Considered in Grand Committee
My Lords, the order was laid before the House on 13 July 2020 in draft. The UK will cease to participate in the EU emissions trading system at the end of the transition period, as a consequence of the UK’s withdrawal from the EU. This draft Order in Council, laid under the Climate Change Act 2008, establishes a UK-wide greenhouse gas emissions trading scheme: the UK ETS.
Emissions trading schemes work on the cap and trade principle, where a cap is set on the total amount of certain greenhouse gases that can be emitted by installations and aircraft covered by the scheme. Within the cap, participants receive or buy emission allowances, which they can then trade with one another as needed. This cap is reduced over time so that total emissions fall. Participants are required to monitor their emissions during a calendar year and surrender one emissions allowance for every tonne of carbon dioxide equivalent they have emitted at the end of each reporting year.
The four Governments of the United Kingdom nations have agreed the policy positions that act as a basis for this UK ETS. These positions are set out in the government response to The Future of UK Carbon Pricing consultation, which was published on 1 June 2020. Further secondary legislation, to be introduced later this year under the Climate Change Act 2008 and the Finance Act 2020, will amend this order to introduce additional elements of the UK ETS.
On the importance of emissions trading for decarbonisation, a UK ETS would support us in pursuing our climate ambitions by enhancing the UK’s carbon market signals. From day one, the cap on emissions within the scheme would be reduced by 5% compared to the UK’s notional share of the EU ETS cap. That is not the limit of our ambition. The Committee on Climate Change will, in December this year, deliver its advice on the level of the sixth carbon budget. Once this advice is published, we will consult within nine months on what the trajectory for the UK ETS cap should be for the remainder of the first phase, to ensure that it is appropriately aligned to our net-zero objective. At the same time as ensuring that we reduce our contribution to climate change, the new scheme will provide a smooth transition for businesses.
The UK was instrumental in developing the EU emissions trading system and has long been a centre of carbon trading. We have drawn on this experience in designing the new system, while simultaneously improving certain scheme elements, like the tightened cap, to reflect our world-leading climate ambition. Reducing emissions while supporting UK industry is central to my department’s mission to deliver our net-zero target. Alongside carbon pricing, the Government have schemes worth nearly £2 billion operating, or in development, to support our vital energy-intensive industries to decarbonise. Our economic recovery from Covid-19 must build on the UK’s proven track record of cutting carbon emissions while still growing our economy. Over the last three decades, we have seen the economy grow by 75%, while cutting emissions by 43%. It is vital that we keep up the pace of change as we rebuild from the pandemic and look ahead to the UK’s presidency of the COP 26 climate talks in November 2021.
The Government have an ambitious range of policies in place to help industry reduce costs and decarbonise while supporting a clean, green recovery. In July, as part of a £350 million package to cut carbon emissions, the Prime Minister announced £140 million to drive the use of innovative materials in heavy industry. The 13 initial projects will include proposals to reuse waste ash in the glass and ceramics industry and the development of recyclable steel. Some £139 million was also committed to cut emissions in heavy industry by supporting the increased use of low-carbon hydrogen as a greener fuel source, instead of natural gas, and scaling up carbon capture and storage technology.
We want to show that the UK can have a thriving, competitive industrial sector, aligned with our net-zero target. To this end, in July we announced that the Government will publish a comprehensive long-term industrial decarbonisation strategy in spring 2021. This strategy will cover greenhouse gas emissions from manufacturing, including steel, cement, chemicals and oil refineries. Carbon pricing will be at the centre of this, incentivising decarbonisation. The UK ETS will provide a clear signal for businesses to invest for a net-zero future, backed by the funding and support we have, and will have, available to them.
This draft Order in Council establishes a UK ETS which will be operational from 1 January 2021. It establishes the following key areas: the scope of the UK ETS, and this includes energy-intensive industries, the electricity generation sector and aviation; the cap on allowances created under the UK ETS each year, which will initially be set at 5% below what would have been the UK’s expected notional share of the EU ETS cap over the 2021-2030 period; a full review of the UK ETS in 2023; the monitoring, reporting and verification requirements for UK ETS participants; a robust and proportionate enforcement system; and the roles of the national regulators in monitoring and enforcing the scheme.
This order will establish a new carbon pricing regime for the UK, encouraging cost-effective contributions to our emission reduction targets and furthering progress towards our net-zero goal. I commend it to the House.
My Lords, I thank the noble Baroness, Lady Bloomfield, for her opening speech. The UK is seen as a world leader in carbon trading. We have played a prominent role in the establishment of the EU’s first emission trading scheme in 2002, which was a pilot to the current EU Emissions Trading Scheme. There are now over 50 carbon pricing initiatives that have been, or are in the process of being, established, covering over 20% of international greenhouse gas emissions. Of these, 28 are emissions trading schemes.
