17. The evidence we received contained a range of objections to aspects of the Levy, ranging from fundamental disagreements with the principles of the measure, to arguments about points of detail. Many of the major issues which arose in our evidence were matters on which the Government took decisions without consultation with industry, something which we return to later.[46] As a consequence, the Customs and Excise consultation exercise dealt almost entirely with matters about which there was little cause for debate, including the precise administrative arrangements for the Levy. Although we have noted the detailed points which came up during the consultation exercise,[47] we have concentrated on the major issues which were not part of the consultation exercise.

Effectiveness of the Levy

  18. A number of witnesses suggested that the Levy would be a costly and ineffective means of reducing carbon dioxide emissions.[48] In terms of cost, the UK Offshore Operators' Association calculated that, if the Levy raised £1.75 billion and reduced CO₂ emissions by the equivalent of 1.5 million tonnes carbon, then the cost of the Levy would be £1,166 per tonne of carbon emissions saved. The Association concluded that "this demonstrates clearly that the tax is wholly disproportionate to the anticipated benefit to be gained and it is likely to compare very unfavourably with what can be achieved by negotiated agreements, tradeable permits or regulation".[49] In terms of effectiveness, several witnesses from the industrial sector, particularly from energy intensive industries, claimed that the Levy would have little or no impact on their ability to improve energy efficiency and therefore cut carbon dioxide emissions.[50] Yule Catto and Co. plc told us that "the increased cost of energy brought about by this tax would largely be a fixed cost...because there are only limited efficiency savings that can be achieved over and above those already made".[51] The Electricity Association argued that the Levy would have the effect of "limiting the resource to pay for capital investment in energy efficiency".[52] Salt Union Limited said that salt manufacturers used highly efficient co-generation plant, the energy efficiency performance of which improved with increased production. The firm claimed that the Levy's impact would be to reduce their sales, cut salt production and therefore make that production less energy efficient.[53]

19. Proponents of the Levy strongly contested the claims made by industry about the cost effectiveness of the Levy. In his written memorandum, Dr Ekins of Forum for the Future said that claims that the Levy was not cost effective were "unjustifiable".[54] In oral evidence he explained that the cost of the Levy should be assessed by examining the measure's overall effect on GDP. Since this effect would be "negligible", Dr Ekins said that the Levy was "the cheapest way of reducing carbon emissions for the UK as a whole".[55] In terms of the Levy's effectiveness in improving the energy efficiency of industry, the Government was adamant that energy efficiency improvements could be secured. Mr Meacher told us that "energy inefficiency by industry is perhaps 30-40%".[56] Figures calculated by the Energy Technology Support Unit (ETSU), and quoted in Lord Marshall's Report, suggest that all industries could improve their energy efficiency performance and reduce their carbon dioxide emissions, some by as much as 50%, if all technically possible measures were taken.[57] The Energy Intensive Users Group questioned ETSU's analysis in relation to the industries it represents.[58] Energy intensive industries strongly argued that energy efficiency was an aspect of their international competitiveness which was discussed at boardroom level; that the laws of physics and chemistry made it increasingly difficult to improve energy efficiency still further; and that further major efficiency improvements would require changes in processes which would not be developed before the 2008-2012 Kyoto deadline.[59]

20. We accept that there are some industries whose international competitiveness depends on their energy efficiency performance. For such industries, improving energy efficiency is already a strategic goal discussed at board level. On the other hand, the pressures to improve energy efficiency are likely to be less in industries whose energy costs are only a tiny fraction of total costs and which have limited exposure to international competition. In particular, and as Lord Marshall identified, there is much small and medium sized enterprises can do to improve their energy efficiency. The British Retail Consortium gave us examples of simple means by which small retailers could improve their energy efficiency, including technology to reduce night lighting and to alter the design of over-door heaters.[60] The Climate Change Levy should provide an incentive for many small and medium sized enterprises to reduce their use of energy. We believe that the Climate Change Levy could improve the energy efficiency of at least some of the UK's industrial and commercial sectors and thereby reduce carbon dioxide emissions.

21. The Institute for Public Policy Research told us that, although the oil price crises of the 1970s had encouraged UK industry to use energy efficiently, the trend towards increased efficiency had stalled and even reversed during the 1990s. The Institute noted that "this had coincided with the liberalisation of the energy supply industry and consequent fall in prices",[61] although the Energy Intensive Users Group disputed the notion that industrial energy prices, particularly electricity prices for very significant users of energy, had fallen relative to prices elsewhere in Europe.[62] The Association for the Conservation of Energy noted that the Levy would claw back only a fraction of the real reductions in fuel prices experienced by most businesses during the 1990s and that "even were the Levy rates to be adjusted so as to bring real prices back to the position of a decade ago, it should be recalled that, even then, many apparently cost-effective energy efficiency measures in this sector were still being foregone".[63] The Economic Secretary to the Treasury accepted that "the incentives towards energy efficiency have been declining very significantly over quite a long period" and argued that the Levy could help give business users "more effective price information that internalises some of the environmental impact of their energy usage".[64] The Minister for Energy and Industry took a different tack when he told us that "I am pressing for energy prices to be reduced".[65] While we agree with Mr Lehmann's comments that "there is no point in having costs higher than they need to be and people either making profits they should not be making or bearing costs they should not be bearing",[66] the Government's policy on the taxation of energy use is pulling in a different direction to the commitment of DTI and the Office of Gas and Electricity Markets to reduce energy prices. If energy prices continue to fall then the signal which the Climate Change Levy is intended to give to industry about the importance of energy efficiency will be obscured. The conflict between these two aspects of the Government's energy policy must be urgently addressed, particularly if businesses are to receive some indication of the long-term direction of that policy, as Lord Marshall recommended.[67]

