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Response to the UK Government’s Review of the energy intensive industries exemption scheme

16 September 2022

The Department for Business, Energy and Industrial Strategy recently sought views on the energy intensive industries exemption scheme. Are the current measures necessary and sufficient? UCL’s Institute for Sustainable Resources submitted a response on the 16th September 2022

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Contributors:  Matthew WinningPaul DrummondNino JordanMichael Grubb, Serguey Maximov Gajardo
With support from: Katherine Page, Policy Manager, UCL Institute for Sustainable Resources

The UCL Institute for Sustainable Resources delivers world-leading research, teaching and enterprise in the sustainable use of global resources. This response is written by several members of the UCL Institute for Sustainable Resources. Across the team of authors, our areas of expertise in energy and environmental policy include: energy innovation, integration of renewable electricity sources into electricity systems, carbon pricing and emissions trading, resource efficiency and decarbonisation. We welcome the opportunity to present our view on the review of the energy intensive industries (EIIs) exemption scheme. We have chosen to answer two questions where we have specific expertise, and have also provided some general comments on the relevance of the Review of Electricity Market Arrangements (REMA) to this review. We would be delighted to discuss this consultation, or any of our other work. Please contact: katherine.page@ucl.ac.uk

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Q1. What benefits does the electricity relief exemption scheme provide to energy intensive industries including, how the scheme addresses the issue of carbon leakage for you?

The scheme provides much needed international competitiveness support for energy intensive industries. In particular, with regards to competition from industrial producers within other European nations who provide high levels of electricity policy cost relief to EIIs in their own countries. It is therefore essential that the UK Government continues to provide such support to guard against potential relocation of electricity- intensive, trade-exposed industries. Those UK industries that are or would otherwise be at competitive disadvantage with other nations would struggle to attract inward investment.

Although this scheme is necessary, it is not sufficient. Even with high levels of exemptions from these levies, electricity-intensive industries in the UK (including those that would become electricity-intensive, as they decarbonise their production processes), experience electricity prices substantially higher than their competitors in other countries – including key countries in Europe such as Germany, France and Italy1. Such countries instead tend to weight policy costs levied on electricity prices, along with network costs, toward smaller commercial and residential consumers. This is an active choice to moderate electricity prices for electricity-intensive industry. In the UK, network, policy and wider system costs are more evenly distributed between all electricity consumers.

As such, other measures are likely to be needed to maintain UK industrial competitiveness with regard to electricity prices.

Measures to directly mitigate the risk of carbon leakage resulting from policy action to tackle CO2 and other Greenhouse Gas emissions must also be maintained and improved. Options include measures to compensate for indirect carbon costs on electricity prices, but also the introduction of a Carbon Border Adjustment Mechanism for those industries participating in the UK Emissions Trading System (UK ETS). In principle consumption-based charging can also be an option.

Whilst compensating for or exempting carbon costs could help alleviate competitive pressures, UK industry has faced higher electricity costs for multiple reasons. In the context of the energy crisis, the structurally high electricity costs arising from the UK and European dependence on marginal pricing, set by gas, is a more fundamental challenge. For this reason, as an alternative approach, BEIS might also consider encouraging and facilitating direct access for electricity-intensive, trade-exposed industries to electricity generation sources divorced from the price of gas, with a particular focus on renewables. This could be through traditional Power Purchase Agreement (PPA) arrangements, or through more fundamental electricity market reform, toward a ‘dual market’ approach, as currently being consulted on by BEIS under the Review of Electricity Market Arrangements (REMA). We provide some general comments on REMA at the end of this response.

Q7: Do you agree that supporting industry to decarbonise through existing decarbonisation and net zero strategies is the appropriate approach for EIIs?

Supporting industry to decarbonise through existing decarbonisation and net zero strategies is not the appropriate approach for EIIs.

In particular, the free allocation of emissions permits renders carbon pricing largely ineffective for industrial decarbonisation. Therefore, either measures to phase out free allocation are required, such as border carbon adjustments2, or complementary instruments, such as carbon standards or excise taxes, which exert incentives for decarbonisation even in the face of free allocation.

Shielding industry from carrying the costs for the decarbonisation of electricity supply has the following negative effects:

  • it reduces incentives for radical energy efficiency improvements,

  • it reduces incentives for switching to less energy intensive materials, and

  • it violates the polluter pays principle by switching the monetary burden of decarbonisation to the taxpayer and other energy consumers

By switching the burden to the taxpayer and other energy consumers, exemptions for EIIs increase the price tag of decarbonisation for those groups and could lead to a reduction in their support for the net zero target.

On the other hand, a low electricity price can provide important incentives for switching from conventional carbon intensive industrial processes to low carbon electrified ones. Therefore, it is important to make affordable renewable energy available to industry.

To counteract the negative effects of free allocation and electricity price exemptions it is important to add‘flanking instruments’ to the policy mix that introduce real incentives for industrial decarbonisation while avoiding carbon leakage.