The UK’s carbon pricing system, made up of the EU Emissions Trading Scheme plus a carbon price support, has overall been a successful mechanism in incentivising the abatement of greenhouse gases in a cost-effective and technologically neutral way, while mobilising the private sector, especially the energy sector, to invest in emissions reduction technologies and solutions. This has been possible because carbon pricing is one of a suite of policies which have enabled alternative and low-cost technologies and infrastructures to come forward. Carbon pricing remains an important catalyst to continue incentivising cost-effective abatement of greenhouse gas emissions.
As the noble Baroness mentioned, a replacement for the EU ETS must be introduced as the UK transitions out of the European Union. Carbon pricing must continue beyond Brexit; we need to make sure that this is replaced at the earliest opportunity. Businesses operating in these markets require more certainty before private sector investment can be deployed. A final decision on replacement of carbon pricing in the UK would be very beneficial to all sectors. Would the noble Baroness agree that Brexit negotiations should not end without agreement on the UK’s replacement for the EU ETS? Surely this should be a priority. It is critical that the EU ETS is replaced by a UK ETS. The preference of the CBI, of which I am president, is that a UK ETS should be introduced as soon as possible and—I ask if the noble Baroness would agree—should be linked to the EU ETS so that markets can align. It is widely known that introducing a UK ETS is relatively easy. It is the linking that will cause problems: computer systems need to be set up, and so on.
Following the sixth carbon budget advice from the Committee on Climate Change during December 2020, any changes to the UK emissions trading scheme, once introduced, whether related to the emission cap or sectors included within scope, should be implemented by at least January 2023. When developing the “UK ETS”, the Government should ensure that sectors negatively impacted by carbon pricing, such as energy-intensive industries, are protected. They will still require compensation by free allowances to protect competition and mitigate the risk of carbon leakage. This is a critical aspect of the UK scheme and emissions abatement moving forward. A heavy industry cannot compete on a level playing field with international counterparts that have a less stringent carbon policy. Competition between these sectors must be protected, and until the Government fix this issue with other policy decision-making, free allowances as a form of compensation must remain. This is critical, and every effort should be made to link the “UK ETS” with the EU ETS.
If the UK Government cannot introduce a UK emissions trading scheme by 1 January linked to the EU ETS, it is possible that a carbon tax would be introduced. Can the Minister inform us whether this is a possibility? The CBI can support such a carbon tax, although only as an interim measure that should be replaced by a UK ETS when it is ready. The carbon tax must be ambitious and fairly implemented, and there should be compensation for heavy industrial emitters: that must continue.
I hear that Treasury officials are said to be interested in a report that suggests that a carbon tax of £75 per tonne of CO2 emitted by 2030 on greenhouse gasses could raise up to £27 billion of taxes, which would, of course, help the Covid recovery, cushion household bill rises and support clean energy. In fact, Guy Newey, strategy director of Energy Systems Catapult, said that a coherent strategy was needed:
“The danger with relying solely on a carbon tax is that no one believes politicians will not scrap it when things get tough, so no one invests. A cap-and-trade scheme that guarantees an outcome, alongside regulation and innovation support, is much more likely to lead to cuts in emissions.”
The International Monetary Fund says that a combination of carbon pricing and an initial green stimulus would turbocharge economic recovery from the coronavirus and help put the global economy on a sustainable growth path post endemic.
Direct emissions in the UK from buildings fell by 4% in 2017. However, 19 million out of 27 million homes in the UK have an EPC rating below C. In fact, only 1 million homes have low-carbon heat. We need to make a huge investment in heat. Does the Minister think that a new green finance bank is a possibility?
As president of the CBI and Chancellor of the University of Birmingham, I have been privileged to chair the Heat Commission, whose report was recently released. It highlights the fact that decarbonising the UK’s heating system is the greatest challenge that the UK faces in meeting its net-zero target of 2050. The commission made various recommendations. It said that it was vital that
“business, Government, regulators and communities work together to shape policies.”
One recommendation is that the Government should include low-carbon skills in the national retraining scheme, including training in heat pumps, hydrogen boilers and the move from gas boilers. This would create almost 1 million jobs and would make us not only more efficient from a sustainability point of view but more effective.
Does the Minister agree with the recommendation that energy-efficiency in heat should be a national infrastructure priority? It would create a new low-carbon heating scheme to replace the domestic renewable heat incentive with a grant system. It recommends creating a national delivery body to co-ordinate heat decarbonisation—an Olympic-style delivery body. It mandates that after 2025, all new boiler installations must be part of a hybrid system or be hydrogen-ready. Heat accounts for about 40% of energy consumption and is in large part delivered through the combustion of natural gas, so if we deal with this, and take these recommendations into account, we will get to net zero by 2050.