22. The Royal Institute of International Affairs argued that the introduction of the Levy would be politically effective, in terms of persuading other nations, not least the US, to take the Kyoto Protocol seriously. Its memorandum argued that "the introduction of the Climate Change Levy will be seen as a powerful sign that the UK is matching its words with deeds, and it will encourage other countries similarly to move forward with specific and substantive implementation measures". The Institute warned that "any delay or watering down of the Levy would have potentially serious and adverse consequences for the great strides already made in the development of the Kyoto agreement, and for the credibility of all that the UK Government has said about its commitment to addressing the major global issue of our times".[68] The Minister for Energy and Industry made a similar point in a domestic context, arguing that both industry and the Government could gain if the effect of the Levy's introduction was "to jump-start some companies into taking energy efficiency seriously".[69] Although the Levy would be a powerful symbol, both domestically and internationally, of the UK's commitment to its Kyoto obligations, this should not detract from the need to ensure that the details of the Levy are fair to UK industry.

Impact on Industry

  23. There were several claims that the Levy contravened one, or most, of the principles applying to environmental taxation, adumbrated by the Treasury in its July 1997 Statement of Intent.[70] In particular, many witnesses commented that their international competitiveness, and the competitiveness of the UK as a whole, would be badly hit by the imposition of the Levy.[71] There were predictions of job losses;[72] firms being forced to migrate abroad;[73] inward investment being deterred from entering the UK;[74] imported goods replacing domestic production in hardest hit sectors;[75] energy production being adversely affected;[76] and water and primary energy prices being increased.[77] Witnesses speculated that, if UK firms were forced to reduce output or close as a result of the Levy being introduced, global greenhouse gas emissions would be reduced due to increased UK demand for goods produced under less energy efficient conditions abroad.[78]

24. We received detailed figures on the potential impact of the Levy on a wide range of individual sectors.[79] For instance:

•  the Teesside Chemical Initiative estimated that, if applied in full, the Levy would cost Teesside chemical firms £37.3 million per annum, causing up to 1000 job losses in the short term[80]
• British Sugar claimed that the Levy would cost the firm £6 million per annum and could put the British sugar beet industry into "a downward spiral that would have a severe impact...on our business [and] on the agricultural community and the 24,000 UK jobs that depend on sugar beet processing"[81]
• the Food and Drink Federation claimed that the Levy would incur a net cost of £150 million on their industry, which "cannot be absorbed by our businesses or passed onto consumers" and would be "strongly detrimental to our position within overseas markets as well as in the UK"[82]
• the British Cement Association told us that the Levy would "actually be a £40 million tax" on its members' operations, which would put the viability of coastal cement works, in particular, "seriously at risk"[83]
• the Energy Intensive Users Group estimated that its members would collectively lose £571 million per annum if the Levy was applied at the full rate and that, even if a 50% rate reduction were granted, as many as 28,000 jobs might be lost[84]
• the British Retail Consortium told us that some of its members would lose millions of pounds per annum if the Levy were introduced[85]
• several salt firms estimated the impact of the Levy on their operations. New Cheshire Salt Works Limited said that the Levy would increase its energy costs by 35% and its total costs by 5%;[86] Salt Union Limited said that the Levy would cost the firm £650,000 making the business "uncompetitive with other EU manufacturers;[87] the Salt Manufacturers Association claimed that the Levy would undermine investment and employment by the industry as a whole[88]
• the Aluminium Federation estimated that the aluminium industry would incur a net cost of £38 million as a result of the Levy, leading to the closure of four primary aluminium smelters and 4000 job losses.[89]

25. These estimates and claims were not universally accepted as showing the full economic impact of the tax. Dr Ekins said that the overall effect of the tax on GDP would be "absolutely negligible".[90] Mr Lehmann argued that although "there is a very small number of firms getting very badly hit...there is a whole host of firms who are gaining but not gaining very significantly" and that "we are hearing from those who are losing but we are not hearing from those who are gaining".[91] Many witnesses complained that the Levy would have the effect of transferring resources from manufacturing industries to the service and public sectors.[92] We heard about only two sectors which stand to gain from the Levy due to being more labour-intensive than energy-intensive — the public sector, which Ms Hewitt estimated might gain £100-150 million per annum,[93] and the construction industry.[94] CBI's estimates of the impact of the Levy, when applied at full rate, on several different sectors, suggested that the Levy would raise £1270.5 million but recycle only £594.66 million back to industry.[95] Clearly, there will be gainers from the Levy, such as, for instance, the financial sector, but any competitiveness gains they might make if the Levy was introduced have so far been overlooked. CBI, for instance, was unable to tell us which of its members stood to gain from the tax.[96]

26. Mr. Battle told us that Government officials were examining the estimates made by industry of the losses they might suffer as a result of the Levy. While emphasising that he did not regard the industry estimates as necessarily exaggerated, he commented that "it is amazing how many people suddenly claim they are energy intensive users".[97] Ministers assured us that the Levy was "not going to disadvantage UK industry".[98] We have been disturbed by the unprecedented scale of the reaction to the Government's proposal. We share the view expressed by several witnesses that, without appropriate modifications and exemptions, the Levy could prove a blunt instrument which does considerable damage to sectors of the British economy already struggling to maintain their profitability.[99] It is imperative that the Levy makes special provisions for energy intensive industries, such as to minimise any damage to their international competitiveness.

