traded sector? The package included an agreed effort-sharing decision that sets targets for reductions in the sectors of member states and economies not covered by the EU ETS. For the UK, that would mean a reduction by 2020 of 16 per cent from the 2005 levels, achieved mainly in transport and heating. It is then left to member states to set out policy measures to meet those targets. In the case of the UK, that is governed by the Climate Change Act, the Energy Act and the renewable energy strategy.

One way that we will do that is through carbon budgets, which will be set for government departments. Departments will then have to take responsibility for the particular sector of the economy where carbon emissions take place. We see that as a way to bear down on emissions not covered by the ETS. We are working very hard across government at the moment on the development of carbon budgets. I believe that that will be a very important tool in the UK’s armoury.

Let me give an example of that: agriculture. Because of the importance of the agricultural sector, which several noble Lords referred to, it is perfectly possible that one of my departments, Defra, will have to take responsibility for a reduction of emissions in that sector. Frankly, that could be very challenging indeed for Defra. Speaking as a DECC Minister, I am delighted that it is that department which is to face the challenge.

I took part, appropriately enough, in a seminar at London Zoo about four weeks ago, where Defra had called together experts from the agriculture/farming sector to discuss how emissions could be reduced. We had very good representation from farming interests, and there was a great deal of encouragement. We are committed to exploring the potential scope and feasibility of a market mechanism to enable the trading of greenhouse gas reductions from agriculture, forestry and land management. We are very much focused on the points that have been raised by a number of noble Lords.

I have heard the noble Lord, Lord Teverson, speak very eloquently before on the question of CDM, when I came in at a late stage on the Climate Change Act. I entirely understand where he is coming from. On the other hand, CDM provides valuable financial flows to developing countries. At heart, the question is the integrity of the system. Noble Lords have essentially said that we have to ensure that monitoring and enforcement are of the highest order. I and the Government agree with that, and we will be working with our EU partners to address those problems. In general, that leads to the point raised by my noble friends Lord Giddens and Lord Brooke about monitoring. I will go on to talk about the issues that were raised about the FSA. Clearly, unless we have confidence that the system is properly monitored and properly enforced, it will not have credibility. It is a tremendous challenge for all of us to ensure that the system has credibility.

My noble friend Lord Sewel and other noble Lords mentioned carbon leakage, which is something that we have to tackle very seriously. Because of the need to tackle it, it raises concern about the directive’s provision to allocate allowances for free to those installations proven to be at significant risk of carbon leakage. We are concerned that the directive provides for rather more sectors to be deemed at risk of carbon leakage than appears justified by the available evidence. I am not sure that I am providing as much comfort here as noble Lords would ideally wish me to provide. I can provide recognition that this is an important matter on which we will continue to have to work with our European colleagues.

A number of noble Lords have raised the issue of the carbon price. It has gone up a bit; it currently stands at €12.50. When I was being briefed for an Oral Question two weeks ago—this did not come up, but it might have done—it was about €9. It is very much lower than it was only a short period ago. There are two points that I want to make. Of course, I accept the question about long-term investment. The noble Lord, Lord Browne, and my noble friend Lord Brooke talked about the considerations in a boardroom in terms of carbon pricing and what factor it bears. They both suggested that at the moment the answer is not a lot; certainly not in terms of making long-term investment decisions. Clearly, the volatility in price has not helped that, nor has the current economic crisis that we face. One of the questions is the extent to which it is still early days. As the trading system matures, companies may become more used to it and it may well factor into their decisions more; we must certainly hope so.

We do not favour caps; in answer to the noble Lord, Lord Teverson, we prefer it to be a market-based mechanism. We will have to monitor the position, but where 2020 is concerned it is important to remember that the commitment, the ETS cap on emissions, is geared to deliver a 21 per cent reduction by 2025, and that has to be delivered regardless of the carbon price. Clearly, the carbon price has an impact on the decisions and the economics that will need to be addressed, but we will hold fast to the cap itself.

On regulation, my noble friend Lord Brooke raised the fact that the European Commission is looking at whether we need greater regulation of the market to avoid the kind of manipulation that he spoke about. This is traded on a regulated market by the FSA. It is equivalent to other commodity markets. Obviously the role of the FSA in general has come under considerable scrutiny, but I have no evidence to suggest that the FSA has not been and is not able to discharge that responsibility effectively.

On the question of a fiscal audit, one accepts the need for additional policies, including regulation, to complement the emissions trading system. We are looking to Her Majesty’s Treasury to keep us on track to ensure that the most effective balance and incentives are in place, and we will be ever vigilant on this.

I turn to the issue of a global market and the links between the regional trading systems. My noble friend Lord Sewel and the noble Lord, Lord Cameron, raised the important problem of the differences between carbon pricing in different regional schemes. There is no doubt that where different regional schemes have different prices, that will cause difficulties in linking schemes. Our overall strategy is to have similar prices and ensure similar amounts of effort in emission reduction. That is our aim in negotiating an agreement in Copenhagen, which I will come back to in a moment.