We cannot hear the noble Baroness, Lady Bennett of Manor Castle, who was next to speak, so we will come back to her and move straight on to the noble Baroness, Lady McIntosh of Pickering.
My Lords, I thank the Minister for introducing this regulation so clearly and comprehensively. I have a number of questions; if for any reason she is not able to answer the questions today, perhaps she will write to me, because some are technical and I have only just had sight of them myself.
I understand that the impact assessment gave a net cost to industry of between £5 million and £11 million which, I understand, is per year. Obviously, my concern is that this will be passed on to customers. All of us as users notice that even if we switch as often as we are asked to do, our electricity bills go only one way. That is as a single energy user rather than having electricity and gas. Is the Minister not concerned that this will impact heavily on customers’ bills? What action, if anything, is the Government likely to take to help those on fixed incomes, particularly in the current situation?
My next question relates to the impact of Covid, particularly on the aviation sector, which obviously has been heavily affected. I declare an interest in that, when I met my husband, he was working in the aviation sector. Its cashflow is clearly a matter of great concern: it has to carry on paying for the use of the aircraft whether they are flying or not. Will the Minister assure us that the impact of Covid, particularly on the aviation and aeronautical sectors, will be kept under review?
I would be pleased to have an update, if possible, on where we are with carbon capture and storage. As I understand it, that would make a massive contribution to reducing our greenhouse gas emissions. It is something that the Government are keen on and I applaud them for that.
The impact assessment says very clearly that one of the objectives of the policy is to incentivise cost-effective emissions reductions while balancing the competitiveness of UK industry. Given that the Government are coming forward with this scheme very late in the day, with two months to go before the end of the transition period, is the Minister absolutely sure that the industry—or all three sectors that are going to fall within this regime —has been given enough time to adapt to a new system?
I would like to place on record the industry’s view that it is critical across the board that the UK emissions trading scheme has the capacity to link to the EU ETS. Is it still the Government’s intention to follow that? I understand that everyone from industry to environmental non-governmental organisations share this view. Were the Government to diverge from the EU ETS, will the Minister assure me that we would not be simply diverging for divergence’s sake and that there would be a very good reason to do so?
I turn to some more specific questions that, as I said, the Minister might wish to write to me about. She said very clearly that this regulation has been consulted upon and has the support of all four devolved nations. Can she assure us today that whichever carbon-pricing scheme is chosen, it will have the full endorsement of the devolved authorities?
What procedure will be followed to ensure that the devolved authorities are actively involved in the decision-making process as we go forward? My noble friend was heavily involved in the discussions yesterday, which are ongoing, on the United Kingdom Internal Market Bill. This is a classic potential example of why we need to ensure we carry all the devolved authorities with us.
The Government have presented their proposals for a UK emissions trading scheme in this form, which is regulated by a legally binding emissions cap. What assurance is my noble friend able to give that it is possible to align the proposed carbon emissions tax with net zero given the lack, as I understand it, of an emissions cap? What further assurances can she give that the revenue collected by a UK emissions trading system would be hypothecated and reserved largely for climate measures and investment in low-carbon energy? That would at least ensure our industry remains competitive going forward.
Will the Government ensure that the level of the carbon emissions tax will also be set in a fair and transparent manner, to ensure that it is not subject to political considerations—Governments may change—and that it can be aligned with the UK’s legally binding net-zero trajectory? On that point, is my noble friend convinced that industry will be able to meet what I understood her to say would be a target capped allowance that will be 5% below what it might have been expecting to meet as part of an EU Emissions Trading Scheme? In opting for a carbon emissions tax instead of an ETS, with months to go before COP 26, is this sending the right message on the UK’s commitment to carbon markets as envisaged by Article 6 of the Paris climate agreement?
As I say, these questions are technical and, since I have a couple of others, it is probably best if I write to my noble friend. However, I am glad of the opportunity to debate this instrument and put the questions to her today.
We are going to return to the noble Baroness, Lady Bennett of Manor Castle.
My Lords, I apologise for the technical hitch, but I was unable to see or hear the Committee. I was going to say that it was a pleasure to follow the focus of the noble Lord, Lord Bilimoria, on the terrible standard of UK housing stock and the need to decarbonise home heating. This is the Cinderella of energy policy and it needs to be put centre stage. But it is also a great pleasure to follow the noble Baroness, Lady McIntosh of Pickering. It is no surprise to be following her, given her intense involvement in environmental issues.
It is always my intention to be positive when I can, so I welcome the fact that there has been consultation with and agreement from the nations of the UK on this order. We would like to see this happening in many other areas of governance. I also welcome the fact that there is a promised and apparently firm timetable for appropriately aligning to a net-zero trajectory by January 2023 and no later than January 2024. However, I would of course like to see faster action.