REGIONAL IMPACT

  27. We received a number of memoranda concerning the impact the Levy might have on Northern Ireland and north west England. The Director General of Electricity Supply for Northern Ireland told us that the Levy would increase the price of natural gas relative to heavy fuel oil and gas oil, "stop dead the expansion of the natural gas industry" as a result and thereby hamper Northern Ireland's ability to contribute to the achievement of the UK's Kyoto target by encouraging a switch in fuels used for electricity generation from oil to gas. The Director General also argued that high electricity prices in the Province already gave consumers adequate incentives to use energy efficiently.[100] Similar concerns were expressed by the CBI (Northern Ireland), the Northern Ireland Consumer Committee for Electricity and the General Consumer Council for Northern Ireland.[101] It has also been reported that the Levy might jeopardise plans for the development of a gas pipeline between Northern Ireland and the Republic of Ireland.[102] The Minister of State, Northern Ireland Office, recently commented that he had put concerns about the Levy "clearly to Treasury colleagues" and that he would "continue to press the Northern Ireland case strongly as work continues on the design of the proposed Levy".[103] With regard to north west England, the North West Business Leadership Team argued that "the impact of the Climate Change Levy, as currently proposed, will fall disproportionately upon the manufacturing industry of a region such as the north west and would inevitably hamper the prospects of redressing the regional economic deficit for many years to come". The Team predicted that the Levy would have a negative impact on the north west totalling £500 million and called for "safeguards" to ensure that the Levy did not "irrevocably harm the competitiveness of manufacturing industry in regions such as the north west".[104] The Government must pay attention to the regional, as well as the sectoral, effects of the Climate Change Levy, especially in relation to Northern Ireland, which has an entirely different energy market to that operating in the rest of the UK.

Recycling Revenues

  28. The revenues raised by the Climate Change Levy are intended to be recycled in full back to the business and commercial sectors through two mechanisms:

• a 0.5% reduction in the rate of employers' National Insurance Contributions
• a new £50 million fund for energy efficiency measures and stimulating renewable sources of energy.

The Government has claimed that, by recycling revenues in this way, the Levy will be "revenue neutral". While this may be true of the economy as a whole, it is not true when examined from the stand-point of individual firms or sectors. We received memoranda from numerous firms and industries which claimed that the NICs reductions from which they would be likely to benefit would be tiny compared to the increased cost of energy resulting from the Levy.[105] As the Government has recognised, energy intensive firms would be net losers as a result of the Levy, unless appropriate compensation mechanisms were found. Even with such mechanisms in place, it seems likely that some firms and sectors will be net losers, and others net gainers as a result of the Levy. The British Retail Consortium explained that the NICs reductions which would apply to retail firms if the Levy was introduced might be lower than anticipated because of complexities in the national insurance system, particularly associated with the status of part-time employees.[106] We received the distinct impression that there was considerable confusion over the meaning of the phrase "revenue neutral", and that some witnesses had wrongly assumed that it was intended to convey the impression that no firm or sector would lose out as a result of the introduction of the Levy. The phrase is not even an accurate description of the Levy's effect on public finances, since there will be a net saving on public expenditure due to the public sector's reduced liability for National Insurance contributions.

29. Levies are normally intended to raise money for the public purse. The concept of "revenue neutrality", even in the broad context seemingly intended by the Government, is a novel one. The Economic Secretary to the Treasury explained that "environmental taxation need not be primarily about revenue raising, in this case it is about changing the structure and the nature of taxation".[107] She insisted that the Treasury had found "no compelling reason to use the Climate Change Levy...to increase business taxation".[108] The revenues raised by the Levy could have been recycled differently than by the proposed reduction of employers' NICs. Ms Hewitt told us that the Treasury had considered cutting corporation tax, as an alternative, but decided not to because business taxes were already at an historically low level. The decision to reduce NICs had been taken as a result of a desire to encourage job creation.[109]

30. A number of witnesses proposed an alternative means of recycling the bulk of the revenues raised by the Levy, using tax credits or capital allowances for investments in energy efficiency equipment.[110] BG plc argued for the introduction of "carbon reduction tax credits" which would give firms investing in CHP, renewable generating plant or other energy efficient or ecologically sound projects reductions in their Levy liability;[111] the Energy Saving Trust advocated a similar idea and the Institute for Public Policy Research submitted to us a detailed scheme for relief on energy tax for "any investment which has a greenhouse gas reduction effect".[112] Ms Hewitt told us that these were "very important" proposals which she would take a look at.[113] As with the need for a broad range of policy options to pursue reductions in greenhouse gas emissions, we believe that there should be a diversity of approaches to recycling the revenues raised by the Levy to the business and commercial sectors. More subtle mechanisms are required than those proposed in order to prevent inequitable distributional impacts which might harm British industry. We are attracted by the option of using tax incentives which promote energy efficient investment to recycle at least some of the revenues raised by the Levy. We recommend that the Treasury seriously consider this option, and, if they choose to reject it, explain in detail the basis for their decision.