On technology, innovation and a competitive market for this country, yes, we must promote innovation. We have funds; I am responsible for one called the environmental transformation fund, which is geared towards companies in the renewables sector that are near to market. Other funds are administered by other government departments, notably DIUS, but we know that there is more to be done and we need to integrate those funds more.

The noble Lord, Lord Browne, took part in a summit on the low-carbon economy about two weeks ago. It became well known for green paint, but it was actually an interesting discussion with stakeholders about how we ensure, with the inevitability of a low-carbon economy, that this country takes advantage of it, that there is proper investment, that we use British skills and that we make the most of our expertise. That will lead into a low-carbon economy strategy that we will publish in the summer. Of course the Budget will soon be upon us; I cannot comment on what is in it, because I do not know, but I will ensure that the comments on fiscal stimulus that were made today are passed on to the Treasury for its consideration. I shall certainly not respond to the comment of the noble Lord, Lord Teverson, about how I shall spend the £8 billion in 2020, much as I should like to.

I hope that I can reassure noble Lords as regards coal and CCS. In the December negotiations we successfully persuaded Europe to support CCS. Of course, it is unproven in terms of scale and there is no getting away from the fact that it is very expensive. However, we are committed to having a commercial-scale CCS project operational by 2014. We have a competition process, the pre-qualification stage of which finished in June 2008. We aim to issue the formal invitations to negotiate shortly. I very much take the point that if we can pull off CCS in this country, it will offer us great potential in terms of exporting our know-how and technology. There is huge potential there, which is why we are committed to CCS. A number of noble Lords said that they were beginning to doubt whether we can pull this off. We should just keep the faith for a little longer. The Government are committed to taking CCS forward. As I said, the competition process will go forward. The Government certainly recognise the importance of CCS alongside all the other developments in the energy sector, including new nuclear and the takeover of British Energy by EDF. Given the expressions of interest now coming forward from a number of other consortia to build new nuclear, there is huge potential there for this country. One can look back to the 1950s and ask what would have happened if Britain had stuck with peaceful nuclear energy. We missed that chance but we have a second chance and we have to ensure that we make the most of it.

As the noble Lord, Lord Teverson, and other noble Lords suggested, a huge effort will be required to reach the renewables target, but we are committed to doing so. We think that we have the stimulus right although a lot more work needs to be carried out. However, we believe that our technical leadership will produce many spin-offs for this country, particularly in the marine area.

So much is riding on Copenhagen. We are optimistic. The discussions of my right honourable friend the Prime Minister in Washington were paralleled by Ed Miliband’s discussions with senior members of the Administration. The Obama Administration have a very important role to play, but so, too, do the developing countries. My noble friend Lord Brooke made the important point that we will not get a deal simply by hectoring developing countries. We know that that is the case. I agree with him and other noble Lords who mentioned the need to incentivise. I agree that the road to Copenhagen may well be very rocky, but at heart I remain optimistic. All the signs are that, although it will be very tough, there is a determination on the part of many countries to reach agreement. That will be very important as regards the renewed targets that Europe will have to discuss.

This has been a very good debate. It has informed the Government about some of the key matters that we still need to take forward and to monitor carefully. The committee’s report is excellent and is improved and enhanced by tonight’s debate. I am most grateful to all noble Lords for all their hard work and the contributions they made tonight. I hope that in a year’s time we will gather together to discuss the outcome of Copenhagen with a view to it being successful, and that the EU ETS will be seen as an important contribution to that which has credibility and integrity. As noble Lords have said, I hope above all that the outcome is that we reduce our emissions.

As it is nearly two and a half hours ago that I moved that we consider the report, we have considered it and considered it right properly, so to speak. At this stage, I shall say very little. I shall underline only three things. Carbon capture and storage is critical. At Copenhagen, the danger is that whatever is agreed will be presented as a success. Whether it is a success in reality is another matter. I have to say that I am a little sceptical about the extent to which we will finish up with a robust agreement at Copenhagen. Finally, there is the need to get a proper market working, to have auctioning across the board and to bring other sectors into the ETS. Those are the key factors in this area.

I thank the Minister for his comments and, as I said earlier, for the Government's reply to our report, which we welcomed. I also thank the members of the sub-committee, who worked so long and hard on the report. If there was ever a learning experience—was that the phrase?—it was not really phase 1 of the ETS but the first dozen meetings of our committee, as we tried to go from a basic level of zero knowledge to a passable awareness of the main issues. For that, we have to thank—this is not just for form’s sake; it is a real debt of thanks—the witnesses who came before us, who were enormously patient in explaining things in a way that some of us with decaying competences could understand; our specialist adviser, Alyssa Gilbert; and the formidable home team of Julia Labeta and Alistair Dillon. All of them helped us to move from negative knowledge—which, if there is such a thing, we started with—to at least an appreciation of some of the main issues. There are some real unintended consequences and perverse factors lurking in the undergrowth that we have not identified.

I thank the two members of the committee who were not members of the sub-committee. We benefited enormously from their breaking the tradition by coming to contribute. There is, of course, another tradition in these debates; every member of the committee gets up and praises the wisdom, diplomacy, forbearance and skills of the chairman of the committee. That is a very good tradition, but on that point I will sit down.