The net zero by 2050 target is grossly inadequate when we look at the science and the facts on the ground —from the failure of the Arctic sea ice to begin reformation this year to the fact that in Colorado they are hoping for snow to end an unprecedentedly long wildfire season. The Green Party is calling for a 2030 net-zero target.
One thing that Covid-19 has shown us is that the way in which our society operates can change quickly under emergency conditions, and we are in a climate emergency now. The whole Arctic Ocean is heading for ice-free conditions in the future, possibly very soon, if defined as less than 1 million square kilometres of ice cover. That is down from 8 million square kilometres just 40 years ago. We have just come out of the warmest global September on record and it is now more likely than not that 2020 will be the warmest year for the earth’s surface since reliable records began—and without a major El Niño event, which has contributed to most of the prior record warmest years. The noble Lord, Lord Bilimoria, painted a picture of successful policy. That does not look like a successful picture.
With the Covid-19 lockdowns, there was a significant drop in emissions in the first half of the year globally, but I want to quote Hans Joachim Schellnhuber, the founding director of the Potsdam Institute for Climate Impact Research. He said:
“While the CO2 drop is unprecedented, decreases of human activities cannot be the answer … Instead we need structural and transformational changes in our energy production and consumption systems. Individual behavior is certainly important, but what we really need to focus on is reducing the carbon intensity of our global economy.”
In simpler terms that is system change, not climate change, which is what this statutory instrument has to be part of delivering. As the Green Party has always said, individual action cannot make a difference on the scale needed; we need to make a massive adjustment to and transform our economy and society, so that we no longer see the few profit from pumping carbon into the air while the rest of us pay with the planet in flames.
I am disappointed that the Minister’s introduction had such a focus on economic growth. To quote a long-term green saying, you cannot have infinite growth on a finite planet. Economic growth has given us an unhealthy, poverty-stricken and unstable society. We need a different target in policies and systems to deliver the energy and goods that people need within the physical limits of this one fragile, damaged planet.
I will make no apologies for continuing to remind your Lordships that the UK has a unique responsibility as the chair of COP 26. If we think about what history will remember from this period, the result of that meeting will feature far higher, for good or ill, than any other events of our time—no matter how hard-pressed we are at this moment by the Covid-19 pandemic interacting with the pressing poverty and inequality in our society, as highlighted in an important report today by another Member of your Lordships’ House, the noble Baroness, Lady Lawrence. I suggest to the Committee that we ask ourselves whether the SI today and all the Government’s policies go far enough. Will they be part of the solution or of the problem?
The position of the UK’s Green Alliance on the UK’s emissions trading replacement for the EU-ETS scheme is that
“the general principle that should apply is that any new regime has to be ‘as strong or stronger’ than current arrangements.”
That would seem to be the promise of government policy although, as so often with what we debate in your Lordships’ House, there is a risk of a devil in the detail. An SI scheduled for next month refers to the arrangements to make free allowances for businesses most at risk of transferring production to other countries with less stringent emissions constraints.
It is of course impossible to talk about the EU ETS without reflecting on how it failed to deliver the needed changes. When the history of the past decade of carbon policy is written, that is likely to figure as one of the great failures. We need to look at this SI in that context.
We come back to the UK’s role as the chair of COP 26. We have the dreadful suffering of the pandemic and the chaos at the end of the Brexit transition period. But we have yet to hear, as the noble Lord, Lord Bilimoria, said, about the talks on the integration of how the EU ETS and Britain’s scheme will interact. What progress is being made? That is one of the many areas on which I look forward to hearing responses from the Minister to my questions, and those of other people.
My Lords, during my days as Energy Minister, when I had a keen interest in sustainability and the renewable energy sector in particular, I had the privilege of launching the non-fossil fuel obligation order—the first steps taken by the UK Government into renewables and the challenge of tackling carbon emissions. I have been strongly supportive of the principle of market-driven solutions to reduce carbon emissions ever since. I should declare that until the end of 2019 I was chairman of Hydrodec plc, a company which used proprietary technology to re-refine used transformer oil in Canton, Ohio, securing the first carbon credits for this process and offsetting what would otherwise be new transformer oil refined from virgin crude.
This order is welcome but, as admitted by the Government, it is tight on time. It is laid before the Grand Committee when the energy sector faces the twin challenges of Covid-19 and the end of the Brexit transition period, in a little over two months’ time. It will be welcomed by the market, but it still faces the twin challenges of some lack of clarity and time constraints.
Before moving on to address the specific problems, I thank Linklaters and Pinsent Masons. They have exceptional knowledge and expertise in the sector, and the work their teams have done on this complex subject is invaluable.