31. There was widespread criticism of the size of the fund intended to be set up out of Levy revenues to promote energy efficiency and renewables.[114] The Energy Saving Trust argued that the fund should total "at least £100 million annually" rather than the £50 million currently planned.[115] The Association for the Conservation of Energy, while admitting that there could be "concern about the administrative capacity available to oversee the spending of larger sums during the first year of the Levy's existence", argued that "in order to stimulate smaller energy users to invest in energy efficiency at appropriate scales, sums of an entirely different magnitude will be required in subsequent years".[116] Some witnesses went further and argued that all of the revenues of the Levy should be recycled by means of an "environmental fund", for instance "to develop and demonstrate technologies and resource-management options for mitigating climate change."[117]

32. It is far from clear what the £50 million fund is intended to be used for. Schemes to promote energy efficiency, for instance the Home Energy Efficiency Scheme, and to promote research and commercial deployment of renewables technologies already exist. The Government has offered few details of how the new fund might be spent or how it will be coordinated with existing schemes. Hoare Lea & Partners argued in their memorandum that the fund should target promotion of renewables as the best means of reducing greenhouse gas emissions, but Mr Battle told us that he was "not actually campaigning for a massive injection [of funds] into renewable energy".[118] RJB Mining called for clean coal technology to be supported by the fund.[119] Ms Hewitt indicated that the £50 million fund would be geared at helping small and medium sized enterprises use energy more efficiently.[120] We are loath, at this stage, to press for an increase in the size of the fund intended to be set up to channel some Levy revenues into energy efficiency and renewables projects when there is so much uncertainty as to its intended functions. We recommend that the Government publicly consult on the options for distributing the fund. We also suggest that the Government indicate its long-term plans for the fund, including the circumstances in which the size of the fund might be increased.

Carbon or Energy Tax?

  33. A common refrain from witnesses was that the Climate Change Levy did not focus strongly enough on the need to reduce carbon dioxide emissions, because it failed to discriminate between energy sources according to their carbon content.[121] As presently proposed, electricity generated from renewables, nuclear fuel, coal and gas would all attract the same rate of Levy. A carbon tax, which would hit carbon-rich fuels such as coal more heavily than fuels which emit little or no carbon dioxide such as renewables, might be preferable to an energy tax because of the incentives it would give energy users to switch their fuel use from fuels with high to low carbon content. The Minister for the Environment acknowledged the "theoretical attraction" of a carbon tax but told us that its potential advantages over an energy tax had been blunted by the decision to apply the Levy to downstream energy consumption, to avoid the taxation of domestic fuel use, rather than at the source of the fuel. He also argued that, with a tax applied on energy consumption rather than production, it would be difficult to determine the carbon content of electricity, except as a broad average, and that this would reduce the extent to which fuel switching would be likely to occur.[122] This analysis was supported by the Energy Saving Trust, which stated that "there is...limited practical scope for reducing the use of carbon intensive fuels in most of the business sector and [therefore] the effects of a carbon tax on the direct use of energy would be very similar to the proposed Levy".[123]

34. Although there might be practical difficulties associated with the design of a carbon tax, there is also a political consideration — the position of the coal industry. Mr. Lehmann told us that "the key area is coal...A carbon tax would tax coal more heavily" than other generating fuels, particularly gas.[124] Although Mr Lehmann argued that this would not make much difference to the amount of coal used in power stations at present, a carbon tax would run contrary to the thrust of Government energy policy which is to protect the coal industry and restrict the expansion of electricity generation by gas. A carbon tax would increase the incentives on electricity generators to switch away from using coal to other fuels. Mr Meacher acknowledged that a carbon tax would have "a very disproportionate impact" on coal use.[125] RJB Mining was one of the few witnesses from the industrial sector to express wholehearted support for an energy, rather than a carbon, tax.[126] There is a tension between the Government's desire to protect the coal industry and the need to cut back carbon dioxide emissions which, at least partly, explains the reluctance to link the taxation of energy use to the carbon content of fuels.

35. It was suggested that the outcome of the Reform of Electricity Trading Arrangements (RETA) might make it easier for a tax on energy consumption to reflect the carbon content of fuels.[127] The Paper Federation, for instance, argued that "under the new market arrangements it will be easy to track generation that is dispatched for specific customers via their contracts...It would seem a simple matter to audit generation through to supply".[128] Lord Marshall made a similar point to us in oral evidence.[129] The Association of Electricity Producers suggested that this interpretation was unduly simplistic, arguing that it was not difficult now to track how electricity supplies had been generated because "a lot of contracts around the pool are bilateral".[130] We were surprised, after hearing Mr Battle and Mr Meacher reiterate the reasons why a carbon tax might not be desirable, that Ms Hewitt did not rule out changing the design of the Levy so that it reflected the carbon content of fuels, including by reference to RETA.[131] She also commented that "it is a mistake to see a carbon-based tax and an energy-based tax as completely separate alternatives" because if means could be found of building into the Levy ways of encouraging renewables or CHP then "an energy-based tax begins to look much more like a carbon-based tax".[132]

36. There would appear to be some confusion within Government about the extent to which the Climate Change Levy could and should reflect the carbon content of fuels. A full carbon tax would clearly conflict with DTI policy on the use of coal and gas for electricity generation. On the other hand, there is a logic deficit inherent in the proposal that electricity generated by fuels which do not cause greenhouse gas emissions should be taxed at the same rate as electricity generated by fuels which do cause such emissions. We suspect that, if the Government decided to link the Levy to the carbon content of fuels, then ways of achieving this could be found during the RETA process. Other countries have succeeded in implementing carbon taxes, suggesting that the difficulties cited by Ministers are not insurmountable.[133] As we set out below, special treatment for renewables and CHP would have the effect of broadly linking the Levy to the carbon content of fuels, perhaps in the manner Lord Marshall's report suggested. We recommend that the Government seek ways to link the Levy, at least broadly, to the carbon content of fuels.