A particular promising avenue is to further press ahead with the Industrial Decarbonisation Agenda (IDA) instigated by the G7 UK Presidency in June 2021. It called for decarbonisation standards development through the creation of international markets for net zero or green products via the establishment of shared approaches and policy alignment on green product standards and public procurement.

Statements from UCL and LSE climate policy experts in response to the Department for Business, Energy and Industrial Strategy’s Call for Evidence: Towards a market for low emissions industrial products decarbonisation are particularly relevant here3. That response provides more context for the following suggestions:

  • HM Government may increase electricity subsidies for EEI but should use embodied carbon standards or excise charges to complement measures so that at least domestic consumption of carbon intensive industrial products gets targeted, to address the electricity-related emissions associated with energy intensive production.4

  • Embodied carbon standards could also be used to make sure that the higher level of renewable energy in the grid has positive consequences for British industry in the domestic market and/or provide incentives for industry abroad to switch to renewables to access the British market.

Furthermore, in June 2022 the G7 Statement on a Climate Club under the German Presidency reiterated the desire to expand markets for green industrial products. In this context it is relevant to take into account the October 2021 US-EU commitment to negotiate a deal to jointly restrict market access to high carbon steel by 2024. While this is a good initiative, in principle, it is in danger of locking in ‘medium’ carbon steel rather thanboosting zero carbon steel. The UK government could align with the US-EU but at the same time introduce more ambitious standards for ultra-low or zero carbon steel, which could help to provide much needed demand side instruments, complementing subsidies for green hydrogen steel.

The relevance of the REMA programme and proposal for a ‘Green Power Pool’

It is now widely recognised that the cost of renewable electricity, particularly new renewables contracted with long-term contracts like Contracts for Differences (CfDs), has fallen sharply. Those were already competitive before the energy crisis; now, they are far cheaper than fossil-fuel based electricity. The most recent CfDs for offshore wind are contracted at round £50/MWh compared to recent and forward wholesale power market prices over £200/MWh.

The Green Power Pool was proposed by Michael Grubb and Paul Drummond in the 2018 report ‘UK Industrial Electricity Prices: Competitiveness in a Low Carbon World’5 specifically to make such low-cost electricity directly available to industry, particularly electro-intensive, internationally exposed industry.

Research including stakeholder engagement underlined that many industrial players find it difficult and inefficient to access such electricity through bilateral Purchasing Power Contracts. This is for multiple reasons, including counterparty risks, transaction costs, collateral requirements, and high balancing costs arising from the bilateral nature of most PPAs. More generally, medium-sized and smaller companies in particular highlighted difficulty of underwriting long-term contracts and the fact that they consider sophisticated electricity contracting and hedging to be too far from their core focus and expertise.

Also, the bulk of renewables are contracted either through CfDs – which have little reason to participate in PPAs since they receive a fixed price whatever – or Renewable Obligation Certificates (ROCs) generators, who in general can make more money selling into the wholesale market, or who enter PPAs with prices partially or wholly linked to wholesale markets.

Consequently, in principle, there are very large gains to be made by government-backed approach to make cheap non-fossil power available through an aggregated pool. Insofar as the government acknowledges a case for targeting support for internationally exposed electro-intensive industries, they would be a natural priority to benefit from such cheap electricity, which would circumvent the gas and carbon prices and thus avoid a great deal of complexity as well as cost.

The underpinning economic principles were set out in our recent paper ‘Navigating the Crises in European Energy’6. Developing design issues and options for a Green Power Pool approach will be outlined in a paper forthcoming in October.

Moreover, the available capacity of relatively low-cost non-fossil energy will likely expand, with tentative agreement for many of the renewables with ROCs, and potentially nuclear power, into long-term contract structures.

Footnotes:

  1. https://www.aldersgategroup.org.uk/publications/post/uk-industrial-electricity-prices-competitiveness-in-a-low-carbon-world/ ; https://www.aldersgategroup.org.uk/content/uploads/2022/03/DELIVERING-COMPETITIVE-INDUSTRIAL-ELECTRICITY-PRICES-IN-AN-ERA-OF-TRANSITION-policy-briefing.pdf  
  2. European Commission (2021) Proposal for a regulation of the European Parliament and of the Council. Establishing a border carbon adjustment mechanism, July 14. Eur. Comm. Doc. https://ec.europa.eu/info/sites/default/files/carbon_border_adjustment_mechanism_0.pdf
  3. https://www.ucl.ac.uk/public-policy/sites/public_policy/files/ucl_lse_climate_experts_response_beis_call4evidence_low_emissions_products_2022.pdf 
  4. For more context, in particularly on excise charges, see also: Grubb, Jordan et al: Carbon Leakage, Consumption, and Trade, in Annual Review of Environment and Resources, 2022. To be published October 2022, available from the authors on request. 
  5. https://www.aldersgategroup.org.uk/content/uploads/2022/03/1802-UK-industrial-electricity-prices-%E2%80%93-FINAL.pdf; supported by the Aldersgate Group
  6. https://www.ucl.ac.uk/bartlett/sustainable/sites/bartlett_sustainable/files/ucl_isr_necc_w p3_with_cover_final_050922.pdf

 

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