As drafted, the order is for a stand-alone domestic emissions trading system—a UK ETS—as the Minister has made clear. By virtue of being stand-alone it will of course be problematic or, at least, introduce complexities for companies with cross-border operations—for example, those that have taken a UK and Ireland approach. It also means that the market for trading allowances is smaller than if it was directly linked with the EU ETS from the outset. This is particularly the case, as it seems from the order that only allowances created under the UK ETS will be capable of being surrendered to meet companies’ obligations under the UK ETS. This means that EUAs would not be capable of being surrendered to meet companies’ obligations. In addition it looks like CERs and emission reduction units under joint implementation—Kyoto units—would not be capable of being used for compliance with the UK ETS, whereas they can under the EU ETS. Would the Minister confirm that this is correct and if so, have the potential impacts of this in terms of effectiveness been considered?
Much is mirror imaged from the EU ETS. Sadly, we will not be part of it, as a number of noble Lords have already said in this Committee. However, in the EU scheme there is a market stability reserve to ensure that no excess or surplus allowances materialise. This is critical to the higher carbon price. I would be grateful if the Minister could explain why there is no similar instrument in this UK ETS. Are the Government taking an approach that does not recognise the wider world markets, and devalues carbon pricing in the UK at a time when Governments are trying to create and support a market where carbon has a robust price? Companies will be keen to know when the first auctions will take place and to have any guidance for this, so that they can prepare, especially given that the first allocation starts in a couple of months’ time. They will want to understand the trading arrangements for allowances and associated documentation. Companies will also be keen to understand how any proposed carbon tax, yet to be consulted on, will interact with the UK ETS.
Although the Government are proposing to broadly mirror the EU ETS, depending on the proposed date of the first auction, there may not be adequate time for companies to prepare after the order is finalised, taking into account the fact that many companies will be operating relevant installations in both the EU and UK at present, and their current strategies in terms of trading and compliance will therefore reflect this. In deciding to take the UK ETS approach, which does not recognise the wider world markets, are the Government concerned that while the proposed initial cap is 5% below the UK’s notional share of the EU ETS levels from last year, it may not actually reduce emissions sufficiently? UK emissions last year covered by the EU ETS stood at some 129 million tonnes, in contrast to the Government’s proposal for an allowance cap of 156 million tonnes—well above that level. What is the Government’s rationale for this decision?
The companies involved will be keen to gain clarity and to know when the first auctions will take place, and to have detailed guidance on this, so that they can prepare, especially given that the first allocation starts, as I said, in 2021.
It is important to recognise that timing is critical. The cost to emitters and the cost to industry is considerable and, with new regulatory costs and a new compliance system, the more time that industry has to prepare the better. Asking industries at this point to adopt a completely different regulatory system and take on additional compliance costs for energy is a major ask.
I would like to pick up on the point that a number of noble Lords have raised and concentrate the attention of the Committee on the question of a carbon tax, which is still on the table, and ask to be informed of the Government’s current thinking. The concern about a tax route is that a tax is completely divorced from the clear net-zero targets which the carbon pricing mechanism is meant to achieve. I cannot see any coherent read-across strategy between the two, since using the tax route will never guarantee the net-zero commitments of Government. How would it be possible to marry a carbon tax regime to the proposed ETS? You need a staged market-led approach, which cannot be achieved by a carbon tax, but can be reached by an ETS. Perhaps the Minister could also give us her view on the benefits of a carbon tax and whether she agrees with my analysis. How will the Government seek to deliver a policy whereby a carbon tax can be aligned with a net-zero trajectory?
For a long time the tax option was very much a third option: a far fallback position. I hope that remains the case and I would be grateful for the Minister’s views on the subject. It would certainly be a troubling message for the UK to convey at COP 26 if we ended up adopting the carbon tax route. It remains my view that the first item the Prime Minister should discuss with Joe Biden should he be elected President of the United States is the challenge of climate change, the energy transition and the global environment. It would affirm the UK as the trusted friend of the US, as we jointly address the biggest challenge that we face together. It is incumbent on the Government to lead on this issue, work closely with industry and provide timely advice. The order is an important and welcome step in that direction.
My Lords, British industry is very concerned about the UK Government’s approach to carbon pricing after Brexit. The Government have committed themselves either to an emissions trading scheme or to a carbon pricing scheme post Brexit. This is despite the fact that witnesses from business, who recently gave evidence to the business Select Committee, were unanimous in their opinion that a UK emissions trading scheme, with a capacity to link to the EU Emissions Trading Scheme, is critical for everyone, both those in industry and the environmental NGOs. Reasons for this are simple: an ETS works by placing emissions under a cap, thereby producing a defined and legally binding environmental outcome in terms of greenhouse gas emissions reductions. By creating a tradable commodity, emissions trading uses the incentives of the market to ensure that emissions reductions are achieved in both the cheapest and most efficient way. The cap provides a long-term price signal for business, and gives predictability for industry in its decarbonisation pathway. Emissions trading ensures that cash flows in the direction of innovation and investment in low-carbon economies. In short, it provides a balance that works for all actors: flexibility for industry and environmental certainty for policymakers.