RENEWABLES

  37. We heard numerous calls for electricity generated from most renewable sources to be exempt from the Levy.[134] Eastern said that "renewable electricity could be readily certified via the Government's proposed Renewable Energy Accreditation scheme" and that "future Non-Fossil Fuel Obligation rounds could also incorporate 'green tickets' which would act as a readily available audit trail to verify that suppliers are meeting their renewables obligation".[135] Hoare Lea & Partners argued that electricity bought using premium green tariff schemes should be automatically exempt from the Levy.[136] The Government concluded that, even if electricity generated from renewables would attract the full rate of Levy, "there would be no tax induced reason in the short term to vary the amount of electricity generated from renewable sources".[137] Nor, however, would the Levy help increase the amount of electricity generated by renewables, a key Government aim. Mr Battle told us that he was looking for most renewables to be exempted from the Levy, an objective with which Ms Hewitt appeared sympathetic.[138] There is one form of currently deployed renewables technology — large-scale hydroelectric plant — which the Government does not currently aim to expand further. The Government has stated that exempting large hydro schemes from the Levy, even when energy is supplied from them direct to the customer, "could not be justified as a means of developing renewables generating capacity".[139] It has been suggested that an exemption from the Levy for large hydro schemes would not serve to encourage new plant to come on-stream, but would instead generate windfall gains for the schemes' owners. We recommend that ways are found to exempt from the Levy electricity generated by renewables technologies without excluding those for which there are no current plans for new plant.

NUCLEAR

  38. Similar considerations to those on large-scale hydroelectric plant apply to the nuclear generators, several of whom called for special treatment under the Levy.[140] Mr. Lehmann suggested that, because there was no great likelihood of new nuclear plant being built in the near future, exempting from the Levy electricity generated from nuclear energy would simply "give a windfall profit to existing nuclear generators".[141] Mr Meacher and Ms Hewitt confirmed that the Government had ruled out exempting nuclear electricity from the Levy. We are not convinced by the Government's case for ruling out an exemption from the Levy for electricity generated by nuclear plant.

COMBINED HEAT AND POWER

  39. The Government has accepted that CHP plant should be eligible for special treatment under the Levy. In its consultation paper, Customs and Excise suggested that CHP plant should be treated as end users, with the Levy applied to their fuel inputs. Electricity, and possibly also heat, exported from CHP plant would need to be exempted from the Levy to avoid double taxation, althought this might prove administratively complex. Above a certain, but unspecified, level of electricity exports to the grid, Customs and Excise concluded that it might be more appropriate to treat CHP plant as normal power generators.[142] A wide range of witnesses raised questions about the way in which the Government proposed to treat CHP plant for the purposes of the Levy.[143] The Paper Federation claimed that the proposals for the Levy "introduce economic conditions which may encourage movement from the thermodynamically efficient process of matching heat load to one where, for revenue purposes, the match shifts towards power production" and that CHP producers should therefore be exempted from the Levy.[144] The Association of Electricity Producers thought that the Government's proposals would introduce "disincentives to the development of CHP'.[145] British Sugar said that the Levy, "as previously envisaged, will act as a positive disincentive to the further development of CHP in the UK...The contradiction within the Government's stated objectives and the encouragement that has been voiced in relation to CHP is obvious...not only should CHP be exempt from the Levy but...the introduction of the Levy provides an ideal opportunity to make the uptake of such plant attractive".[146] We warned in our Report on Energy Policy last year that, without suitable financial incentives, the Government ran the risk of failing to achieve its targets of having 5 gigawatts (GW) CHP capacity installed by 2000 and 10GW by 2010.[147] We recommend that the Government use the design of the Climate Change Levy to give a fiscal boost to the installation of CHP capacity in the UK.

Energy Intensive Industries

  40. Lord Marshall, in his report, suggested that energy intensive firms would need special treatment were an energy tax introduced, because:[148]

• the additional costs of energy attributable to the tax could form a significant part of the total costs of the firm, perhaps even exceeding the profit typically made by the firm
• there might be limited scope for energy intensive firms, which already strive to minimise their energy costs, to improve significantly their energy efficiency.

The Government accepted the "special circumstances of intensive energy users within business, including their exposure to international competition and their regulation under the EU Integrated Pollution Prevention and Control Directive" and announced that there would be "significantly lower rates of the levy for those energy intensive users which enter negotiated agreements with the Government".[149]