In comparison, a carbon tax is not designed to provide certainty as to environmental outcomes. Put simply, the lack of a cap means that is not possible to align a carbon tax with the UK’s legally binding net-zero target. Setting the carbon tax at a level necessary to achieve climate action is extremely difficult, as emissions are controlled by a set of external factors. Experience shows that taxes face additional challenges in the long run—as has been said by the noble Lord, Lord Bilimoria—because they are highly politicised. No Government can provide long-term certainty over future pricing levels. This restricts the industry’s ability to hedge and puts in jeopardy the popular support for carbon pricing among the general public.
I too have a few questions. To some extent, they overlap with those of the noble Baroness, Lady McIntosh of Pickering. I want an assurance that whatever carbon pricing scheme is chosen, it will have full endorsement of the devolved authorities and that they will be actively involved in the decision-making process. The Government have presented their proposals for a UK emissions trading system that is regulated by a legally binding emissions cap. What assurance can they give us that it is possible to be regulated by a legally binding emissions cap? What assurance can they give us that it is possible to align the proposed carbon emissions tax with net zero, given the lack of an emissions cap? What assurances can the Government give that that the revenue collected by a UK emissions trading system, or a UK tax, would be hypothecated and largely reserved for climate measures and investment in low-carbon energy?
Article 6.2 of the Paris climate change agreement allows two countries to link their emissions trading systems. I was talking this morning about two such linked systems, both of which have a partner in the EU and one outside. Evidence shows that this will enable the UK to move to net zero more quickly and at less cost. Are the Government aware that opting for a carbon emissions tax would negate any possibility of such a linkage, given that an operational emissions trading scheme is necessary to allow linkage negotiations to begin?
Are the Government aware that opting for a carbon emissions tax only weeks before the end of the transition period will result in significant new regulatory costs for industry as it grapples with a new compliance system in the middle of a global economic crisis? Do the Government understand that an emissions trading scheme provides continuity for industry at a difficult time? Do the Government agree that by opting for a carbon emissions tax instead of an ETS just before COP 26 would send a troubling message to it about the UK’s commitment to carbon markets, as envisaged in the Paris climate agreement?
I fully concur with what has been said about heat emissions; they are most troubling and something on which every Government should get a firm grip. Despite the fact that there is a lot of sympathy for the aviation sector, as a big emitter, it needs to be included in any system.
I thank the Minister for her introduction to the order and welcome her to the duties of responding for the Government on energy and climate change. As she explained, it is important that the UK continues with an emissions trading scheme, having left the EU scheme, as it covers 33% of UK emissions. It is an essential element of decarbonisation policies to encourage cost-effective emission reductions along the pathway to the net-zero target. I approve of the order very much on that basis, and on the basis that the clear preference is for the UK ETS to be linked to the EU ETS post the implementation or transition period. I am glad that the CBI agrees with that position, as outlined by the noble Lord, Lord Bilimoria. Paragraph 6 of the Explanatory Memorandum states this in terms of the Government being
“open to considering a link between a future UK ETS and the EU ETS … to establish a much larger carbon market”,
creating more opportunities for emissions reductions, greater cost efficiencies and increased flexibility.
As climate change and the ETS are devolved matters, the tussles of the scheme at EU level will be replaced with tussles to which any UK scheme may give rise with the devolved Administrations. Would the Minister care to comment on which set of tussles she considers may be the more intractable? I will not widen discussion into the dispute-resolving mechanisms of the common framework and how effective they may or may not be. However, the noble Lord, Lord Bradshaw, is correct to be anxious that dialogue with the devolved Administrations is constructive.
The subject gives rise to my first question regarding whether the UK will resolve the remaining difficulties in negotiations with the EU and include the preferred option of linkage with the EU ETS. Does the Minister have any important news on that? It is understood that the order envisages the UK emissions trading scheme as a fallback position, and that this will by and large shadow the EU ETS. Can the Minister say whether development of the UK’s ETS will take place with a view to future linkage, or will a carbon emissions tax be set up instead? Time is now becoming critical to provide leadership and credibility in the run-up to COP 26 next year. A separate carbon emissions tax would become more open to political intervention, and more institutional safeguards would be needed to ensure that pricing would remain consistent with the pathway to net zero. Can she now rule out the possibility of a carbon tax regime? I understand that the question still has to be settled with the Treasury. The noble Lord, Lord Moynihan, is also concerned with that continuing uncertainty.
Regarding the shape of the proposed UK ETS, there are some curious figures. In paragraph 7 of the Explanatory Memorandum, it is proposed that the initial cap
“be set at 5% below the UK’s expected notional share of the EU ETS cap for Phase IV of the EU ETS”.
First, is that 5% lowering of the cap ambitious enough? Secondly, are the figures that the Government calculate the correct ones? The figures given are that 156 million allowances be set for 2021. However, I understand that carbon emission reductions are progressing at a faster rate, and that 129 million allowances would be more likely as the expected figure. Can the Minister explain why the latest data is not being used?
We can agree that the moving target of reduction percentages remain in line with the EU scheme. However, as the Government concede that the cap progression will be assessed against the trajectory towards net zero as advised by the Committee on Climate Change and its sixth carbon budget, this could amount to quite a demanding correction, as the Government have not maintained compliance with the fourth or fifth carbon budgets. Given how important the climate emergency is, as the noble Baroness, Lady Bennett, explained, and how ambitious we must be in continuing to set the pathways to the future, why do the Government consider that they have the luxury of delaying the correction until at least 2023 or even January 2024? This may need to be considerably more than setting a cap lower than the 5% level, and with more realistic figures. Can the Minister explain more fully the rationale behind the proposals outlined, and commit to giving more urgency to the matter in the long-delayed energy White Paper?
The noble Baroness, Lady McIntosh, asked whether the UK emissions trading scheme would set any more net cost on consumers. My understanding is that it would not, but the Minister may know whether that answer will still be correct in relation to any emissions tax alternative, and whether the 5% cap below the UK’s share of the EU scheme would also be commensurate with that understanding. What more stringent level below the 5% would still be consistent with the same net costs to the consumer, should a more radical correction be required in either 2023 or 2024?
Many more elements still need further clarity, such as the amount of free allowances and details of carbon auctions, and I welcome any further detail that the Minister may be able to give the Committee today.
I thank noble Lords for their valuable contributions to this short debate, and for their broadly supportive comments on carbon pricing and this SI. I recognise the strength of feeling about the carbon emissions tax and reassure noble Lords that no decisions have been taken about it; I shall certainly make sure that their voices are heard.
The noble Lord, Lord Bilimoria, raised the need to ensure that our heavy industrial emitters receive free allocation to ensure competitiveness. Free allocation of allowances will continue to be the main policy instrument through which carbon leakage risk and competitiveness impacts are addressed in the UK emissions trading scheme. Our initial UK ETS free allocation approach will be similar to that of the EU ETS period 2021-30, to ensure a smooth transition for participants for the 2021 launch. In 2019, the value of those free allowances given to the UK installations was over £1 billion, taking an average EU allowance price of £22. The Government also compensate some energy-intensive industries for the indirect cost of the ETS and other climate policies passed on to electricity prices.
The noble Lord, Lord Bilimoria, also mentioned the CBI’s heat commission report. I welcome his commission’s thoughtful recommendations on how to decarbonise this too often forgotten sector, which the noble Baroness, Lady Bennett of Manor Castle, described as a Cinderella sector. As he will know, industrial heat processes are within the UK ETS, but heating in domestic and non-domestic buildings is not. The Government plan to publish a heat and building strategy in due course that sets out our immediate and long-term actions for decarbonising heating in buildings. An industrial decarbonisation strategy will be published in the spring.
My noble friend Lady McIntosh raised a series of important and detailed questions. Given time constraints, I will be happy to respond to them in writing, but she also raised the impact of Covid on the aviation sector, as did other noble Lords. Our absolute focus in government at this time is combating Covid-19. We recognise the challenges that Covid-19 has caused the aviation sector and are working closely with the industry to provide support, but it is important that we continue to work on our longer-term priorities, including tackling climate change. There should be a minimal impact on the sector, as the UK ETS will ensure that aircraft operators continue to face obligations for emissions on UK routes that will no longer be part of an EU ETS.
The noble Baroness, Lady Bennett of Manor Castle, rightly said that we should question whether we are going far enough. That is the right question to ask and why we are committed to consulting within nine months of receiving the Committee on Climate Change’s sixth carbon budget advice, to ensure that the cap is net-zero consistent.
My noble friend Lord Moynihan, the noble Baroness, Lady Bennett, and the noble Lords, Lord Bilimoria, Lord Bradshaw and Lord Grantchester, all raised linking a UK ETS with the EU ETS and the status of negotiations with the EU. As noble Lords will appreciate, negotiations are still ongoing and it would clearly be wrong of me to prejudice the outcome of those discussions. We are continuing discussions with the EU on carbon pricing, and we have also been clear with the EU that we are open to considering a link if it is in both sides’ interests. We have been clear that, whatever decisions we take on carbon pricing and whatever the outcome of those negotiations, we will ensure that the UK will have an ambitious carbon pricing system, in line with our net-zero commitments.