41. Once it has been established that energy intensive users should receive special treatment in relation to the Levy, it is necessary to define which industries and firms should be classified as energy intensive. The Government has stated that "sectors will be able to enter into agreements provided that they also meet the qualifying criterion of coverage by the EU Integrated Pollution Prevention and Control Directive".[150] The Marshall Report, however, concluded that "IPPC coverage is not a good way of identifying energy intensive users" because some sites covered by IPPC are not energy intensive users — for instance around 2,000 landfill sites — and some energy intensive users — for instance SMEs in the foundry industry — are not covered by IPPC.[151] We received evidence from a number of industry sectors which claimed that they were not covered by the IPPC regime but deserved to be treated as intensive users of energy.[152] The Institute for Public Policy Research described IPPC coverage as a "very poor match" for energy intensity and suggested instead that the focus should be on the proportion of energy costs to total costs for individual firms. The Institute analysed the latest figures on the energy intensity of UK industry — dating back to 1989 — and concluded that only 1.8% of manufacturing sites have at least 10% of their total costs taken by energy and that, even in the sectors covered by the Energy Intensive Users Group, only 9% of plant have at least 10% of their total costs accounted for by energy.[153] Over 3,500 manufacturing installations in England and Wales, responsible for 58% of total energy use by industry, are covered by IPPC.[154] Only a small proportion of these installations are likely to be intensive users of energy. The IPPC regime is designed to deal with industrial pollution and is only indirectly related to the energy intensity of industry. Administrative convenience would seem to be the only reason why the Government has chosen to use IPPC coverage to define energy intensive industries. We understand that DTI is updating its ten year old figures on energy use by UK industry. These figures should be used to specify which firms and plant are energy intensive and therefore deserve special treatment under the Levy. The use of other, less accurate, measures of energy intensity is likely to create anomalies and inequities which will serve only to discredit the Levy.

VOLUNTARY AGREEMENTS

  42. The written memorandum submitted by DTI and DETR made clear that voluntary agreements on energy efficiency would be sought with trade associations representing sectors covered by IPPC, with arrangements also made to cater for firms which were not members of relevant trade associations and for firms in relevant sectors which were too small to be covered by IPPC.[155] It was reported that nine trade bodies, representing the steel, chemicals, cement, glass, ceramics, aluminium, foundries, paper, and food and drink industries, were involved in negotiations with DETR.[156] Mr Meacher told us that "we have already started intensive negotiations with ten initial sectors, and there are another fifteen who are in line for further negotiation".[157] In a Parliamentary written answer, published on the same day as we heard oral evidence, Mr Battle said that negotiations had begun with nine sectors and that meetings were now underway with "twenty further sectors".[158] DETR's door seems to be open to a wide range of firms seeking special treatment under the Levy. We seek clarification from the Government of those sectors with which it is currently negotiating agreements on energy efficiency.

43. Many industry representatives were critical of the suggestion by Customs and Excise that the reward for signing agreements with DETR might be a 50% reduction in the Levy. CBI demanded a 90 to 95% rebate;[159] the UK Offshore Operators' Association proposed that any firm signing up to an agreement with DETR or regulated by the IPPC regime should be entirely exempt from the Levy;[160] Eastern thought that firms participating in emissions trading might qualify for exemption from the Levy.[161] The Government told us that final decisions on the reductions which might be offered to energy intensive industries had not been made.[162] Ms Hewitt said that once proposals for agreements between DETR and industries had been sketched out then the Treasury would propose corresponding reductions in the rate of the Levy. Firms would then be able to sign up to binding agreements in return for the reductions, or walk away from the agreements.[163] The Paper Federation was particularly critical of this approach.[164] It argued that the agreements would be "blank cheques" if there were no negotiations about the reductions in the rate of the Levy on offer and said that firms were "being asked to negotiate with one hand tied behind their backs". The Energy Intensive Users Group stated that the Treasury were not represented at the talks being held between DETR and industry representatives and that energy intensive industries had no idea what reductions they might eventually be offered.[165] There will not be negotiations between industry and the Treasury about the reductions in the rate of Levy offered as a result of energy efficiency agreements being reached — these will be decided within Government, possibly entirely within the Treasury. The mechanism, if such exists, by which information about the quality of the agreements reached can be factored into the process of deciding the reductions to offer firms is not obvious, particularly since the Treasury is not represented in the talks between DETR and industry representatives. We ask the Treasury to think again about the way in which it intends to offer reductions in the rate of Levy to firms. This approach has done nothing to encourage a cooperative relationship between Government and industry on emissions reductions and we are concerned about the investment implications of the uncertainty about the rates of Levy which will apply to many major UK manufacturing industries.

44. We commented above on some of the difficulties associated with regulatory approaches to emissions reductions.[166] Negotiated agreements between Government and industry are a relatively new initiative in the UK, although they have been used as part of emissions control strategies abroad.[167] The Energy Saving Trust warned that agreements could be slow to deliver and that there was a probability of difficulties being encountered in sectors without a strong trade association or where energy use differed significantly from firm to firm.[168] We note in this context that some witnesses, including the Energy Intensive Users Group, bemoaned that DETR was attempting to move forward too quickly.[169] Mr Robertson of Terra Nitrogen UK said of the experience of the Chemical Industries Association with regard to the energy efficiency agreement it had signed voluntarily with DETR in 1997 that "a few lessons are being learned but it is quite a complex business...I think to go on to envisage 30 or 40 such agreements all being started up within the next year or two is going to be chaos".[170] We agree that energy intensive industries require special treatment under the Climate Change Levy and that one way such treatment might be provided is by agreements on energy efficiency negotiated with Government. We are concerned, however, that the Government is considering negotiating 25 or more agreements, some with sectors which are not intensive users of energy, when the efficacy of such agreements is untested, and the experience reported by the chemical industry less than persuasive.