The noble Lord, Lord Grantchester, asked why the cap, while 5% lower than the EU ETS, has been set at 156 million tonnes above current emission levels. The cap we are setting at the start will enable a smooth transition from the EU ETS to the new UK ETS to provide certainty for business. Demand for allowances is expected to come from the banking of allowances for future years or as a hedge against price increases. As such, some headroom is crucial to allow for these behaviours to continue without risking price spikes in the early years of the system. This has been acknowledged by the Committee on Climate Change in its advice to us. This initial cap is already more ambitious than the UK’s notional share would have been if we had stayed in the EU ETS. I reassure the noble Lord that once we have received the Committee on Climate Change’s advice on the sixth carbon budget, we will consult next year on a net-zero consistent cap. It would not be right to set the level of the cap before we have received this advice, but I reassure him that we are seized of the urgency of making this decision once this advice has been received.
I confirm to my noble friend Lord Moynihan that international credits cannot be accepted for compliance with the UK ETS. This is the same as would have applied in the EU ETS during the same period. With the UK ETS we will continue to lead the world in carbon pricing, which is why we plan for the UK ETS to be the first truly net-zero consistent emissions trading scheme.
My noble friend asked how the devolved Administrations will be actively involved in the decision on the eventual carbon pricing mechanism. This concern was also raised by the noble Lord, Lord Bradshaw. We have worked closely with the devolved Administrations throughout the development of the UK ETS. Their views on the ETS and the potential carbon emissions tax have been communicated clearly and are understood by the UK Government. The final policy decision will be made collectively by the UK Government, but with full consideration given to the devolved authorities’ views. We will of course work with them to ensure that they have the support needed to implement either policy option.
My noble friend also asked for the likely date of the first UK ETS auction in 2021 and about the operation of a market stability reserve. The current proposed timing for introducing UK emissions allowance auctions is the second quarter of 2021. We will not bring in a supply management mechanism like the MSR from day one because an SAM cannot be operational in a stand-alone UK ETS until approximately mid-2022. This is due to the requirement for at least one year of verified UK emissions data. We will have a transitional auction reserve price in place to prevent very low allowance prices and ensure minimum price continuity. We will consult separately on the design of a stand-alone SAM if it is required in due course.
The noble Lords, Lord Grantchester and Lord Bradshaw, and others asked questions about whether the Government will proceed with the UK emissions trading scheme or a carbon emissions tax. We understand businesses’ need for policy certainty and will provide it as soon as we can. This instrument is required to establish a UK ETS, either stand-alone or linked. It is critical to ensure that this can be delivered for the end of the transition period.
I think I have answered most questions. I will read Hansard and, if I have not, I will reply in writing.
This Order in Council, laid under the Climate Change Act 2008, establishes a UK-wide greenhouse gas emissions trading scheme, which will drive cost-effective emissions reductions across our intensive industries, and our power generation and aviation sectors. As we reach the end of the transition period, this legislation will ensure that the UK has a domestic carbon pricing policy fit for the net-zero future that we have led the world in committing to. The UK was a pioneer in carbon pricing and trading almost 20 years ago and has taken a leading role in the continued development and improvement of the concept through our participation in the EU ETS. We have therefore designed the system with the benefit of that knowledge and experience.
In this way, many features will be familiar to businesses. We will fulfil our promise of a smooth transition to our future carbon pricing policy. At the same time, launching a UK ETS will allow us to have autonomy to pursue our climate goals in the way that works best for UK. In some areas, we have already taken the opportunity to make the system work better for the UK and we will continue to do this as the UK ETS evolves over time. Most crucially, we will consult on aligning the emissions cap of the UK ETS with our net-zero commitments. We will seek to implement changes by January 2023 and no later than January 2024.
Alongside the UK ETS, the Government have an ambitious range of policies in place to help industry to reduce cost and decarbonise while supporting a clean, green recovery from Covid-19. These schemes must of course be supported by an effective carbon pricing policy. With the EU ETS having covered around a third of UK emissions between 2013 and 2020, carbon pricing is a key tool for achieving our carbon emission reduction targets at the least cost to business.
As a point of clarification, one of the difficulties we have in hybrid sittings is that those present cannot be permitted to follow up and ask additional questions, simply because those participating remotely cannot do so. But should any of those present wish to pursue these matters with the Minister I am sure she would be amenable—I can see her happy smiling face—to doing that should it be required.
My Lords, I remind you all to hose down your desks and seats before you leave.