Operation of the Levy

  45. The Customs and Excise consultation exercise threw up numerous detailed points which, although requiring attention by the Government, we have chosen not to consider in depth in this inquiry. One important point raised was that energy used in several industrial processes — particularly electrolysis, in which electricity is, in effect, used as a raw material and where it was suggested that there was no scope for reducing consumption other than by reducing output — should be exempted from the Levy.[171] Other points included: —

• the interaction between the Levy and the taxation of mineral oils should be considered in order to avoid the introduction of perverse incentives, for instance to encourage switching of electricity generation from gas-fired to oil-fired plant[172]
• the costs of collecting the Levy would be borne disproportionately by energy supply companies[173]
• suppliers of retail-packs of fuel — for instance liquid petroleum gas canisters or bags of coal — should be exempted from registration as fuel suppliers.[174]

Many of these points, especially that made with respect to electrolysis, are more than matters merely of technical interest. They deserve to receive the full attention of the Government.

47   Paragraph 45 Back

48   Ev, p51 paragraph 7; Apps, p4 paragraph 14; p7 (and unprinted memorandum from the Teesside Chemical Initiative, p6), p1 paragraph 13, p38 paragraph 12, p40, p45 paragraph 23, p57, p58 paragraph 2, pp59, 62; C&E response from the UK Steel Association section 1 Back

49   Apps, p11 paragraph 13 Back

50  Apps, p5 paragraph 16, pp8, 10, p20 paragraph 16, p26 paragraph 37, p33 paragraphs 5-6, p34; unprinted memorandum from the Teesside Chemical Initiative, pp4-5 Back

51   Apps, p33 paragraph 5 Back

52   Apps, p1 paragraph 3 Back

53   Apps, p67 Back

54   Ev, pp33-4 section 2 Back

55   Q116 Back

56   Q8 Back

57   Marshall Report, tables E1 and E2, p56 Back

58   Q56 Back

59   Qq55-6;Ev, p14; Apps, pp8, 22, p33 paragraph 5, pp34, 71 Back

60   Qq182, 190 Back

61   Ev, pp30, 38, 4; for latest statistics on price falls see Office of Gas and Electricity Markets press notice R/9, 8 Jul 99 Back

62   Q55 Back

63   Apps, p17 paragraph 4 Back

64   Q98 Back

65   Q11 and Q21 Back

66   Q133 Back

67   See also paragraphs 34 and 36 Back

68   Apps, p41 section 4 Back

69   Q8 Back

70   Apps, p3 paragraph 5, pp8-9, p11 paragraph 14, pp13-14 paragraph 13 Back

71   Ev, p75; Apps, p2 paragraph 12, p2 (appendix 2), pp6-7, p13 paragraph 9; p19 paragraphs 5-7, p21 annex, p23, p25 paragraph 23, p28 paragraph 4.1, pp34, 36, p45 paragraph 22, pp63, 67-9, 72, 74-5; C&E responses from the UK Steel Association section 1; unprinted memorandum from Lanstar Ltd Back

72   Ev, p52 paragraph 10, p75; Apps, p2 paragraph 13, p2 (appendix 2), pp3-4 paragraph 6, p7, p13 paragraph 7, p23, p33 paragraph 2, pp56-7, 63, 67; C&E response from British Alcan, section 4 Back

73  Apps, p2 paragraph 12, pp4-5 paragraph 13, p20 paragraph 14, p67 Back

74   Apps, p7 Back

75   Q223; Apps, p7, p13 paragraph 10, pp 75, 77 Back

76   Apps, p11 paragraph 11 Back

77   Apps, p62 on water; Apps, pp3-4 paragraph 6 and p5 paragraph 5 on gas for the commercial and industrial sectors; Apps, p30 on liquid petroleum gas Back

78   For instance Apps, p69 Back

79   For instance the paper industry Apps p12 paragraph 2; glass Apps pp 8, 22-3; the water industry Apps p62; vehicle manufacture Apps p25 paragraphs 21-3; chemicals Apps, pp 6-7, 19-21, 76 and C&E responses from Dow Corning and Brunner Mond; whisky Apps, pp71-2; flour milling Apps, p68; forging and fastener industry Apps, p75; soft drinks Apps, pp76-7; farmers, C&E response from National Farmers Union paragraphs 5-16 Back

80   Apps, p7 Back

81   Apps, p28 paragraphs 3.2 and 4.1 Back

82   Apps, p42 Back

83   Qq222-3 Back

84   Q60; Ev, p16 annex 2 and Apps, p70 Back

85   Qq176-8; Ev, p57 section 3; and see C&E responses from Tesco, J. Sainsbury plc and Marks and Spencer Back

86   Apps, p63 Back

87   Apps, p67 Back

88   Apps, p34 Back

89   Apps, p73 paragraph 5 Back

90   Q116 Back

91   Q124 Back

92   Apps, pp75-6 Back

93   Q87 Back

94  Ev, p70 annex 1 Back

95   Ibid Back

96   Qq211-2 Back

97   Q4 Back

98   Q21 Back

99   Q203 Back

100   Apps, p75 Back

101   Apps, p79; C&E response from CBI (Northern Ireland). Also see response from KeySpan UK Ltd Back

102   Financial Times, 9 Jun 99 Back

103  Northern Ireland Information Service, press release 1 Jul 99 Back

104   Apps, pp77-9; and also pp68-9 Back

105   Apps, pp 6-8, p 12 paragraph 2, p17, p20 paragraph 13, p22, p33 paragraph 4, pp34-5, p45 paragraph 24, pp57, 59, 62-3, 67-9, 76 Back

106   Q176 Back

107   Q96 Back

108   Q97 Back

109   Q92 Back

110   C&E response from J. Sainsbury's paragraph 6.1 Back

111   Apps, p25 paragraphs 25-6, p47 paragraphs 35-7 Back

112   Ev, pp32-3, 42-4 Back

113   Q92 Back

114   Apps, p3 paragraph 5, p18, paragraph 9, p25 paragraphs 25-6, p36, p38 paragraph 12, p43, p46 paragraph 31, p65 paragraph 10; C&E response from the British Photovoltaic Association, paragraph 2.1 Back

115   Ev, p30 Back

116   Apps, p18 paragraph, 9 Back

117   Apps, p49 paragraph 1 Back

118  Q17; Apps, pp51-2 paragraph 2.2 Back

119   Apps, p74 Back

120   Qq109-10; and Qq16-7 Back

121  Apps, p3 paragraph 3, p9, p11 paragraph 8, p12 paragraphs 4-5, p16, p32 section 1, p46 paragraph 32, p49 paragraph 1, pp52-3 paragraph 2.3, p58 section 5, pp65 and 67 paragraphs 10 and 30, p69; C&E response from the British Wind Energy Association Back

122   Qq11-2 Back

123   Ev, p31 Back

124   Q139 Back

125   Q14 Back

126   Apps, p74 Back

127   Apps, p9, pp14-15 paragraphs 19 and 36, p16, p29 paragraph 4.9; C&E responses from the British Nuclear Industry Forum paragraphs 39-43; and Power UK, 27 May 99, pp24-5 Back

128   Apps, p15 paragraph 36 Back

129   Q40 Back

130   Q153 Back

131   Q104 Back

132   Q102 Back

133   Memorandum from POST (Appendix 56) Back

134   Ev, pp31-2; Apps, p21, p39 paragraph 20, pp40, 43, p46 paragraph 31, p54 paragraph 2.5, p58 section 4,; C&E responses from the British Photovoltaic Association paragraphs 2.1, 2.3, the Landfill Gas Association p2, the British Wind Energy Association p2, the Electricity Association paragraph 2.1; renewable sources of energy used directly by businesses would be exempt under the Government's proposals - C&E paragraph 4.3 Back

135   Apps, p39 paragraph 20 Back

136   Apps, p54 section 2.5 Back

137   C&E paragraph 15.1 Back

138   Qq15, 105 Back

139   C&E paragraph 15.3 Back

140   Q159; Apps, p16; C&E responses from British Energy, paragraphs 14-17 and the British Nuclear Industry Forum, paragraphs 6 and 28 Back

141   Q137; and see Apps, p74 Back

142   C&E, section 16 Back

143   Ev, p52 paragraph 11, p59 section 16; Apps, pp5-6 annex, pp15-16 paragraphs 37 and 38, p28 paragraphs 4.4-4.9, p39 paragraphs 21-3, 26, p52 paragraph 2.6, pp57, 78; C&E response from the Combined Heat and Power Association Back

144   Apps, p13 paragraph 8 Back

145   Ev, p52 paragraph 11 Back

146   Apps, p28 paragraph 4.5 Back

147   Trade and Industry Committee, Fifth Report, 1997/98, Energy Policy, HC471, paragraph 90 Back

148   Marshall Report, paragraph 134 Back

149   Ev, p2 section 4 Back

150   Ev, p2 section 4 Back

151   Marshall Report, annex D, paragraph D4; and see Q219 Back

152   Ev, p72; Apps, p23 paragraph 6, p26 paragraphs 29-34, p72; also C&E responses from the National Farmers Union paragraphs 19, 28, Tesco p3 and J. Sainsbury plc paragraph 5.1 Back

153   Ev, p39 Back

154   Marshall Report, table D1, p53 Back

155   Ev, p2 section 4 Back

156   ENDS Report, #20, Mar 99 Back

157   Q2 Back

158   HC Deb 99, 6 Jul 99, c456 Back

159   Q208 Back

160   Apps, p11 paragraph 10; also unprinted memorandum from the Teesside Chemical Initiative p8 Back

161   Apps, p38 paragraph 11; other suggestions included a rebate for firms switching their transport of goods from road to rail Apps, pp73-4 and for firms which have put in place Environmental Management Systems, Apps, pp25-6 paragraph 31 Back

162   Q83; Ev, p2 section 4 Back

163   Q108 Back

164   Apps, p15 paragraph 31 Back

165   Qq69-71 Back

166   Paragraph 12 Back

167   Netherlands - Q131; Memorandum from POST (Appendix 56) Back

168   Ev, p32 Back

169   Q58; Apps, p4 paragraph 8 Back

170   Q75 Back

171   Ev, p52 paragraph 11; Apps, p4 paragraph 9 and pp5-6 annex, p15 paragraph 29, pp56, 74-5; C&E responses from Pilkington plc section 1, UK Steel Association p10, Rhodia, Chemical Industries Association annex l Back

172   Ev, p31; Apps, p4 paragraph 10 and pp5-6 annex, p14 paragraphs 15-16; RMC Group plc p2 Back

173   Apps, p2 paragraph 9, p5 paragraph 16, pp38-40 paragraphs 17 and 24-5, p58 section 5, pp60-1; C&E responses from the Energy Information Centre, the Electricity Association and SEEBOARD Back

174   Ev, p58 section 7; and C&E response from Tesco, p3 Back